DA ITAD BIR Ruling No. 131-06

October 27, 2006 DA ITAD BIR RULING NO. 131-06 Articles 7 & 5, Philippines-Switzerland tax treaty; Section 109, NIRC of 1997, as amended by R.A. No. 9337; R.A. No. 7916 Sycip Gorres Velayo & Co. 6760 Ayala Avenue1226 Makati City Attention: Emmanuel C. Alcantara Co-Head, Tax Services Gentlemen/Ladies : This refers to your application for relief from double taxation dated October 21, 2005, on behalf of your client, Philippine Associated Smelting and Refining Corporation (PASAR), requesting confirmation of your opinion that the sale of goods by Glencore AG and Glencore International AG (collectively referred to hereunder as "GLENCORE") shall not be taxable in the Philippines, pursuant to the Philippines-Switzerland tax treaty. It is represented that the PASAR is an enterprise registered with the Philippine Economic Zone Authority (PEZA) under Certificate of Registration No. 82-40 dated September 23, 1982 as an Ecozone Export Enterprise, with principal office at Leyte Industrial Development Estate, Isabel, Leyte; that PASAR is entitled to the 5% on gross income tax incentive in lieu of all national and local taxes, per certification issued by PEZA dated February 28, 2003; that it is also a VAT-registered taxpayer; that it is registered to engage in the manufacture of copper cathodes and its by-products namely: dore metal, sulfuric acid, granulated slag, iron concentrate slag, tellurium, palladium, platinum, gypsum, EP dust, selenium powder, and copper telluride; that PASAR has storage facilities at its plant site in Isabel, Leyte (the Warehouse), where it stores copper concentrates for processing at its smelting and refining facilities; that Glencore AG is a nonresident foreign corporation duly organized and existing under the laws of Switzerland with office address at Baarermattstrasse 3, P.O. Box 666, CH-6341 Baar, Switzerland; that it is engaged in the business of trading in raw materials of all kinds on an international scale; that it is not registered either as a corporation or a partnership in the Philippines per certification dated October 7, 2005 issued by the SEC; that Glencore International AG is also a nonresident foreign corporation duly organized and existing under the laws of Switzerland with office address at Baarermattstrasse 3, P.O. Box 777, CH-6341 Baar, Switzerland. It is further represented that on August 29, 2005, PASAR entered into separate Consignment Agreements ("Agreements") with GLENCORE for the deposit and storage of copper concentrates ("Concentrates"); that such Agreements have been duly approved by the PEZA in its letter dated October 12, 2005; that under the Agreements, it is the primary concern of PASAR to reduce the accumulation of inventory, reduce order scheduling, production and delivery leadtime, ensure continuous supply for its continuous operations/production even in times of global shortages of Concentrates and improve over-all efficiency in production; that GLENCORE wishes to ensure timely supply and delivery of the Concentrates to PASAR; and that to achieve these objectives, GLENCORE and PASAR intend to deposit and store Concentrates in the Warehouse owned by PASAR subject to the following terms and arrangements, to wit: I. Upon arrival of Concentrates in the Philippines, PASAR will store the Concentrates delivered by GLENCORE in separate lots. Each parcel of Concentrates will be segregated from all other materials and will be clearly identified and marked as GLENCORE's property. The Concentrates will be kept safe, secure and in good condition; II. The storage area provided in the Warehouse must meet GLENCORE's reasonable satisfaction. GLENCORE or its duly appointed representative will have the right to access and inspect the storage area as well as the stored quantity of Concentrates at any time. Cost of inspection to be at GLENCORE's expense. The stored Concentrates will furthermore be kept at GLENCORE's irrevocable disposal until release of the material. In case PASAR should need to transfer the Concentrates to another location, PASAR must get the prior written consent of GLENCORE. PASAR shall bear the risk and expense of such transfer and also the liability for storage and/or reduction in value as the result of the transfer of the goods. GLENCORE shall have the right to access and inspect the new storage area as well as the transferred Concentrates at any time; III. PASAR will provide storage in the Warehouse for a monthly fee at the prevailing market rate of US$ 0.20 per wet metric ton, to be paid by GLENCORE in US Dollars promptly after receipt of the invoice for storage by telegraphic transfer. At the end of each month, PASAR will undertake an inventory in the presence of a GLENCORE representative, which will be submitted together with the invoice for storage fees. PASAR will undertake to issue a Holding Certificate in such form as provided in the Schedule immediately upon arrival of each