DA ITAD BIR Ruling No. 051-08

July 9, 2008 DA ITAD BIR RULING NO. 051-08 Arts. 5 & 7 of the Philippines-Singapore and Philippines-Malaysia Tax Treaties; BIR Ruling No. DA-ITAD 129-06; BIR Ruling No. DA-ITAD 134-06 C.L. Manabat & Co. 5th Floor, Salamin Building 197 Salcedo St., Legaspi Village Makati City Attention: Atty. Alvin Noel R. Saldaa Tax Assistant Manager Gentlemen : This refers to your letter dated October 23, 2006 filed on behalf of your client, Posterscope Philippines Corporation (Posterscope-Philippines), requesting confirmation of your opinion that the respective service fees to be paid by Posterscope Philippines to Aegis Media Asia Pacific Mgt. Pte., Ltd. (Aegis-Singapore) and Avagard Corporation Sdn Bhd (Avagard-Malaysia) are in the nature of business profits and not royalties under the provisions of the Philippines-Singapore and Philippines-Malaysia tax treaties and therefore, are exempt from Philippine income and withholding taxes pursuant to the pertinent provisions of the National Internal Revenue Code (Tax Code) of 1997, as amended and related BIR rulings. It is represented that Aegis-Singapore is a nonresident foreign corporation, organized and existing under the laws of Singapore with registered address at 152 Beach Road, #36-05 Gateway East., Singapore 189721; that it is not registered either as a corporation or as a partnership in the Philippines as shown in the Certificate of Non-Registration dated October 11, 2006 issued by the Securities and Exchange Commission; that Avagard is a nonresident foreign corporation, organized and existing under the laws of Malaysia with registered address at 125 Kampong Cempaka, 47301 Petaling Jaya, Selangor Darul Ehsan, Malaysia; that it is not registered either as a corporation or as a partnership in the Philippines as shown in the Certificate of Non-Registration dated August 22, 2006 issued by the Securities and Exchange Commission; that Posterscope-Philippines is a domestic corporation with registered office address at 1002 Liberty Center Building, 104 H.V. Dela Costa cor. L.P. Leviste Streets, Salcedo Village, Makati City; that Posterscope-Philippines is engaged in the business of advertising including the preparation of media plans and buying of airtime and space to employ any form of advertising for any person, association, company, corporation, partnership or governmental agency and to provide all advertising services including but not limited to strategy, research, planning, buying, sponsorship, direct marketing and promotion. SECIcT It is further represented that Posterscope-Philippines entered into a separate Technical Services Agreements with Aegis-Singapore and Avagard-Malaysia (hereinafter collectively referred to as "Foreign Affiliates") whereby the following advice and technical services shall be rendered separately by the Foreign Affiliates to the former: 1. The Foreign Affiliates will monitor Posterscope-Philippines' identity and will advise the latter how its international identity within its own territory can be improved for its international clients: it will also coordinate and manage the Carat identity in each country of operation with a view to ensuring that the identity is protected to the maximum benefit of Posterscope-Philippines acting within its own territory and in relation to international clients; 2. The Foreign Affiliates will develop and make available to Posterscope-Philippines personnel training courses, including management development, and building customer relationship workshops; 3. The Foreign Affiliates will also provide advice and assistance in connection with the recruitment of senior personnel, and develop the remuneration policy and bonus and share option schemes for senior executives; 4. The Foreign Affiliates will develop and manage the information technology infrastructure to enable Posterscope-Philippines to communicate efficiently with both its clients and within the Aegis Group plc group, and to manage access to centrally located and managed software and data; 5. Where relevant, the Foreign Affiliates will provide information, consultancy and guidance on key management decisions such as strategic and business plans, support for and improvement in systems and controls, financial policy manuals, assistance if necessary with local accounting procedures, legal assistance and any assistance with fund raising, bank relationships and acquisitions, in particular where this involves non-Filipino third parties; HCISED 6. In the area of business development and client liaison, the Foreign Affiliates will assist Posterscope-Philippines in the negotiation of contracts with customers, advise Posterscope-Philippines on business development plans formulated by Posterscope-Philippines, with particular reference to expanding Posterscope-Philippines' business on an international scale, develop and recommend marketing strategies to Posterscope-Philippines and advise the same of international business development opportunities that come to the Foreign Affiliates notice; 7. The Foreign Affiliates will assist with marketing and promoting the services of Posterscope-Philippines internationally, advise on and assist Posterscope-Philippines in the development of new business services to be offered in conjunction with existing operations internationally, coordinate marketing, advise Posterscope-Philippines on pricing policies, particularly on multinational clients, generally advise Posterscope-Philippines on operational matters, and introduce international clients and contacts and undertake a coordinating role where a number of recipients are involved; and 8. In the area of communications, branding and public affairs, the Foreign Affiliates will maintain contacts with relevant international organizations and handle the relations with such associations and institutions, coordinate product related presentations and advise on directory listing, material development, website update and maintenance, newsletters, trade shows, awards, sponsorship, video presentations and similar activities. That the