BIR Ruling [DA-484-04]

September 10, 2004 BIR RULING [DA-484-04] 108; 181-92; DA-353-97; 153-99; DA-113-03 Cadiz Carag & De Mesa Law Offices Suite 2602, 26th Floor, The Atlanta Centre No. 31 Annapolis Street, Greenhills 1500 San Juan, Metro Manila Attention: Attys. Othelo C. Carag Maria Theresa C. San Pablo and Liza H. Abiera Gentlemen : This refers to your letter dated August 24, 2004 requesting for a confirmation of your opinion on the tax consequences of the transactions entered into between Telecoms Infrastructure Corporation of the Philippines ("Telicphil") and the co-owners of the National Digital Transmission Network ("NDTN"), the particulars of which is represented to be as follows: Telicphil is a corporation duly organized and existing under the laws of the Philippines. Under its Articles of Incorporation, as amended, Telicphil's primary purpose is to perform design, planning, technical administration, maintenance and other similar or related services for and in behalf of the stockholders of the corporation, geared toward the establishment of a telecommunications backbone facility or network for the mutual use and benefit of the stockholders of the corporation, including but not limited to the preparation or conduct of feasibility studies, market research, marine and terrestrial surveys, construction and maintenance activities for such backbone facility or network, under and only on a reimbursement-of-cost basis, without any mark-up or profit. On November 28, 1996, some of the stockholders of Telicphil consisting of Eastern Telecommunications Philippines, Inc., Express Telecommunications Co., Inc., Digital Telecommunications Philippines, Inc. GMCR, Inc., International Communications Corporation, Isla Communications Co., Inc., Philippine Telephone & Telegraph Corporation and Smart Communications, Inc. (hereinafter referred to as the "Parties"), in their individual capacity, agreed to establish the NDTN, an integrated telecommunications network which would serve as a "backbone" to link the islands, and regions of the country and in the process, interconnect inland carriers operating in various provinces, cities and municipalities and, in turn, address the needs of their respective clients and subscribers, and the general public at large (hereinafter referred to as the "Agreement"). It was agreed that the NDTN shall be owned by the Parties in common and undivided share in the proportions set forth in the Agreement. Capital costs to construct and install the NDTN and maintenance costs therefor, are to be shared based on the Parties' respective ownership interest. It is represented that paragraph 21 of the Agreement provides that the relationship between or among the Parties shall not be that of partners and nothing therein shall be deemed to constitute a partnership or joint venture between or among them, and the common enterprises among the Parties shall be limited to the express provisions of the Agreement. Pursuant to paragraph 3(a) of the Agreement, the Parties constituted a Management Committee consisting of one (1) representative from each of the Parties for the purpose of directing the progress of the engineering, provision, construction, installation, and bringing into continued service and maintenance of the NDTN. As represented, paragraph 3(d) of the Agreement provides that the Management Committee may designate or appoint an agent, or create sub- or ad-hoc committees such as: (i) procurement sub-committee; (ii) operational assignments, routing, and restoration sub-committee; (iii) operations and maintenance sub-committee; (iv) financial and contractual sub-committee; and/or (v) network administration sub-committee, as it may deem necessary, to assist it in carrying out any of its responsibilities, duties or powers, or to exercise any and all such responsibilities, duties and powers under the Agreement, for and in its behalf and stead. In this connection, through a Special Power of Attorney executed by the Management Committee on January 2, 1997, Telicphil was appointed as the duly constituted attorney-in-fact of the Management Committee, with full power and authority for themselves, in their names and on their behalf, to exercise the responsibilities, duties and powers specified therein in connection with the construction and continued service and maintenance of the NDTN. It is represented that in the performance of its above obligations as agent of the Management Committee, Telicphil incurs two types of costs, which it previously classified into Telicphil costs and NDTN costs. Telicphil costs refer to costs incurred by Telicphil which are not directly related to the maintenance of the NDTN. These are costs incurred by Telicphil within its organization to enable it to deliver the required services under the Special Power of Attorney, such as staff salaries, transportation expenses and other benefits, office rental, water, electric and telephone bills, stationeries and office supplies, vehicle maintenance and fuel. Telicphil