BIR Ruling [DA-121-04]

March 16, 2004 BIR RULING [DA-121-04] 42 (C) (3), 28 (B) (1), 114 (C) 059-89, ITAD 009-03 & 134-00 VAT 074-99 & 024-01 Cadiz Carag & De Mesa Law Offices Suite 2602, 26th Floor, The Atlanta Centre No. 31 Annapolis Street, Greenhills 1500 San Juan, Metro Manila Attention: Attys. Othelo C. Carag and Marie Christine E. Avaricio Gentlemen : This refers to your letter dated March 5, 2004 requesting for a confirmation of your opinion on the tax consequences of the sale and installation of a fatty alcohol hydrogenation reactor (hereinafter referred to as "Equipment") to United Coconut Chemicals, Inc. ("COCOCHEM"). It is represented that your client, COCOCHEM, is a domestic corporation duly organized and existing under Philippine laws and is a duly registered Ecozone Export Enterprise at the Cocochem Agro-Industrial Park ("CAIP") in Bauan, Batangas under Republic Act 7916, otherwise known as the Philippine Export Zone Authority (PEZA) law; that it is primarily engaged in the manufacture, sale and distribution of fatty acids, fatty alcohol and glycerine in the Philippines and abroad; that pursuant to its primary function, Cocochem desires to acquire the Equipment from Lurgi Life Science GmbH ("LURGI"), a non-resident foreign corporation duly existing and organized under the laws of Germany with principal office at Augustusburger Str. 34 D-09111 Chemnitz, Federal Republic of Germany; that Lurgi is not licensed to do business here in the Philippines as per certification issued by the Securities and Exchange Commission dated February 20, 2004, and that it does not render any service here in the Philippines, nor does it have a permanent establishment here in the Philippines; that, under the Contract for Supply of Equipment, Lurgi will undertake to provide the design, manufacture and engineering services, particularly the supply of materials for the Equipment, as well as the plant, mechanical, piping and instrumentation engineering services; that Lurgi shall likewise be responsible for pre-qualifying and evaluating the credentials of the domestic contractor that will install/commission the Equipment on site, including the foreign contractor who will render advisory services in connection with such installation and commissioning; and that all the foregoing services shall be performed, completed an delivered in Germany. It is further represented that Cocochem is the entity which will be in charge of importing the Equipment into the Philippines and of transporting the same to CAIP in Bauan, Batangas; that upon arrival of such Equipment in the ecozone restricted area, the Equipment will be installed on site by Aboitiz Construction Group Inc., Metaphil Division ("Aboitiz"), a corporation duly organized and existing under the laws of the Philippines with principal office at Tipolo, Mandaue City, Metro Cebu, Cebu City; that Aboitiz is a VAT-registered entity; that, under the Installation Contract between Cocochem and Aboitiz, Aboitiz will provide the necessary services for the installation and successful commissioning of the Equipment; and that the installation and commissioning shall be completed in three stages, within an aggregate period of not more than one hundred twenty (120) days, as follows: 1. First stage: Foundation and Demolition works, which will be for a period of not more than 30 days; 2. Second stage: Erection of the reactor and steel structure as well as the pipe support, to be accomplished within a period of not more than 30 days; and 3. Third stage: Tie-ins and Leak Testing to be completed also within a period of not more than 30 days. Likewise, it is represented that Cocochem will be engaging the services of a non-resident, non-VAT registered German contractor ("Foreign Contractor") to render advisory services in connection with the construction and foundation works, installation, start-up and commissioning of the Equipment on site; and that the Foreign Contractor will perform these professional services here in the Philippines for an aggregate period of not more than one hundred twenty (120) days, in accordance with the schedule of completion described above. aAHDIc Based on the foregoing facts, you now request for a confirmation of your opinion on the following tax-related matters: 1. Payments to be made to Lurgi, a non-resident foreign corporation not engaged in trade or business here in the Philippines, for the design, fabrication, engineering and manufacture of the Equipment shall not be subject to income and. withholding taxes and Value-Added Tax (VAT); 2. The proposed importation by Cocochem of the aforesaid Equipment to the Philippines shall be exempt from VAT; 3. The advisory services which will be rendered by the Foreign Contractor, a non-resident, non-VAT Registered German contractor, here in the Philippines for an aggregate period of not more than one hundred twenty (120) days will