Tax Consequences of Businesses Within the Clark Special Economic Zone

October 13, 2003 BIR RULING NO. 012-03 UPS International, Inc. UPS Inter-Asia Hub Civil Aviation Complex Diosdado Macapagal International Airport Clark Special Economic Zone Pampanga Attention: Mr. Nick Kyrzakos Director Gentlemen : This refers to your letter dated May 2, 2002 stating that UPS International, Inc. Company (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; ground handling services; customs brokerage; warehousing services; sorting 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 derived 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; that WWF is responsible for coordinating the international transportation network of UPS; that in respect of the package business, the contractual arrangements will be as follows: (1) in respect of outbound packages, UIIC will contract with Philippine shippers inside and outside the Clark zone to ship their packages or documents out of the Philippines; (2) where the Philippine shipper is inside the Customs territory, UIIC will subcontract the pick up activities to a local transportation service provider; (3) UIIC will perform the sorting and handling activities within the CSEZ. Alternatively, UIIC will subcontract certain ramp activities to other Clark entities; (4) UIIC will contract with WWF for the supply of international transportation services. That is, WWF will be responsible for transportation of packages from the Philippines to the destination country; (5) UIIC will invoice the Philippine shipper for the total transportation charge from pick up delivery, including all service components relating to activities in the customs territory, CSEZ and outside the Philippines; and (6) in respect of inbound packages, UIIC will be contracted by WWF for the delivery of packages. Where the delivery destination is inside the customs territory then UIIC will subcontract the activity to a local transporter. In connection therewith, you now request for confirmation of your opinion that "1. For purposes of Section 4(A)(f.1)(3) of Revenue Regulations No. 16-99, amending Revenue Regulations No. 1-95, the revenue of UIIC sourced from within the Customs Territory will be determined by reference to the services actually rendered inside the Customs Territory; and "2. The pick-up and delivery services provided by the transportation subcontractors between the CSEZ and locations within the Customs Territory would be considered to be rendered within the Customs Territory; and "3. The services performed by UIIC within the CSEZ and provided by WWF outside of the Philippines are considered to be rendered outside of the Customs Territory." In reply thereto, please be informed as follows: 1. Executive Order No. 62 dated February 27, 1993 was promulgated prescribing the policies and guidelines to implement Republic Act No. 7227, otherwise known as the Bases Conversion and Development Authority (BCDA). Section 2.1.2 of the said Executive Order provides that the Clark Air Base shall "be developed as a special economic zone with such incentives and privileges granted to Special Economic and Freeport Zone and Export Processing Zones". Executive Order No. 80 dated 03 April 1993 was subsequently issued authorizing the establishment of the Clark Development Corporation (CDC) as the implementing arm of the BCDA for the Clark Special Economic Zone (CSEZ). Section 5 of the said Executive Order provides that: ". . . the CSEZ shall have all the applicable incentives in the Subic Special Economic and Freeport Zone under RA 7227 and those applicable incentives granted in the Export Processing Zones, the Omnibus Investments Code of 1987, the Foreign Investments Act of 1991 and the new investment laws which may hereinafter be enacted." On 24 January 1995, Revenue Regulations No. 1-95 implemented the incentive provisions of Section 12 (b) and (c) of R.A. 7227 as they are applicable to the Subic Special Economic Zone. On 27 September 1999, Revenue Regulations No. 16-99 amended Revenue Regulations No. 1-95 which created the Subic Bay Regional Enterprise (SBRE) and entitled to certain incentives, among which is the 5% preferential tax rate on gross income. Section 4.(A).(f.1).(3) of Revenue Regulations No. 1-95 as amended by Revenue Regulations No. 16-99, provides in part as follows: "Section 4(A)(f.1)(3) of the Revenue Regulations No. 16-99, amending Revenue Regulations No. 1-95, provides that Subic Bay Regional Enterprise may generate revenues from sources within the Customs Territory up to 50% of its total revenues. The income generated from the customs territory will be subject to the tax of 5% on gross income earned as defined under Sec. 3(o)(4) of these Regulations; Provided, That, if the revenues derived from the customs territory exceed 50% of its total revenues, the excess of the income generated by the Regional Enterprise will be subject to the regular income tax rates in the customs territory." Considering that the incentives and privileges granted to Subic Special Economic and Freeport Zone (SSEFZ) are made applicable to CSEZ, then the incentives and privileges applicable to SBRE shall likewise apply to a Clark Regional Enterprise duly registered with the CDC. The Subic Bay Regional Enterprise may generate revenues from sources within the Customs Territory up to 50% of its total revenues. The income generated from the customs territory will be subject to the tax of 5% on gross income earned as defined under Sec. 3(o)(4) of these Regulations; Provided, That, if the revenues derived from the customs territory exceed 50% of its total revenues, the excess of the income generated by the Regional Enterprise will be subject to the regular income tax rates in the customs territory. It is submitted that the phrase 'revenues from the sources within the customs territory' refers to the portion of revenue relating to the transportation services physically performed inside the Customs Territory ( i.e. , pick-up and delivery) through local subcontractors. Thus, the portion of the revenue derived by UIIC from the services performed inside the CSEZ or outside the Philippines is not revenue from sources inside the customs territory for purposes of measuring the 50% threshold. Section 42 (A) (3) of the Tax Code of 1997 provides that compensation for labor or personal services performed in the Philippines shall be treated as gross income from sources within the Philippines. In interpreting the said section, this Office in BIR Ruling No. 138-84 dated August 10, 1984 ruled that the important factor which determines the source of income, if from services, for purposes of income taxation, is the place where services are actually rendered. (Mertens, Law of Federal Taxation, Vol. 8, Chap. 45 p. 141; cited in CTA Case No. 2373 and 2561, British Overseas Airways Corp. vs. Commissioner, January 26, 1983) . 2. The pick-up and delivery services provided by the transportation subcontractors between the CSEZ and locations within the customs territory would be considered as rendered within the customs territory. The revenue of UIIC relating to services rendered in the customs territory can be determined based on the charges billed by the transportation subcontractors. Thus, if UIIC performs transportation activities within customs territory, then the revenue derived by UIIC should equal the charges of the independent contractors. However, regulatory restrictions necessitate that UIIC subcontracts these transportation activities to local contractors. 3. The services performed by UIIC within the CSEZ and those provided by WWF outside the Philippines are considered as rendered outside of the Customs Territory. Accordingly, the portion of revenue for services rendered within the CSEZ shall be treated as derived within the CSEZ and revenue derived for the services performed outside the Philippines by WWF as revenue derived from sources outside the Philippines. This ruling is being issued on the basis of the foregoing facts represented. However, if upon investigation, it will be disclosed that the facts are different, then this ruling shall be considered null and void. DISHEA Very truly yours, (SGD.) GUILLERMO L. PARAYNO, JR. Commissioner of Internal Revenue