DA ITAD BIR Ruling No. 083-08

October 29, 2008 DA ITAD BIR RULING NO. 083-08 Articles 7 in relation to 5 and Article 15, Philippines-China Tax Treaty; BIR Ruling No. DA-ITAD 084-05 Manabat Delgado Amper & Co. 3rd-6th Floor, Salamin Building 197 Salcedo St., Legaspi Village Makati City Attention: Richard R. Lapres Tax Director Gentlemen : This refers to your letter dated May 31, 2007, filed on behalf of your client, Amertron Incorporated (Amertron-Philippines), requesting for confirmation of your opinion that the payments made by Amertron-Philippines to Amertron Technology (Kunshan) Co., Ltd. (Amertron-China) for the marketing services done in Pan-Pacific areas, are in the nature of business profits and not royalties under the provisions of the Philippines-China Tax Treaty, and are therefore, exempt from the Philippine income tax and final withholding tax pursuant to the pertinent sections of the National Internal Revenue Code of 1997 (Tax Code of 1997), as amended. TAaIDH It is represented that Amertron-China is a corporation organized and existing under the laws of the People's Republic of China with registered address at Export Processing Zone, No. 8, Xin Zhu Road, Kunshan City, Jiangsu Province 215300, China; that it is not registered either as a corporation or as a partnership as shown in the Certificate of Non-Registration of Corporation/Partnership dated April 25, 2007 issued by the Philippine Securities and Exchange Commission; that Amertron-Philippines is a domestic corporation with registered address at Kilometer 17, West Service Road, South Superhighway, Paraaque City; that it is engaged in the business of manufacturing, importing, exporting, buying, selling or otherwise dealing in optoelectronic products and services, and any and all equipment materials and supplies used or employed in or related to the manufacture of finished products or services. It is further represented that on April 1, 2007, Amertron-China and Amertron-Philippines entered into a Marketing Agreement (Agreement) whereby Amertron-China agreed to perform the marketing and promotion of the optoelectronic semiconductor products and services (OSPS) of Amertron-Philippines in the Pan-Pacific Areas as well as in the People's Republic of China; that Amertron-China may send its personnel in the Philippines for a period or periods aggregating not more than six (6) months within any twelve-month period in the performance of the said services; that in consideration thereof, Amertron-Philippines commits to make payments to Amertron-China a Marketing Development Fee equal to 1% per month on the portion of aggregate gross revenues of Amertron-Philippines which exceeds that of the same month in previous year (in case of zero or negative growth on aggregate revenue in a particular month compared to the same calendar month in the previous year, 0% of the growth should be paid), on top of a monthly fixed amount of United States Dollar Twenty Thousand Only (USD20,000); that the term of the Agreement shall be effective as of April 1, 2007 unless terminated according to the provisions set forth herein; and that the issue or transaction subject of the above application is not under investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings, or a judicial appeal. In reply, please be informed that the Section 28 (B) (1) of the National Internal Revenue Code (Tax Code) of 1997 as amended, applies in general. It provides: "Section 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 subparagraph 5(c) and (d): Provided, That effective January 1, 2009, at the rate of income tax shall be thirty percent (30%). xxx xxx xxx However, Section 32 (B) (5) of the Tax Code of 1997, as amended provides: "Section 32. Gross Income . xxx xxx xxx (B) Exclusions from Gross Income. The following items shall not be included in gross 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. DcCIAa xxx xxx xxx" Thus, you invoke the provisions of the Philippines-China tax treaty. Article 12 (3) of the Philippines-China tax treaty provides, viz. : "Article 12 Royalties xxx xxx xxx 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 cinematography films, or films or tapes for radio or television 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. "xxx xxx xxx" The abovementioned 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 CO-OPERATION AND DEVELOPMENT (OECD) Committee on Fiscal Affairs on the Model Tax Convention on Income and on Capital [par. 11, Commentary on Article 12 (royalties), 2005, p. 181), such information alludes to the concept of "know-how". The definition of know-how, which has been 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 agree 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. (BIR Ruling No. DA-ITAD 49-02 dated April 15, 2002) In relation to this, it is noteworthy that in the case of Philippine Refining Company (PRC) 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." Based on the above, the subject payments under the Agreement are not within the definition of royalties under Article 12 (3) of the Philippines-China tax treaty as nothing in the said Agreement would require transfer in the Philippines of "know-how" or any property of the payee over which the payee has proprietary interest. Accordingly, instead of Article 12 as aforequoted, Article 7 in relation to Article 5 of the same tax treaty is applicable to the subject fees. It 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 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" "Article 5 Permanent Establishment 1. For the purposes of this Agreement, the term 'permanent establishment' means a fixed place of business through which the business of an 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; and f) a mine, an oil or gas well, a quarry or any other place of extraction of natural resources. 3. The term 'permanent establishment' likewise encompasses: a) a building site, a construction, assembly or installation project or supervisory activities in connection therewith, but only where such site, project or activities continue for a period of more than 6 months. b) an installation, drilling rig or ship used for the exploration of natural resources, but only if so used for a period of more than three months; and c) the furnishing of services, including consultancy services, by an enterprise through employees or other personnel engaged by the enterprise for such purpose, but only where activities of that nature continue (for the same or a connected project) within the country for a period or periods aggregating more than 6 months within any twelve-month period. xxx xxx xxx" Pursuant to Article 7 in relation to Article 5 of the Philippines-China tax treaty, the Philippines is allowed to tax the business profits of an enterprise which is a resident of China if such enterprise has a permanent establishment situated in the Philippines and only so much of such profit that is attributable to that permanent establishment. Thus, the marketing fees to be paid by Amertron-Philippines for the services rendered by Amertron-China under the subject Agreement are not subject to Philippine income tax if it will be established that it has no permanent establishment in the Philippines. ATESCc Inasmuch as it is represented that the services will generally be performed by Amertron-China 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 a period or periods aggregating more than six months within any twelve-month period in their rendition of services to Amertron-Philippines, Amertron-China may be considered as not having a permanent establishment in the Philippines. In other words, Amertron-China 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 twelve-month period in the course of their rendition of services to Amertron-Philippines. (BIR Ruling No. DA-ITAD 084-05 dated August 23, 2005) Thus, the income derived by Amertron-China from services rendered to Amertron-Philippines shall not be subject to Philippine income tax and, consequently, to withholding tax. Moreover, while the payments for services rendered outside the Philippines are not subject to VAT, the fees paid for the services rendered for Amertron-Philippines within the Philippines are, however, subject to the 12% value-added tax (VAT) pursuant to Section 108 of the Tax Code of 1997, as amended. Accordingly, Amertron-Philippines, being the resident withholding agent and payor in control of payment shall be responsible for the withholding of the final VAT on such fees before making any payment to Amertron-China. In remitting the VAT withheld, Amertron-Philippines 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 from Amertron-Philippines if it is VAT-registered taxpayer. In case it is non-VAT registered taxpayer, 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, it is 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 Amertron-China and the fourth copy for Amertron-Philippines as its file copy. (Sections 4 & 6, Revenue Regulations (RR) No. 4-2002; Section 3 of RR 8-2002; Section 7 of RR 14-2002) EaHcDS 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. Very truly yours, Commissioner of Internal Revenue By: (SGD.) GREGORIO V. CABANTAC Deputy Commissioner