shipment of Concentrates, countersigned by GLENCORE's independent inspector. Each Holding Certificate will set out the exact point of stockpiling, confirm that the Concentrates are stockpiled separately at the Warehouse and are clearly identified as the property of GLENCORE, and show the wet weight and origin of the Concentrates stockpiled in the Warehouse as evidenced in the weighing notes (as set out in clause VI below) upon the arrival of the Concentrates at the port of discharge. If the Concentrates are not sold to PASAR, but directed to another destination, all charges related to loading/handling from the carrying vessel to the Warehouse and from the Warehouse to the new carrying vessel will be at GLENCORE's expense. On such charges PASAR will recognize a mark-up of 10%; IV. PASAR will make periodic withdrawals of Concentrates from the Warehouse. The parcel(s) withdrawn by PASAR will be determined by GLENCORE subject to the technical constraints of PASAR. Withdrawal by PASAR shall be made in line with the instructions given by GLENCORE and only upon receipt of GLENCORE's prior consent to such release. After the sales of the Concentrates and the issuance of the invoice for such Concentrates, GLENCORE will release the corresponding quantity of Concentrates to PASAR by means of a fax or e-mail (the "Release") as soon as PASAR has made provisional payment to GLENCORE as agreed in the corresponding contract; V. As long as the title to the Concentrates has not passed to PASAR as per the corresponding Sales Contract, GLENCORE has unconditional property in the Concentrates as set out in the Holding Certificate and PASAR confirms not to part with possession, charge or otherwise encumber the Concentrates or prejudice GLENCORE's rights to it or give any third party any rights (whether possessory or legal) to the Concentrates; VI. GLENCORE will not recognize any sale upon delivery of the Concentrates to the Warehouse. It will only recognize the sale and issue the invoice upon withdrawal by PASAR of the Concentrates for production purposes. On the other hand, PASAR will not recognize the Concentrates stored in its Warehouse as part of its inventory until GLENCORE's Release. ADSTCI It is further represented that PASAR is a custom smelter of Concentrates; that it smelts the Concentrates to produce copper anodes; that these anodes are in turn processed in the refinery to produce copper cathodes which are then sold to the export market; that the smelter is fed a mix of Concentrates with an average copper content of between 29-32%; that PASAR purchases Concentrates with a copper content ranging from 25-37%; that raw materials with content below 25% are considered too low a quality to be able to blend with higher grade material (to produce 29-32%) due to the scarcity of high grade (32%+) raw materials; that PASAR, with the consent of GLENCORE, may transfer the Concentrates to another storage area also within PASAR's plant site in Isabel, Leyte, if the existing storage area will be required by PASAR for other purposes; that the Concentrates may not be sold to PASAR should the Concentrates' physical and chemical composition differ significantly from the required specifications or should the Concentrates not be of the quality and/or quantity specified by PASAR for the copper smelting process. Further, if due to production limitations, PASAR is unable to consume the raw materials within reasonable time, GLENCORE has the option to ship the materials to another customer outside the Philippines; possibly to any custom smelter in the world, but most likely one in South East Asia; that as spelled out in the Agreements, the Concentrates are owned by GLENCORE and PASAR cannot (i) part with the possession, (ii) charge or otherwise encumber the Concentrates, (iii) prejudice GLENCORE's right to it, or (iv) give any third party any rights (whether possessory or legal) to the Concentrates; and that in no instance may a third party acquire any possessory or legal rights to the Concentrates since PASAR is specifically prohibited from giving any third party such right. In reply, please be informed that Article 7 (1) of the Philippines-Switzerland tax treaty provides as follows, viz : "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 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." Applying the foregoing provision, the income payments to GLENCORE by PASAR in case the Concentrates are sold to PASAR are subject to Philippine income tax if such payments are attributable to a permanent establishment which GLENCORE has or might have in the Philippines. A permanent establishment , as defined in the paragraph 1, Article 5 (Permanent Establishment) of the same tax treaty, means " a fixed place of business through which the business of the enterprise is wholly or partly carried on ". In the instant case, the warehouse which will be utilized (in whole or in part) by GLENCORE under its Agreement