DA ITAD BIR Ruling No. 070-08

October 29, 2008 DA ITAD BIR RULING NO. 070-08 Articles 5 (Permanent Establishment), 8 (Business Profits) and 16 (Dependent Personal Services); Philippines-United States of America tax treaty; BIR Ruling No. DA-ITAD 149-06 Sycip Gorres Velayo & Co. 6760 Ayala Avenue 1226 Makati City Attention: Atty. Joel L. Tan-Torres Partner, Tax Services Gentlemen : This refers to your letter dated April 23, 2007, 1 requesting confirmation that service fees to be paid by GenOSI, Inc. (GenOSI) to OSI Industries, Inc. (OSI Industries) under an Intercompany Services Agreement are exempt from income tax and from value-added tax. STcHEI BASIC FACTS It is represented that OSI Industries is a corporation organized and existing under the laws of the United States of America based on its Certificate of Incorporation dated July 7, 1975; that OSI Industries has entered into agreements of merger with the following corporations in the United States: 1. Otto & Sons, Inc. of Illinois under an Agreement of Merger dated September 30, 1976. 2. Kaybe Foods, Inc. of Texas under a Certificate of Ownership and Merger dated March 24, 1980. 3. Otto & Sons International, Ltd. of Delaware under a Certificate of Ownership and Merger dated September 22, 1982. 4. OSI Food Company, L.L.C. of Illinois under a Certificate of Merger dated December 20, 2002. That in all these mergers, OSI Industries became the surviving corporation and the other corporations became the corporations ceasing to exist; that based on the Certificate of Conversion and Certificate of Formation dated January 2, 2004, issued by the State of Delaware, that State has approved the conversion and formation of OSI Industries, Inc. from one of a corporation to one of a limited liability company, effective on January 4, 2004, which is subsequently reflected in the change of the last part of the name of OSI Industries from "Incorporated" or "Inc." to "Limited Liability Company" or "LLC"; that OSI Industries is situated at the Corporation Trust Center, 1209 Orange Street, Wilmington, New Castle, Delaware, United States, and that it is not registered as a corporation or partnership in the Philippines based on a certification issued by the Securities and Exchange Commission dated May 8, 2007; and that, on the other hand, GenOSI is a corporation organized and existing under the laws of the Philippines, and that it is situated at F.P. Felix Avenue, Sto. Domingo, Cainta, Rizal, Philippines. IcAaEH It is further represented that on January 4, 2002, GenOSI and OSI Industries entered into an Intercompany Services Agreement (Agreement) wherein OSI Industries have agreed to provide GenOSI the following services involving the manufacture, marketing and distribution of food products: Accounting Acquisitions and joint ventures Employee benefits administration Engineering Finance Insurance Intellectual property licensing and management Internal audit Legal Management information systems and information technology Personnel management, recruitment and training Product marketing and business development Quality assurance and food safety Real estate purchase, sale, leasing and management Research and development for products and production processes Tax Technical support and manufacturing Treasury TacSAE That in providing these services, both parties have acknowledged that OSI Industries will be incurring direct and indirect costs relating thereto, which include but are not limited to compensation and travel expenses, outside fees, and miscellaneous expenses; that taking this into account, GenOSI will compensate OSI Industries in the following manner: a) GenOSI will pay OSI Industries an amount equal to its (GenOSI) Budgeted Allocation Percentage multiplied by the total Service Costs of OSI Industries . Budgeted Allocation Percentage means the percentage of Service Costs allocated to GenOSI as determined during the annual budgeting process of OSI Industries . Service Costs means the sum of all costs and expenses incurred by OSI Industries during a year in the course of providing services to GenOSI and its affiliates. b) Charges on a time and disbursement basis for services directly allocated to GenOSI's business. Personnel of OSI Industries will keep a log of services performed for GenOSI. Rates for such services will be set not later than January 30 of each year which will be based on the personnel's compensation for the Fiscal Year concerned. Fiscal Year means the accounting year adopted by OSI Industries comprising of a 52- or 53-week period ending on a Saturday closest to December 31. That such compensation will be in U.S. dollars or in any other currency acceptable to both parties; that for compensation described in Item (a), for a particular fiscal year, GenOSI