ITAD Ruling No. 176-02

2002 ITAD RULING NO. 176-02 Article 12, RP-Netherlands tax treaty BIR RULING 026-94/ITAD 102-00/64-02 Joaquin Cunanan & Co. 14/F, Multinational Bancorporation Centre 6805 Ayala Avenue, Makati City Attention: Ms. Mary Assumption S. Bautista Principal, Tax Services Department Gentlemen : This refers to your letter dated August 11, 1998, requesting confirmation of your opinion, as follows: (1) the 2.5% royalty paid by DiverseyLever (Philippines) Corporation (DLPC) to DiverseyLever International B.V. (DLIBV) as consideration for research and development under the Central Research and Development Services (CRDS) Agreement between the parties is subject to Philippine income tax at the preferential rate of 15% pursuant to Article 12(2)(B) of the Philippines-Netherlands Tax Treaty; (2) the compensation paid by DLPC to DLIBV as consideration for central regional operating services made available by DLIBV to DLPC under the CRDS Agreement between the parties is exempt from Philippine income tax and consequently from the withholding tax pursuant to Article 7(1) of the Philippines-Netherlands Tax Treaty; (3) the compensation for central and regional services rendered outside the Philippines paid by DLPC to DLIBV is also exempt from the 10% value-added tax (VAT); (4) the 2.5% royalty for research and development and the compensation for central and regional services mentioned above are deductible from DLPCs gross income. It is represented that DLPC is a domestic corporation duly registered with the Securities and Exchange Commission (SEC); that it is engaged in the business of industrial chemists, biochemists, manufacturing chemists and manufacturer of chemical products and preparations, as well as wholesale dealers and traders in chemical substances and preparations of all kinds; that DLPC is part of the Diverseylever Group of Companies, which consists of various affiliated companies operating worldwide; that DLIBV on the other hand, is a corporation organized and existing under the laws of Netherlands; that on April 1, 1998, DLPC and DLIBV entered into a Central Research and Development Services Agreement which provides for payment by DLPC to DLIBV of the following: (a) royalty of 2.5% on External Net Turnover payable in respect of research and development and other intellectual property rights; and (b) compensation for central and regional operating services rendered by both the DiverseyLever Group and the Unilever Group consisting of DLPCs share in the costs incurred by DLIBV in respect of such central and regional operational services including an amount for notional interest and risk premium; that DiverseyLever Group maintains various centres for research and development situated in different parts of the world (i.e. The Netherlands, United Kingdom, United States, Switzerland, and Sweden, among others); that these research and development centres conduct research and development activities that cover fundamental research, product development and application, market research and customer service and production services for improved and new products and processes; that the costs and expenses of such services are in the first instance borne by DLIBV; that the DiverseyLever Group likewise has access to and makes use of Unilever Groups central research and other know-how, patents, trademarks and other industrial property rights, the costs of which are also in the first instance borne by DLIBV; that under the CRDS Agreement, DLIBV grants to DLPC access to the results and other pertinent information of the DiverseyLever Groups research and development and the use of various patents, trademarks and other intellectual property rights and to Unilever Groups central research and other know-how, patents, trademarks and other industrial property rights; that in consideration for access to research and development, DLPC will pay DLIBV a royalty equal to 2.5% on DLPCs external net turnover; that on the other hand, Central and regional operational service departments are maintained for the Diverseylever Group; that the DiverseyLever Group is likewise granted access to Unilever Groups central services; that these services include, but are not limited to, the following: - Product, customer and business coordination; - Marketing and Sales; - Public Relations; - Personnel and Management Development; - Commercial, Administrative and Financial Issues; - Information Technology, Legal and Tax Matters; - International and Trademark Services; - Logistics; and - Purchasing that these services in general aims to drive the innovation of new products and systems and to provide technical support to sales and marketing through addressing product complaints, providing brochures and training, and other support services through centralized locations; that the information technology services are limited to central hub services through DLIBVs established wide area network (WAN) central hubs to facilitate global internet, e-mail services and other means of information sharing wherein DLIBV have been provided access to these services; that the international trademark services refer to the centralized advisory and consulting services on legal, documentation and other support services relative to the protection of the groups trademark; that logistics services rendered by DLIBV consist of