DA ITAD BIR Ruling No. 079-06

July 19, 2006 DA ITAD BIR RULING NO. 079-06 Arts. 5 & 7, Philippines-Japan Tax Treaty; BIR Ruling No. DA-ITAD 128-05 Punongbayan & Araullo 20th Floor, Tower 1 The Enterprise Center 1200 Makati City Attention: Maria Victoria C . Espao Tax Partner Gentlemen : This refers to your letter dated February 6, 2006 on behalf of your client, Koshin Philippines Corporation (Koshin), seeking for confirmation of your opinion that the service fees paid by Koshin to KJ Corporation (KJ) under the Support Service Agreement are not subject to income tax and value-added tax pursuant to the provision of the Philippines-Japan tax treaty and the National Internal Revenue Code (Tax Code of 1997). It is represented that KJ is a nonresident foreign corporation and is a taxable person in Japan with address at 609-C KSP West Belg, 3-2-1 Sakado, Takatsu-ku, Kawasaki, Kanagawa, Japan, as shown in the Certificate of Status of Taxable Person issued by the District Director of Kawasaki-kita Tax Office; that KJ is not registered either as a corporation or as a partnership in the Philippines as shown in the Certificate of Corporate Filing/Information issued by the Securities and Exchange Commission Cebu Extension Office on January 6, 2006; that Koshin is a corporation duly organized and existing under the laws of the Philippines with principal address located at Mactan Economic Zone II, Lapu-Lapu City, Cebu; that Koshin is engaged in the manufacture of various thin film optical elements and modular fiber-optic devices for electronic, medical, optical, photographic, communications, and general industrial application. HSaCcE It is further represented that on October 1, 2005, Koshin and KJ entered into a Support Service Agreement (SSA) whereby KJ commits the following services to Koshin: 1. Promotion and marketing of the products of Koshin to customers in Japan and other countries; 2. Assistance for Koshin in the procurement of raw materials and supplies in Japan with regard to quality and specifications; 3. Review of the financial and other aspects of Koshin's operation; and 4. Provision for training services; That the above services shall in no case involve the transfer of KJ's technology, know-how, or other intellectual property rights; that KJ shall perform the aforementioned services in Japan and in cases where it would be necessary for KJ to send its employees in the Philippines, the stay of these individuals in the Philippines shall not, in any case, exceed six (6) months; that as a consideration for the said services, Koshin will pay KJ a fixed monthly fee, as indicated in the SSA; and that the SSA shall be effective for a twelve month term commencing on October 01, 2005 subject to renewal for another twelve-month term, unless one of the parties serves a written notice of non-renewal to the other party not later than one (1) month prior to the expiration of the current term. In reply, please be informed of Article 7 of the Philippines-Japan tax treaty quoted as follows: "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" Based on the above, 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 that is attributable to that permanent establishment. Applying this to the instant case, the service fees received by KJ for services rendered in the Philippines under the SSA 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 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. ASIDTa 2. The term 'fixed place of business' includes especially: xxx xxx xxx 6. 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. However, if the furnishing of such services is effected under an agreement between the Governments of the two Contracting States regarding economic or technical cooperation, that enterprise shall, notwithstanding any provisions of this Article, not be deemed to have a permanent establishment in that other Contracting State. xxx xxx xxx." Inasmuch as it has been represented that the services will generally be performed by KJ outside the Philippines and that its employees will 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 Koshin, KJ may be considered as not having a permanent establishment in the Philippines. In other words, KJ 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 Koshin. (BIR Ruling No. DA-ITAD 128-05 dated November 10, 2005) In such a case, the income derived by KJ from services rendered to Koshin shall not be subject to Philippine income tax and, as such, shall likewise be exempt from withholding tax. As regards the imposition of the VAT on the rendition of services of KJ, please be informed further that Section 108 of the Tax Code of 1997 1 provides as follows: "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%) 2 of gross receipts derived from the sale or exchange of services, including the use or lease of properties. 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, . . . ." (Emphasis supplied). Thus, in general, the VAT is imposed on services rendered by KJ in the Philippines. On every payment of service fees, Koshin is required to withhold such VAT and treat the same as a "passed on" VAT, pursuant to Section 4.11.0-3(b) of Revenue Regulations No. 7-95 as amended [ now Section 4.114-2(b) of Revenue Regulations No. 16-05 ]. CSAaDE However, in Commissioner of Internal Revenue vs . Seagate Technology ( Philippines ) (G.R. No. 153866, February 11, 2005), the Supreme Court held, viz : "Special laws may certainly exempt transactions from the VAT. 3 However, the Tax Code provides that those falling under PD 66 are not. PD 66 is the precursor of RA 7916 the special law under which respondent was registered. The purchase transactions it entered into are, therefore, not VAT-exempt. These are subject to the VAT; respondent is required to register. xxx xxx xxx Since the purchases of respondent are not exempt from the VAT, the rate to be applied is zero. Its exemption under both PD 66 and RA 7916 effectively subjects such transactions to a zero rate, because the ecozone within which it is registered is managed and operated by the PEZA as a separate customs territory . This means that in such zone is created the legal fiction of foreign territory. Under the cross-border principle of the VAT system being enforced by the Bureau of Internal Revenue (BIR), no VAT shall be imposed to form part of the cost of goods destined for consumption outside of the territorial border of the taxing authority. If exports of goods and services from the Philippines to a foreign country are free of the VAT, then the same rule holds for such exports from the national territory except specifically declared areas to an ecozone. xxx xxx xxx Applying the special laws we have earlier discussed, respondent as an entity is exempt from internal revenue laws and regulations. This exemption covers both direct and indirect taxes, stemming from the very nature of the VAT as a tax on consumption, for which the direct liability is imposed on one person but the indirect burden is passed on to another. Respondent, as an exempt entity, can neither be directly charged for the VAT on its sales nor indirectly made to bear, as added cost to such sales, the equivalent VAT on its purchases. Ubi lex non distinguit, nec nos distinguere debemus . Where the law does not distinguish, we ought not to distinguish. Moreover, the exemption is both express and pervasive for the following reasons: . . ., RA 7916 states that 'no taxes, local and national, shall be imposed on business establishments operating within the ecozone.' Since this law does not exclude the VAT from the prohibition, it is deemed included. Exceptio firmat regular in casibus non exceptis . An exception confirms the rule in cases not excepted; that is, a thing not being excepted must be regarded as coming within the purview of the general rule. Moreover, even though the VAT is not imposed on the entity but on the transaction, it may still be passed on and, therefore, indirectly imposed on the same entity a patent circumvention of the law. That no VAT shall be imposed directly upon business establishments operating within the ecozone under RA 7916 also means that no VAT may be passed on and imposed indirectly. Quando aliquid prohibetur ex directo prohibetur et per obliquum . When anything is prohibited directly, it is also prohibited indirectly. DSacAE xxx xxx xxx" Based on the foregoing, transactions exempt from VAT by reason of PD 66 and RA 7916 are effectively zero-rated. However, instead of zero-rating which is not available to non-resident suppliers, the provision for exempt transactions under Section 109(q) [now Section 109(K)] of the Tax Code of 1997 which provides VAT exemption for transactions that are exempt under specials laws, e . g ., Republic Act No. 7916 or PEZA Law, is particularly applicable to the instant case. Such being the case, the payment of services fees by Koshin, being a PEZA-registered enterprise, to KJ under the above SSA should be, as it is hereby confirmed to be, exempt from VAT. 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. Please note that this cited provision has been retained by Republic Act (RA) No. 9337, although with the modification as to the applicable rate when the circumstances so warrant. 2. Effective February 1, 2006, the rate shall be 12%. 3. Referring to the old Section 109 (q) of the Tax Code of 1997 [now Section 109(K), as amended by RA No. 9337].