ITAD Ruling No. 156-04

December 28, 2004 ITAD RULING NO. 156-04 Article 12, Philippines-Netherlands; Sec. 108 of the Tax Code of 1997 BIR Ruling Nos. ITAD 152-00 & DA-ITAD 207-02 Joaquin Cunanan & Co. 29th Floor, Philamlife Tower 8767 Paseo de Roxas Avenue Makati City 1200 Attention: Mary Assumption S. Bautista-Villareal Principal, Tax Service Department Gentlemen : This refers to your letter dated September 9, 2004, on behalf of your client, Unilever Philippines, Inc. (UPI), formerly Philippine Refining Company Inc., requesting confirmation of your opinion that: (1) the fees paid by UPI to Unilever N.V. (UNV) under the Trademark License Agreement and Technology License Agreement are subject to the preferential tax rate of 10% in accordance with Article 12(2)(a) of the Philippines-Netherlands Tax Treaty; and (b) the service fees paid by UPI to UNV under the Central Services Agreement are business profits and not royalties, hence, not subject to Philippine taxation since UNV does not have a permanent establishment in the Philippines. It is represented that UNV is a nonresident foreign corporation duly organized and existing under the laws of Netherlands, with office address at Weena 455, 3013 AL Rotterdam, Netherlands; that it is not registered either as a corporation or as a partnership licensed to do business in the Philippines per certification issued by the Securities and Exchange Commission dated June 18, 2004; that UPI is registered with the Board of Investments (BOI) as a preferred non-pioneer enterprise (expansion) per Certificate of Registration No. 85-1031 dated November 29, 1985; that in 1993, UNV and UPI entered into a Service Agreement wherein the former has undertaken to assist in the development of UPI's business in the Philippines by making available to the latter its services; that the Agreement covered a period of five (5) years from January 1, 1993 to December 31, 1997; that the said Service Agreement was later renewed by the parties when it expired on December 31, 1997 for another ten (10) years effective January 1, 1998 to December 31, 2007. It is further represented that, subsequently, on August 27, 2003, the 1998 Service Agreement was amended and split into three (3) separate Agreements, namely: (a) Trademark License Agreement; (b) Technology License Agreement and; (c) Central Services Agreement; that under the Trademark License Agreement, UNV will continue to grant UPI an exclusive license to use and apply the intellectual property rights including the trademarks on or in relation to the products in the Philippines for the duration of the Agreement; that in consideration thereof, UPI shall pay a royalty fee of 2.5% of the turnover determined in Philippine currency; that it shall be deemed renewed for subsequent period of one (1) year but otherwise on the same terms, unless otherwise terminated; that it is covered by Certificate of Compliance No. 5-2004-00039 dated March 18, 2004, valid until December 31, 2004; that under the Technology License Agreement, UNV will continue to grant UPI an exclusive license under the intellectual property rights and/or the technology, to make, have made, use, keep, offer for sale, sell and import products, and services embodying or utilizing the technology in the Philippines; that in consideration thereof, UPI shall pay a royalty fee of 3.5% of the turnover determined in Philippine currency; that it is covered by Certificate of Compliance No. 5-2003-00023 dated September 1, 2003 valid until December 31, 2007; that it shall be deemed renewed for the subsequent period of five (5) years but otherwise on the same terms, unless otherwise terminated; that under the amended Central Services Agreement, UNV shall continue to make available to UPI the same corporate or central services covered in both the 1993 and 1998 Service Agreements, however, the corporate and central services are described in detail, as follows: a) "Corporate Services" which are services provided by Unilever's board of directors and supporting staff, which benefit the Group Companies which include, but are not limited to the following: providing corporate strategic leadership; assisting the management of the Division, Business Groups and/or Group Companies, to translate the corporate strategies into regional strategies; the provision of expert and transactional support, assistance and advice by the corporate functional departments including but not limited to legal matters, taxation, finance, human resources and information technology. aTEADI b) "Divisional Services" are those services provided by the management and supporting staff of a Division and certain Group Companies as agreed by the management of such Division, which benefit the Group Companies within that Division. Such services include, but are not limited to the following: developing global business strategies and providing strategic global leadership; assisting the management of Business Groups and/or Group Companies to translate Divisional strategies into regional strategies; provisioning of support, assistance and advice from staff departments of the Division, including but not limited to