Tax Consequences of Businesses Within the Clark Special Economic Zone

September 19, 2003 BIR RULING NO. 011-03 000-00 SGV & Co. 6760 Ayala Avenue Makati City Attention: Atty. Veronica A. Santos Gentlemen : This refers to your letter dated September 18, 2001 stating that your client, UPS International, Inc. (UIIC) is a wholly-owned subsidiary of a US incorporated entity, UPS International, Inc.; that the ultimate parent company of UIIC is United Parcel Service, Inc. (UPS); that UPS is a leading global package distribution group with subsidiaries joint ventures or agents operating throughout most countries in Asia Pacific; that UIIC has been incorporated to operate as the intra-Asia air hub for the UPS package and cargo business within the Clark Special Economic Zone (CSEZ); that the air hub activities to be performed by UIIC in respect of packages and cargo include loading and unloading, transferring between aircraft, temporary holding, and facilitating the ground transportation of air cargo and on-board-courier materials; package pickup and delivery; and performance of related administrative and operational services; that for outbound packages from the CSEZ, UIIC will derive revenue from shippers within the CSEZ; that UIIC will pay UPS Worldwide Forwarding, Inc. (WWF), a company organized and existing under U.S. laws, for the supply of international transportation services outside of the Philippines; that for inbound packages to the CSEZ, WWF will pay delivery compensation to UIIC for the provision of the brokerage, sorting and delivery services; that for packages transiting through the air hub, WWF will pay a service fee to UIIC; and that WWF is responsible for coordinating the international transportation network of UPS. In connection therewith, you now request for confirmation of your opinion that "1. Subsections 4(A)(f.1) and (2) [sic] of Revenue Regulations No. 1-95, as amended by Revenue Regulations No. 16-99, subject gross income arising only form business transactions of UIIC to Philippine taxation. The provisions will not be construed as treating the business transactions of other UPS entities as having their situs in the CSEZ; "2. UIIC should maintain only one set of books of account which record only its own income and not the income of the other UPS entities engaged in business transactions which cannot be considered as having their situs in the CSEZ." In reply thereto, please be informed that Section 2 of Executive Order No. 62 specifies that Clark Air Base will be developed as a special economic zone with such incentives and privileges as those granted to the Subic Special Economic and Freeport Zone and Export Processing Zones (Subic Zones). Consequently, the incentives applicable to a CSEZ enterprise are those granted by Executive Order No. 80, all incentives granted to a Subic Bay Freeport Enterprise under R.A. 7227 and P.D. No. 66, the Omnibus Investments Code of 1987, the Foreign Investments Act of 1991 and new investment laws that may hereinafter be enacted. Revenue Regulations no. 1-95 was promulgated to govern the tax regimes applicable to entities operating within the Subic Zones and the CSEZ. On September 27, 1999, Revenue Regulations No. 16-99, amending Revenue Regulations No. 1-95, was implemented introducing the "Subic Bay Regional Enterprise" (SBRE) and prescribing the requirements for its registration. As a Clark Regional Enterprise (CRE), UIIC should therefore satisfy the conditions under Section 3 (4) (p) of Revenue Regulations No. 1-95, as amended by Revenue Regulations no. 16-99, to wit: TcHCDE "(p) Registration of Subic Bay Regional Enterprises . Any multinational company, whose purpose, as expressed in its organizational documents or by resolution of its Board of Directors or its equivalent, is to engage in regional and/or international trade/services and in business activities such as, but not limited to, manufacturing, including entering into toll and contract manufacturing arrangements, employing commission agents and/or distributors; trading, marketing, financial services and treasury services may establish in the Subic Special Economic and Freeport Zone (SSEFZ) its seat of management and the situs of its business transactions, including the recording of its income, from some or all countries in the Asia-Pacific region and or other parts of the world, including the Philippines, by registering as a Subic Bay Regional Enterprise with the Subic Bay Metropolitan Authority." Moreover, Section 3 (o) (4) of the Revenue Regulations No. 16-99 provides in part as follows: (4) Subic Bay Regional Enterprise . For purposes of this paragraph, the term "Gross income earned" refers to the gross sales or gross revenues derived from the business activity within the zone, net of sales discounts