DA ITAD BIR Ruling No. 111-06

September 19, 2006 DA ITAD BIR RULING NO. 111-06 Arts. 5&7, Philippines-Japan tax treaty; BIR Ruling No. DA-ITAD-02-03; BIR Ruling No. DA-ITAD 39-03; BIR Ruling No. DA-161-05; VAT Ruling No. 004-04 Punongbayan & Araullo 20th Floor, Tower I, The Enterprise Center 6766 Ayala Avenue 1200 Makati City Attention: Maria Victoria C. Espao Tax Partner Gentlemen : This refers to your letter dated November 7, 2005 on behalf of your client, Ina Micro Opto Corporation (IMO),requesting confirmation of your opinion that service fees paid by IMO to Masuda Co.,Ltd. (MCL) under the Management and Marketing Agreement are not subject to Philippine income tax and to value-added tax (VAT), pursuant to the provisions of the Philippines-Japan tax treaty and the National Internal Revenue Code of 1997 (Tax Code). It is represented that MCL is a nonresident foreign corporation duly organized and existing under the laws of Japan with office address at 6689-1 Miyada-Mura, Kamiina-Gun, Nagano-Ken, Japan; that it is not registered either as a corporation or as a partnership in the Philippines per Certification of Non-Registration issued by the Securities and Exchange Commission (SEC) dated December 15, 2005; that, on the other hand, IMO is a corporation duly organized and existing under the laws of the Philippines with office address at Mactan Economic Zone II, Basak, Lapu-Lapu City, Cebu; that IMO is registered with the Philippine Economic Zone Authority (PEZA) with Certificate of Registration No. 00-007 dated January 25, 2000. It is further represented that, on April 1, 2004, MCL and IMO entered into a Management and Marketing Service Agreement (Agreement) whereby MCL shall provide marketing and management services to IMO in the following areas: 1. Administrative support, such as but not limited to the accounting, reconciliation and administration of IMO's bank accounts maintained in Japan; 2. Support in the procurement and shipment of IMO's raw materials and supplies in and their shipment in Japan; 3. Training of IMO's employees and managerial support in Japan; 4. Advertisement and promotion of the products manufactured by IMO in the Philippines to potential clients in Japan and other countries outside the Philippines; 5. MCL may identify, contact and make presentations to potential buyers of IMO's products; 6. MCL can participate in the initial stages of the negotiation of the terms and conditions of the contract by and between the potential buyer and IMO; 7. Development and maintenance of marketing strategies for IMO outside the Philippines; and 8. Undertake such other incidental marketing services as may be required by IMO to promote the latter's business in other countries; that the above-described services shall in no case involve the transfer of MCL's technology, know-how or other intellectual property rights; that the aforementioned services are to be performed in Japan or in other countries outside the Philippines; that in case it would be necessary for MCL to send its employees to the Philippines, the stay of these individuals in the Philippines shall not, in any case, exceed six (6) months; that in consideration for the above services, IMO shall pay MCL a monthly fee of Three Million Five Hundred Thousand Japanese Yen (JPY3,500,000) and a maximum of Five Million Japanese Yen (JPY5,000,000) covering the period from April 1, 2004 to March 31, 2005; that thereafter, the monthly fee shall be evaluated and agreed upon by IMO and MCL; and that the Agreement shall be subject to automatic 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. DEcITS In reply, please be informed that Article 7, and, in relation thereto, Article 5 of the Philippines-Japan tax treaty provide that: "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" "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. (2) The term 'permanent establishment' includes especially: (a) a store or other sales outlet; (b) a branch; (c) an office; (d) a factory; (e) a workshop; (f) a warehouse; (g) a mine, an oil or gas well, a quarry or other place of extraction of natural resources. 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" Based on the abovementioned provisions and inasmuch as it has been represented that the services will generally be performed by MCL outside the Philippines, and that if it be necessary to send its employees to the Philippines, said employees will not stay in the Philippines for more than six months in their rendition of services to IMO, MCL may be considered as not having a permanent establishment in the Philippines. In other words, MCL 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 in the course of their rendition of services to IMO. Such being the case, the service fees to be paid by IMO to MCL under Management and Marketing Agreement are not subject to Philippine income tax. However, the service fees paid by IMO for the portion of the services to be rendered in the Philippines are subject to VAT pursuant to Section 108 of the Tax Code. 1 Accordingly, IMO, 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 MCL. In remitting the VAT withheld, IMO shall use the 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 IMO if it is a VAT-registered taxpayer. In case IMO is a 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, IMO is required to issue the Certificate of Creditable Tax Withheld at Source (BIR Form No. 2307) in quadruplicate, the first three copies thereof be given to MCL and the fourth copy to be retained by IMO. (Sections 4 & 6, Revenue Regulations (RR) No. 4-2002; Section 3 of RR No. 8-2002; Section 7 of RR No. 14-2002) This ruling is issued on the basis 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. TIADCc 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, 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 receipt derived from the sale or exchange of services, including the use or lease of properties selling price of 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' shall likewise include: xxx xxx xxx 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.