DA ITAD BIR Ruling No. 098-06

August 25, 2006 DA ITAD BIR RULING NO. 098-06 Sections 105, 108 [(A) and (B) (3)] and 109 (q) National Internal Revenue Code of 1997 Articles II and IV, Philippines-United States of America Economic and Technical Cooperation Agreement; BIR Ruling No. DA-ITAD 16-05 Punongbayan & Araullo 20th Floor, Tower 1 The Enterprise Center 6766 Ayala Avenue 1200 Makati City Attention: Atty. Maria Victoria C. Espao Tax Partner Gentlemen : This refers to your letter dated February 3, 2006 requesting confirmation that the service fees to be paid by the United States Agency for International Development (USAID) to Tetra Tech EM, Inc. (Tetra Tech) (formerly, PRC-Environmental Management, Inc .) in connection with Philippine projects funded by the USAID are not subject to value-added tax (VAT). BASIC FACTS It is represented that Tetra Tech is a corporation, organized and existing under the laws of the United States of America, with address at 233 North Michigan Avenue, Suite 1621, Chicago, Illinois 60601, united States of America; that pursuant to an application approved by the Securities and Exchange Commission, Tetra Tech is licensed to establish a branch office in the Philippines to engage in the business of rendering technical support, preparation of feasibility studies, and project management in the area of environment; that the branch office refers to Tetra Tech Philippine Branch with Registration No. AF0930043, and with address at One Magnificent Mile, San Miguel Avenue, Ortigas Center, Pasig City, Philippines; and that on July 9, 1992, February 21, 1996 and September 19, 2003, respectively, the USAID granted Tetra Tech the Awards/Contracts to implement the following projects in the Philippines: 1. The Industrial Environmental Management (IEMP) Project (Contract No. AID 492-0465-C-00-2147-00) 2. The Natural Resources Management Program Coastal Resources Management (CRM) Project (Contract No. 492-0444-C-6028-00), and 3. The Fisheries Improved for Sustainable Harvest (FISH) Project (Contract No. 492-C-00-03-00022-00). a. The IEMP Project That under the IEMP Project, Tetra Tech , through Tetra Tech Philippine Branch , will implement activities that will directly impact upon the Government of the Republic of the Philippines, Industry Associations, public/private sector industrial firms and non-government organizations, by providing services including technical assistance, support for policy studies, public/private sector dialogue, training and commodity procurement; that Tetra Tech will deal with three project components; (1) Pollution Reduction Initiative, (2) Policy Studies and Public/Private Dialogues, and (3) Capacity Building; and that the service fee for the IEMP Project is US$10,358,525.00 (composed of project cost at US$9,591,227.00 and service fee at US$767,298.00). b. The CRM Project That under the CRM Project, Tetra Tech , through Tetra Tech Philippine Branch , will implement the following performance objectives: (1) effective management of coastal waters along 2,000 kilometers of shoreline by communities for sustainable harvest, (2) increased public sector investment in CRM activities and policy implementation, and (3) mechanisms for providing equity in access to coastal resources, (4) sustainable management and an improved investment climate, and (5) other activities; and that the service fee for the CRM Project is US$10,789,707.12 (composed of project cost at US$10,083,838.43, fixed fee at US$201,676.77, and possible award fee at US($504,191.92). IAaCST c. The FISH Project That under the FISH Project, Tetra Tech , through Tetra Tech Philippine Branch , will implement a wide range of activities it deems fit to achieve the Project's objective to conserve biological diversity in at least four biologically important marine ecosystems in the Philippines, as measured by an increase in targeted marine fish stocks and the maintenance of selected coastal resources that support them with environmental services; that the project activities are expected to reverse current trends on fish stock depletion and degradation of coastal resources in target areas and bring about more sustainable catch levels of marine fish stocks the benefit productivity and stakeholders; that the Project is designed, and will be implemented, to encourage the Bureau of Fish and Aquatic Resources of the Department of Agriculture and Local Government Units to replicate this ecosystem management approach in other marine and coastal ecosystems; that the service fee for the FISH Project for the base contract period (Years 1 to 5) is US$8,860,476.00 (composed of project cost at US$8,242,303.00 and fixed fee at US$618,173.00); and