BIR Ruling [DA-438-03]

December 4, 2003 BIR RULING [DA-438-03] Rev. Reg. 6-2001 DA 158-97 Punongbayan & Araullo 20th Floor, Tower I The Enterprise Center 6766 Ayala Avenue Makati City Attention: Maria Victoria C . Espao Tax Partner Gentlemen : This refers to your letter dated May 9, 2003 stating that your client Power Sector Assets and Liabilities Management Corporation (PSALM) is a government-owned and controlled corporation (GOCC) created under Republic Act No. 9136; that it mandates to take ownership of and manage the orderly sale, disposition and privatization of all existing National Power Corporation (NPC) generation assets, liabilities, Independent Power Producer (IPP) contracts, real estate and all other disposable assets; that on the other hand, Credit Suisse First Boston (CSFB) is an entity organized and existing under the laws of the United States and with offices located at Eleven Madison Avenue, New York City, USA; that CSFB is a full service securities firm engaged in securities trading and brokerage activities as well as investment banking and financial advisory services; that CSFB has a registered representative office in the Philippines, Credit Suisse First Boston (Hong Kong), Limited located at 18th Floor, Tower 2, The Enterprise Center, Ayala Avenue corner Paseo de Roxas, Makati City; that the said representative office is not involved in this particular transaction; that the Republic of the Philippines, through the Department of Finance (DOF)/Department of Energy (DOE) entered into an agreement (Agreement) with CSFB and its affiliates, successors and assigns, as appropriate, to act as its lead privatization advisor (the Lead Advisor) in connection with the design and implementation of a privatization plan for the sale of the transmission assets, generation assets, real estate and other assets and existing IPP contracts (Assets) of NPC through the PSALM; that pursuant to the said Agreement, the DOF and DOE entered into the agreement with CSFB since, at that time, PSALM was still in the process of formally organizing itself; that today, PSALM is already organized and functioning as a GOCC, and thus, has assumed the obligations of the DOF and DOE under the Agreement. Services Provided by CSFB Under the Agreement, CSFB is tasked and/or authorized to engage the services of other advisors, both foreign and local (CSFB Third-Party Advisors), to render international and local legal services, tax and accounting services, market modeling services and special IPP services; that it coordinates with PSALM and its other advisors for all activities required for a successful sale of the assets along with the transfer of management control to various strategic investors; and that together with CSFB Third-Party Advisors, CSFB will: 1. Provide advice on asset sale, guiding principles, pre-qualification requirement, asset sequencing and timing of sale process, optional privatization modalities and structures or grouping of the Assets into the Business for privatization including preliminary valuation consequences, as well as advising on financial implications of the transitional rules and regulations leading up to the final implementing rules and regulations; 2. Gather data, conduct a detailed review of NPC's core assets for privatization and IPP contracts, formulate financial models and prepare data room for potential bidders; 3. Review NPC's most recent evaluation for its core generation and transmission assets and associated liabilities; 4. Conduct pre-marketing activities, prepare marketing materials for distribution to potential bidders, prepare an efficient marketing strategy, formulate terms of reference for the tender auctions, provide optional methods of sale and advise the Republic on their advantages and disadvantages, taking account of expected market conditions and other relevant factors including the objective of minimizing NPC's net liabilities; 5. Conceptualize and implement a marketing process to the relevant investor community through local, regional and international road shows; 6. Formulate and implement a pre-qualification process as well as a bidding process with emphasis on transparency and fairness for all bidders; 7. Evaluate bids in terms of price structure, financial strength and likelihood to close in a timely manner; 8. Provide preliminary recommendations on specific aspects of the Privatization Plan; caEIDA 9. Engage CSFB Third-Party Advisors; and 10. Otherwise formulate and implement a Privatization Plan of the Assets as well as conceptualize a valuation approach of the Assets. Remuneration In the event that a sale is consummated in whole or in part, as compensation for the services rendered by CSFB, PSALM will pay CSFB a fee (Transaction Fee) equal to a determined percentage of the aggregate consideration of each and any sale; that the Transaction Fee shall be due and payable upon the closing of a sale, which shall be the date upon which at least a portion of the purchase consideration is paid an amount that exceeds the Transaction Fee. Expenses In addition, PSALM agrees to reimburse CSFB the following expenses: (a) CSFB's own expenses; and (b) Fees and expenses to be paid by CSFB in connection with the engagement of each of the CSFB Third-Party Advisors for work performed resulting from or arising out of the engagement. that the Agreement sets forth an estimate of CSFB's expenses that directly relate to its own personnel who will be involved in the project and an estimate of the fees and expenses of each of the CSFB Third-Party Advisors; that it also provides that if CSFB expects the actual expenses to be incurred by it for the engagement either for itself or for any CSFB Third-Party Advisor to exceed such estimates, CSFB will consult with PSALM and obtain the approval of PSALM before incurring any additional out-of-pocket expenses exceeding each of the CSFB