DA ITAD BIR Ruling No. 164-06

December 18, 2006 DA ITAD BIR RULING NO. 164-06 Arts. 5 & 7, Philippines-Japan Tax Treaty; BIR Ruling No. DA-ITAD 79-06 JPN, Inc . Lot 9, Block 13, Phase 1 Cavite Economic Zone, Rosario, Cavite Attention: Mr. Yoshitaka Fukumoto President Gentlemen : This refers to your tax treaty relief application dated February 21, 2006, received by this Office on August 9, 2006, for the service fees paid by JPN, Inc. (JPN-Philippines) to Ishii Hyoki Co. Ltd. (Ishii-Japan). It is represented that Ishii-Japan is a nonresident foreign corporation organized and existing under the laws of Japan with principal office address at No. 5 Asahioka, Kannabe-cho, Fukayasugun, Hiroshima 720-22 Japan; that Ishii-Japan is not registered either as a corporation or as a partnership in the Philippines as shown in the Certification of Non-Registration issued by the Securities and Exchange Commission on April 19, 2006; that JPN-Philippines is a corporation duly organized and existing under the laws of the Philippines with principal address located at Lot 9 Block 13, CEPZ, Rosario, Cavite; that JPN-Philippines is a PEZA-registered enterprise engaged in the manufacture, assemble or fabricate nameplates, seal printing membrane panel and other products related to marking and signs. It is further represented that on February 1, 2004, Ishii-Japan and JPN-Philippines entered into a Contract whereby Ishii-Japan commits the following services to JPN-Philippines: 1. General consultation and management (e.g. assist in strategic planning and forecasting) CHEIcS Advice and assistance on JPN-Philippines' current operations Development of global business strategies and provision of strategic global leadership Advice on maintaining and administering proper accounting procedures, ledgers, payroll processing and other bookkeeping records Advice necessary to ensure that the manufacture, marketing and/or sale of the products are at the standard of quality 2. Administrative support services 3. Training and personnel development (e.g. give advice on standards recruitment of executive staff) 4. Financial and budgetary planning (e.g. budget review, financial projection and analysis) and 5. Marketing services (e.g. give advice on marketing strategies, business development, and marketing analysis) Advertising, marketing, sales support to increase the sales business for JPN-Philippines including but not limited to: market research requirements and questionnaire structure/content; packaging design Advice on expansion in the sales share in the Japan market. That the foregoing services will be performed by Ishii-Japan outside the Philippines; that in cases where it would be necessary for Ishii-Japan to send its personnel in the Philippines, the stay of these individuals in the Philippines shall not exceed 183 days in any given year; that said services shall in no case involve the transfer of Ishii-Japan of any know-how; that as a consideration for the said services, JPN-Philippines will pay Ishii-Japan a fixed monthly fee, in addition to bearing out-of-pocket expenses which are separately reimbursable to Ishii-Japan at their actual cost; that the Contract shall be valid and binding for a period of one (1) year from the effective date, 1 February 2004, and, unless terminated by either party at least thirty (30) days prior to the date of expiration, shall be automatically renewed for successive period of one (1) year; and that the issue or transaction subject of the above application is not under investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings, or a judicial appeal. In reply, please be informed of Article 7 of the Philippines-Japan tax treaty quoted 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. AHSaTI xxx xxx xxx" Based on the above, 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 that is attributable to that permanent establishment. Applying this to the instant case, the service fees received by Ishii-Japan for services rendered in the Philippines under the Contract 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 that other Contracting State consultancy services, or supervisory 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." Paragraph 6 of Article 5 provides that an enterprise of Japan shall be deemed to have a permanent establishment in the Philippines if it furnishes in the Philippines 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. Thus, Ishii-Japan 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 JPN-Japan. Such being the case, the income derived by Ishii-Japan from services rendered to JPN-Japan shall not be subject to Philippine income tax and, as such, shall likewise be exempt from withholding tax. (BIR Ruling No. DA-ITAD 79-06 dated July 19, 2006) As regards the imposition of the VAT on the rendition of services of Ishii-Japan, please be informed further that Section 108 of the Tax Code of 1997 1 provides as follows: DEAaIS "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 Ishii-Japan in the Philippines. On every payment of service fees, JPN-Philippines 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 P D 6 6 are not. P D 6 6 is the precursor of R A 79 16 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 P D 6 6 and R A 79 16 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 if 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 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. AaEcHC Moreover, the exemption is both express and pervasive for the following reasons: . . ., R A 79 16 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 79 16 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 JPN-Japan, being a PEZA-registered enterprise, to Ishii-Japan under the subject Contract 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].