costs are recognized and recorded by Telicphil in its books subject to reimbursement at cost by the NDTN Co-owners. For tax purposes, the reimbursements received by Telicphil from the NDTN Co-owners are reported as its Sales. On the other hand, Telicphil costs form part of the Purchases of Telicphil. Telicphil pays value-added tax ("VAT") on reimbursements it receives from the NDTN Co-owners for Telicphil costs. NDTN costs, on the other hand, are those which could be directly identified as maintenance costs, including the following: a. Various NDTN stations' security service; b. All stations' rental costs; c. Construction, repair and replacements of the various stations, cables poles and equipment of the NDTN; d. Pole rentals; and e. Electricity and telephone services at the various stations. It is represented that with regard to the NDTN costs, Telicphil merely serves as the agent of the NDTN Co-owners in negotiating contracts with suppliers or contractors and as a flow-through entity in the payment of the obligations by the NDTN Co-owners to the said suppliers or contractors. Hence, the NDTN Co-owners, as principals of Telicphil, are deemed the real parties who entered into the contracts with the suppliers or contractors. In this regard, NDTN costs are recognized only in the books of the NDTN Co-owners as their costs but not in the books of Telicphil. Thus, unlike in the case of Telicphil costs in which it is Telicphil which claims the input. VAT corresponding thereto, it is the NDTN Co-owners which claim the input VAT in relation to the NDTN costs. However, considering that the NDTN Co-owners are entities distinct and separate from each other, the documentation and recording of the transactions entered into by the NDTN Co-owners with the suppliers or contractors, as well as the allocation and invoicing of the costs borne by each NDTN Co-owner reportedly proved to be complex and particularly confusing on the part of the suppliers or contractors. In the same manner, the classification of costs into Telicphil and NDTN costs allegedly proved to be administratively difficult to implement and monitor on the part of Telicphil and the Co-owners. For this reason, it is represented that, for expediency, considering that it is Telicphil which disburses the funds to the suppliers or contractors, it is Telicphil which withholds the tax on payments made to suppliers or contractors both for Telicphil and NDTN costs, remits the same to the BIR using its own tax identification number and issues the corresponding withholding tax certificates to the suppliers or contractors. Because of the above difficulties encountered, on April 1, 2004, it is represented that the Management Committee, represented by its Chairman, and Telicphil entered into a Maintenance Contract expanding the obligations of Telicphil to include procurement on its own account of the equipment, systems, spare parts, materials, labor, services utilities, co-location or leasehold rights and software licenses required to bring into continued service and maintenance the NDTN (previously referred to as the "NDTN costs"), except in specific instances as directed by the Management Committee, for purposes of simplifying the documentation, invoicing and recording of contracts entered into with suppliers or contractors. Telicphil is reimbursed by the NDTN Co-owners for the said costs plus a contractor's fee at the rate agreed upon between Telicphil and the NDTN Co-owners. Such rate approximates the cost of additional services rendered by Telicphil under the Maintenance Contract. Thus, under the present set-up of recording transactions, Telicphil no longer makes a distinction between Telicphil costs and NDTN costs, except in specific instances when the Management Committee directs that procurement not be done by Telicphil for its own account but rather for the account and in behalf of the Co-owners. All costs incurred by Telicphil in relation to the NDTN, subject to the above exception, are thus recognized and recorded in the books of Telicphil subject to reimbursements from the NDTN, Co-owners. Based on the foregoing, you requested for a confirmation of your opinion that: 1. Under the previous set-up of classifying costs into Telicphil and NDTN costs, deposits for Telicphil costs received by Telicphil from the NDTN co-owners shall be subject to VAT upon receipt of said deposits based on the definition of "gross receipts" under Section 108(A) of the Tax Code of 1997. 