will make a monthly payment of one-twelfth (1/12) of the estimated fees invoiced to it by OSI Industries and will settle all outstanding fees not later than February 28 of the following fiscal year; and that for compensation described in Item (b), for each month of a particular fiscal year, GenOSI will make a monthly payment for charges invoiced to it by OSI Industries and will settle these charges not later than the 20th day of the second month following the month in which the invoice was issued. It is further represented that the Agreement became effective on January 4, 2002, and will be automatically renewed upon the end of each successive fiscal year, unless either party gives a notice of termination to the other party at least 90 days after the end of a particular previous fiscal year; that in entering into the Agreement, both parties have considered that, on the one hand, OSI Industries has assembled an experienced staff and offers a complete range of services to its affiliates, and, on the other hand, GenOSI is engaged in the same type of business of OSI Industries, which is manufacturing and distributing food products for quick service restaurants, foodservice distributors, branded products marketers, and grocery and other food retailers; and that GenOSI conducts its business in a similar manner with OSI Industries and it has basically the same need for expertise of specialists like those of OSI Industries, which the latter is willing to provide to GenOSI. DTIcSH It is further represented that based on the notarized certification by GenOSI dated March 19, 2008, OSI Industries has been sending its personnel to GenOSI in the Philippines to perform services for the latter pursuant to the Agreement; and that for the fiscal years 2002 to 2007, the duration of these services and the personnel sent are as follows: Fiscal Year Duration Personnel 2002 30 days Mr. David McDonald Mr. Frank Latimer Mr. Andrew Wang Mr. James Youker Mr. Liang Fuyan Mr. Zhicheng Qiao Mr. Harry Xia Mr. Way Chen 2003 14 days Mr. Frank Latimer Mr. James Youker Mr. Harry Xia Mr. Way Chen Mr. Tom Shih 2004 6 days Mr. James Youker Mr. Wade Smith Ms. Juliana Macedo 2005 33 days Mr. Frank Latimer Mr. Tom Shih Mr. Mao Yijia Mr. Way Chen Mr. Zhicheng Qiao Mr. Lai Kaifatt Mr. James Youker Mr. Steven Zhang 2006 14 days Mr. Lai Kaifatt Mr. James Youker Mr. Steven Zhang 2007 32 days Mr. Frank Latimer Mr. Steven Zhang Mr. Lai Kaifatt Mr. James Youker Mr. BK Girdhar It is finally represented that based on the notarized certification by GenOSI dated July 31, 2008, services performed by OSI Industries to GenOSI in the Philippines under the Agreement do not involve the transfer by OSI Industries of information concerning industrial, commercial or scientific experience which are unrevealed to the public, but rather involves only the use of customary skills by OSI Industries. AIcaDC A. On income tax In reply, please be informed that under Section 23 (F) of the National Internal Revenue Code of 1997 (Tax Code of 1997), a foreign corporation like OSI Industries, whether or not engaged in trade or business in the Philippines, is taxable on income derived from sources within the Philippines. It provides: "SEC. 23. General Principles of Income Taxation in the Philippines . Except when otherwise provided in this Code: xxx xxx xxx (F) A foreign corporation, whether engaged or not in trade or business in the Philippines, is taxable only on income derived from sources within the Philippines." In this case, since OSI Industries is not engaged in trade or business in the Philippines, based on the relevant certification issued by the Securities and Exchange Commission, it is generally subject to income tax under Section 28 (B) (1) of the Tax Code of 1997 (as amended by Republic Act No. 9337) 2 at the rate of thirty-five percent (35%) based on the gross amount of income it derives from sources in the Philippines. It provides: "SEC. 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 subparagraphs 5(c). Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)." THIcCA However, under Section 32 (B) (5) of the Tax Code of 1997, such income derived by OSI Industries in the Philippines may be exempt from tax (or partially exempt from tax if subject only to a reduced income tax rate) if the same is so exempt (or partially exempt ) pursuant to a treaty obligation binding upon the Philippine government. Section 32 (B) (5) provides: "SEC. 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." With respect to a treaty that may be invoked by OSI Industries and all other residents of the United States, there is the Convention between the Government of the Republic of the Philippines and the Government of the United States of America with Respect to Taxes on Income (Philippines-United States tax treaty) . 