Agreement between SMC and CCBPI More of a Sale of Service Rather than a Sale of Products

November 17, 1986 BIR RULING NO. 249-86 170 154-86 249-86 Gentlemen : This refers to your letters dated September 4 and 14, 1986 stating that Coca-Cola Bottlers Philippines, Inc. (CCBPI), a domestic corporation engaged in the manufacture and distribution of soft drink products known under and identified by trademarks, such as Coca-Cola, Royal and Sprite, entered into a service agreement with San Miguel Corporation (SMC) in 1986 for the manufacture of glass containers for its soft drink products; and that the said agreement provides, among others, that: cd "1. The CONTRACTOR (San Miguel Corporation) shall make softdrink bottles, in the name and for the account of the CONTRACTEE (Coca-Cola Bottlers Philippines, Inc.) and the CONTRACTEE shall pay unto the CONTRACTOR such fees or payment for services rendered in accordance with the term hereinafter provided for (par. no. 1). "2. In connection with the production of the soft drink bottles pursuant to this agreement, the CONTRACTEE shall supply the CONTRACTOR the essential raw materials, product specifications, technical directions, procedures, design, manufacturing instruction and standards and other directions (collectively called "Specifications"), which the CONTRACTEE may deem as required for the CONTRACTOR's faithful performance of its obligation under this agreement (1st sentence, par. no. 2). "3. The CONTRACTOR shall use such Specifications solely and exclusively for the purpose of producing the bottles for soft drink products known and identified by their trademarks referred to in the first "WHEREAS" clause above, and shall return to the CONTRACTEE, all such Specifications upon termination of this agreement (par. no. 3). "4. The essential raw materials, supplies and other materials required for the production of bottles shall be purchased by and for the account of the CONTRACTEE and supplied and delivered to the CONTRACTOR (1st sentence, par. no. 8). "5. In consideration for all the service provided to the CONTRACTEE by the CONTRACTOR pursuant to this agreement, the CONTRACTEE shall pay the CONTRACTOR a processing fee in accordance with Annex "A" hereof (1st sentence, par. no. 10). "6. Likewise, the CONTRACTOR agrees to be bound by the standard quantity usage rates for the essential raw materials furnished by the CONTRACTEE as set forth in Annex "B" hereof (2nd sentence, par. no. 16). "7. The CONTRACTOR shall deliver to the CONTRACTEE on the date set for the termination, any materials supplied by CONTRACTEE pursuant to paragraph no. 8 of this agreement but which were not used by CONTRACTOR, with all applicable transportation charges being for the account of the CONTRACTEE (par. no. 25)." Based on the foregoing representations, you now request, in effect, for a ruling as to whether on this particular service rendered under the aforementioned agreement, SMC is considered as a contractor rather than as a manufacturer. You contended that BIR Ruling No. 304-82 dated November 29, 1982 citing the case of Celestino Co & Company vs. Collector of Internal Revenue (No. L-8506, August 31, 1986) does not apply to the instant case because of material differences in fact and laws involved; that in the case of Celestino Co & Company, although the sash, windows and doors are made by the taxpayer only upon a previous order and subject to the specifications of the buyer, the court argues that "anyone who sees and likes the doors ordered by Don Toribio Teodoro and Sons, Inc., may purchase from Appellant, doors of the same kind, provided, he pays the price." On the other hand, in the query at hand, SMC cannot manufacture and sell to anybody, bottles with the same specifications ordered by CCBPI because paragraph no. 3 of the agreement between them is very specific that, "the CONTRACTOR (SMC) shall use such specifications solely and exclusively for the purpose of producing the bottles for soft drink products known and identified by their trademarks referred to in the first "WHEREAS' clause above, and shall return to the CONTRACTEE (CCBPI) all such specifications upon termination of this agreement"; that in the case of Celestino Co & Company, the court found that, "it is at once apparent that Oriental Sash Factory did not merely sell at its services to Don Toribio Teodoro & Co. (to take one instance), it also sold the materials." On the other hand, in the query at hand, SMC sells only its services to CCBPI but not the materials. This is very clear in the 1st sentence of paragraph no. 2 of the service agreement, which provides that, "in connection with the production of the softdrink bottles pursuant to this agreement, the CONTRACTEE (CCBPI) shall supply the CONTRACTOR (SMC) the essential raw materials, product specifications, technical directions, procedures, design, manufacturing instructions and standards and other directions (collectively called `specifications'), which the CONTRACTEE may deem as required for the CONTRACTOR's faithful performance of its obligation under this Agreement". This is further made clear in the 1st sentence of paragraph 8, which provides that, "the essential raw materials, supplies and other materials required for the production of bottles shall be purchased by and for the account of the CONTRACTEE and supplied and delivered to the CONTRACTOR."; and that the case of Celestino Co & Company arose in 1952; hence, the Court's decision was based on the provision of then Section 191 of the Tax Code which did not yet include "other independent contractors" within its purview. cdti In reply, please be informed that the above agreement between SMC and CCBPI is more of a sale of service rather than a sale of products. The theory of the contractor's tax is that, it is a tax on the sale of service or labor. Accordingly, SMC is an independent contractor subject to the P200.00 annual fixed tax imposed by Section 161(1) of the Tax Code and to the 4% contractor's tax based on the gross receipts/payments by CCBPI which in this case consist only of the cost of labor rendered pursuant to Section 170 of the same code. Very truly yours, (SGD.) BIENVENIDO A. TAN, JR. Commissioner of Internal Revenue