with PASAR for the deposit and storage of the Concentrates, can be considered a permanent establishment if the general requisites of a permanent establishment are determined to be attendant in the use of the warehouse. The 2003 Organization for Economic Cooperation and Development (OECD) Model Tax Convention Commentary (pages 85-91) give guidance as to when a facility such as a warehouse can become a permanent establishment, as it explains: "2. Paragraph 1 gives a general definition of the term 'permanent establishment' which brings out its essential characteristics of a permanent establishment in the sense of the Convention (tax treaty), i.e ., a distinct 'situs', a 'fixed place of business'. The paragraph defines the term 'permanent establishment' as a fixed place of business, through which the business of an enterprise is wholly or partly carried on. This definition, therefore, contains the following conditions: the existence of a 'place of business', i.e ., a facility such as premises or, in certain instances, machinery or equipment; this place of business must be 'fixed', i.e ., it must be established at a distinct place with a certain degree of permanence; the carrying on of the business of the enterprise through this fixed place of business. This means usually that persons who, in one way or another, are dependent on the enterprise (personnel) conduct the business of the enterprise in the State in which the fixed place is situated. xxx xxx xxx 4. The term 'place of business' covers any premises, facilities or installations used for carrying on the business of the enterprise whether or not they are used exclusively for that purpose. A place of business may also exist where no premises are available or required for carrying on the business of the enterprise and it simply has a certain amount of space at its disposal. It is immaterial whether the premises, facilities or installations are owned or rented or are otherwise at the disposal of the enterprise. A place of business may thus be constituted by a pitch in a market place, or by a certain permanently used area in a customs depot ( e.g ., for the storage of dutiable goods). Again the place of business may be situated in the business facilities of another enterprise. This may be the case for instance where the foreign enterprise has at its constant disposal certain premises or a part thereof owned by the other enterprise. 4.1 As noted above, the mere fact that an enterprise has a certain of space at its disposal which is used for business activities is sufficient to constitute a place of business. No formal legal right to use that place is therefore required. Thus, for instance, a permanent establishment could exist where an enterprise illegally occupied a certain location where it carried on its business. 4.2 Whilst no formal legal right to use a particular place is required for that place to constitute a permanent establishment, the mere presence of an enterprise at a particular location does not necessarily mean that the location is at the disposal of that enterprise. These principles are illustrated by the following examples where representatives of one enterprise are present on the premises of another enterprise. A first example is that of a salesman who regularly visits a major customer to take orders and meets the purchasing director in his office to do so. In that cases, the customer's premises are not at the disposal of the enterprise for which the salesman is working and therefore do not constitute a fixed place of business through which the business of that enterprise is carried on . . . . xxx xxx xxx 4.6 The words 'through which' must be given a wide meaning so as to apply to any situation where business activities are carried on at a particular location that is at the disposal of the enterprise for that purpose. Thus, for instance, an enterprise engaged in paving a road will be considered to be carrying on its business 'through' the location where this activity takes place. 5. According to the definition, the place of business has to be a 'fixed' one. Thus in the normal way there has to be a link between the place of business and a specific geographical point. . . . cTIESD xxx xxx xxx 6. Since the place of business must be fixed, it also follows that a permanent establishment can be deemed to exist only if the place of business has a certain degree of permanency, i.e ., if it is not of a purely temporary nature. . . . xxx xxx xxx 7. For a place of business to constitute a permanent establishment the enterprise using it must carry on its business wholly or partly through it. As stated in paragraph 3 above, he activity need not be of a productive character. Furthermore, the activity need not be permanent in the sense that there is no interruption of operation, but operations must be carried out on a regular basis. xxx xxx xxx 10. The business of an enterprise is carried on mainly by the entrepreneur