not be subject to income and withholding tax; 4. The payments to be made by Cocochem, a PEZA-registered entity, for the advisory services which will be rendered by the non-resident, non-VAT Registered German contractor shall likewise be exempt from VAT and creditable VAT withholding under Section 114(C) of the Tax Code of 1997; and 5. The installation and commissioning services which will be provided by Aboitiz, a domestic VAT-registered corporation, under the Installation Contract will be subject to the 2% creditable withholding tax, which shall be withheld at source by COCOCHEM and VAT at zero-percent (0%). In reply thereto, please be advised as follows: 1. Payments to be made to Lurgi for the design, fabrication, engineering and manufacture of the Equipment shall not be subject to income and withholding, taxes, including VAT. A foreign corporation not engaged in trade or business here in the Philippines shall pay a tax equivalent to thirty-two percent (32%) of the gross income received during each taxable year from all sources within the Philippines. However, if the sale of services is consummated outside the Philippines, such sale of services is not taxable in Philippines. In the case of CIR vs. Marubeni Corporation, Inc ., G.R. No. 137377 dated December 18, 2001, the Supreme Court laid down the following doctrine: "if the services for the design, fabrication, engineering and manufacture of the materials and equipment under the Offshore Contract were entirely completed and delivered abroad, then such sale of services is not taxable in our jurisdiction." Under the Contract for Supply of Equipment, the Equipment will be designed, manufactured, completed and delivered in German. Further, Lurgi shall conduct the pre-qualification and evaluation of both the domestic contractor and the foreign contractor's credentials in Germany. Thus, since the services that will be rendered by Lurgi in Germany are not subject to tax, all income payments, which Lurgi shall receive from Cocochem shall not be subject to Philippine income and withholding taxes, as well as VAT. Considering, further, that the design, manufacturing and engineering services, including the pre-qualification services to be rendered under the Contract for Equipment Supply, shall be consummated in Germany, the income derived from such sale of services is considered income from sources without the Philippines since the same constitutes compensation for labor or personal services performed without the Philippines, pursuant to Section 42(C)(3) of the Tax Code of 1997. And, since Lurgi is a non-resident corporation subject to income tax only on income from sources within the Philippines, said income earned by Lurgi for services rendered in Germany is not subject to income tax prescribed in Section 28(B)(1) of the same Code and, consequently, not subject to the 32% withholding tax as well as VAT. ( BIR Ruling No. 097-80 dated 08 July 1980; BIR Ruling No. 266-88 dated 28 June 1988; BIR Ruling No. 059-89 dated 7 April 1989; and ITAD Ruling No. 009-03 dated 16 January 2003 ). Further, Article 7, of the RP-Germany Tax Treaty provides that: "Article 7 BUSINESS PROFITS 1) The profits of an enterprise of a Contracting State shall be taxable only in that 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 the other State but only so much of them as is attributable to that permanent establishment." Moreover, Article 5(1) and (2) of the same Treaty states that: "Article 5 Permanent Establishment 1) For the purposes of this Agreement, the term "permanent establishment" means a fixed place of business in which the business of the enterprise is wholly or partly carried on. 2) The term "permanent establishment" shall include especially: a) a place of management; b) a branch; c) an office; d) a factory; e) a workshop; f) a warehouse, in relation to person providing storage facilities for others; DTaAHS g) mine, quarry or other place of extraction of natural resources; h) a building site or construction or assembly project or supervisory services in connection therewith, where such site, project or activity continues for a period of more than six (6) months ." (emphasis supplied) From the foregoing, Article 7 of the RP-Germany Tax treaty allows the Philippines to tax the business profits of an enterprise which is a resident of Germany if such enterprise has a permanent establishment here in the Philippines. A German Corporation may be deemed to have a permanent establishment in the Philippines if, among others, the furnishing of services of that corporation is through a building site or construction or assembly project, or supervisory services in connection therewith, where such site, project or activity continues for a period of more than six (6) months under Article 5(2)(h). In the case at bar, Lurgi does not have a permanent establishment in the Philippines to which its business profits or income may be attributed pursuant to Article 5(2)(h) of the RP-Germany Tax Treaty. Thus, the income profits which Lurgi, a resident corporation of Germany, shall receive from Cocochem shall be taxable only in Germany and will not be taxable here in the Philippines. ( ITAD Ruling No. 009-03 dated 16 January 2003; BIR Ruling No. 198-87 dated 10 July 1987; BIR Ruling No. 059-89 dated 07 April 1989 ). 