The Philippine government continues to push for the commercialization of inventions and other intellectual property assets and is providing funding support for it. At the heart of any IP commercialization programme is the need for IP valuation, which is necessary to be able to decide whether to sell, license or enter into other types of commercial agreements based on IP. Most IP owners, particularly those in the public sector, prefer licensing to be able to have a steady stream of earnings. Whether the simple 25 percent rule or the more reliable income method is used in valuing IP, in many instances, the issue of taxation and its effects are not given as much attention as it should be given. Taxation has a direct impact on the revenue streams generated by the commercialized IP and affects such issues of IP ownership and location, and the cost of compliance with tax regulations can influence the overall bottom line of a company.

Individuals and juridical entities possess the freedom of contract, or that ability to determine the subject matter, consideration and other terms and conditions of their agreements. In transactions involving IP, the valuation of the payments to use said intangible assets form part of this freedom. These payments are called royalties. Under Philippine taxation, royalties are taxed as income. A taxpayer though may apply for exemption or a lower taxable rate based on treaty obligations which are binding on the Philippines.

In one such application for tax treaty relief filed with the Bureau of Internal Revenue (BIR) involving the popular magazines Cosmopolitan and Esquire owned by Hearst Magazine Media, Inc., an American company, tax relief was sought from the royalties paid to Hearst by Summit Publishing Company Inc., a Philippine company (BIR Ruling No. ITAD 022-25, April 14, 2025). The relevant facts are as follows.

Summit was given the license to publish Philippine editions of Cosmopolitan and Esquire magazines, to which it obligated itself to pay royalties in the amount of 8 percent of its net turnover for each publication year.

The application requested for confirmation from the BIR that the lower tax rate of 10 percent under the Philippine-United Arab Emirates Tax Treaty (PH-UAE tax treaty) should be applied, instead of the 25 percent tax rate under the Philippine-United States of America Tax Treaty (PH-US tax treaty). This is due to the inclusion of a most favoured nation clause in the PH-US tax treaty. A most favoured nation clause allows a taxpayer to avail of the lowest tax rate extended to another country, in this case the United Arab Emirates, so that there will be equality of treatment. However, there are two conditions that need to be met before the most favoured nation clause can apply:

(1) similarity in subject matter; and 

(2) similarity in circumstances in the payment of tax.

The BIR ruled that the first condition is present, the subject matter in the PH-UAE and PH-US tax treaties both being royalties. However, as to the second condition, the BIR ruled that while the PH-UAE tax treaty allowed a taxpayer to deduct in full the tax paid in the Philippines, the PH-US tax treaty proscribed a limitation based on the current US law. Hence, the PH-US tax treaty stated:

ARTICLE 23 

Relief from Double Taxation

x x x 

(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 for the taxable year. x x x

Therefore, the lower rate of 10 percent under the PH-UAE tax treaty cannot be applied on the royalties paid by Summit to Hearst. Instead, the higher 25 percent tax rate under the PH-US tax treaty applies.

This is in keeping with the Supreme Court’s ruling in Cargill Philippines Inc v. CIR (G.R. No. 203346, September 9, 2020), where the second condition was likewise found to be absent as between the PH-US tax treaty on one hand, and the Philippine-Czechoslovakia tax treaty (PH-CZECH tax treaty) in the other. In said case, the PH-CZECH tax treaty was found to have already specified the limitations on the tax credit in the tax treaty itself, whereas the PH-US tax treaty requires reference to current US laws. Thus:

Moreover, under the RP-Czech Tax Treaty, the limitation on credit is already specified—that the Philippine tax should not exceed the Czech tax payable for the same income. Under the RP-US tax treaty, the limitation on credit is not determinable unless we look into the internal tax law of the United States.

The BIR also imposed a 12% Value-Added Tax (VAT) on the royalties, for being a sale or exchange of services as contemplated under Philippine tax law. The BIR clarified that the right to use intellectual property within the Philippines (i.e., the license to publish Philippine editions of Cosmopolitan and Esquire) is one such service that is subject to 12 percent VAT. This is pursuant to the principle that services or licenses to be exercised within the Philippines are subject to 12 percent VAT. 

The Supreme Court, in a recent case (Subic Bay Freeport Chamber of Commerce Inc. and Antonio III v. Dept of Finance, et al., G.R. No. 266016, February 4, 2025, published on April 29, 2025), had the occasion to discuss the same. After the passage of the Republic Act No. 11534 or the Corporate Recovery and Tax Incentives for Enterprises Act, March 26, 2021 (CREATE Act). The BIR issued implementing rules and regulations (IRR) which had a provision limiting the availment of VAT zero-rating only to “Registered Export Enterprises” – or those with at least 70 percent export output. The IRR had effectively excluded domestic market enterprises. 

The Supreme Court nullified the said IRR provision, on the ground that since the CREATE law did not distinguish between “Domestic Market Enterprises” and “Registered Export Enterprises”, VAT zero-rating should be available to both types of entity. More importantly, this follows the destination principle, which provides that no VAT is imposed on goods or services that are destined outside the Philippines. As the Subic Bay Freeport Zone is treated as a separate customs territory by law, goods and services destined thereat are VAT zero-rated.

With the foregoing, in strategies to lower taxes on the payment of royalties on intellectual property transactions, the parties should be aware of the applicable tax treaty and ensure that there is similarity in circumstances in the payment of taxes in the tax treaties being relied on. Further, one should also be mindful of the destination principle as the exercise of intellectual property licenses may or may not be VAT zero-rated.