ITAD BIR Ruling No. 006-16

February 29, 2016 ITAD BIR RULING NO. 006-16 Articles 5 (Permanent Establishment) and 8 (Business Profits), Philippines-United States of America tax treaty Villanueva Caa and Associates Law Offices 23rd Floor Cityland 10, Tower II H.V. Dela Costa Street corner Ayala Avenue, Salcedo Village Makati City Attention: Atty. Isagani C. Villanueva Atty. Ranhel A. Perez Atty. Lorelei Enya J. Meneses Gentlemen : This refers to your tax treaty relief application filed on April 21, 2009 requesting confirmation, among others, that service fees paid by San Roque Power Corporation ("San Roque") to R.W. Beck International Ltd. ("R.W. Beck") are exempt from income tax pursuant to the Convention between the Government of the Republic of the Philippines and the Government of the United States of America with Respect to Taxes on Income ("Philippines-United States tax treaty") . Facts R.W. Beck is a foreign corporation and a resident of the United States based on its Certificate of Residence issued by the Internal Revenue Service on January 2, 2008. R.W. Beck is located at 1001 Fourth Avenue, Suite 2500, Seattle, Washington, United States. It is not registered as a corporation or partnership in the Philippines based on the Certification of Non-Registration of Corporation/Partnership issued by the Securities and Exchange Commission on August 27, 2008. On the other hand, San Roque is a domestic corporation with principal office at San Roque, San Manuel, Pangasinan, and administration office at 36th Floor, Tower 1, The Enterprise Center, 6766 Ayala Avenue, Makati City, in the Philippines. On November 17, 1998, R.W. Beck, the National Power Corporation ("NPC") 1 and the Bank of Tokyo-Mitsubishi, Ltd. ("Bank of Tokyo-Mitsubishi") 2 entered into a Professional Services Agreement where R.W. Beck agreed to perform independent engineering services to the San Roque Multipurpose Project . The project involved the construction of a 200-meter-high rock-filled dam with a clay core and spillway structure; a 12-square kilometer reservoir pool; a water conveyance system consisting of a headrace, power tunnels and penstocks; and a powerhouse with three 115-megawatt Francis turbines, generating sets, and associated electrical systems. The project will be designed, built, and operated for 25 years under a concession agreement with NPC and it will be transferred to NPC after concession. The project has three stages. Stage 1 includes a review of the dam's design and strength to resist seismic loadings anticipated at the site and a check of the cofferdam's proposed structure to divert water during construction. Stage 2 requires R.W. Beck to act as an independent technical advisor to the project where it will make periodic site visits to the project and prepare monthly reports and certifications for payment to the various contractors of the project. Stage 3 requires R.W. Beck to perform special assessment of the operation and maintenance of the project, which includes a review of the facilities of and equipment installed at the project. The project cost is US$43,069.00 (Stage 1: Design Review), US$948,692.00 (Stage 2: Construction Monitoring) and US$59,462.00 (Stage 3: Operational Maintenance). The Agreement was amended on July 14, 2003 to authorize R.W. Beck to render additional services to the project where the latter will receive service fees of US$8,453.84 (first amendment) and US$62,710.00 (second amendment). Based on a certification issued by San Roque on April 16, 2009, R.W. Beck sent the following personnel to the Philippines to render services to the project: (1) Reynold A. Hokenson, (2) John A. Bakkin, (3) Paul J. Harmon and (4) Scott J. Rbiman. The total number of days these services were rendered is as follows: CAIHTE 1998 Total Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec - - - - - - - - 11-15 - - 9-12 Total - - - - - - - - 5 - - 4 9 1999 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec - 18-21 - 20-27 - 17-22 19-31 - 24-28 - - 7-15 Total - 4 - 8 - 6 13 - 5 - - 9 45 2000 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec - 17-22 21-28 - 23-30 - 27-31 - 24-30 1 28-30 1-4 Total - 6 8 - 8 - 5 - 7 1 3 4 42 2001 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec - 13-20 25-31 1 - 1-7 - 21-28 - - - 9-18 Total - 8 7 1 - 7 - 8 - - - 10 41 2002 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 28-31 1-2 - 14-21 13-17 10-10 22-27 - 17-21 27-31 1-2 15-20 12-22 Total 4 2 - 8 5 11 6 - 5 5 13 6 65 2003 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec - 6-19 3-11 - - 16-23 - - 15-20 22-31 - - Total - 14 9 - - 8 - - 6 10 - - 47 2004 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec - 23-27 - - - - - - 19-28 - - - Total - 5 - - - - - - 10 - - - 15 2005 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec - - - 10-25 - - - - - 23-29 - - Total - - - 16 - - - - - 7 - - 23 2006 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec - - - - - - - - - - 4-10 - Total - - - - - - - - - - 7 - 7 2007 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec - - - - - 3-9 - - - - - - Total - - - - - 7 - - - - - - 7 2008 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec - - 29-31 1-10 - - - - - - - - Total - - 3 10 - - - - - - - - 13 Grand Total 314 ==== Ruling In reply, please