DA ITAD BIR Ruling No. 111-09

December 28, 2009 DA ITAD BIR RULING NO. 111-09 Article 12 (Royalties), Article 7 (Business Profits) in relation to Article 5 (Permanent Establishment) of the Philippines-Singapore tax treaty; BIR Ruling Nos. 101-95; 17-07; 74-06; 59-04; 69-02; 37-02 Castillo Laman Tan Pantaleon & San Jose Law Firm The Valero Tower, 122 Valero St. Salcedo Village, 1227 Makati City Attention: J. Gregson A. Castillo and Divina P. de la Cerna Gentlemen/Ladies : This refers to your letter dated 23 December 2008, on behalf of Harem, Inc. (hereinafter referred to as "Harem" ) requesting confirmation of your opinion that, (a) the franchise fee, royalty fee and extension fee payable by Harem to Spa Esprit Group Franchise Pte Ltd. (hereinafter referred to as "Spa Esprit" ) are subject to a 25% income tax rate and (b) The initial outlet assistance fee, support services fee and extension fee payable by Harem are not subject to income tax in the Philippines, pursuant to the provision of the Convention between the Republic of the Philippines and the Republic of Singapore for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income (hereinafter referred to as "Philippines-Singapore tax treaty" ). It is represented that Spa Esprit is a foreign corporation organized and existing under the laws of Singapore with principal address at 1 Scotts Road, #19-04, Shaw Centre, Singapore, 228208; that Spa Esprit is not registered either as a corporation or as a partnership in the Philippines, as shown in the Certification of Non-Registration of Corporation/Partnership dated 15 December 2008 issued by the Securities and Exchange Commission; that Spa Esprit carry on business of a franchisor for Spa Esprit Group's branding products, services and business models; that Spa Esprit carry on the trade of beauty services such as facial, lashing, brow trimming and makeup services, manicures and pedicures, body massage, aromatherapy, SPA bath, health centre and other beauty treatment, personal grooming; general importers and exporters of beauty products, retailing, marketing and distributing in personal care products and pharmaceutical products such as cosmetics and beauty toiletries; hairdressers, hair and scalp specialist and experts, beauty salon equipment wholesaling and souvenir retailing and marketing; that Spa Esprit operates a chain of brow shaping and beauty outlets under the name of "BROWHOUS" and a chain of hair removal and beauty outlets under the name of "STRIP"; that on 04 October 2008 Spa Esprit and Harem , a domestic corporation with office address at 14th Floor, Net Cube Center, 3rd Avenue cor. 30th Street, E-Square Crescent Park West, Bonifacio, Global City, entered into Area Franchise Agreements (hereinafter referred to as "AFAs" ), whereby Spa Esprit grants to Harem the franchise to set up and operate a chain of hair removal and beauty outlets under the name of BROWHOUS and STRIP; that five (5) Outlets 1 for each AFAs which may be located in any or all of the cities listed in the Territory 2 and to the use of the System, 3 the Trade Marks 4 and the Intellectual Property 5 in relation to the Outlets; 6 that the exclusivity shall be given by Spa Esprit to Harem for the Territory for the minimum of fifteen (15) months from the date of signing of the AFA and the exclusivity shall be extended for five (5) years commencing from the Franchise Commencement Date or 15 November whichever is earlier in the event that all 5 outlets are opened within 12 months from the opening of the first Outlet; that the rights granted may be extended for the period of five (5) years by giving notice in writing to Spa Esprit not later than twelve (12) months prior to the expiration of the term; and that in consideration for the rights granted, Harem shall pay Spa Esprit : 1) Singapore Dollars Fifteen Thousand (S$15,000) for the upfront Franchise Fee and Singapore Dollars One Thousand (S$1,000) per month or part thereof per Outlet which has commenced the Business, for the royalty. cCAIES It is further represented that Spa Esprit and Harem entered into Service Agreements pursuant to the AFAs to utilize a distinctive business format and method developed by Spa Esprit for the implementation in connection with the operation of the Business; 7 that Spa Esprit provide certain specialized support services and assistance with respect to the Business to ensure compliance with the System; the services in relation to the setting up and operation of a chain of hair removal and beauty outlets under the name of BROWHOUS and STRIP are as follows: Initial Outlet Assistance (i) Advice on shopfitting, refurbishment, dcor, design and layout, product display and signage to assist Harem in complying with the standard operations manual provided by Spa Esprit ; (ii) Advice on the hiring and advice on training of personnel and staffing for each outlet; (iii) If requested by Harem, assist in the official opening of Harem's hair removal and beauty outlets. Support Services (i) Advice on the inventory level of Products; (ii) Handling of procurement of supplies, services and equipment; (iii) Dissemination of relevant and available market information or research findings; (iv) Assistance in performance reviews; CTDAaE (v) Assistance in market development planning; (vi) Assistance in problem solving; (vii) Introduction of new Products or Services; (viii) Advice in relation to advertising and promotional activities for the Business. Support for Official Opening of the first Outlet of the Business 1. Spa Esprit will send one manager one week before the outlet opening to assist in ensuring the Harem's outlet is ready for operations. 2. Spa Esprit will send one trainer one week before the outlet opening to ensure all the Harem's therapists are ready to provide the required services. During the period of one week, Spa Esprit's trainer will also perform quality control checks on all the Harem's therapists. 