3 Inasmuch as based on the notarized certification by GenOSI dated July 31, 2008, the performance of services by OSI Industries to GenOSI under the Intercompany Services Agreement does not involve the transfer by OSI Industries to GenOSI of information concerning industrial, commercial or scientific experience which are unrevealed to the public, but rather involves only the use of customary skills by OSI Industries, compensation to be paid by GenOSI to OSI Industries for such services will not be deemed as royalties, but merely as payments for services . This being the case, paragraph 1, Article 8 of the Philippines-United States tax treaty, which generally treats payments for services as business profits, provides as follows: aHIDAE "Article 8 Business Profits 1. Business profits of a resident of one of the Contracting States shall be taxable only in that State unless the resident has a permanent establishment in the other Contracting State. If the resident has a permanent establishment in that other Contracting State, tax may be imposed by that other Contracting State on the business profits of the resident but only on so much of them as are attributable to the permanent establishment." Based on paragraph 1, business profits ( e.g. , income from the sale of goods or merchandise, income from the supply of services, income from the lease of personal property) derived by a resident of the United States from sources in the Philippines may be taxed in the Philippines if they are attributable to a permanent establishment which that resident has in the Philippines. Relative thereto, a permanent establishment is defined as a fixed place of business through which a resident of the Philippines or the United States engages in a trade or business. Paragraphs 1 and 2, Article 5 of the Philippines-United States tax treaty provide as follows: "Article 5 Permanent Establishment 1. For the purposes of this Convention, the term 'permanent establishment' means a fixed place of business through which a resident of one of the Contracting States engages in a trade or business. 2. The term 'fixed place of business' includes 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; h) A mine, quarry, or other place of extraction of natural resources; acITSD i) A building site or construction or assembly project or supervisory activities in connection therewith, provided such site, project or activity continues for a period of 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." Based on paragraphs 1 and 2, OSI Industries is considered to have a permanent establishment in the Philippines if (a) it has a fixed place of business in the Philippines, such as an office or a branch, through which it engages in a trade or business; or (b) it furnishes services in the Philippines, through employees or other personnel thereof, for a period or periods aggregating more than 183 days. Concerning a permanent establishment in the form of a branch, an office or any other similar fixed place of business, it is unlikely for OSI Industries to have this kind of permanent establishment in the Philippines if it is not engaged in trade or business in the Philippines, which can be determined generally by taking into account the status of registration of OSI Industries with the Securities and Exchange Commission. Thus, on account of the relevant certification issued by the Securities and Exchange dated March 14, 2007, that OSI Industries is not registered as a corporation or as a partnership in the Philippines, OSI Industries is deemed unlikely to have a permanent establishment in the Philippines of this nature at least as of the date of the certification on March 14, 2007. Concerning a permanent establishment in the form of furnishing of services lasting for more than 183 days, a summary of the duration of the services performed by personnel of OSI Industries in the Philippines for the fiscal years beginning 2002 (the year of effectivity of the subject Agreement between GenOSI and OSI Industries ) up to 2007 reveals that such services lasted for 129 days only. This being the case, the furnishing of services by personnel of OSI Industries does not constitute also a permanent establishment of the latter at least for the fiscal years 2002 to 2007. STaHIC Therefore, since OSI Industries is deemed as not having a permanent establishment in the Philippines for the fiscal years 2002 to 2007, compensation to be paid to it by GenOSI under the Agreement for these fiscal years are not subject to income tax pursuant to paragraph 1, Article 7, in relation to paragraphs 1 and 2, Article 5, of the Philippines-United States tax treaty. (BIR Ruling No. DA-ITAD 149-06 dated December 8, 2006) However, for the succeeding fiscal years