By an End-user -

-a. From local subsidiaries, resellers, distributors of resellers

-Payments made by the end-user to the local subsidiaries, resellers, distributors of resellers for the purchase of copyrighted articles are business income subject to 30% income tax, based on the net taxable income of a domestic corporation (Sec. 27[A], NIRC).

When making payments to the local subsidiaries, resellers, distributors of resellers, the end-user shall withhold 2% income tax of the gross amount of the payments creditable against the taxable income of the local subsidiaries, reseller or distributors (Sec.

RR 2-98, as amended by Sec. 2, RR 14-02), provided the end-user is any of the following persons (under Section 2.57.3 of RR 2-98, as amended by Section 3 of RR 14-02) required to withhold such tax:

(a) A juridical person, whether or not engaged in trade or business;

(b) An individual, with respect to payments made in connection with his trade or business; or (c) A government office including a

government-owned or controlled corporation, a provincial, city, or municipal government.

b. Directly from the foreign owner and/or licensor of the software

A local end-user may acquire license to use software directly from the foreign licensor/owner of the software. Payments made by the end-user to the licensor/owner are royalties subject to 30% income tax, based on the gross amount thereof, imposed on royalties derived by a non-resident foreign corporation (Sec. 28[B][1], NIRC), which amount shall be withheld and collected by the end-user making the payments (Sec. 2.57-l[I][l], RR 2-98).

However, if the foreign licensor/owner is a resident of a country which has an existing tax treaty with the Philippines, royalties paid thereto are subject to the reduced tax rates on royalties under the relevant tax treaty, provided the condition prescribed therein are complied with by the

owner.

In General

Royalty can be sold regularly and thus be considered as an active business income subject to the normal corporate income or passive income subject to final withholding tax. The rules on royalty as a passive income under the Philippine Tax Code are summarized hereunder:

Royalty paid by a domestic corporation

Recipient is a citizen or a resident alien, or a non-resident alien engaged in trade or business in the Philippines, or a domestic corporation, or a resident foreign corporation Royalty income from sources within the Philippines is subject to 20% final withholding (income) tax, except royalty on books, other literary works and musical compositions received by individuals cited above which is subject to 10%

final

Ruling No. 57-2000 (Midas 24(B)(1) and Sec. 25(A)(2), NIRC.

Recipient is a non-resident alien not engaged in trade or business in the Philippines

Royalty income from sources within the Philippines is subject to 25% final withholding (income) tax, unless a lower tax rate is allowed under an existing tax

Recipient is a non-resident foreign corporation

Royalty income from sources within the Philippines is subject to the 30% final withholding tax, unless a lower tax rate is allowed under an existing tax

Under the Philippines-United States Tax Treaty, royalty paid by a Philippine company to a resident of the United States shall be subject to the following rates: 15%, if the payee is a firm registered with the BOI, or 25%, in all other cases. However, should the Philippines subsequently grant to a resident of another Contracting State a lower rate of tax on royalty, said lower rate of tax shall be available also to a resident of the U.S.

under the most-favored-nation clause of the

Tax Treaty. Thereafter, the Philippines concluded a tax treaty with West Germany, whereby the withholding tax rate that shall be imposed on the royalty paid by a Philippine company to a corporation organized under the laws of West Germany shall be 10%, provided that it is paid under similar circumstances to a resident of a third state.

Phrase under similar shall

refer to payment of royalty, and not to the payment of the tax. - The Supreme Court ruled that the phrase "paid under similar circumstances" in Article 13(2)(b)(iii) of the Philippines-U.S. Tax Treaty should be interpreted to refer to payment of royalty, and not to the payment of the tax, for the reason that the phrase "paid under similar circumstances" is followed by the phrase "to a resident of a third state." Words are to be understood in the context in which they are used, and since what is paid to a resident of a third state is not a tax but a royalty, logic instructs that the treaty provision in question should refer to royalties of the same kind paid under similar circumstances. This construction is based principally on syntax or sentence structure but fails to take into account the purpose

25(B), NIRC.

