DA ITAD BIR Ruling No. 107-08

December 18, 2008 DA ITAD BIR RULING NO. 107-08 Articles 9 (Shipping and Air Transport) and 11 (Dividends); Philippines-United States of America tax treaty Punongbayan & Araullo 20th Floor, Tower 1 The Enterprise Center 6766 Ayala Avenue 1200 Makati City Attention: Atty. Fulvio D. Dawilan Tax Partner Gentlemen : This refers to your letter dated August 7, 2007, requesting confirmation that (1) the Gross Philippine Billings of United Parcel Service Company (United Parcel) is subject to a preferential income tax of 1 1/2%, and (2) branch profits remitted by the branch office of United Parcel in the Philippines to its head office in the United States are exempt from the branch profits remittance tax of 15%, both pursuant to the Convention between the Government of the Republic of the Philippines and the Government of the United States of America with Respect to Taxes on Income (Philippines-United States tax treaty) . 1 BASIC FACTS It is represented that United Parcel is a corporation organized and existing under the laws of the United States of America; that United Parcel was originally named as Air Parcel, Inc., based on its Certificate of Incorporation dated January 22, 1953, and later as United Parcel Service Air, Inc., based on its Certificate of Amendment of Certificate of Incorporation dated May 22, 1953, and currently as United Parcel Service Company, based on its Certificate of Amendment of Certificate of Incorporation dated December 28, 1987; that on December 28, 1987, United Parcel entered into an Agreement of Merger with International Parcel Express, Inc. (another United States corporation) with United Parcel as the surviving corporation in the merger and International Parcel Express, Inc. as the corporation ceasing to exist; that United Parcel has a registered office at 2711 Centerville Road, Suite 400, Wilmington, New Castle, Delaware, United States of America, based on the Certificate of Change of Location of Registered Office and of Registered Agent dated January 11, 2007 issued by the Division of Corporations of the Office of the Secretary of State of Delaware; and that United Parcel is licensed by the Securities and Exchange Commission (SEC) to establish a branch office in the Philippines (that is, United Parcel Philippine Branch Office) to coordinate the movement of air freight, and to carry property, cargo, and mail as a certificated international United States carrier, under SEC Registration No. A1997-6125 and dated May 14, 1997, with address at UPS Intra-Asia Hub, Civil Aviation Complex, Diosdado Macapagal International Airport, Clark Special Economic Zone, Clark Field, Pampanga, 2009 Philippines. CHcESa RULING In reply, please be informed that concerning the applicable income tax rate on the Gross Philippine Billings of United Parcel, paragraph 2, Article 9 of the Philippines-United States tax treaty and Item 2 of the text of the resolution of the ratification of the tax treaty by the United States Senate provide as follows: "Article 9 SHIPPING AND AIR TRANSPORT xxx xxx xxx 2. Nothing in the Convention shall affect the right of a Contracting State to tax, in accordance with domestic laws, profits derived by a resident of the other Contracting State from sources within the first-mentioned Contracting State from the operation of aircraft in international traffic." RESOLUTION OF RATIFICATION "Resolved (two-thirds of the Senators present concurring therein), That the Senate advise and consent to the ratification of the Convention signed at Manila on October 1, 1976, between the Government of the United States of America and the Government of the Republic of the Philippines with Respect to Taxes on Income, and an Exchange of Notes done at Washington on November 24, 1976, subject to the following: xxx xxx xxx (2) reservation that, notwithstanding the provisions of paragraph 2 of Article 9 of the Convention, the tax imposed on profits derived by a resident of one of the Contracting States from sources within the other Contracting State from the operation of aircraft in international traffic may be as much as, but shall not exceed, the lesser of one and one-half percent of the gross revenue derived from sources within that State, and the lowest rate of Philippine tax that may be imposed on profits of the some kind derived under similar circumstances by a resident of a third State." AIHECa Paragraph 2 of Article 9 above provides that the Philippines can tax profits or revenues derived by a resident of the United States from the operation of aircraft in international traffic from sources in the Philippines. In Item 2 of the text of the resolution, however, it is provided that the tax that can be imposed by the Philippines on such profits or revenues shall not exceed the lesser of 1 1/2% of the gross amount of the profits or revenues or the lowest rate of Philippine income tax that may be imposed on such profits or revenues derived under similar circumstances by a resident of a third State (or the most favored-nation tax rate). Accordingly, since the Philippines has not, as of this date, granted a most-favored-nation tax rate on profits or revenues from the operation of aircraft in international