Third-Party Advisors; that it also provides that if CSFB expects the actual expenses to be incurred by it for the engagement either for itself or for any CSFB Third-Party Advisor to exceed such estimates, CSFB will consult with PSALM and obtain the approval of PSALM before incurring any additional out-of-pocket expenses exceeding such estimate; that the Agreement states that all fees and expenses payable under it are payable in US dollars and are net of all applicable withholding and other taxes; and that PSALM will pay any VAT properly chargeable on CSFB's fees and expenses together with any taxes to which it becomes liable as a result of this engagement. Based on the foregoing representations, you now request confirmation of your opinion that "1. Payments to be received by CSFB for services rendered in the Philippines would only be subject to Philippine income tax if CSFB has created a permanent establishment in the Philippines, as provided under the tax treaty between the Philippines and the United States; and that in the event that CSFB has created a permanent establishment, CSFB shall be subject to income tax at the rate of thirty two percent (32%) on its taxable income derived from sources within the Philippines pursuant to Section 28 of the Tax Code of 1997; "2. The Transaction Fees to be received by CSFB are in the nature of payments for technical and management services. Hence, as provided under Revenue Regulations No. 2-98, as amended, PSALM shall be required to subject such payments to 10% creditable withholding tax. For this purpose, only the portion of the Transaction Fees attributable to services performed in the Philippines shall be subject to withholding tax. Moreover, since the Agreement provides that payment for the Transaction Fees shall be net of all applicable withholding and other taxes, PSALM shall bear the burden of paying for the 10% withholding tax. Accordingly, the withholding tax shall be computed based on the grossed-up amount of the taxable portion of the Transaction Fees; "3. Payments covering CSFB's own expenses and the fees and expenses of the CSFB Advisors, being merely reimbursements of costs, are not subject to the 10% withholding tax; "4. Payments to CSFB for services performed by it in the Philippines shall be subject to 10% VAT. Pursuant to Revenue Regulations No. 8-2002, PSALM shall withhold a final ten percent (10%) VAT; "5. The final withholding VAT shall be applied by PSALM on payments for the Transaction Fees of CSFB and its own expenses, to the extent attributable to services performed within the Philippines; and "6. Payments for CSFB for the fees and expenses of its Third-Party Advisors do not constitute gross receipts of CSFB, and thus, shall not be subjected by PSALM to the 10% final withholding VAT." In reply thereto, please be informed that your opinion is hereby confirmed as follows: 1. Article 8(1) of the Philippines-United States Tax Treaty provides that business profits derived by a US resident from sources within the Philippines will be taxable in the Philippines only if it has a permanent establishment herein and only so much that are attributable to the said permanent establishment: The term "Business Profits" means income derived from any trade or business whether carried on by an individual, corporation or any other person, or group of persons, including the rental of tangible personal (movable) property. ( Article 8(6), Philippines-United States Tax Treaty ) In relation thereto, Article 5 of the said treaty states that the term "Permanent Establishment" is defined as a fixed place of business through which the business of an enterprise is wholly or partly carried on. The term "fixed place of business" includes but is not limited to: EDACSa a) A seat of management; b) A branch; c) An office; d) A store or other sales outlet; e) A factory; f) A workshop; g) A warehouse; h) A mine, quarry, or other place of extraction of natural resource; i) A building site or construction or assembly project or supervisory activities in connection therewith, provided such site, project or activity continues for a period of more than 183 days; and j) The furnishing of services, including consultancy services, by a resident of one of the Contracting States through employees or other personnel, provided activities of that nature continue (for the same or a connected project) within the other Contracting State for a period or periods aggregating more than 183 days. Applying the foregoing provisions to the instant case, if CSFB sent employees to the Philippines to work under the engagement with PSALM and such employees will stay in the Philippines for an aggregate period exceeding 183 days, CSFB will be deemed to have created a permanent establishment in the Philippines and shall be considered as a resident foreign corporation doing business in the Philippines. Accordingly, it shall be taxed at the rate of 32% on taxable income derived from sources within the Philippines under Section 28 of the Tax Code of 1997. On the other hand, if the same employees will not stay in the Philippines for a period exceeding 183 days, CSFB is deemed not to have a permanent establishment in the country and therefore its income arising from the engagement will be exempt from income tax pursuant to the Philippines-United States Tax Treaty. 