Quiason Makalintal Barot Torres Ibarra & Sison

August 26, 2009 BIR RULING [DA-(C-188) 477-09] 28 (B) (1); 42 (C); #1-90; 36-90; 110-97; 076-99; DA-037-04; DA-293-00; DA-173-01 Quiason Makalintal Barot Torres Ibarra & Sison 21st Floor, Robinsons-Equitable Tower 4 ADB Avenue corner Pedro Poveda Street 1605 Ortigas Avenue, Pasig City Attention: Atty. Benedict R. Tugonon Gentlemen : This refers to your letter dated August 5, 2009 stating that your client, Ore Consultancy & Services Limited (ORE), is a non-resident foreign corporation duly organized and existing under and by virtue of the laws of Hong Kong, Special Administrative Region, with address at Goveton Limited, 1102 Lucky Commercial Centre, 103 Des Voeux Road West, Hong Kong; that it is not engaged in trade or business within the Philippines and it has no permanent establishment in the Philippines; that it is not registered either as a corporation or as a partnership and has not been licensed to do business in the Philippines; that on the other hand, Petnet, Inc. (PETNET) is a corporation duly organized and existing under the laws of the Republic of the Philippines, with office business address at 114 Aguirre St., Legaspi Village, Makati City; that PETNET is engaged in the business of money transfer service in the Philippines and is a duly appointed agent of Western Union; that ORE entered into a Memorandum of Agreement (MOA) with Petnet whereby ORE will render the following services to Petnet outside the Philippines: TaHIDS a. Marketing Services. ORE will conduct market research among OFWs, particularly in Hong Kong, Macau, Singapore, Europe, Middle East and other countries. In this regard, PETNET will provide ORE with its business profile and all other necessary information that ORE will require. PETNET may at its option mail the documents to ORE or send the same electronically. b. ORE shall provide PETNET data analysis and review of the operation of key industry players in the Asian region. c. PETNET hereby appoints ORE to be its attorney-in-fact and agent with full power and authority to coordinate with Western Union and negotiate the terms and conditions of the renewal of the contract between Western Union and PETNET. d. Conduct a review of the operation of other Western Union agents in other territories, particularly those in Asia. and that in consideration of the performance by ORE of the abovementioned services, it will be paid service fees by PETNET as provided for in the MOA; that the services listed in the MOA do not involve the licensing of any technological or proprietary rights to PETNET; that none of the services to be performed by ORE requires performance thereof within the Philippines; and that ORE will perform all the services outside of the Philippines. In connection therewith, you now request confirmation of your opinion that 1. The service fees are not in the nature of royalties. 2. The payment of the service fees to ORE by the PETNET is not subject to Philippine income tax pursuant to the provisions of Section 28 (B) (1) in relation to Section 42 (C) of the National Internal Revenue Code of 1997, as amended ("Tax Code"). 3. The payment of the service fees is not subject to VAT since the services are performed outside the Philippines, consequently the payments are not subject to withholding VAT. SADECI 4. The service fees paid by PETNET to ORE for services performed by the latter constitute an ordinary and necessary business expense of PETNET which are allowed as a deduction from its gross income pursuant to Section 34 (A) (1) of the Tax Code. In reply thereto, please be informed that your opinion is hereby confirmed as follows 1. The service fees payable by PETNET to ORE are business profits and not royalties if ORE carries on business in the Philippines through a permanent establishment (PE). If it carries on business as aforesaid, the profits of the enterprise may be taxed in the Philippines but only so much of them as are attributable to such PE. In other words, if the income is in the form of business profits, the same will only be subject to Philippine income tax if a PE is created in the Philippines. Conversely, if there is no PE, there will be no tax consequences in the Philippines. Thus, it is important to differentiate between business profits and royalties. One must inquire on whether the payee has proprietary interest in the property giving rise to the income. If the payee has no proprietary interest, then the payment is a compensation for personal services or business profits. (Philippine Refining Co., Inc. vs. Commissioner of Internal Revenue, CTA Case No. 2872 dated January 15, 1986 citing Ingram vs. Bowers, 5 F 2d 65; and Oppenhein vs. Commissioner of Internal Revenue, 31 BTA 563) . To be considered as royalties, there must be a transfer in the Philippines of scientific, technical, industrial or commercial knowledge or information or other property where the payee has proprietary interest. (BIR Ruling No. 036-90 dated March 27, 1990) In the instant case, the service fees payable by PETNET to ORE are clearly business profits, since there is nothing in the MOA that would require the transfer into the Philippines of technology, equipment or other property where ORE has proprietary interest or would otherwise permit ORE to impart to PETNET its special knowledge and experience which remain unrevealed to the public. 