DA ITAD BIR Ruling No. 149-06

December 8, 2006 DA ITAD BIR RULING NO. 149-06 Articles 5, 7 & 15 Philippines-Korea tax treaty; BIR Ruling No. DA-ITAD-69-00 Kepco Ilijan Corporation 18 Floor, Citibank Tower 8714 Paseo de Roxas Makati City Attention: Atty. Ricardo A. Galano III Corporate Counsel Gentlemen : This refers to your letter dated May 25, 2006, requesting tax treaty relief on behalf of Korea Electric Power Corporation ("KEPCO" for brevity), pursuant to the Philippines-Korea tax treaty. It is represented that KEPCO is a nonresident foreign corporation, with principal address at 167 Samseong-Dons, Gangnam-Gu, Seoul, 135-791, Korea, and is a resident of Korea for the purpose of the Philippines-Korea tax treaty, with Tax Identification No. 120-82-020052 as confirmed by the Certification of Residence issued by the Commissioner of the National Tax Administration of Korea dated May 2006; that KEPCO is not registered either as a corporation or as a partnership in the Philippines per certification issued by Securities and Exchange Commission dated May 29, 2006; that Kepco Ilijan Corporation ("KEPCO" for brevity), on the other hand, is a corporation duly organized and existing under the laws of the Philippines. SDHCac It is further represented that KEPCO has an existing Energy Conversion Agreement (ECA) with the National Power Corporation (NPC) for the operation and maintenance of the 1200 MW Ilijan Combined Cycle Power plant located in Batangas City; that on November 9, 2000, KEPCO and KEILCO entered into a Managerial and Technical Services Agreement (MTSA), pursuant to which KEPCO shall provide the following managerial and technical advisory services to KEPCO as follows: Scope of Work Major Scope of Work The Contractor 1 shall provide the following major services, including all incidental services related thereto, to the Owner 2 during the term of this Agreement. 3 1. consulting and advisory services to the Owner; 2. advisory services in respect of technical and engineering matters as may be required by the Owner in the development, implementation and administration of the Project, 4 and for the design, construction, testing, commissioning, operation and maintenance of the Power Station; 5 3. training of the Owner's staff and a personnel in accordance with Schedule "B" at the Contractor's facilities in Korea and coordinating such training with the training to be provided to the Owner's staff and personnel by the Construction Constructors 6 pursuant to the Construction Contracts; and 4. supply or procurement of equipment, instruments, tools spare parts and other materials and supplies for the Power Station as the Owner may request. Technical Support Without limiting the Contractor's responsibilities in Section 2.2.1, the Contractor shall provide the following specific technical support services, and all incidental services related thereto, to the Owner during the term of this Agreement: 1. assistance to the Owner in the formulation of various procedures and guidelines for the safe operation and maintenance of the Power Station, including but not limited to the procedures relating to the operation of all equipment, corrective and preventive maintenance and emergency actions, in accordance with Good Operating Procedures; 2. review and evaluation of the designs of the Power Station in order to check conformity with the specifications set forth in the Construction Contracts and the ECA, and providing recommendations on improvements or other necessary changes to such designs; 3. review and evaluation of the training, operation and maintenance manuals in order to check conformity with the requirements of the ECA and the O&M Protocol, and providing recommendations on the improvements or other necessary changes to such manuals; 4. review and evaluation of the equipment warranties provided by the Construction Contractors and other equipment suppliers of the Owner, if any, and providing recommendations on improvements or other necessary changes to such warranties; IaHAcT 5. review of the various Projects Documents entered into or to be entered into by the Owner as they may impact on or related to the financing, design, construction, testing, commissioning, operation and maintenance of the Power Station and the development, implementation and administration of the Project, and providing recommendations on necessary amendments to such Project Documents; 6. provision of a computerized maintenance and logistics management system, including specific routines or programs for materials and spare parts inventory and for the administration, control, supervision, operation and maintenance of the Power Station; 7. advice on the structuring of an efficient organizational and personnel set-up in respect of the construction, operation and maintenance of the Power Station, including the identification of the qualification requirements of the Owner's operation and maintenance personnel; 8. provision of technical and engineering advice (a) in the administration of the Project Document, (b) during the testing of the various equipment at the place of manufacture, and (c) during the commissioning and testing of the Power Station; 9. inspection of, reporting on and evaluation and monitoring of (a) all proposed designs or amended designs of