BIR Ruling

March 13, 1967 Messrs. Sycip, Gorres, Velayo & Co. Certified Public Accountants 85 Ayala Avenue, Makati Rizal Attention: Mr . B . V . Abela Gentlemen : This refers to your letter dated October 8, 1966, requesting information as to the tax implications of a manufacturing and distributorship transaction to be carried out substantially in the following manner. cdt A foreign corporation as the owner of certain patents and trademarks registered in the Philippines. This corporation, hereinafter identified as X, will now establish a branch in the Philippines to engage in the manufacture of the patented products. For this purpose it will utilize the services of a domestic corporation, hereinafter identified as Y, to manufacture for it said products under the two possible alternatives described below, viz: I. Y provides all raw and packaging materials needed in the manufacture of the products. For its manufacturing fee, Y bills X an amount constituting of the total of the following items: (a) Actual cost of raw and packaging materials, (b) Actual cost of labor plus allocated factory overhead, (c) 5% of item (a) as allowance for financing, and (d) 10% of the total of items (a) (b) and (c) as allowance for processing. II. X provides all raw and packaging materials. Y, however actually effects the procurement with funds advanced by X. For its services, Y bills X an amount constituting of the total of the following items: cdtech (a) Allowance for procurement and manufacturing. (b) Cost of labor and allocated factory overhead. Under this alternative the total manufacturing fee of Y is reduced in an amount equivalent to the cost of raw and packaging materials, they being supposedly supplied by X. Distribution of the finished products shall be effected as follows: X will appoint a second company, hereinafter referred to as Z, as the exclusive distributor of the products. The principal terms and conditions of the distributorship agreement shall be as follows: a) The Philippine Branch will sell the finished products to the distributor under such terms that the title over the products passes to the distributor. b) Although the products may be sold on credit for a certain period, the risks of loss over the goods and of collection of the distributor's accounts remain with the distributor after delivery of the goods to the distributor. llcd c) There will be a list price of such products to be agreed upon between X and Z which list price will be appended to the agreement and will be subject to periodic change by X upon reasonable notice in writing given to Z. Price changes may be effected upon the grounds set out in the distributorship agreement. d) There will be a minimum floor to be specified in the distributorship agreement for the amount and/or value of the purchase orders to be made by Z each month. e) The distributorship agreement shall include a schedule for submitting the purchase orders and the time required to deliver the products covered by the purchase orders. A deposit may be required to assure the capacity of the distributor to accept delivery and pay for the products ordered. f) The agreement with Z will state the period covered by the relationship and the manner by which the agreement could be terminated earlier. g) Z shall be given the right to fix the selling price to the trade, although, in the interest of competitiveness of the products, Z will agree to consult with X on the selling price of the products to the trade. In all events, the mark-up of Z on the goods will not partake the nature of a disguised selling commission. cdll It is also manifested that Y and Z may be affiliated companies controlled by the same group of interests. However, there will be no direct transaction between Y and Z the processor and the distributor; each one of them will have a contractual relationship with X but not with each other. In reply, I have the honor to inform you as follows: X under the two possible alternatives, shall be considered the manufacturer of the finished products. The sales tax payable by it shall be based on its selling price of the products to Z. Y shall be considered an independent contractor. The 3% contractor's tax payable by it, also under both alternatives, shall be based on the total of the items comprised in alternative No. 1. This Office believes that there is no difference between the two alternatives. The alleged advance by X of the funds for procurement of the raw and packaging materials will not in the least alter the operating procedure of Y. The alleged advance may simply be considered as advance payment by X of the processing fee of Y. It is to be noted that with or without the advance, the activity to be pursued by Y under the transaction remains the same. The business tax status of a person is essentially predicated on the activity undertaken by him. However, if X will actually procure personally the raw and packaging materials, then the cost thereof shall not form part of the taxable receipts of Y. Please be further informed that this Office may reverse or modify this ruling if, after investigation, it will appear that the facts are different from those represented. Very truly yours, (SGD.) MISAEL P. VERA Commissioner of Internal Revenue