Punongbayan & Araullo

January 30, 2008 BIR RULING [DA-053-08] Punongbayan & Araullo 20th Floor, Tower 1 The Enterprise Center 6766 Ayala Avenue Makati City Attention: Atty. Fulvio D. Dawilan Tax Partner Gentlemen : This refers to your letter dated July 19, 2007 stating that your client, BRANDERS.COM (Philippines), Inc. (the PEZA Company), is a company organized and existing under the laws of the Philippines with business address at the 30th Floor, Union Bank Plaza, Meralco Avenue corner Onyx Road, Ortigas Center, Pasig City; that it is duly registered with the Philippine Economic Zone Authority (PEZA) and is engaged in business process outsourcing services using computer based IT enabled systems to service the needs of its global clients; that it is an affiliate of Branders.Com, Inc.; that on the other hand, Branders.Com, Inc. (Branders-USA) is a US entity engaged in the wholesale and design of various business promotional items, gifts and giveaways on the internet; that it has a Regional Operating Headquarters in the Philippines, BRANDERS.COM (ROHQ), INC. (ROHQ); that the ROHQ renders general administration, sourcing/procurement, corporate finance advisory services as well as engineering, IT and other technical support to Branders-USA; that the ROHQ also handles order management, product design, credit and collection, finance, engineering, IT as well as merchandising and marketing services for the PEZA Company; that the PEZA Company leases from the Union Bank of the Philippines (Union Bank) the 17th and 30th Floor of the Union Bank Plaza, with rentable areas of one thousand four hundred and 10/100 (1,400.10) and one thousand five hundred nine and 68/100 (1,509.68) square meters, respectively; that the PEZA Company occupies the 30th Floor of the building and subleases the 17th Floor (the subleased property) to the ROHQ; that being the lessee, the PEZA Company is billed by Union Bank for the rentals on the 17th and 30th Floors; that in turn, the PEZA Company bills the ROHQ for the latter's share of the rental over the subleased property; that VAT official receipts are issued by the PEZA Company for the rental payments received from the ROHQ; that the collection is recorded by the PEZA Company as rental income in its books; that for its part, the ROHQ treats the same as its rental expense; that the PEZA Company, likewise, owns certain equipment consisting of servers, computers, printers and such other office facilities which it leases to the ROHQ; that the terms of this equipment leasing is embodied in the Memorandum of Agreement (MOA) dated June 6, 2007, executed by the parties; that a rental fee for the use of the equipment is charged by the PEZA Company to the ROHQ; that as in the case of the office space being subleased to the ROHQ, the PEZA Company issues VAT Official Receipts on the rentals for these equipment; that the same is recorded as other income in the books of the PEZA Company with the corresponding output VAT; that in addition, the PEZA Company pays for some expenses common to the PEZA Company and the ROHQ, that the suppliers of goods and services, such as electric and water companies, issue their respective invoices and/or receipts only to the PEZA Company since it is the PEZA Company that holds the contract with such suppliers; that however, since some of these costs and expenses pertain to the ROHQ, the PEZA Company subsequently bills the ROHQ on a reimbursement of cost basis; that this arrangement is embodied in a separate MOA, dated March 21, 2007, between the PEZA Company and the ROHQ; that it is stipulated in the said MOA that the PEZA Company will advance ROHQ's share for the following common expenses; aDcHIC 1. Rental/Facilities Expenses/Association Dues; 2. Travel Costs; 3. Professional Services Costs (such as consultants, accounting and auditing services); 4. Office Expense and Supplies (including office, kitchen supplies and toiletries); 5. Telephone/Communications; 6. Other Costs (including dues, licenses, fees, etc.) that other than the receipt for the subleasing of office space which is being treated as income by the PEZA Company and as expense by the ROHQ, all other common expenses are initially paid by the PEZA Company, subject to subsequent reimbursement by the ROHQ for its share; that in short, certain purchases are centralized with the PEZA Company; that after paying the bills for these common expenses, the PEZA Company bills and collects from the ROHQ for the latter's proportionate share in these common expenses by issuing a billing statement and a non-VAT official receipt in the name of the ROHQ; that in effect, the PEZA Company only advances the payment of the utility bills and other expenses corresponding to the ROHQ's share and then the ROHQ subsequently reimburses the same at cost and without any profit; and that the MOA contains the details on how the PEZA Company and the ROHQ apportion these common expenses, such as floor area, number of personnel, etc. Based on the foregoing representations, you now request confirmation of your opinion that 1. The billings by the PEZA Company for a portion of the office space subleased to the ROHQ as well as from the lease of certain equipment to the latter are subject to the 35% corporate income tax and 12% VAT; 2. The payments made by the ROHQ to the PEZA Company representing reimbursement for certain common expenses initially advanced by the PEZA Company are mere reimbursements of costs and not service fees; 3. The amount paid by the ROHQ to the PEZA Company, being "pure reimbursement of costs", i.e., reimbursements for certain common expenses initially advanced by the PEZA Company, are not subject to income tax, withholding tax and VAT. In reply thereto, please be informed as follows: 1. BIR Ruling No. DA166-04 dated April 5, 2004, it was held that "ASE, being a domestic