Foreign Affiliates will perform the aforesaid services outside the Philippines, except only in respect of activities that its personnel will conduct for specific services, which require highly qualified and experienced personnel, for a short period of time not exceeding one hundred eighty three (183) days within any twelve-month period; that the services to be rendered by the Foreign Affiliates do not involve the provision or licensing of any know-how to Posterscope-Philippines; that in consideration for the effort and tasks performed by the Foreign Affiliates, Posterscope-Philippines shall pay a service fee for: (a) all costs arising from performance of the services to and are specifically identifiable with Posterscope-Philippines will be charged directly to Posterscope-Philippines; and (b) a fair and equitable method of apportionment for all other indirectly allocable costs used; and that the issues or transactions subject of the above application are not under investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings, or a judicial appeal. TaHIDS In reply, please be informed of Article 12 (3) of the Philippines-Singapore tax treaty quoted as follows: "Article 12 Royalties xxx xxx xxx 3. The term "royalties" as used in this Article means payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work, including cinematographic films or tapes for television or broadcasting, any patent, trade mark, design or model, plan, secret formula or process, or for the use of, or the right to use, industrial, commercial or scientific equipment, or for information concerning industrial, commercial or scientific experience. "xxx xxx xxx." The abovementioned tax treaty defines "royalties" to include "payments of any kind received as a consideration for information concerning industrial, commercial or scientific experience." According to the commentaries of the ORGANISATION FOR ECONOMIC COOPERATION AND DEVELOPMENT (OECD) Committee on Fiscal Affairs on the Model Tax Convention [par. 11., Commentary on Article 12 (royalties), 1998, p. 151), such information alludes to the concept of "know-how". The definition of know-how, which has been adopted by the said Committee, is "all the undivulged technical information, whether capable of being patented or not, that is necessary for the industrial reproduction of a product or process, directly and under the same conditions; inasmuch as it is derived from experience, know-how represents what a manufacturer cannot know from mere examination of the product and mere knowledge of the progress of technique." In the know-how contract, one of the parties agree to impart to the other, so that he can use them for his own account, his special knowledge and experience which remain unrevealed to the public. (BIR Ruling No. DA-ITAD 49-02 dated April 15, 2002) cSITDa Furthermore, in the case of Philippine Refining Company (PRC) vs. CIR, CTA Case No. 2872 dated January 15, 1986, the Court of Tax Appeals had an occasion to rule on the distinction of service fees from royalties, to wit: "To distinguish between compensation for service and royalty, payments, one must inquire on whether the payee has proprietary interest in the property giving rise to the income. If the payee has none, then the payment is a compensation for personal services, if the payee has proprietary interest then the payment is royalty". Based on the above, the subject payments under the respective Technical Services Agreements are not within the definition of royalties under Article 12 (3) of the Philippines-Singapore tax treaties. Nothing in the respective Technical Services Agreements would require transfer in the Philippines of "know-how" or any property of which the payee has proprietary interest. Thus, the applicable provision on the tax treatment of payments under the subject Agreement is Article 7 of the RP-Singapore tax treaty which provides: "Article 7 BUSINESS PROFITS 1. The profits of an enterprise of a Contracting State 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 or has carried on business as aforesaid, the profits of the enterprise may be taxed in the other 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 Singapore enterprise shall be taxable only in Singapore unless such enterprise carries on business in the Philippines through a permanent establishment situated therein. If the Singapore 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 Aegis-Singapore 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. DEHcTI In relation thereto, Article 5 of the same tax treaty provides: "Article 5 PERMANENT ESTABLISHMENT 1. For the purposes of this Convention, the term 'permanent establishment' means a fixed place of business in which the business of the enterprise is wholly or partly carried on. 2. The term 'permanent establishment' includes specially but is not limited to: a) A seat of management; b) A branch; c) An office; d) A store or other sales outlet; e) A factory; f) A workshop; g) A warehouse, in relation to a person providing storage facilities for others; h) A mine, quarry, or other place of extraction of natural resources; i) A building site or construction or assembly project or installation project or supervisory activities in connection therewith, provided such site, project or activity continues for a period more than 183 days; and j) The furnishing of services, including consultancy services, by a resident of one of the Contracting States through employees or other personnel, provided activities of that nature continue (for the same or a connected project) within the other Contracting State for a period or periods aggregating more than 183 days. DEcSaI xxx xxx xxx" The 183 day period provided for under paragraph 2 (j) quoted above shall be counted based on the total number of days the services are rendered in the Philippines upon effectivity of the Agreement, including all periods resulting from its automatic renewal. Accordingly, for as long as the employees of Aegis-Singapore do not stay in the Philippines for a period or periods aggregating more