traffic, lower than 1 1/2%, profits or revenues derived by United Parcel (through United Parcel Philippine Branch Office ) from the operation of aircraft in international traffic from sources in the Philippines shall be subject to income tax at the rate of 1 1/2%, based on the gross amount thereof. cEHSIC With respect to the definition of the term profits or revenues from the operation of aircraft in international traffic subject to income tax of 1 1/2%, the Philippines as the country of source will limit this term to the Gross Philippine Billings of the aircraft as defined in Section 28 (A) (3) (a) of the National Internal Revenue Code of 1997 (Tax Code of 1997), which provides: "SEC. 29. Rates of Income Tax on Foreign Corporations. (A) Tax on Resident Foreign Corporations. xxx xxx xxx (3) International Carrier. An international carrier doing business in the Philippines shall pay a tax of two and one-half percent (2 1/2%) on its 'Gross Philippine Billings' as defined hereunder: (a) International Air Carrier. 'Gross Philippine Billings' refers to the amount of gross revenue derived from the carriage of persons, excess baggage, cargo and mail originating from the Philippines in a continuous and uninterrupted flight, irrespective of the place of sale or issue and the place of payment of the ticket or passage document; Provided, that tickets revalidated, exchanged and/or indorsed to another international airline form port of the Gross Philippine Billings if the passenger boards a plane in a port or point in the Philippines: Provided, further, That for a flight which originates from the Philippine, but transshipment of passenger takes place at any port outside the Philippines on another airline, only the aliquot portion of the cost of the ticket corresponding to the leg flown from the Philippines to the point of transshipment shall form part of Gross Philippine Billings." TCHcAE Therefore, the Gross Philippine Billings of United Parcel (through United Parcel Philippine Branch Office ) includes profits or revenues from the carriage of property, cargo, and mail originating in the Philippines to a point outside the Philippines in a continuous and uninterrupted flight. The concept of Gross Philippine Billings is further explained in Revenue Regulations No. 15-02. 2 On the other hand, please be informed that profits or revenues of United Parcel (through United Parcel Philippine Branch Office ) from sources in the Philippines which do not form part of its Gross Philippine Billings shall be subject to income tax applicable to the income of a foreign corporation engaged in trade in business in the Philippines. Particularly, when such income is not subject to a final withholding tax on income, the same should be included in the taxable income of United Parcel (through United Parcel Philippine Branch Office ) subject to 35% income tax, pursuant to Section 28 (A) (1) of the Tax Code of 1997, as amended by Republic Act No. 9337, 3 which provides: "SEC. 28. Rates of Income Tax on Foreign Corporations. (A) Tax on Resident Foreign Corporations. (1) In General. Except as otherwise provided in this Code, a corporation organized, authorized, or existing under the laws of any foreign country, engaged in trade or business within the Philippines, shall be subject to an income tax equivalent to thirty-five percent (35%) of the taxable income derived in the preceding taxable year from all sources within the Philippines: Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)." ADaECI As to the question on whether or not branch profits remitted by United Parcel Philippine Branch Office to the head office of United Parcel in the United States are exempt from the branch profit remittance tax of 15%, it is noteworthy that paragraph 6, Article 11 of the Philippines-United States tax treaty and Item 3 of the text of the resolution of the ratification of the tax treaty by the United States Senate provide as follows: "Article 11 DIVIDENDS xxx xxx xxx 6. Nothing in this Convention (except Article 9 (Shipping and Air Transport)) shall be construed as preventing the Philippines from imposing on the earnings of a corporation (other than a Philippine corporation) attributable to a permanent establishment in the Philippines, a tax in addition to the tax which would be chargeable on the earnings of a Philippine corporation, provided that any additional tax so imposed shall not exceed 20 percent of the amount of such earnings which have not been subjected to such additional tax in previous taxable years. For the purpose of this provision, the term "earnings" means business profits attributable to a permanent establishment in the Philippines in a year and previous years after deducting therefrom all taxes, other than the additional tax referred to herein, imposed on such profits by the Philippines." RESOLUTION OF RATIFICATION "Resolved (two-thirds of the Senators present concurring therein), That the Senate advise and consent to the ratification of the Convention signed at Manila on October 1, 1976, between the Government of the United States of America and the Government of the Republic of the Philippines with Respect to Taxes on Income, and an Exchange of Notes done at