3. Spa Esprit's manager and trainer will stay behind up to one more week after the outlet's official opening as post-opening support when necessary, as mutually agreed upon. 4. Fees payable by Harem for Spa Esprit's manager and trainer's support provided for the official outlet opening include return airfares, accommodation, transport and subsistence allowances. 5. In the event that initial training is to be provided at Harem's location, the trainers' and managers' return airfares, accommodation, transport and subsistence allowances shall be borne by Harem . HDCAaS That for and in consideration of the Services to be rendered by Spa Esprit in the Initial Outlet Assistance Fee, Harem shall pay the contract amount of Singapore Dollars (S$) Four Hundred Ninety Thousand Five Hundred and Fifty Only (S$490,550) and for the Support Services Fee shall be according to the percentages table or a minimum of S$4,370 per month or part thereof per Outlet which has commenced the Business, whichever is the higher. Tier Aggregate Yearly Gross Turnover 8 of all Outlets Percentage 1. Less than PHP 9 100MM 7% 2. From PHP100MM to PHP130MM 6.5% 3. From PHP131MM to PHP190MM 6% 4. From PHP161MM to PHP190MM 5.5% 5. More than 190MM 5% That the Extension Fee payable by Harem to Spa Esprit pursuant to term and renewal of the agreement shall be S$245,275; that none of the Spa Esprit's personnel will be present in the Philippines for more than 183 days in any calendar year for the purpose of rendering any services or activities under the said Service Agreement; and that the issue or transaction subject of the above request for ruling 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 of the taxpayer/s involved. 1. On the Franchise Fee, Royalty Fee and Extension Fee for the Area Franchise Agreement. In reply, please be informed that 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 . . ., royalties, . . ., profits and income . . .: Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)." cACHSE 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 income 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." In accordance with the foregoing, Article 12 of the Philippines-Singapore tax treaty provides: "Article 12 ROYALTIES 1. Royalties arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State. 2. However, such royalties may also be taxed in the Contracting State in which they arise, and according to the law of that State, but, if the recipient is the beneficial owner of the royalties, the tax so charged shall not exceed: a) in the case of the Philippines, 15 per cent of the gross amount of the royalties, where the royalties are paid by an enterprise registered with the Philippine Board of Investments and engaged in preferred areas of activities and also royalties in respect of cinematographic films or tapes for television or broadcasting; DCATHS b) in the case of Singapore, where the royalties are approved under the Economic Expansion Incentives (Relief from Income Tax) Act of Singapore, the royalties shall be exempt; c) in all other cases, 25 per cent of the gross amount of the royalties. 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 cinematographic films or tapes for television or 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." According to paragraph 2, royalties arising in the Philippines derived by a resident of Singapore are subject to either (a) 15% of the gross amount of royalties paid by an enterprise registered with the Philippine Board of Investments and engaged in preferred areas of activities and also royalties in respect of cinematographic films or tapes for television or broadcasting; or (b) 25% in all other cases. Inasmuch as Harem is not registered with the BOI and not engaged in preferred areas of activities in the Philippines, as required for the availment of the preferential tax rate of 15%, in accordance with the above-quoted Article 12 (2) (a), royalties arising in the Philippines and payable to Spa Esprit under the subject AFAs are subject to Philippine tax at the rate of 25% of the gross amount of royalties pursuant to Article 12 (2) (c) of the Philippines-Singapore tax treaty. (BIR Ruling No. 101-95 dated 05 July 1995; BIR Ruling No. DA-ITAD 17-07 dated 09 February 2007) CDHacE 2. On the Initial Outlet Assistance Fee, Support Services Fee (including Support for the Official Opening of the First Outlet) and Extension Fee for Services Agreement. Article 7 (1), in relation to Article 5 of the Philippines-Singapore 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 or has carried 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 Convention, the term 'permanent establishment' means a fixed place of business in which the business of the enterprise is wholly or partly carried on. 2. The term 'permanent establishment' includes specially but is not limited to: a) A seat of management; b) A branch; EHTIDA c) An office; d) A store or other sales outlet; e) A factory; f) A workshop; g) A warehouse, in relation to a person providing storage facilities for others; h) A mine, quarry, or other place of extraction of natural resources; i) A building site or construction or assembly project or installation project or supervisory activities in connection therewith, provided such site, project or activity continues for a period more than 183 days; and j) The furnishing of services, including consultancy services, by a resident of one of the Contracting States through employees or other personnel, provided activities of that nature continue (for the same or a connected project) within the other Contracting State for a period or periods aggregating more than 183 days. xxx xxx xxx" Based on the foregoing provisions, a corporation which is a resident of Singapore and does not carry on business in the Philippines through a permanent establishment situated therein shall not be subject to Philippine income tax for profits derived in the Philippines. For this purpose, a Singaporean corporation may be deemed to have a permanent establishment in the Philippines if, among others, the furnishing of services through its employees or other personnel continue for the same or a connected project within the Philippines for a period or periods aggregating more than 183 days (paragraph j). SDEHCc