that if the option to extend the contract period (Years 6 to 7) is exercised, the service fee for the FISH Project for the option period is US$3,266,488.00 (composed of project cost at US$3,038,556.00, fixed fee at US$106,349.00, and possible performance/award fee at US$121,542.00). That pursuant to the above-mentioned Awards/Contracts, the USAID will reimburse Tetra Tech for project-related costs and pay it a fixed fee for its services; and that Tetra Tech Philippine Branch will invoice the USAID for the projects costs and fixed fees in United States dollars, and the USAID will remit the payments directly to Tetra Tech in the United States. RULING In reply, please be informed that under Section 108(A) of the National Internal Revenue Code of 1997 (Tax Code), the service fees to be paid by the USAID to Tetra Tech (composed of project costs, fixed fees, and possible performance/award fees), being payments for the performance of services in the Philippines, are generally subject to VAT: "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. 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 . . . : 1 Under Section 105 of the Tax Code, because the VAT is an indirect tax, it may be shifted or passed on by Tetra Tech to the USAID : "SEC. 105. Persons Liable . Any person who, in the course of trade or business, sells, barters, exchanges, leases goods or properties, renders services, and any person who imports goods shall be subject to value-added tax (VAT) imposed in Sections 106 to 108 of this Code. The value-added tax is an indirect tax and the amount of tax may be shifted or passed on to the buyer, transferee or lessee of the goods, properties or services . . ." Additionally, Sections 109(q) and 108(B)(3) of the Tax Code provide: "SEC. 109. Exempt Transactions . The following shall be exempt from the value-added tax: xxx xxx xxx (q) Transactions which are exempt under international agreements to which the Philippines is a signatory or under special laws, except those under Presidential Decree Nos. 66, 529 and 1590; 2 "SEC. 108. Value-added Tax on Sale of Services and Use or Lease of Properties . xxx xxx xxx (B) Transactions Subject to Zero Percent (0%) Rate. The following services performed in the Philippines by VAT-registered persons shall be subject to zero percent (0%) rate: xxx xxx xxx (3) Services rendered to persons or entities whose exemption under special laws or international agreements to which the Philippines is a signatory effectively subjects the supply of such services to zero percent (0%) rate." Under the above-cited provisions, the transaction between Tetra Tech and the USAID may be treated either as an exempt transaction or as one subject to zero percent (0%) VAT rate . In an exempt transaction. Tetra Tech will not subject to VAT (output tax) the service fees paid to it by the USAID and it is not allowed any tax credit on VAT (input tax) it previously paid. Tetra Tech will not bill any output tax to the USAID because the said transaction is not subject to VAT. On the other hand, Tetra Tech , if it is a VAT-registered purchaser of VAT-exempt goods/properties or services, it is not entitled to any input tax on its purchases despite the issuance of a VAT invoice or receipt. (Section 4.103-1, Revenue Regulations 7-95) 3 On the other hand, in a zero-rated transaction, which is a taxable transaction for VAT purposes, the transaction which Tetra Tech has with the USAID , assuming Tetra Tech is a VAT-registered person, will not result in any output tax. However, the input tax on Tetra Tech's purchases of goods, properties or services related to such zero-rated sale shall be available as tax credit or refund. (Section 4.102-2, Ibid. ) 4 Further, in an effectively zero-rated transaction, which refers to the sale by a VAT-registered person to a person or entity who was granted indirect tax exemption under special laws, or international agreements, a prior application by Tetra Tech with the appropriate offices of the Bureau of Internal Revenue for effective zero-rating is required. Without an approved application for effective zero-rating, the transaction otherwise entitled to zero-rating shall be considered exempt. (Section 4.107-1, Ibid .) 