than 183 days in the course of their rendition of services to Posterscope-Philippines for the "same or connected project", then the Aegis-Singapore is deemed not to have a permanent establishment in the Philippines to which payment of the service fees may be attributed to and therefore, exempt from Philippine income tax and consequently, withholding tax. (BIR Ruling No. DA-ITAD 129-06 dated October 27, 2006) As regards the service fee derived by Avagard-Malaysia, Article 7 of the Philippine-Malaysia tax treaty provides: "Article 7 BUSINESS PROFITS 1. The profits of an enterprise of a Contracting State 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 the other State but only on so much thereof as is attributable to that permanent establishment. xxx xxx xxx" In relation thereto, Article 5 of the same treaty provides: "Article 5 PERMANENT ESTABLISHMENT 1. For the purposes of this Agreement, the term 'permanent establishment' means a fixed place of business in which the business of the enterprise is wholly or partly carried on. acHCSD 2. The term 'permanent establishment' shall include especially: a) a place of management; b) a branch; c) an office; d) a factory; e) a workshop; f) a mine, an oil or gas well, a quarry or other place of extraction of natural resources including timber or other forest produce; g) a farm or plantation; h) a building site or construction, installation or assembly project which exists for more than 6 months. xxx xxx xxx" Pursuant to Article 7 in relation to Article 5 of the Philippines-Malaysia tax treaty, the Philippines is allowed to tax the business profits of an enterprise which is a resident of Malaysia if such enterprise has a permanent establishment situated in the Philippines and only so much of such profit that is attributable to that permanent establishment. Inasmuch as Avagard-Malaysia does not have a fixed place of business in the Philippines, and, as such, is deemed not to have a permanent establishment in the Philippines, the service fees to be paid by Posterscope-Philippines to Avagard-Malaysia for the services rendered under the subject Agreement are not subject to Philippine income tax. (BIR Ruling No. DA-ITAD 134-06 dated October 27, 2006) In addition, inasmuch as it has been represented that Avagard-Malaysia may send its personnel to the Philippines to perform the abovementioned services for purposes of better coordination to areas of concern that may arise, whenever necessary, please be informed that Section 25 (A) (1) of the National Internal Revenue Code (Tax Code) of 1997 provides: aSTECA "Sec. 25. Tax on Nonresident Alien Individual. A. Non-resident Alien Engaged in Trade or Business Within the Philippines. (1) In General. A nonresident alien individual engaged in trade or business in the Philippines shall be subject to income tax in the same manner as an individual citizen and a resident alien individual, on taxable income received from all sources within the Philippines. A nonresident alien individual who shall come to the Philippines and stay therein for an aggregate period of more than one hundred eighty (180) days during any calendar year shall be deemed a 'nonresident alien doing business in the Philippines', Section 22(G) of this Code notwithstanding. xxx xxx xxx" Based on the foregoing provision, a nonresident alien individual who shall come to the Philippines and stay therein for an aggregate period of more than 180 days during any calendar year shall be deemed a nonresident alien doing business in the Philippines and therefore shall be subject to Philippines income tax in the same manner as an individual citizen and a resident alien individual, on taxable income received from all sources within the Philippines. Applying this to the instant case, any income that would be received by the Avagard-Malaysia personnel in the course of their rendition of the abovementioned services to Posterscope-Philippines, shall be subject to Philippine income tax if their aggregate period of stay in the Philippines exceeds 180 days. Otherwise, said income shall be tax-exempt. Moreover, while the payments for services rendered outside the Philippines are not subject to VAT, the fees paid for the services rendered for Posterscope-Philippines within the Philippines are, however, subject to 10% (12% effective February 1, 2006, under Republic Act No. 9337) 1 value-added tax (VAT) pursuant to Section 108 of the Tax Code of 1997. Accordingly, Posterscope-Philippines, being the resident withholding agent and payor in control of payment shall be responsible for the withholding of the final VAT on such fees before making any payment to Aegis-Singapore and Avagard-Malaysia. In remitting the VAT withheld, Posterscope-Philippines shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax & Other Percentage Taxes Withheld). The duly filed BIR Form No. 1600 and proof of payment thereof shall serve as documentary substantiation for the claim of input tax to be applied against the output tax that may be due from Posterscope-Philippines if it is VAT-registered taxpayer. In case it is non-VAT registered taxpayer, the passed-on VAT withheld shall form part of the cost of the service purchased or treated as an "expense" or as an "asset", whichever is applicable. In addition, it is required to issue in quadruplicate the relevant Certificate of Creditable Tax Withheld at Source (BIR Form No. 2307) in quadruplicate, the first three copies for Aegis-Singapore and Avagard-Malaysia and the fourth copy for Posterscope-Philippines as its file copy. (Sections 4 & 6, Revenue Regulations (RR) No. 4-2002; Section 3 of RR 8-2002; Section 7 of RR 14-2002) ACIDSc 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. Very truly yours, Commissioner of Internal Revenue By: (SGD.) GREGORIO V. CABANTAC Deputy Commissioner Footnotes 1. RMC 7-2006 Publishing the Full text of the Memorandum from Executive Secretary Eduardo R. Ermita dated January 31, 2006, Approving the Recommendations of the Secretary of Finance to Value Added Tax Rate from Ten Percent to Twelve Percent.