Sycip Gorres Velayo and Co.

June 3, 2019 ITAD BIR RULING NO. 009-19 Articles 5 (Permanent Establishment) and 8 (Business Profits) Philippines- United States of America tax treaty Sycip Gorres Velayo and Co. 6760 Ayala Avenue 1226 Makati City Attention: AAA __________ Gentlemen : This refers to your tax treaty relief application filed on July 15, 2013 requesting confirmation that rentals paid by Air Drilling Associates Pte. Ltd. Philippine Branch (" Air Drilling SG-Philippine Branch ") to Air Drilling Associates, Inc. (" Air Drilling US ") 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: Air Drilling US is a corporation organized and existing under the laws of the United States and a resident thereof based on its amended Articles of Incorporation and Certificate of Residence issued by the Internal Revenue Service. Air Drilling US is engaged in providing air, foam, and aerated fluid drilling services to petroleum and geothermal industries. 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 (" SEC ").On the other hand, Air Drilling SG-Philippine Branch is the branch office in the Philippines of Air Drilling Associates Pte. Ltd. (" Air Drilling SG ") of Singapore, pursuant to a License to Transact Business in the Philippines issued by the SEC to Air Drilling SG . Air Drilling US is the ultimate parent of Air Drilling SG .The purpose of the branch office is to pursue geothermal aerated drilling services and related opportunities in the Philippines. The branch office is located in Makati City, Philippines. Based on Air Drilling SG-Philippine Branch 's Audited Financial Statements (" AFS ") as of December 31, 2015, the branch office has been engaged to provide aerated fluid drilling services to the Northern Negros Geothermal Project and Orka Energy Project in the provinces of Leyte and Biliran in the Philippines. On July 1, 2013, Air Drilling US and Air Drilling SG-Philippine Branch entered into a Lease Agreement (" Agreement ") where Air Drilling US agreed to lease machinery, equipment and other personal property to the branch office, consisting of boosters, compressors and mist pump of certain specifications and numbers (" leased equipment "). Air Drilling US warrants that the leased equipment are in good order and condition and in accordance with the prescribed manufacture, design, and capacity. The leased equipment shall at all times be the sole and exclusive property of Air Drilling US ,and Air Drilling SG-Philippine Branch shall not have nor acquire any right, title or interest in the leased equipment, or any part thereof, except the right to use them under the terms and conditions of the Agreement. Upon expiration or termination of the Agreement, the leased equipment shall be returned to Air Drilling US in the same condition as when received, excluding any ordinary wear and tear. In consideration for the lease, Air Drilling SG-Philippine Branch will pay rental fees to Air Drilling US during the term of the Agreement, amounting to US$540,000.00 every quarter. The Agreement shall commence on July 1, 2013 and shall continue for a period of 36 months until June 30, 2016, unless earlier terminated. Air Drilling SG-Philippine Branch had recognized cost of services and operating expenses in relation to the leased equipment amounting to US$3,240,000.00 in 2015, based on its AFS. Based on the Certification issued by Air Drilling SG-Philippine Branch ,the leased equipment is located in the branch office's area of operations, and is being used and necessary for the branch office's business operations; that the branch office's personnel are knowledgeable and capable of operating, maintaining and repairing the leased equipment, and no personnel of Air Drilling US were sent to the Philippines to operate, maintain or repair the leased equipment during the term of the Agreement; that the branch office has no similar lease agreements with third party lessors; and that the leased equipment from Air Drilling US will result in cost savings and efficiency for the branch office's operations. Based on the sworn statement issued by Air Drilling SG-Philippine Branch ,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 proceedings, or judicial appeal. RULING: In reply, please be informed that under Section 28 (B) (4) of the National Internal Revenue Code of 1997 (" Tax Code "),as amended, rentals derived by a nonresident lessor of machineries and equipment are subject to income tax at the rate of 7 1/2%,to wit: " SEC. 28. Rates of Income Tax on Foreign Corporations . xxx xxx xxx (B) Tax on Nonresident Foreign Corporation . xxx xxx xxx (4) Nonresident Owner or Lessor of Aircraft, Machineries and Other Equipment. Rentals, charters and other fees derived by a nonresident lessor of aircraft, machineries and other equipment shall be subject to a tax of seven and one-half percent (7 1/2%) of gross rentals or fees." However, under Section 32 (B) (5) of the Tax Code, such rentals are 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." For this purpose, paragraphs 1 and 6 of Article 8 and paragraphs 1 and 2 of Article 5 of the Philippines-United States tax treaty provide: " 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. xxx xxx xxx 6. The term 'business profits' means income derived from any trade or business whether carried on by an individual, corporation or any other person, or group of persons, including the rental of tangible personal (movable) property." " 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 8, business profits derived by a resident