be informed that under Section 28 (B) (1) of the National Internal Revenue Code of 1997, as amended ("Tax Code") , income derived in the Philippines by a foreign corporation not engaged in trade or business in the Philippines is subject to income tax at the rate of 30 percent, to wit: "SEC. 28. Rates of Income Tax on Foreign Corporations . xxx xxx xxx (B) Tax on Nonresident Foreign Corporation . (1) In General. Except as otherwise provided in this Code, a foreign corporation not engaged in trade or business in the Philippines shall pay a tax equal to thirty-five percent (35%) of the gross income received during each taxable year from all sources within the Philippines, such as interests, dividends, rents, royalties, salaries, premiums (except reinsurance premiums), annuities, emoluments or other fixed or determinable annual, periodic or casual gains, profits and income, and capital gains, except capital gains subject to tax under subparagraph 5(c) and (d) above: n Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%). " However, under Section 32 (B) (5) of the Tax Code, such income is exempt or partially exempt to the extent required by any treaty obligation on the Philippines, to wit: "SEC. 32. Gross Income. xxx xxx xxx (B) Exclusions from Gross Income. The following items shall not be included in gross income and shall be exempt from taxation under this Title: xxx xxx xxx (5) Income Exempt under Treaty. Income of any kind, to the extent required by any treaty obligation binding upon the Government of the Philippines." For this purpose, you invoke paragraph 1, Article 8 of the Philippines-United States tax treaty, which provides: DETACa "Article 8 Business Profits 1. Business profits of a resident of one of the Contracting States shall be taxable only in that State unless the resident has a permanent establishment in the other Contracting State. If the resident has a permanent establishment in that other Contracting State, tax may be imposed by that other Contracting State on the business profits of the resident but only on so much of them as are attributable to the permanent establishment." Under this article, business or commercial profits derived in the Philippines by an enterprise of the United States may be taxed in the Philippines only if they are attributable to a permanent establishment which the enterprise has in the Philippines. The term permanent establishment is defined in paragraphs 1 and 2, Article 5 of the same treaty, thus: "Article 5 Permanent Establishment 1. For the purposes of this Convention, the term 'permanent establishment' means a fixed place of business through which a resident of one of the Contracting States engages in a trade or business. 2. The term 'fixed place of business' includes but is not limited to: a) A seat of management; b) A branch; c) An office; d) A store or other sales outlet; e) A factory; f) A workshop; g) A warehouse; h) A mine, quarry, or other place of extraction of natural resources; i) A building site or construction or assembly project or supervisory activities in connection therewith, provided such site, project or activity continues for a period of more than 183 days; and j) The furnishing of services, including consultancy services, by a resident of one of the Contracting States through employees or other personnel, provided activities of that nature continue (for the same or a connected project) within the other Contracting State for a period or periods aggregating more than 183 days." Under Article 5, a permanent establishment means a fixed place of business through which the business of an enterprise is wholly or partly carried on, and includes especially, a seat of management, a branch, an office, a store or other sales outlet, a factory, and a workshop. It includes also a building site or construction or assembly project or supervisory activities in connection therewith, provided such site, project or activity continues for a period of more than 183 days. Accordingly, since R.W. Beck has rendered independent engineering services to the San Roque Multipurpose Project for 314 days from 1998 to 2008, it is deemed to have a permanent establishment in the Philippines under paragraph 2(i), Article 5 of the Philippines-United States tax treaty. Therefore, service fees paid by San Roque to R.W. Beck are subject to income tax under paragraph 1, Article 7 of the same treaty. Particularly, R.W. Beck is deemed a foreign corporation engaged in trade or business in the Philippines and it is entitled to deduct ordinary and necessary expenses from its business or commercial profits, pursuant to paragraph 4, Article 7 of the Philippines-United States tax treaty and Section 28 (A) (1) of the amended Tax Code, to wit: Philippines-United States tax treaty "4. In the determination of the business profits of a permanent establishment, there shall be allowed as deductions ordinary and necessary expenses which are reasonably allocable to such profits, including executive and general administrative expenses, whether incurred in the Contracting State in which the permanent establishment is situated or elsewhere. . ." aDSIHc Tax Code "SEC. 28. Rates of Income Tax on Foreign Corporations. (A) Tax on Resident Foreign Corporation . (1) In General. Except as otherwise