the Power Station, (b) the Construction Contractors' progress reports and invoices, (c) all payments to the Construction Contractors and other suppliers, (d) all expenditures, and (e) all contractual claims; 10. preparation and submission of periodic and adhoc reports, based on information provided by the Owner, within such periods as the Owner and the Contractor may subsequently agree on, on matters relating to the construction, operation and maintenance of the Power Station and the development, implementation and administration of the Project; 11. review and evaluation of all engineering matters pertaining to the construction, operation and maintenance of the Power Station, including any major overhaul thereof; and 12. provision of other technical assistance and advisory services as the Owner may request and deem necessary or as the Contractor may deem appropriate, Administrative Support (a) The Contractor shall advise the Owner as may be necessary to ensure that the Power Station will be constructed, managed, operated and maintained in accordance with (i) the standard set out in the ECA, (ii) Good Operating Procedures, (iii) the operation and maintenance manuals provided by the Construction Constructors or any other equipment vendor and such other requirements as may be applicable to the warranties of the Construction Contractors or any other equipment vendor, (iv) the Annual Operating Budget and Annual Operation Plan, (v) applicable Law, Consents and all other requirements of Governmental Authorities, (vi) the requirements of the Project's insurers, (vii) applicable dispatch instructions given by NPC in accordance with the ECA, (viii) such operating rules, procedures and standards of NPC, as may be applicable to the Project from time to time, (ix) the O&M Protocol and (x) such security requirements or measures as may be agreed to by the Owner and the Contractor; CIDcHA (b) Without limiting the Contractor's responsibilities in Section 2.2.1, Section 2.2.2, and paragraph (a) of this Section the Contractor shall provide the following specific administrative support services, and all incidental services related thereto, during the term of the Agreement: 1. advice on the Owner's performance of corporate business activities; 2. advice on the administration and management of the various Project Documents; 3. advice on matters relating to the Owner's application for, and renewal and maintenance of, the various Consents required for the Owner's business operations and as may be required by the Project; 4. advice on matters relating to the planning, supervision and implementation of the various financial requirements of the Owner and the management of the Owner's financial resources, such as the maintenance of financial records and books of accounting; 5. advice on matters relating to the negotiation, execution and performance of the Financing Agreements and the administration and performance of the Owner of its obligations under the Financing Agreements; 6. advice on matters relating to the formulation and review of various internal procedures, guidelines and regulations of the Owner, including such regulations governing the Construction Contractors and other suppliers, their subcontractors and their employees, agents, representatives and personnel as may be deemed necessary to ensure the safe, timely and successful construction, commissioning, testing, start-up and operation and maintenance of the Power Station; 7. advice on matter relating to the recruitment and mobilization of the personnel (including staff) of the Owner; 8. advice on matters relating to the preparation, review and implementation of the Annual Operating Budget, Annual Operating Plan and the Long-Term Major Maintenance Plan; 9. Assistance in the formulation of the Owner's internal auditing procedures from time to time; 10. advice on matters relating to the preparation and monitoring of the schedules for the construction, operation and maintenance of the Power Station; 11. advice on matters relating to any dispute arising out of any of the Project Documents; and 12. provision of other administrative assistance, support and resources as the Owner may reasonably request or as the Contractor may deem appropriate. HICEca Under the said contract it is also stipulated on Article 8.2 Licenses: 8.2 Licenses 8.2.1 Provisions of Licenses The Contractor shall grant or cause to be granted to Owner such licenses of all patents and other proprietary rights held by any person as may be reasonably required for the provision of the services and fulfillment of the Contractor's obligations under this Agreement. Such licenses shall be in such form as shall be reasonably approved by the Owner, and shall be irrevocable, non-exclusive and royalty free to the Owner and its successors and assigns. Furthermore, per Certification dated October 10, 2006 issued by Ricardo A. Galano III, Corporate Counsel of Kepco Ilijan Corporation, it is represented that services under the Management and Technical Service Agreement for the year 2005 rendered both outside the Philippines and those performed in the Philippines did not exceed an aggregate of 183 days within any twelve-month period; and as a service agreement, the MTSA only involves the rendition of the following: a) consulting