Nonato and Nonato Law Offices

March 15, 2018 ITAD BIR RULING NO. 038-18 Articles 5 and 7 Philippines-Japan tax treaty, as amended Nonato and Nonato Law Offices Room 406, Tulips Center A.S. Fortuna Street, Bakilid 6014 Mandaue City Cebu Attention: AAA Gentlemen : This refers to your tax treaty relief application filed on July 12, 2010 requesting confirmation that service fees paid by Yamashin Cebu Filter Manufacturing Corporation (" Yamashin Cebu ") to Hitachi Information Systems Ltd. (" Hitachi Information ") 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 . 1 CHTAIc FACTS Hitachi Information is a corporation organized and existing under the laws of Japan and a resident thereof based on its Articles of Incorporation and Certificate of Residence issued by the Shinagawa Tax Office in Japan. Hitachi Information is engaged primarily in providing data processing services, developing software, and selling small and medium-sized computers, work stations and computer-related supplies. 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 the other hand, Yamashin Cebu is a domestic corporation engaged in the manufacture and sale of hydraulic oil filters (as used mainly for construction machinery such as hydraulic excavators, bulldozer, wheel loader and cranes) and process filters (for use in precise washing in various cutting-edge fields, purifying filtration in food and beverage industry, precise filtration of high viscosity fluid, and oil filtration for industrial machinery). It is registered with the Philippine Economic Zone Authority (" PEZA ") as an ecozone export enterprise. On March 2, 2010, Yamashin Cebu and Hitachi Information entered into a SAP Software Maintenance Agreement where Hitachi Information agreed to provide Yamashin Cebu maintenance services in connection with the SAP Business One Software for the period January 1 to December 31, 2010. The service will be done remotely via telecommunication lines. Based on the Sworn Statement and Secretary's Certificate issued by Yamashin Cebu , the Agreement expired on December 31, 2010, as stipulated, and that service fees for the whole 2010 amounting to __________ were paid by Yamashin Cebu to Hitachi Information in that year through telegraphic transfer. Hitachi Information sent two personnel (Messrs. BBB and CCC) to the Philippines in 2010 to provide maintenance services to Yamashin Cebu . Their aggregate length of stay in the country is 41 days. 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 in the Philippines 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 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 this article, profits derived by an enterprise of Japan from carrying on business in the Philippines may be taxed in the Philippines if the profits are attributable to a permanent establishment situated therein. EATCcI In relation to a permanent establishment , paragraphs 1, 2 and 6, Article 5 of the treaty define this term 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." 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, a workshop and a warehouse. It includes also the furnishing of services in the Philippines by an enterprise of Japan through employees or other personnel thereof, particularly, consultancy services, or supervisory services in connection with a contract for a building, construction or installation project, where such activities continue for a period or periods aggregating more than six months within any twelve-month period. ISHCcT Accordingly, since Hitachi Information 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 Philippines, and it did not furnish services in the Philippines for more than six months within any twelve-month period, Hitachi Information does not have a permanent establishment under paragraphs 1, 2 and 6, Article 5 of the Philippines-Japan tax treaty. As represented, Hitachi Information furnished maintenance services in connection with the SAP Business One Software for the period January 1 to December 31, 2010, but for services done in the Philippines, the duration thereof is 41 days only . This being so, such service fees paid by Yamashin Cebu to Hitachi Information are exempt from income tax pursuant to paragraph 1, Article 7 of the tax treaty. Finally, under Section 108 (A) of the Tax Code, services performed in the Philippines by Hitachi Information are 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 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%) . . ." However, since Yamashin Cebu is a PEZA-registered enterprise and entitled to fiscal incentives under Republic Act No. 7916 2 the Supreme Court, in Commissioner of Internal Revenue vs. Seagate Technology (Philippines) (G.R. No. 153866 dated February 11, 2005) (" Seagate case "), ruled that: "Applying the special laws we have earlier discussed, respondent as an entity is exempt from internal revenue laws and regulations. This exemption covers both direct and indirect taxes, stemming from the very nature of the VAT as a tax on consumption, for which the direct liability is imposed on one person but the indirect burden is passed on to another. Respondent, as an exempt entity, can neither be directly charged for the VAT on its sales nor indirectly made to bear, as added cost to such sales, the equivalent VAT on its purchases. Ubi lex non distinguit, nec nos distinguere debemus. Where the law does not distinguish, we ought not to distinguish. Moreover, the exemption is both express and pervasive for the following reasons: First, RA 7916 states that 'no taxes, local and national, shall be imposed on business establishments operating within the ecozone .' Since this law does not exclude the VAT from the prohibition, it is deemed included . Exceptio firmat regulam in casibus non exceptis. An exception confirms the rule in cases not excepted; that is, a thing not being excepted must be regarded as coming within the purview of the general rule . Moreover, even though the VAT is not imposed on the entity but on the transaction, it may still be passed on and, therefore, indirectly imposed on the same entity a patent circumvention of the law. That no VAT shall be imposed directly upon business establishments operating within the ecozone under RA 7916 also means that no VAT may be passed on and imposed indirectly. Quando aliquid prohibetur ex directo prohibetur et per obliquum. When anything is prohibited directly, it is also prohibited indirectly." Applying the Seagate case, since Hitachi Information (the nonresident service provider) is not a VAT-registered taxpayer, service fees paid to it by Yamashin Cebu (the PEZA-registered entity) are, for purposes of VAT, treated as exempt and not zero-rated. In either case, pursuant to Revenue Regulations No. 16-2005 , 3 no output VAT is shifted or passed-on to Yamashin Cebu on those fees. " SEC. 4.106-5. Zero-Rated Sales of Goods or Properties. A zero-rated sale of goods or properties (by a VAT-registered person) is a taxable transaction for VAT purposes, but shall not result in any output tax. However, the input tax on purchases of goods, properties or services related to such zero-rated sale, shall be available as tax credit or refund in accordance with these Regulations." " SEC. 4.109-1. VAT-Exempt Transactions. (A) In general. 'VAT-exempt transactions' refer to the sale of goods or properties and/or services and the use or lease of properties that is not subject to VAT (output tax) and the seller is not allowed any tax credit of VAT (input tax) on purchases. The person making the exempt sale of goods, properties or services shall not bill any output tax to his customers because the said transaction is not subject to 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. An Act Providing for the Legal Framework and Mechanism for the Creation, Operation, Administration, and Coordination of Special Economic Zones in the Philippines, Creating for this Purpose, the Philippine Economic Zone Authority (PEZA), and for Other Purposes , as amended. 3. Consolidated Value-Added Tax Regulations of 2005 , as amended. n Note from the Publisher: Copied verbatim from the official document.