CLARIFYING THE IMPLICATION OF ARTICLE 12(2)(B) ON ROYALTIES OF THE RP-CHINA TAX TREATY, IN RELATION TO ARTICLE 13(2)(B)(III), OTHERWISE KNOWN AS THE “MOST-FAVORED-NATION” CLAUSE…

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 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.

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“

Article 13(2)(b)(iii) of the
RP-US tax treaty speaks of 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.”  This is known as the “most-favored-nation” clause of the RP-US tax treaty.  The purpose of the “most-favored-nation” clause is to grant to the other Contracting State a tax treatment that is no less favorable than that which is granted to the “most favored” among other countries.  Therefore, the tax treatment of royalty payments to a US entity must be taken in relation to other tax treaties what provide for a lower rate of tax on the same type of income.

In this regard, Article 12 of the RP-China tax treaty provides as follows:

“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.

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 competes 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“

In the case of Commissioner of Internal Revenue vs. S.C. Johnson and Son., Inc. and Court of Appeals
(G.R. No. 127105, June 25, 1999), the Supreme Court interpreted the
phrase “paid under similar circumstances” under the most-favored-nation
clause of the RP-US tax treaty as referring to the payment of taxes and
not royalties.  The Court did not allow the
application of the lower rate of 10% under the RP-Germany tax treaty for
royalties paid to US residents because the RP-US tax treaty contains no
“matching credit” provision similar to that found in Article 24 of the
RP-Germany tax treaty.

On the other hand, the RP-China
tax treaty does not contain a “matching credit” provision similar to
that found in the RP-Germany tax treaty.  Thus, the tax on royalty payments to residents of US and China can be considered paid under similar circumstances.

Article 23 of the RP-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 or the
taxable year x x x“

On the other hand, Article 23 of the RP-China tax treaty provides, viz:

“Article 23
“METHODS FOR THE ELIMINATION OF DOUBLE TAXATION

“I,      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 RP-US tax treaty and Article 23 of the RP-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,
trademark, design or model, plan, secret formula or process, x x x,
or for information concerning industrial, commercial or scientific
experience” under the RP-China tax treaty, pursuant to the
“most-favored-nation” clause of the RP-US tax treaty.

It bears stressing, however, that
there are two important requirements that should be complied with before
the 10% rate of withholding tax on royalties remitted to a resident of
US and China may be availed of, to wit:

1.  It is
necessary that there be an agreement or a contract whereby the royalties
paid to the US must originate 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, or the right to use, industrial, commercial or scientific
experience; and

2.  For
as long as the contract or agreement is subject to approval under
Philippine law, the same must be duly approved by the Philippine
competent authorities.

All internal revenue officers, employees and others concerned are enjoined to give this Circular the widest publicity possible.

Adopted: 2 Sept. 2002

(SGD.) GUILLERMO L. PARAYNO, JR.
Commissioner of Internal Revenue