Sumitomo-Major Telecoms Contract for the Supply of Equipment and Services to the Mindanao Telecommunications Project

February 6, 1998 BIR RULING NO. 016-98 RR 6-85-RAMO 1-95-000-00-016-98 SGV & Company 6760 Ayala Avenue 1226 Makati City Attention: F . G . Tagao Tax Division Gentlemen : This refers to your letter dated September 4, 1996 stating that your client, Sumitomo of Japan, Head Office, has concluded a contract with Major Telecoms, Inc. (MTI), a Philippine company, for the supply of equipment and services for the Mindanao Telecommunications Project; that Sumitomo has a branch in the Philippines which is registered with the BIR and is listed as one of the top 5,000 corporations; that MTI is a Philippine company that is not listed as one of the top 5,000 corporations; that the contract between MTI and Sumitomo is divided into two (2) portions, namely: the Inside Plant Portion (ISP) and the Outside Plant Portion (OSP); that the ISP does not include local supply of materials but only imported materials; that the imported materials intended for the ISP consist of switching system, radio system, multiplex system, supervisory and control system; that it also includes services for local installation, operations and maintenance support and foreign training; that the contract further provides for the supply of telephone sets with a separate price for them but there is no installation being undertaken; that the whole ISP is in turn subcontracted to Nissho-Iwai of Japan Head Office; that Nissho-Iwai also has a branch in the Philippines registered with the BIR; that the OSP includes both foreign and local supply of materials, local engineering and design services and local training; that it also includes services for local installation; that the necessary imported spare parts are also included. On the basis of the foregoing facts, you now request for our opinion on the following: 1. Whether or not the payments to be made by MTI to Sumitomo based on the ISP and OSP portions of their contract, and the subsequent payments to be made by Sumitomo to Nissho-Iwai on the ISP portions of the contract are subject to the one per centum (1%) creditable expanded withholding tax under Section 1(e) of Revenue Regulations No. 6-85; and 2. Whether or not the supply of imported materials, including the imported telephone sets by Nissho-Iwai to Sumitomo would be subject to the one per centum (1%) creditable tax under Section 1(n) of Revenue Regulations No. 6-85, as amended by Revenue Regulations No. 12-94. In reply thereto, please be informed that: 1. Payments to be made by MTI to Sumitomo on the ISP and OSP portions of their contract, and the payments to be made by Sumitomo to Nissho-Iwai on the ISP of the contract, are subject to the 1% creditable expanded withholding tax imposed on specially contractors under Section 1(e)(1)(c) of Revenue Regulations No. 6-85, as amended. The withholding shall be made by MTI on its payments to Sumitomo, and by Sumitomo on its payments to Nissho-Iwai. Sumitomo and Nissho-Iwai, being foreign corporations existing under the laws of Japan, the pertinent provisions of the RP-Japan Tax Treaty (Treaty) shall apply. Article 7 of the Treaty provides that: "Article 7" "1. Profits of an enterprise of one of the Contracting States shall be taxable only in that 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" Under Article 5(1)(b) of the Treaty, it is stated that a "permanent establishment" includes a branch. Since both Sumitomo and Nissho-Iwai have their respective branches in the Philippines, they would be considered as "doing business in the Philippines" under the Tax Code and therefore shall be taxed as resident foreign corporations at 35% of their net income from Philippine sources (BIR Ruling No. 023-95 dated February 14, 1995) and be subject to the Creditable Expanded Withholding Tax which covers all Philippine residents (Section 1 of Revenue Regulations No. 6-85, as amended; BIR Ruling No. 237-90 dated December 19, 1990) Thus, the total gross payments of MTI to Sumitomo on the ISP and OSP portions of the contract would be subject to the one per centum (1%) creditable withholding tax imposed on specialty contractors under Section 1(e)(c) of the Revenue Regulations No. 6-85 as amended, otherwise known as the Consolidated Expanded Withholding Tax Regulations. Accordingly, MTI should withhold the 1% tax from the total gross payments made to Sumitomo and remit the same to the Philippine Government. The tax withheld may then be applied by Sumitomo as a credit against its Philippine income tax. [Section 50(b), Tax Code] However, with respect to the offshore supply of equipment, the formula prescribed under RAMO 1-95 will be used for purposes of determining the taxable income subject to the 35% corporate income tax. LLphil In the same manner, the gross payments to be made by Sumitomo to Nissho-Iwai based on the ISP portion shall also be subject to the 1% withholding tax which shall be applied against the corporate income tax due on their sub-contract. [Section 50(b), supra] Similarly, the formula prescribed under RAMO 1-95 will be used for purposes of determining the taxable income tax on the offshore portion of the contract. Furthermore, as a contract for the supply of equipment and services, the total gross sales and receipts of Sumitomo on the contract with MTI shall be subject to the 10% VAT (Section 102, Tax Code, as amended). However, if MTI has already paid the 10% VAT on the imported equipment/services, then this should not be further subjected to the 10% VAT. (Kanematsu Corporation, Manila Branch vs. CIR, CTA Case No. 4875 dated February 12, 1997) For the same reason, the total gross sales and receipts on the ISP of the subcontract with Nissho-Iwai shall be subject to the 10% VAT (Section 102, supra.) even if the materials/services are paid abroad since the situs of privilege taxes like VAT is determined by the place the privilege is exercised or enjoyed, in your case, the Philippines. (VAT Ruling No. 261-89) Again, if MTI has already paid the 10% VAT on the imported equipment/services, then this should not be further subjected to the 10% VAT. (Kanematsu vs. CIR, supra.) 2. As to whether or not the supply of imported materials, including the imported telephone sets, by Nissho-Iwai to Sumitomo, under the ISP of the contract, is subject to the 1% creditable withholding tax under Section 1 of Revenue Regulations No. 12-94 [amending Section 1(n) of Revenue Regulations No. 6-85] which imposes a 1% withholding tax on income payments made by the top 5,000 corporations as determined by the Commissioner of Internal Revenue, please be informed that the answer is in the negative. The supply of imported materials and telephone sets are parts of the same indivisible contract, the gross payments under which are subject to the 1% withholding tax on specialty contractors under Section 1(e) of Revenue Regulations No. 6-85, as amended. The contract between MTI and Sumitomo calls for the rendition of certain services, of which the supply of imported materials and telephone sets are merely incidental thereto. Such being the case, the supply of imported materials and telephone sets cannot be separately subjected to the 1% withholding tax on income payments made by the top 5,000 corporations to their local supplier of goods. dctai Summarizing, the following shall be the tax liabilities of MTI, Sumitomo and Nissho-Iwai, respectively: SUMITOMO MTI NISSHO-IWAI W/H 1% EWT on the OSP MTI to withhold the 1% OSP - Not applicable TAX and ISP portions of the EWT on the gross contract payments on the OSP ISP - 1% EWT and ISP portions of the [Sec. 1(e)(1)(c), Rev. contract [Sec. 1(e)(1)(c), Rev. Regs. No. 6-85] Regs. No. 6-85] VAT 10% VAT on gross 10% VAT on 10% VAT on gross sales/receipts on the importation of materials/ sales/receipts from the contract services rendered subcontract (ISP) (Section 102, Tax Code, (Section 102, Tax Code) (Section 102, Tax Code) as amended) 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. LLjur Very truly yours, (SGD.) LIWAYWAY VINZONS-CHATO Commissioner of Internal Revenue