BIR Ruling [DA-195-06]

March 28, 2006 BIR RULING [DA-195-06] Sections 22 (EE), 25 (C), 31 SPI Technologies SPI Bldg., Pascor Drive Sto. Nio, Paraaque City Attention: Mr. Francisco H. Suarez, Jr. Vice President Finance Gentlemen : This refers to your letter dated December 18, 2005 requesting for confirmation of your opinion on tax matters relating to the operation of SPI Netherlands B.V. (SPIBV) in the Philippines, as a regional operating headquarters (ROHQ), to wit: 1. Alien and Filipino executives, directors and managers employed by SPIBV are subject to income tax at 15% of gross income. 2. The billings to be made by SPIBV to its affiliates and subsidiaries will not be subject to income tax and value-added tax (VAT) since these are mere reimbursements of their share in the allocated expenses of the ROHQ of SPIBV. 3. No expanded withholding tax shall apply to the payments to be made by the Philippine companies to the ROHQ of SPIBV. As represented, SPIBV is a multinational company organized and existing under the laws of Netherlands. It was authorized by the Securities and Exchange Commission (SEC) on September 13, 2005, with the consent of the Board of Investments (BOI), to establish an ROHQ in the Philippines. SPIBV has been authorized to engage in general administration and planning, business planning and coordination, sourcing and procurement of raw materials and components, corporate finance advisory services, marketing control and sales promotion, training and personnel management, logistic services, research and development services and product development, technical support and maintenance, data processing and communication, and business development for affiliates and, subsidiaries within the Asia Pacific region and other countries. SPIBV has affiliates and subsidiaries in the Philippines, India, United States of America, Mexico and Europe. Its office in the Philippines is at the Pacific Information Technology Center, Pascor Drive, Sto. Nio, Paraaque City, Metro Manila. SPIBV is part of the SPI Group of Companies, whose principal activity is business process outsourcing for offshore and unrelated customers. The ROHQ of SPIBV in the Philippines will supervise, oversee and guide the activities of these affiliates and subsidiaries. It intends to recover its operating expenses by seeking reimbursements from its affiliates and subsidiaries of their share in the actual expenses incurred by the ROHQ. The reimbursements, without any mark-up or profit element, shall consist of salaries of the executives, rental costs, office supplies, traveling costs, professional fees and other operating expenses. There will be no excess of the amount billed over the actual expenses of SPIBV as all costs will be shared among the affiliates and subsidiaries. SDHAEC SPIBV has employed expatriates and Filipinos who occupy executive, director and manager positions. They are performing functions for the affiliates and subsidiaries of SPIBV that involve: 1. Capacity and authority to make plans and policies 2. Formulation of major decisions that affect finance, corporate development, human resources, information technology, operations, production, social work, quality and audit 4. Recommending measures in matters of policy determination and execution 5. Supervising specific departments and units in the affiliates and subsidiaries of SPIBV 6. Establishment of operational objectives and assignments In reply, please be informed as follows: 1. Alien executives, directors and managers employed by SPIBV are subject to income tax at 15% of their gross income whereas their Filipino counterparts have the option to be taxed at either 15% of their gross income or the graduated tax rates of 5%-32% . Section 25(C) of the Tax Code of 1997 as implemented by Section 2.57.1(D) of Revenue Regulations No. 2-98, as amended by Revenue Regulations No. 6-2001 provides, viz : cCAIaD "(D) Income Derived by Alien Individuals Employed by Regional or Area Headquarters and Regional Operating Headquarters of Multinational Companies and Those Employed by Offshore Banking Units and Petroleum Service Contractors and Subcontractors. A final withholding tax equivalent to fifteen percent (15%) shall be withheld by the withholding agent from the gross income received by every alien individual occupying managerial and technical positions in regional or area headquarters and regional operating headquarters established in the Philippines by multinational companies as salaries, wages, annuities, compensation, remuneration, and other emoluments, such as honoraria and allowances, except income which is subject to the fringe benefits tax, from such regional or area headquarters and regional operating headquarters. The same tax treatment is applicable to Filipinos employed and occupying the same positions as those aliens employed by multinational companies, regardless of whether or not there is an alien executive occupying the same position, provided, that such Filipinos shall have the option to be taxed at either 15% of gross income or at the regular tax rate on their taxable income in accordance with the Tax Code of 1997. In case of the latter, the withholding tax rates under