LMA Law

March 5, 2018 ITAD BIR RULING NO. 026-18 Articles 5 and 7 Philippines-Japan tax treaty, as amended LMA Law Unit 22, 2nd Floor, Zeta Building 191 Salcedo Street Legaspi Village Makati City Attention: AAA Gentlemen : This refers to your tax treaty relief application filed on March 10, 2016 requesting confirmation that service fees paid by SMCC Philippines, Inc. (" SMCC Philippines ") (formerly Sumicon Philippines, Inc. ) to Sumitomo Mitsui Construction Company Ltd. ("SMCC ") 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 SDHacT FACTS SMCC is a foreign corporation organized and existing under the laws of Japan and a resident thereof based on its amended Articles of Incorporation and Certificate of Residence issued by the Kyobashi Kita Tax Office under the National Tax Agency of Japan. SMCC is engaged in planning, design, supervision, contracting and undertaking civil engineering, architectural, pre-stressed concrete, electrical, piping and other construction works, among others. SMCC is the result of the merger between Japan's two leading construction companies, Mitsui Construction Company Ltd. and Sumitomo Construction Company Ltd. on April 1, 2003. SMCC is licensed to engage in business in the Philippines based on a certification issued by the Securities and Exchange Commission. On the other hand, SMCC Philippines is a domestic corporation organized and existing under the laws of the Philippines. It provides architectural and civil engineering services that include planning, design, project implementation and management, and other ancillary services related to construction. SMCC Philippines is a wholly-owned subsidiary of SMCC established on September 25, 1995. 2 MOL Magsaysay Academy Project On June 1, 2015, SMCC Philippines and SMCC entered into an Engineering and Consultancy Service Agreement where SMCC Philippines engaged SMCC to carry out preparation works for bidding, promoting coordination with, and giving presentation to Magsaysay MOL Marine, Inc. regarding the MOL Magsaysay Academy Project at Trinidad Avenue, Barangay Salitran 2, Dasmarias, Cavite, Philippines. SMCC Philippines is participating in the bidding of this project. The works to be provided by SMCC are described below: 1. Civil, architectural and structural facility SMCC will prepare the concept drawing for the educational facilities including land development works for the entire project. After approval of the drawings, SMCC will prepare the details design drawings for construction purposes. 2. Electrical facility The electrical facility will cover the entire electrical works including internal wirings, panels, distribution boards, lighting works, fire alarm system, telephone system, public address system, and local area network system. The power load distribution will be finalized by SMCC Philippines . 3. Mechanical facility The mechanical facility will cover the entire mechanical works including the air conditioning works, firefighting arrangements, water supply system, air ventilation system, air cooling system and elevator. The design for the entire facility will be finalized by SMCC Philippines . SMCC Philippines will provide the detailed scope of work and other information to facilitate the services. All drawings will be finalized by SMCC Philippines. SMCC will provide suitable staff with relevant experience to execute the works under the Agreement. All works will be performed by SMCC in its office in Tokyo, Japan. Once completed, ownership of presentation documents, perspective drawings and design drawings vest entirely with SMCC Philippines. In consideration, SMCC Philippines will pay service fees to SMCC amounting to P ___________ . Payment will be made through telegraphic transfer upon submission of invoice and after completion of the works by SMCC to the satisfaction of SMCC Philippines. The relationship of the parties is on a principle-to-principle basis and as independent contractors. The Agreement takes effect on June 1, 2015, and the works will be completed on or before December 15, 2015. Oji New Factory Project On July 1, 2015, SMCC Philippines and SMCC entered into another Engineering and Consultancy Service Agreement where SMCC Philippines engaged SMCC to carry out preparation works for bidding, promoting coordination with, and giving presentation to Oji Engineering Company Ltd. regarding the Oji New Factory Project at First Industrial Township, Sto. Tomas, Batangas, Philippines. SMCC Philippines is participating in the bidding of this project. The works to be provided by SMCC are described below: ACETID 1. Civil, architectural and structural facility SMCC will prepare the concept drawing for the new factory and external works, road works and drainage works for the entire project. 2. Electrical facility The electrical facility will cover the entire electrical works including internal wirings, panels, distribution boards, lighting works, fire alarm system, telephone system, public address system, and local area network system. The power load distribution will be finalized by SMCC Philippines. 3. Mechanical facility The mechanical facility will cover the entire mechanical works including the air conditioning works, firefighting arrangements, water supply system, air ventilation system, and air cooling system. The design for the entire facility will be finalized by SMCC Philippines. SMCC Philippines will provide the detailed scope of work and other information to facilitate the services. All drawings will be finalized by SMCC Philippines. SMCC will provide suitable staff with relevant experience to execute the works under the Agreement. All works will be performed by SMCC in its office in Tokyo, Japan. Once completed, ownership of presentation documents, perspective drawings and design drawings vest entirely with SMCC Philippines. In consideration, SMCC Philippines will pay service fees to SMCC amounting to P ___________ . Payment will be made through telegraphic transfer upon submission of invoice and after completion of the works by SMCC to the satisfaction of SMCC Philippines. The relationship of the parties is on a principle-to-principle basis and as independent contractors. The Agreement takes effect on June 1, 2015, and the works will be completed on or before October 31, 2015. Based on a certification issued by SMCC Philippines on October 18, 2016, for the entire duration of the Agreements, the design works of the projects were conducted by SMCC in its office in Tokyo, Japan, in strict accordance with the stipulations in the Agreements, and that no employees of SMCC were dispatched in the Philippines to oversee the execution of those designs. Likewise, based on the Certificate of Final Acceptance issued by SMCC Philippines on October 14, 2016, the concept drawings, detail design drawings, perspective drawings, and other documents of the projects have been successfully completed by SMCC and delivered to SMCC Philippines . Based on a certification issued by SMCC Philippines on February 11, 2016, 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. SMCC has a permanent establishment in the Philippines SMCC is licensed to engage in business in the Philippines through a branch office and a representative office, namely, Sumitomo Mitsui Construction Company Ltd.