NIRC.

animating the treaty provisions in point. We are not aware of any law or rule pertinent to the payment of royalties, and none has been brought to our attention, which provides for the payment of royalties under dissimilar circumstances. The tax rates on royalties and the circumstances of payment thereof are the same for all the recipients of such royalties and there is no disparity based on nationality in the circumstances of such payment. On the other hand, a cursory reading of the various tax treaties will show that there is no similarity in the provisions on relief from or avoidance of double taxation as this is a matter of negotiation between the contracting Given the purpose underlying tax treaties and the rationale for the most favored nation clause, the concessional tax rate of 10% provided for in the Republic of the Philippines Tax Treaty should apply only if the taxes imposed upon royalties in the RP-U.S. Tax Treaty and in the Tax Treaty are paid under similar circumstances. The RP-US and the

Germany Tax Treaties do not contain similar provisions on tax crediting. Article 24 of the RP-Germany Tax Treaty expressly allows crediting against German income and corporation tax of 20% of the gross amount of royalties paid under the law of the Philippines. On the other hand, Article 23 of the RP-U.S.

Tax Treaty does not provide for similar crediting of 20% of the gross amount of royalties paid. The reason for construing the phrase "paid under similar circumstances" as referring to taxes is anchored upon a logical reading of the text in the light of the fundamental purpose of such treaty, which is to grant an incentive to the foreign investor by lowering the tax and at the same time crediting against the domestic tax abroad a figure higher than what was collected in the Philippines. Laws are not just mere compositions, but have ends to be achieved and that the general purpose is a more important aid to the meaning of a law than any rule which grammar may lay down. It is the duty of the courts to look to the object to be accomplished, the evils to be remedied, or the purpose to be subserved, and should give the law a reasonable or liberal construction which will best effectuate its purpose (Commissioner vs. Johnson and Son, Inc. and CTA, G.R. No. 127105, June 25,

decisions overturned the decision of the CA in the case Commissioner vs. Tire & Rubber Corp. GR 42300, Apr. 11, 1997), where the application of the preferential rate of 10% on royalties paid to a U.S. company, in view of the most-favored-nation clause in the Philippines-United States Tax Treaty was upheld.

Under the Philippines-China Tax Treaty effective January 1, 2002, the tax on royalties shall not exceed:

1. Fifteen per cent (15%) 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 cinematographic films or tapes for television or broadcasting; or

2. Ten per cent (10%) 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

Considering that the treaty with China does not contain a provision similar to that found in the treaty with Germany, the tax on royalty payments to residents of China can be considered paid under similar circumstances to a resident of the U.S. and the most-favored-nation clause in the RP-US Tax Treaty shall

Interpretation of the Term in Preferred Areas of

The term "engaged in preferred areas of activities" used under Article 12 on Royalties of the Tax Treaty between the Republic of the Philippines and the Netherlands shall have the proper interpretation as provided in BIR Ruling No. 12-02 dated January 29, 2002, hereunder quoted, viz.:

"In the absence of a definition of the term in preferred areas of activities' in the said tax treaty, it is therefore necessary to refer to Article 161 of Executive Order No. 226, as amended, otherwise known as the Omnibus Investments Code of 1987, which defines the term areas of investments' as economic activities that the Board of Investments shall have declared as such, in accordance with Article 28 of the said Code which shall either be pioneer or non-pioneer.

Memo. Circular No. 46-02, Sept. 2, 2002 15-2002, Apr. 24, 2002.

"Moreover, it appears that the phrase

registered and engaged in preferred areas of activities' does not refer to enterprises but

to enterprises, because the

RP-Netherlands Tax Treaty was signed on March

or prior to the of Republic Act No. 7916, otherwise known as the Special Economic Zone Act of 1995.

"Thus, in applying A r t i c l e 12 of the RP-Netherlands Tax Treaty, this Office already had the occasion to issue rulings where the phrase

registered and engaged in preferred areas of

consistently referred to BOI-registered enterprise engaged in preferred areas of investments (BIR Ruling No. 129-98 and Ruling No.