facilitating and coordinating the global supply agreements entered into by various affiliates with third party suppliers, so that the group and its members can benefit from lower material costs through the Global Supply Chain/Purchasing Group; that the costs of maintenance and/or costs of accessing the aforementioned central and regional operational services are borne in the first instance by DLIBV; that under the CRDS Agreement, DLIBV makes available to DLPC the expertise of the central and regional services departments of both the DiverseyLever Group and the Unilever Group and provides services, which can supplement various management functions necessary to the successful operation of DLPC; that these services are rendered outside the Philippines; that, however, in cases where it may be necessary for DLIBV to send employees to the Philippines to consult with DLPC, said employees stay in the Philippines will not exceed an aggregate of 183 days within any twelve-month period; that as consideration for the above services, DLPC shall pay to DLIBV a share in the costs incurred by DLIBV in respect of central and regional services; and that such costs shall include an amount for notional interest and risk premium. ETDaIC In reply, please be informed of this Offices ruling on the foregoing issues as follows 1. On Royalties Article 12 of the RP-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. xxx xxx xxx 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 Accordingly, your opinion that the 2.5% royalty paid by DLPC to DLIBV as consideration for research and development under the Central Research and Development Services Agreement between the parties is subject to Philippine income tax at the preferential rate of 15% pursuant to Article 12(2)(B) of the Philippines-Netherlands tax treaty. (BIR Ruling No. 026-94 dated January 21, 1994) 2. On Business Profits Article 7(1) of the said tax treaty reads: 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. Moreover, Article 5(1) and 2(h) of the same treaty provides, viz: 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 term permanent establishment includes especially: "xxx xxx xxx (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. Based on the foregoing representation, the following are among others, central and regional services, to be rendered by DLIBV: (1) Product, customer and business coordination; (2) Marketing and Sales; (3) Public Relations; (4) Personnel and Management Development; (5) Commercial, Administrative and Financial Issues; (6) Information Technology, Legal and Tax Matters; (7) International and Trademark Services; (8) Logistics; and (9) Purchasing. The payment for these services are not considered royalties because the information to be imparted in these instances do not involve the transfer of know-how. Accordingly, they are to be regarded as business profits. The business profits of DLIBV shall only be taxable in the Philippines if it has permanent establishment in the Philippines. The existence of DLIBVs permanent establishment in the Philippines cannot be established considering that the presence of its employees in the Philippines will not exceed an aggregate of 183 days within any twelve-month period. Accordingly, this Office is of the opinion and so holds that DLIBV, as represented, does not have a permanent establishment in the Philippines and that as a result thereof, the compensation income derived by DLIBV from DLPC for rendering the above-enumerated services is not subject to the Philippine income tax and consequently to withholding tax imposed under Section 57(A) in relation to Section 28(B)(1) both of the Tax Code of 1997. ( ITAD 102-00/64-00 ) 3. On VAT Compensation paid by DLPC to DLIBV for central and regional operational services rendered outside the Philippines is not subject to the 10% value-added tax imposed under Section 108(A) of the Tax Code of 1997. Accordingly, DLPC being the payor in control of the payment shall be responsible for the withholding of VAT on such fees on behalf of DLIBV by filing a separate VAT return for and on behalf of DLIBV using 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 sufficient basis for the claim of input tax to be applied against the output tax that may be due from DLPC if it is a VAT-registered taxpayer. In case DLPC is a non-VAT registered taxpayer, the passed-on VAT withheld shall form part of the cost of the service purchased or treated as expense, whichever is applicable. In addition, DLPC is required to issue the Certificate of Creditable Tax Withheld at Source (BIR Form 2307) in quadruplicate upon request of DLIBV, the first three copies thereof to be given to DLIBV and the fourth copy to be retained by DLPC as its file copy. [Section 4 & 6, Revenue Regulation 4-2002] 4. Deductibility from gross income As regards to your query on whether the above royalty payment and the service fees of DLPC are considered ordinary and necessary expenses deductible from gross income pursuant to Section 34(A)(1)(a) of the Tax Code of 1997, please be informed that we decline to rule on the matter considering the factual nature of the issue. 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 parties herein are concerned. Very truly yours, Commissioner of Internal Revenue By: (SGD.) MILAGROS V. REGALADO Assistant Commissioner Legal Service