and advisory services; b) technical support services; and c) administrative support services; that during the term of the agreement no technological processes, intellectual property rights, patients, technical information and other "know-how" were transferred by KEPCO to the Corporation so as to constitute any royalties within the contemplation of the applicable laws. That in consideration for the aforementioned services, KEILCO shall pay to KEPCO annual fees, to be prorated and paid on a monthly basis as provided in Article 6 of the Agreement; that the services shall be done in Korea subject to a few exceptions wherein it is necessary to perform certain service in the Philippines for purposes of verifying and confirming all the works done in Korea; that on May 3, 2006, KEPCO issued a certification stating that the aggregate number of days of stay in the Philippines by KEPCO's personnel are forty eight (48) days for the year 2005. In reply, please be informed that Article 7(1) and, in relation thereto, Article 5 of the Philippines-Korea tax treaty which respectively provide, as follows: "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. "Article 5 PERMANENT ESTABLISHMENT 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. 2. The term 'permanent establishment' includes especially: a) a place of management; b) a branch; c) an office; d) a factory; TAaEIc e) a workshop; f) a mine, an oil or gas well, a quarry or any other place of extraction of natural resources; g) premises used as a sales outlet; and h) a warehouse, in relation to a person providing storage facilities for others. 3. a) a building site or construction, installation or assembly project or supervisory activities in connection therewith, constitute a permanent establishment only if such site, project or activity continues for a period of more than six months; b) the furnishing of services including consultancy services by an enterprise through an employee or other personnel constitutes a permanent establishment only if activities of that nature continue within a Contracting State for a period or periods exceeding in the aggregate 183 days within any twelve-month period; and c) a place of exploration of natural resources constitutes a permanent only if it exists for more than six months xxx xxx xxx" Based on the aforequoted provisions, the profits of KEPCO are taxable only in Korea unless it carries on business in the Philippines through a permanent establishment situated therein to which such profits may be attributable. For this purpose, KEPCO may be deemed to have a permanent establishment in the Philippines, if among others, it furnishes services in the Philippines through its personnel for a period or periods exceeding in the aggregate 183 days within any twelve-month period. The documents submitted to this Office show that the personnel of KEPCO rendered services under the MTSA, for an aggregate period not exceeding 183 days within a twelve-month period. Thus, KEPCO is not deemed to have a permanent establishment by virtue of the rendition of said services in the Philippines to which its profits could be attributable. In view thereof, this Office is of the opinion and so holds that the profits derived by KEPCO from the rendition of services under the MTSA shall not be subject to Philippine income tax pursuant to Article 7(1) in relation to Article 5(3)[b] of the Philippines-Korea tax treaty. (BIR Ruling No. DA-ITAD-202-02 dated November 25, 2002; BIR Ruling No. ITAD-069-00 dated April 07, 2000) As regards the remuneration to be paid to KEPCO's personnel who will render services in the Philippines, Article 15 of the same treaty provides, viz : "Article 15 DEPENDENT PERSONAL SERVICES 1. Subject to the provisions of Article 16 (Directors' Fees), 18 (Pensions and Annuities), 19 (Government Service), 20 (Students and Apprentices), and 21 (Professors and Teachers), salaries, wages and other similar remuneration derived by a resident of a Contracting State in respect of an employment shall be taxable only in that State unless the employment is exercised in that other Contracting State. If the employment is so exercised, such remuneration as is derived therefrom may be taxed in that other State. 2. Notwithstanding the provisions of paragraph 1, remuneration derived by a resident of a Contracting State in respect of an employment exercised in the other Contracting State shall be taxable only in the first-mentioned State if: EAIcCS a) the recipient is present in the other State for a period or periods not exceeding in the aggregate 183 days in the calendar year concerned, and b) the remuneration is paid by, or on behalf of an employer who is not a resident of the other State, and c) the remuneration is not borne by a permanent establishment or a fixed base which the employer has in the other State. xxx xxx xxx" Based on the above provision, the remuneration derived by KEPCO's personnel in connection with their visit to the Philippines shall be subject to Philippine income tax if their presence in the Philippines exceeds in the aggregate 183 days in a calendar year, and if their remuneration is paid by an enterprise which is a resident of the Philippines, and finally, if the remuneration is borne by a fixed base which KEPCO has in the Philippines. Inasmuch as the presence of KEPCO's personnel in the Philippines did not exceed in the aggregate, a period of more than 183 days for the year 2005, their remuneration for said taxable years shall not be subject to Philippine income tax, pursuant to Article 15 of the Philippines-Korea tax treaty. (BIR Ruling No. DA-ITAD-083-05 dated August 22, 2005) In the event that a transfer of information or know-how arises from the MTSA, the pertinent paragraphs of Article 12 of the above mentioned tax treaty shall apply to payments therefor. It 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 if such resident is the beneficial owner of the royalties. 