DA ITAD BIR Ruling No. 044-09

April 2, 2009 DA ITAD BIR RULING NO. 044-09 Arts. 5 & 7, Philippines-Japan tax treaty; BIR Ruling No. DA-ITAD 47-07 Isla Lipana & Co. 29th Floor Philamlife Tower 8767 Paseo de Roxas 1226 Makati City Attention: Malou P. Lim Partner, Tax Services Gentlemen : This refers to your letter dated October 9, 2007 requesting confirmation that the service fees paid by Exas Philippines, Inc. (Exas-Philippines) to Aidex Co. Ltd. (Aidex-Japan) are exempt from Philippine income tax and from value-added tax (VAT) pursuant to the pertinent sections of the National Internal Revenue Code of 1997 (Tax Code) and the Philippines-Japan tax treaty. aCcEHS It is represented that Aidex-Japan is a corporation organized and existing under the laws of Japan with business address at 1-Aza-Unotei Yamane, Towada Kazuno-City, Akita 018-5331 Japan as evidenced by the English-translated Certificate of Total Present Records dated January 15, 2007 of Mr. Takashi Ishii, Register of Deeds from the District Legal Affairs Bureau of Akita, Odate Branch; that Aidex-Japan is not registered either as a corporation or as a partnership licensed to engage in business in the Philippines as confirmed by the Certificate of Non-Registration of Corporation/Partnership issued by the Securities and Exchange Commission on October 11, 2006; that Exas-Philippines, on the other hand, is a domestic company with principal office at 2nd St., Mactan Economic Zone I, Lapu-Lapu City, Cebu; that Exas-Philippines is registered as an Ecozone Export Enterprise under Registration Certificate No. 92-058 dated October 23, 1992. It is further represented that on April 3, 2003, Exas-Philippines and Aidex-Japan entered into a Marketing Services and Sales Development Agreement (Agreement) whereby Aidex-Japan shall provide Exas-Philippines the following marketing services and sales development services: a) To liaise, make representation and solicit sales of Exas-Philippines' products with companies in Japan and other companies in foreign countries; b) To assist Exas-Philippines in marketing strategy in terms of price, design and quality for its products to be sold and/or exported to Japan and other countries; c) To occasionally deliver/send parts purchased by Exas-Philippines which shall be used in the production of pressed parts and die sets assembly; d) To provide Exas-Philippines with latest indispensable, necessary, customary and public market information concerning, but not limited to, its market, market base, market trend, sales quotas, sales outlook, sales progressions and other related information through market research and sales development research for the formulation of management policy in terms of market trend and market preferences in the end view of increasing Exas-Philippines' sales and profits; e) To provide Exas-Philippines with preferential consultancy on immediate/emergency market and/or sales concerns. That any and all marketing services to be performed by Aidex-Japan under this Agreement shall be rendered wholly in Japan and none of Aidex-Japan personnel is expected to come or stay in the Philippines except in certain isolated cases where Exas-Philippines requests for and deems it necessary; that their length of stay shall be for a brief period of one to two weeks but in no case exceed six months in total per taxable year; that this Agreement shall be valid and in force for a period of one (1) year (Effective Period) starting from June 2003; that if either party decides to terminate the contract, prior notice within 30 days prior to the end of the current contract term, must be sent to the other party; that this Agreement shall be automatically renewed without prior notice to any party until the end of the new term and upon prior notice or until a new agreement has been executed; that in consideration for the services, Exas-Philippines shall pay Aidex-Japan a monthly fee of Seventy Eight Thousand US Dollars (US$78,000), net of all applicable charges; and that the issue or transaction subject of the above application is not under investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings, or a judicial appeal. In reply, please be informed that Section 28 (B) (1) of the National Internal Revenue Code (Tax Code) of 1997 as amended, applies in general. It provides: "Section 28. Rates of Income Tax on Foreign Corporations. xxx xxx xxx (B) Tax on Nonresident Foreign Corporation. (1) In General. Except as otherwise provided in this Code, a foreign corporation not engaged in trade or business in the Philippines shall pay a tax equal to thirty-five percent (35%) of the gross