ITAD Ruling No. 142-00

September 21, 2000 ITAD RULING NO. 142-00 RP-US Art. 13, RP-Japan Art. 12 & Art. 23 Balane, Tamase Alampay Law Office 12th Floor, PDCP Bank Centre, corner Herrera and Alfaro Streets Salcedo Village, 1277 City of Makati Attention: Atty . Jose Maria A . Ochave Tax Division Gentlemen : This refers to your letter dated June 2, 1999 applying on behalf of your client, CENTER FOR LEADERSHIP AND CHANGE, INC., the local licensee and withholding agent of FRANKLIN COVEY CO. (then known as the Covey Leadership Center, Inc.), for a preferential tax treaty rate on royalties pursuant to Article 13 of the RP-US Tax Treaty in relation to the 10% rate on royalties provided for under the RP-Japan Tax Treaty. It is represented that Franklin Covey Co. is a non-resident foreign corporation organized and existing under and by virtue of the laws of the State of Utah, U.S.A.; that it has no permanent establishment in the Philippines as evidenced by the certificate issued by the Securities and Exchange Commission dated July 26, 1999; that under the Exclusive International License and Distribution Agreement between your client and Franklin Covey Co., your client was granted the right to use, promote and market several Covey programs and products in the Philippines; that foremost among these programs are The Seven Habits Training Program and the First Things First Training Program, which are video assisted programs developed by Covey for use in providing leadership, management and effectiveness training to interested persons; that to enable your client to conduct these training programs, Franklin Covey Co. authorized your client to distribute training manuals and resource guides for facilitators and participants thereof; that in exchange for the license, your client agreed to pay Franklin Covey Co., royalties equivalent to Fifteen percent (15%) of all gross revenues resulting from the marketing of the Covey programs by your client. In reply thereto, please be informed that Article 13 of the RP-US Treaty provides as follows: "Article 13 "(1) Royalties derived by a resident of one of the Contracting States from sources within the other Contracting States 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 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 State. "(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 productivity , use or disposition thereof. (emphasis ours) "(4) . . . "(5) . . ." On the other hand, Article 12 of the RP-Japan Tax Treaty provides, viz: "Article 12 "(1) Royalties arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other Contracting State. "(2) However, such royalties may also be taxed in the Contracting State in which they arise, and according to the laws of that Contracting 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 the royalties if the royalties are paid in respect of the use of or the right to use cinematograph films and films or tapes for radio or television broadcasting; (b) 25 per cent of the gross amount of the royalties in all other cases. "(3) Notwithstanding the provisions of paragraph (2), the amount of tax imposed by the Philippines on the royalties paid by a company, being a resident of the Philippines, registered with the Board of Investments and engaged in preferred pioneer areas of investment under the investment incentives laws of the Philippines to a resident of Japan, who is the beneficial owner of the royalties, shall not exceed 10 per cent of the gross amount of the royalties. "(4) . . . "(5) . . . "(6) . . . "(7) . . ." The most favored nation clause provided for under paragraph (2)(b) subparagraph (iii) of Article 13 of the RP-US Treaty in relation to Article 12 paragraph 3 of the RP-Japan Tax Treaty providing for a 10% withholding tax on royalties paid to a resident of Japan by a Philippine BOI registered pioneer enterprise is not applicable. Clearly, the rate of 10% under the RP-Japan Tax Treaty applies only to those registered with the Board of Investments and engaged in pioneer areas of investment under the investment laws of the Philippines. Your client is not registered with the Board of Investments. Further, such rate is applicable only for royalties "paid under similar circumstances" (Commissioner of Internal Revenue vs. S.C. Johnson and Son Inc., and Court of Appeals, G.R. No. 127105). Under the RP-Japan Tax Treaty (Article 23, paragraph 3), there is a matching credit of 15% of the gross amount of the royalties while under the RP-US Tax Treaty there is no similar credit. aDHCcE Article 23 paragraph 1 and 3 of the RP-Japan Tax Treaty provides: "(1) Subject to the laws of Japan regarding the allowance as a credit against Japanese tax of tax payable in any country other than Japan, Philippine tax payable in respect of income derived from the Philippines shall be allowed as a credit against Japanese tax payable in respect of that income. Where such income is a dividend paid by a company which is a resident of the Philippines to a company which is a resident of Japan and which owns not less than 25 per cent either of the voting shares of the company paying the dividend or of the total shares issued by that company, the credit shall take into account Philippine tax payable by the company paying the dividend in respect of its income. "(2) . . . "(3) For the purposes of the credit referred to in the first sentence of paragraph (1), Philippines tax shall always be considered as having been paid at the rate of 20 peer cent in the case of dividends to which the provisions of paragraph (3) of Article 19 apply, and at the rate of 15 per cent in the case on interest to which the provisions of paragraph (2)(a) or (3) of Article 11 apply, and in the case of royalties to which the provisions of paragraph (3) of Article 12 apply." Hence, based on the provisions of Article 13(2)(i) of the RP-US Tax Treaty, the royalty fee of 15% on all gross revenues paid by CENTER FOR LEADERSHIP AND CHANGE, INC. to FRANKLIN COVEY under their Exclusive International License and Distribution Agreement dated June 17, 1997 and the Merger-Related Addendum to International License and Distribution Agreement dated January 1, 1998 is subject to withholding tax at the rate of 25%. STaIHc However, inasmuch as you wish to avail of a preferential rate on royalties paid by your client by virtue of the most favored nation clause of the RP-US Tax Treaty, please be informed that you may avail of lower tax rates in other tax treaties which are more appropriate under the circumstances. In addition to the foregoing, please note that the royalty payments remitted by your client to Franklin Covey is subject to the ten percent (10%) value-added tax (VAT) pursuant to Section 108(A)(1) and (3) of the Tax Code and that your client, Center For Leadership And Change, Inc., shall, before making payment of royalties to Franklin Covey, withhold and remit to this Bureau the said 10% VAT due thereon, by filing a separate VAT return using BIR Form 1600. The duly validated VAT declaration/return is sufficient evidence for your client in claiming input tax credit.(Section 4.110-3(b) of Revenue Regulations No. 7-95); This ruling is being issued on the basis of the foregoing facts as represented and will be considered null and void if upon investigation it will be disclosed that the facts are different. Very truly yours, (SGD.) DAKILA B. FONACIER Commissioner of Internal Revenue