2. Under the previous set-up, money received by Telicphil from the NDTN co-owners for NDTN costs shall not be subject to VAT as these are merely funds held in trust by Telicphil for eventual remittance to the suppliers or contractors. ( McCann-Erickson (Philippines), Inc. vs. Commissioner of Internal Revenue , C.T.A. Case No. 5966, March 13, 2003). Likewise, it shall not be subject to withholding tax. 3. Considering that Telicphil had control over the payment to suppliers or contractors for Telicphil and NDTN costs, the withholding of taxes by Telicphil, in lieu of the NDTN co-owners, on income payments made to suppliers or contractors of NDTN costs and the remittance thereof to the BIR using the tax identification number of Telicphil is deemed substantial compliance with the withholding tax requirements insofar as the correct amount of taxes were withheld and remitted to the government. Hence, said remittance may be credited to the account of the NDTN co-owners, as the actual payors. (BIR Ruling DA-353-97 dated October 30, 1997) 4. Gross payments made by the NDTN co-owners to Telicphil for the services of Telicphil (exclusive of the NDTN costs under the previous set-up) are subject to two percent (2%) withholding tax on income payments made to general engineering contractors under Section 2.57.2(E)(1) of Revenue Regulations No. 2-98, as amended by Section 3 of Revenue Regulations No. 6-01 dated July 31, 2001 (BIR Ruling DA-113-03 dated April 8, 2003). In the alternative, on the assumption that the NDTN Co-owners have been duly notified in writing by the Commissioner of Internal Revenue as belonging to the Top 10,000 Corporations, gross payments made by the NDTN Co-owners for services rendered by Telicphil shall be subject to two percent (2%) withholding tax on income payments made by top 10,000 Corporations under Section 2.57.2(M) of Revenue Regulations No. 2-98, as amended by Section 3 of Revenue Regulations No. 17-03. 5. Under the present set-up of recording transactions where Telicphil recognizes and records in its books purchases of equipment, systems, spare parts, materials, labor, services utilities, co-location or leasehold rights and software licenses used to maintain the NDTN (previously referred to as "NDTN Costs") and procured by Telicphil on its own account pursuant to the Maintenance Contract dated April 1, 2004, said costs shall constitute costs of services of Telicphil under Revenue Memorandum Circular No. 04-03. Hence, these are deductible to arrive at Telicphil's gross income subject to the two percent (2%) Minimum Corporate Income Tax ("MCIT"). 6. Finally, inasmuch as the NDTN does not engage in activities for profit and merely represents pooled resources co-owned by the Parties for the mutual use and benefit of the Parties, the NDTN is, therefore, not considered a separate entity for tax purposes. Hence, costs incurred for the operation and maintenance of the NDTN are to be allocated to and recorded by the individual NDTN co-owners. Accordingly, it is the individual NDTN co-owners which has the right to claim the corresponding input tax on the said costs (BIR Ruling No. 153-99 dated October 6, 1999). In reply to the foregoing, we proceed to rule as follows: 1. As represented, Telicphil costs are costs incurred by Telicphil within its organization to enable it to deliver its services to the NDTN co-owners. The reimbursements received by Telicphil for Telicphil costs are, therefore, consideration received by Telicphil for services rendered. Hence, it is subject to value added tax ("VAT") under Section 108 of the Tax Code of 1997 which provides that there shall be levied, assessed and collected, a value-added tax equivalent to ten percent (10%) of gross receipts derived from the sale or exchange of services. It must be noted that under Section 108 of the Tax Code of 1997, the gross receipts subject to tax include deposits and advanced payments actually or constructively received during the taxable quarter for the services performed or to be performed for another person. The reason why advance payments and deposits for work not yet accomplished are already included in the gross receipt subject to VAT is that the receipt thereof are generally acknowledged with VAT-registered receipts which generate input tax-credit in the hands of the holder. Hence, it is our opinion that such advances or deposits for work not yet started or accomplished are includible as part of the gross receipts subject to 10% VAT, without waiting for liquidation through actual accomplishments. (BIR Ruling No. 181-92 dated June 1, 1992.) Thus, on the basis of the foregoing, we confirm your opinion that deposits received by Telicphil from the NDTN Co-owners for Telicphil costs are subject to VAT upon receipt thereof. 2. Telicphil is not liable to pay VAT on money received from the NDTN co-owners for payment of NDTN costs under the previous set-up inasmuch as these are funds merely held in trust by Telicphil for eventual remittance to the suppliers of goods and the contractors of services for the construction, operation and maintenance of the NDTN. The money received, therefore, is not in the nature of fee or consideration for the services of Telicphil. Hence, this Office is of the opinion that it is not subject to VAT. The above position is supported by the decision of the Court of Tax Appeals ("CTA") in McCann-Erickson (Philippines), Inc. vs. Commissioner of Internal Revenue , C.T.A. Case No. 5966, March 13, 2003, in which the CTA ruled that since advances from petitioner's