ITAD BIR Ruling No. 042-17

November 24, 2017 ITAD BIR RULING NO. 042-17 Articles 5 and 7 Philippines-Japan tax treaty, as amended Philippine-International Manufacturing and Engineering Services Corporation Block 16, Phase 4, Cavite Economic Zone 4106 Rosario, Cavite Attention: AAA _______________ Gentlemen : This refers to your tax treaty relief application filed on February 22, 2012, on behalf of International Manufacturing and Engineering Services Company Ltd. ("IMES") , requesting confirmation that service fees paid by Philippine-International Manufacturing and Engineering Services Corporation ("P.IMES") to IMES are not subject to 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 HTcADC It is represented that IMES is a corporation organized and existing under the laws of Japan as evidenced by its Corporate Registration issued by the Yokohama District Legal Affairs Bureau and Certificate of Status of Taxable Person issued by the Fujisawa Tax Office in Japan; that IMES is engaged in design, preproduction, manufacturing, sale, and repair of computer-oriented equipment and components; that it is not registered as a corporation or partnership in the Philippines as confirmed by the Certification of Non-Registration of Company issued by the Securities and Exchange Commission; that, on the other hand, P.IMES is a corporation organized and existing under the laws of the Philippines; that it is engaged in the manufacture and sale of printed circuit board assembly, medical device, mold parts, test and assembly equipment for hard disk drive, electronics and semiconductors, high technology parts and other computer-related goods; that P.IMES is registered with the Philippine Economic Zone Authority ("PEZA") and is currently enjoying incentives such as the 5% gross income tax in lieu of all national and local taxes; and that P.IMES is a wholly-owned subsidiary of IMES . It is also represented that on February 1, 2012, P.IMES and IMES entered into a Management and Engineering Consulting Agreement where IMES agreed to provide consultancy services to P.IMES on the following projects: mold business, hard disk drive test equipment, and medical device; that the services cover management, engineering and manufacturing, and other types of assistance that P.IMES may request with IMES ; that in consideration, P.IMES will pay service fees to IMES based on the latter's staff level and the estimated time spent by these staff in rendering the services; that the fees shall not exceed __________ per month; and that the Agreement shall commence on February 1, 2012 for a period of one year, and shall be extended automatically for subsequent periods of one year. It is further represented based on certification issued by P.IMES on July 31, 2017, that from 2012 to 2017, IMES dispatched the following personnel to the Philippines pursuant to the Agreement BBB, CCC, DDD, EEE, FFF, GGG, HHH, III, JJJ, KKK, LLL, MMM, NNN, and OOO; and that the services were rendered for less than six months (180 days) within any twelve-month period in the years concerned, particularly: (a) 2012 (49 days): May 8-9, 12-13; July 29-31; August 1-4; October 3-31; November 1-9; (b) 2013 (81 days): January 17-26, February 5-9, 18-22; March 20-23; April 4-8, 11-13; July 10-14, 23-24; September 4-10, 18-21; October 7-11, 20-29; November 23, 28-30; December 1-3, 15-22; (c) 2014 (129 days): January 15-18, 21-23; February 12-28; March 1-9, 12-13, 19-31; April 1-16; June 3-8, 12-14, 25-29; July 2-3, 17-19, 23-25, 31; August 1-3, 6-8; October 15-18, 28-31; November 1, 19-29; December 3-13, 17-21; (d) 2015 (83 days): January 20-24, 28-31; February 1-2, 5-7, 17-21; March 4-9, 12-14, 17-18, 21-25; April 22-27, 29-30; May 1, 20-25; June 22-24; July 22-27, 29-31; August 24-27; December 3-20; (e) 2016 (35 days): February 1-3; March 16-17, 22; June 13-24; July 20-24; October 10-15; December 18-23; and (f) 2017 (115 days): January 5-31; February 1-28; March 1-13, 22-28; April 3-30; May 1-9; June 28-30. It is further represented based on a Transfer Pricing Report dated March 9, 2015 that the provision of management and engineering consulting services by P.IMES to IMES is carried out at arm's length basis. It is finally represented based on certification issued by P.IMES on January 27, 2012 that the income subject of the application for tax treaty relief is not subject of investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings, or judicial appeal. 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, said income is exempt to the extent required by any treaty obligation upon the Philippine government, viz. : "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 7 of the Philippines-Japan tax treaty provides: aScITE "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." Based on the above article, the profits of an enterprise of a Contracting State shall be taxable only in that State unless it carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as such, its profits may be taxed in the other State but only so much of them as are attributable to the permanent establishment. With regard to a permanent establishment, Article 5 of the treaty defines 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. 3. A building site or construction or installation project constitutes a permanent establishment only if it lasts more than six months. 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, and a workshop. In the case of services, a permanent establishment exists if it furnishes in a Contracting State consultancy services, or supervisory services in connection with a contract for a building, construction or installation project through employees or other personnel, where such activities continue (for the same project or two or more connected projects) for a period or periods aggregating more than six months (180 days) within any twelve-month period. Accordingly, since IMES 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 does not furnish services in the Philippines for more than six months (180 days) within any twelve-month period from 2012 to present, IMES does not have a permanent establishment under paragraphs 1, 2 and 6, Article 5 of the Philippines-Japan tax treaty. This being the case, service fees paid by P.IMES to IMES for furnishing management and engineering consulting services to P.IMES in the years concerned are not subject to income tax in the Philippines pursuant to paragraph 1, Article 7 of the treaty. Finally, under Section 108 (A) of the Tax Code, services rendered in the Philippines are generally subject to value-added tax ("VAT") at the rate of 12%, 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%). . ." However, since P.IMES is a PEZA-registered enterprise and entitled to fiscal incentives under Republic Act No. 7916, the Supreme Court ruled in Commissioner of Internal Revenue vs. Seagate Technology (Philippines) (G.R. No. 153866 dated February 11, 2005) 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 ." Accordingly, since P.IMES is a PEZA-registered enterprise and the services furnished to it are directly connected with its PEZA-registered activities (particularly, mold business, hard disk drive test equipment, and medical devices), P.IMES cannot be imposed VAT on transactions related to these activities. Directly, P.IMES cannot be treated as a regular VAT-registered taxpayer with respect to these activities, and indirectly, P.IMES cannot be shifted or passed-on VAT on services procured from IMES which are necessary for P.IMES to carry out its activities. HEITAD 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 . n Note from the Publisher: Copied verbatim from the official document.