It should be noted that the term "enterprise registered and engaged in preferred areas of is also found in the Philippines' tax treaties with Pakistan, and Sweden and shall thus be given a similar interpretation as enunciated in BIR Ruling No. 12-02, having been signed respectively on

January January and January or prior

to the effectivity of Republic Act No. 7916, otherwise known as the Special Economic Zone Act of 1995. The same or similar phrase, found in other tax treaties to which the Philippines is a signatory, shall likewise be given the same interpretation.

Royalty paid by a foreign corporation

Recipient a resident citizen and a domestic corporation The royalty paid by a foreign corporation to a resident citizen and a domestic corporation is subject to tax at the graduated rates of tax ranging from 5% to 32% (in the case of resident citizens) or at 30% (in the case of domestic corporations), because they are liable to income tax on worldwide income.

Recipient is a citizen, an alien, and a foreign corporation

Since they are liable to Philippine income tax only on income, the source of which is from the Philippines, they are exempt from income on royalties received from a foreign corporation. Following the principle of mobilia sequuntur

personam, the situs of taxation of intangibles is the place where the residence or domicile of the owner is located.

Distinction between Royalty income and income Services that do not involve the grant of a license for the use of proprietary rights nor the transfer of technology shall be treated as business profits (and not as royalties). This has been the position of the BIR in a long line of rulings

However, the C T A seems to have a different view on this matter. In one case, petitioner entered into a management contract with a non-resident foreign corporation, whereby the latter shall perform for the former the following services for a fee; provide advice and recommendations with respect to new products; provide assistance in the production of international business in the employee benefits, pensions and other fields;

provide assistance in the sale of ordinary life business; provide training courses, seminars and other educational programs for underwriters, actuaries and other personnel; provide scholarship program for personnel; recommend standard accounting procedures and forms for financial and budgetary statements and other accounting provide assistance with regard to data processing; arrange and supervise internal audits; provide recommendations with respect to systems and procedures. The lower court ruled that the compensation for advisory services admittedly performed abroad by personnel of the non-resident foreign corporation is considered "rentals and royalties from properties located in the Philippines." Petitioner pointed out that it has no properties located in the Philippines from which rentals and royalties can be derived. The services call for the supply by the non-resident foreign corporation of technical and commercial information, knowledge, advice, assistance or services in connection with technical management or administration of an insurance business - a commercial undertaking. Therefore, the income derived for the services done abroad are from sources outside the Philippines. But the appellate court said that it is not the presence of any property from which one derives rentals and royalties that is controlling, but rather as expressed under the "expanded" meaning of royalties, it includes "royalties for

Ruling No. 054-01, June 11, 2001; No. 032-01, Mar. 13, 2001; No. 062-00, Mar. 21, 2000; No. 042-01, Apr. 10, 2001; No. 168-062-00, Oct. 30, 2000. These rulings are in accord with the commentaries of the OECD countries.

the supply of scientific, technical, industrial, or commercial knowledge or information; and the technical advice, assistance or services rendered in connection with the technical management and administration of any scientific, industrial or commercial undertaking, venture, project or scheme (Philippine American Life Insurance Co., vs. Commissioner and CTA,

No. 31283, Apr. 25, 1995).

Royalty income paid by a domestic corporation to a resident foreign corporation which is a resident of a Contracting State with which the Philippines has an effective tax treaty is generally subject to 15% final withholding tax, but the rate may be reduced to 10% for certain royalty payments or under the most-favored-nation clause of the tax treaty.

Rental

Rental income on property located in the Philippines paid to a non-resident alien or non-resident foreign corporation shall be subject to the 25% or 30% final withholding tax, respectively.

Rental income on the lease of personal property located in the Philippines and paid to a non-resident taxpayer shall be taxed as follows:

Non-Resident Corp. Non-Resident Alien

Vessel 4.5% 25%

Aircraft, machineries

and other Equipment 7.5% 25%

Other assets 30% 25%

Under the Philippines-United Tax Treaty, rental income from lease of machinery and equipment shall be treated as business profits, such that if the foreign lessor has no permanent establishment in the Philippines in accordance with treaty rules, said rental income from sources within the Philippines shall not be subject to Philippine income tax and withholding tax. In other tax treaties, there is no similar express provision in the U.S. tax treaty with respect to rental income from lease of machinery and equipment; hence, the rental income shall be similarly treated as royalty income. Thus, if the personal property is located or used

income from financial leasing is subject to income tax. The finance company-lessor is granted accelerated depreciation on the equipment under lease (Rev.

