ITAD Ruling No. 163-05

December 20, 2005 ITAD RULING NO. 163-05 RP-US Article 13 (2) (b) (iii) RP-China Article 12 (2) (b) BIR Ruling DA-ITAD-142-03 Riguera & Riguera Law Office 2/F Azucena Arcade 255 Alabang-Zapote Road Las Pias City Attention: Atty. Hazel E. Rebadulla Riguera Gentlemen : This refers to your letter dated August 2, 2005, on behalf of your client, Ecolab Phils., Inc. requesting confirmation that the royalty payments of Ecolab Phils., Inc. to Ecolab Inc. are subject to the withholding tax rate of ten percent (10%) pursuant to the "most-favored-nation" clause of the Philippines-United States of America (Philippines-US) tax treaty in relation to the Philippines-China tax treaty. It is represented that Ecolab Inc. is a nonresident foreign corporation duly organized and existing under the laws of the United States of America (USA) and is a resident of the USA for purposes of US taxation, with Tax Identification Number 41-0231510, as certified by the U.S. Department of Treasury Internal Revenue Service in Philadelphia, PA, on March 31, 2005; that Ecolab Inc. is not registered either as a corporation or as a partnership in the Philippines per certification issued by the Securities and Exchange Commission dated July 5, 2005; that Ecolab Phils.,Inc. is a corporation duly organized and existing under the laws of the Philippines with business address at 2/F Alabang Business Tower, Acacia Ave.,Madrigal Business Park, Ayala Alabang, Muntinlupa City, Philippines; that Ecolab Phils.,Inc. and Ecolab Inc. entered into a Know-How and Trademark License and Distribution Agreement (Agreement) on December 1, 2004 which is registered with the Philippine Intellectual Property Office under Certificate of Compliance No. 5-2004-00026, valid for ten (10) years from December 1, 2004 to November 30, 2014, concerning the grant of a license to manufacture and sell certain chemical products, equipment systems and services using the know-how, technical assistance and trademarks of the Ecolab Inc.;and that pursuant to the Agreement, Ecolab Phils.,Inc. shall pay Ecolab Inc.,in consideration for the license grants, a remittance based on chemical products sold by Ecolab Phils.,Inc.,its agent or its subcontractor, which are based in whole or in part on the know-how or which are sold by Ecolab Phils.,Inc. using the trademarks licensed thereunder. In reply, please be informed that Article 13 of the Philippines-United States 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 State .(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 productivity, use, or disposition thereof. xxx xxx xxx" and, in relation thereto, Article 12 of the Philippines-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 percent 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, trademark, 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). xxx xxx xxx" Based on the above-mentioned provisions, 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 and paid under similar circumstances to a resident of a third State. Relative thereto, it is noteworthy that under Article 12(2)(b) of the Philippines-China tax treaty, the tax charged shall not exceed 10% of the gross amount of royalties arising from the use of, or the right to use, any patent, trademark, 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. In the case of Commissioner of Internal Revenue vs. S.C. Johnson and Son, Inc . and Court of Appeals, G.R. No. 127105, promulgated on June 25, 1999, the Supreme Court interpreted the "most-favored-nation" clause, particularly the phrase "paid under similar circumstances" under the Philippines-United States tax treaty, as referring to the manner of payment of taxes and not to the subject matter of the tax which is royalties. (BIR Ruling No. DA-ITAD 142-03 dated September 23, 2003) Article 23 of the Philippines-US tax treaty reads: " Article 23 RELIEF FROM DOUBLE TAXATION Double taxation of income shall be avoided in the following manner: 1. In accordance with the provisions and subject to the limitations of the law of the United States (as it may be amended from time to time without changing the general principle hereof),the United States shall allow to a citizen or resident of the United States as a credit against the United States tax the appropriate amount of taxes paid or accrued to the Philippines and, in the case of a United States corporation owning at least 10 percent of the voting stock of a Philippine corporation