2. Section 28 (B) (1) of the Tax Code of 1997, as amended by Republic Act (R.A.) No. 9337, provides that "(B) Tax on Nonresident Foreign Corporation. "(1) In General. Except as otherwise provided in this Code, a foreign corporation not engaged in trade or business in the Philippines shall pay a tax equal to thirty-five percent (35%) of the gross income received during each taxable year from all sources within the Philippines , such as interests, dividends, rents, royalties, salaries, premiums (except reinsurance premiums), annuities, emoluments or other fixed or determinable annual, periodic or casual gains, profits and income, and capital gains, except capital gains subject to tax under subparagraph 5(c): Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%) . (Emphasis supplied) AIHECa In defining what income payments are considered from sources without the Philippines, Section 42 (C), supra , provides "Section 42 (C). Gross income from sources without the Philippines. The following items of gross income shall be treated as income from sources without the Philippines: (1) Interests other than those derived from sources within the Philippines as provided in paragraph (1) of subsection (A) of this Section; (2) Dividends other than those derived from sources within the Philippines as provided in paragraph (2) of subsection (A) of this Section; (3) Compensation for labor or personal services performed without the Philippines; aIAcCH (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." (Emphasis ours) This Office had already occasioned to rule on the matter, when it said in BIR Ruling No. DA-037-04 dated February 2, 2004 that "xxx xxx xxx 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 VSLHK, the service fees to be paid by VSLPH to VSLHK shall not be subject to Philippine income tax. Consequently, such payments are not also 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. Thus, if the income is derived from sources outside the Philippines, the same is not subject to final withholding tax. VSLPH is, therefore, not required to withhold the 34% final income tax on its payments under the aforementioned Service Agreements to VSLHK." Considering that the above-cited ruling is in all fours similar to the instant case, the service fees payable to ORE for services rendered outside the Philippines are not subject to Philippine income tax. 3. Section 108 of the Tax Code of 1997, as amended by R.A. No 9337, 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, including those performed or rendered by construction and service contractors; . . .:" DIcSHE It is clear that the VAT applies only to services performed in the Philippines and not to services rendered outside the Philippines. Inasmuch as the services to be rendered by ORE to PETNET will be performed outside the Philippines, it is axiomatic that the said services are not subject to VAT. Thus, in BIR Ruling No. DA-037-04 created February 2, 2004, this Office ruled that "xxx xxx xxx" "2. Pursuant to Section 108(A) of the Tax Code of 1997 a VAT equivalent to ten percent (10%) of gross receipts is imposed on the sale or exchange of services, and the 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. Conversely, services performed outside the Philippines are not subject to VAT. Accordingly, VSLPH's payment of service fee to VSLHK pursuant to the aforementioned Services Agreement, shall not be subject to VAT. Consequently, no VAT may be passed on by VSLHK to VSLPH, as conversely suggested under Section 105 of the Tax Code of 1997." 4. Finally, in the same BIR Ruling No. DA-037-04, this Office likewise ruled that: "3. Pursuant to the aforementioned Section 34(A)(1) of the Tax Code 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. "It is noted that per VSLHK's representation, comparable companies usually avail of the above services in order to stay competitive, that the services that VSLHK will provide to VSLPH outside the Philippines will make the latter more efficient and effective in providing services to its customers; and that the engagement of VSLHK services outside the Philippines will improve VSLPH's net income. "Since the engagement of VSLHK by VSLPH to perform services covered under the Services Agreement is directly connected with and appropriate in the conduct of VSLPH's business the same may be considered as ordinary and necessary business expenses pursuant to aforementioned Income Tax Section 34(A)(1) of the Tax Code of 1997. "Accordingly, the service fees paid to VSLHK are deductible expenses from VSLPH's gross income pursuant to Section 34(A)(1) of the Tax Code of 1997." It is apparent from the above-cited ruling that the service fees payable to ORE pursuant to the MOA are ordinary and necessary expenses incurred by PETNET in its money transfer service in the Philippines and as the duly appointed agent of Western Union. Such being the case, the said service fees are valid deductions of PETNET for income tax purposes. 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, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service