income received during each taxable year from all sources within the Philippines, such as interests, dividends, rents, royalties, salaries, premiums (except reinsurance premiums), annuities, emoluments or other fixed or determinable annual, periodic or casual gains, profits and income, and capital gains, except capital gains subject to tax under subparagraph 5(c) and (d): Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%). xxx xxx xxx" However, Section 32 (B) (5) of the Tax Code of 1997, as amended provides: "Section 32. Gross Income. xxx xxx xxx (B) Exclusions from Gross Income. The following items shall not be included in gross income and shall be exempt from taxation under this Title: xxx xxx xxx (5) Income Exempt under Treaty. Income of any kind, to the extent required by any treaty obligation binding upon the Government of the Philippines. cdll xxx xxx xxx" Thus, you invoke the provisions of the Philippines-Japan tax treaty. Article 7 of the Philippines-Japan tax treaty provides: "Article 7 1. The profits of an enterprise of a Contracting State shall be taxable only in that Contracting 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" In view of the foregoing, the profits of a Japanese enterprise shall be taxable only in Japan unless such enterprise carries on business in the Philippines through a permanent establishment situated therein. If the Japanese enterprise carries on business as aforesaid, the profits of such enterprise may be taxed in the Philippines but only so much of them as is attributable to that permanent establishment. Applying this to the instant case, the service fees received by Aidex-Japan for the services rendered in the Philippines shall be taxable in the Philippines only if it has a permanent establishment in the Philippines in connection with the activities giving rise to such income. In relation thereto, Article 5 of the same tax treaty defines a permanent establishment, as follows: "Article 5 1. For the purposes of this Convention, the term 'permanent establishment' means a fixed place of business through which the business of an enterprise is wholly or partly carried on. xxx xxx xxx 6. An enterprise of a Contracting State shall be deemed to have a permanent establishment in the other Contracting State if it furnishes in the other Contracting State consultancy services, or supervisory services in connection with a contract for a building, construction or installation project through employees or other personnel-other than an agent of an independent status to whom paragraph (7) applies-, provided that such activities continue (for the same project or two or more connected projects) for a period or periods aggregating more than six months within any taxable year. . . . xxx xxx xxx." Inasmuch as it has been represented that the services will generally be performed by Aidex-Japan outside the Philippines and that should it be necessary to send its employees to the Philippines, said employees will stay in the Philippines for a brief period of one to two weeks but in no case exceed six months in total per taxable year, Aidex-Japan may be considered as not having a permanent establishment in the Philippines. In other words, Aidex-Japan is deemed not to have a permanent establishment for as long as its employees do not stay in the Philippines for a period or periods aggregating more than six months within any taxable year in the course of their rendition of services to Exas-Philippines. (BIR Ruling No. DA-ITAD 47-07 dated April 13, 2007) In such a case, the income derived by Aidex-Japan from services rendered to Exas-Philippines shall not be subject to Philippine income tax and, consequently, to withholding tax. cAaDHT As regards the imposition of the VAT on the rendition of services of Aidex-Japan, please be informed further that Section 108 of the Tax Code of 1997 1 provides as follows: "SEC. 108. Value-added Tax on Sale of Services and Use or Lease of Properties. (A) Rate and Base of Tax. There shall be levied, assessed and collected, a value-added tax equivalent to ten percent (10%) 2 of gross receipts derived from the sale or exchange of services, including the use or lease of properties. The phrase 'sale or exchange of services' means the performance of all kinds of services in the Philippines for others for a fee, remuneration or consideration, . . . ." (Emphasis supplied). Thus, in general, the VAT is imposed on services rendered by Aidex-Japan in the Philippines. On every payment of service fees, Exas-Philippines is required to withhold such VAT and treat the same as a "passed on" VAT, pursuant to Section 4.110-3 (b) of Revenue Regulations No. 7-95 as amended [now Section 4.114-2 (b) of Revenue Regulations No. 16-05]. IaDTES However, in Commissioner of Internal Revenue vs. Seagate Technology (Philippines) (G.R. No. 153866, February 11, 2005), the Supreme Court held, viz. : "Special laws may certainly exempt transactions from the VAT. 3 However, the Tax Code provides that those falling under P.D. 66 are not. P.D. 66 is the precursor of R.A. 7916 the special law under which respondent was registered. The purchase transactions it entered into are, therefore, not VAT-exempt. These are subject to the VAT; respondent is required to register. xxx xxx xxx Since the purchases of respondent are not exempt from the VAT, the rate to be applied is zero. Its exemption under both P.D. 66 and R.A. 7916 effectively subjects such transactions to a zero rate, because the ecozone within which it is registered is managed and operated by the PEZA as a separate customs territory. This means that in such zone is created the legal fiction of foreign territory. Under the cross-border principle of the VAT system being enforced by the Bureau of Internal Revenue (BIR), no VAT shall be imposed to form part of the cost of goods destined for consumption outside of the territorial border of the taxing authority. If exports of goods and services from the Philippines to a foreign country are free of the VAT, then the same rule holds for such exports from the national territory except specifically declared areas to an ecozone. xxx xxx xxx Applying the special laws we have earlier discussed, respondent as an entity is exempt from internal revenue laws and regulations. This exemption covers both direct and indirect taxes, stemming from the very nature of the VAT as a tax on consumption, for which the direct liability is imposed on one person but the indirect burden is passed on to another. Respondent, as an exempt entity, can neither be directly charged for the VAT on its sales nor indirectly made to bear, as added cost to such sales, the equivalent VAT on its purchases. Ubi lex non distinguit, nec nos distinguere debemus. Where the law does not distinguish, we ought not to distinguish. Moreover, the exemption is both express and pervasive for the following reasons: . . ., R.A. 7916 states that 'no taxes, local and national, shall be imposed on business establishments operating within the ecozone.' Since this law does not exclude the VAT from the prohibition, it is deemed included. Exceptio firmat regulam in casibus non exceptis. An exception confirms the rule in cases not excepted; that is, a thing not being excepted must be regarded as coming within the purview of the general rule. acAIES Moreover, even though the VAT is not imposed on the entity but on the transaction, it may still be passed on and, therefore, indirectly imposed on the same entity a patent circumvention of the law. That no VAT shall be imposed directly upon business establishments operating within the ecozone under R.A. 7916 also means that no VAT may be passed on and imposed indirectly. Quando aliquid prohibetur ex directo prohibetur et per obliquum. When anything is prohibited directly, it is also prohibited indirectly. xxx xxx xxx" Based on the foregoing, transactions exempt from VAT by reason of P.D. 66 and R.A. 7916 are effectively zero-rated. However, instead of zero-rating which is not available to non-resident suppliers, the provision for exempt transactions under Section 109 (q) [now Section 109 (K)] of the Tax Code of 1997 which provides VAT exemption for transactions that are exempt under specials laws, e.g. , Republic Act No. 7916 or PEZA Law, is particularly applicable to the instant case. Such being the case, the payment of services fees by Exas-Philippines, being a PEZA-registered enterprise, to Aidex-Japan under the above Agreement should be, as it is hereby confirmed to be, exempt from VAT. This ruling is issued on the basis of the facts as represented. However, if upon investigation it shall be disclosed that the actual facts are different, then this ruling shall be without force and effect insofar as the herein parties are concerned. STIcaE Very truly yours, Commissioner of Internal Revenue By: (SGD.) GREGORIO V. CABANTAC Deputy Commissioner Footnotes 1. Please note that this cited provision has been retained by Republic Act (R.A.) No. 9337, although with the modification as to the applicable rate when the circumstances so warrant. 2. Effective February 1, 2006, the rate shall be 12%. AHDacC 3. Referring to the old Section 109 (q) of the Tax Code of 1997 [now Section 109 (K), as amended by R.A. No. 9337].