5 Relative thereto, based on paragraph 1, Article IV of the Economic and Technical Cooperation Agreement between the Government of the United States of America and the Government of the Republic of the Philippines (Agreement) (which was signed on of April 27, 1951 and entered into force on May 21, 1951), for purposes of according privileges and immunities to the Special Technical and Economic Mission and its personnel of comparable diplomatic rank, the Philippine government shall, upon appropriate notification by the Ambassador of the United States in the Philippines, consider the Special Technical and Economic Mission and its personnel as part of Diplomatic Mission of the United States in the Philippines, to wit: "Article IV Missions 1. The Government of the Philippines agrees to receive a Special Technical and Economic Mission which will discharge the responsibilities of the Government of the United States of America in the Philippines under this Agreement and the Government of the Philippines will, upon appropriate notification from the Ambassador of the United States of America in the Philippines, consider this Mission and its personnel as part of the Diplomatic Mission of the United States of America for the purpose of enjoying privileges and immunities accorded to that Mission and its personnel of comparable rank. Such Mission shall include but not be limited to experts whose services are made available to implement Article II of this Agreement." The special Technical and Economic Mission will discharge the responsibilities of the United States government to the Philippine government under the Agreement of providing economic and technical assistance in the Philippines, and it is not limited to experts who provide services to implement Article II of the Agreement, quoted hereunder: "Article II Undertakings In order to further the objectives of economic and social well being and preserve free institutions for the Philippine people and to achieve the maximum benefits through the employment of assistance received from the Government of the United States of America, and the Government of the Philippines will use its best efforts to: 1. Adopt and enforce measures necessary to ensure the efficient and practical use of all resources available to it, including among other means; (a) such measures as may be necessary to insure that the commodities or services furnished under this Agreement, including commodities or services obtained from the funds deposited in the Special Account under Section 1 of the Annex to this Agreement, are used only for purposes agreed upon by the two Governments, and (b) the observation and review of the use of such commodities and services through an effective follow-up system established in agreement with the Government of the United States of America with precautions to prevent the diversion of these commodities into illegal or irregular channels of trade. cTADCH 2. Initiate and further implement social, economic and technical programs based upon the recommendations of the Economic Survey Mission and such other measures as will strengthen democratic and free institutions in the Philippines." On the matter of privileges and immunities, the Philippine government, being a signatory to the Vienna Convention on Diplomatic Relations of April 18, 1961, accord to diplomatic missions in the Philippines and their personnel those privileges and immunities set forth in the Vienna Convention. In terms of taxation privileges, Articles 23 and 34 of the Convention mention: "Article 23 1. The sending State and the head of the mission shall be exempt from all national, regional or municipal dues and taxes in respect of the premises of the mission, whether owned or leased, other than such as represent payment for specific services rendered. 2. The exemption from taxation referred to in this Article shall not apply to such dues and taxes payable under the law of the receiving State by persons contracting with the sending State or the head of the mission." "Article 34 A diplomatic agent shall be exempt from all dues and taxes, personal or real, national, regional or municipal, except: (a) indirect taxes of a kind which are normally incorporated in the price of goods or services; (b) dues and taxes on private immovable property situated in the territory of the receiving State, unless he holds it on behalf of the sending State for the purposes of the mission; (c) estate, succession or inheritance duties levied by the receiving State, subject to the provisions of paragraph 4 of Article 39; (d) dues and taxes on private income having its source in the receiving State and capital taxes on investments made in commercial undertakings in the receiving State; (e) charges levied for specific services rendered; (f) registration, court or record fees, mortgage dues and stamp duty, with respect to immovable property, subject to the provisions of Article 23." As far as VAT exemption is concerned, under Article 23, the sending State (represented by the embassy) and the head of the mission are exempt from all dues and taxes relating to their premises only. Under Article 34, diplomatic agents are