2. We also confirm your opinion that Cocochem's proposed importation of the aforesaid Equipment to CAP in Bauan, Batangas is exempt from VAT. To encourage investments in special economic zones, PEZA-registered enterprises enjoy certain tax privileges. Section 1 Rule XV of the Rules and Regulations to Implement RA 7916 (IRR of RA 7916) provides that equipment and machineries which are brought into the ecozone restricted area by an Ecozone Export Enterprise to be assembled and installed therein shall not be subject to customs and internal revenue laws and regulations of the Philippines nor to local tax ordinances. However, the capital equipment which will be imported must be directly and actually needed and utilized exclusively by the Ecozone Export Enterprise in its registered activity and that the rated capacity of the capital equipment must be within its registered capacity. It has been represented that Cocochem will cause the installation of the Equipment in CAIP in Bauan, Batangas for use in the production and manufacture of fatty alcohol, one of its major products which are being exported to other countries. Therefore, since the subject importation will comply with the foregoing requisites enumerated in Section 1(A) Rule XV of the IRR of RA 7916, it follows that the contemplated importation of the Equipment will not be subject to customs duties and national and local taxes. This exemption will extend to the payment of VAT (Section 2 Rule XV in relation to Section 1(A) of Rule XIV of IRR of RA 7916; BIR Ruling No. 085-98 dated 02 June 1998, VAT Ruling No. 033-03 dated 07 July 2003 and VAT Ruling No. 074-99 dated 27 July 1999). 3. The advisory services that will be rendered by the non-resident, non-VAT registered German contractor here in the Philippines for an aggregate period of not more than one hundred twenty (120) days will not be subject to income and withholding tax. Article 14 of the RP-Germany Tax Treaty provides that: "Article 14 Independent personal services 1) Income derived by a resident of a Contracting State in respect of professional services or other independent activities of a similar character shall be taxable only in that State unless: "xxx xxx xxx" c) He is present in the other Contracting State for the purpose of performing his activities for a period or periods exceeding in the aggregate 120 days in the calendar year concerned , in which case, only so much of the income as is attributable to the activities performed in that other State may be taxed in that other State. 2) The term " professional services " includes especially independent scientific, literary, artistic, educational or teaching activities as well as the independent activities of physicians, lawyers, engineers , architects, dentists and accountants." (emphasis supplied) Considering, therefore, that the Foreign Contractor, a non-resident German contractor, will be rendering the advisory services for the installation and commissioning of the Equipment here in the Philippines within an aggregate period of not more than one hundred twenty (120) days, the income payments for such advisory services which shall be performed herein will be exempt from Philippine income and withholding taxes. ( BIR Ruling No. 116-97 dated 06 November 1997; BIR Ruling No. DA-376-98 dated 20 August 1988; ITAD Ruling No. 134-00 dated 19 September 2000 ). 4. The payments to be made by Cocochem, a PEZA-registered entity, for the advisory services which will be rendered by the non-resident, non-VAT registered Contractor shall be exempt from VAT and creditable VAT withholding under Section 114(C) of the Tax Code of 1997. Likewise, the payments to be made for the aforementioned advisory services will be exempt from VAT. The BIR has consistently ruled that the 10% VAT imposed on income payments to non-resident service providers will not apply if such services will be rendered to PEZA-registered enterprises such as Cocochem: "While payment for the sale of services is, in general, subject to the 10% creditable VAT withholding, this rule shall not apply to a PEZA-registered enterprise because, as a PEZA-registered person, it may not be legally passed on with nor claim input VAT. Further, the non-resident supplier cannot avail of the benefits of zero-rating. In view thereof, and the provisions of Revenue Regulations No. 8-2002 notwithstanding, as a PEZA-registered enterprise, payments for the services of the non-resident person is exempt from VAT, hence, also