Ilao & Ilao Law Offices

July 18, 2008 BIR RULING [DA-(C-011) 060-08] Sec. 28 (B) (1); DA-345-06; DA 037-04 Ilao & Ilao Law Offices 5K Vernida Building, 120 Amorsolo Street, Legaspi Village, Makati City Attention: Atty. Gina V. Ilao M a d a m : This refers to your letter dated April 16, 2008 requesting, on behalf of your client, EDAW Limited, confirmation of your opinions relative to service fees payable by UEM-MARA Philippines Corporation ("UEM-MARA") to EDAW Limited. It is represented that your client, EDAW Limited ("EDAW") is a corporation duly organized and existing under the laws of the Hong Kong, SAR with business address at 20/F China Merchant's Tower Shun Tak Center, 168-200 Connaught Road Central, Hong Kong; that EDAW has no license to operate or do business in the Philippines; that EDAW has not secured a license to engage in trade or business in the Philippines from the Securities and Exchange Commission; that UEM-MARA proposes to engage the services of EDAW through an Off Shore Services Agreement ("Agreement") wherein the latter shall provide UEM-MARA with highly technical urban design and landscape planning services and related support services and activities; that according to the Agreement, UEM-MARA shall pay EDAW the amount of US$300,000.00 for Basic Services and US$110,000.00 for Optional Services to provide optional comprehensive financial analysis; and that in rendering the services, EDAW shall utilize its resources outside the Philippines, particularly those in Hong Kong; and that in support of your request, you attached the SEC Certification of Non-Registration of Corporation/Partnership, the Special Power of Attorney granted to Ilao & Ilao Law Offices by EDAW, and the Services Agreement between EDAW and UEM-MARA. DTEHIA You now request for the confirmation of your opinions as follows: 1) Service Income to be derived from services to be rendered by EDAW outside the Philippines under an Offshore Services Agreement is not subject to income tax for being derived from sources without the Philippines; 2) Payments for the services derived by EDAW will not be subject to the final withholding tax; 3) Services rendered by EDAW are not subject to value-added tax (VAT); and 4) The service fees paid by UEM-MARA to EDAW for the offshore services performed by the latter constitute ordinary and necessary business expenses of UEM-MARA which are allowed as deduction from its gross income under Section 34 (A) (1) of the NIRC of 1997 despite the non-withholding of any tax thereon. Discussion/Opinion 1. Income Tax Section 28 (B) (1) of the NIRC provides that non-resident foreign corporations are subject to income tax only on income derived from all sources within the Philippines. Conversely, non-resident foreign corporations are not subject to income tax on income derived from sources outside the Philippines. For purposes of determining which income is considered not of Philippine source, Section 42 (C) of the Tax Code of 1997 enumerates the following items of gross income as income from sources without the Philippines: (1) Interests other than those derived from sources within the Philippines; (2) Dividends other than those derived from sources within the Philippines; CDHcaS (3) Compensation for labor or personal services performed without the Philippines; (4) Rentals or royalties from property located without the Philippines or from any interest in such property including rentals or royalties for the use of or for the privilege of using without the Philippines patents, copyrights, secret processes and formulas, goodwill, trademarks, trade brands, franchises and other like properties; and (5) Gain, profits and income from the sale of real property located without the Philippines. 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. Under the Services Agreement, there will be no transfer of scientific, technical, industrial or commercial knowledge or information by EDAW to UEM-MARA nor of equipment or other property, where the payee has proprietary interest. In view of this, the service fees do not fall within the contemplation of "Rentals and Royalties" defined under Section 42 (A) (4) of the Tax Code of 1997. Furthermore, since the services of EDAW are to be performed abroad, the service fees to be paid to EDAW by UEM-MARA 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-345-06 dated June 2, 2006) 2. Withholding Tax Moreover, such payments are not subject to final withholding tax required to be withheld pursuant to Section 2.57 (A) in relation to Section 57-1 (I) (1), both of Revenue Regulations (Rev. Regs.) 2-98, as amended. Section 2.57-1 (I) (1) provides that non-resident foreign corporations are subject to final withholding tax only on their income derived from all sources within the Philippines. Section 2.57-(I) (1) does not provide that non-resident foreign corporations are subject to final withholding tax on their income from sources outside the Philippines. (BIR Ruling No. DA 037-04 dated February 2, 2004). HCSEcI 3. Value Added Tax Section 108 (A) of the Tax Code of 1997 provides that VAT shall be imposed on gross receipts derived from the sale or exchange of services, and the use or lease of properties. The same provision of the Tax Code 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. Conversely, services performed outside the Philippines are not subject to VAT. In the case of UEM-MARA and EDAW, the services to be rendered by the latter to the former will be done outside the Philippines. Consequently, payments of service fees by UEM-MARA to EDAW, pursuant to the Agreement, shall not be subject to VAT. (BIR Ruling No. DA 037-04 dated February 2, 2004). 4. Deductible Business Expenses Section 34 (A) (1) of the Tax Code of 1997 provides that all 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. The service fees that UEM-MARA will pay to EDAW, pursuant to the provisions of the Services Agreement, are ordinary and necessary business expenses, which are directly connected with and appropriate in the conduct of UEM-MARA's business. The service fees are ordinary business expenses since comparable companies usually avail of the above services in order to stay competitive. Moreover, the service fees are necessary business expenses because the services that EDAW will provide to UEM-MARA outside the Philippines will make it efficient and effective in providing services to its customers. UEM-MARA's payments to EDAW pursuant to the provisions of the Services Agreement, fall within the contemplation of the foregoing Tax Code provisions, revenue regulations and BIR rulings. CONCLUSION/BIR Reply: Accordingly, this Office hereby confirms your opinions as follows: HSaEAD 1. Based on Section 42 (C) (3) in relation to Section 28 (B) (1) both of the Tax Code of 1997, non-resident foreign corporations deriving income for services performed abroad are not subject to Philippine income tax since such services are considered income from sources without the Philippines. Accordingly, since the services are to be performed abroad by EDAW, the service fees to be paid by UEM-MARA to EDAW shall not be subject to Philippine income tax. 2. The service fees to be paid by UEM-MARA to EDAW is also not subject to final withholding tax pursuant to Section 2.57-1 (I) (1) in relation to Section 2.57 (A), both of Rev. Regs. No. 2-98, as amended. Section 2.57-1 (I) (1) of Rev. Regs. No. 2-98 provides that non-resident foreign corporations are subject to final withholding tax only on their income derived from all sources within the Philippines. 3. UEM-MARA's payment of service fees to EDAW pursuant to their Agreement shall not be subject to VAT considering that the phrase "sale of goods and services" under Section 108 (A) means the performance of all kinds of services in the Philippines for others for a fee, remuneration or consideration. Consequently, services performed outside the Philippines are not subject to VAT. 4. Pursuant to the aforementioned Section 34 (A) (1) of the Tax Code of 1997 all 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. Since the engagement of EDAW by UEM-MARA to perform services covered under the Services Agreement is directly connected with and appropriate in the conduct of UEM-MARA's business the same may be considered as ordinary and necessary business expenses pursuant to aforementioned Section 34 (A) (1) of the Tax Code of 1997. DScTaC 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 null and void. Very truly yours, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service