DA ITAD BIR Ruling No. 120-06

October 11, 2006 DA ITAD BIR RULING NO. 120-06 Articles 5 & 7, Philippines-Singapore tax treaty; BIR Ruling No. DA-ITAD-160-02; BIR Ruling No. ITAD-16-05 Samsung Electro-Mechanics Philippines Corp . Blk. 5 Calamba Premier International Park Bgy. Batino, Prinza, Calamba Laguna Attention: Mr. Hoseok Han Finance Group Senior Manager Gentlemen : This refers to your letter dated January 6, 2006, requesting clarification on the taxability of commissions received by Samsung Electro-Mechanics Pte., Ltd. (SEMPL) from Samsung Electro-Mechanics Philippines Corporation (SEMPHIL) under a Commission Agreement. It is represented that SEMPL is a nonresident foreign corporation with office address at 83 Clemenceau Ave., 09-01 UE Square, Singapore; that per certification issued by the Securities and Exchange Commission dated October 26, 2005, SEMPL with SEC No. A200300008 was licensed to establish a representative office in the Philippines on February 6, 2003 to carry out the following activities: (a) to conduct a market survey of electronic components, appliances, apparatus, equipment, workstation, facsimile machines and other business equipment, software products and all other related works; (b) to act as communication link between its Head Office and the customers in the Philippines; and (c) to conduct such other activities which will be purely coordination work and to act as the message center between the Head Office and the affiliates of SEMPL; that SEMPHIL is a PEZA-registered corporation organized and existing under the laws of the Philippines with principal address at Blk 5 Calamba Premier International Park, Bgy. Batino, Prinza, Calamba City, Laguna. It is further represented that on January 1, 2006, SEMPL and SEMPHIL entered into a Commission Agreement (Agreement) wherein SEMPHIL appoints SEMPL as non-exclusive and independent sales representative to market and sell SEMPHIL's Products within the territory 1 upon the terms and conditions under the said Agreement; that the services rendered by SEMPL to SEMPHIL under the said Agreement are done outside the Philippines per Sworn Statement issued by SEMPHIL dated June 8, 2006; and that SEMPL shall use its best efforts to perform and complete the following objectives: SCETHa 1. Customer Relation SEMPL acknowledges that prompt, courteous and professional service to all customers and fostering and maintenance of good relations with customers is of paramount importance to SEMPHIL and the said Agreement, and SEMPL agrees to use its best effort to serve customers and promote such relations with customers. SEMPL shall call upon customers regularly, provide assistance and information to customers as requested by customers or SEMPHIL, serve liaison between customers and SEMPHIL and comply with such policies and procedures as SEMPHIL may from time to time communicate to SEMPL 2. SEMPL's Expertise SEMPL shall take all necessary steps to ensure that it and all its sales personnel are fully familiar with the Products, SEMPHIL then-current price list, and applicable SEMPHIL's policies and procedures. 3. Delinquent Account SEMPL shall, when requested by SEMPHIL, call upon customers with delinquent accounts and use its best efforts to procure payment thereon. 4. Meetings and Conventions SEMPL shall attend such sales meeting for, among other things the training and education of its personnel, as SEMPHIL may request. SEMPL shall attend such conventions as SEMPL deems necessary to meet its best efforts obligation hereunder. All expenses, including such meeting shall be borne by SEMPL. 5. Reports (a) SEMPL shall promptly furnish complete and detailed reports of every new potential customers contact to enable SEMPHIL to make proper judgments for this new potential business. (b) SEMPL shall provide SEMPHIL in written form with as much as possible information concerning change of business activity, strategy, change of personnel, change in technology and potential new sales opportunities with all customers and competing products, business activities of competitors and any proposal for product improvement on an ongoing basis. (c) SEMPL shall supply the following to SEMPHIL to assist SEMPHIL in maintaining scheduled delivery dates, planning new production, maintaining customers quality standards, and assist SEMPHIL in planning long term growth and expansion. a three month rolling forecast copies of all quotations made, negotiated and transmitted by SEMPL regarding sales or potential sales of Products new market information, if any. that SEMPHIL, at its expense, shall provide periodic sales and technical assistance to SEMPL and its personnel to assist them in effective marketing of products, education of customers and relations with customers, and may accompany SEMPL or its personnel from time to time on calls to customers; that SEMPHIL, agrees to pay, as compensation for SEMPL's service, commission for Applicable Sales Revenue (0.8%) as a Direct Sale per purchase order obtained from the customers in the