Correction of Error in Act No. 1910

November 23, 2005 ITAD RULING NO. 145-05 Arts. 5 & 7, Philippines-Japan tax treaty BIR Ruling No. DA-ITAD 24-04 Punongbayan & Araullo 20th Floor, Tower 1 The Enterprise Center 6766 Ayala Avenue 1200 Makati City Attention: Maria Victoria C. Espao Tax Partner Gentlemen : This refers to your letter dated September 5, 2005 requesting confirmation that the service fees paid by KMP Engineering, Inc. (KMP) to Ohmori Kogyo Co., Ltd. (Ohmori) are exempt from Philippine income tax and from value-added tax (VAT) pursuant to the pertinent sections or the National Internal Revenue Code of 1997 (Tax Code) and the Philippines-Japan tax treaty. It is represented that Ohmori is a nonresident foreign corporation taxable under the laws of Japan with business address at 323, Chigusa-Cho, Hanamigawa-Ku, Chiba-Shi, 262-0012 Japan and Tax Reference Number 00082821, as certified by the District Director of the Chiba-Nishi Tax Office in Japan on August 2, 2005; that Ohmori is not registered either as a corporation or as a partnership licensed to engage in business in the Philippines as confirmed by the Certificate of Corporate Filing/Information issued by the Securities and Exchange Commission Cebu Extension Office on July 19, 2005; that KMP, on the other hand, is a company organized and existing under the laws of the Philippines with principal office at Salvage Road, Looc, Lapu-Lapu City, Cebu; that it is registered with the Board of Investments (BOI);that KMP is engaged in the manufacture of pre-fabricated steel structure; that on January 1, 2005, KMP entered into a Business Support Agreement (BSA) with Ohmori; that under the said BSA, Ohmori shall provide the following services to KMP: 1. Promotion of KMP's products to prospective customers and maintenance of the business relationship with the existing customers in Japan and other countries outside the Philippines; 2. Assistance to KMP in the procurement of raw materials and supplies in Japan with regard to quality and specifications; 3. Review of the financial and other aspects of KMP's operation; and 4. Formulation of marketing and business strategy. EHCDSI that the foregoing services shall in no case involve the transfer of Ohmori's technology, know-how or other intellectual property rights; that in general, Ohmori shall perform the aforementioned services in Japan or in other countries outside the Philippines; that in cases where it would be necessary for Ohmori to send employees to the Philippines, the stay of these individuals in the Philippines shall not, in any case, exceed six (6) months in a year; and that in consideration for the services, KMP will pay Ohmori a monthly fee of One Million Two Hundred Thousand Yen ( 1,200,000.00);as indicated in the BSA; and that the Agreement shall be effective for a twelve-month term commencing on January 1, 2005 until December 31, 2005, subject to an automatic renewal for another twelve-month term, unless one of the parties serves a written notice of non-renewal to the other party not later than one (1) month prior to the expiration of the current term. 06taxcdtai In reply, please be informed that paragraph 1 of Article 7 of the Philippines-Japan tax treaty provides: "Article 7 1. The profits of an enterprise of a Contracting State shall be taxable only in that Contracting State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in that other Contracting State but only so much of them as is attributable to that permanent establishment. xxx xxx xxx" In view of the foregoing, the profits of a Japanese enterprise shall be taxable only in Japan unless such enterprise carries on business in the Philippines through a permanent establishment situated therein. If the Japanese enterprise carries on business as aforesaid, the profits of such enterprise may be taxed in the Philippines but only so much of them as is attributable to that permanent establishment. Applying this to the instant case, the service fees received by Ohmori for the services rendered in the Philippines shall be taxable in the Philippines only if it has a permanent establishment in the Philippines in connection with the activities giving rise to such income. In relation thereto, Article 5 of the same tax treaty defines a permanent establishment, as follows: "Article 5 1. For the purposes of this Convention, the term 'permanent establishment' means a fixed place of business through which the business of an enterprise is wholly or partly carried on. xxx xxx xxx 6. An enterprise of a Contracting State shall be deemed to have a permanent establishment in the other Contracting State if it furnishes in that other Contracting State consultancy services, or supervisory services in connection with a contract for a building, construction or installation project through employees or other personnel-other than an agent of an independent status to whom paragraph (7) applies-,provided that such activities continue (for the same project or two or more connected projects) for a period or periods aggregating more than six months within any taxable year. ..." cIaHDA Inasmuch as it has been represented that the services will generally be performed by Ohmori outside the Philippines and that should it be necessary to send its employees to the Philippines, said employees will not stay in the Philippines for more than six months in their rendition of services to KMP, Ohmori may be considered as not having a permanent establishment in the Philippines. In other words, Ohmori is deemed not to have a permanent establishment for as long as its employees do not stay in the Philippines for a period or periods aggregating more than six months within any taxable year in the course of their rendition of services to KMP. (BIR Ruling No. DA-ITAD 24-04 dated March 11, 2004) In such a case, the income derived by Ohmori from services rendered to KMP shall not be subject to Philippine income tax and, consequently, to withholding tax. Moreover, while the compensation for services rendered outside the Philippines is not subject to the 10% VAT, the fees paid for that portion of the services of Ohmori which are rendered in the Philippines are, however, subject to 10% VAT pursuant to Section 108 of the Tax Code of 1997. Accordingly, KMP, being the resident withholding agent and payor in control of payment shall be responsible for the withholding of the 10% final VAT on such fees before making any payment to Ohmori. In remitting the VAT withheld, KMP shall use the BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax & Other Percentage Taxes Withheld). The duly filed BIR Form No. 1600 and proof of payment thereof shall serve as documentary substantiation for the claim of input tax to be applied against the output tax that may be due from KMP if it is a VAT-registered taxpayer. In case KMP is a non-VAT registered taxpayer, the passed-on VAT withheld shall form part of the cost of the service purchased or treated as an "expense" or as an "asset", whichever is applicable. In addition, KMP is required to issue the Certificate of Creditable Tax Withheld at Source (BIR Form No. 2307) in quadruplicate upon request of Ohmori, the first three copies thereof be given to Ohmori and the fourth copy to be retained by KMP. (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. Very truly yours, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service