BIR Ruling [DA-037-04]

February 2, 2004 BIR RULING [DA-037-04] DA-148-98, 173-01 and 293-00 Quisumbing Torres Attorneys At Law 12th Floor, Net One Center 26th Street Corner 3rd Avenue Crescent Park West, Bonifacio Global City Taguig, Metro Manila Attention: Atty. Jose R. Sandejas Gentlemen : This refers to your letter dated July 14, 2003 requesting on behalf of your client, VSL Hong Kong Ltd. ("VSLHK"), for confirmation of your opinion that: "1. Service income to be derived from services to be rendered by VSLHK outside the Philippines under a Services Agreement is not subject to income tax for being derived from sources without the Philippines; "2. Payments for the services derived by VSLHK will not be subject to the 10% final withholding value-added tax ("VAT"); and "3. The service fees paid by VSL Philippines, Inc. ("VSLPH") to VSLHK for services performed by the latter constitute an ordinary and necessary business expenses of VSLPH which are allowed as a deduction from its gross income pursuant to Section 34(A)(1) of the National Internal Revenue Code of 1997 ("NIRC"). Statement of Facts VSLPH is a domestic corporation engaged in the business of providing project supervision and management services, such as consultation services and advice on planning, design, management, procurement, evaluation, valuation, supervision, inspection, and maintenance and operation of projects in the Philippines. VSLPH's main Office is located at Suite 1502, Jollibee Center Building, San Miguel Avenue, Ortigas Center, Pasig City, Metro Manila. VSLHK is a foreign corporation with principal office at 1505 Devon House, Taikoo Place, 979 King's Road, Quarry Bay, Hong Kong, VSLHK's activities involved tending, conforming and alternative designs, value-added engineering, pricing and methods of construction. VSLHK does not have any business operation in the Philippines. It has not secured a license to engage in trade or business in the Philippines from the Philippine Securities and Exchange Commission ("SEC"). To remain competitive in the Philippines, VSLPH proposes to engage the services of VSLHK, VSLPH will thus enter into a Services Agreement with VSLHK whereby the latter shall provide VSLPH planning assistance, inspection, design, quality control and certain related support services and activities. The Services Agreement also provides that VSLPH shall pay VSLHK a monthly retainer fee creditable against the services fee payable to VSLHK based on the actual services provided by VSLHK. The services fee will be determined by multiplying the actual hours spent with the hourly rate of the VSLHK personnel that will provide the services. In rendering the services, VSLHK shall utilize its resources outside the Philippines, particularly those in Hong Kong. In connection with your request, you submitted the following documents, to wit: 1. Duly authenticated certified true copy of the Business Registration Certificate and Memorandum and the Memorandum and Articles of Association of VSLHK; 2. Certification from the Philippines Securities and Exchange Commission that VSLHK is not currently registered to engage in business in the Philippines; 3. Duly notarized and authenticated special power of attorney authorizing Quisumbing Torres to file the request for ruling; and 4. Draft of the Services Agreement between VSLPH and VSLHK. Discussion/Opinion I. Income Tax/Final Withholding Tax Section 28(B)(1) of the NIRC provides that non-resident foreign corporations are subject to income tax only on income derived from all sources within the Philippines. Conversely, non-resident foreign corporations are not subject to income tax on income derived from sources outside the Philippines. For purposes of determining which income is considered not of Philippine source, Section 42 (C) of the Tax Code of 1997 enumerates the following items of gross income as income from sources without the Philippines: (1) Interests other than those derived from sources within the Philippines; (2) Dividends other than those derived from sources within the Philippines; (3) Compensation for labor or personal services performed without the Philippines; (4) Rentals or royalties from property located without the Philippines or from any interest in such property including rentals or royalties for the use of or for the privilege of using without the Philippines patents, copyrights, secret processes and formulas, goodwill, trademarks, trade brands, franchises and other like properties; and (5) Gain, profits and income from the sale of real property located without the Philippines. In order for the service fees to be considered as rentals or royalties, there must be a transfer of scientific, technical industrial or commercial knowledge or information. 1 Under the Services Agreement, there will be no transfer of scientific, technical, industrial or commercial knowledge or information by VSLHK to VSLPH nor of equipment or other property, where the payee has proprietary interest. In view of this, the service fees do not fall within the contemplation of "Rentals and Royalties" defined under Section 42(A)(4) of the Tax Code of 1997. Furthermore, since the services are to be performed abroad by VSLHK the service fees to be paid to VSLHK shall constitute compensation for labor or personal services performed outside the Philippines pursuant to Section 42 (C)(3) of the Tax Code of 1997. Hence, the said service fees shall not be subject to Philippine income tax. Moreover, such payments are not subject to final withholding tax 2 required to be withheld pursuant to Section 2.57(A) in relation to Section 57-1(I)(l), both of Revenue Regulations (Rev. Regs.) 2-98, as amended. Section 2.57-1(I)(1) provides that non-resident foreign corporations are subject to final withholding tax only on their income derived from all sources within the