from which it receives dividends in any taxable year, shall allow credit for the appropriate amount of taxes paid or accrued to the Philippines by the Philippine corporation paying such dividends with respect to the profits out of which such dividends are paid. Such appropriate amount shall be based upon the amount of tax paid or accrued to the Philippines, but the credit shall not exceed the limitations (for the purpose of limiting the credit to the United States tax on income from sources within the Philippines or on income from sources outside the United States) provided by United States law for the taxable year. ...." On the other hand, Article 23 of the Philippines-China tax treaty provides, viz: Article 23 METHODS FOR THE ELIMINATION OF DOUBLE TAXATION 1. In China, double taxation shall be eliminated as follows: Where a resident of China derives income from the Philippines the amount of tax on that income payable in the Philippines in accordance with the provisions of this Agreement, may be credited against the Chinese tax imposed on that resident. The amount of the credit, however, shall not exceed the amount of the Chinese tax on that income computed in accordance with the taxation laws and regulations of China. xxx xxx xxx" Article 23 of the Philippines-US tax treaty and Article 23 of the Philippines-China tax treaty, though differently worded, plainly reveal a similarity in the provisions on relief from or avoidance of double taxation to their respective residents. Thus, the tax on royalty payments to residents of US and China are paid under similar circumstances, i.e ., the amount of royalty income tax paid or accrued to the Philippines under the respective tax treaties is available as tax credit against the income tax payable in their respective countries. US residents may, therefore, invoke the preferential tax rate of 10% on royalties, accruing beginning January 1, 2002, arising in the Philippines "from the use of, or the right to use, any patent, trade mark, design or model, plan, secret formula or process, . . ., or for information concerning industrial, commercial or scientific experience" under the Philippines-China tax treaty, pursuant to the "most-favored-nation" clause of the Philippines-US tax treaty. Such being the case, this Office is of the opinion and so holds that the royalty payments of Ecolab Phils., Inc. to Ecolab Inc. under the subject Agreement are subject to final withholding tax at the rate of 10% pursuant to the "most-favored-nation" provision of the Philippines-US tax treaty in relation to the Philippines-China tax treaty. [ Revenue Memorandum Circular (RMC) No. 46-2002 dated September 2, 2002; BIR Ruling No. DA-ITAD 101-03 dated July 24, 2004 ] Accordingly, Ecolab Phils.,Inc. shall deduct and withhold the tax at the time the royalty income payment is paid or payable, or the income payment is accrued or recorded as an expense or as an asset, whichever is applicable, and whichever comes first. The term "payable" refers to the date the obligation become due, demandable, or legally enforceable. [ Section 4 Time of Withholding, Revenue Regulations No. 12-2002 ] Moreover, the said royalty payments by Ecolab Phils., Inc. to Ecolab Inc. shall be subject to the 10% value-added tax (VAT) under Section 108 of the Tax Code of 1997. Accordingly, Ecolab Phils., Inc., 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 Ecolab Inc. In remitting the VAT withheld, Ecolab Phils., Inc. 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 Ecolab Phils., Inc. upon filing its own VAT return, if it is a VAT-registered taxpayer. In case Ecolab Phils., Inc. is a non-VAT registered taxpayer, the passed-on VAT withheld shall form part of the cost of goods or properties purchased which may be treated as an "expense" or as an "asset", whichever is applicable. In addition, Ecolab Phils., Inc. is required to issue the Certificate of Final Tax Withheld at Source (BIR Form No. 2306) in quadruplicate, the first three copies thereof to be given to Ecolab Inc. upon its request and the fourth copy to be retained by Ecolab Phils., Inc. as its file copy. [ Section 4.110.3(b), Revenue Regulations No. (RR) 7-95, as amended by RR 08-02 (now Section 4.114-2, RR 16-05); Section 4.114(d), as last amended by RR 28-03 ] This ruling is issued on the basis of 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. TaCDAH Very truly yours, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service