DA ITAD BIR Ruling No. 078-06

July 12, 2006 DA ITAD BIR RULING NO. 078-06 Arts. 5 & 7, Philippines-Netherlands tax treaty; BIR Ruling No. DA-ITAD 134-02 Punongbayan & Araullo 20th Floor, Tower 1, The Enterprise Center 6766 Ayala Avenue, 1200 Makati City Attention: Atty . Benedicta Du-Baladad Tax Partner Gentlemen : This refers to your letter, on behalf of your clients Hemisphere Leo Burnett, Inc. (Hemisphere), Arc Worldwide Philippines Co., Inc. (Arc Worldwide) and Starcom Mediavest Group Philippines, Inc. (Starcom), requesting confirmation of your opinion that the advisory service fees paid to Publicis Worldwide BV (PWW) under their respective Advisory Service Contracts are in the nature of business profits under Article 7 of the Philippines-Netherlands tax treaty, and are therefore, exempt from Philippine income tax and ten percent (10%) value-added tax (VAT). cCaSHA It is represented that PWW is a nonresident foreign corporation organized and existing under the laws of The Netherlands with principal office at 1183 DJ Amstelveen, Prof. W.H. Keesomlaan 12, The Netherlands as evidenced by an authenticated copy of its Articles of Incorporation; that it is not registered either as a corporation or as a partnership in the Philippines as evidenced by the Certification of Non-Registration issued by the Securities and Exchange Commission on December 5, 2005; that Hemisphere, Arc Worldwide and Starcom are domestic corporations with principal office address at 24/F Tower 2, The Enterprise Center, 6766 Ayala Avenue, Makati City, 25/F Tower 2, The Enterprise Center, 6766 Ayala Avenue, Makati City and 24/F Tower 2, The Enterprise Center, 6766 Ayala Avenue, Makati City, respectively. It is further represented that PWW entered into three separate Advisory Service Contracts with Hemisphere, Arc Worldwide and Starcom, respectively; that under the said contracts, PWW will provide services to Hemisphere, Arc Worldwide and Starcom consisting in, but not limited to, the following: I. Advice in Commercial & Creative Development (Quality & Product) Advise on the development of worldwide advertising strategies. Represent the Beneficiary in appropriate international business and trade association. Advise on the methods of approaching new clients and the means and methods of developing big national budgets. Acquisition of new clients and participation in "Pitches". Advise on the availability of new products and services on the advertising market. Advise as to their introduction and their development in the local market. These services or products can be used either by the Beneficiary or made available to its clients. Such advice will include, but will not be limited to: a) Having Expert Staff make contact with potential clients and explaining the scope and nature of the services offered by the Beneficiary. b) Having Expert Staff prepare potential clients' written proposals covering the objectives (what they cover and include) and expected benefits of the Beneficiary's services. Advise regarding the planning, design layout and content of advertising material, promotion programs, sales promotion, etc. Advise to insure the presence, in all the Group's companies, of a high level of quality and excellence in campaigns. II. Advise in Media and Research Assistance in this area is as follows: General advice in Research (methodology, approach) Advise regarding national and international market surveys and any specific analysis in relation to local clients. Advise regarding the drawing up of action plans and the definition of media operations. III. Advise in Finance and Administration The financial and technical advice includes the following areas: Drawing up financing plans. Advise on available credit and assistance in procuring funds. Advise on treasury management. Statistical evaluations and cost comparisons. Advise on setting guidelines for accounting, cost accounting, management accounting, auditing procedures and financial management. Initiating and monitoring yearly business plans and budget. Cash flow planning and reduction of foreign exchange exposure. Providing management systems including short and long range financial planning. Tax and legal advice and assistance. Advise with respect to the Publicis Group worldwide insurance management service. Procurement of insurance plan and payment of insurance costs. Advise on the selection of software systems and the installation of these systems. Advise on computer engineering and technology. Advise on telecommunications procurement and services. Advise on Human resource management issues. Advise on the training of personnel, personnel evaluation, and remuneration and profit-sharing plans. Advise on administrative organization. IV. Advise on Other Issues Advise on the development of the commercial strategy of the Beneficiary. Advise on the global knowledge database. Advise on the selection of key staff member. Advise oil strategies for pursuing new business and key growth strategies. Help select aid manage growth of new markets. Advise on accounting and cost control. Advise on efforts to maintain profitability of units. TAaHIE that the abovementioned services are and will be performed primarily outside the Philippines, and in the event that the presence of PWW's personnel are required in the Philippines, their stay will not exceed an aggregate period of 183 days within any twelve-month period; and that the three contracts are made effective as of January 1, 2003 and shall remain in force and effect until terminated for any reason by either Party. In reply, please be informed that Article 7 of the Philippines-Netherlands tax treaty provides, viz : "Article 7 BUSINESS PROFITS 1. The profits of an enterprise one of the States shall be taxable only in that State unless the enterprise carries on business in the other 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 so much of them as is attributable to that permanent establishment. xxx xxx xxx." Based on the above provision, the profits of an enterprise which is a resident of The Netherlands shall be taxable only in The Netherlands unless such enterprise carries on business in the Philippines through a permanent establishment situated therein. If the enterprise which is a resident of The Netherlands 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 PWW 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 Philippines-Netherlands 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 especially: a) a place of management; b) a branch; c) an office; d) a factory; e) a workshop; f) a mine, quarry, or other place of exploration or extraction of natural resources; g) a building site or construction or assembly project or supervisory activities in connection therewith, where such site, project or activity continues for a period more than 183 days; and h) the furnishing of services including consultancy services by an enterprise through an employee or other personnel where activities of that nature continue (for the same or a connected project) for a period or periods exceeding in the aggregate 183 days within any twelve-month period. xxx xxx xxx." Inasmuch as it is represented that the Advisory Service Contracts shall continue until terminated by either of the respective parties, the whole of such Contract, including its continuance, upon its automatic renewal, shall be regarded as being the "same or connected project" for the purpose of counting the aggregate 183 days within any twelve-month period. In other words, the 183-day period shall be counted based on the total number of days the services are rendered in the Philippines upon effectivity of the subject Contract within any twelve-month period. Accordingly, for as long as the employees or agents of PWW do not stay in the Philippines for a period or periods aggregating 183 days within any twelve-month period in the course of their rendition of services to Hemisphere. Arc Worldwide and Starcom under their respective Contracts, then PWW is deemed not to have a permanent establishment in the Philippines to which payment of the service fees may be attributed. Therefore, such service fees derived by PWW for the rendition of service under the Advisory Service Contracts are exempt from Philippine income tax pursuant to Article 7 in relation to Article 5 of the Philippines-Netherlands tax treaty. (BIR Ruling No. DA-ITAD 132-02 dated October 9, 2003) Moreover, while the payments for services rendered outside the Philippines are not subject to VAT, the fees paid for the services rendered for Hemisphere, Arc Worldwide and Starcom 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, Hemisphere, Arc Worldwide and Starcom, being the resident withholding agents and payors in control of payment shall be responsible for the withholding of the final VAT on such fees before making any payment to PWW. In remitting the VAT withheld, Hemisphere, Arc Worldwide and Starcom 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, respectively, from Hemisphere, Arc Worldwide and Starcom if they are VAT-registered taxpayers. In case they are non-VAT registered taxpayers, 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, they are 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 PWW and the fourth copy for them as their respective file copy. (Sections 4 & 6, Revenue Regulations (RR) No. 4-2002; Section 3 of RR 8-2002; Section 7 of RR 14-2002) 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 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.