DA ITAD BIR Ruling No. 138-06

November 8, 2006 DA ITAD BIR RULING NO. 138-06 Arts. 5 & 7, Philippines-Japan tax treaty; BIR Ruling No. DA-ITAD 145-05 Punongbayan & Araullo 20th Floor, Tower 1 The Enterprise Center 6766 Ayala Avenue 1200 Makati City Attention: Romeo H. Duran Tax Principal Gentlemen : This refers to your letter dated January 16, 2006 requesting confirmation that the service fees paid by Creative Diecast Philippines Corporation (CDPC) to Creative Diecast Corporation (CDC) are exempt from Philippine income tax and from value-added tax (VAT) pursuant to the pertinent sections of the National Internal Revenue Code of 1997 (Tax Code) and the Philippines-Japan tax treaty. It is represented that CDC is a nonresident foreign corporation taxable under the laws of Japan with business address at 3677-4 Ohata, Tsuru-shi, Yamanashi 402-0045, Japan and Tax Reference Number 00501271, as certified by the District Director of Ohtsuki Tax Office in Japan on October 5, 2005; that CDC is not registered either as a corporation or as a partnership licensed to engage in business in the Philippines as confirmed by the Certificate of Non-Registration of Corporation/Partnership issued by the Securities and Exchange Commission on June 23, 2005; that CDPC, on the other hand, is a company organized and existing under the laws of the Philippines with principal office at Block 7, Lot 5, Complex Avenue, CCIE Compound, Maduya, Carmona, Cavite; that it is primarily engaged in the manufacture of aluminum and zinc alloy diecast products, machine parts and other related products and merchandise, such as, but not limited to, electric appliances, communication and office automation equipment; that CDPC is registered with the Philippine Economic Zone Authority as an export enterprise per Certificate of Registration No. 05-04 dated January 27, 2005. It is further represented that CDPC and CDC entered into a Service Agreement dated December 29, 2003, pursuant to which CDC agreed to provide the following services to CDPC for a fee: 1. Procurement/sourcing qualified vendors residing overseas; 2. Marketing and sales promotion planning; 3. Customer relations and handling of product complaints, if any; 4. Periodic business and financial reviews, as may be requested; 5. Consultancy services; and 6. Related services. that the foregoing services shall in no case involve the transfer of CDC's technology, know-how or other intellectual property rights; that in general, CDC shall perform the aforementioned services in Japan or in other countries outside the Philippines; that in cases where it would be necessary for CDC to send employees to the Philippines, the stay of these individuals in the Philippines shall not, in any case, exceed 90 days in any given 12-month period; and that in consideration for the services, CDPC shall pay CDC an annual fee in the amount of Japanese Yen, Twenty Two Million Three Hundred Forty Thousand Nine Hundred Forty Nine (JPY22,340,949.00) for a completed year of service; and that the Service Agreement shall be effective for a period of one (1) year commencing on January 1, 2004 and ending December 31, 2004, subject to an automatic renewal for another twelve-month period, unless one party gives written notice to the other of its intent not to renew at least thirty (30) days prior to the expiration of the initial or renewed term. TEacSA In reply, please be informed that paragraph 1 of Article 7 of the Philippines-Japan tax treaty provides: "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" In view of the foregoing, the profits of a Japanese enterprise shall be taxable only in Japan unless such enterprise carries on business in the Philippines through a permanent establishment situated therein. If the Japanese enterprise carries on business as aforesaid, the profits of such enterprise may be taxed in the Philippines but only so much of them as is attributable to that permanent establishment. Applying this to the instant case, the service fees received by CDC for the services rendered in the Philippines shall be taxable in the Philippines only if it has a permanent establishment in the Philippines in connection with the activities giving rise to such income. In relation thereto, Article 5 of the same tax treaty defines a permanent establishment, as follows: "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. 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 the 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. . . . xxx xxx xxx." Inasmuch as it has been represented that the services will generally be performed by CDC outside the Philippines and that should it be necessary to send its employees to the Philippines, said employees will not stay in the Philippines for more than ninety (90) days in any given 12-month period in their rendition of services to CDPC, CDC may be considered as not having a permanent establishment in the Philippines. In other words, CDC 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 within any taxable year in the course of their rendition of services to CDPC. (BIR Ruling No. DA-ITAD 145-05 dated November 23, 2005) In such a case, the income derived by CDC from services rendered to CDPC shall not be subject to Philippine income tax and, consequently, to withholding tax. SaTAED As regards the imposition of the VAT on the rendition of services of CDC, please be informed further that Section 108 of the Tax Code of 1997 1 provides as follows: "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%) 2 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 is imposed on services rendered by CDC in the Philippines. On every payment of service fees, CDPC is 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. 3 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. 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. DScTaC 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(q) [now Section 109(K)] of the Tax Code of 1997 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 of services fees by CDPC, being a PEZA-registered enterprise, to CDC under the above Service 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. 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. 2. Effective February 1, 2006, the rate shall be 12%. 3. Referring to the old Section 109(q) of the Tax Code of 1997 [now Section 109(K), as amended by RA No. 9337].