No. 19-86). However, under Rev. Regs. No. 12-2003 which implements the VAT on banks and finance companies, the interest income (not the rental income) is subject to VAT.

in the Philippines, the situs of the income is in the Philippines and can, therefore, be taxed in the Philippines either under the provisions of the Philippine Tax Code or under the provisions of the applicable tax treaty, whichever is lower. The purpose of tax treaties is to prevent or avoid double taxation, not to increase the rate of tax on particular incomes.

Rental payments received by a domestic corporation from the offshore lessee of the container vans are subject to income tax of 30% based on net income. The firm can claim depreciation deduction against its rental

Prizes and Awards

Prizes (except prizes amounting to P10,000 or less) and other winnings (except Philippine Charity Sweepstakes Office and lotto winnings) from sources within the Philippines shall be subject to 20% final withholding tax, if received by a citizen, resident alien or non-resident alien engaged in trade or business in the Philippines. However, if the recipient is a non-resident alien not engaged in trade or business in the Philippines, the prizes and other winnings shall be subject to 25% final withholding tax. And if the recipient is a corporation (domestic or foreign), the prizes and other winnings are added to the corporation's operating income and the net income is subject to 30% corporate income tax.

However, prizes and awards made primarily in recognition of religious, charitable, scientific, educational, artistic, literary, or civic achievement are excluded from gross income only if (a) the recipient was selected without any action on his part to enter the contest or proceeding; and (b) the recipient is not required to render substantial future services as a condition to receiving the prize or Moreover, all prizes and awards granted to athletes in local and international sports competitions and tournaments whether held in the Philippines or abroad and sanctioned by their national sports associations are also excluded from gross

The P H P 1 million prize money won by the Filipino International Chess Grand Master from the First Pambansa

Ruling No. 004-2001, Feb. 15, 2001.

32(B)(7)(c), NIRC.

32(B)(7)(d), NIRC.

(National) Millennium Chess Grand Prix sanctioned by the National Chess Federation is subject to the 20% final withholding tax. To be eligible for exemption, the national sports association referred to in the law that should sanction said sport activity is the Philippine Olympic

Prizes that winning inventors will receive from the nationwide contest for the most innovative New and Renewable Energy Systems jointly sponsored by the PNOC and other organizations are exempt from taxes during the first ten years reckoned from the date of the first sale of the invented products, provided that such sale does not exceed P200,000 during any twelve-month

The prize received by Luisito Espinosa from WBC Featherweight Championship Fight in Cotabato in 1997 is exempt from income tax, but the prize of Challenger Rios of Argentina is subject to 30% (now 25%) final withholding

The grand prize the Philippine Centennial Commemorative 100,000 National Raffle Draw of one Jaguar Daimler is subject to the 20% final withholding tax, despite the fact that the raffle draw is a government-sponsored

Other Income

Section 32(A) of the Tax Code enumerates various other sources of revenue, including but not limited to annuities, prizes and winnings, pensions, and partner's distributive share from the net income of the general professional partnership.

Income from any source whatever

The words "income from any source whatever" discloses a legislative policy to include all income not expressly exempted from the class of taxable income under our laws (Madrigal vs.

Ruling No. 026-2000, June 13, 2000.

5 and 6, R.A. No. 7459 (Inventors and Inventions Incentives Act of 1991);

BIR Ruling 069-2000, Dec 2000.

Ruling No. 126-97, Dec. 3, 1997. However, the prize money of Manny Pacquiao in his fights in Las Vegas, USA shall be subject to Philippine income tax, he being a resident citizen, but the federal income tax withheld or paid to the U.S.

government shall be credited against his Philippine income tax liability.

Ruling No. 005-2001, Feb. 15, 2001.