-Branch Office ( "SMCC Branch Office" ) and Sumitomo Mitsui Construction Company Ltd.-Representative Office ( "SMCC Representative Office" ). Based on an affidavit issued by the concurrent ___________ of SMCC Branch Office and SMCC Representative Office , BBB, the Agreements for the projects were made directly and independently by SMCC in Japan with SMCC Philippines , and not through SMCC Branch Office and SMCC Representative Office. Likewise, neither SMCC Branch Office nor SMCC Representative Office has knowledge nor effective participation in those agreements. The concept drawings, electrical designs, and mechanical designs were performed in SMCC 's office in Tokyo, Japan, and the consideration for these designs will be remitted directly to SMCC. Based on SMCC Branch Office 's General Information Sheet as of September 10, 2015 and Audited Financial Statements as of March 31, 2016, it is primarily engaged in the implementation of various civil works and other government projects funded by the Japan International Cooperation Agency ( "JICA" ). SMCC Branch Office 's current contracts and commitments pertain solely to the construction of the Outpatient Department in the Eastern Visayas Regional Medical Centre pursuant to a contract dated August 13, 2015 between SMCC in Japan and the Department of Health. The construction is expected to be finished in May 2017. RULING 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 in the Philippines is subject to income tax at the rate of 30%, to wit: SDHCac "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, 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 7 of the Philippines-Japan tax treaty provides 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." Under Article 7, profits derived by an enterprise of a Contracting State in the other Contracting State may be taxed in the other State, but only so much of the profits as are attributable to a permanent establishment situated in that State. The term permanent establishment is defined in paragraphs 1 and 2, Article 5 of the treaty below: " 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." Under Article 5, a permanent establishment means a fixed place of business 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. In the case at hand, since SMCC is engaged in business in the Philippines, it is deemed to have a permanent establishment pursuant to Article 5 of the Philippines-Japan tax treaty. On whether service fees paid by SMCC Philippines to SMCC are attributable to the latter's permanent establishments, SMCC Branch Office and SMCC Representative Office , based on the representations given, those fees are not attributable by reason of the following: 1. The Agreements for the two projects were entered into by and between SMCC Philippines and SMCC in Japan, without the participation of SMCC Branch Office or SMCC Representative Office ; 2. All design works of the projects were done entirely in SMCC 's office in Tokyo, Japan, and not within the premises of SMCC Branch Office or SMCC Representative Office in the Philippines; 3. In the case of SMCC Branch Office , its business activity is limited to the implementation of civil works and other government projects funded by the JICA. The two projects are owned by private entities, Magsaysay MOL Marine, Inc. and Oji Engineering Company Ltd., and not funded by JICA; hence, beyond the scope of SMCC Branch Office 's activity; and 4. SMCC Branch Office 's current contracts and commitments pertain only to construction of the Outpatient Department in the Eastern Visayas Regional Medical, which started in 2015 and will be finished in May 2017. Records do not show any commitments and contracts with private entities. SETAcC In Marubeni Corporation vs. Commissioner of Internal Revenue and the Court of Tax Appeals (G.R. No. 76573 dated September 14, 1989), the Supreme Court ruled that income derived by a foreign corporation directly and independently of its branch office in the Philippines cannot be attributed to the branch office, thus: "The general rule that a foreign corporation is the same juridical entity as its branch office in the Philippines cannot apply here. This rule is based on the premise that the business of the foreign corporation is conducted through its branch office, following the principal-agent relationship theory. It is understood the branch becomes its agent here. So that when the foreign corporation transacts business in the Philippines independently of its branch, the principal-agent relationship is set aside. The transaction becomes one of the foreign corporation, not the branch or the resident foreign corporation. Corollarily, if the business transaction is conducted through the branch office, the latter becomes the taxpayer, and not the foreign corporation." (Emphasis ours) This being the case, since the service fees paid by SMCC Philippines to SMCC in Japan for the design works of the projects are not attributable to SMCC Branch Office and SMCC Representative Office , the fees are exempt from income tax in the Philippines pursuant to paragraph 1, Article 7 of the Philippines-Japan tax treaty. Finally, the service fees are not subject to 12% VAT imposed under Section 108 (A) of the Tax Code below: "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 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 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' means the performance of all kinds of services in the Philippines for others for a fee, remuneration or consideration. . ." (Emphasis ours) Under the cross-border or destination principle of the VAT system, services performed in the Philippines are subject to VAT, while those performed outside are exempt. In the instant case, the design works of the projects were carried out entirely by SMCC in Japan and not the Philippines; hence, service fees therefor 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. Very truly yours, (SGD.) CAESAR R. DULAY 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. http://www.smcc.com.ph/our-company/about-us/ . n Note from the Publisher: Copied verbatim from the official document.