Prescribing the Rules Governing Appeals to the Court of Appeals from a Final Order or Decision of the Court of Tax Appeals and Quasi-Judicial Agencies

August 18, 2003 ITAD RULING NO. 128-03 RP-US tax treaty, Art. 13 RP-China tax treaty, Art. 12 RP-Netherlands tax treaty, Art. 12 RMC 46-2002 BIR Rulings No. ITAD-126-01; 101-03; 102-03; 103-03 Gerald L. Cabrera and Associates Law Office Medical Plaza Ortigas, Suite 1009 25 San Miguel Avenue, Ortigas Pasig City 1600 Attention: Atty. Gerald L. Cabrera Gentlemen : This refers to your application for relief from double taxation dated July 3, 2002, on behalf of your client, BUSINESS ONE INC. (BUSINESS 1), requesting confirmation of your opinion that its royalty payments to OFFICE 1 SUPERSTORES INTERNATIONAL INC. (OFFICE 1) are subject to the preferential tax rate of ten per cent (10%) effective January 2002, and fifteen per cent (15%) from September 10, 1999 to December 2001, pursuant to the provisions of the RP-US tax treaty in relation to the RP-China and the RP-Netherlands tax treaties, respectively. It is represented that OFFICE 1 is a corporation duly organized and existing under the laws of the State of Delaware, USA, with business address at 83 Wainscott N.W.R.D. Wainscott, New York 199975 USA; 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 Securities and Exchange Commission dated April 24, 2002; that BUSINESS 1 is a corporation organized and existing under the laws of the Philippines with principal office address at 270 Vito Cruz Extension, Makati City; that BUSINESS 1 entered into a MASTER FRANCHISE AGREEMENT (Agreement) with OFFICE 1 on July 18, 1997; that under the said Agreement, BUSINESS 1 was granted the right to operate establishments in the Philippines known as "Office 1 Superstores", utilizing OFFICE 1's name and mark, as well as the unique and comprehensive system developed by OFFICE 1 in the sales and distribution of office supplies and light machines and other complementary products and services; that in consideration for the rights granted in said Agreement, BUSINESS 1 paid an initial franchise fee of Two Hundred Twenty Five Thousand U.S. Dollars (US$225,000) and undertook to pay OFFICE 1 a monthly royalty fee based on its net sales from the operations of "Office 1 Superstores" according to the following schedule: (a) three percent (3%) on net sales up to Three Million U.S. Dollars, (b) two percent (2%) on net sales between Three Million U.S. Dollars and Ten Million U.S. Dollars, and (c) one percent (1%) on net sales over Ten Million U.S. Dollars; that BUSINESS 1 shall, before making payments to OFFICE 1, withhold the applicable income tax and promptly remit the tax withheld to the appropriate tax authorities; and that the Agreement was registered with, and approved by, the Bureau of Patents, Trademarks and Technology Transfer of the Department of Trade and Industry under Certificate of Registration No. 2107 which is valid for ten (10) years from December 23, 1997 to December 22, 2007. In reply, please be informed that Article 13 of the RP-US tax treaty provides as follows: "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 Contacting State may be taxed by both Contracting States. "2. However, the tax imposed by that other Contracting State shall not exceed: "(a) . . . "(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 Philippines 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) "(c) 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 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. HISAET "2. However, such royalties may also be taxed in the Constructing 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) "For as long as the transfer of technology, under Philippine law, is subject to approval, the limitation of the tax rate mentioned under (b) shall, in the case of royalties arising in the Republic of the Philippines, only apply if the contract giving rise to such royalties has been approved by the Philippine competent authorities. "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 cinematography films, or films or tapes for radio or television broadcasting, any patent, trade mark, 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" Moreover, 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. (Emphasis supplied). "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 aforequoted provisions, the tax imposed on royalties derived by a resident of the United States from sources within the Philippines shall, when applicable, by 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, Article 12(2) of the RP-Netherlands tax treaty provides that royalties arising from the Philippines and paid to a resident of Netherlands may also be taxed in the Philippines but the tax so charged shall not exceed 15% of the gross amount of royalties. On the other hand, Article 12(2)(b) of the RP-China tax treaty provides that royalties arising from the Philippines and paid to a resident of China may also be taxed in the Philippines but the tax so charged shall not exceed 10% of the gross amount of royalties. 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. A perusal of the RP-US, RP-China and the RP-Netherlands tax treaty provisions on the avoidance of double taxation shows a similarity on the manner of payment of taxes, that is, the allowable foreign tax credit on 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 BUSINESS 1 to OFFICE 1 under their Licensing Agreement, for the years 1999 up to 2001, are subject to Philippine tax at the rate of fifteen percent (15%), pursuant to Article 13(2)(b)(iii) of the RP-US tax treaty in relation to Article 12(2)(b) of the RP-Netherlands tax treaty, while the royalty payments from January 1, 2002 onwards shall be subject to tax at the 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 which took effect on January 1, 2002. (BIR Ruling No. ITAD 126-01 dated October 30, 2001; Revenue Memorandum Circular (RMC) No. 46-2002 dated September 2, 2002)(BIR Rulings No. DA-ITAD 101-03; 102-03; and 103-03) Moreover, the said royalty payments are subject to the 10% value-added tax (VAT) pursuant to Sec. 108 of the Tax Code of 1997. Accordingly, BUSINESS 1, 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 fees before making any payment to OFFICE 1. In remitting the VAT withheld, BUSINESS 1 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 BUSINESS 1 upon filing its own VAT Return, if it is a VAT-registered taxpayer. In case BUSINESS 1 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, BUSINESS 1 is required to issue the Certificate of Final Tax Withheld at Source (BIR Form 2306) in quadruplicate upon request of OFFICE 1, the first three copies thereof to be given to OFFICE 1 and the fourth copy to be retained by BUSINESS 1 as its file copy. [Sections 4 & 6, Revenue Regulations (RR) No. 4-2002; 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. aDCIHE Very truly yours, Commissioner of Internal Revenue By: (SGD.) MILAGROS V. REGALADO Assistant Commissioner Legal Service