ITAD BIR Ruling No. 020-14

February 25, 2014 ITAD BIR RULING NO. 020-14 Articles 5 and 7, Philippines-Bahrain tax treaty Castillo Laman Tan Pantaleon & San Jose The Valero Tower, 122 Valero St., Salcedo Village, 1227 Makati Attention: Ma. Pilar Pilares-Gutierrez Legal Counsel Gentlemen : This refers to your Tax Treaty Relief Application ("TTRA") filed on April 18, 2011, requesting confirmation that the income received by ARIMA INSURANCE SOFTWARE COMPANY W.L.L. ("Arima") for the technical support services that it has rendered to NATIONAL REINSURANCE CORPORATION OF THE PHILIPPINES ("NRCP") pursuant to their Software License and Technical Support Agreement is not subject to Philippine income tax pursuant to the Convention between the Republic of the Philippines and the State of Bahrain for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and on Capital ("Philippines-Bahrain tax treaty"). It is represented that Arima , is a resident of Bahrain within the meaning of Article 4 of the Philippines-Bahrain tax treaty, as evidenced by the Certificate of Residence issued on March 30, 2011 by the Director of Foreign Economic Relations, Ministry of Finance; that Arima is a foreign corporation organized and existing under the laws of the Bahrain with office address at Building 131, Road 1702, Diplomatic Area 317, Manama, Kingdom of Bahrain, based on its Memorandum of Association; that the primary objects of Arima are the development and supply of advance computer software; that Arima is not registered as a corporation or as a partnership per Certification of Non-Registration issued by the Securities and Exchange Commission dated March 17, 2011; and that, on the other hand, NRCP is a domestic corporation, organized and existing under the laws of the Philippines, with office address at 18th Floor, Philippine AXA Life Centre, Sen. Gil Puyat Avenue, Makati City. It is also represented that on March 23, 2011, Arima and NRCP entered into a Software License and Technical Support Agreement ("Agreement") 1 wherein it was stipulated among others that, Arima shall extend to NRCP Technical Support as it may require in relation to the use of the Licensed Programs, 2 particularly: a) advice by telephone, e-mail, fax or post on the use of the Licensed Programs; b) advice and support via 24 hour contact number for the ARIMA Help Desk for major faults/bugs; c) notification, information and advice by telephone, fax, post on forthcoming New Releases of the Licensed Programs; d) diagnosis of errors and/or faults/bugs in the Licensed Programs and the rectification of such faults (remotely utilizing connection between Arima and the Site, 3 or by attendance on Site as determined by ARIMA); that in order to render the services needed, personnel of Arima may be dispatched to NRCP, upon the latter's request; that the amount of Eighty-four Thousand Two Hundred and Eighty-six US Dollars (USD84,286.00) shall be paid by NRCP to Arima as consideration for the Technical Support; and that said fee shall commence to be payable 3 months after live implementation, which will deem to occur upon the earlier of a ) the use by NRCP of the Licensed Programs for the purpose of its trade or business; or b ) 6 months after delivery of the Licensed Program material to the site; and that, the Agreement shall continue to be in full force and effect unless terminated by either Arima or NRCP. ASETHC It is further represented that Arima has not yet supplied any personnel to NRCP and that should Arima supply its personnel to NRCP, such personnel shall not stay in the Philippines for an aggregate period of 180 days in any given year, per certification by the Executive Vice-President of NRCP dated March 28, 2011; 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 judicial appeal as certified by IPI. It is finally represented, as shown in the Certification issued by Citibank dated October 11, 2012, that actual remittances were made by NRCP in favor of Arima in consideration for the subject technical support services of the latter to the former beginning on June 07, 2011 until August 23, 2012. In reply, please be informed that Section 28 (B) (1) of the 1997 National Internal Revenue Code (1997 NIRC), as amended, applies in general to income derived in the Philippines by a nonresident foreign corporation. It provides: "Section 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 . . . profits and income, . . .: Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%). xxx xxx xxx" However, Section 32 (B) (5) of the Tax Code of 1997, as amended, provides: "Section 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. xxx xxx xxx" In this particular case, what is invoked is Article 7 of the Philippines-Bahrain tax treaty. It provides: "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 are attributable to CaDSHE a) that permanent establishment; or b) sales within that other Contracting State of goods of similar kind as those sold through that permanent establishment; or c) other business activities carried on in that other State of the same or similar kind as those effected through that permanent establishment." In view of the foregoing, the profits of a Bahraini enterprise shall be taxable only in Bahrain unless such enterprise carries on business in the Philippines through a permanent establishment situated therein. If the Bahraini enterprise carries on business as aforesaid, the profits of such enterprise may be taxed in the Philippines but only so much of them is attributable to that permanent establishment. Applying this to the instant case, the technical support fees received by Arima for the services rendered in the Philippines 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, paragraph 2 (j), Article 5 of the same tax treaty defines a permanent establishment, as follows: "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' includes especially: xxx xxx xxx j) the furnishing of services, including consultancy services, by