territory; and that the term of the said Agreement shall commence on the date first written and remain in full force until December 31 of the same calendar year, and it shall be automatically renewed for successive terms of one (1) year each unless either party notifies the other in writing of its intention not to renew at least sixty (60) days prior to the expiration of the initial, or any extension thereof. TaDAHE In reply, please be informed that Article 5 (Permanent Establishment) and, in relation thereto, Article 7 (Business Profits) of the Philippines-Singapore tax treaty provides: "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 arrangement; b) A branch; 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" "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" According to paragraph 1 of Article 7, the service fees are subject to Philippine income tax only if they are attributable to a permanent establishment which SEMPL has in the Philippines. ISDCaT A permanent establishment, as defined in paragraphs 1 and 2, Article 5 (Permanent Establishment) of the same tax treaty, means "a fixed place of business through which a resident of one of the Contracting States engages in trade or business," and includes, for example, "a seat of management, a branch, an office, a store or other sales outlet, a factory, and a workshop." It also includes "the furnishing of services, including consultancy services, which continues for a period or periods aggregating more than 183 days." In the first instance, where it is required that there be a fixed place of business and with respect to the representation that SEMPL has an office in the Philippines (representative office), the same may constitute a permanent establishment if the activities carried out therein are not preparatory and auxiliary in character and if the representative office has a certain degree of permanency. As regards examples of activities that have a preparatory and auxiliary character, paragraph 3, Article 5 of the tax treaty mentions: "3. Notwithstanding paragraphs 1, 2, and 4, a permanent establishment shall be deemed not to include any one or more of the following: a) The use of facilities solely for the purpose of storage, display, or occasional delivery of goods or merchandise belonging to the resident; b) The maintenance of a stock of goods or merchandise belonging to the resident solely for the purpose of storage, display, or occasional delivery; c) The maintenance of a stock of goods or merchandise belonging to the resident solely for the purpose of processing by another person; d) The maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise, or for collecting information, for the resident; e) The maintenance of a fixed place of business solely for the purpose of advertising, for the supply of information, for scientific research, or for similar activities which have a preparatory or auxiliary character, for the resident; or f) The furnishing of services, including the provision of equipment, in one of the Contracting States by a resident of the other Contracting State, including consultancy firms, in accordance with, or in the implementation of an agreement between the Contracting States regarding technical cooperation." Where it is represented that the representative office's functions are to conduct a market survey, act as communication link between its Head Office and the customers in the Philippines, and to conduct such other activities which will be purely coordination work and to act as the message center between the Head Office and the affiliates of SEMPL, the same may be considered as preparatory or auxiliary. However, if such activities extend to negotiation and/or signing of contracts and/or after-sales services, the same are regarded as being beyond preparatory and auxiliary and as such can deem the representative office a permanent establishment. AaIDCS As regards permanency, where it is represented that the representative office has been in existence immediately after it was given license by the Securities and Exchange Commission on February 6, 2003 and it continues to be so at present or for more than three years now, the representative office is considered as already having acquired a certain degree of permanency. However, since the activities carried out by the representative office are merely preparatory and auxiliary, the fact that it has, over time, already acquired a certain degree of permanency, still said representative office does not yet constitute a permanent establishment of SEMPL. ( BIR Ruling No. ITAD-16-05 dated February 24, 2005 ) Considering that the income derived by SEMPL under the Agreement is not attributable to its representative office in the Philippines as the latter is not privy to the transaction, and that the representative office of SEMPL is not deemed to be a permanent establishment in the Philippines to which its business profits may be attributed to since it is merely performing preparatory and auxiliary activities, the payments made by