clients for payment to media networks do not pertain to advance payments for the services performed or to be performed by petitioner but are merely held in trust for payment to the media networks, the same do not fall within the definition of gross receipts under then Section 102 of Tax Code, as amended. Further, in the case of Commissioner of Internal Revenue vs. Tours Specialists, Inc. and The Court of Tax Appeals , 183 SCRA 402, the Supreme Court held that gross receipts subject to tax under the Tax Code do not include monies or receipts entrusted to the taxpayer which do not belong to them and do not redound to the taxpayer's benefit; and it is not necessary that there must be a law or regulation which would exempt such monies and receipts within the meaning of gross receipts under the Tax Code. Accordingly, inasmuch as the money received by Telicphil for NDTN costs does not represent income to Telicphil, said amount, therefore, shall not likewise be subject to income tax and consequently to withholding tax. 3. Under Section 2.57.3 of Revenue Regulations No. 2-98 as amended by Section 5 of Revenue Regulations No. 30-03 dated November 12, 2003, agents purchasing goods or services/paying for and in behalf of the withholding agents shall likewise withhold in their behalf, provided that the official receipts of payment/sales invoice shall be issued in the name of the person whom the former represents and the corresponding certificate of taxes withheld (BIR Form No. 2307) shall immediately be issued upon withholding of the tax. In the instant case, however, instead of withholding the taxes on payments made for NDTN costs in behalf of the NDTN co-owners, Telicphil withheld and remitted the taxes for its own account using its own tax identification number and issuing its own certificate of taxes withheld. In BIR Ruling No. DA-353-97 dated October 30, 1997, this Office ruled that ". . . considering that the expanded withholding tax in the amount of P5,812,171.88 and documentary stamp tax in the amount of P1,162,434.38 relative to the sale of the aforementioned properties have already been paid and remitted to Far East Bank and Trust Company, UN Avenue Branch on September 25, 1997, although the Withholding Tax Remittance Return (BIR Form No. 1601) and Documentary Stamp Tax Declaration (BIR Form No. 2000) were erroneously filled up in the name and TIN of the Philippine American Life and General Insurance Co. (for the account of Kalakhan, Inc.), the same constitutes a substantial compliance with Revenue Regulations No. 6-85, as amended by Revenue Regulations No. 12-94, implementing Section 50(b) of the Tax Code, as amended. In this connection, the RDO of Intramuros-Malate shall credit the aforestated amount for the account of the payor, Kalakhan, Inc., being the withholding agent-payor." Thus, the withholding and remittance by Telicphil for its account of the withholding tax on gross payments made by the NDTN co-owners to the suppliers or contractors of NDTN costs, insofar as the correct amount of taxes has been withheld and remitted to the BIR, shall constitute substantial compliance of the withholding tax requirements under the regulations. Thus, upon proof of the withholding and remittance of taxes by Telicphil, said amount may, therefore, be credited for the account of the NDTN co-owners, being the withholding agents-payors. 4. As for the applicable withholding tax rate on gross payments made by the NDTN Co-owners for services rendered by Telicphil, please be informed that Section 3 of Revenue Regulations No. 6-01, amending Section 2.57.2(E)(1) of Revenue Regulations No. 2-98 defines the term "General Engineering Contractor" as those whose principal contracting business is in connection with fixed works requiring specialized engineering knowledge and skills. Gross payments to such persons are subject to creditable withholding tax at the rate of two percent (2%). In BIR Ruling DA-113-03 dated April 8, 2003, this Office ruled that "A careful scrutiny of the above regulations disclosed that SPOI is indeed a general engineering contractor with respect to its activity of repairing the power plants, as its principal contracting business is to engage in the operation, maintenance, service (including user-training) and repair of power plants for generation of electric power and to engage in the importation of raw materials, components and spare parts for power plants. xxx xxx xxx IN VIEW OF THE FOREGOING, this Office hereby holds that SPOI is a general engineering contractor . Accordingly, as a general engineering contractor, payments made by FGPC to SPOI are subject to a creditable withholding tax at the rate of 2% effective October 1, 2001 (formerly 1%), in accordance with Section 3 of Revenue Regulations No. 6-2001, amending Section 2.57.2 (E) of Revenue Regulations No. 2-98." (Emphasis Supplied) Thus, inasmuch as Telicphil, based on its Articles of Incorporation, as amended, is a corporation authorized to perform design, planning, technical