corporation, is subject to the regular income tax rate of 32% based on the net taxable income ( i.e., gross income less allowable deductions) derived from non-registered activities as provided under Section 27(A) in relation to Section 32(A), both of the Tax C od e of 1997. This position finds basis in BIR Ruling No. DA-023093 dated January 28, 2003, where this Office ruled that the sale by a PEZA-registered enterprise enjoying ITH and subsequently, the preferential tax rate of 5%, of its manufacturing plant and equipment such as generator sets and others is subject to an ordinary income tax at the rate of 33% or 32%, as the case may be, based on its net taxable income ( i.e., gross income less allowable deductions). The registered enterprise was engaged in the sale of disk drives and the sale of said plant and equipment was not among the activities duly approved and registered with PEZA. Such being the case and considering that ASE realized a gain from the sale of machineries and equipments resulting from the foreign exchange translation of their US Dollar denominated book value in pesos, the gain derived therefrom is subject to regular income tax rate of 32% based on the net taxable income as provided in Section 27(A), in relation to Section 32(A) of the Tax C od e." IDcTEA Under the circumstances, the PEZA Company entered into a Contract of Sublease with the ROHQ covering the portion of the rented office space being used by the ROHQ. Since it is the PEZA Company which contracted with Union Bank for the rental of the office spaces being used by both entities, the PEZA Company is billed by Union Bank for the entire space being occupied by these two companies. In this regard, the PEZA Company records the entire rental payments as rental expense in its books. Thereafter, the PEZA Company bills the ROHQ for the latter's share in the office space rental under the sublease agreement and records the billings as rental/other income, together with the corresponding output VAT. With respect to the lease of the equipment, the PEZA Company also records the rental as its income, together with the corresponding output VAT. The leasing activity is not one of the activities of the PEZA Company registered with PEZA. Accordingly, since the rental income is not derived from a registered activity of the PEZA Company, it shall be subject to the 35% regular corporate income tax. Likewise, the PEZA Company shall be liable for 12% VAT on the rental income which shall be passed on as input tax to the ROHQ. 2. It is a common principle in taxation that reimbursement of expenses, by its very nature, is not income but merely a return of capital. This is enunciated in BIR Ruling No. DA076-06 dated March 3, 2006 , where it was held that ". . . monies received by TPI from its tenants as payments for direct utilities and services are not subject to value-added tax (VAT) and Expanded Withholding Tax (EWT). xxx xxx xxx The expenses directly and indirectly attributable to TPI's tenants are billed to its various tenants depending on their levels of consumption: These amounts are actually payments for such direct and indirect expenses. As such, they are not income payments subject to income and withholding tax. . . ." In the instant case, the arrangement between the PEZA Company and the ROHQ under the MOA is similar to the above cost-sharing arrangement since it is agreed that the PEZA Company will be reimbursed by the ROHQ for its share in the common expenses. The MOA between the PEZA Company clearly states that the PEZA Company shall initially pay for the common expenses * subsequent reimbursement by the ROHQ of that portion allocated to * a reasonable cost-benefit arrangement ( i.e., floor area, number of personnel, etc.). The payments made by the ROHQ to the PEZA Company which actually represent reimbursement for certain common expenses that were initially advanced by the PEZA Company should be treated as a reimbursement of cost. Accordingly, such reimbursement is not income but merely a return of capital. 3. Finally, reimbursement-at-cost transactions, expenses which are incurred by the advancing party for the benefit and for the account of the party accommodated can be considered reimbursable expenses not forming part of gross receipts of the advancing party subject to tax. Since the party seeking reimbursement does not sell, barter, exchange, nor lease any food or property, and neither does it render any service to the party accommodated, the reimbursements are not subject to the 12% VAT. DHcEAa Such being the case, since payments received by the PEZA Company from the ROHQ for the latter's share in the common expenses do not represent income to the PEZA Company, the said payments shall not be subject to income tax and consequently to withholding tax. Moreover, payments made by the ROHQ to the PEZA Company are likewise not subject to VAT. WHEREFORE, in view of the foregoing , this Office hereby confirms your opinion that 1. The billings by the PEZA Company for a portion of the office space subleased to the ROHQ as well as from the lease of certain equipment to the latter are subject to the 35% corporate income tax and 12% VAT; 2. The payments made by the ROHQ to the PEZA Company representing reimbursement for certain common expenses initially advanced by the PEZA Company are mere reimbursements of costs and not service fees; and 3. The amount paid by the ROHQ to the PEZA Company, being "pure reimbursement of costs", i.e., reimbursements for certain common expenses initially advanced by the PEZA Company, are not subject to income tax, withholding tax and VAT. This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it will be disclosed that the facts are different, then this ruling shall be considered null and void. Very truly yours, (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service