Inasmuch as it is represented that the consultancy services to be rendered by SPA Esprit to Harem are to be performed outside of the Philippines by SPA Esprit except for the Initial Outlet Assistance, if requested by Harem , in the official opening of hair removal and beauty outlets under the name of BROWHOUS and STRIP, which shall in no case exceed 183 days during the entire duration of the consultancy project, then the furnishing of said services by SPA Esprit through its employees or other personnel shall not constitute as carrying of business through a permanent establishment in the Philippines. Such being the case, income derived by SPA Esprit which are in the nature of business profits are not subject to Philippine tax pursuant to Article 7 (1) in relation to Article 5 of the RP-Singapore tax treaty. (BIR Ruling DA-ITAD Nos. 74-06 dated 22 June 2006; 59-04 dated 03 June 2004; 69-02 dated 25 April 2002; 37-02 dated 02 April 2002; 101-95 dated 5 July 1995) However, the fees to be paid by Harem to SPA Esprit covering the services rendered in the Philippines through the Initial Outlet Assistance, as well as the fees for the Support for the Official Opening of the first outlet of the Business, are subject to the value-added tax as provided in Section 108 of the Tax Code of 1997, as amended, quoted as follows: "SEC. 108. 10 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%) 11 of gross receipts derived from the sale or exchange of services, including the use or lease of properties: xxx xxx xxx The phrase 'sale or exchange of service' means the performance of all kinds of services in the Philippines for others for a fee, remuneration or consideration, . . . . The phrase 'sale or exchange' of services shall likewise include: aDcETC (1) The lease or the use of or the right or privilege to use any copyright, patent, design or model, plan, secret formula or process, goodwill, trademark, trade brand or other like property or right; xxx xxx xxx" (Emphasis ours) With regard to the procedures for the withholding and payment of the VAT, pursuant to Sections 4 and 6 of Revenue Regulations (RR) No. 4-2002, Section 3 of RR No. 8-2002, Section 7 of RR No. 14-2002, Section 4.114-2 of RR No. 16-05, as amended by RR No. 04-07, Harem shall be responsible for the withholding of VAT on the service fee before remitting it to Spa Esprit . In remitting to the Bureau of Internal Revenue the VAT withheld, Harem shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax & Other Percentage Taxes Withheld). If it is a VAT-registered taxpayer, Harem may use as documentary substantiation for its claim of input VAT the duly filed BIR Form No. 1600 and the proof of payment accompanying such form. On the other hand, if it is, a non-VAT-registered taxpayer, Harem may include as part of the cost of the service fees to it by Spa Esprit the VAT consequently shifted or passed on to it. In addition, Harem is required to issue the Certificate of Final Tax Withheld at Source (BIR Form No. 2306) in quadruplicate, the first three copies for Spa Esprit and the fourth copy for Harem as its file copy. This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it will 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.) JAMES H. ROLDAN Assistant Commissioner Legal Service Footnotes 1. "Outlet(s)" means the site(s) within which the Business is operated pursuant to this Agreement, which address(es) is set out in Schedule B, which may be amended from time to time by Agreement of the Parties, including but not limited to when new outlets are opened by the Franchisee in accordance with the terms of this Agreement. 2. "Territory" refers to cities of Metro Manila, Metro Davao and Metro Cebu (including Boracay Island) in the Philippines. 3. "System" means the distinctive business format and method including but not limited to operational procedures, plans, directions, retailing, marketing and advertising strategies and techniques developed by the Franchisor and its group of companies for implementation in connection with the operation of the Business. 4. "Trade Mark(s)" means the "BROWHOUS" trade mark, trade name and logo and all other trade marks, tradenames, logos, designs, symbols, emblems, insignia, fascia and slogans, whether or not registered or capable of registration owned by or licensed to the Franchisor now or at time subsequently and made available to the Franchisee for use in connection with the Business including but not limited to the trade marks set out in Schedule G, which may be added to, amended or modified from time to time by the Franchisor. 5. "Intellectual Property" means the Trade Mark(s), copyrights, patents, designs, know-how, information, drawing, plans, shop layout and decoration, colour schemes, lighting and sound system, staff uniforms, all other identifying materials and property rights which may subsist in any part of the world owned by or licensed of the Franchisor (now or at any time subsequently) and which the Franchisor has approved for use by the Franchisee in connection with the Business. 6. "Outlets" means the site(s) within which Business is operated pursuant to this Agreement, which address(es) is set out in Schedule B, which may be amended from time to time by Agreement of the Parties, including but not limited to when new outlets are opened by the Franchisee in accordance with the terms of this Agreement. 7. "Business" means the business of a hair removal and beauty services outlet which offers the Services. 8. "Gross Turnover" means the turnover of the Business conducted by the Client or any party authorized by the Client as invoiced, excluding sales taxes, whether or not the amounts are received. 9. "PHP" refers to Philippine peso. 10. 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, 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 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 two and four-fifth percent (2 4/5%); or (ii) National government deficit as a percentage of GDP of the previous year exceeds one and one half percent (1 1/2%). xxx xxx xxx 11. 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.