and sales returns and allowances and minus the costs of sales or direct costs and other costs that are material in the operations of the business and involves a significant amount in determining the profitability and viability of the business (but before any deduction for administrative expenses or incidental losses during a given taxable period) . . . ." The tax treatment of a CRE is defined by Sections 4 (A) (f.1) and (2) of Revenue Regulations No. 1-95, as amended by Revenue Regulations No. 16-99: "Section 4. Exemptions and Incentives . A. All SBMA registered enterprises doing business within the Secured Area in the Zone shall enjoy the following: f. . . . f.1 Subic Bay Regional Enterprise . (1) The Subic Bay Regional Enterprise shall pay a tax of 5% on Gross Income Earned from business transactions in some or all of the countries in the Asia-Pacific region and/or other parts of the world, including the Philippines. (2) The Subic Bay Regional Enterprise shall establish in the SSEFZ its seat of management and situs of its business transactions, including the recording of income, in some or all of the Asia-Pacific region and/or other parts of the world. The Regional Enterprise may engage the services of toll manufacturers, commission agents, and/or distributors in some or all of the countries if in the Asia-Pacific region and/or other parts of the world. (RR 1-95, as amended by RR 16-99) It is clear that the seat of management-and-situs provisions of Revenue Regulations No. 1-95, as amended by Revenue Regulations No. 16-99, apply to a regional entity with toll manufacturers, commissionaries, and distributors located in different countries in the region, and not to a service entity with regional affiliates, all of which are engaged in the business of providing services. Thus, income of the non-Philippine UPS entities for services rendered outside the Philippines cannot be subject to Philippine taxes. UIIC cannot be compelled by virtue of Section 4 (A) (f.1) and (2) of the said regulations to record and report the income of its regional affiliates and to include said income in the computation to its income tax due to the Philippine government. Thus, Section 4 (A) (f.1) (1) and (2) of Revenue Regulations No. 1-95, as amended by Revenue Regulations No. 16-99, do not treat income earned by related UPS entities as being earned by UIIC for Philippine taxation purposes for the following reasons: 1. The UPS operations in Asia Pacific were established before the incorporation of UIIC. 2. UIIC is an entity incorporated under Philippine laws, which is separate and distinct from the UPS entities operating outside the Philippines (the "non-Philippine UPS entities"). 3. The air hub services of UIIC are performed wholly in the Philippines. While there is a UPS joint venture operating within the customs territory, the non-Philippine UPS entities perform services entirely outside the Philippines. Under the Tax Code, only income from services performed in the Philippines shall be considered as service income derived from the Philippine sources [Tax Code, Section 42 (A) (3)]. The business transactions of these non-Philippine UPS entities could not be considered as having their situs in the CSEZ. As regards the requirements on record keeping imposed on a CRE, Section 6 of Revenue Regulations No. 1-95, as amended by Revenue Regulations No. 16-99, specifies the following: "Section 6. Monitoring and Reporting Requirements . All registered enterprises embraced under these Regulations shall keep separate Books of Accounts, for each country in the Asia Pacific Region in which it operates, which books shall be duly registered with the concerned Revenue District Office, showing among others all transactions within and without the Philippines and the gross income earned therefrom for purposes of the tax herein imposed. Schedules showing sales and gross income earned per country shall be included as part of the enterprise's duly audited financial statement to be filed with its annual final adjustment return." [RR 1-95, as amended by RR 16-99] EIcSTD In fine, it is the opinion of this Office as it hereby holds that Revenue Regulations No. 1-95, as amended by Revenue Regulations No. 16-99, subjects only the gross income arising from business transactions of UIIC to Philippine taxation. The said provisions will not be construed as treating the business transactions of other UPS entities as having their situs in the CSEZ. Finally, UIIC should maintain only one set of books of account which records only its own income of the other UPS entities engaged in business transactions which cannot be considered as having their situs in CSEZ. 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.) GUILLERMO L. PARAYNO, JR. Commissioner of Internal Revenue