generally exempt from all dues and taxes, except those enumerated in Items (a) to (f) of the article like VAT since it is an indirect tax normally incorporated in the price of goods or services (Section 105, Tax Code). Nonetheless, although selectively, the VAT exemption privilege of diplomatic missions in the Philippines and their personnel is made to rest on the principle of reciprocity . In BIR Ruling No. 246-92 dated September 3, 1992, the precursor ruling that cited reciprocity as a basis for the grant of VAT exemption to diplomatic missions in the Philippines and their personnel, this Bureau ruled that the French Embassy's purchase of a motor vehicle is exempt from VAT and from ad valorem tax on the basis of reciprocity, if the French Embassy can submit to the Commissioner of Internal Revenue (or his duly authorized representative) a copy of a special legislation or an international agreement that shows that the French government allows similar tax exemption to the Philippine Embassy in France and its personnel on their purchase of goods and services in France. The same requirement is invoked in the predecessor ruling, BIR Ruling No. 206-93 dated May 11, 1993, where this Bureau ruled that the British Embassy's purchase of a motor vehicle is exempt from VAT and ad valorem tax on the basis of reciprocity. Based on the British Embassy's letter to the Commissioner of Internal Revenue dated April 7, 1993, the British government allows similar tax exemption to the Philippine Embassy in the United Kingdom and its personnel on their purchase of goods and services in the United Kingdom. From then on, the determination of the existence of a special legislation or an international agreement that allows similar tax exemption to Philippine Embassies abroad and their personnel now lies with the Office of Protocol and State Visits of the Department of Foreign Affairs (DFA) who furnishes this Bureau, from to time, of an updated list of diplomatic missions in the Philippines which may enjoy VAT exemption on the basis of reciprocity. As far as the USAID is concerned, inasmuch as it discharges the responsibilities of the United States government to the Philippine government under the 1951 Economic and Technical Cooperation Agreement on the provision of economic and technical assistance in the Philippines, the USAID constitutes as part of the Special Technical and Economic Mission mentioned in the Agreement. As it is, the USAID is an agency of the United States government and is a part of and working dependently with the United States Embassy in the Philippines. Hence, pursuant to Article IV of the Agreement, the Philippine government will accord to the USAID and its personnel of comparable diplomatic rank those privileges and immunities presently enjoyed by the United States Embassy in the Philippines and its (Embassy's) personnel, including VAT exemption on the purchase of goods and services in the Philippines. SHTcDE Thus, on the basis of reciprocity as has always been reiterated in all VAT exemption rulings, VECs and VEICs issued by this Bureau to the United States Embassy and its personnel, this Office extends the same exemption to the USAID and its personnel of comparable diplomatic rank. Thus, this Office is of the opinion and so holds that the service fees to be paid by the USAID to Tetra Tech (composed of project costs, fixed fees, and possible performance/award fees) in connection with the IEMP, CRM, and FISH Projects funded by the USAID are exempt from VAT. (BIR Ruling No. DA-ITAD 16-05 dated February 24, 2005) 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. Section 108 was amended by Republic Act No. 9337 (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), which was signed into law on May 24, 2005 and became effective on November 1, 2005, to read as: "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 deprived 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 agreement 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 Philippine 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. 2. Section 109(q) was amended and renumbered by Republic Act 9337 to read as: "SEC. 109. Exempt Transactions. (1) Subject to the provisions of Subsection (2) hereof, the following shall be exempt from the value-added tax. xxx xxx xxx (K) Transactions which are exempt under international agreements to which the Philippines is a signatory or under special laws, except those under Presidential Decree No. 529;" 3. Now Section 4.109-1 of Revenue Regulations 16-2005, the accompanying regulations of Republic Act 9337. 4. Now Section 4.108-5 of Revenue Regulations 16-2005. 5. Now Section 4.108-6 of Revenue Regulations 16-2005.