Mahle Filter Systems Philippines Corporation

June 17, 2009 BIR RULING [DA-(VAT-058) 304-09] 109 (k); 23 (F); 42 (C) (3); DA 580-06 Mahle Filter Systems Philippines Corporation Block 8 Lots 5, 6, & 7 PEZA Drive First Cavite Industrial Estate Brgy. Langkaan, Dasmarias Cavite Attention: Eleonor F. Ledesma Department Head General Accounting and Tax Gentlemen : This refers to your letter dated June 8, 2009 requesting for a ruling that the royalty fees and service fees paid by Mahle Filter Systems Philippines Corporation to Mahle Filter Systems Japan are not subject to value added taxes and Philippine income taxes. TcIAHS It is represented that Mahle Filter Systems Philippines Corporation ("MFSP" for brevity) formerly, Mahle Tennex Philippines Corporation, was incorporated and registered with the Securities and Exchange Commission (SEC) on May 27, 1996. It was registered with the Philippine Economic Zone Authority (PEZA) on June 3, 1996 and the Bureau of Internal Revenue on December 23, 1996. MFSP is primarily engaged in the business of manufacturing of air filter elements and other automotive products. Majority of its product line are now subject to 5% regime in lieu of other taxes under Republic Act No. 7916 after its income tax holiday incentive expired on September 30, 2007. It is a 100% subsidiary company of Mahle Filter Systems Japan ("MFSJ"), a corporation duly organized and operating under the laws of Japan and a manufacturer of various kinds of automotive parts. It is further represented that on January 1, 2007, MFSP entered into a Consulting and Technical Service Agreement ("CTS Agreement") with MFSJ. MFSJ is a company duly incorporated and existing under the laws of Japan with principal address at 3-1-2 Ikeburo, Toshima-ku, Tokyo, 171-0014 Japan. It is not doing business and has no permanent establishment in the Philippines as evidenced by a certification issued by SEC. For tax purposes, it is, therefore, considered a non-resident foreign corporation. Under the CTS Agreement, MFSJ will provide all the necessary and appropriate technical support and information such as product design that will enable the company to manufacture and sell certain products in various geographical areas. MFSP pays royalty fees and service fees to MFSJ in consideration of the latter's provision of technical information, technical assistance and know-how in the manufacturing of licensed products. Upon the foregoing, you now request for opinion that the royalty fees and service fees paid by MFSP to MFSJ are not subject to VAT. Moreover, it is your opinion that the services fees are not subject to Philippine income taxes. In reply, please be informed that as a general rule, sale of services to be rendered in the Philippines is subject to twelve percent (12%) VAT. Section 108 (A) of 1997 Tax Code, as amended by R.A. 9337, provides: "Section 108. Value-Added Tax on Sale of Services and Use or Lease of Properties . A) Rate and Base of Tax. There shall be levied, assessed and collected, a value-added tax equivalent to ten percent (10%) [now 12%] of gross receipts derived from the sale or exchange of services, including the use or lease of properties. HacADE The phrase 'sale or exchange of services' means the performance of all kinds of services in the Philippines for a fee, remuneration or consideration . . ." However, it should be noted that Section 109 (K) of the same Tax Code exempts from VAT transactions which are exempt under international agreements or under special laws, to wit: "SEC. 109. Exempt Transactions . The following shall be exempt from the value-added tax: xxx xxx xxx (K) Transactions which are exempt under international agreements to which the Philippines is a signatory or under special laws, except those under Presidential Decree No. 529; xxx xxx xxx" Concerning special laws relevant to MFSJ and other PEZA-registered enterprises, Section 24 of Republic Act No. 7916 (An Act Providing for the Legal Framework and Mechanism for the Creation, Operation, Administration, and Coordination of Special Economic Zones in the Philippines, Creating for this Purpose, the Philippine Economic Zone Authority (PEZA), and for Other Purposes), to wit: "Section 24. Exemption from Taxes under the National Internal Revenue Code . Any provision of existing laws, rules and regulations to the contrary, notwithstanding, no taxes, local and national, shall be imposed on business establishments operating within the ECOZONE. In lieu of paying taxes, five percent of the gross income earned by all business and enterprises within the ECOZONE shall be remitted to the national government . . ." It is clear from the aforequoted provisions of law that MFSP is exempt from payment of all national internal revenue taxes including VAT. As an exempt entity, MFSP, therefore, cannot be directly charged for VAT on its sales nor