ITAD Ruling No. 140-03

September 18, 2003 ITAD RULING NO. 140-03 RP-US, Art. 12, RP-China Art. 12 BIR Ruling No. ITAD 101-03 BIR Ruling No. ITAD 109-02 RMC No. 46-2002 dated September 2, 2002 SGV & Co. 6760 Ayala Avenue, 1226 Makati City Attention: Joel L. Tan-Torres Partner, Tax Division Gentlemen : This refers to your tax treaty relief application dated June 15, 2003, on behalf of Stepan Philippines, Inc., (STEPAN Phils), requesting confirmation that the royalty payments of STEPAN Phils to STEPAN USA are subject to the preferential tax rate of 10% pursuant to the most favored nation clause of the RP-US tax treaty in relation to the RP-China tax treaty. It is represented that STEPAN USA is a corporation duly organized and existing under the laws of the United States of America (USA); that it is a resident of Northfield, Illinois, USA, for purposes of US taxation; that it is not registered either as a corporation or as a partnership and has not been licensed to do business in the Philippines per certification issued by the Securities and Exchange Commission dated June 19, 2003; that STEPAN Phils. is a corporation duly organized and existing under the laws of the Philippines with office address at UCPB Bldg., Makati Avenue, Makati City; that STEPAN Phils entered into Licensing and Technical Assistance Agreement ("Agreement") with STEPAN USA dated December 1, 1994 covered by Certificate of Registration No. 1772 issued by the Intellectual Property Office of the Department of Trade and Industry dated January 4, 1996, valid for 10 years from December 1, 1994 to November 30, 2004; that under the Agreement, STEPAN USA grants STEPAN Phils the right to use its patents, trademarks and know-how to manufacture, handle and sell alcohol sulfates and other surfactants; that pursuant to the agreement, STEPAN Phils shall pay STEPAN USA royalty of three percent (3%) based on net sales of the licensed products sold by STEPAN Phils or three percent (3%) of the toll fees earned by STEPAN Phils for the manufacture and sale of the licensed products. In reply, please be informed that Article 13 of the RP-US tax treaty provides, viz : "Article 13 "Royalties "1. Royalties derived by a resident of one of the Contracting States from sources within the other Contracting State may be taxed by both Contracting States. "2. However, the tax imposed by that other Contracting State shall not exceed "a) In the case of the United States, 15 percent of the gross amount of the royalties, and "b) In the case of the Philippines, the least of: "(i) 25 percent of the gross amount of the royalties, "(ii) 15 percent of the gross amount of the royalties, where the royalties are paid by a corporation registered with the Philippine Board of Investments and engaged in preferred areas of activities, and "(iii) the lowest rate of Philippine tax that may be imposed on royalties of the same kind paid under similar circumstances to a resident of a third . (Emphasis supplied) "3. The term 'royalties' as used in this article means payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work, including cinematographic films or films or tapes used for radio or television broadcasting, any patent, trade mark, design or model, plan, secret formula or process, or other like right or property, or for information concerning industrial, commercial or scientific experience. The term 'royalties' also includes gains derived from the sale, exchange or other disposition of any such right or property which are contingent on the product ivity, use, or disposition thereof. CTAIDE "xxx xxx xxx" and, in relation thereto, Article 12 of the RP-China tax treaty provides, viz: "Article 12 "ROYALTIES "1. Royalties arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State. "2. However, such royalties may also be taxed in the Contracting State in which they arise and according to the laws of that State, but if the recipient is the beneficial owner of the royalties, the tax so charged shall not exceed; "a) 15 per cent of the gross amount of royalties arising from the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph films or tapes for television or broadcasting, or "b) 10 per cent of the gross amount of royalties arising from the use of, or the right to use, any patent, trade mark, design or model, plan, secret formula or process, or from the use of, or the right to use, industrial, commercial, or scientific equipment, or for information concerning industrial, commercial or scientific experience. (Emphasis supplied) Pursuant to the aforequoted "most favored nation" clause under Article 13(2)(b)(iii) of the RP-US tax treaty, the tax imposed on royalties derived by a resident of the United States from sources within the Philippines shall be the lowest rate of Philippine tax that may be imposed on royalties of the same kind paid under similar circumstances to a resident of a third State. Relative thereto, pursuant to Article 12(2)(b) of the RP-China tax treaty, the tax charged shall not exceed 10% of the gross amount of royalties. It is noteworthy that in the case of Commissioner of Internal Revenue vs. S.C. Johnson and Son, Inc. and Court of Appeals , G.R.N. 127105, promulgated on June 25, 1999, the Supreme Court interpreted the "most-favored-nation" clause, particularly the phrase "paid under similar circumstances", as referring to the manner of payment of taxes and not to the subject matter of the tax which is royalties. ( BIR Ruling No. ITAD 118-01 dated February 23, 2001 and BIR Ruling No. ITAD 109-02 dated May 30, 2002 ) A plain reading of the RP-US and RP-China tax treaty provisions in the avoidance of the double taxation shows a similarity on the manner of payment of the taxes, that is, the allowable foreign tax credit on both treaties is the amount actually paid in the Philippines. Such being the case, this Office is of the opinion and so holds that the royalty payments of STEPAN Phils to STEPAN USA under the License Agreements effective January 1, 2002, shall be subject to tax rate of ten percent (10%), pursuant to the RP-US tax treaty in relation to Article 12(2)(b) of the RP-China tax treaty. (Revenue Memorandum Circular (RMC) No. 46-2002 dated September 2, 2002) ( BIR Ruling No. DA-ITAD 101-03 dated July 4, 2003 ) Moreover, the said royalty payments to be paid by STEPAN Phils to STEPAN USA in the Philippines are subject to the 10% value-added tax pursuant to Sec. 108 of the Tax Code. Accordingly, STEPAN Phils, being the resident withholding agent and payor in control of the payment shall be responsible for the withholding of the 10% final VAT on such royalty before making any payment to STEPAN USA. In remitting the VAT withheld, STEPAN Phils shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld). The duly filed BIR Form 1600 and proof of payment thereof shall serve as documentary substantiation for the claim of input tax by STEPAN Phils upon filing its own VAT return, if it is a VAT-registered taxpayer. In case STEPAN Phils is a non-VAT registered taxpayer, the passed on VAT withheld shall form part of the cost of the service purchased which may be treated as "expense" or "asset" whichever is applicable. In addition, STEPAN Phils is required to issue the Certificate of Final Tax Withheld at Source (BIR Form 2306) in quadruplicate upon request of STEPAN USA, the first three copies thereof to be given to STEPAN USA and the fourth copy to be retained by STEPAN Phils as its file copy. [Sections 4 & 6, Revenue Regulations (RR) No. 4-2000; Section 3 of RR 8-2002; Section 7 of RR 14-2002] This ruling is issue based on the facts as represented. However, if upon investigation it shall be disclosed that the facts are different, then this ruling shall be without force and effect insofar as the herein parties are concerned. Very truly yours, Commissioner of Internal Revenue By: (SGD.) MILAGROS V. REGALADO Assistant Commissioner Legal Service