2. However, such royalties may be taxed in the Contracting State in which they arise, and according to the laws of that State, but if the recipient is the beneficial owner of the royalties the tax so charge shall not exceed 15 per cent of the gross amount of the royalties. 3. Notwithstanding the provisions of paragraph 2 thereof, the amount of tax by the Philippines on the royalties paid by a company, being a resident of the Philippines, registered with the Board of Investments under the investment incentives laws of the Philippines to a resident of Korea, who is the beneficial owner of the royalties, shall not exceed 10 per cent of the gross amount of the royalties. 4. 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, any patent, trademark 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, and includes payments of any kind in respect of motion picture films and works on films or videotapes for use in connection with television or tapes for the use of radio broadcasting. CcTHaD xxx xxx xxx" Thus, pursuant to the foregoing provisions, payments to be made by KEPCO under the MTSA for any transfer of information or know-how are royalties which may be subject to a 10% preferential tax rate if the paying company is registered with the Board of Investments and engaged in preferred areas of investment and 15% in all other cases as long as the recipient of the royalty payments is the beneficial owner of the royalties and a resident of the Contracting State. Finally, royalty payments which might be made under the MTSA for the services to be rendered by KEPCO in the Philippines are subject to the value-added tax (VAT) pursuant to Section 108 of the Tax Code of 1997. With regard to the procedures for withholding and paying the VAT, Sections 4 and 6 of Revenue Regulations No. 4-2000, Section 3 of Revenue Regulations No. 8-2002, and Section 7 of Revenue Regulations No. 14-2002, provide that KEILCO shall be responsible for the withholding of the VAT on the service fees before remitting them to KEPCO. In remitting to the Bureau of Internal Revenue the VAT withheld on the service fees, KEILCO shall use BIR Form No. 1600 (Monthly Remittance Return of VAT and Other Percentage Taxes Withheld). If a VAT-registered taxpayer, KEILCO may use as documentary substantiation for its claim of input VAT the duly filed BIR Form No. 1600 and the proof of payment accompanying it. If a non-VAT-registered taxpayer, KEILCO may include as part of the cost of the services furnished to it by KEPCO the VAT consequently shifted or passed on to it and may treat such VAT either as an expense or as an asset , whichever is applicable. In addition, KEILCO is required to issue the Certificate of Final Tax Withheld at Source (BIR Form No. 2306) in quadruplicate, the first three copies thereof to be given to KEPCO upon its request, and the fourth copy to be retained by KEILCO as its file copy. (BIR ITAD Ruling No. DA-ITAD-147-05 dated November 29, 2005) This ruling is issued based on the facts as represented. However, if upon investigation it shall be disclosed that the actual facts are different, then thus 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. Contractor refers to Korea Electric Power Corporation (KEILCO). 2. Kepco Ilijan Corporation (KEPCO). 3. Managerial and Technical Services Agreement between KEPCO and KEILCO. 4. "Project". 5. "Power Station" means the 1200 MV natural gas fired combined cycle power plant with diesel fuel fire capability to be located in Ilijan, Batangas on a build, operate and transfer basis, and all other facilities constructed or to be constructed in respect thereof by the Owner to enable the Owner to fulfill its obligations under the ECA, and including the Switchyard Facilities, Access Road, Diesel Fuel Pipeline and Jetty. 6. "Construction Contractors" means Raytheon Ebasco Overseas Ltd, and United Engineers International, Inc. and Mitsubishi Corporation. 7. Republic Act No. 9337 (An Act Amending Section 27, 28, (An Act Amending Sections 27, 28, 34, 106, 107, 108, 109, 110, 111, 112, 113, 114, 116, 117, 119, 121, 148, 151, 151, 236, 237 And 288 Of The National Internal Revenue Code Of 1997, As Amended, And For Other Purposes), signed into law on May 24, 2005 and became effective on November 1, 2005, amended Section 108(A), which now reads: "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 one and one-half percent (1 1/2%); or (ii) National government deficit as a percentage of GDP of the previous year exceeds one and one-half percent (1 1/2%). 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. . ." 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.