ITAD Ruling No. 186-03

December 1, 2003 ITAD RULING NO. 186-03 Art. 12 of the RP-US and RP-China Tax Treaties BIR Ruling DA-ITAD-140-03 RMC No. 46-2002 dated September 2, 2002 Diversion Industries, Inc . DII Building, 150 San Vicente Road, Brgy. San Vicente, San Pedro, Laguna Attention: Mr. Alfredo A. Baria Controller Gentlemen : This refers to your letter dated July 25, 2003, requesting for a ruling that Diversion Industries Inc. (Diversion) be allowed to apply the 10% withholding tax rate on its royalty payments to Guess?, Inc. (Guess) based on the "most favored nation" clause of the RP-US tax treaty in relation to the RP-China tax treaty. It is represented that Guess is a corporation organized and existing under the laws of the United States of America (USA) with principal address at Executive Office, 1444 South Beverly Drive, Beverly Hills, CA 90212; that it is not registered either as a corporation or as a partnership and has not been licensed to do business in the Philippines per certification issued by the Securities and Exchange Commission dated August 12, 2003; that Diversion is a corporation organized and existing under the laws of the Philippines with principal address at 150 DII Bldg., San Vicente Road, Brgy. San Vicente, San Pedro Laguna; that on July 1, 1994, Diversion and Guess entered into a Manufacturing License Agreement which was amended on October 23, 2001 under the following conditions: (a) To renew the Manufacturing License Agreement for a four (4) year term commencing January 1, 2002 and ending December 31, 2005, (b) "Trademark Royalty" means eight and one-half percent (8 %) of the net sales of women's, men's and sock products by Diversion and six percent (6%) of the net sales of infants and kids product, which represent the amount payable by Diversion to Guess in consideration for the grant by Guess to Diversion of the right to use the trademarks and intellectual property rights, (c) Beginning January 1, 2002, for each contract year during the term of this agreement, Diversion shall expend for advertising two and one-half percent (2 %) of the amount that is the greater of (1) net sales and (2) minimum net sales for such contract year, (d) Twice a year, Diversion shall pay all costs for business class round trip travel and accommodations for five (5) days and five (5) nights for two (2) representatives of Guess to travel to Diversion's principal place of business for any purpose related to the agreement, (e) All provisions of the Manufacturing License Agreement with respect to the manufacture and sale of products and the relationship between Guess and Diversion shall apply to the amended agreement unless expressly provided otherwise; that this agreement is registered with the Intellectual Property Office under Certificate of Registration No. 5-2002-00020; and that the Manufacturing License Agreement is confirmed and shall continue to be and remain in full force and effect in accordance with its terms except as expressly modified by the amended agreement. 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. DIcSHE "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, at 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 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, 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 13(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 140-03 dated September 18, 2003) A plain reading of the 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. Such being the case, this Office is of the opinion and so holds that the royalty payments of Diversion to Guess under the Manufacturing License Agreement shall be subject to the 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-140-03 dated September 18, 2003) AHTICD Moreover, the said royalty payments to be paid by Diversion to Guess are subject to the 10% value-added tax pursuant to Sec. 108 of the Tax Code. Accordingly, Diversion, 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 Guess. In remitting the VAT withheld, Diversion 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 the proof of payment thereof shall serve as documentary substantiation for the claim of input tax by Diversion upon filing its own VAT, if it is a VAT-registered taxpayer. In case Diversion 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, Diversion is required to issue the Certificate of Final Tax Withheld at Source (BIR Form 2306) in quadruplicate upon request of Guess, the first three copies thereof to be given to Guess and the fourth copy to be retained by Diversion as its file copy. [Sections 4 & 6, Revenue Regulations (RR) No. 4-200; Section 3 of RR 8-2002; Section 7 of RR 14-2002] 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. Very truly yours, Commissioner of Internal Revenue By: (SGD.) MILAGROS V. REGALADO Assistant Commissioner Legal Service