after 2007, compensation to be paid by GenOSI to OSI Industries under the Agreement will be subject to income tax as soon as performance of services in the Philippines by OSI Industries' personnel exceeds 183 days, as OSI Industries will then be deemed to have a permanent establishment in the Philippines pursuant to Article 5 (2) (j) of the Philippines-United States tax treaty. On the other hand, remuneration of OSI Industries' personnel who perform the services in the Philippines for GenOSI are generally taxable in the Philippines. However, such remuneration will be exempt from income tax if all the following conditions in paragraph 2, Article 16 of the Philippines-United States tax treaty are attendant for each of such personnel, to wit: "Article 16 Dependent Personal Services 1. Except as provided in Article 20 (Governmental Functions), wages, salaries, and similar remuneration derived by an individual who is a resident of one of the Contracting States from labor or personal services performed as an employee, including income from services performed by an officer of a corporation, may be taxed by that Contracting State. Except as provided by paragraphs 2 and 3 and in Articles 20 (Governmental Functions), 21 (Teachers), and 22 (Students and Trainees), such remuneration derived from sources within the other Contracting State may also be taxed by that other Contracting State. 2. Remuneration described in paragraph 1 derived by an individual who is a resident of one of the Contracting States shall be exempt from tax by the other Contracting State if: a) He is present in that other Contracting State for a period or periods aggregating less than 90 days in the taxable year; AIHaCc b) He is an employee of a resident of, or of a permanent establishment maintained in, the first-mentioned Contracting State; and c) The remuneration is not borne as such by a permanent establishment which the employer has in that other Contracting State." The first requirement [subparagraph (a)] is satisfied for the fiscal years 2002 to 2007 because the duration of the services performed by each personnel individually, for each fiscal year was less than 90 days. The second requirement [subparagraph (b)] is also satisfied because the personnel are employees of GenOSI, who is a resident of the United States. The third requirement [subparagraph (c)] is also satisfied for the fiscal years 2002 to 2007 because GenOSI does not have a permanent establishment in the Philippines in these fiscal years. (BIR Ruling No. DA-ITAD 149-06 dated December 8, 2006) B. On value-added tax Under Section 108 (A) (1) and (3) of the Tax Code of 1997, as amended by Republic Act No. 9337, the sale or exchange of services, including the use or lease of properties, in the Philippines is subject to value-added tax (VAT). It provides: "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%) of gross receipts derived from the sale or exchange of services, including the use or lease of properties: Provided, that the President, upon the recommendation of the Secretary of Finance, shall, effective January 1, 2006, raise the rate of value-added tax to twelve percent (12%), after any of the following conditions has been satisfied: (i) Value-added tax collection as a percentage of Gross Domestic Product (GDP) of the previous year exceeds one and one-half percent (1 1/2%); or cHECAS (ii) National government deficit as a percentage of GDP of the previous year exceeds one and one-half percent (1 1/2%). 4 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, . . ." As mentioned, the Agreement between GenOSI and OSI Industries calls for OSI Industries to provide services to GenOSI involving the manufacture, marketing and distribution of food products. Clearly, the provision of these services in the Philippines falls within the phrase "sale or exchange of services" in Section 108 (A) (1) above which is subject to VAT. Under Section 105 of the Tax Code of 1997, while the VAT is imposed on any person who sells, barters, exchanges, leases goods or properties, and renders services, generally in the course of its trade or business, this section likewise provides that services rendered in the Philippines by a nonresident foreign person like OSI Industries is considered rendered in the course of trade or business and as such will be subject to VAT. Section 105 provides: "SEC. 105. Persons Liable . Any person who, in the course of trade or business, sells, barters, exchanges, leases goods or properties, renders services, and any person who imports goods shall be subject to the value-added tax (VAT) imposed in Sections 106 to 108 of this Code. The value-added tax is an indirect tax and the amount of tax may be shifted or passed on to the buyer, transferee or lessee of the