SGV & Co.

April 20, 2007 BIR RULING [DA-249-07] DA 037-04 SGV & Co. 6760 Ayala Avenue Makati City Attention: Atty. Emmanuel C. Alcantara Co-Head, Tax Services Gentlemen : This refers to your letter dated January 16, 2007 stating that your client, CONNELL BROS. COMPANY PILIPINAS, INCORPORATED (CBC), is a corporation duly incorporated and existing under the laws of the Philippines with principal place of business at the 5/F Guada Building, No. 31 EDSA, Mandaluyong City; that its primary business purpose is to carry on a general mercantile business and to purchase, sell at wholesale and deal with such goods, supplies and merchandise as are or may be sold in a general store and to act as distributors, manufacturers' representatives or agents, commission merchant, merchandising brokers, indentors, factors, consignment agent and in any other representative capacity for natural or juridical persons and other entities, either domestic or foreign; that on the other hand, WILBUR-ELLIS COMPANY (WECO) is a foreign non-resident corporation duly incorporated and existing under the laws of the State of California, United States of America, having its principal place of business at No. 345 California Street, 27th Floor, San Francisco, California, USA; that WECO has not secured a license to engage in trade or business in the Philippines as shown by Philippine Securities and Exchange Commission (SEC) Certification dated January 10, 2007 to show that it has no permanent establishment (PE) in the Philippines; that CBC, pursuant to its corporate purpose, entered into a Service Agreement (Agreement) with WECO; that CBC is a subsidiary of WECO, and WECO, in turn, performs a variety of functions in the course of its primary purpose and ownership of CBC and other related entities; that in the said Agreement, WECO will provide CBC with the management services such as negotiation and administration of Global Insurance Coverage, claims processing of any insurance or other type of claims, negotiation of any bank lines of credit and corporate guarantees, assistance in the evaluation and negotiation of acquisitions including legal-accounting tax due, diligence, management of the integration of the acquired assets/entity into corporate structure, legal consultation and advice, tax consultation, planning and assistance with local tax compliance and overall consolidated tax planning and compliance, management and oversight of corporate direction, negotiation of Global Freight rates, logistics assistance and support for transportation of goods worldwide, export documentation and invoicing, supplier relations and business development, financial consolidations, financial reporting and financial and tax audits, capitalization of all mergers and acquisitions, general management support, other Management and financial services as requested, and implementation of the JD Edwards worldwide accounting system and support including other Information Technology (IT) services; that the term of the Agreement commenced on January 1, 2006 and shall be effective for one (1) year, unless terminated earlier by the agreement of the parties, and may be renewed automatically for successive one (1) year period, unless, again, otherwise terminated; that in turn, CBC will pay service fees in the amount allocated by WECO for the said management services and other IT services; that the allocation for the management services are based on a matrix of budget sales, budgeted pretax net profits excluding any allocation, prior year's sales, and prior year's pretax net profit excluding any allocations; that as provided for in the Agreement, the matrix fairly allocates the management services expenses; that on the other hand, the other IT services are allocated based on a matrix which is comprised of the number of technology users, the number of employees, sales, number of invoices issued and the number of purchase receipts transactions; and that as expressly provided for in Section 2 of the Agreement, any and all management services and other IT services shall entirely be provided by WECO in the United States and other foreign countries except the Philippines. Based on the foregoing representations, you now request confirmation of your opinion that 1. The service fee payments to be made by CBC to WECO are not in the nature of royalty payments; 2. Such payment for services to be made by CBC to WECO is not subject to Philippine income tax, and consequently withholding tax, as well as to value-added tax (VAT) since the services are to be performed by WECO outside the Philippines. In reply thereto, please be informed that your opinion is hereby confirmed as follows: 1. Section 28 (B) (1) of the Tax Code of 1997 provides that non-resident foreign corporations are subject to income tax only on income derived from all sources within the Philippines. Conversely, non-resident foreign corporations are not subject to income tax on income derived from sources outside the Philippines. For purposes of determining which income is considered not of Philippine source, Section 42 (C), supra , enumerates the following items of gross income as income from sources without the Philippines: (1) Interest other than those derived from sources within the Philippines; (2) Dividends other than those derived from sources