Aranas Consunji & Barleta Law Office

August 22, 2008 BIR RULING [DA-(C-047) 167-08] 28 (B); 42 (C); DA-345-06; DA 037-04; DA-065-07 Aranas Consunji & Barleta Law Office Unit 106 G/F Le Metropole Condominium Tordesillas Corner Dela Costa Streets, Salcedo Village, Makati City Attention: Atty. Jesus Clint O. Aranas Partner Gentlemen : This refers to your letter dated July 11, 2008, on behalf of your client, SINGAPORE COMPONENT PTE. LTD ("SINCOM" for brevity),requesting confirmation of your opinion that the marketing support service fees to be paid directly to SINCOM by TOMS MANUFACTURING CORPORATION (hereinafter "TOMS") for offshore non-technical marketing services shall have the following tax consequences: 1. The income derived by SINCOM from the Marketing Support Agreement shall not be subject to Philippine income and withholding tax, pursuant to Section 23 (F) and Section 28 (B) (1) in relation to Section 42 (A) (3),of the 1997 Tax Code, as amended. 2. The service fees paid by TOMS to SINCOM shall not be subject to VAT imposed under Section 108 of the Tax Code. 3. SINCOM being a non-resident foreign corporation without a permanent establishment in the Philippines shall not be subject to Philippine taxes following the provisions of the R.P.-Singapore Tax Treaty and not royalty payments subject to tax on royalties under the R.P.-Singapore Tax Treaty. It is represented that SINCOM is a company incorporated and existing under the laws of Singapore with principal office at 79 Anson Road #08-01, Singapore; that SINCOM does not have a permanent establishment in the Philippines as defined under the R.P.-Singapore Tax Treaty; that SINCOM entered into a "Marketing Support Service Agreement" with TOMS; that TOMS is a corporation duly organized and existing under Philippine laws, with principal office located at Blk 1 Lot 2, Daiichi Industrial Park Econozone, Maguyam Road, Silang, Cavite; that under the said Agreement, SINCOM will undertake to render exclusively offshore ( i.e. to be performed entirely outside the Philippines) services for TOMS as follows: TaDIHc 1. To promote or market the products of TOMS to Japanese and other foreign clients of SINCOM; 2. To assist TOMS in developing marketing strategies and specific marketing activities outside the Philippines; 3. To collect various information (such as Production Plans, new parts needed by client, necessary product drawing and product information for the manufacturing of the parts, part qualification, price range) concerning TOMS' clients; 4. To help mediate between TOMS and the client; and 5. To undertake such other incidental marketing activities as may be requested by TOMS to promote the latter's business in other countries. that all the above services shall be performed outside the Philippines, primarily in Singapore; that the services shall not involve any transfer of technology, know-how or other intellectual property rights; and that for and in consideration of its services under the aforementioned Agreement, SINCOM shall be paid by the TOMS a monthly service fee as agreed upon by the parties. In reply, please be informed as follows: 1. Income Tax & Withholding 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. Since the services of SINCOM are to be performed abroad, primarily in Singapore, the service fees to be paid to SINCOM by TOMS 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) 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 2.57-1 (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). EICSDT Even under the provisions of the RP-Singapore tax treaty, the service fees paid by TOMS to SINCOM are still exempt from Philippine withholding taxes because SINCOM does not have any permanent establishment in the Philippines to which the said business profits may be attributed. Pursuant to Article 7 of RP-Singapore Tax Treaty, the profits of a foreign enterprise shall be taxable in the Philippines only to the extent that such enterprise is carrying on business in the Philippines through a permanent establishment situated therein, such as a branch, and only so much of the profits as may be attributable to that permanent establishment. The term "permanent establishment" means a fixed place of business through which the business of an enterprise is wholly or partly carried on. It includes especially a store or other sales outlet, a branch, an office, a factory, a workshop, a warehouse, a mine, an oil or gas well, a quarry or other place of extraction of natural resources, or a building site or construction or installation project lasting more than 183 days. 2. Value Added Tax Similarly, the service fee is not subject to 12% value-added tax (VAT) imposed under Section 108 (A) of the Tax Code: 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 SINCOM and TOMS, the services to be rendered by the former to the latter will be done outside the Philippines. Consequently, payments of service fees by TOMS to SINCOM, pursuant to their Agreement, shall not be subject to VAT. (BIR Ruling No. DA 037-04 dated February 2, 2004) Like any other business tax, VAT is subject to the inherent limitation of taxation, among others, the principle of territoriality that is, taxation may be exercised only within the territorial jurisdiction of that taxing authority (BIR Ruling No. 165-95, 23 October 1995, citing Jose C. Vitug, Tax Law and Jurisprudence, 1993, 3rd Revised Edition, p. 9 citing 51 Am. Jur. 88) 3. Service Fees 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: cHCIDE a) Training; b) Research; c) Availability of Services and Advisory Departments Buying of Raw Materials; 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." On the other hand, Article 12 (3) of the RP-Singapore tax treaty provides that: "(3) The term "royalties" as used in this Article means payments of any kind received as a consideration for the use of, or the right to use, any copyright or literary, artistic or scientific work, including cinematographic films or tapes for television or broadcasting, any patent, trade mark, design or mode, plan secret formula or process, or for the use of, or the right to use, industrial, commercial or scientific equipment, or for information concerning industrial, commercial or scientific experience." The treaty defines "royalties" to include "payment of any kind received as a consideration for information concerning industrial, commercial or scientific experience".According to the commentaries of the ORGANIZATION FOR ECONOMIC COOPERATION AND DEVELOPMENT (OECD) Committee on Fiscal Affairs on the Model Tax Convention [par. 11, Commentary on Article 12 (royalties),(C) 1998, p. 151),such information alludes to the concept of "know-how".The definition of know-how, which has been adopted by the said Committee, is "all the undivulged technical information, whether capable of being patented or not, that is necessary for the industrial reproduction of a product or process, directly and under the same conditions; inasmuch as it is derived from experience, know-how represents what a manufacturer cannot know from mere examination of the product and mere knowledge of the progress of technique".In the know-how contract, one of the parties agree to impart to the other, so that he can use them for his own account, his special knowledge and experience which remain unrevealed to the public. (BIR Ruling No. DA-ITAD No. 59-03 dated April 21, 2003). HSaIDc Thus, it is clear that the service fees paid in consideration of services rendered by SINCOM for TOMS under the Marketing Support Service Agreement are not in the nature of royalties as the same does not involve any transfer of technology, know-how or other intellectual property rights, but as business profits under the provisions of the R.P.-Singapore tax treaty. In BIR Ruling No. DA-065-07 dated February 5, 2007 wherein SINCOM entered into the same marketing support service agreement with several corporations, the BIR ruled, to wit: "In view of the foregoing, the service fees paid in consideration of services rendered by SINCOM to PHILIPPINE CORPORATIONS under the Marketing Support Service Agreement are not in the nature of royalties as the same does not involve any transfer of technology, know-how or other intellectual property rights, but as business profits under the provisions of the R.P.-Singapore tax treaty." 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 as represented 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