ITAD BIR Ruling No. 008-21

March 17, 2021 ITAD BIR RULING NO. 008-21 Articles 5 (Permanent Establishment), 7 (Business Profits) and 12 (Royalties) Philippines-Finland tax treaty AAA BBB 19th Floor, Philippine AXA Life Center Sen. Gil Puyat Avenue corner Tindalo Street 1224 Makati City Gentlemen : This refers to your tax treaty relief application filed on December 27, 2016 requesting confirmation that software payments made by the Bank of the Philippine Islands ("BPI") to Granite Partners Ltd. ("Granite") are exempt from income tax pursuant to the Convention between the Republic of the Philippines and the Republic of Finland for the Avoidance of Double Taxation and Prevention of Fiscal Evasion with Respect to Taxes on Income ("Philippines-Finland tax treaty") . HTcADC FACTS Granite is a foreign corporation organized and existing under the laws of Finland and a resident thereof based on the Extract issued by the Trade Register of Finland and the Certificate of Fiscal Residence issued by the Finnish Tax Administration. Granite is a cloud service company that provides development for business risk management, cyber security and privacy and occupational safety and health. 1 It is not registered as a corporation or partnership in the Philippines based on the Certificate of Non-Registration of Company issued by the Securities and Exchange Commission. On the other hand, BPI is a domestic corporation that provides banking services. It is a universal bank and together with its subsidiaries and affiliates, offers a wide range of financial products and solutions that serve both retail and corporate clients. Its services include consumer banking and lending, asset management, insurance, securities brokerage and distribution, foreign exchange, leasing, and corporate and investment banking. 2 On December 13, 2016, BPI and Granite entered into a Granite Licence and Service Agreement whereby the latter granted the former (and its subsidiaries) a fixed-term user license for the Granite Online Information Security Training Software ("software") . Granite is the owner of the software and has the right to grant such license under the Agreement. All intellectual property rights of the software, its contents, documents and materials including modifications made on the software are the property of Granite and its licensors. The license granted to BPI during the license period is unlimited; as such, the number of visits to and users of the software is not limited. BPI shall not transfer the license further and this applies to future versions of the software developed by Granite or developed in cooperation with the latter. The license is valid for an initial period of one year from October 1, 2016 to September 30, 2017. Thereafter, the license shall remain valid for successive periods of three months, unless terminated. Granite will provide the following courses for the software: 1. Introductory course on information security; 2. Basic course on information security; 3. Follow-up course on information security; and 4. Nixu System Administrator Training. Granite will also provide maintenance, updates and support services for the software. It will provide a web-based service to BPI through which users can register for personal user ID's. The software will be maintained and updated with possible error fixes at least until December 31, 2022. The license fee for the software for the initial term is US$__________ broken down as follows: US$$__________ (delivery cost),US$$__________ (license cost per month for twelve months for basic course),and US$$__________ (license cost per month for a specialized course).After the initial term, the monthly license cost will increase to US$$__________. BPI will pay the license fee within thirty days after the receipt of invoice from Granite .Additional services undertaken or to be performed and other deliverables to be provided by Granite will be set out in a work order. The price for customization work is US$$__________ per hour and US$$__________ per day. These services will be invoiced monthly. Based on the Certifications issued by BPI ,the above services were performed by Granite outside the Philippines, and that the income subject of this ruling is not under investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceeding, or judicial appeal. RULING Income tax In reply, please be informed that under Section 28 (B) (1) of the National Internal Revenue Code of 1997 ("Tax Code") ,as amended, income derived by a nonresident foreign corporation is subject to income tax at the rate of 30%,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: * 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 to the extent required by any treaty obligation binding upon the Philippine government, 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." In Commissioner of Internal Revenue vs. Smart Communication, Inc. (G.R. Nos. 179045-46, August 25, 2010) ,the Supreme Court made a distinction between payments for software as business profits and as royalties under a tax treaty, to wit: " In the instant case, it was established during the trial that Prism does not have a permanent establishment in the Philippines. Hence, 'business profits' derived from Prism's dealings with respondent are not taxable. The question is whether the payments made to Prism under the SDM, CM, and SIM Application agreements are 'business profits' and not royalties. CAIHTE Paragraph 1.3 of the Programming Services (Schedule A) of the SDM Agreement, reads: '1.3 Intellectual Property Rights (IPR) The SDM shall be installed by PRISM, including the SDM Libraries, the IPR of which shall be retained by PRISM. PRISM, however, shall provide the Client the APIs for the SDM at no cost to the Client. The Client shall be permitted to develop programs to interface with the SDM or the SDM Libraries, using the related APIs as appropriate.' Whereas, paragraph 1.4 of the Programming Services (Schedule A) of the CM Agreement and paragraph 1.3 of the Programming Services (Schedule A) of the SIM Agreement provide: '1.4 Intellectual Property Rights (IPR) The IPR of all components of the CM belong to the Client with the exception of the following components, which are provided, without technical or commercial restraints or obligations: xxx xxx xxx 1.3 Intellectual Property Rights (IPR) The Client shall own the IPR for the Specifications and the Source Code for the SIM Applications. PRISM shall develop an executable compiled code (the "Executable Version") of the SIM Applications for use on the aSIMetric card which, however, shall only be for the Client's use. The Executable Version may not be provided by PRISM to any third [party] without the prior written consent of the Client. It is further recognized that the Client anticipates licensing the use of the SIM Applications, but it is agreed that no license fee will be charged to PRISM or to a licensee of the aSIMetrix card from PRISM when SIMs are supplied to the Client.' The provisions in the agreements are clear. Prism has intellectual property right over the SDM program, but not over the