BIR Ruling [DA-345-06]

June 2, 2006 BIR RULING [DA-345-06] 23 (F); DA-076-99; DA 037-04 SGV & Co . 6760 Ayala Avenue Makati City Attention: Atty. M.F.A. Balili Tax Division Gentlemen : This refers to your letter dated August 18, 2005 requesting for a confirmation that service fees to be paid by Doughnut People, Inc. (DPI) to Ripley Capital Corporation (RCC) for services to be rendered outside of the Philippines are not subject to Philippine income tax pursuant to Section 28(B)(1) in relation to Section 42(A)(3) of the 1997 Tax Code, as amended. It is represented that DPI is a corporation duly organized and existing under the laws of the Philippines; that it has an office address at Filia Corporate Center, 4347 Valdez Street, Makati City; that on October 28, 2004, DPI entered into a Consultancy and Support Services Agreement (Service Agreement) with RCC, a corporation duly organized and existing under the laws of the British Virgin Islands with office address at Wickhams Cay, Road Town, Tortola, British Virgin Islands; and that under the Service Agreement, RCC shall perform the following services to DPI exclusively in the British Virgin Islands: 1. Consultancy and Advisory Services : a) Provide advice and support services in the construction of new retail stores; b) Provide advice on DPI's advertising, marketing and promotional activities; c) Provide advice on general economic trends and competition from substitute products; d) Provide advice on the improvement of management systems and organizational structures; e) Provide advice on the structures, plan and layout of retail stores; f) Provide advice on the preparation of the quality control system for the materials and equipment used in the operation of the business to ensure the maintenance within international standards; g) Provide advice and assistance in the preparation and/or conduct of market research and surveys; h) Provide updates on market trends, conditions and latest retail food requirements in the industry. i) Provide advice on financial matters of DPI including budgeting and financial planning; and j) Such other activities and services, as may be agreed from time to time, that would redound to the benefit of the DPI. 2. Procurement Support Services : a) Identify prospective suppliers that will help maintain the quality of DPI's products; b) Organize trade visits to enable suppliers tend DPI to meet and negotiate their deals effectively; c) Obtain samples and/or description from possible suppliers of capital equipment and raw materials; AIDSTE d) Provide assistance in negotiating with suppliers; e) Arrange for and monitor the purchase, handling, shipment and importation of capital equipment and raw materials of DPI; and f) Assist in the sourcing and procurement of capital equipment and raw material requirements for use in the retail food business of DPI. that for the above-mentioned services, DPI shall compensate RCC with the following service fees, as follows: 1. For General Consultancy and Advisory Services a fee equivalent to 15% of DPI's annual net income, before tax and before service fees plus 15% of improvements in the retail stores, payable within ninety (90) days from the close of DPI'S taxable year. 2. For Procurement Support Services a fee in the amount equal to 12% of the total value of raw materials and capital equipment used in the retail food business of DPI. For 2004, the applicable procurement fee due for the entire year shall be payable within ninety (90) days from the close of DPI's fiscal year. For 2005 and beyond, the procurement fee on raw material and capital equipment shall be payable thirty (30) days from the end of each taxable quarter. 3. Bonus Fee DPI agrees to pay a bonus fee equivalent to 3% of the gross margin of DPI for the initial year payable within ninety (90) days from the close of DPI's taxable year. In reply, please be informed that Section 23(F) of the Tax Code of 1997, as amended provides: "Sec. 23. General Principles of Income Taxation in the Philippines . Except when otherwise provided in this Code: xxx xxx xxx (F) A foreign corporation, whether engaged or not in trade or business in the Philippines, is taxable only on income derived from sources within the Philippines." According to Section 23(F), a foreign corporation like RCC is taxable only on income derived from sources within the Philippines. In the case of income from the provision of services, such income is considered derived from sources within the Philippines if the services are performed in the Philippines, as stated in Section 42(A)(3) of the 1997 Tax Code below: "Sec. 42. Income from Sources Within the Philippines . (A) Gross Income From Sources Within the Philippines . The following items of gross income shall be treated as gross income from sources within the Philippines: xxx xxx xxx (3) Services . Compensation for labor or personal services performed in the Philippines;" Such being the case and since the services rendered by RCC consisting of consultancy, advisory and procurement support are exclusively carried out beyond the territorial jurisdiction of the Philippines, the fees for general consultancy and advisory and procurement support services, as well as the bonus fee to be paid to RCC, being income not derived from sources within the Philippines by a foreign corporation, are exempt from Philippine income tax and consequently from withholding tax. (BIR Ruling No. ITAD No. 079-05 dated August 5, 2005) With respect to the nature of the services to be rendered, this Office confirms your opinion that the service fees under the aforestated Service Agreement are payments for personal services, and not in the nature of royalties. 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. (BIR Ruling No. DA-037-04 dated February 2, 2004). The Court of Tax Appeals had an occasion to rule on the distinction of services fees from royalties in Philippine Refining Company (PRC) vs. Commissioner of Internal Revenue (CIR) , CTA Case No. 2872 dated January 15, 1986. In said case, PRC entered into an agreement with Unilever Limited of England (Limited) whereby the latter will provide the following services: a) Training; b) Research; c) Availability of Services and Advisory Departments Buying of Raw Materials; TSIEAD d) Trademarks; and e) Communication of Patents, Secret Patents, Secret Processes, etc. The CTA ruled as follows with respect to legal and advisory fees (a, b and c) which are considered services fees: " 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. An examination of the records satisfies us that far be it from a comedy of errors, "In all these undertakings, Unilever Ltd., does not have any interest or right to whatever is the result of services performed." The results of all these services, and the products manufactured by PRC to which these are integrated are owned by PRC. Unilever has no interest or right to them." (Emphasis ours) In the instant case, since the Service Agreement does not involve the transfer of technology but the rendition of consultancy, advisory and procurement support services where RCC will have no interest or right to whatever in the result of the services, then income payments to RCC constitute service fees. (BIR Ruling No. DA 076-99 dated February 8, 1999) Since the services are to be performed abroad by RCC, the service fees to be paid to RCC shall constitute compensation for labor or personal services performed outside the Philippines pursuant to Section 42(C)(3) of the Tax Code of 1997, as amended. Hence, the said service fees shall not be subject to Philippine income tax. (BIR Ruling No. DA 037-04 dated February 2, 2004) This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it will be ascertained that the facts are different, then this ruling shall be considered as null and void. Very truly yours, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service