Asia Pacific Business Legal Consulting

December 10, 2009 BIR RULING [DA-(C-312) 766-09] Sections 28 (B) (1) & 42 (C) (3); BIR Ruling No. DA-037-04, DA-272-06 & DA-249-07 Asia Pacific Business Legal Consulting 2nd Floor Bldg. B. Mactan Marina Mall Mactan Economic Zone I Ibo, Lapulapu City Attention: Atty. Ma. Cristina L. Latonio Deputy Managing Director Gentlemen : This refers to your letter dated February 18, 2009 requesting on behalf of your client, Tsunetetsu (Cebu), Inc. ("TCI" or "Company" for brevity) for confirmatory ruling that the service fees paid by TCI to Tsuneishi Holdings Corporation ("THD" for brevity) under the Technical Consultancy Service Agreement are not subject to income, withholding and value-added taxes. As represented, TCI is a domestic corporation duly organized and existing under Philippine laws with principal office at West Cebu Industrial Park-Special Economic Zone (WCIP-SEZ), Buanoy, Balamban, Cebu. It was registered with the Securities and Exchange Commission (SEC) to engage in the business of ship repair under the supervision of a duly licensed naval architect or marine engineer, to manufacture, produce, fabricate, smelt, treat, and work all other products thereof in any and all forms, derivation and combinations. The Company is also registered with PEZA as an Ecozone Export Enterprise under Registration Certificate No. 99-039 dated June 1, 1999 and is entitled to a 5% special tax on gross income in lieu of payment of all national and local taxes and Income Tax Holiday on other registered activities with Supplemental Agreement dated January 29, 2009 under Resolutions No. 08-641. On the other hand, THD is a non-resident foreign corporation organized and existing under the laws of Japan with office address at Tsuneishi, Numakuma-cho, Fukuyama City, Hiroshima Prefecture, Japan. THD is not engaged in trade or business in the Philippines as evidenced by a Certificate of Non-Registration of Corporation issued by the SEC. AEHCDa On December 3, 2008, TCI and THD entered into a Technical Consultancy Service Agreement ("Agreement" for brevity). Under the said Agreement, TCI shall engage the services of THD and the latter agrees to provide to the former technical assistance for vessel pipe production and installation works and for stern frame and rudder structure production works and consulting works incidental thereto. Specifically, these services are in the nature of: I. Technical Assistance for vessel pipe production and installation works, and work incidental thereto a. Work of providing technical guidance for pipe production and installation works b. Work of providing advice on pipe production plant construction c. Work of negotiating with contractors determined by each section and of managing and supervising works d. Work of providing advice on the selection of contractors e. Work of managing the progress of works, and of providing reports on the progress II. Technical Assistance for stern frame and rudder structure production works, and work incidental thereto a. Work of providing technical guidance for press-bending, steel plate heat-bending and warping correction b. Work of providing technical guidance for ironworks and assembly (sub-assembly and main assembly) c. Work of providing technical guidance for welding procedures and execution procedures d. Work of providing technical guidance for machining, bush insertion, spin finishing and supervising works e. Work of negotiating with contractors determined by each section, and of managing and supervising works IaDSEA f. Work of managing the progress of works, and of providing reports on the progress The above services shall be performed by THD entirely outside the Philippines except for occasional visits or consultation required by TCI in the Philippines which visit shall only be for short duration and in no case shall exceed an aggregate period of six (6) months within any twelve-month period. In consideration for the above services, TCI shall pay THD a fixed monthly service fees. We proceed to rule on the particular issues raised for our consideration: 1. To be considered as rental or royalties within the purview of Section 42 (A) (4) of the Tax Code of 1997, as amended, there must be transferred into this country technology, equipment or other property, where the payee has proprietary interest. Specifically, under sub-paragraph (c) thereof, there must be a transfer of scientific, technical, industrial or commercial knowledge or information. Under the Agreement, there is no stipulation to the effect that would require the transfer into the Philippines of technology, equipment or other property, where TCI has proprietary interest or would otherwise sanction THD to convey to TCI their special knowledge and experience which remain unrevealed to the public. What will be provided by THD are technical guidance, advice, management and negotiation services, none of which are characterized as payment for "know-how." Thus, the compensation to be received by THD from TCI shall not amount to payment for the use of, or the right to use, any copyright, patent, trademark, design or model, plan, secret formula or process, or transfer of technology. In other words, the remuneration of THD is not considered royalty rather it constitutes compensation for labor or personal service performed without the Philippines (BIR Ruling No. 093-89 dated May 2, 1989). 2. Pursuant to Section 42 (C) (3) in relation to Section 28 (B) (1) of the Tax Code of 1997, as amended, 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 THD, the technical consultancy services are not subject to Philippine income tax. Consequently, such services are not also subject to final withholding tax required to be withheld pursuant to Section 2.57-1 (I) (1) in relation to Section 2.57 (A), both of Revenue Regulations (Rev. Regs.) 2-98, as amended. Section 2.57-1 (I) (1) of Rev. Regs. 2-98, as amended, 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. TCI is, therefore, not required to withhold the 30% final income tax on its payments under the aforementioned Agreement. Moreover, under Article 7 in relation to Article 5 of the Philippines-Japan tax treaty, the service fees received by THD for services rendered in the Philippines under the Contract shall be taxable in the Philippines only if it has a permanent establishment in the Philippines in connection with the activities giving rise to such income. THD is deemed not to have a permanent establishment for as long as its employees do not stay in the Philippines for a period or periods aggregating more than six months within any taxable year in the course of their rendition of services to TCI. Thus, for as long as THD personnel do not stay in the Philippines for an aggregate period of six (6) months within any twelve-month period, the income they receive from services rendered to TCI shall not be subject to Philippine income tax and, as such, shall likewise be exempt from withholding tax. (BIR Ruling No. DA-ITAD 056-07 dated April 27, 2007). IDTHcA 3. Section 108 (A) of the Tax Code of 1997, as amended, provides that value-added tax (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. Moreover, under the current regulations, the sale of services to Ecozone Enterprises may be considered effectively zero-rated for VAT purposes but subject to the limitation that the sale of service is made to persons or entities who enjoy indirect tax exemption. Zero-rating is not available to non-resident suppliers. Instead, the provision for exempt transactions under Section 109 of the Tax Code of 1997, as amended, which provides VAT exemption for transactions which are exempt under special laws, i.e., Republic Act No. 7916 or the PEZA law is applicable. In the case of payment for technical services/assistance rendered by THD, a non-resident to TCI, the responsibility for withholding the VAT and paying the same rests on the payor. Since the services to be rendered by THD to TCI will be done outside the Philippines and PEZA-registered export enterprises like TCI may not be passed on with or claim input VAT, technical consultancy services pursuant to the Agreement shall not be subject to VAT. 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 as null and void. Very truly yours, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service