Sections 2.78 and 2.79 of Revenue Regulati ons N o. 2-98 shall apply. The term "multinational company means a foreign firm or entity engaged in international trade with affiliates or subsidiaries or branch offices in the Asia Pacific Region and other foreign markets." The expatriate employees of Regional Operating Headquarters in the Philippines are subject to tax at the rate of 15% on their gross compensation income. The term "expatriate employees" however, is classified to refer only to aliens employed in managerial, confidential or highly technical positions. Thus, under Philippine Labor Law, the employment of non-resident aliens is limited only to positions which are managerial or highly technical in nature or where there are no Filipinos who are competent, able and willing to perform the services for which the aliens are desired. However, if Filipinos are employed and occupying managerial or technical positions as those of aliens employed by the regional headquarters or representative office, they are likewise, subject to the preferential tax rate of 15% on their gross compensation income. Clearly, the rationale for this proviso is to equalize the enjoyment of the preferential tax rate accorded to an alien with a Filipino who is occupying a similar position in the regional headquarters. Based on the foregoing, the income payments to your alien employees occupying managerial, confidential or highly technical positions are subject to the preferential rate of 15% of their gross income, pursuant to Revenue Regulations No. 2-98, as amended by Rev. Regs. No. 6-2001. On the other hand, the Filipino counterparts have the option to be taxed at either 15% of their gross income or the graduated tax rates of 5%-32% in accordance with Section 24 of the Tax Code of 1997 as implemented by Revenue Regulations No. 2-98, as, amended by Revenue Regulations No. 6-2001 and 12-2001 (BIR Ruling No. 251-03 dated August 1, 2003 and BIR Ruling No. DA-081-05 dated March 11, 2005). 2. The billings to be made by SPIBV to its affiliates and subsidiaries are subject to income tax and VAT. In BIR Ruling No. 21-2004 dated September 24, 2004, this Office had occasion to rule ". . . Republic Act No. 8 7 56 (R.A. 8 7 56), amending certain portions of Executive Order No. 2 2 6 (E.O. 2 2 6) (otherwise known as the Omnibus Inv estments Co de of 1987) defines regional or area headquarters (RHQ) and regional operating headquarters (ROHQ) as follows: 'SEC. 2. Definition of Terms For purposes of this Act, the term: xxx xxx xxx 2) Regional or Area Headquarters (RHQ) shall mean an office whose purpose is to act as an administrative branch of a multinational company engaged in international trade which principally serves as a supervision, communications and coordination center for its subsidiaries, branches or affiliates in the Asia-Pacific Region and other foreign markets and which does not earn or derive income in the Philippines; and 3) Regional Operating Headquarters (ROHQ) shall mean a foreign business entity which is allowed to derive income in the Philippines by performing qualifying services to its affiliates, subsidiaries or branches in the Philippines, in the Asia Pacific Region and in other foreign markets.' cDSAEI Based on the foregoing, it is clear that as distinguished from an RHQ, which does not earn or derive income in the Philippines, an ROHQ is allowed to derive income in the Philippines by performing qualified services to its affiliates, subsidiaries or branches in the Philippines, in the Asia-Pacific Region and in other foreign markets, which income shall be taxed in accordance with Article 64 of E.O. 2 2 6, as amended by R.A. 8 7 56, as follows: 'Art. 64. Corporate Income Tax Incentive to Regional or Area Headquarters and Regional Operating Headquarters. . . . Regional operating headquarters shall be subject to a tax rate of ten percent (10%) of their taxable income as provided for under the National Internal Revenue Code, as amended by Republic Act No. 8424: Provided, That any income derived from Philippine sources by the ROHQ when remitted to the parent company shall be subject to the tax on branch profit remittances as provided for in Section 28(A)(5) of the National Internal Revenue Code.' xxx xxx xxx Likewise, pursuant to Article 65 E.O. 2 2 6, as amended by R.A. 8 7 56, 'Regional operating headquarters shall be subject to the ten percent (10%) value-added tax as provided for under the National Internal Revenue Code, as amended.' In sum, an ROHQ may be subject to the following taxes: 1. ten percent (10%) income tax based on taxable income; 2. fifteen percent (15%) BPRT under Section 28(a)(5) of the Tax Code of 1997 on income of the ROHQ derived from Philippine sources, when remitted to the parent company; and 3. ten percent (10%) value-added tax. The ten percent (10%) tax on ROHQ shall be based on taxable income from its qualifying services to its affiliates, subsidiaries or branches in the Philippines, in the Asia-Pacific Region and in other foreign markets, said taxable income shall consists in '. . . the pertinent items of gross income specified in this Code, less the deductions and/or personal and additional exemptions, if any