ITAD BIR Ruling No. 012-09

April 3, 2009 ITAD BIR RULING NO. 012-09 Article 11 Philippines Korea tax treaty; Sections 106 and 107 National Internal Revenue Code of 1997, as amended; Section 14 General Appropriations Act of 1997 Hanjin Heavy Industries & Construction Co., Ltd. 12th Floor, 1128 University Parkway, North Bonifacio Global City, Taguig, Metro Manila Gentlemen : This refers to your letter dated 14 April 2008 regarding your contract with the Philippine National Railways (PNR) for the construction of the Southrail-Northrail Linkage Project from Caloocan to Alabang being funded by a mixed credit facility granted by the Economic Development Cooperation Fund (EDCF) of the Government of Korea and the Export-Import Bank of Korea (KEXIM) by way of Loan Agreement No. PHL-7 signed on 07 May 2004 by and between The Philippine National Railways, Republic of the Philippines, as the 'Borrower' and The Export-Import Bank of Korea, as the 'Lender', seeking legal opinion on whether the Project is tax-exempt or if not, what obligations have to be paid to the Bureau of Internal Revenue (BIR) by your office and PNR in the context of value-added tax (VAT), import duties and taxes and withholding taxes. IDaEHC It is represented that the Project is being undertaken by a consortium of 3 companies, namely Hanjin Heavy Industries & Construction Co., Ltd. (HHIC), Daewoo International Corporation and Rotem Industries, all of which are Korean companies; that the bid documents and price submitted by the consortium to PNR did not include a provision on duties, taxes and other levies because it was provided in the Section 11-11.3 of the Instructions to the Bidders that the PNR shall have the sole responsibility for the said obligations, as follows: "All duties and other levies imposed in the Philippines shall be borne by PNR, hence shall not be included in the rates, prices and total Bid price submitted by the Bidder"; that based on the said provision, it is your understanding that either PNR shall, in its capacity as the executing agency of the government for this project, secure pertinent documents for exemption of taxes from the Bureau of Customs and the BIR, or in the event that PNR is unable to secure an exemption, to provide an allocation of its funds to pay the corresponding taxes on the importation of materials including materials and services that shall be generated from local suppliers and sub-contractors although such was not made clear by the PNR to the bidders. It is further represented that PNR may have requested for exemption from the Department of Finance (DOF) but was not able to secure the same as evidenced by the DOF's letter to PNR dated 9 August 2007 explicitly imposing the responsibility to pay tax on the borrower of the loan; but that the DOF further stated that if by PNR's Charter it is deemed exempted from paying taxes, PNR may apply for tax-exemption with the tax authorities; that in view of the foregoing, Hanjin is now placed at a situation of having to assume all the taxes which, in your opinion, should be the responsibility of the executing agency; and that in view of the foregoing circumstances, you now seek legal advise on how Hanjin can pass-on the taxes which were not incorporated in the bid price to PNR and on the available remedies to recover such taxes under existing Philippine regulations. In reply, please be informed as follows. Tax on Interest Income Income from interest on foreign loans are generally governed by Section 28 (B) (5) (a) of the National Internal Revenue Code (Tax Code) of 1997, as amended by Republic Act No. 9337 . It provides: "SEC. 28. Rates of Income Tax on Foreign Corporations. xxx xxx xxx B) Tax on Nonresident Foreign Corporation. (5) Tax on Certain Incomes Received by a Nonresident Foreign Corporation. xxx xxx xxx (a) Interest on Foreign Loans. A final withholding tax at the rate of twenty percent (20%) is hereby imposed on the amount of interest on foreign loans contracted on or after August 1, 1986;" SEIcAD However, Section 32 (B) (5) of the same Tax Code provides, viz. : "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: 1 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 relation thereto, there is the Philippines-Korea tax treaty, 2 Article 11 of which provides, viz. : "Article 11 INTEREST 1. Interest arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in the other State. 2. However, such interest may also be taxed in the Contracting State in which it arises, and according to the laws of that State, but if the recipient is the beneficial owner of the interest the tax so charged shall not exceed: a) 10 per cent of the gross amount of the interest if the interest is paid in respect of public issues of bonds, debentures or similar obligation; and cSDHEC b) 15 per cent of the gross amount of the interest in all other cases. 3. Notwithstanding the provisions of paragraph 2 hereof, the amount of tax imposed by the Philippines on the interest paid by a company, being a resident of the Philippines, registered with the Board of Investments and engaged in preferred pioneer areas of investment under the investment incentives laws of the Philippines to a resident of Korea, who is the beneficial owner of the interest, shall not exceed 10 per cent of the gross amount of the interest. 4. Notwithstanding the provisions of paragraph 2 hereof, interest arising in a Contracting State and paid to a resident of the other Contracting State shall be taxable only in that other State if the interest is paid in respect of: (i) a bond, debenture or other similar obligation of the government of that State or a political subdivision or local authority thereof, or (ii) a loan made, guaranteed or insured, or a credit extended, guaranteed or insured by: (aa) in the case of the Philippines, the Central Bank of the Philippines, (bb) in the case of Korea, the Bank of Korea, the Export-Import Bank of Korea , the Korea Exchange Bank and (cc) other lending institutions as may be specified and agreed in letters of exchange between the competent authorities of the Contracting States. 