ITAD BIR Ruling No. 021-14

February 25, 2014 ITAD BIR RULING NO. 021-14 Articles 5 and 7, Philippines-Japan tax treaty Punongbayan and Araullo 20th Floor, Tower 1 The Enterprise Center 6766 Ayala Avenue Makati City Attention: Atty. Lina P. Figueroa Principal Tax Advisory and Compliance Gentlemen : This refers to your tax treaty relief application ("TTRA") filed on July 19, 2011 requesting confirmation that training fees paid by HPOI Corporation ("HPOI") to Hoya Corporation ("Hoya") are exempt from income tax pursuant to the Convention between the Republic of the Philippines and Japan for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income ("Philippines-Japan tax treaty"). 1 Facts Hoya is a foreign corporation and a resident of Japan based on its amended Articles of Incorporation and Certificate of Status of Taxable Entity issued by the Shinjuku Tax Office in Japan on April 27, 2011. Hoya is located at 2-7-5 Naka-Ochiai, Shinjuku, Tokyo, Japan. It is not registered as a corporation or partnership in the Philippines based on the Certification of Non-Registration of Company issued by the Securities and Exchange Commission on March 14, 2011. On the other hand, HPOI is a domestic corporation located at 2nd Street, Mactan Economic Zone 1, Lapu-Lapu City, Cebu, Philippines. On May 18, 2011 , HPOI and Hoya entered into an Overseas Training Agreement where Hoya agreed to provide overseas training in Japan to HPOI's personnel and relating to a) Operating equipment in relation to super high precision optical devices; b) Methods in maintaining and modifying these equipment; c) Inspection method of these manufactured devices and their order of packaging as finished products. The training will be conducted entirely in Japan but in the event it becomes necessary for Hoya to send its employees or personnel to the Philippines to conduct the training, the entire period of stay of these individuals will not exceed 180 days in any given twelve-month period. In consideration, HPOI will pay training fees to Hoya equivalent to the training day rate plus a margin of 5 percent. The service fees are payable within thirty days upon receipt of invoice by HPOI from Hoya every month and will be remitted to the latter's designated bank account. The Agreement took effect on July 15, 2011 for an initial term of one year; thereafter, the Agreement will be automatically renewed for another one year. aDHScI Based on the Certification issued by HPOI on June 5, 2012, HPOI sent its personnel to Japan in batches to receive training from Hoya , to wit: Batch Period of Training Number of Trainees 1 July 16 to October 12, 2011 20 2 July 20 to October 17, 2011 62 3 August 25 to November 22, 2011 28 4 July 30, 2011 to May 19, 2012 13 5 August 30, 2011 to February 26, 2012 5 6 September 11 to October 2, 2011 2 The training fees were paid as follows: Date of Payment Amount (in US Dollars) Remitting Bank Transaction Reference Number Receiving Bank Apr. 23, 2012 63,754.71 Banco de Oro Unibank Mactan Branch 2 6141200333 TXT The Bank of Tokyo-Mitsubishi Otemachi Branch 3 May 23, 2012 55,302.38 6141200455 TXT Jun. 22, 2012 31,677.65 6141200534 TXT Jul. 24, 2012 34,547.98 6141200608 TXT Aug. 24, 2012 48,995.78 6141200716 TXT Sep. 21, 2012 38,295.16 6141200787 TXT Oct. 24, 2012 60,438.14 6141200880 TXT Nov. 23, 2012 10,042.68 6141200991 TXT Dec. 21, 2012 15,221.63 6141200889 TXT Jan. 25, 2013 75,652.58 Rizal Commercial Banking Corporation Mactan Branch 4 Feb. 21, 2013 548.61 Banco de Oro Unibank Mactan Branch 6141300126 TXT Mar. 22, 2013 25,943.14 6141300191 TXT Apr. 23, 2013 34,556.09 6141300274 TXT Total 494,976.53 Ruling In reply, please be informed that under Section 14 of Revenue Memorandum Order No. 72-2010 (Guidelines on the Processing of Tax Treaty Relief Applications (TTRA) Pursuant to Existing Philippine Tax Treaties) ("RMO 72-2010") , any availment of tax treaty relief (exemption from income tax or reduction of tax) shall be preceded by an application filed at the International Tax Affairs Division ("ITAD") of this Bureau before the first taxable event subject of the TTRA, to wit: " 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 . (Emphasis ours) In view of the foregoing, since the relevant TTRA was filed on July 19, 2011 , and the first payment of the training fees was made afterwards on April 23, 2012 , such fees paid on that date and thereafter shall be subject to relief pursuant to Section 14 of RMO 72-2010. Relative thereto, Article 7 of the Philippines-Japan tax treaty provides relief as follows " Article 7 1. The profits of an enterprise of a Contracting State shall be taxable only in that Contracting 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 that other Contracting State but only so much of them as is attributable to that permanent establishment." HSAcaE Under Article 7, profits derived by an enterprise of Japan from sources in the Philippines may be taxed in the Philippines if the profits are attributable to a permanent establishment which the enterprise has in the Philippines; otherwise, such profits are exempt. Article 5 of the treaty defines a permanent establishment as follows: " Article 5 1. For the purposes of this Convention, the term 'permanent establishment' means a fixed place of business through which the business of an enterprise is wholly or partly carried on. 2. The term 'permanent establishment' includes especially: a) a store or other sales outlet; b) a branch; c) an office; d) a factory; e) a workshop; f) a warehouse; g) a mine, an oil or gas well, a quarry or other place of extraction of natural resources. xxx xxx xxx 6. An enterprise of a Contracting State shall be deemed to have a permanent establishment in the other Contracting State if it furnishes in that other Contracting State consultancy services, or supervisory services in connection with a contract for a building, construction or installation project through employees or other personnel other than an agent of an independent status to whom paragraph 7 applies provided that such activities continue (for the same project or two or more connected projects) for a period or periods aggregating more than six months within any twelve-month period. However, if the furnishing of such services is effected under an agreement between the Governments of the two Contracting States regarding economic or technical cooperation, that enterprise shall, notwithstanding any provisions of this Article, not be deemed to have a permanent establishment in that other Contracting State." As defined, a permanent establishment means a fixed place through which the business of an enterprise is wholly or partly carried on, and includes especially, a store or other sales outlet, a branch, an office, a factory, and a workshop. It also includes the furnishing of consultancy services by an enterprise (through employees or other personnel thereof), or supervisory services in connection with a contract for a building, construction or installation project, which continue for more than an aggregate of six months within any twelve-month period. DaTEIc Accordingly, since Hoya is not engaged in trade or business in the Philippines to which a branch, an office, or other fixed place of business is necessary, and since it did not furnish consultancy services in the Philippines, or supervisory services in connection with a contract for a building, etc., but provided training to HPOI's personnel entirely in Japan, Hoya shall not be deemed to have a permanent establishment in the Philippines under paragraphs 1, 2 and 6, Article 5 of the Philippines-Japan tax treaty. This being the case, the training fees paid by HPOI to Hoya shall be exempt from income tax under paragraph 1, Article 7 of the treaty. Furthermore, on the classification of the training fees as business profits (which are exempt from income tax if not attributable to a permanent establishment) rather than payments for know-how or royalties (which are subject to income tax at a reduced rate), the following commentaries of the Organisation for Economic Co-operation and Development Model Tax Convention on Income and on Capital (Condensed Version, July 22, 2010) mention that: "11.1 In the know-how contract, one of the parties agrees to impart to the other, so that he can use them for his own account, his special knowledge and experience which remain unrevealed to the public. It is recognised that the grantor is not required to play any part himself in the application of the formulas granted to the licensee and that he does not guarantee the result thereof. 11.2 This type of contract thus differs from contracts for the provision of services, in which one of the parties undertakes to use the customary skills of his calling to execute work himself for the other party. Payments made under the latter contracts generally fall under Article 7. 11.3 The need to distinguish these two types of payments, i.e. , payments for the supply of know-how and payments for the provision of services, sometimes gives rise to practical difficulties. The following criteria are relevant for the purpose of making that distinction: Contracts for the supply of know-how concern information of the kind described in paragraph 11 that already exists or concern the supply of that type of information after its development or creation and include specific provisions concerning the confidentiality of that information. In the case of contracts for the provision of services, the supplier undertakes to perform services which may require the use, by that supplier, of special knowledge, skill and expertise but not the transfer of such special knowledge, skill or expertise to the other party. In most cases involving the supply of know-how, there would generally be very little more which needs to be done by the supplier under the contract other than to supply existing information or reproduce existing material. On the other hand, a contract for the performance of services would, in the majority of cases, involve a very much greater level of expenditure by the supplier in order to perform his contractual obligations. For instance, the supplier, depending on the nature of the services to be rendered, may have to incur salaries and wages for employees engaged in researching, designing, testing, draining and other associated activities or payments to sub-contractors for the performance of similar services." (Pages 225-226) AcICTS Based on the commentaries, in a contract for the supply of know-how, there would generally be very little more which needs to be done by the supplier other than to supply existing information or reproduce existing material. On the other hand, in a contract for the performance of services, this involves, in a majority of cases, a very much greater level of expenditure by the supplier in order to perform his contractual obligations to the other party, such as salaries and wages for employees engaged in researching, designing, testing, drawing and other associated activities or payments to subcontractors for the performance of similar services. Accordingly, since the Overseas Training Agreement does not call for Hoya to supply existing information or reproduce existing material to HPOI, but to provide actual training to HPOI's personnel relating to operating equipment used in manufacturing super high precision optical devices; methods in maintaining and modifying these equipment; and inspection of these manufactured devices and the order of their packaging as finished products, the said agreement is clearly a contract for the performance of services rather than for the supply of know-how or other royalty-bearing property. This is buttressed by the fact that the training was done in Japan continuously from July 16, 2011 to May 19, 2012 and in six batches, which would require Hoya to incur a greater level of expenditure to fulfill its contractual obligations to HPOI such as salaries and other remuneration paid by Hoya to its trainors. Moreover, unlike royalties which require payment for the use of an intangible property based on the useful life of the property and on the duration of the lease contract, the training fees in question were calculated based on the daily rate of the trainors multiplied by the number of days of training plus a margin of 5 percent. The mark-up would constitute Hoya's operating income in providing the training and such income arises only if there was actual training rendered and throughout the duration of the training. This being the case, the training fees paid by HPOI to Hoya constitute clearly as business profits rather than royalties. Finally, under Section 108 (A) of the National Internal Revenue Code of 1997, as amended, the training fees paid to Hoya for services it rendered entirely abroad are not 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, 5 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 . . ." Taking into account the cross-border or destination principle of the VAT system, only those services which are performed in the Philippines are subject to VAT; hence, services performed abroad are exempt from VAT. 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. aTCADc Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes 1. As amended by the Protocol Amending the Convention between the Republic of the Philippines and Japan for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income effective January 1, 2009. 2. Located at Mactan-EPZA Compound, Lapu-Lapu City, Cebu. 3. Located at 1-1-1, Otemachi, Chiyoda-ku, Tokyo, Japan. 4. Located at Pueblo Verde, Mactan Economic Zone II, Lapu-Lapu City, Cebu. 5. 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.