authorized for such types of income by this Code or other special laws.' (Section 31, Tax Code of 1997) Further, a BPRT at the rate of fifteen percent (15%) may be imposed when the taxable income is remitted to the parent company. xxx xxx xxx" In view of the foregoing, SPIBV is subject to the ten percent (10%) tax on taxable income from its qualifying services to its affiliates and subsidiaries within the Asia Pacific region and other countries. On the other hand, Section 106(A)(2)(c) of the Tax Code of 1997 states that "SEC. 106. Value-added Tax on Sale a Goods or Properties. (A) . . . (1) . . . (2) . . . (a) . . . (b) . . . (c) Sales to persons or entities whose exemption under special laws or international agreements to which the Philippines is a signatory effectively subjects such sales to zero rate." DaHSIT Section 65 of E.O. 226, as amended by R.A. No. 8756 provides as follows, viz : "SEC. 6. . . . Articles 63, 64, 65, 66 and 67 are hereby amended to read as follows: CHAPTER IV 'INCENTIVES TO REGIONAL OR AREA HEADQUARTERS AND REGIONAL OPERATING HEADQUARTERS' xxx xxx xxx Art. 65. Value-Added Tax . . . . Regional operating headquarters shall be subject to the ten percent (10%) value-added tax as provided for under the National Internal Revenue Code, as amended. Article 65 of the Omnibus Investments Code, as amended by R.A. No. 8756 is implemented by Section 14 of its Implementing Rules and Regulations, as follows: "Section 14. Value-Added Tax . . . . In general, the regional operating headquarters shall be subject to the ten percent (10%) value-added tax unless otherwise provided under the National Internal Revenue Code, as amended or other existing laws." Based on the foregoing, services rendered by SPIBV remain subject to the ten percent (10%) VAT pursuant to Article 65 of E.O. 226, as amended by R.A. 8756 (VAT Ruling No. 035-2001 dated June 13, 2001). 3. SPIBV is not subject to EWT on services rendered exclusively to its affiliates and subsidiaries . Section 22(EE) of the Tax Code of 1997 qualifies regional operating headquarters " a branch established in the Philippines, by multinational companies which are engaged in any of the following services: general administration and planning; business planning and coordination; sourcing and procurement of raw materials and components; corporate finance advisory services; marketing control and sales promotion; training and personnel management: logistic services; research and development services and product development; technical support and maintenance; data processing and communication; and business development ." Article 58(b)(1) of E.O. No. 226, as amended by R.A. No. 8756, specifically identifies ROHQ as an entity which is permitted to perform only certain qualifying services as enumerated above. It is also prohibited from offering qualifying services to entities other than its affiliates, branches or subsidiaries, as specified in its registration with the SEC. Furthermore, ROHQs cannot participate in any manner in the management of any subsidiary or branch that they may have in the Philippines. In the light of your representation that SPIBV is merely a ROHQ as it is permitted by law to perform only certain qualifying services for the benefit of its affiliates, branches and subsidiaries such as those enumerated above, this Office is of the opinion that the imposition of the 10% or 15% creditable withholding tax, as the case may be, will not apply to them. Moreover, the 10% or 15% creditable withholding tax, as the case may be, for services rendered as "management and technical consultants" is deducted and withheld from gross fees or gross payments which in all probability, will exceed the income tax liability of the ROHQ. It is noted that ROHQs are entitled to a reduced tax rate of 10% based on their net income. On this basis, this Office further opines that the 10% or 15% creditable withholding tax, as the case may be, ordinarily imposed on management and technical consultants, if applied to ROHQs, such as SPIBV, will result in a situation where the preferential income tax rate granted to them is effectively negated or rendered meaningless. The imposition of the 10% or 15% creditable withholding tax, as the case may be, is patently and grossly disproportionate to the tax due from, or payable by, ROHQs on such income derived from their rendition of certain qualifying services to their affiliates, branches or subsidiaries. Considering the foregoing, SPIBV, as ROHQ rendering the above enumerated qualifying services exclusively to its affiliates and subsidiaries, is not subject to the 10% creditable withholding tax imposed under Section 2.57(B) of Rev. Regs. No. 2-98, as amended by Rev. Regs. No. 30-2003. Finally, the tax liability of SPIBV shall be computed in accordance with Section 28(A)(6)(b) of the Tax Code of 1997(BIR Ruling No. DA-265-04 dated May 17, 2004). DaAETS This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it will hey disclosed that the facts are different, then this ruling shall be considered as null and void. Very truly yours, Commissioner of Internal Revenue: By: (SGD.) PABLO M. BASTES, JR. OIC-Head Revenue Executive Assistant Legal Service