DA ITAD BIR Ruling No. 146-06

November 23, 2006 DA ITAD BIR RULING NO. 146-06 Article 5 & 7 of the Philippines-Japan tax treaty; BIR Ruling No. DA-ITAD-69-04 Luzon Electronics Technology, Inc . Special Export Processing Zone Gateway Business Park Javalera, Gen. Trias, Cavite Attention: Ms. Luz G. Cuyco Manager for Finance Department Gentlemen : This refers to your letter dated January 9, 2006, applying for relief from double taxation on income payments made by Luzon Electronics Technology, Inc. (LETI) to Marubun Corporation (Marubun) in consideration for engineering and technical support rendered by the latter pursuant to the Philippines-Japan tax treaty. It is represented that Marubun is a corporation duly organized and existing under the laws of Japan, with office address at Marubun Daiya Bldg. 8-1, Nihonbashi Odenmacho, Chuo-Ku, Tokyo 103, Japan as evidenced by a copy of its Company Registration certified by the Registration Officer of the Tokyo legal Affairs Bureau on September 27, 2005; that it is not registered either as a corporation or as a partnership licensed to do business in the Philippines per certification issued by the Securities and Exchange Commission dated August 18, 2005; that LETI is a PEZA registered enterprise with Certificate of Registration No. 95-121 duly organized and existing under the laws of the Philippines with principal office at SEZ, Gateway Business Park, Javalera, General Trias, Cavite City. It is further represented that on June 21, 2005, LETI and Marubun entered into an Agreement for the purpose of providing services of a Technical Supervisor to support Engineering requirements for Akim (Index type mounter equipment of LETI) consisting of the following: (a) test run and adjustment work, (b) scheduled maintenance, (c) claim and complaints; that the cost of one Supervisor dispatched to LETI shall be at 70,000 yen/day, however, for a move day, LETI pays 35,000 yen/day; that the Agreement shall be valid one year after signing of the Agreement and such term shall be automatically extended for successive terms of one (1) year at the same condition unless either party gives notice of termination not less than three (3) months prior to the current term; and that the subject transaction is not under any investigation, audit, administrative protest, claim for refund or issuance of tax credit certificate, collection proceedings, or a judicial appeal of the taxpayer involved. HCacTI In reply, please be informed that Article 7 of the Philippines-Japan tax treaty provides as follows: "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" Moreover, Article 5 of the said treaty provides, viz : "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 is 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 aforequoted provisions, it is clear that if a corporation which is a resident of Japan carries on business in the Philippines through a permanent establishment situated therein, the profits of the same shall be subject to Philippine income tax, but only so much of such profits as is attributable to that permanent establishment. For this purpose, a corporation which is a resident of Japan may be deemed to have a permanent establishment in the Philippines if, among others, the furnishing of consultancy or supervisory services by such corporation, through its employees or other personnel, in the same or connected project, continue within the Philippines for a period or periods aggregating more than six months in any taxable year except when the furnishing of such services is effected under an agreement between the Governments of Japan and Philippines regarding economic or technical cooperation, in which case, the corporation shall not be deemed to have a permanent establishment in the Philippines. Considering that the services specified in the Agreement are generally performed by Marubun in its office in Japan and that if such services are performed in the Philippines, the length of stay of personnel of Marubun shall not exceed six (6) months, and that for the succeeding periods covering the renewed terms of the Agreement, Marubun employees who would be coming to the Philippines to render the services under the Agreement will not stay in the Philippines for a period or periods aggregating more than six (6) months within any taxable year per certification issued by LETI dated July 26, 2006, Marubun is not deemed to have a permanent establishment in the Philippines to which its business profits may be attributed to. Therefore, the income derived by Marubun from services rendered to LETI is not subject to Philippine income tax, pursuant to Article 7(1) in relation to Article 5 of the Philippines-Japan tax treaty. (BIR Ruling No. DA-ITAD-69-04 dated July 13, 2004) SEACTH As the regards the imposition of the VAT on the rendition of services of Marubun, please be informed further that Section 108 of the Tax Code of 1997 1 provides as follows, to wit: "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 should be imposed when Marubun 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". LETI 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. 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. cTaDHS 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 of services fees by LETI, being a PEZA-registered enterprise to Marubun, 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. 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].