CM and SIM Application programs as the proprietary rights of these programs belong to respondent. In other words, out of the payments made to Prism, only the payment for the SDM program is a royalty subject to a 25% withholding tax. A refund of the erroneously withheld royalty taxes for the payments pertaining to the CM and SIM Application Agreements is therefore in order." (Emphasis ours) Clearly, the license fee for the software constitutes royalties as Granite holds all intellectual property rights of the software, its contents, documents and materials including modifications made on the software during the license period. On the other hand, payments for after-sales services, which will be set out in future work orders and invoiced monthly to BPI are considered business profits since they are compensation for services rendered by Granite 's designated employees or personnel to maintain and address possible errors of the software. For royalties , paragraphs 1 and 2, Article 12 of the Philippines-Finland tax treaty provide that royalties arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in the first-mentioned State at the rate of 15% or 25%, provided the income recipient is the beneficial owner of such royalties, to wit: aScITE " 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. Such royalties may also be taxed in the Contracting State in which they arise, and according to the law of that State. However, the tax so charged shall not exceed a) 15 per cent of the gross amount of the royalties, where the royalties are paid by an enterprise registered with and engaged in preferred areas of activities, and also royalties in respect of cinematographic films or tapes for television or broadcasting, and royalties for the use of, or the right to use, any copyright of literary, artistic or scientific work; and b) in all other cases, 25 per cent of the gross amount of the royalties. Royalties are subject to 15% withholding tax if they are paid by an enterprise registered with and engaged in preferred areas of activities, are paid in respect of cinematographic films or tapes for television or broadcasting, or are paid for the use of, or the right to use, any copyright of literary, artistic or scientific work. In all other case, the royalties are subject to 25% withholding tax. Since software is treated in the Philippines as a copyrighted artistic, literary or scientific work, the license fees paid by BPI to Granite for the use of the software are, therefore, considered royalties .As such, the license fees are subject to income tax at the rate of 15% under paragraph 2 (a), Article 12 of the Philippines-Finland tax treaty. On the other hand, for the service fees paid by BPI for after-sales services provided by Granite , paragraph 1, Article 7 and paragraphs 1 and 2, Article 5 of the Philippines-Finland tax treaty 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: a) that permanent establishment; or b) sales within that other Contracting State of goods or merchandise of the same or similar kind as those sold, or from other business activities of the same or similar kind as those effected, through 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 the enterprise is wholly or partly carried on. 2. The term 'permanent establishment' shall include especially: a) a place of management; b) a branch; c) an office; d) a factory; e) a workshop; f) a mine, quarry or other place of extraction of natural resources; g) a building or construction site or installation project or supervisory activities in connection therewith, where such site, project or activities continue for a period more than 183 days; h) premises used as a sales outlet; i) a warehouse, in relation to a person providing storage facilities for others; j) the furnishing of services, including consultancy services, by a resident of one of the Contracting States through employees or other personnel, provided the 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 7, 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 such, the profits may be taxed in the other State but only so much of them as are attributable to the permanent establishment, among others. Under Article 5, the term permanent establishment means a fixed place of business through which the business of the enterprise is wholly or partly carried on, and includes especially, a place of management, a branch, an office, a factory and a workshop. It includes also the furnishing of services, including consultancy services, by a resident of a Contracting State through employees or other personnel, provided the 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. Accordingly, since Granite is not engaged in trade or business in the Philippines, does not have a branch, an office or other fixed place of business in the Philippines, and did not furnish services in the Philippines but performed them outside, Granite is deemed not to have a permanent establishment pursuant to paragraphs 1 and 2, Article 5 of the Philippines-Finland tax treaty. Thus, payments made by BPI to Granite for after-sales services in connection with the software ,being in essence business profits ,are exempt from income tax under paragraph 1, Article 7 of the tax treaty. Value-Added Tax Under Section 108 (A) of the Tax Code, payments for the sale or exchange of services including the use or lease of property in the Philippines are subject to value-added tax (" VAT ") at the rate of 12%,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, raise the rate of value-added tax to twelve percent (12%)... 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 ours) Based on the destination principle of the VAT system, services rendered in the Philippines, including the use or lease of properties in the Philippines, are subject to VAT, while those performed abroad are exempt. Therefore, the license fees paid by BPI to Granite for the use of the latter's software in the Philippines are subject to VAT ,while payments for after-sales services in connection with the software that were performed outside the Philippines are exempt from VAT under Section 108 (A) of the Tax Code. HEITAD Pursuant to Section 4.114-2 of Revenue Regulations No. 16-2005, 3 BPI shall withhold VAT on the license fee at the rate of 12% before remitting it to Granite . BPI shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld).The duly filed form and its accompanying proof of payment shall serve as documentary substantiation for BPI 's claim of input VAT on the fee. VAT withheld shall be remitted within ten days following the end of the month the withholding was made. This ruling is issued on the basis of the facts as represented. However, if it shall be disclosed upon investigation that the actual facts are different, then this ruling shall be without force and effect insofar as the herein parties are concerned. Very truly yours, (SGD.) CAESAR R. DULAY Commissioner of Internal Revenue Footnotes 1. https://granitegrc.com/about/ 2. https://www.bpiexpressonline.com/p/1/776/about-bpi 3. 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).