or persons who are in paid-employment relationship with the enterprise (personnel). This personnel includes employees and other persons receiving instructions from the enterprise (e.g. dependent agents). The powers of such personnel in its relationship with third parties are irrelevant. It makes no difference whether or not the dependent agent is authorized to conclude contacts if he works at the fixed place of business. . . ." Accordingly, the subject warehouse can constitute a permanent establishment if (1) it is a place of business at the disposal of GLENCORE; (2) it is fixed, or established at a distinct place with a certain degree of permanence; and (3) it is used for carrying on the business of GLENCORE where personnel dependent on them conduct business on their behalf at the warehouse. Concerning requirement number (1), the subject warehouse owned by PASAR can become a place of business at the disposal of GLENCORE if the warehouse will be used for a sufficiently long period of time and if the activities that will be performed in the warehouse go beyond preparatory and auxiliary activities. As to whether or not the warehouse will be used for a sufficiently long period, the fact that the relevant Agreements do not contain a fixed term of at most six months for GLENCORE to deliver the Concentrates to PASAR and to use the warehouse to store the Concentrates shows that the warehouse will be used for a sufficiently long period of time. As to whether or not the activities that will be performed in the warehouse go beyond preparatory and auxiliary activities, it is noteworthy that the respective subparagraphs (a) and (b), paragraph 3, Article 5 of the Philippines-Switzerland tax treaty provides that " the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise " and " the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery " by themselves are activities of a preparatory and auxiliary character. The fact that the activities of storing and delivering the Concentrates are of a preparatory and auxiliary character shows that the warehouse for this purpose cannot be regarded as a place of business that will constitute a permanent establishment of GLENCORE. Concerning requirement number (2), the fact that the warehouse is established at a distinct place in the Philippines with a certain degree of permanence constitutes the same as a fixed place of business. Concerning requirement number (3), although not expressly mentioned in the relevant Consignment Agreements, the fact that PASAR will store the Concentrates in its warehouse prior to its use thereof for GLENCORE's account and that PASAR's personnel will be responsible for the storage, inventory and security of the Concentrates, is sufficient to consider these personnel as dependent on GLENCORE who conduct businesses on their behalf. AcICTS In view of the foregoing, this Office is of the opinion and so holds that although the subject warehouse can be considered a fixed place of business through which the business of Glencore can be wholly or partly carried on, the same does not constitute a permanent establishment under the Philippines-Switzerland tax treaty because the activities connected to such warehouse as embodied in the subject Agreements are merely of a preparatory and auxiliary character. This is buttressed by the fact that GLENCORE ( i.e., Glencore AG and Glencore International AG ) are not licensed to engage in business in the Philippines as confirmed by the relevant certificates issued by the SEC which support the conclusion that GLENCORE do not have other fixed places of business in the Philippines which may be constituted as their permanent establishments. Hence, payments received by GLENCORE from the sale of their Concentrates to PASAR are exempt from Philippine income tax. However, Section 107 of the National Internal Revenue Code of 1997 (Tax Code) provides that the importation of the Concentrates is subject to ten percent (10%) value-added tax (VAT), to wit: "Section 107. Value-added Tax on Importation of Goods . (A) In General. There shall be levied, assessed and collected on every importation of goods a value-added tax equivalent to ten percent (10%) 1 based on the total value used by the Bureau of Customs in determining tariff and customs duties, plus customs duties, excise taxes, if any, and other charges, such tax to be paid by the importer prior to the release of such goods from customs custody . . ." For purposes of this provision, an " importer " refers to any person who brings goods into the Philippines, whether or not made in the course of his trade or business ( Section 4.107-1, Revenue Regulations No. 16-2005 ). GLENCORE is deemed to be the importer of the Concentrates because it retains it ownership over such Concentrates until the time they reach the territorial jurisdiction of the Philippines and that PASAR will acquire ownership over the Concentrates only when such have been sold