goods, properties or services. This rule shall likewise apply to existing contracts of sale or lease of goods, properties or services at the time of the effectivity of Republic Act No. 7716. The phrase 'in the course of trade or business' means the regular conduct or pursuit of a commercial or an economic activity, including transactions incidental thereto, by any person regardless of whether or not the person engaged therein is a non-stock, nonprofit private organization (irrespective of the disposition of its net income and whether or not it sells exclusively to members or their guests), or government entity. The rule of regularity, to the contrary notwithstanding, services as defined in this Code rendered in the Philippines by nonresident foreign persons shall be considered as being rendered in the course of trade or business ." (emphasis supplied) Accordingly, pursuant to Section 4.112-2 of Revenue Regulations No. 16-2005, 5 as amended by Revenue Regulations No. 4-2007, 6 GenOSI, as a resident withholding agent, is liable to withhold VAT on such compensations to be made under the Agreement before remitting them to OSI Industries, the nonresident recipient, at the rate of twelve percent (12%) beginning February 1, 2006, and onwards. (BIR Ruling No. DA-ITAD 60-07 dated May 11, 2007.) Section 4.112-2 provides: "SEC. 4.114-2. Withholding of VAT on Government Money Payments and Payments to Non-Residents . xxx xxx xxx (b) The government or any of its political subdivisions, instrumentalities or agencies including GOCCs, as well as private corporation, individuals, estates and trust, whether large or non-large taxpayers, shall withhold twelve percent (12%) VAT, starting February 1, 2006, with respect to the following payments: HTAEIS (1) Lease or use of properties or property rights owned by non-residents; and (2) Other services rendered in the Philippines by non-residents. In remitting VAT withheld, the withholding agent shall use BIR Form No. 1600 Remittance Return of VAT and Other Percentage Taxes Withheld. VAT withheld and paid for the non-resident recipient (remitted using BIR Form No. 1600), which VAT is passed on to the resident withholding agent by the non-resident recipient of the income, may be claimed as input tax by said VAT-registered withholding agent upon filing his own VAT Return, subject to the rule on allocation of input tax among taxable sales, zero-rated sales and exempt sales. The duly filed BIR Form No. 1600 is the proof or documentary substantiation for the claimed input tax or input VAT. Nonetheless, if the resident withholding agent is a non-VAT taxpayer, said passed-on VAT by the non-resident recipient of the income, evidenced by the duly filed BIR Form No. 1600, shall form part of the cost of purchased services, which may be treated either as an 'expense' or 'asset', whichever is applicable, of the resident withholding agent. VAT withheld under this Section shall be remitted within ten (10) days following the end of the month the withholding was made." 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. SDaHEc Very truly yours, Commissioner of Internal Revenue By: (SGD.) GREGORIO V. CABANTAC Deputy Commissioner Footnotes 1. Originally addressed to the Law Division who already prepared a draft ruling for it. However, upon review of that ruling by the Deputy Commissioner for Legal and Inspection Group, the Deputy Commissioner, through a marginal note, forwarded the ruling to the International Tax Affairs Division on December 17, 2007, for further review. TcEaDS 2. Entitled An Act Amending Sections 27, 28, 34, 106, 107, 108, 109, 110, 111, 112, 113, 114, 116, 117, 119, 121, 148, 151, 236, 237 and 288 of the National Internal Revenue Code of 1997, As Amended, and for Other Purposes, which was signed into law on May 24, 2005, and effective in November 2005. 3. Signed on October 1, 1976, and effective on January 1, 1983. 4. The VAT rate was increased to 12% on February 1, 2006, in accordance with the Memorandum of the Executive Secretary to the Secretary of Finance dated January 31, 2006, as circularized under Revenue Memorandum Circular No. 7-2006 (Publishing the Full Text of the Memorandum from Executive Secretary Eduardo R. Ermita dated January 31, 2006 Approving the Recommendation of the Secretary of Finance to Increase the Value Added Tax Rate from Ten Percent to Twelve Percent) dated January 31, 2006. 5. Entitled Consolidated Value-Added Tax Regulations of 2005, dated September 1, 2005, and effective fifteen days after its publication. 6. Entitled Amending Certain Provisions of Revenue Regulations No. 16-2005, As Amended, Otherwise Known as the Consolidated Value-Added Tax Regulations of 2005, dated February 7, 2007, and which is effective fifteen days after its publication. SITCcE