supply chain activities. c) "Other Services are those services which benefit the Group Companies in one or more regions and which are not corporate services, divisional, services or, and include but are not limited to the activities of the Global Infrastructure Organization which provides services in the area of information technology and communications including but not limited to infrastructure management services. "Infrastructure management services" includes but is not limited to the organization, management, procurement, operation and maintenance of computer servers and proprietary hardware, desktop and mobile computers, printers and scanners, Unilever networks (local, national and global), voice, data and video communications, facsimile equipment, platform software (operating system, database, standard desktop and), end-user support (helpdesk) and training for the above; that these "central services'" shall be provided, or made available, in such manner and at such time as may be agreed between the parties and which are: (i) necessary for UPI's activities in respect of the products in territory and in the countries authorized by Unilever, (ii) of mutual benefit to UPI and Unilever Group, and (iii) necessary to ensure that the manufacture, marketing and/or sale of the products is at the standard of quality and appearance required by Unilever of the Group Companies; and that these services shall be rendered entirely by UNV outside of the Philippines. In reply, please be informed as follows: 1. The payments made under the Trademark and Technology License Agreements are considered royalties . Article 12 of the Philippines-Netherlands Tax Treaty provides, viz : "Article 12 ROYALTIES "1. Royalties arising in one of the States and paid to a resident of the other State may be taxed in that other State. "2. However, such royalties may also be taxed in the 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) 10 per cent of the gross amount of the royalties where the royalties are paid by an enterprise registered, and engaged in preferred areas of activities in that State; and b) 15 per cent of the gross amount of the royalties in all other cases. "3. The competent authorities of the States shall by mutual agreement settle the mode of application of paragraph 2. "4. 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 cinematograph films or tapes for radio or television broadcasting, any patent, trademark, design or model, plan, secret formula or process, or for the use of, or the right to use, industrial, commercial or scientific equipment, or for information concerning industrial commercial or scientific experience. "xxx xxx xxx" Based on the foregoing, royalties arising in the Philippines and paid to a resident of the Netherlands may be subject to Philippine tax at a rate not to exceed ten percent (10%) of the gross amount of royalties where such are paid by an enterprise registered and engaged in preferred areas of activities, or fifteen percent (15%) of the gross amount of the royalties in all other cases. Such being the case and since UPI is BOI-registered and engaged in preferred areas of activities in the Philippines, this Office hereby confirms your opinion that the royalty remittances of UPI to UNV under the Trademark Agreement and Technology License Agreement are subject to tax at a rate of ten percent (10%) of the gross amount of the royalties. ( BIR Ruling No. 152-00 dated October 30, 2000 ) 2. The payments made pursuant to the Central Services Agreement are in the nature of business profits and not royalties . The above tax treaty defines " royalties " to include " payments of any kind received as a consideration for information concerning industrial, commercial or scientific experience ." According to the commentaries of the ORGANISATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT (OECD) Committee on Fiscal Affairs on the Model Tax Convention [par. 11, Commentary on Article 12 (royalties), 1998, p. 151), such information alludes to the concept of "know-how". The definition of know-how, which has been adopted by the said Committee, is "all the undivulged technical information, whether capable of being patented or not, that is necessary for the industrial reproduction of a product or process, directly and under the same conditions; inasmuch as it is derived from experience, know-how represents what a manufacturer cannot know from mere examination of the product and mere knowledge of the progress of technique." In the know-how contract, one of the parties agree to impart to the other, so that he can use them for his own account, his special knowledge and experience which remain unrevealed to the public. ( BIR Ruling DA-ITAD No. 49-02 dated April 15, 2002 ). EACIcH Furthermore, in the case of Philippine Refining Company (PRC) vs. CIR, CTA Case No. 2872 dated January 15, 1986 , the Court of Tax Appeals had an occasion to rule on the distinction of service fees from royalties, to wit: "To distinguish between compensation for service and royalty payments, one must inquire on whether the payee has proprietary interest in the property giving rise to the income. If