can it be indirectly made to bear, as added cost to such sales, the equivalent VAT on its purchases. Since MFSJ may not be passed on with nor claim input VAT on its purchases, services rendered to it by MFSJ effectively subject to VAT at zero percent rate. Section 108 (B) (3) of the Tax Code provides thus: "Section 108. Value-added Tax on Sale of Services and Use or Lease of Properties . EAaHTI (B) Transactions Subject to Zero Percent (0%) Rate. The following services performed in the Philippines by VAT-registered persons shall be subject to zero percent (0%) rate: (3) Services rendered to persons or entities whose exemption under special laws or international agreements to which the Philippines is a signatory effectively subjects the supply of such services to zero percent (0%) rate;" However, since effective zero-rating is not available to non-resident suppliers, the sale of services by such suppliers is considered exempt and the provisions of Section 109 (K) apply accordingly. Such being the case, the payment of service fees and royalty fees by MFSP to MFSJ under the CTS agreement should be exempt from VAT. This position finds support in VAT Ruling No. 100-99 dated September 16, 1999, as reiterated in BIR Ruling Nos. DA-ITAD 62-05 dated June 27, 2005 and DA-ITAD 112-05 dated September 30, 2005, where the BIR held that the payment of royalties by a PEZA-registered export enterprise to a non-resident owner is exempt from VAT. Similarly, in BIR Ruling No. ITAD 130-05 dated November 14, 2005, the BIR ruled that inspection service fees paid by a PEZA-registered export enterprise to a non-resident foreign corporation is exempt from VAT. With respect to the income tax implications of the payment of service fees to a resident corporation of Japan, Article 7 and Article 5 of the RP-Japan tax treaty provide as follows: "Article 7 Business Profits 1. The profits of an enterprise of a Contracting State shall be taxable only in that Contracting State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in that other Contracting State but only so much of them as is attributable to that permanent establishment. xxx xxx xxx" "Article 5 Permanent Establishment 1. For the purposes of this Convention, the term "permanent establishment" means a fixed place of business through which the business of an enterprise is wholly or partly carried on. 2. The term "permanent establishment" includes especially: ISAaTH a) a store or other sales outlet; b) a branch; c) an office; d) a factory; e) a workshop; f) a warehouse; g) a mine, an oil or gas well, a quarry or other place of extraction of natural resources. xxx xxx xxx" It is clear from the aforequoted provisions that if a corporation which is a resident of Japan does not carry on business in the Philippines through a permanent establishment situated therein, the profits of such corporation shall not be subject to Philippine income tax. For this purpose, a corporation which is a resident of Japan may be deemed to have a permanent establishment in the Philippines if, among others, the furnishing of services through its employees continues (for the same or a connected project) within the Philippines for a period or periods aggregating more than 183 days in a year or if the installation project or supervisory activities in connection therewith constitutes a period of more than six months. Considering that the services to be performed in the Philippines by the personnel of MFSJ will not exceed 183 days in any twelve-month period, nor will the installation project and supervisory activities in connection therewith last more than six months, MFSJ, accordingly, cannot be deemed to have a permanent establishment in the Philippines to which the business profits may be attributed. Such being the case, the service fees to be made to MFSJ are considered compensation for labor or services performed outside the Philippines and are therefore considered income derived from sources outside the Philippines. In this regard, Section 23 (F), in relation to 42 (C) (3) of the Tax Code, provides: "Sec. 23. General Principles of Income Taxation in the Philippines . xxx xxx xxx F) A foreign corporation, whether engaged or not in trade or business in the Philippines, is taxable only on income derived from sources within the Philippines." SDEITC "Sec. 42. Gross Income from Sources Without the Philippines . xxx xxx xxx (3) Compensation for labor or personal services performed without the Philippines." Since the service fees are considered income derived from sources outside the Philippines, this Office hereby rules that the service fees paid by MFSP to MFSJ pursuant to the CTS Agreement are not subject to Philippine income tax and consequently to withholding tax. 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, (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service