ITAD BIR Ruling No. 035-20

March 11, 2020 ITAD BIR RULING NO. 035-20 Articles 5 (Permanent Establishment) and 8 (Business Profits) Philippines-United States of America tax treaty AAA ____________________ ____________________ Dear AAA : This refers to your tax treaty relief application filed on August 2, 2018 requesting confirmation that service fee paid by METAL INDUSTRY RESEARCH AND DEVELOPMENT CENTER ("MIRDC") to DASTUR INTERNATIONAL, INC. ("Dastur") is exempt from income tax 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 Dastur is a corporation organized and existing under the laws of the United States and a resident thereof based on its Certificate of Incorporation and Certificate of Residence issued by the Internal Revenue Service of the United States. 1 It is engaged in providing services relating to architecture, engineering and design, and construction. It is not registered as a corporation or partnership in the Philippines based on the Certification of Non-Registration of Corporation/Partnership issued by the Securities and Exchange Commission. On the other hand, MIRDC is an attached agency of the Department of Science and Technology pursuant to Executive Order No. 494 2 dated December 6, 1991, whose mandate is to work for close rapport between the government and the metals industry to advance the metals, engineering and allied industries in the Philippines. On November 27, 2017, Dastur and MIRDC entered into an Agreement where Dastur agreed to do an economic feasibility study of putting up an iron making facility in the Philippines in the context of metallurgical testing results, availability and location of black sand and possible reductants, the location of market and other necessary factors such as transport facilities, power sourcing and others. The project has a contract price of Php_______________. The project is divided into two phases, namely: TIADCc a) Bench scale testing . This covers laboratory test works to determine suitability of magnetile sand as raw material for ironmaking process specifically RK/EF ( e.g. , New Zealand steel process), MIDREX and COREX. The two Ironmaking Technology providers, namely, Outotec and Primetals, were commissioned to conduct bench scale tests based on RK/EF and MIDREX/COREX, respectively. The test works are underway and results will be used as bases in coming up with a comparative evaluation of the three ironmaking technologies in terms of operating expense and capital expenditure. b) Pre-feasibility study . This aims to present comparative evaluation of project options and determine the most economically viable investment option to be considered for Philippine ironmaking facility. This study includes market study, technical study, financial study, and conclusion and recommendations. Based on the contract, the preparation and submission of final report on the study shall be completed within six (6) months from the date of award and signing of agreement or contract. Dastur was declared as the consultant with the highest rated and responsive bid for the consultancy service and was issued the Notice of Award on November 23, 2017. The Notice to Proceed dated December 5, 2017 was accepted by Dastur on February 20, 2018 and the project commenced only after three (3) calendar days thereafter. The study team was comprised of personnel of Dastur , in association with M.N. Dastur & Co. (P) Ltd. of India. BBB, _____________ of Dastur , was tasked to provide professional service for economic feasibility and CCC, ____________ of Dastur , was given the responsibility to oversee the project. According to BBB, the feasibility study was undertaken in the United States and India, based on inputs provided by MIRDC . For its part, MIRDC certified that economic and market pre-feasibility studies/services were done by Dastur personnel outside the Philippines during the entire duration of the contract. CCC's passport showed, however, that he was in the Philippines from June 30 to July 4, 2018 or for a total of five (5) days. Dastur successfully completed the project in 159 days, i.e. , from February 23 to July 31, 2018, and was given a very satisfactory remark therefor. It was given full payment for the project within 60 days from the time the final acceptance of complete pre-feasibility study by MIRDC . 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 nonresident foreign corporation 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%)." AIDSTE However, under Section 32 (B) (5) of the Tax Code, such income is exempt to the extent required by any treaty obligation binding upon the Philippine government, thus: " 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." In this connection, paragraph 1, Article 8 and paragraphs 1 and 2, 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." 