DA ITAD BIR Ruling No. 074-06

June 22, 2006 DA ITAD BIR RULING NO. 074-06 Article 5 & 7 of the Philippines-Singapore tax treaty; BIR Ruling No. 088-86 SGV & Co . 6760 Ayala Avenue 1226 Makati City Attention: R.C. Vinzon Tax Services Gentlemen : This refers to your letter dated March 2, 2005, on behalf of your client, Samsung Electronics Philippines Manufacturing Corporation (SEPHIL), requesting confirmation of your opinion that the fees paid by SEPHIL to Samsung Asia Pte. Ltd. (SAPL) for consultancy services are not subject to Philippine income tax pursuant to Articles 5(2)(j), 7(1) and 12(3) of the Philippines-Singapore tax treaty. It is represented that SAPL is a corporation duly organized and existing under the laws of Singapore with principal at 83 Clemenceau Avenue, #08-01 UE Square, Singapore 239920; that it engaged in the business of research, development, manufacture, procurement, sale and distribution of electrical and electric components, appliances, apparatus, equipment, workstations, facsimile machines and other business equipment, software products and all related products thereto; that SAPL has a representative office in the Philippines, the activities of which are limited to gathering economic, market, and industry information, conducting market research for the market development in the Philippines, assisting Filipino distributors, buyers and end-users in the importation of materials, supplies and components from the Samsung Electro Mechanics companies abroad, conducting such other activities which consists of purely coordination work, and acting as a liaison office between the company and the Samsung Group of Companies; that SEPHIL is a PEZA-registered corporation duly organized and existing under the laws of the Philippines with principal address at Block 6, Calamba Premiere International Park, Batino, Calamba, Laguna; that it is engaged in the design, manufacture and sale of electronic products including but not limited to optical disk drive products, their components and parts. It is further represented that on January 1, 2003, SEPHIL and SAPL entered into a Consultancy Agreement where, as attested by the Certification made by SAPL dated January 12, 2006, SAPL sent employees to the Philippines to provide (a) Overall Business Consulting Services and (b) Shared Services; that in the event that SEPHIL would request SAPL to require personnel from SAPL to be seconded or assigned to SEPHIL, the aggregate stay of SAPL's personnel rendering the services in the Philippines shall not exceed 183 days in a year; that as of this date, SAPL has not yet sent any employees to the Philippines; and that as a consideration for the services rendered, SEPHIL shall pay SAPL an annual service fee, which for 2003 was in the amount of US$310,000. In reply, please be informed that Article 12(3) of the Philippines-Singapore tax treaty defines the term "royalties", as follows: HcTIDC "Article 12 ROYALTIES 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." The above 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), 2005, p. 181], such information alludes to the concept of " know-how ". The definition of " know-how " 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 agrees 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. Further, in the case of Philippine Refining Company 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." Applying the above discussions to the instant case, there is nothing in the subject Agreement that requires transfer to SEPHIL of technology, equipment or other property where SAPL has proprietary interest or that permits SAPL to impart to SEPHIL its special knowledge and experience which remain unrevealed to the public. Inasmuch as SAPL shall render these services using its customary skills, the compensation to be received therefor shall not constitute as consideration for the use of, or the right to use, any copyright, patent, trademark, design or model, plan, secret formula or process, or for the transfer of technology. In this regard, Article 7 in relation to Article 5 of the Philippines-Singapore 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 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" Moreover, Article 5 of the same 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; AaHcIT 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 . (Emphasis supplied) xxx xxx xxx" Based on the foregoing, a corporation which is a resident of Singapore and does not carry on business in the Philippines through a permanent establishment situated therein shall not be subject to Philippine income tax for profits derived in the Philippines. For this purpose, a Singaporean corporation may be deemed to have a permanent establishment in the Philippines if, among others, the furnishing of services through its employees or other personnel continue for the same or a connected project within the Philippines for a period or periods aggregating more than 183 days. Inasmuch as it is represented that the services are to be performed outside of the Philippines by SAPL except for occasional visits to render overall business consultancy services and shared services with SEPHIL, which visits shall in no case exceed 183 days during the term of the contract, then the furnishing of said services by SAPL through its employees or other personnel shall not constitute the carrying on of business through a permanent establishment in the Philippines. Such being the case, payments by SEPHIL to SAPL are considered compensation for labor or personal services performed outside the Philippines and are therefore considered income derived from sources outside the Philippines pursuant to Section 42(C)(3) of the Tax Code of 1997. Furthermore, since the service fees are considered income derived from sources outside the Philippines, the payments made by SEPHIL to SAPL shall not be subject to Philippine income tax, and consequently also to withholding tax under Section 28(B)(1) of the Tax Code of 1997. (BIR Ruling No. 088-86 dated June 24, 1986) 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