provided in this Code, a foreign corporation organized, authorized, or existing under the laws of any foreign country, engaged in trade or business within the Philippines, shall be subject to an income tax equivalent to thirty-five percent (35%) of the taxable income 3 derived in the preceding taxable year from all sources within the Philippines: Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)". Furthermore, under Section 108 (A) of the Tax Code, the service fees paid by San Roque to R.W. Beck are subject to value-added tax ("VAT"), 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%) of gross receipts derived from the sale or exchange of services, including the use or lease of properties: Provided, that the President, upon the recommendation of the Secretary of Finance, shall, effective January 1, 2006, 4 raise the rate of value-added tax to twelve percent (12%). . ." Relative thereto, San Roque shall withhold VAT on the service fees at the rate of 12 percent before remitting them to R.W. Beck. San Roque shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld). The duly filed BIR Form No. 1600 and its accompanying proof of payment shall serve as documentary substantiation for San Roque 's claim of input VAT on the fees. Otherwise, if it is not a VAT-registered taxpayer, San Roque may treat the passed-on VAT as asset or expense which forms part of the cost of providing the services. VAT withheld shall be remitted within ten days following the end of the month the withholding was made. 5 Finally, on your other request for ruling that service fees and other authorized reimbursements paid or to be paid to R.W. Beck as well as expenses for accommodation and transportation of R.W. Beck's representatives relative to the Project be treated as ordinary and necessary expenses deductible for the purpose of computing the taxable income of San Roque , the nature of your request is considered a "NO-RULING AREA" pursuant to Section 2 (k) of Revenue Bulletin No. 1-2003 , 6 which reads: " Section 2. List of No-Ruling Areas . The following shall hereby be construed and identified as 'No-Ruling Areas': xxx xxx xxx. k) Determination of whether an expense is ordinary or necessary ;" (Emphasis ours) Please be guided accordingly. Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes 1. Located at Quezon Avenue corner Agham Road, Diliman, Quezon City, Philippines. 2. Located at 7-1 Marunouchi 2-chome, Chiyoda-ku, Tokyo, Japan. 3. "SEC. 31. Taxable Income Defined . The term 'taxable income' means the pertinent items of gross income specified in this Code, less the deductions and/or personal and additional exemptions, if any, authorized for such types of income by this Code or other special laws." 4. The VAT rate was increased to 12 percent beginning 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. 5. Pursuant to Section 4.114-2 of Revenue Regulations No. 16-2005 (Consolidated Value-Added Tax Regulations of 2005) , as amended by Revenue Regulations No. 4-2007 (Amending Certain Provisions of Revenue Regulations No. 16-2005, As Amended, Otherwise Known as the Consolidated Value-Added Tax Regulations of 2005) , which provides: "SEC. 4.114-2. Withholding of VAT on Government Money Payments and Payments to Non-Residents . xxx xxx xxx (b) The government or any of its political subdivisions, instrumentalities or agencies including GOCCs, as well as private corporation, individuals, estates and trust, whether large or non-large taxpayers, shall withhold twelve percent (12%) VAT, starting February 1, 2006, with respect to the following payments: (1) Lease or use of properties or property rights owned by non-residents; and (2) Services rendered to local insurance companies with respect to reinsurance premiums payable to non-residents; and (3) Other services rendered in the Philippines by non-residents. In remitting VAT withheld, the withholding agent shall use BIR Form No. 1600 Remittance Return of VAT and Other Percentage Taxes Withheld. VAT withheld and paid for the non-resident recipient (remitted using BIR Form No. 1600), which VAT is passed on to the resident withholding agent by the non-resident recipient of the income, may be claimed as input tax by said VAT-registered withholding agent upon filing his own VAT Return, subject to the rule on allocation of input tax among taxable sales, zero-rated sales and exempt sales. The duly filed BIR Form No. 1600 is the proof or documentary substantiation for the claimed input tax or input VAT. Nonetheless, if the resident withholding agent is a non-VAT taxpayer, said passed-on VAT by the non-resident recipient of the income, evidenced by the duly filed BIR Form No. 1600, shall form part of the cost of purchased services, which may be treated either as an 'asset' or 'expense', whichever is applicable, of the resident withholding agent. VAT withheld under this Section shall be remitted within ten (10) days following the end of the month the withholding was made." 6. Prescribing the Procedure and Guidelines for the Proper Handling of Request for Rulings which are Determined Hereunder as "No-Ruling Areas", and Providing the Initial List of "No-Ruling Areas" . n Note from the Publisher: The phrase "and (d) above" no longer appears in RA 9337, the law amending this provision.