Philippines. Section 2.57-1(I) does not provide that non-resident foreign corporations are subject to final withholding tax on their income from sources outside the Philippines. II. VAT Section 108(A) of the Tax Code of 1997 provides that VAT shall be imposed on gross receipts derived from the sale or exchange of services, and the use or lease of properties. The same provision of the Tax Code provides that the phrase "sale or exchange of services means the performance of all kinds of services in the Philippines for others for a fee, remuneration or consideration. Conversely, services performed outside the Philippines are not subject to VAT. In the case of VSLPH and VSLHK, the services to be rendered by the latter to the former will be done outside the Philippines. Consequently, VSLPH"s payments of service fees to VSLHK, pursuant to the Services Agreement, shall not be subject to VAT. Thus, no VAT may be passed on by VSLHK to VSLPH. III. Deductible Business Expenses Section 34(A)(1) of the Tax Code of 1997 provides that all ordinary and necessary expenses paid or incurred during the taxable year in carrying on or which are directly attributable to the development, management, operation and/or conduct of the trade, business or exercise of profession are allowed as deduction from gross income. 3 The service fees that VSLPH will pay to VSLHK, pursuant to the provisions of the Services Agreement, are ordinary and necessary business expenses, which are directly connected with and appropriate in the conduct of VSLPH's business. The service fees are ordinary business expenses since comparable companies usually avail of the above services in order to stay competitive. Moreover, the service fees are necessary business expenses because the services that VSLHK will provide to VSLPH outside the Philippines will make VSLPH efficient and effective in providing services to its customers. By availing of the services that VSLHK will provide outside the Philippines, VSLPH will improve its net income. Consequently, the service fees are deductible expenses from VSLPH's gross income pursuant to Section 35(A)(1) of the Tax Code of 1997. VSLPH's payments to VSLHK pursuant to the provisions of the Services Agreement, fall within the contemplation of the foregoing Tax Code provisions, revenue regulations and BIR rulings. Conclusion/BIR Reply: Accordingly, we confirm as follows: 1. Based on Section 42(C)(3) in relation to Section 28(B)(1) both of the Tax Code of 1997, non-resident foreign corporations deriving income for services performed abroad are not subject to Philippine income tax since such services are considered income from sources without the Philippines. Accordingly, since the services are to be performed abroad by VSLHK, the service fees to be paid by VSLPH to VSLHK shall not be subject to Philippine income tax. Consequently, such payments are not also subject to final withholding tax pursuant to Section 2.57-1(I)(1) in relation to Section 2.57(A), both of Rev. Regs. No. 2-98, as amended. Section 2.57-1(I)(1) of Rev. Regs. No. 2-98 provides that non-resident foreign corporations are subject to final withholding tax only on their income derived from all sources within the Philippines. Thus, if the income is derived from sources outside the Philippines, the same is not subject to final withholding tax. VSLPH is, therefore, not required to withhold the 34% final income tax on its payments under the aforementioned Service Agreements to VSLHK. 2. Pursuant to Section 108(A) of the Tax Code of 1997 a VAT equivalent to ten percent (10%) of gross receipts is imposed on the sale or exchange of services, and the use or lease of properties. The phrase "sale or exchange of services" means the performance of all kinds of services in the Philippines for others for a fee, remuneration or consideration. Conversely, services performed outside the Philippines are not subject to VAT. Accordingly, VSLPH's payment of service fee to VSLHK pursuant to the aforementioned Services Agreement, shall not be subject to VAT. Consequently, no VAT may be passed on by VSLHK to VSLPH, as conversely suggested under Section 105 of the Tax Code of 1997. 3. Pursuant to the aforementioned Section 34(A)(1) of the Tax Code of 1997 all ordinary and necessary expenses paid or incurred during the taxable year in carrying on or which are directly attributable to the development, management, operation and/or conduct of the trade, business or exercise of profession are allowed as deduction from gross income. It is noted that per VSLHK's representation, comparable companies usually avail of the above services in order to stay competitive, that the services that VSLHK will provide to VSLPH outside the Philippines will make the latter more efficient and effective in providing services to its customers; and that the engagement of VSLHK services outside the Philippines will improve VSLPH's net income. Since the engagement of VSLHK by VSLPH to perform services covered under the Services Agreement is directly connected with and appropriate in the conduct of VSLPH's business the same may be considered as ordinary and necessary business expenses pursuant to aforementioned Section 34(A)(1) of the Tax Code of 1997. Accordingly, the service fees paid to VSLHK are deductible expenses from VSLPH's gross income pursuant to Section 35(A)(1) of the Tax Code of 1997. This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it shall be disclosed that the facts are different, then this ruling shall become null and void. Very truly yours, (SGD.) JOSE MARIO C. BUAG Deputy Commissioner Legal & Inspection Group Footnotes 1. BIR Ruling DA-148-98 dated April 20, 1998. 2. BIR Ruling Nos. DA-173-01 and DA-293-00, dated September 21, 2001 and July 28, 2000, respectively. 3. BIR Ruling No. DA-293-00, supra , and DA-145-97 dated April 7, 1997.