to PASAR. Section 24 of Republic Act No. (RA) 7916 (The Special Economic Zone Act of 1995), as amended by RA 8748, provides as follows, viz : "SEC. 24. Exemption from National and Local Taxes . Except for real property taxes on land owned by developers, no taxes, local and national, shall be imposed on business establishments operating within the ECOZONE . In lieu thereof, five percent (5%) of the gross income earned by all business enterprises within the ECOZONE shall be paid and remitted as follows: (a) Three percent (3%) to the National Government; (b) Two percent (2%) which shall be directly remitted by the business establishments to the treasurer's office of the municipality or city where the enterprise is located." (Emphasis supplied) Furthermore, Section 4(c) of the same law states that " (e)nterprises located in export processing zones are allowed to import capital equipment and raw materials free from duties, taxes and other import restrictions ." It is clear from the foregoing provisions, that the incentives given by RA 7916 such as tax exemptions from payment of taxes pertain only to " business establishments operating within the ECOZONE " or " (e)nterprises located in export processing zones ". Thus, it cannot be said that such incentives may extend to GLENCORE since statutes that allow exemptions are construed strictly against the grantee and liberally in favor of the government. Otherwise stated, any exemption from the payment of a tax must be clearly stated in the language of the law; it cannot be merely implied therefrom. ( Davao Gulf Lumber Corp. vs. Commissioner of Internal Revenue, et al., G.R. No. 117359, July 23, 1998, 96 SCRA 527 ). Such being the case, GLENCORE shall pay value-added tax prior to the release of the Concentrates from customs custody. It must be emphasized, however, that PASAR shall still be enjoying the incentives given to it by the aforequoted Section 24 and jurisprudence for being a " Philippine Economic Zone Authority (PEZA)-registered enterprise under Certificate of Registration No. 82-40 dated September 23, 1982 as Ecozone Export Enterprise " in line with " the policies of the special law creating the zone ". 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. 2 However, the Ta x Co de provides that those falling under P D 6 6 are not. P D 6 6 is the precursor of R A 7 916 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. . . . An ecozone indubitably a geographical territory of the Philippines is, however, regarded in law as foreign soil. This legal fiction is necessary to give meaningful effect to the policies of the special law creating the zone . . . . 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: . . ., R A 7 916 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 R A 7 916 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" It is clear from the foregoing pronouncement that no VAT may be passed on, whether directly or indirectly, to PASAR, being a PEZA-registered enterprise. And GLENCORE, not being a VAT registered taxpayer, cannot directly pass on VAT to PASAR. However, GLENCORE may still include the VAT charged on the importation of Concentrates as part of its cost to sell and thereby indirectly passing VAT to PASAR. Accordingly, to comply with the mandate of RA 7916 that no VAT may be passed on to business establishments operating in the ECOZONE like PASAR, the importation of Concentrates by GLENCORE which will ultimately be sold to PASAR is hereby considered exempt from VAT, pursuant to Section 109(q) 3 of the Tax Code, as amended. To recapitulate, this Office is of the opinion and so holds that: (a) the subject warehouse, although a fixed place of business through which the business of GLENCORE can be wholly or partly carried on, is not a permanent establishment because the activities that are performed therein are merely of a preparatory and auxiliary character. Hence, income payments received by GLENCORE from the sale of the Concentrates to PASAR are exempt from Philippine income tax, pursuant to Article 7 in relation to Article 5 of the Philippines-Switzerland tax treaty; (b) The importation of the Concentrates by GLENCORE with a copper content ranging from 25% to 37% AND are ultimately sold to PASAR are exempt from VAT, pursuant to Section 109 of the Tax Code, as amended by RA 9337. All rulings inconsistent herewith are therefore modified or amended accordingly. 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 considered to be without force and effect insofar as the herein parties are concerned. DcTAIH Very truly yours, (SGD.) JOSE MARIO C. BUAG Commissioner of Internal Revenue Footnotes 1. Effective February 1, 2006, the rate shall be twelve percent (12%). 2. Referring to the old Section 109 (q) of the Tax Code of 1997 [now Section 109(K), as amended by RA No. 9337] . 3. SEC. 109. Exempt Transactions . The following transactions 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;