ITAD Ruling No. 179-03

November 24, 2003 ITAD RULING NO. 179-03 Articles 13 & 23, RP-US Articles 12 & 23, RP-China BIR Ruling No. ITAD 101-03 BIR Ruling No. ITAD 109-02 RMC No. 46-2002 dated September 2, 2002 Sycip Salazar Hernandez & Gatmaitan Attorneys-At-Law SSHG Law Center, 105 Paseo de Roxas, City of Makati, 1226 Metro Manila Attention: Ernesto S. Taio, Jr. Euney Marie J. Mata-Perez Gentlemen : This refers to your tax treaty relief application dated December 18, 2002, on behalf of your client, Unisys Corporation (Unisys), requesting confirmation that the payment of royalties to Unisys under the existing license agreements entered into by Unisys with Unisys Australia Limited (Philippine Branch) ("UAL-PB") and Unisys Public Sector Services Corporation ("UPSS") are subject to the preferential tax rate of 10% pursuant to the "most-favored-nation clause" under the Philippine-US tax treaty, in relation to the Philippines-China tax treaty. It is represented that Unisys is a U.S. corporation and a resident of the USA for purposes of U.S. taxation under Tax Identification No. 38-0387840 per certification dated July 11, 2001 issued by the IRS, with principal address at Blue Bell, Pennsylvania, USA; that Unisys is not registered either as a corporation or as a partners and has not been licensed to do business in the Philippines per certification dated October 18, 2002 issued by the Securities and Exchange Commission; that UPSS is a corporation organized and existing under the laws of the Philippines with office address at 20/F Tower 2, The Enterprise Centre, 6766 Ayala Avenue cor. Paseo de Roxas, Makati City; that it is primarily engaged in the business of licensing and modifying computer hardware, computer system software programs, application, components, devices and supplies, as well as providing support, training and consultancy services in the use and application of said products; that UPSS entered into an Intellectual Property License Agreement with Unisys, effective October 1, 1998, for a period of two (2) years, subject to automatic and successive renewal for additional periods of one year, unless a notice of termination is given by either party; that the UPSS Agreement complies with the provisions of the Intellectual Property Code on Voluntary Licensing as per Certificate of Compliance No. 5-1998-00089 dated January 4, 1999 issued by the Intellectual Property Office of the Department of Trade and Industry; that said Agreement grants UPSS a non-exclusive license to reproduce, translate, distribute and prepare derivative works of, and use in its business such present and future rights in patents, copyrights, trademarks, trade secrets, software, documentation, know-how, maintenance and products support materials and professional service support materials under patent, copyright and mask work, trade secret and trademark law in the Philippines; that in consideration for the said grant, UPSS pays Unisys royalties, to wit: (1) an amount equal to fifty percent (50%) of UPSS Software Revenue, (2) an amount equal to ten percent (10%) of UPSS Maintenance Revenue, (3) an amount equal to five percent (5%) of UPSS Professional Services Revenue, and (4) an amount equal to either, at UPSS option, (a) three percent (3%) of revenues from UPSS OEM Products or (b) four and four-fifths percent (4 4/5%) of UPSS OEM Product Costs; that UAL-PB is a branch of Unisys Australia Limited, a corporation organized and existing under the laws of Michigan, U.S.A., duly registered with the Philippine Securities and Exchange Commission; that it is doing business in the Philippines under the business style "Unisys Philippines"; that it is primarily engaged in the business of designing, manufacturing and marketing components, products, systems and forms and supplies for the recording, storing, handling, computing, processing and communicating of information and data, and of providing related services; that UAL-PB entered into an Intellectual Property License Agreement (UAL-PB Agreement) with Unisys, effective April 1, 1998, for a period of two (2) years, subject to automatic and successive renewal for additional periods of one year, unless a notice of termination is given by either party; that the said Agreement complies with the provisions of the Intellectual Property Code on Voluntary Licensing per Certificate of Compliance No. 5-1998-00090 dated January 4, 1999 issued by the Intellectual Property Office of the Department of Trade and Industry; that UAL-PB Agreement grants UAL-PB a non-exclusive to reproduce, translate, distribute and prepare derivative works of, and use in its business such present and future rights in patents, copyrights, trademarks, trade secrets, software, documentation, know-how, maintenance and products support materials and professional service support materials under patent, copyright and mask work, trade secret and trademark law in the Philippines; that in consideration for the said grant, UAL-PB pays to Unisys, to wit: (1) an amount equal to fifty percent (50%) of UAL-PB Software Revenue, (2) an amount equal to ten percent (10%) of UAL-PB Maintenance Revenue, (3) an amount equal to five percent (5%) of UAL-PB Professional Services Revenue, and (4) an amount equal to either, at UAL-PB option, (a) three percent (3%) of revenues from UAL-OEM Products or (b) four and four-fifths percent (4 4/5%) of UAL-PB OEM Product Costs; and that the UPSS Agreement and the UAL-PB Agreement continue to be in full force and effect and constitute the valid and binding obligations of the parties thereto per certification dated November 2002 by Mr. Juan Pablo Garduo, Finance Director for UPSS and UAL-PB. 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. EDSHcT "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 productivity, use, or disposition thereof. "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 3(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 on 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. AHCaES Such being the case, this Office is of the opinion and so holds that the royalty payments of UPSS to Unisys 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 24, 2003 ) Moreover, the said royalty payments to be paid by UPSS and UAL-PB to UNISYS in the Philippines are subject to the 10% value-added tax pursuant to Sec. 108 of the Tax Code. Accordingly, UPSS, and UAL-PB, 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 Unisys. In remitting the VAT withheld, UPSS and UAL-PB 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 UPSS and UAL-PB upon filing its own VAT return, if it is a VAT-registered taxpayer. In case UPSS and UAL-PB 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, UPSS and UAL-PB are required to issue the Certificate of Final Tax Withheld at Source (BIR Form 2306) in quadruplicate upon request of Unisys, the first three copies thereof to be given to Unisys and the fourth copy to be retained by UPSS and UAL-PB 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 issued 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. EDATSC Very truly yours, Commissioner of Internal Revenue By: (SGD.) MILAGROS V. REGALADO Assistant Commissioner Legal Service