5. The term "interest" as used in this Article means income from debt-claims of every kind, whether or not secured by mortgage and whether or not carrying a right to participate in the debtor's profits, and in particular, income from government securities and income from bonds or debentures, including premiums and prizes attaching to such securities, bonds or debentures, as well as income assimilated to income from money lent by the taxation laws of the State in which the income arises, including interest on deferred payment sales. (Emphasis supplied) Based on the above provision, interest arising in the Philippines and paid to a resident of Korea shall be taxable only in Korea if the interest is paid in respect of a bond, debenture or other similar obligation of the government of Korea or a political subdivision or local authority thereof, or when the same is paid on a loan made, guaranteed or insured, or a credit extended, guaranteed or insured by (1) in the case of the Philippines, the Central Bank of the Philippines, (2) in the case of Korea, the Bank of Korea, the Export-Import Bank of Korea, the Korea Exchange Bank and (3) other lending institutions as may be specified and agreed in letters of exchange between the competent authorities of the Philippines and Korea. Accordingly, since the lender of the subject loan is the Export-Import Bank of Korea (KEXIM), this Office is of the opinion that the interest arising from the subject loan is exempt from Philippine income tax. Value-added Tax Value-added tax (VAT) obligations which arise in relation to the Project are generally governed by Sections 106 and 107 of the Tax Code of 1997. They provide, viz. : "SEC. 106. Value-added Tax on Sale of Goods or Properties. (A) Rate and Base of Tax. There shall be levied, assessed and collected on every sale, barter or exchange of goods or properties, a value-added tax equivalent to ten percent (10%) of the gross 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 recommendation of the Secretary of Finance, shall, effective January 1, 2006, raise the rate of value-added tax to twelve percent (12%), 3 after any of the following conditions has been satisfied: EIAScH xxx xxx xxx" "SEC. 107. Value-added Tax on Importation of Goods. (A) In General. There shall be levied, assessed and collected on every importation of goods a value-added tax equivalent to ten percent (10%) based on the total value used by the Bureau of Customs in determining tariff and customs duties, plus customs duties, excise taxes, if any, and other charges, such tax to be paid by the importer prior to the releases of such goods from customs custody: Provided, That where the customs duties are determined on the basis of the quantity or volume of the goods, the value-added tax shall be based on the landed cost plus excise taxes, if any: Provided, further, 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: xxx xxx xxx" Based on the aforequoted provision, purchases of goods and services and importation of goods in the Philippines are subject to VAT. Accordingly, VAT will be imposed on all importation and purchase of goods as well as purchase of services in the Philippines in connection with the herein Project. In relation thereto, worth mentioning is Part 8, Section 22 (g) of the Loan Agreement which provides that: "All taxes, duties, and levies imposed in the Philippines on the Consulting Services shall be either made exempt or borne by the Borrower". A cursory reading of the aforequoted provision of the Loan Agreement will reveal that there is no clear grant of tax-exemption. What it clearly says is that the taxes imposed on the payments for consulting services shall be made exempt, but if not made exempt, shall be borne by the borrower, which is PNR. At the most, however, the intended exemption provided in the Loan Agreement may be achieved not through a direct grant of tax-exemption to the service contractors/suppliers in relation to the Project, but through the assumption by the PNR of the taxes on the payments to these contractors/suppliers. It might be argued that the assumption by PNR of the VAT imposed under Section 12 of Republic Act No. 4156 (PNR Charter), PNR is not liable to tax. Section 12 of the PNR Charter provides, viz. : "REPUBLIC ACT NO. 4156 AN ACT CREATING THE PHILIPPINE NATIONAL RAILWAYS, PRESCRIBING ITS POWERS, FUNCTIONS AND DUTIES, AND PROVIDING FOR THE NECESSARY FUNDS FOR ITS OPERATION. xxx xxx xxx Section 12. Exemption from taxes, duties and port charges. The Corporation is hereby exempt from payment of all taxes of every name and nature municipal, city, provincial, or national upon its capital stock, franchises, rights of way, earnings, and all other property owned or operated by it and all duties on all railways materials, supplies and equipment imported in the Philippines for and/or by the said Corporation and this exemption shall extend to port charges upon vessels whose entire cargo consist of materials for the construction or equipment of the Corporation and to such proportion of the prescribed port charges on other vessels as the tonnage of materials for such constructions or equipment may bear to the tonnage of the entire cargo of the vessel. (Emphasis supplied) Under the abovequoted provision, PNR is exempt from taxes on its capital stock, franchises, rights of way, earnings, and other properties it owns and operates. However, a strict construction of laws granting tax-exemptions dictates that the tax-exemption granted to PNR under its charter cannot extend to include tax on importation of goods and that which is normally incorporated in the purchase of goods and services in the Philippines, i.e. , indirect taxes, such as VAT. In relation to the assumption by PNR of the VAT obligations arising from the herein Project, Section 14 of the General Appropriations Act quoted below, provides for the appropriation for national internal revenue taxes, to wit: "Sec. 14. National Internal Revenue Taxes and Import Duties. The following are deemed automatically appropriated: (a) National internal revenue taxes and import duties payable by national government agencies to the national government arising from foreign donations, grants and loans; . . . . (Emphasis supplied) aDcHIC xxx xxx xxx The amounts pertaining to such taxes, and duties covered by this section shall be considered as revenue and expenditure of the government. Implementation of this section shall be in accordance with guidelines jointly issued by the DOF and DBM." In view of all of the foregoing, this Office is of the opinion that the importation and purchase of goods as well as purchase of services in the Philippines, in connection with the undertaking of the Southrail-Northrail Linkage Project, are subject to VAT. Consequently, PNR, the herein borrower, shall be made to assume the VAT due thereon, pursuant to the provision of the Loan Agreement and shall reimburse the VAT paid or accruing to PNR's contractors from the latter's suppliers/sub-contractors. CEASaT Very truly yours, (SGD.) SIXTO S. ESQUIVIAS IV Commissioner of Internal Revenue Footnotes 1. TITLE II TAX ON INCOME. 2. Formally known as the "Convention between the Republic of the Philippines and the Republic of Korea for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income". 3. The VAT rate was increased from 10% 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.