Picazo Buyco Tan Fider & Santos Law Offices

March 6, 2008 BIR RULING [DA-134-08] R.A. 7227; RR 2-40; UN-296-95 Picazo Buyco Tan Fider & Santos Law Offices 18th, 19th & 17th Floors, Liberty Center 104 H.V. dela Costa Street, Salcedo Village Makati City Attention: Atty. Cynthia L. De La Paz Gentlemen : This refers to your letter dated September 18, 2007 requesting on behalf of your client, Mabuhay Satellite Corporation ("MSC"), for confirmation of your opinion that MSC's provision of transponder capacity services to its customers constitute business activities within the Subic Special Economic and Freeport Zone (SSEFZ) such that all revenues derived from said activities shall be subject to five percent (5%) rate on gross income earned applicable to SBMA-registered enterprises pursuant to Republic Act (R.A.) No. 7227. Background MSC is an enterprise registered with the Subic Bay Metropolitan Authority (SBMA), for the purpose of engaging in the business of management and control of satellites and telecommunication traffic via satellite. MSC currently owns, operates, and maintains a satellite system which is used to provide space segment capacity to telecommunication, broadcast, and other public utility companies operating in the Philippines and other countries within its footprint, which covers the Philippines, coastal China, northern Vietnam, Taiwan and Hong Kong for its Ku-band transponders, and Asia, from India to the Philippines, Japan to Indonesia as well as a spot beam over Hawaii for direct access to the U.S. mainland for its C-band transponders. MSC's satellite system is comprised of a space segment composed of a satellite located in space in an Indonesian orbital slot registered with the International Telecommunication Union (ITU) 1 as Palapa Pacific 146E and a ground segment or earth station, composed of satellite control and monitoring facilities located within the SSEFZ. This satellite system enables MSC's customers to transmit information from and to the Philippines and other countries within its footprint through the use of transponders. All of MSC's revenues are payments received from its provision of transponder capacity services to customers. A "transponder" is a device on a satellite which amplifies and relays transmission between transmitting and receiving earth stations of a customer. It is effectively a controlled amplifying repeater in space. A single satellite may have several transponders. 2 In the case of MSC, while its satellite is in outer space, its earth station/ground segment is located within the SSEFZ and manned by MSC personnel who perform therein all monitoring, operations, control, interference management and station keeping of transponders used by its customers. The documentation of the contractual arrangement between MSC and its customers generally refer to the arrangement as "lease". Under the New Civil Code, lease "may be of things, or of work and service". 3 In the lease of things, one of the parties binds himself to give to another the enjoyment or use of a thing for a price certain, while in the lease of work or service, one of the parties binds himself to execute a piece of work or to render to the other some service for a price certain. 4 As no control of the transponder, which is in outer space, actually passes to the "lessee", the contractual arrangement between MSC and its customer in respect of the provision of transponder capacity service appears to be more appropriately characterized as a contract for the provision of facilities and services, that falls under the category of "lease of work or service" under the New Civil Code. In reply, please be informed that Section 42 (A) (3) of the Tax Code of 1997, as amended, provides that revenues/compensation derived from services performed in the Philippines shall be treated as income from sources within the Philippines. Section 155 of Revenue Regulations (RR) No. 2-40 (the Income Tax Regulations) further states that "gross income from sources within the Philippines includes compensation for labor or personal services performed within the Philippines regardless of the residence of the payor, of the place on which the contract for service was made, or of the place of payment." Based on the above provisions, the situs of the income derived from services performed by a taxpayer is the place where said taxpayer performs such services. Specifically transposing the above "source rule" stated in the Tax Code and the Income Tax Regulations in relation to provision of services by MSC within the SSEFZ, all revenues derived by MSC from performing transponder capacity services within the SSEFZ are derived from sources within the SSEFZ subject to the 5% tax rate on gross income. There appears to be no question that the Rules and Regulations Implementing of R.A. 7227 (the "IRR") have adopted the "source rules" on income stated under the Tax Code to Subic Bay Freeport enterprises ("SBF Enterprises") as can be concluded from Section 43 of the IRR: "SBF Enterprises shall be exempt from all national and local taxes, including but not limited to the following: xxx xxx xxx c. Income tax on all income from sources within the SBF, . . . as well as all other areas that may now or hereafter be considered to be outside the Customs Territory, 5 whether or not payment of such income is actually received, made or collected within such areas ; . . . ." 6 Thus, the above provision (Section 43) of the IRR merely tracks the language and principle stated in Section 155 of Revenue Regulations No. 2-40, such that gross income from sources within the "taxing authority" ( i.e. , SBMA in the case of an SBF enterprise) includes compensation for labor or personal services performed within the said "taxing authority" of the place on which the contract for service was made, or of the place of payment. The IRR has likewise adhered to the "source rules" on income stated under the Tax Code in providing a maximum percentage of income generated from the Customs Territory ( i.e. , 30%) in order for the 5% rate on gross income earned to be applicable to an SBF Enterprise. The IRR thus states "should an SBF Enterprise's income from sources within the Customs Territory exceed Thirty Percent (30%) of its total income from all sources, then it shall be subject to the income tax laws of the Customs Territory; . . .". 7 In the case of MSC, it has one earth station/ground segment which is located within the SSEFZ manned by MSC personnel who perform therein all monitoring, operations, control, interference management and station keeping of transponders used by its customers. Thus, the income derived by MSC from rendering these transponder capacity services at its earth station/ground segment located within the SSEFZ constitutes 100% of its total income, leaving nothing (or 0%) of its income generated from sources within the Customs Territory. Definitely, therefore, MSC is compliant with the 30% maximum threshold of income derived from "Customs Territory set forth under Section 44 of the IRR, thereby making it unequivocally eligible to the 5% rate on gross income earned on transponder capacity services rendered to all its customers, the place where the contract for service was made/executed, or the place of payment for such services. In BIR Ruling No. UN-269-1995 dated July 24, 1995, this Office had occasioned to rule that Philippine Communications Satellite Corporation ("Philcomsat"), an entity which owns and operates an earth station inside Subic Special Economic and Freeport Zone which is used to transmit and receive telecommunication signals to and from various parts of the world, is subject to the five percent (5%) preferential income tax rate imposed by R.A. No. 7227. In view of the foregoing, this Office confirms your opinion that MSC's provision of transponder capacity services to its customers constitute business activities within the Subic Special Economic and Freeport Zone (SSEFZ) such that all revenues derived from said activities shall be subject to five percent (5%) rate on gross income earned applicable to SBMA-registered enterprises. 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.) JAMES H. ROLDAN Assistant Commissioner Legal Service Footnotes 1. The ITU is the United Nations agency for information and communication technology tasked with, among others, the governance of satellite operations. 2. Julian Hermida, Transponder Agreements, 24 J. SPACE L. 35, 35-36 (1996). 3. Art. 1642, New Civil Code. 4. Arts. 1643 and 1644, New Civil Code. 5. The term "Customs Territory" refers to the portion of the Philippines outside the Subic Bay Freeport (SBF) where the Tariff and Customs Code of the Philippines and other national tariff and customs laws are in force and effect. 6. Section 43 of the IRR. 7. Section 44 of the IRR.