Washington on November 24, 1976, subject to the following: xxx xxx xxx (3) understanding that under Article 9 and paragraph 6 of Article 11 of the Treaty, the Philippines may not impose on the earnings of a corporation attributable to a permanent establishment in the Philippines, which earnings are described in Article 9 of the Treaty, a tax in addition to the tax which would be chargeable on the earnings of a Philippine corporation; and" SEIcHa Paragraph 6 of Article 11 provides that the Philippines can impose an additional income tax on the earnings (except profits or revenues from the operation of ships and aircraft in international traffic) of a United States corporation attributable to its permanent establishment in the Philippines, which tax shall not exceed 20% of the gross amount of the earnings. In the Philippines, this additional tax is construed as the branch profit remittance tax introduced in 1975 under Presidential Decree No. 778 4 and later reduced to 15% in 1977 under the National Internal Revenue Code of 1977. 5 In Item 3 of the text of the resolution, it is reiterated that the additional tax cannot be imposed on profits or revenues derived by a United States corporation from the operation of ships and aircraft in international traffic from sources in the Philippines. Accordingly, since profits or revenues derived by United Parcel (through United Parcel Philippine Branch Office ) from the carriage of property, cargo, and mail originating in the Philippines to a point outside the Philippines is within the scope of profits or revenues from the operation of aircraft in international traffic under Article 9 of the Philippines-United States tax treaty, such profits or revenues of United Parcel (through United Parcel Philippine Branch Office ) shall not be subject to the additional income tax generally allowed under paragraph 6, Article 11 of the tax treaty. cEaCAH This additional tax on the earnings of a foreign corporation attributable to a permanent establishment or a fixed place of business in the Philippines is construed as the branch profits remittance tax which is currently at 15%, as embodied in Section 28 (A) (5) of the Tax Code of 1997, which provides: "SEC. 28. Rates of Income Tax on Foreign Corporations. (A) Tax on Resident Foreign Corporations. xxx xxx xxx (5) Tax on Branch Profits Remittances. Any profit remitted by a branch to its head office shall be subject to a tax of fifteen percent (15%) which shall be based on the total profits applied or earmarked for remittance without any deduction for the tax component thereof (except those activities which ore registered with the Philippine Economic Zone Authority). The tax shall be collected and paid in the same manner as provided in Sections 57 and 58 of this Code: Provided, That interests, dividends, rents, royalties, including remuneration for technical services, salaries, wages, premiums, annuities, emoluments or other fixed or determinable annual, periodic or casual gains, profits, income and capital gains received by a foreign corporation during each taxable year from all sources within the Philippines shall not be treated as branch profits unless the same are effectively connected with the conduct of its trade or business in the Philippines." DaTEIc Finally, aside from income tax, United Parcel Philippine Branch Office is liable to pay an international carrier's percentage tax of three percent (3%) of its quarterly gross receipts, under Section 118 of the Tax Code of 1997, thus: "SEC. 118. Percentage Tax on International Carriers. (A) International air carriers doing business in the Philippines shall pay a tax of three percent (3%) of their quarterly gross receipts." The base of this tax is the same as that of the 1 1/2% income tax on the Gross Philippine Billings of United Parcel Philippine Branch Office, as provided in Section 10 of Revenue Regulations No. 15-02. "SEC. 10. Common Carrier's Tax Liability of International Airline Companies. For purposes of determining Common Carrier's Tax liability of international airline companies pursuant to Section 118 of the Code, gross receipts shall be the same as the tax base for computing Gross Philippine Billings as prescribed by these Regulations." cATDIH 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, (SGD.) SIXTO S. ESQUIVIAS IV Commissioner of Internal Revenue Footnotes 1. Signed on October 1, 1976, and effective January 1, 1983. 2. Entitled Revenue Regulations Governing the Imposition of Income Tax on the Gross Philippine Billings, Other Income of International Air Carriers and Common Carrier's Tax Pursuant to Section 28 (A) (3) (A), 28 (A) (1), and 118 of the National Internal Revenue Code of 1997 as well as the Manner of Claiming Deductions on Travel Expenses and Freight Charges Incurred Pursuant to Section 32 of the Same Code, effective May 30, 2002. 3. Entitled 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 effective November 2005. 4. Entitled Amending Certain Sections of the National Internal Revenue Code, as Amended, effective August 24, 1975. 5. Presidential Decree No. 1158 (A Decree to Consolidate and Codify All the Internal Revenue Laws of the Philippines), effective June 3, 1977.