Rubio and Rubio

March 11, 2020 ITAD BIR RULING NO. 023-20 Articles 5 (Permanent Establishment) and 8 (Business Profits) Philippines-United States of America tax treaty Rubio and Rubio Level 3, Joy Nostalg Center 17 ADB Avenue, Ortigas Center 1605 Pasig City Attention: AAA Gentlemen : This refers to your tax treaty relief application filed on August 12, 2016 requesting confirmation that Barracuda Networks, Inc. ("Barracuda Networks") does not have a permanent establishment with respect to the distribution of its products and services in the Philippines through Exclusive Networks-PH, Inc. ("Exclusive Networks") (formerly Transition Systems Philippines Pte. Ltd. ) 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 Barracuda Networks is a foreign corporation organized and existing under the laws of the United States and a resident thereof based on its amended and restated Certificate of Incorporation and Certificate of Residence issued by the Internal Revenue Service of the United States. Barracuda Networks offers industry-leading solutions designed to solve mainstream IT problems, particularly, content security, networking and application delivery, and data storage, protection and disaster recovery. 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, Exclusive Networks is a domestic corporation engaged in trading and distribution activities on a wholesale basis, based on its amended Articles of Incorporation, General Information Sheet as of September 21, 2017 and Audited Financial Statements as of December 31, 2016. Exclusive Networks ' immediate parent is Transition Systems Asia Pte. Ltd., a foreign corporation in Singapore, and its ultimate parent is Exclusive France Holding SAS, a foreign corporation in France. On August 22, 2013, Barracuda Networks and Exclusive Networks entered into an International Distribution Agreement ("Agreement") where Barracuda Networks appoints Exclusive Networks as an independent and non-exclusive authorized distributor of Barracuda products and services in the Philippines. Barracuda products and services consist of network products and services including hardware, cloud computing services, firewall services, and renewals, and technically termed as Barracuda Cloud Services, Barracudaware, Barracuda Next Generation Firewalls, and Renewals. During the term of the Agreement, Barracuda Networks agrees to produce, sell and make available to Exclusive Networks the above products and services including other products and services that may be agreed upon by the parties from time to time. The price for each product and service shall be the current published list price in the Philippines, but Exclusive Networks shall be eligible for discounts based on the volume of products or services ordered. Barracuda Networks may appoint other distributors or representatives in the Philippines for the same or similar products and services. Exclusive Networks agrees to a minimum quarterly sales target of US$_________. Barracuda Networks and Exclusive Networks will set larger sales targets after the end of the first two quarters. Exclusive Networks agrees to have sufficient sales staff to handle inquiries regarding Barracuda products and services and their applications. These staff shall be able to respond, within a reasonable time frame, to all sales leads provided by Barracuda Networks . Exclusive Networks will establish a credit line with Barracuda Networks to supply the products and services within a reasonable time frame. Terms of the credit line will be set at 30 days. Exclusive Networks will not copy, alter, disassemble, decompile, or rent any product or service, nor modify or reverse engineer such product or service. Exclusive Networks will use strong and typical efforts to promote, market, and distribute the products and services to end-users, customers and resellers. Exclusive Networks will provide resellers, warehouse and distribution service of the products. Exclusive Networks will process and handle warranty returns, repairs, any other returns and replacements for end-users, customers and resellers. Exclusive Networks will pay for shipping of all warranty and other returns to Barracuda Networks , and the latter will pay for repaired units back to Barracuda Networks . Exclusive Networks will provide first level technical support, provide a support phone number, and assist with translation of product manuals. Delivery of Barracuda products shall be made free-on-board from the nearest Barracuda Networks ' shipping location, with transportation expense and insurance paid by Exclusive Networks . Risk of loss or damage to the products shall fall upon Exclusive Networks . Title of the products shall pass to Exclusive Networks at free-on-board point. The Agreement shall remain in effect indefinitely unless terminated by either party by giving a written notice to the other party at least 30 days prior to termination. Based on sworn statements issued by Exclusive Networks , the company has also existing distributorship agreements with other suppliers of network products and services. These agreements were entered into by Exclusive Networks in 2008 and 2012, prior to the distributorship agreement with Barracuda Networks on August 22, 2013, and afterwards, in 2015, 2016 and 2018. Percentage of sales of Barracuda products and services sold by Exclusive Networks in taxable years 2014, 2015 and 2016 constitutes only 3.72%, 3.39% and 1.61%, respectively, of the former's total sales respectively. Based on another sworn statement issued by Exclusive Networks , 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, as amended ("Tax Code") , income derived by a foreign corporation not engaged in trade or business 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: n 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 on 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, paragraph 1, Article 8 and paragraphs 1, 2 and 5, Article 5 of the Philippines-United States tax treaty provide as follows: " 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." " 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. xxx xxx xxx 5. A resident of one of the Contracting States shall not be deemed to have a permanent establishment in the other Contracting State merely because