an enterprise through employees or other personnel engaged by the enterprise for such purpose, but only where activities of that nature continue in the territory of the other Contracting State for a period or periods aggregating more than six months within any twelve-month period. Services furnished in connection with paragraph 3 of Article 12 shall be governed by provisions of Royalties. xxx xxx xxx" It is clear from the aforequoted provision that a Bahraini enterprise may be considered to have a permanent establishment in the Philippines if the furnishing of services by such corporation in the Philippines, through its employees or other personnel, exceeds a period or periods aggregating more than six months within any twelve-month period. Inasmuch as it is represented that Arima has not yet supplied any personnel to NRCP and that should Arima supply its personnel to NRCP, such personnel shall not stay in the Philippines for an aggregate period of 180 days in any given year, then the furnishing of said services by Arima through its employees or other personnel shall not constitute as carrying of business through a permanent establishment in the Philippines. HDAaIS Relative thereto, however, the availment of preferential tax rate under a tax treaty is governed by Revenue Memorandum Order ("RMO") No. 72-2010. 4 Section 14 of which provides: "SEC. 14. When and Where to File the TTRA. All tax treaty relief applications (updated BIR Forms No. 0901-D, 0901-I, 0901-R, 0901-P, 0901-S, 0901-T, 0901-O and 0901-C) relative to the implementation and interpretation of the provisions of Philippine tax treaties shall only be submitted to and received by the International Tax Affairs Division (ITAD). If the forms or any necessary documents are submitted to any other BIR Office, the application shall be considered as improperly filed. Filing should always be made BEFORE the transaction. Transaction for purposes of filing the TTRA shall mean before the occurrence of the first taxable event. Failure to properly file the TTRA with ITAD within the period prescribed herein shall have the effect of disqualifying the TTRA under this RMO." In view of the foregoing, in the absence of a permanent establishment of Arima in the Philippines to which its profits may be attributable, this Office hereby GRANTS relief to all profits derived by Arima for its supply of technical services to NRCP under the Agreement on 19 April 2011 5 and thereafter , and are therefore exempt from Philippine income tax, pursuant to Article 7 in relation to Article 5 of the Philippines-Bahrain tax treaty. However, all the technical service fees of NRCP to Arima made on and before 18 April 2011 are DENIED relief and are accordingly subject to 30 percent Philippine income tax pursuant to Section 28 (B) (1) of the 1997 Tax Code, as amended. Moreover, should any Arima employee or personnel be sent to NRCP to render service in the Philippines, the technical support fees paid to Arima in relation to the same shall be subject to value-added tax ("VAT") pursuant to Section 108 of the 1997 NIRC, as amended. It provides: " 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%), 6 after any of the following conditions has been satisfied: (i) Value-added tax collection as a percentage of Gross Domestic Product (GDP) of the previous year exceeds two and four-fifth percent (2 4/5%); or (ii) National government deficit as a percentage of GDP of the previous year exceeds one and one-half percent (1 1/2%). The phrase 'sale or exchange of services' means the performance of all kinds of services in the Philippines for others for a fee, . . ." (Underscoring supplied) ECSaAc With regard to the procedures for the withholding and the payment of the VAT, NRCP, being the resident withholding agent and payor in control of payment shall be responsible for the withholding of the final VAT on such fees before making any payment to Arima. In remitting the VAT withheld, NRCP shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax & Other Percentage Taxes Withheld). The duly filed BIR Form No. 1600 and the proof of payment thereof shall serve as documentary substantiation for the claim of input tax to be applied against the output tax that may be due from NRCP, if it is a VAT-registered taxpayer. In case NRCP is a non-VAT-registered taxpayer, the passed-on VAT withheld shall form part of the cost of the service purchased and may treat such VAT as an "expense" or as an "asset", whichever is applicable. In addition, NRCP is required to issue a Certificate of Final Tax Withheld at Source (BIR Form No. 2306) in quadruplicate, the first three copies for Arima and the fourth copy for NRCP as its file copy. (Sections 4 & 6, Revenue Regulations (RR) No. 4-2002; Section 3 of RR 8-2002; Section 7 of RR 14-2002) 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.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes 1. The Agreement grants NRCP a non-exclusive and non-transferable license to use the Licensed Programs and Relevant Program Documentation (instruction manuals, user guides and other information to be made available from time to time to NRCP during the term of the Agreement) upon the Designated Equipment (oracle database server and windows workstation located at 18th Floor, Philippine AXA Life Centre, Sen. Gil Puyat Avenue, Makati) and to process and refer to the Program Documentation. 2. "Licensed Programs" means the software and application programs in object code form developed by Arima for the management of reinsurance operations and any New Release of the same. 3. "Site" means the place or address specified by NRCP for the delivery of the Licensed Program Material. 4. Guidelines on the Processing of Tax Treaty Relief Applications (TTRA) Pursuant to Existing Philippine Tax Treaties (effective November 4, 2010). 5. 19 April 2011 is the date after the filing of the TTRA. 6. The VAT rate was increased 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.