Isla Lipana and Co.

September 29, 2021 ITAD BIR RULING NO. 042-21 Articles 5 (Permanent Establishment) and 7 (Business Profits); Philippines-Singapore tax treaty Isla Lipana and Co. 29th Floor, Philamlife Tower 8767 Paseo de Roxas Makati City Attention: Ms. ____________ Partner, Tax Services Gentlemen : This refers to your tax treaty relief application ("TTRA") filed on August 1, 2011 requesting confirmation that service fees paid by Electrolux Philippines, Inc. ("Electrolux Philippines") to Electrolux SEA Pte. Ltd. ("Electrolux") are exempt from income tax pursuant to the Convention between the Republic of the Philippines and the Republic of Singapore for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income ("Philippines-Singapore tax treaty") . FACTS Electrolux is a foreign corporation organized and existing under the laws of Singapore and a resident thereof based on its Memorandum and Articles of Association and Certificate of Residence issued by the Inland Revenue Authority of Singapore. It is engaged primarily as manufacturer, merchant, importer, exporter, repairer and agent for the sale and purchase of and dealer in domestic appliances, equipment, apparatus and accessories of all descriptions. 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, Electrolux Philippines is a domestic corporation organized and existing under the laws of the Philippines. It is engaged primarily in the trading of goods like household appliances, kitchen cabinets, and fixtures on wholesale basis and provide after-sales related services. On January 1, 2011, Electrolux Philippines and Electrolux entered into a Service Agreement where Electrolux agreed to provide services to Electrolux Philippines in the fields of regional management, human resources, communication, information technology, marketing and branding, product development, manufacturing support and regional distribution center. The services will be based on cost plus a mark-up of five percent (5%), which shall be reviewed on a regular basis and adjusted as necessary by the parties in writing. Cost for services are either directly allocable or indirectly allocable to the company benefitting from the services. For direct services, the basis will be the directly allocable costs or on the time spent by the employees within a regional function and set with reference to rates charged by third party service providers of equivalent expertise in comparable circumstance. For indirect services, these cover activities provided to a company where separate recording and analysis of benefits is not possibly identifiable to that company or involve a burden of administrative work disproportionate to the activities themselves. The cost for indirect services shall be pooled among group of companies benefitting from the services on the basis of an allocation key which shall be the budgeted net sales of the group, or their non-factory employees, or production volumes. Electrolux will calculate the total services provided to Electrolux Philippines and will invoice the same accordingly. The service fee payable to Electrolux will be paid in United States dollar or Philippine peso. The Agreement takes effect on January 1, 2011 and will continue in effect indefinitely unless terminated or modified. CAIHTE Based on sworn statements issued by Electrolux Philippines on May 30, 2013 and January 31, 2012, Electrolux Philippines paid service fees to Electrolux amounting to US$__________ for services rendered in 2012 and US$________ for services in 2011. Based on a sworn statement issued by Electrolux Philippines on May 30, 2013 and the attached passports, the following, Electrolux sent its employees (namely, __________________ and __________________) to the Philippines to render services to Electrolux Philippines which lasted for seven days. 1 Based on a sworn statement issued by Electrolux Philippines on July 8, 2011, the transaction 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 In reply, please be informed that under Section 28 (B) (1) of the National Internal Revenue Code of 1997, as amended ("Tax Code") , profits derived in the Philippines by a foreign corporation not engaged in trade or business is subject to income tax at the rate of 30 percent, 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: * 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, the profits are exempt or partially exempt to the extent required by any treaty obligation on the Philippines, 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." In this regard, Article 7 of the Philippines-Singapore tax treaty provides relief as follows: " Article 7 BUSINESS PROFITS 1. The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on or has carried on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is attributable to that permanent establishment." Under Article 7, profits derived by an enterprise of Singapore may be taxed in the Philippines if it carries on business in the Philippines through a permanent establishment and the profits are attributable to that permanent establishment. Relative thereto, Article 5 of the treaty defines a permanent establishment as follows: DETACa " Article 5 PERMANENT ESTABLISHMENT 1. For the purposes of this Convention, the term 'permanent establishment' means a fixed place of business in which the business of the enterprise is wholly or partly carried on. 2. The term 'permanent establishment' includes specially 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, in relation to a person providing storage facilities for others; h) A mine, quarry, or other place of extraction of natural resources; i) A building site or construction or assembly project or installation project or supervisory activities in connection therewith, provided such site, project or activity continues for a period 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." As defined, 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 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 an enterprise of Singapore (through employees or other personnel thereof), where such activities continue (for the same or a connected project) within the Philippines for a period or periods aggregating more than 183 days. