DA ITAD BIR Ruling No. 087-06

August 7, 2006 DA ITAD BIR RULING NO. 087-06 Philippines-Denmark tax treaty; Article 5 & 7; BIR Ruling No. DA-ITAD-64-02 SGV & Co. 6760 Ayala Avenue 1226 Makati City Attention: Atty. Joel L. Tan-Torres Partner, Tax Services Gentlemen : This refers to your letter dated May 19, 2006, on behalf of your client, ANHYDRO A/S (ANHYDRO), requesting confirmation that the payments made by Alaska Milk Corporation (AMC), pursuant to a machinery/equipment supply contract, are not subject to Philippine income tax pursuant to Article 7 in relation to Article 5 of the Philippines-Denmark tax treaty. It is represented that ANHYDRO is a nonresident foreign corporation duly organized and existing under laws of Denmark, with registered Office at Oestmarken 7, DK-2860 Soeborg Copenhagen, Denmark; that ANHYDRO is not registered either as a corporation or as a partnership in the Philippines per certification issued by Securities and Exchange Commission dated May 9, 2006. IATSHE It is further represented that on December 8, 2005, ANHYDRO confirmed to supply AMC, a domestic corporation with office address at 6th Floor, Corinthian Plaza, 121 Paseo de Roxas, Makati City, a complete Instant Filled Milk Powder Processing Plant as per quotation no. PHI 0167-H/jih dated November 16, 2005 consisting of an ANHYDRO Spray Drying Plant Type SBD 81, IFB 47, EFB 49 and APV Recombined Milk Processing Plant specially designed for production of 2 tons per hour of Instant Filled Milk Powder amounting to Five Million Eighty Nine Thousand Eighty Six US Dollars (US$5,089,086) including technical documentation, installation and commissioning, delivered Cost, Insurance and Freight (CIF Manila Port), including necessary packing under the machinery/equipment supply contract; that per letter by Clause Madeen, Project Manager and Bent Kurastair, Commercial Controller of ANHYDRO, dated July 11, 2006, it was confirmed that the actual number of days to be spent in the installation and additional supervisory assistance by ANHYDRO under the machinery/equipment supply contract will not exceed 183 days. In reply, please be informed that Article 7 and, in relation thereto, Article 5 of the Philippines-Denmark 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 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 a) that permanent establishment; or b) sales within that other Contracting State of goods or merchandise of the same or similar kind as those sold through that permanent establishment. xxx xxx xxx "Article 5 Permanent Establishment 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. 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, an oil or gas well, a quarry or any other place of preliminary surveys, exploration or extraction of natural resources; g) a building site, a construction, assembly or installation project or supervisory activities within the country in connection therewith, but only where such site, project or activities continue for a period of more than 183 days (emphasis supplied); cCDAHE h) 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 183 days within any twelve month period; i) a drilling rig if its activities are carried on for a period or periods exceeding 365 days in any 18 month period. xxx xxx xxx" Paragraph (g) of the foregoing provisions provides expressly that a building site, a construction, assembly or installation project or supervisory activities in connection therewith constitutes a permanent establishment only if it lasts more than 183 days. In other words, if the duration of a contract, until its completion, in connection with an installation project or supervisory activities, exceeds 183 days, it will constitute carrying on of business in the Philippines through a permanent establishment by the enterprise engaging in such activities. "The term 'building site or construction or installation project' includes not only the construction of buildings but also the construction of roads, bridges or canals, the renovation (involving more than mere maintenance or redecoration) of buildings, roads, bridges or canals, the laying of pipe-lines and excavating and dredging. Additionally, the term 'installation project' is not restricted to an installation related to a construction project; it also includes the installation of new equipment, such as a complex machine, in an existing building or outdoors ." (Paragraph 16, Commentary on Article 5, OECD Model Tax Convention of 2005) (Emphasis ours) In determining when ANHYDRO commenced the installation of the plant the OECD notes: "A site exist from the date on which the contractor begins his work, including any preparatory work, in the country where the construction is to be established, e.g. if he installs a planning office for the construction. In general, it continues to exist until the work is completed or permanently abandoned. A site should not be regarded as ceasing to exist when work is temporarily discontinued. Seasonal or other temporary interruptions include interruptions due to bad weather. . . ." (Paragraph 19, Commentary on Article 5, OECD Model Tax Convention of 2005) Thus, by analogy, ANHYDRO commenced the installation of the plant when it begins its work. including the preparatory work, in the Philippines. The installation activity continues to exist until the installation is completed or permanently abandoned. Based on the foregoing and on your representation that ANHYDRO will not perform the installation activity in the Philippines for more than 183 days, this Office is of the opinion and so holds that the installation fees (including the additional supervisory assistance fees) to be paid to ANHYDRO by AMC are not subject to Philippine income tax. Finally, the fees paid by AMC for the services to be rendered by ANHYDRO in the Philippines are subject to the value-added tax (VAT) pursuant to Section 108 of the Tax Code of 1997. 1 With regard to the procedures for withholding and paying the VAT, Sections 4 and 6 of Revenue Regulations No. 4-2000, Section 3 of Revenue Regulations No. 8-2002, and Section 7 of Revenue Regulations No. 14-2002, provide that AMC shall be responsible for the withholding of the VAT on the service fees before remitting them to ANHYDRO. In remitting to the Bureau of Internal Revenue the VAT withheld on the service fees, AMC shall use BIR Form No. 1600 (Monthly Remittance Return of VAT and Other Percentage Taxes Withheld.). If a VAT-registered taxpayer, AMC may use as documentary substantiation for its claim of input VAT the duly filed BIR Form No. 1600 and the proof of payment accompanying it. If a non-VAT-registered taxpayer, AMC may include as part of the cost of the services furnished to it by ANHYDRO the VAT consequently shifted or passed on to it and may treat such VAT either as an expense or as an asset, whichever is applicable. In addition, AMC is required to issue the Certificate of Final Tax Withheld at Source (BIR Form No. 2306) in quadruplicate, the first three copies thereof to be given to ANHYDRO upon its request, and the fourth copy to be retained by AMC as its file copy. (BIR ITAD Ruling No. DA-ITAD-147-05 dated November 29, 2005) This ruling is issued based on 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. CSHDTE Very truly yours, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service Footnotes 1. Republic Act No. 9337 (An Act Amending Section 27, 28, (An Act Amending Sections 27, 28, 34, 106, 107, 108, 109, 110, 111, 112, 113, 114, 116, 117, 119, 121, 148, 151, 151, 236, 237 And 288 Of The National Internal Revenue Code Of 1997, As Amended, And For Other Purposes), signed into law on May 24, 2005 and became effective on November 1, 2005, amended Section 108(A), which now reads: "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 selling price or gross value in money of the goods or properties sold, bartered or exchanged, such tax to be paid by the seller or transferor: 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 (ii) National government deficit as a percentage of GDP of the previous year exceeds one and one-half percent (1 1/2%). 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 . . ." 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 by 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.