2. Section 2.57.2(A)(6) of Revenue Regulations No. 2-98, as amended by Revenue Regulations No. 6-2001, provides that a creditable withholding tax at the rate of 10% shall be imposed for services rendered by management and technical consultants. Accordingly, if CSFB creates a permanent establishment in the Philippines, the services rendered by its employees which are in the nature of technical and management services, shall be subject to the 10% creditable withholding tax. However, having been deemed as a resident foreign corporation doing business in the Philippines, by reason of having created a permanent establishment therein, CSFB is liable to pay income tax only on its income derived from sources within the Philippines. It is a cardinal rule in taxation that with respect to services, the situs of income is the place where the services are performed. Accordingly, only the portion of the Transaction Fees attributable to services performed by CSFB in the Philippines shall be taxable and therefore subject to the 10% creditable withholding tax. Moreover, since the Agreement between CSFB and PSALM provides that the fees stated in the Agreement shall be net of all applicable withholding and other taxes, PSALM shall bear the burden of paying the 10% creditable withholding tax. Thus, the taxes paid by PSALM on behalf of CSFB are considered part of its compensation. Accordingly, the 10% creditable withholding tax shall be computed based on the grossed-up amount of the taxable portion of the Transaction Fees. 3. Payments to be made by PSALM for CSFB's own expenses and the fees and expenses of the CSFB Third Party Advisors are not in the nature of income but are mere reimbursements of its own actual expenses. The BIR, in numerous rulings has consistently ruled that reimbursement of actual expenses are mere return of capital and hence, does not constitute income and as such should not be considered as part of the gross receipts for purposes of creditable withholding tax. ( BIR Ruling No. DA158-97 dated April 14, 1997 ) Such being the case, payments to be made by PSALM to CSFB for its own expenses and the fees and expenses of CSFB Third-Party Advisors are not subject to the creditable withholding tax. 4. Section 4.110-3(b) of Revenue Regulations No. 8-2002 provides "(b) Withholding of Final VAT . The government or any of its political subdivisions, instrumentalities or agencies, including government-owned or controlled corporations (GOCCs), as well as private corporations, individuals, estates and trusts, whether large or non-large taxpayers, shall withhold ten percent (10%) VAT with respect to the following payments: (1) Lease or use of properties or property rights owned by non-residents; (2) Services rendered to local insurance companies, with respect to reinsurance premiums payable to non-residents; and (3) Other services rendered in the Philippines by non-residents. "In remitting the VAT withheld, whether creditable or final, the withholding agent shall use BIR Form No. 1600 Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld. "The VAT withheld and paid for by the non-resident recipient (remitted using BIR Form No. 1600), which VAT is passed on to the resident withholding agent by the non-resident recipient of the income, may be claimed as input tax by said VAT-registered withholding agent upon filing his own VAT Return, subject to the rule on allocation of input tax among taxable sales, zero-rated sales and exempt sales. The duly filed BIR Form No. 1600 is the proof or documentary substantiation for the claimed input tax or input VAT. HDAECI xxx xxx xxx" It is likewise significant to note that Section 105 of the Tax Code of 1997 provides that services rendered in the Philippines by non-resident foreign persons shall be considered as being rendered in the course of trade or business. Thus, in applying the foregoing to the instant case, the services rendered in the Philippines by CSFB to PSALM are subject to the final withholding VAT of 10%. VAT being an indirect tax may be shifted or passed on to the buyer of the service, which in this case is PSALM. Being the payor in control of the payment, PSALM shall be responsible for withholding the VAT and remitting the same to the BIR. Since the Agreement provides that the payments to CSFB shall be net of all applicable withholding and other taxes, the VAT due on the payments to CSFB shall be passed on to PSALM in accordance with the terms and conditions of the Agreement. Consequently, PSALM shall remit the final withholding VAT to the BIR equal to 10% of the service fees paid to CSFB for services rendered in the Philippines. 5. Section 108(A) of the Tax Code of 1997 provides that value-added tax shall be imposed on gross receipts derived from the sale or exchange of services, and use or lease of properties. 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 . . .." In relation thereto, the term "gross receipts" means the total amount of money or its equivalent representing the contract price, compensation, service fee, rental or royalty, including the amount charged for materials supplied with the services and deposits and advance payments actually or constructively received during the taxable quarter for the services performed or to be performed for another person, excluding VAT. ( Revenue Regulations No. 7-95 ) Accordingly, payments by PSALM of the Transaction Fees of CSFB and CSFB's own expenses shall be subject to 10% final withholding VAT but only to the extent attributable to the services rendered in the Philippines. 6. The payments received by CSFB from PSALM covering the fees and expenses of its CSFB Third-Party Advisors are not compensation for services rendered by CSFB in the Philippines but for the work rendered within and without the Philippines by its CSFB Third-Party Advisors. This can be gleaned from the fact that CSFB does not impose any margin or profit on the fees and expenses of the CSFB Advisors and the manner the invoices are billed and the corresponding payments are made by and between the CSFB Third-Party Advisors, CSFB and PSALM. Such being the case, payments to CSFB for the fees and expenses of its Third-Party Advisors do not constitute gross receipts of CSFB and consequently such payments to be made by PSALM shall not be subject to the 10% final withholding 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.) JOSE MARIO C. BUAG Deputy Commissioner Legal & Inspection Group