within the Philippines; (3) Compensation for labor or personal services performed without the Philippines; (4) Rentals or royalties from property located without the Philippines or from any interest in such property including rentals or royalties for the use of or for the privilege of using without the Philippines patents, copyrights, secret processes and formulas, goodwill, trademarks, trade brands, franchises and other like properties; and (5) Gain, profits and income from the sale of real property located without the Philippines. HCaDIS In order for the service fees to be considered as rentals or royalties, there must be a transfer of scientific, technical, industrial or commercial knowledge or information. Under the Agreement, there is no stipulation to the effect that would require the transfer into the Philippines of technology, equipment or other property where the CBC has proprietary interest or would otherwise sanction WECO to convey to CBC their special knowledge and experience which remain unrevealed to the public. What will be provided by WECO are supporting management services and other IT services, none of which are characterized as payment for "know-how". Inasmuch as WECO shall render these services using their customary skills in financial services and the like, then the compensation to be received from CBC shall not amount to as payment for the use of, or the right to use, any copyright, patent, trademark, design or model, plan, secret formula or process, or for the transfer of technology. SUCH BEING THE CASE, since WECO will have no interest or right to whatever in the result of the services, then payments to WECO constitute service fees. Accordingly, the payments made by CBC to WECO for the above-mentioned services are properly characterized as payment for services and not royalties. (BIR Ruling No. DA037-04 dated February 2, 2004) 2. Section 42 of the Tax Code of 1997 enumerates those which shall be considered as income from sources without the Philippines. "SEC. 42. Income From Sources Within the Philippines . xxx xxx xxx "(C) Gross Income from Sources Without the Philippines . The following items of gross income shall be treated as income from sources without the Philippines: (3) Compensation for labor or personal services performed without the Philippines; xxx xxx xxx" In stressing the rationale of the above-mentioned rule, this Office elucidated the matter in BIR Ruling No. DA037-04 dated February 2, 2004 as follows: ". . . since the services are to be performed abroad by VSLHK the service fees to be paid to VSLHK shall constitute compensation for labor or personal service performed outside the Philippines pursuant to Section 42(C)(3) of the Tax Code of 1997. Hence, the said service fees shall not be subject to Philippine income tax. Moreover, such payments are not subject to final withholding tax required to be withheld pursuant to Section 2.57(A) in relation to Section 2.57-1(I), both of Revenue Regulations No. 2-98, as amended. Section 2.57-1(I) provides that non-resident foreign corporations are subject to final withholding tax only on their income subject to final withholding tax only on their income derived from all sources within the Philippines. Section 2.57-1(I) does not provide non-resident foreign corporations are subject to final withholding tax on their income from sources outside the Philippines. Section 108(A) of the Tax Code of 1997 provides that VAT shall be imposed on gross receipts derived from the sale or exchange of services, and the use or lease of properties. The same provision of the Tax Code provides that the phrase 'sale or exchange of services' means the performance of all kinds of services in the Philippines for others for a fee, remuneration or consideration. Conversely, services performed outside the Philippines are not subject to VAT. In the case of VSLPH and VSLHK, the services to be rendered by the latter to the former will be done outside the Philippines. Consequently, VSLPH's payments of service fees to VSLHK, pursuant to the Service Agreement, shall not be subject to VAT. Thus, no VAT may be passed on by VSLHK to VSLPH. xxx xxx xxx Considering that the services to be rendered by WECO to CBC shall be rendered abroad, or beyond the taxing jurisdiction of the parties, the payment for the said services of WECO, a non-resident foreign corporation, shall not be subject to Philippine income tax. On the other hand, since the withholding tax regulations do not apply to payments made to nonresident foreign corporations for services rendered by them abroad, such payments made by CBC to WECO shall likewise not be subject to withholding tax. In the same manner, VAT should also not be applied to the said payments made by CBC to WECO for services rendered abroad under the aforesaid Agreement. WHEREFORE, in view of the foregoing , this Office hereby confirms your opinion that 1. The service fee payments to be made by CBC to WECO are properly characterized as payments for services and not in the nature of royalty payments. SCaDAE 2. The payment for services to be made by CBC to WECO is not subject to Philippine income tax and consequently to withholding tax, as well as to VAT since the services are to be performed outside the Philippines. 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