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 as such, the profits may be taxed in the other State but only on so much of them as are attributable to the permanent establishment. Under Article 5, the term permanent establishment means a fixed place of business through which the resident engages in trade or business, and includes, especially, a seat of management, a branch, an office, a store or other sales outlet, a factory, and a workshop. It includes also the furnishing of services including consultancy services by a resident, through employees or other personnel thereof, which continue for a period or periods aggregating more than 183 days. AaCTcI Accordingly, since Dastur is not engaged in trade or business in the Philippines, and that it has no branch, office, or other fixed place of business in the Philippines, and it did not furnish services in the country for a period or periods aggregating more than 183 days within any twelve-month period, but furnished such services for five days only during the contract period, Dastur is not deemed to have a permanent establishment under paragraphs 1 and 2, Article 5 of the Philippines-United States tax treaty. This being so, the contract price paid by MIRDC to Dastur for conducting an economic feasibility study of putting up an iron making facility in the Philippines is exempt from income tax pursuant to paragraph 1, Article 8 of the treaty. Moreover, in Hutchison Ports Philippines Limited vs. Subic Bay Metropolitan Authority, International Container Terminal Services, Inc., Royal Port Services, Inc. and the Executive Secretary, G.R. No. 131367 dated August 31, 2000 , the Supreme Court held that a foreign corporation participating in any bidding process is already doing business in the Philippines , thus: "The maelstrom of this issue is whether participating in the bidding is a mere isolated transaction, or did it constitute engaging in or transacting business in the Philippines such that petitioner HPPL needed a license to do business in the Philippines before it could come to court. There is no general rule or governing principle laid down as to what constitutes doing or engaging in or transacting business in the Philippines. Each case must be judged in the light of its peculiar circumstances. Thus, it has often been held that a single act or transaction may be considered as doing business when a corporation performs acts for which it was created or exercises some of the functions for which it was organized. The amount or volume of the business is of no moment, for even a singular act cannot be merely incidental or casual if it indicates the foreign corporations intention to do business. Participating in the bidding process constitutes doing business because it shows the foreign corporations intention to engage in business here. The bidding for the concession contract is but an exercise of the corporations reason for creation or existence . Thus, it has been held that a foreign company invited to bid for IBRD and ADB international projects in the Philippines will be considered as doing business in the Philippines for which a license is required. In this regard, it is the performance by a foreign corporation of the acts for which it was created, regardless of volume of business, that determines whether a foreign corporation needs a license or not." (Underscoring supplied) In the instant case, Dastur , a foreign corporation, has participated in a government bidding process and is deemed doing business in the Philippines based on the above jurisprudence. However, under Articles 8 and 5 of the Philippines-United States tax treaty, the Philippines can tax the service fee received by Dastur from sources in the Philippines only if such income is attributable to a permanent establishment ( e.g. , a fixed place of business) situated in the country. Since Dastur does not have a permanent establishment, its service fee shall be exempt from income tax. However, since the services are performed in the Philippines, the service fee paid to Dastur is subject to VAT at the rate of 12 percent under Section 108 (A) of the Tax Code, thus: " 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 twelve percent (12%) of gross receipts derived from the sale or exchange of services, including the use or lease of properties. EcTCAD 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 . . ." (Underscoring supplied) Pursuant to Section 4.114-2 of Revenue Regulations No. 16-2005, 3 as amended, MIRDC shall withhold VAT on the contract price at the rate of 12 percent before remitting it to Dastur . MIRDC 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 MIRDC 's claim of input VAT on the contract price; otherwise, if it not a VAT-registered taxpayer, MIRDC may treat the passed-on VAT as part of the cost of services 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 is 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. SDHTEC Very truly yours, (SGD.) CAESAR R. DULAY Commissioner of Internal Revenue Footnotes 1. https://www.zoominfo.com/c/dastur-international-inc/348169930 2. Reorganizing Certain Government-Owned or Controlled Corporations and for Other Purposes. 3. Consolidated Value-Added Tax Regulations of 2005. n Note from the Publisher: Copied verbatim from the official document.