BDO Alba Romeo & Co.

April 4, 2007 BIR RULING [DA-211-07] Secs. 22 (B) & 27 (A); DA-058-2007 dtd. 02/05/07 BDO Alba Romeo & Co. Certified Public Accountants 7/F Multinational Bancorporation Centre 6805 Ayala Ave., Makati City Attention: Mr. Romeo Alba Tax and Legal Counsel Gentlemen : This refers to your letter dated March 23, 2007 in behalf of your client, CHINA OILFIELD SERVICES LIMITED ("COSL" for brevity), requesting a ruling regarding the tax implications of its transaction in the Philippines. It is represented that COSL is a corporation duly organized and existing under the laws of China with principal office address at P.O. Box 232, Beijing, P.R. China; that on October 17, 2005, COSL entered into a Consortium Agreement with Euro Products, Inc. ("EPI" for brevity) for the Cementing Services Contract for PNOC-Energy Development Corporation; that subsequently, a contract was entered specifying the terms, rights and obligations of the parties with COSL and EPI on one hand and PNOC-EDC on the other hand for the carrying out of a geothermal well drilling program; that the initial term of the contract is 24 months commencing from January 21, 2006; that COSL and EPI started the work specified in the contract in early 2006; that on March 29, 2006, this Bureau through Revenue District Office No. 056 issued a Certificate Authorizing Registration (CAR) in the name of "CONSORTIUM EPI-COSL (JOINT VENTURE)"; that the value added tax on the services rendered by the Joint Venture Partners (COSL and EPI) as well as the input tax on the purchase of goods and services have been reported under the Joint Venture account while the income and expenses have been reported separately by both COSL and EPI; that COSL has imported most of its raw materials and equipments from China, which are being shipped directly to PNOC-FDC. Hence, you request for a ruling confirming your opinion that: 1. The joint venture between COSL and EPI will not create a taxable joint venture within the meaning of Section 22 (B), in relation to Section 27 (A) of the Tax Code of 1997. Consequently, income payment to the joint venture is not subject to withholding tax; 2. COSL and EPI are separately subject to the corporate income tax on their respective taxable income during each taxable year derived by them from the aforesaid geothermal drilling project; 3. The joint venture shall be the one responsible as to the reporting of the value-added tax on the joint venture transaction; 4. COSL is considered to have a permanent establishment in the Philippines by virtue of Article 7 in relation to Article 5 of the RP-China Tax Treaty; 5. The payments made to the joint venture by PNOC-EDC shall subject to the 5% final VAT in accordance with Sec. 4.114-2 of Revenue Regulations No. 16-2005; 6. COSL can claim as deductible expense the raw material and depreciation of the equipment. In reply, please be informed as follows: 1. Pursuant to Section 22 (B) of the Tax Code of 1997, the term "corporation" shall include partnerships, no matter how created or organized, joint stock companies, joint accounts ( cuentas en participacion ), associations or insurance companies, but does not include general professional partnerships and a joint venture or consortium formed for the purpose of undertaking construction project or engaging in petroleum, coal, geothermal and other energy operations pursuant to an operating or consortium agreement under a service contract with the Government. Such being the case, the joint venture formed as a result of the JVA between COSL and FPI for the carrying out of a geothermal well drilling program is not subject to the corporate income tax under Section 27 (A) of the Tax Code of 1997. In view thereof, it is our opinion that the joint venture is exempt from income tax pursuant to Sections 22(B) and 27(A), both of the Tax Code of 1997. Likewise, gross payments to the joint venture are not likewise subject to the 2% withholding tax prescribed under Section 57 (B) of the same Code, as implemented by Revenue Regulations No. 2-98, as amended by Revenue Regulations Nos. 6-2000 and 12-2000. DSIaAE 2. However, the co-ventures are separately subject to the regular corporate income tax imposed under Section 27 (A) of the Tax Code of 1997, on their taxable income during each taxable year respectively derived by them from the aforesaid construction project. 3. The joint venture shall be the one responsible as to the reporting of the VAT in the joint venture transaction. 4. COSL is considered to have a permanent establishment in the Philippines by virtue of Article 7 in relation to Article 5 of the RP-China Tax Treaty, which provide as follows: "ARTICLE 7 Business Profits I. 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 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." "ARTICLE 5 Permanent Establishment 1. For the purposes of this Agreement, the term 'permanent establishment' means a fixed place of business through which the business of an enterprise is wholly or partly carried on. 2. . . . 3. The term 'permanent establishment' likewise encompasses: a) a building site, construction, assembly or installation project or supervisory activities in connection therewith, but only where such site, project or activities continue for a period of more than 6 months." Thus, being an entity with a permanent establishment in the Philippines, COSL shall be taxed in the same manner as that of a domestic corporation under Section 27 of the Tax Code. 5. The payments made to the joint venture, by PNOC-EDC shall be subject to the 5% final VAT in accordance with Sec. 4.114-2 of Revenue Regulations No. 16-2005, which provides as follows: "SEC. 4.114-2. Withholding of VAT on Government Money Payments and Payments to Non-Resident s. (a) The government of any of its political subdivisions, instrumentalities or agencies, including government-owned or controlled corporations (GOCCs) shall, before making payment on account of each purchase of goods and/or services taxed at 10% VAT pursuant to Secs. 106 and 108 of the Tax Code, deduct and withhold a final VAT due at the rate of five percent (5%) of the gross payment thereof The five percent (5%) final VAT withholding rate shall represent the net VAT payable of the seller. The remaining five percent (5%) effectively accounts for the standard input VAT for sales of goods or services to government or any of its political subdivision, instrumentalities or agencies including GOCCs, in lieu of the actual input VAT directly attributable or ratably apportioned to such sales. Should actual input VAT exceed five percent (5%) of gross payments, the excess may form part of the sellers' expense or cost. On the other hand, if actual input VAT is less than 5% of gross payment, the difference must be closed to expense or cost." prcd 6. COSL can claim as deductible expense the raw materials and depreciation of the equipments that were imported from China considering that these expenses are ordinary and necessary expenses which are paid or incurred during the taxable year in carrying on, or which are directly attributable to the operation and/or conduct of, trade or business. 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