Follosco Morallos & Herce

April 25, 2008 BIR RULING [DA-272-08] Follosco Morallos & Herce Suite 2500, 25th Floor, 88 Corporate Center 141 Valero Street corner Sedeo Street Salcedo Village, Makati City Attention: Atty. Rachel P. Follosco and Atty. Froilyn D. Pagayatan Gentlemen : This refers to your letter dated February 15, 2008 stating that your client, Yukosha Co., Ltd. (Yukosha-Japan), is a corporation duly organized and existing under the laws of Japan with principal office in 6-16-4 Yahiro Sumida-ku, Tokyo and with no license to operate/do business in the Philippines; that on the other hand, Yukosha Philippines, Inc. (Yukosha Philippines) is a corporation duly organized and existing under the laws of the Philippines; that Yukosha Japan and Yukosha Philippines executed a Service Agreement (Agreement) pursuant to which Yukosha Japan undertook to perform the following services for Yukosha Philippines: 1. Material and Product Testing; 2. Procurement of Painting Equipment and Materials; 3. Manpower Training; 4. Marketing and Liaison; and 5. Trouble Shooting on Coating-Related Activities; that all the foregoing services will be performed by Yukosha Japan in Japan or else where outside the Philippines; and that under the Agreement, in consideration of the foregoing services, Yukosha Philippines shall pay Yukosha Japan a fixed monthly fee (Service Fee) as well as all out-of-pocket payments or advances (OPE) that may be made by Yukosha Japan on behalf of Yukosha Philippines. SAcCIH Based on the foregoing representations, you now request for confirmation of your opinion that 1. The Service Fees payable to Yukosha Japan are not in the nature of royalties as defined under the Tax Code; 2. The Service Fees payable to Yukosha Japan under the Agreement constitute income from sources outside the Philippines of a non-resident foreign corporation which is not subject to Philippine income tax; accordingly, Yukosha Philippines has no obligation to withhold any income tax upon remittance of such Service Fees; and 3. The Service Fees and OPE are not subject to value-added tax (VAT) since the services being remunerated are performed outside of the Philippines and the OPE pertain to such services so rendered. In reply thereto, please be informed that your opinion is hereby confirmed as follows: 1. For income payments to be considered as royalties, there must be a transfer into the Philippines of technology or know-how, where the payee has proprietary interest. Thus, in the case of Philippine Refining Company vs. Commissioner of Internal Revenue, CTA Case No. 2872 dated January 15, 1986, which involved an agreement between PRC and Unilever Limited of England (Limited) for the latter to provide training and research services, the Court of Tax Appeals ruled on the distinction of services from royalties, to wit: "To distinguish between compensation for service and royalty payments, one must inquire on whether the payee has proprietary interest in the property giving rise to the income. If the payee has none, then the payment is a compensation for personal services, if the payee has proprietary interest then the payment is royalty." From the foregoing, it is undisputed that the Service Fees payable to Yukosha Japan under the Agreement are not within the definition of royalties under Section 42 (A) (4) of the Tax Code of 1997. Considering that nothing in the said Agreement would require transfer to Yukosha Philippines of "know-how" or any property of which Yukosha Japan has proprietary interest. Consequently, the Service Fees are not royalties but compensation for services. 2. Since the above-mentioned services of Yukosha Japan pursuant to the Agreement would be performed outside of the Philippines, the Service Fees payable to Yukosha Japan would be considered as income from sources outside of the Philippines of a non-resident foreign corporation and therefore, not subject to Philippine income tax. Accordingly, the Service Fees payable to Yukosha Philippines pursuant to the Agreement are not subject to income tax and therefore Yukosha Philippines is not obliged to withhold any tax on the said Service Fees payable to Yukosha Japan. 3. Finally, Section 108 (A) of the Tax Code of 1997, as amended by Republic Act No. 9337, 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 . . . ." Prescinding from the above-cited provisions, it is undisputed that the value-added tax (VAT) applies only to services performed in the Philippines and not to services rendered outside the Philippines. Thus, since Yukosha Japan will be performing all the contracted services under the Agreement outside the Philippines, the Service Fees payable by Yukosha Philippines to Yukosha Japan are not subject to VAT. 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