administration, maintenance and other similar or related services for and in behalf of the stockholders of the corporation, including but not limited to the preparation or conduct of feasibility studies, market research, marine and terrestrial surveys, construction and maintenance activities , and as such, actually maintains the NDTN by virtue of the Special Power of Attorney dated January 2, 1997 and the Maintenance Contract dated April 1, 2004, it is, therefore considered a general engineering contractor. Hence, gross payments by the NDTN co-owners (excluding the NDTN costs under the previous set-up of recording transactions) to Telicphil is subject to creditable withholding tax at the rate of 2% effective October 1, 2001 (formerly 1%), in accordance with Section 3 of Revenue Regulations No. 6-01, amending Section 2.57.2(E) of Revenue Regulations No. 2-98. 5. Under the present set-up of recording transactions, Telicphil now records in its books purchases of materials and labor required for the maintenance of the NDTN (previously referred to as the "NDTN costs") pursuant to the Maintenance Contract between the Management Committee, represented by its Chairman, and Telicphil dated April 1, 2004. Said Maintenance Contract allows Telicphil to purchase on its own account the said materials and labor subject to reimbursement by the NDTN co-owners. In reply to your query on whether or not the above materials and labor constitute the cost of services of Telicphil for purposes of computing the MCIT, please be informed that Revenue Memorandum Circular No. 04-03 provides as follows: " Gross Receipts and Cost of Services Per Industry . For purposes of applying the MCIT, the `gross receipts' and `cost of services' of taxpayers engaged in the following types of services, or any other kind but of a similar nature, shall be determined as follows: xxx xxx xxx (vi) General engineering and/or building contractors refer to those engaged in contracting business in connection with fixed works requiring specialized engineering knowledge and skill (e.g. reclamation works, railroads, highways, street roads, tunnels, airports), or with any structure built, for the support, shelter and enclosure of persons, animals, chattels, or movable property of any kind, requiring in its construction the use of more than two unrelated building trades or crafts, or to do or superintend the whole or any part thereto (e.g. sewers and sewerage, disposal plants and systems, parks, playgrounds, refineries). Their gross receipts shall mean actual or constructive receipts representing the contract price, including the amount charged for materials supplied with the services. Their costs of services shall refer to those incurred directly and exclusively for such activities, and shall be limited to the following: 01. Cost of materials used in construction ; 02. Salaries, wages and other employee benefits of site laborers and supervisors; 03. Health insurance, workers compensation and general liability insurance of site laborers and supervisors; 04. Fees and costs paid to sub-contractors ; 05. Costs of performance bonds on the particular contract; 06. Depreciation/amortization, rentals, repairs and maintenance of equipment directly used in the said activities ; 07. Costs of moving equipment and materials to and from the contract site; 08. Costs of design and technical assistance; and, 09. Supplies and tools directly used in the said activities ." (Emphasis added.) As represented, the materials and labor required for the maintenance of the NDTN include the following: 1. Various NDTN stations' security service; 2. All stations' rental costs; 3. Construction/repair of the various stations; 4. Pole rentals; and, 5. Electricity at the various stations. Inasmuch as the foregoing fall under the above enumeration of costs under Revenue Memorandum Circular No. 04-03 constituting the cost of services of a general engineering contractor, these are therefore deductible to arrive at the gross income of Telicphil subject to the two percent (2%) MCIT. 6. Finally, as for the NDTN, inasmuch as it is not engaged in trade or business, it is, therefore, not a person liable for VAT under Section 105 of the Tax Code of 1997. Consequently, it need not be registered for VAT purposes. TcIaHC As to who may claim the input VAT on purchases made for the construction, operation and maintenance of the NDTN, this Office rules that it can be apportioned among the NDTN Co-owners considering that each co-owner was charged with their allocated cost of the operation and maintenance of the NDTN, which necessarily includes any input VAT that was accumulated in connection thereto. (BIR Ruling No. 153-99 dated October 6, 1999) 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, and/or any of the requirements imposed in this letter are not complied with, then this ruling shall be considered null and void. Very truly yours, Commissioner of Internal Revenue By: (SGD.) JOSE MARIO C. BUAG Deputy Commissioner Legal and Inspection Group