the payee has none, then the payment is a compensation for personal services, if the payee has proprietary interest then the payment is royalty." Applying the above discussions to the case at hand, it is clear in the Central Services Agreement that the service fees are not within the definition of "royalties" under Article 12 of Philippines-Netherlands tax treaty. Inasmuch as UNV shall render these services using only their customary skills, then the compensation to be received therefore shall not constitute as consideration for the use of, or the right to use, any copyright, patent, trademark, design or model, plan, secret formula or process, or for the transfer of technology. Thus, the service fees paid to UNV shall not be considered as royalties but shall constitute as business profits derived from sources outside the Philippines. 3. The service fees are business profits not subject to Philippine taxation . However, Article 5 of the Philippines-Netherlands tax treaty provides: "Article 5 PERMANENT ESTABLISHMENT "1. For the purposes of this Convention, the term "permanent establishment" means a fixed place of business in which the business of the enterprise is wholly or partly carried on. "2. The terms "permanent establishment" includes especially: a) a place of management; b) a branch; c) an office; d) a factory; e) a workshop; f) a mine, quarry or other place of exploration or extraction of natural resources; g) a building site or construction or assembly project or supervisory activities in connection therewith, where such site, project or activity continues for a period of more than 183 days; h) the furnishing of services including consultancy services by an enterprise through an employee or other personnel where activities of that nature continue (for the same or a connected project) for a period or periods exceeding in the aggregate 183 days within any twelve-month period . (Emphasis supplied) "xxx xxx xxx" In relation thereto, Article 7 of the same treaty also provides: "Article 7 BUSINESS PROFITS "1. The profits of an enterprise of one of the States shall be taxable only in that State unless the enterprise carries on business in the other State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is attributable to that permanent establishment. "xxx xxx xxx" Based on the aforequoted provisions, an enterprise which is a resident of Netherlands may be deemed to have a permanent establishment in the Philippines when, among others, the furnishing of services in the Philippines by that enterprise, through its employees or other personnel, continue (for the same or connected project) for a period or periods aggregating more than 183 days within any twelve month period. Inasmuch as these services will be performed by UNV outside the Philippines, that is, in Netherlands, UNV is not deemed to have a permanent establishment in the Philippines. In view thereof, this Office is of the opinion and so holds that since the services covered by the subject Central Services Agreement are rendered by UNV outside the Philippines, and are considered income from sources without the Philippines, the payments made by UPI to UNV for said services shall not be subject to Philippine income tax and consequently to the withholding tax under Section 28(B)(1) of the Tax Code of 1997. ( BIR Ruling No. DA-ITAD-101-02 dated May 28, 2002 and DA-ITAD-207-02 dated November 26, 2002 ) 3. On Value-Added Tax Thus, while the compensation for services rendered outside the Philippines is not subject to the 10% VAT, the fees paid for that portion where the services of UNV are rendered in the Philippines are, however, subject to the 10% VAT pursuant to Section 108 of the Tax Code of 1997. Moreover, the royalty fees to be paid by UPI to UNV shall also be subject to the 10% value-added tax (VAT). Accordingly, UPI, being the resident withholding agent and payor in control of the payment, shall be responsible for the withholding of the 10% VAT on such royalty and consultancy fees before making any payment to UNV. In remitting the VAT withheld, UPI shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax and Other percentage Taxes Withheld). The duly filed BIR Form No. 1600 and proof of payment thereof shall serve as documentary substantiation for the claim of input tax by UPI upon filing its own VAT return, if it is a VAT-registered taxpayer. In case UPI is a non-VAT registered taxpayer, the passed-on VAT withheld shall form part of the service purchased which may be treated as "expense" or "asset" whichever is applicable. In addition, UPI is required to issue the Certificate of Final Tax Withheld at Source (BIR Form No. 2306) in quadruplicate upon request of UNV, the first three copies thereof to be given to UNV and the fourth copy to be retained by UPI as its file copy. [Sections 4 & 6, Revenue Regulations (RR) No. 4-2000; Section 3, RR No. 8-2002; Section 7, RR No. 14-2002] This ruling is issued on the basis of the foregoing 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. TacSAE Very truly yours, Commissioner of Internal Revenue By: (SGD.) MILAGROS V. REGALADO Assistant Commissioner Legal Service