exempt from the creditable withholding otherwise prescribed under Section 114(C) of the National Internal Revenue Code of 1997." (VAT Ruling No. 005-03 dated 09 January 2003; VAT Ruling No. 025-02 dated 25 April 2002; VAT Ruling No. 16-00 dated 20 March 2000; VAT Ruling No. 100-99 dated 16 September 1999; VAT Ruling No. 95-99 dated 14 September 1999; and VAT Ruling No. 94-99 dated 14 September 1999). Thus, the payments to the non-resident, non-VAT registered Contractor, for the advisory services to be rendered pursuant to the Service Agreement shall be exempt from VAT. 5. With respect to the installation and commissioning services to be provided by Aboitiz, a domestic VAT-registered corporation, under the Installation Contract, we hereby hold that such sale of services will be subject to the 2% creditable withholding tax and zero-percent (0%) VAT. To further support, promote and encourage the export industry, the government has promulgated various tax laws to lessen, if not totally eradicate, the impact of taxation on such transactions. Hence, the State grants tax incentives not only to these exporters but also gives preferential tax treatments to the suppliers of the latter. Under Section 3 of the Revised Memorandum Circular No. 74-99 (RMC 74-99) dated 15 October 1999, the sale of services by a VAT-Registered Supplier from the Customs Territory to a PEZA-registered enterprise shall be subject to VAT at zero-rate. In VAT Ruling No. 024-01 dated 17 May 2001, it was stated that: cETCID "In the final analysis, any sale of goods, property or services made by a VAT registered supplier from the Customs Territory to any registered enterprise operating in the ECOZONE, regardless of the class or type of the latter's PEZA registration, is actually qualified and thus legally entitled to the zero percent (0%) VAT." Thus, since ABOITIZ is a VAT-Registered entity and is a supplier from the Customs Territory, it follows, therefore, that such transaction will be an effectively zero-rated transaction. Moreover, ABOITIZ need not apply for approval to zero-rate its transaction with COCOCHEM in accordance with Revenue Regulations 7-95 because RMC 74-99 shall serve as a sufficient basis to entitle such supplier of goods, property or services to the benefit of the zero-percent VAT for sales made to the aforementioned ecozone enterprises and shall serve as sufficient compliance to the requirement for prior approval of zero-rating imposed by RR No. 7-95. Nevertheless, ABOITIZ will have to imprint on its duly-registered VAT invoice the word "zero-rated" covering such zero-rated sales pursuant to Section 4.108-1 of RR No. 7-95 ( VAT Ruling No. 002-01 dated 12 February 2001 and VAT Ruling No. 001-00 dated 06 January 2000; VAT Ruling No. 037-98 dated 05 November 1998 ). Anent the obligation of Cocochem, as the withholding agent, to deduct the withholding tax from the income received by Aboitiz under the Installation Contract, Section 2.57.2 (E) of Revenue Regulations No. 02-98, as amended by Revenue Regulations No. 6-01 dated 31 July 2001, mandates that: " Section 2.57.2 (E) Income payments to certain contractors On gross payments to the following contractors, whether individual or corporate Two Percent (2%) "xxx xxx xxx" (2) General engineering contractors those whose principal contracting business is in connection with any structure built, for the support, shelter and enclosure of persons, animals, chattels or movable property of any kind, requiring in its construction the use of more than two unrelated building trades or crafts or to do or superintend the whole or any part thereto. Such structure includes . . . chemical plants and similar industrial plants requiring specialized engineering knowledge and skills, powerhouse, powerplants and other utility plants and installation, mines and metallurgical plants, cement and concrete works in connection with the above-mentioned fixed works. (3) Specialty contractors those whose operations pertain to the performance of construction work requiring special skill and whose principal contracting business involves the use of specialized building trades or crafts" "xxx xxx xxx" Since Aboitiz is a contractor as defined herein, then Cocochem will have to withhold the 2% creditable withholding tax on the gross payments to Aboitiz and subsequently remit the same to the BIR authorities, pursuant to Section 2.57(B) in relation to 2.57.4 of RR 2-98 as amended (Hon. Efren Plana, in his capacity as the Commissioner of Internal Revenue vs. The Court of Tax Appeals and Engineering Development Corporation of the Philippines , G.R. No. 52018 dated 23 February 1990; BIR Ruling No. 006-03 dated 15 August 2003 and BIR Ruling No. 024-99 dated 25 February 1999). 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, Commissioner of Internal Revenue By: (SGD.) MILAGROS V. REGALADO Assistant Commissioner Legal Service