SEMPHIL to SEMPL are therefore, not subject to Philippine income tax. ( BIR Ruling No. DA-ITAD-160-02 dated September 13, 2002 ) (A) Rate and Base of Tax . There shall be levied, assessed and collected, a value-added tax equivalent to ten percent (10%) 3 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, . . ." (Emphasis supplied). Thus, in general, the VAT should be imposed when SEMPL provides the above services in the Philippines "for short durations and in no case shall exceed an aggregate of 3 months in any given calendar year" . SEMPHIL shall then be required to withhold such VAT and treat the same as a "passed on" VAT, pursuant to Section 4.110-3(b) of Revenue Regulations No. 7-95 as amended [ now Section 4.114-2(b) of Revenue Regulations No. 16-05 ]. However, in Commissioner of Internal Revenue vs. Seagate Technology (Philippines) (G.R. No. 153866, February 11, 2005), the Supreme Court held, viz : "Special laws may certainly exempt transactions from the VAT. 4 However, the Tax Code provides that those falling under PD 66 are not. PD 66 is the precursor of RA 7916 the special law under which respondent was registered. The purchase transactions it entered into are, therefore, not VAT-exempt. These are subject to the VAT; respondent is required to register. xxx xxx xxx Since the purchases of respondent are not exempt from the VAT, the rate to be applied is zero. Its exemption under both PD 66 and RA 7916 effectively subjects such transactions to a zero rate, because the ecozone within which it is registered is managed and operated by the PEZA as a separate customs territory . This means that in such zone is created the legal fiction of foreign territory. Under the cross-border principle of the VAT system being enforced by the Bureau of Internal Revenue (BIR), no VAT shall be imposed to form part of the cost of goods destined for consumption outside of the territorial border of the taxing authority. If exports of goods and services from the Philippines to a foreign country are free of the VAT, then the same rule holds for such exports from the national territory except specifically declared areas to an ecozone. caIACE xxx xxx xxx Applying the special laws we have earlier discussed, respondent as an entity is exempt from internal revenue laws and regulations. This exemption covers both direct and indirect taxes, stemming from the very nature of the VAT as a tax on consumption, for which the direct liability is imposed on one person but the indirect burden is passed on to another. Respondent, as an exempt entity, can neither be directly charged for the VAT on its sales nor indirectly made to bear, as added cost to such sales, the equivalent VAT on its purchases. Ubi lex non distinguit , nec nos distinguere debemus . Where the law does not distinguish, we ought not to distinguish. Moreover, the exemption is both express and pervasive for the following reasons: . . ., RA 7916 states that 'no taxes, local and national, shall be imposed on business establishments operating within the ecozone.' Since this law does not exclude the VAT from the prohibition, it is deemed included. Exceptio firmat regulam in casibus non exceptis . An exception confirms the rule in cases not excepted; that is, a thing not being excepted must be regarded as coming within the purview of the general rule. Moreover, even though the VAT is not imposed on the entity but on the transaction, it may still be passed on and, therefore, indirectly imposed on the same entity a patent circumvention of the law. That no VAT shall be imposed directly upon business establishments operating within the ecozone under RA 7916 also means that no VAT may be passed on and imposed indirectly. Quando aliquid prohibetur ex directo prohibetur et per obliquum . When anything is prohibited directly, it is also prohibited indirectly. xxx xxx xxx" Based on the foregoing, transactions exempt from VAT by reason of PD 66 and RA 7916 are effectively zero-rated. However, instead of zero-rating which is not available to non-resident suppliers, the provision for exempt transactions under Section 109 (K) of the Tax Code of 1997, as amended which provides VAT exemption for transactions that are exempt under specials laws, e.g., Republic Act No. 7916 or PEZA Law, is particularly applicable to the instant case. Such being the case, the payment by SEMPHIL, being a PEZA-registered enterprise to SEMPL, under the above Agreement should be as it is hereby confirmed to be exempt from VAT. 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. The Territory shall be Asia and Oceania, excluding Korea, Japan, China, Hongkong, Taiwan, Turkey, Israel and former Soviet Bloc countries. 2. Please note that this cited provision has been retained by Republic Act (RA) No. 9337, although with the modification as to the applicable rate when the circumstances so warrant. 3. Effective February 1, 2006, the rate shall be 12%. 4. Referring to the old Section 109 (q) of the Tax Code of 1997 [now Section 109(K), as amended by RA No. 9337] .