BIR Ruling [DA-596-06]

October 6, 2006 BIR RULING [DA-596-06] 34; DA-053-2004; DA-384-1998; DA-037-2004 Sycip Gorres Velayo & Co . 6760 Ayala Avenue 1226 Makati City Attention: Atty. E.C. Alcantara Tax Division Gentlemen : This refers to your letter dated May 2, 2006 requesting for a ruling on the tax consequences of the Service Agreement entered into by and between Marubeni Corporation (MC) and Marubeni Philippines Corporation (MPC). It is represented that MC is a corporation duly organized and existing under the laws of Japan with principal business address at 4-2 Ohtemachi 1-Chome, Chiyoda-ku, Tokyo, Japan; that MC is licensed to do business in the Philippines through its Philippine branch, Marubeni Corporation Manila Branch (MC-Manila) duly registered with the Securities and Exchange Commission (SEC); that MPC is a corporation duly organized and existing under and by virtue of the laws of the Philippines with registered office and principal place of business at 8th and 9th Floors, L.V. Locsin Bldg. Ayala Avenue corner Makati Avenue, Makati City; that MPC is a 100% subsidiary of MC; that pursuant to the intra-group services (IGS) charge policy between MC and its domestic and foreign subsidiaries, MC and MPC entered into a Service Agreement dated April 1, 2005 whereby MC's Corporate Staff Division shall perform services in favor of MPC, consisting in: 1. Information and advice with respect to general administration, human resources, media relations & advertisement, accounting, finance, risk management and information with respect to legal matters and economic & industrial research; 2. Services with respect to payroll and welfare for Japanese expatriates; 3. Advice and assistance with regard to certain information peculiar to each country by Regional Strategy & Coordination Department of MC. It is further represented that for all the abovementioned services which will be performed by MC outside the Philippines, MPC shall pay MC compensation for services to be semi-annually agreed in writing by the parties based on agreed allocation ratios without additional mark-up or profit; that such compensation for services determined to be on arm's-length basis, represents allocation or reimbursement of actual costs by MC to MPC based on actual costs and expenses incurred by staff of MC in providing the service to MPC; and that MC-Manila Branch has no participation in the Service Agreement between MC and MPC. DcTAIH In this regard, you are requesting confirmation of your opinion, as follows: 1. The compensation to be derived by MC from MPC for services rendered pursuant to the Service Agreement is not subject to income/withholding tax since the same is mere reimbursement of costs without mark-up or profit; and 2. The said compensation to be paid by MPC to MC under the Service Agreement is deductible from MPC's gross income as a valid expense. In reply, please be informed as follows: 1. The compensation for services being mere reimbursement of costs without mark-up or profit and rendered outside the Philippines shall be exempt from Philippine income tax . Inasmuch as it has been represented that the MPC shall pay MC compensation for services based on agreed allocation ratios without additional mark-up or profit, the service fees, pursuant to the Service Agreement, are not subject to Philippine income tax. Payments covering actual and direct costs and expenses without mark-up or profit are mere reimbursement of costs and therefore, do not constitute taxable income. ( BIR Ruling No. DA-053-04 dated February 6, 2004 ) By its very nature, reimbursement of costs is not income for being mere returns of capital (BIR Ruling No. DA-384-98 dated August 24, 1998). Accordingly, the service fees to be paid by MPC to MC are not considered as taxable income subject to Philippine income tax and consequently to withholding tax. Further, since the services are to be rendered by MC outside the Philippines, the service fees pursuant to the Service Agreement are not subject to Philippine income tax pursuant to Section 28(B)(1) of the Tax Code of 1997, as amended. 2. The compensation for services is deductible from MPC's gross income as a valid expense . The compensation for services to be paid by MPC to MC is deductible from the gross income of MPC. The services to be performed by MC to MPC pursuant to an IGS charge policy between MC and its domestic and foreign subsidiaries like MPC, which services include information and advice with respect to general administration, human resources, media relations & advertisement, accounting, finance, risk management and information with respect to legal matters and economic & industrial research among others are ordinary and necessary expenses deductible on the part of MPC. The said expenses being directly connected with and appropriate in the conduct of the business of MPC, the same may thus be considered as ordinary and necessary expenses pursuant to Section 34(A)(1) of the Tax Code of 1997, as amended, which provides that such ordinary and necessary expenses paid or incurred during the taxable year in carrying on or which are directly attributable to the development, management, operation and/or conduct of the trade, business or exercise of profession are allowed as deduction from gross income. ( BIR Ruling No. DA-037-04 dated February 2, 2004 ) Moreover, for the expenses to be deductible on the part of MPC, it is understood that the parties have exerted reasonable efforts to ensure that the method of allocation and charges is consistent with the arm's length principle as may be determined through adequate documentation. Finally, in the event that transfer pricing regulations implementing Section 50 of the Tax Code of 1997, as amended, are issued by the BIR, the parties shall comply with the requirements thereof. This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation it shall be disclosed or discovered that the facts are different, then this ruling shall be considered as null and void. HaEcAC Very truly yours, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service