of the United States in the Philippines may be taxed in the Philippines if the resident has a permanent establishment therein and those profits are attributable to the permanent establishment. The term business profits means income derived from any trade or business whether carried on by an individual, corporation or any other person, or group of persons, including rental of tangible personal (movable) property . Under Article 5, a permanent establishment means a fixed place of business through which a resident engages in a trade or business, and includes especially a seat of management, a branch, an office, a store or other sales outlet, a factory, and a workshop. In relation to lease of equipment becoming a permanent establishment, the following commentaries of the Organisation for Economic Co-operation and Development Model Tax Convention on Income and on Capital (Condensed Version, November 21, 2017) provide: "8. Where tangible property such as facilities, industrial, commercial or scientific (ICS) equipment, buildings, or intangible property such as patents, procedures and similar property, are let or leased to third parties through a fixed place of business maintained by an enterprise of a Contracting State in the other State, this activity will, in general, render the place of business a permanent establishment. The same applies if capital is made available through a fixed place of business. If an enterprise of a State lets or leases facilities, ICS equipment, buildings or intangible property to an enterprise of the other State without maintaining for such letting or leasing activity a fixed place of business in the other State, the leased facility, ICS equipment, building or intangible property, as such, will not constitute a permanent establishment of the lessor provided the contract is limited to the mere leasing of the ICS equipment, etc. This remains the case even when, for example, the lessor supplies personnel after installation to operate the equipment provided that their responsibility is limited solely to the operation or maintenance of the ICS equipment under the direction, responsibility and control of the lessee. If the personnel have wider responsibilities, for example, participation in the decisions regarding the work for which the equipment is used, or if they operate, service, inspect and maintain the equipment under the responsibility and control of the lessor, the activity of the lessor may go beyond the mere leasing of ICS equipment and may constitute an entrepreneurial activity. In such a case a permanent establishment could be deemed to exist if the criterion of permanency is met. When such activity is connected with, or is similar in character to, those mentioned in paragraph 3, the time limit of twelve months applies. Other cases have to be determined according to the circumstances." Based on the commentaries, a foreign enterprise which leases equipment to an enterprise of a State is deemed to have a permanent establishment in that State if it supplies personnel in that State, and those personnel have wider responsibilities in relation to the leased equipment (for example, participation in the decisions regarding the work for which the equipment is used, or the personnel personally operate, service, inspect and maintain the equipment under the responsibility and control of the lessor). Accordingly, since Air Drilling US is not engaged in trade or business in the Philippines, and it does not have a branch, an office, or other fixed place of business in the country, and it did not send personnel to the Philippines during the term of the Agreement who had wider responsibilities in relation to the leased equipment, Air Drilling US is not deemed to have a permanent establishment under paragraphs 1 and 2, Article 5 of the Philippines-United States tax treaty. This being the case, rentals paid by Air Drilling SG-Philippine Branch to Air Drilling US for the leased equipment are exempt from income tax in the Philippines pursuant to paragraph 1, Article 8 of the tax treaty. However, the rentals for the leased equipment, which are situated and used in the Philippines, are subject to value-added tax (" VAT ") under Section 108 (A) of the Tax Code, 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" shall likewise include: xxx xxx xxx (2) The lease of the use of, or the right to use of any industrial, commercial or scientific equipment" ; 2 Relative thereto, pursuant to Section 4.112-2 of Revenue Regulations No. 16-2005, 3 as amended, Air Drilling SG-Philippine Branch shall withhold VAT on the rentals at the rate of 12% before remitting them to Air Drilling US . Air Drilling SG-Philippine Branch 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 Air Drilling SG-Philippine Branch 's claim of input VAT on the rentals. Otherwise, if Air Drilling SG-Philippine Branch is not a VAT-registered taxpayer, it may treat the VAT as an asset or expense, whichever is applicable. 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 upon investigation, it shall be disclosed 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. http://airdrilling.com/ . 2. Republic Act No. 10963, otherwise known as the TRAIN (Tax Reform for Acceleration and Inclusion) Law ,amended Section 108(A) as follows: 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 twelve percent (12%) of gross receipts derived from the sale or exchange of services, including the use or lease of properties ... " 3. Entitled Consolidated Value-Added Tax Regulations of 2005 .