DA ITAD BIR Ruling No. 062-06

June 1, 2006 DA ITAD BIR RULING NO. 062-06 Arts. 5 & 7, Philippines-Japan tax treaty; BIR Ruling No. DA-ITAD 128-05; VAT Review Committee Ruling No. 005-2003 Isla Lipana & Co . 29th Floor Philamlife Tower 8767 Paseo de Roxas 1226 Makati City Attention: Atty. George J. Lavadia Principal Gentlemen : This refers to your letter dated November 14, 2005 requesting confirmation that the service fees paid by F. Tech Philippines Manufacturing, Inc. (FTP) to F. Tech, Inc. (FTI) are exempt from Philippine income tax and from value-added tax (VAT) pursuant to the Philippines-Japan tax treaty. It is represented that FTI is a nonresident foreign corporation taxable under the laws of Japan with business address at 19 Showannma, Shoburmachi Minam-Saitamagun, Saitama Pref., Japan as evidenced by its Articles of Incorporation; that FTI 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 November 11, 2005; that FTP, on the other hand, is a company organized and existing under the laws of the Philippines with principal office at 118 North Science Avenue, Laguna Technopark, Bian, Laguna; that it was registered with the then Export Processing Zone Authority, now Philippine Economic Zone Authority (PEZA) under Certificate of Registration No. 94-42 dated June 17, 1994 as evidenced by the Certification issued by the Deputy Director General for Operations of PEZA on January 18, 2005; that on April 1, 2005, FTP entered into a Service Agreement (SA) with FTI; that under the said SA, FTI shall provide the following services to FTP: 1. Management and administration : (i) Assistance in defining and implementing FTP business strategies and policies; (ii) Provision of data on international business trends; (iii) Assistance in improving management and administration systems and provision of solutions to problems encountered by FTP in its operations on an on-going basis; (iv) Assistance in implementing and improving financial and management reporting systems, operational and financial control reviews; (v) Assistance in foreign exchange management as well as procurement of financial support and facilities from both local and offshore sources; and (vi) Evaluation of capital investment and risk management. IAEcCT 2. Marketing : (i) Review and advise on FTP's marketing and promotional plans; (ii) Organization and participation in promotional activities; (iii) Analysis of potential market, clients, competitive factors, etc. (iv) Preparation of advertising materials and assistance in advertising campaign; (v) Provision of marketing financial analysis and assistance to FTP in developing and implementing pricing and marketing strategies; (vi) Advise and assistance in the framework of contracts with the clients and with the regional, national and international organization; and (vii) Assistance in the negotiation with potential customers for possible supply agreement. 3. Purchasing : (i) Assistance in the purchase of services including but not limited to central sourcing for raw material and negotiating with international suppliers to achieve competitive prices; (ii) Assistance in the implementation of purchasing procedures; and (iii) Provision of useful information relating to market conditions and costs saving; that the foregoing services shall in no case involve the transfer of FTI's technology, know-how or other intellectual property rights; that in general, FTI shall perform the aforementioned services in Japan; that in cases where it would be necessary for FTI to send employees to the Philippines, the stay of these individuals in the Philippines shall not, in any case, exceed six (6) months in a year; that in consideration for the services, FTP will pay FTI in the amount of Thirty Six Million Eight Hundred Fifteen Thousand Two Hundred Ninety Five Japanese Yen (Y36,815,295.00), which may be adjusted annually as agreed upon by the parties; and that the SA shall be effective from April 1, 2005 and shall continue to be valid unless terminated according to the provisions of the SA. In reply, please be informed that Article 7(1) 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 FTI 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. HSaCcE 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 An enterprise of a Contracting State shall be deemed to have a permanent establishment in the other Contracting State if it furnishes in that 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. . . ." Inasmuch as it is represented that the services will generally be performed by FTI outside the Philippines and that should it be necessary to send its employees to the Philippines, said employees will not stay in the Philippines for more than six months in their rendition of services to FTP, FTI may be considered as not having a permanent establishment in the Philippines. In other words, FTI 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 FTP. (BIR Ruling No. DA-ITAD 128-05 dated November 10, 2005) Thus, the income derived by FTI from services rendered to FTP shall not be subject to Philippine income tax and, consequently, to withholding tax. Finally, as a PEZA registered enterprise, FTP is subject to the "5% special tax regime, in lieu of all taxes". Hence, its payment for the services rendered by FTI are exempt from VAT, and consequently, from the creditable VAT withholding prescribed under Section 114 (C), NIRC of 1997. (VAT Review Committee Ruling No. 005-2003) This ruling is issued on the basis of the facts as represented. However, if upon investigation it shall be disclosed that the 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.) JAMES H. ROLDAN Assistant Commissioner Legal Service