such resident carries on business in that other Contracting State through a broker, general commission agent, or any other agent of an independent status, where such broker or agent is acting in the ordinary course of his business. However, when the activities of such an agent are devoted wholly or almost wholly on behalf of that resident, he shall not be considered an agent of independent status within the meaning of this paragraph if the transactions between the agent and the resident were not made under arm's length conditions." Under Article 8, business profits derived by a resident of a Contracting State 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, the other State may impose tax on the business profits of that resident but only on those that are attributable to the permanent establishment. Under paragraphs 1 and 2 of Article 5, a permanent establishment means a fixed place through which the business of a resident of Contracting State is wholly or partly carried on, and includes especially, a seat of management, a branch, an office, a store or other sales outlet, and a factory. With respect to a broker, general commission agent, or any other agent of an independent status, under paragraph 5 of this article, a resident of a Contracting State is not deemed to have a permanent establishment in the other Contracting State merely because it carries on business in the other State through such broker or agent, where the latter is acting in the ordinary course of his business when acting for his principal. However, when the activities of such broker or agent are devoted wholly or almost wholly on behalf of his principal, he shall no longer be considered independent thereby becoming a permanent establishment of his principal. Accordingly, since Barracuda Networks 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, it is not deemed to have a permanent establishment in the Philippines under paragraphs 1 and 2, Article 5 of the Philippines-United States tax treaty. Moreover, Barracuda Networks is not deemed to have a permanent establishment when it carries on business in the Philippines through its distributor, Exclusive Networks , where the latter is considered an agent of independent status, under paragraph 5, Article 5 of the Philippines-United States tax treaty. Based on the company's Articles of Incorporation and other relevant documents, it is established to engage primarily in trading and distribution activities on a wholesale basis, without reference to any particular principal or principals . With respect to Exclusive Networks' acting in the ordinary course of its business when acting for Barracuda Networks , the company has been entering into similar distributorship agreements with other foreign principals prior to Barracuda Networks on August 22, 2013, and even afterwards . To allow Exclusive Networks to fulfill its contractual obligations to Barracuda Networks and earn a reasonable amount of profit therefrom, Exclusive Networks will use its customary skills and bear certain risks, which are expected of the company when acting for other principals. Regarding customary skills under any distributorship agreement, Exclusive Networks will maintain sufficient sales staff to handle inquiries regarding the products and services of its foreign principals and the application of these products and services. These staff shall be able to respond, within a reasonable time frame, to all sales leads provided by the principals. Exclusive Networks will exercise efforts to promote, market, and distribute the products and services to end-users, customers and resellers. Exclusive Networks will process and handle warranty returns, repairs, any other returns and replacements of the products. Exclusive Networks will provide first level technical support for the products and services, provide a support phone number, and even assist with translation of product manuals. As to risks, since title to the products belongs to Exclusive Networks once shipped from the territory of its foreign principal, any risk of loss or damage to the products belongs to Exclusive Networks while the products are in transit and while in physical custody of Exclusive Networks . Lastly, Exclusive Networks' activities are not devoted wholly or almost wholly on behalf of Barracuda Networks since Exclusive Networks has several principals aside from the latter, and the percentage of sales of Barracuda products and services to the total sales of Exclusive Networks is minimal, i.e. , 3.72% in 2014, 3.39% in 2015, and 1.61% in 2016. Considering, therefore, that Barracuda Networks does not have a permanent establishment in the Philippines, all payments received from the sale of Barracuda products and services in the Philippines through its distributor, Exclusive Networks , are exempt from income tax in the Philippines pursuant to paragraph 1, Article 8 of the Philippines-United States tax treaty. Value-Added Tax Finally, such payments to Barracuda Networks , being payments for the privilege to use any trade brand or other like property or right in the Philippines, are subject to 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: (1) The lease or the use of or the right or privilege to use any copyright , patent, design or model, plan, secret formula or process, goodwill, trademark, trade brand or other like property or right;" (Underscoring supplied) Pursuant to Section 4.114-2 of Revenue Regulations No. 16-2005, 2 Exclusive Networks shall withhold VAT on those payments to Barracuda Networks at the rate of 12% before remitting them to Barracuda Networks . Exclusive Networks 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 Exclusive Networks ' claim of input VAT on the payment; otherwise, if it is not a VAT-registered taxpayer, Exclusive Networks may treat the passed-on VAT as part of the cost of the privilege or right to use Barracuda Networks ' trade brand in the Philippines and treat the same as asset or expense, whichever is applicable. VAT withheld shall be remitted within 10 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. https://www.barracuda.com/company/index 2. Entitled 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). n Note from the Publisher: Copied verbatim from the official document.