"Subcontractor" and "Direct-Billing Method" Clarified

May 24, 2000 BIR RULING NO. 024-00 57 RR 2-98 000-00 024-2000 SGV & Co. 6760 Ayala Avenue Makati City Attention: Mr . Jose A . Osana and Mr . Joel L . Tan Torres Gentlemen : This refers to your letter dated February 11, 2000 requesting confirmation that: 1. The term "subcontractor" as used in Presidential Decree No. (PD) 1354 refers to subcontractors at whatever tier who perform "Petroleum Operations" as defined under PD 87 (also known as the Oil Exploration and Development Act) and therefore that the 8% final income tax is applicable to subcontractors at whatever tier and is in lieu of all national and local taxes; and 2. The "direct-billing method" you have described which ensures that the 8% final income tax is withheld and paid by your client Shell Philippines Exploration B.V. (SPEX), a service contractor under PD 1354, on the amounts invoiced by and paid to the subcontractors at whatever tier, is acceptable for tax purposes pursuant to Rev. Regs. No. 2-98. It is represented that your client, Shell Philippines Exploration B.V. (SPEX), is a company formed and organized under the laws of the Netherlands; that it operates in the Philippines through a branch that is duly licensed by the Securities and Exchange Commission and the Board of Investments; that SPEX is a petroleum service contractor of the Government of the Philippines under PD No. 87, as amended, otherwise known as the Oil Exploration and Development Act, and under Service Contract No. 38 ("SC 38"); that in its capacity as petroleum service contractor to the Government, SPEX and its co-venturers in SC 38 perform petroleum operations for the development of the Malampaya natural gas field located in offshore Palawan (the "Project"); that SPEX implements the Project under the supervision and control of the Government, through the Department of Energy ("DOE"); that the major components of the Project include: (i) the installation of five development wells and a subsea manifold to bring gas to a shallow water platform; (ii) the construction of a shallow water platform to process the gas, and to separate and store condensate; (iii) the installation of a buoy that will be used by tankers to lift condensate from the platform; (iv) installation of a 504-kilometer pipeline on the seabed to connect the platform to the gas landfall site in Batangas City; and (v) the construction of an onshore gas plant to treat and process dry gas prior to sale. It is also represented that in line with the prevailing practice in the oil and gas industry, and with a view to complete the Project in a relatively short time, SPEX has entered into a number of subcontractors for portions of the work described in 3 above; that these SPEX subcontractors may subcontract certain portions of their work to other subcontractors, and so on; that although a major portion of the actual work is conducted by SPEX contractors and their subcontractors, SPEX remains ultimately responsible for the execution of the Work Program as approved by the DOE under SC 38; that under SC 38, SPEX is entitled to recover Project costs out of the proceeds from the sale of the gas; that Project costs are subject to audit and review by the DOE; that in order to ensure cost recovery under SC 38, SPEX must effectively control Project costs, monitor payments, and ensure the correct withholding and payment of taxes; that to achieve this, SPEX has agreed with its subcontractors that each subcontractor at a lower tier will issue its invoices directly to SPEX for the value corresponding to the work performed at such lower tier; that SPEX then makes payment directly to the subcontractor at the lower tier; that similarly, the subcontractors at the highest tier will invoice SPEX only for the value corresponding to their respective portions of the work, i.e. , only for that portion of the contract price for which SPEX has not yet been invoiced by any subcontractor at the lower tier; that the foregoing is referred to as the "direct-billing method"; that, for example, SPEX enters into a pipeline installation subcontract with A for P100 and A then subcontracts a portion of the work, e.g. the seabed survey, to B for 30; that under the direct billing method A will invoice SPEX for P70 and B will invoice SPEX for P30; that SPEX will then pay P70 to A and withhold 8% therefrom and that, likewise, SPEX will pay P30 to B and withhold 8% therefrom; that under this method, SPEX will withhold on actual payments made to each of the subcontractors at whatever tier. In reply, please be informed that under Presidential Decree No. 1354, any subcontractor, whether domestic or foreign, entering into a contract with a service contractor engaged in petroleum operations in the Philippines, shall be subject to a final tax of 8% of its gross income derived from such contract, such tax to be in lieu of all taxes, whether national or local. Applying this provision in the instant case, and considering that the services performed by SPEX subcontractors at whatever tier for the Project are directly related and necessarily incidental to SPEX Petroleum Operations, as the term is defined in SC 38 and PD 87, these subcontractors are likewise subject to the 8% final tax on gross income, in lieu of all taxes, national and local, as imposed under Presidential Decree No. 1354. (BIR Ruling No. 180-81 dated September 17, 1981). It shall be understood, however, that any income earned by such sub-contractors from all other sources within the Philippines shall be subject to the regular income tax imposed under the Tax Code of 1997. LibLex As regards your question on who has the obligation to withhold the 8% final tax, please be informed that it is specifically required under Section 57 of the Tax Code that the payor should withhold the proper amount of tax on certain payments made, as follows: "SEC. 57. Withholding of tax at source . (A) Withholding of final tax on certain incomes . Subject to rules and regulations that the Secretary of Finance may promulgate, upon recommendation of the Commissioner, requiring the filing of income tax return by certain income payees, the tax imposed under Sections 24(B)(1) . . . on specified items of income shall be withheld by the payor-corporation and/or person and paid in the same manner and subject to the same conditions as provided in Section 58 of this Code." (Emphasis supplied) The above provision is further clarified by Section 2.57 (A) of Revenue Regulations No. 2-98, which states: "(A) Final Withholding Tax Under the final withholding tax system the amount of income tax withheld by the withholding agent is constituted as a full and final payment of the income tax due from the payee of the said income. The liability for payment of the tax rests primarily on the payor as withholding agent . Thus, in case of his failure to withhold the tax or in case of underwithholding, the deficiency tax shall be collected from the payor/withholding agent. The payee is not required to file an income tax return for the particular income." (Emphasis supplied) Thus, when the SPEX receives an invoice from a subcontractor at whatever tier, and makes payment to such subcontractor based on the amount invoiced, it is SPEX which has control and custody over all payments. Therefore SPEX, and not any of its subcontractors, must withhold the 8% final tax based on the amount invoiced by and actually paid to, a particular subcontractor. In summary, this Office holds and hereby confirms that: (1) The term "subcontractor" as used in PD 1354 includes subcontractors at whatever tier, who perform "Petroleum Operations" as defined under PD 87 (also known as the Oil Exploration and Development Act) and, therefore, the 8% final tax which is in lieu of all national and local taxes, is applicable to subcontractors at whatever tier. It shall be understood, however, that any income earned by such sub-contractors from all other sources within the Philippines shall be subject to the regular income tax imposed under the Tax Code of 1997; and (2) The "direct-billing method" you have described which ensures that the 8% final income tax is withheld and paid by SPEX on the amounts invoiced by and paid to the subcontractors at whatever tier, is acceptable for tax purposes. 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. cdll Very truly yours, (SGD.) ROMEO S. PANGANIBAN Deputy Commissioner (Operations Group) Officer-in-Charge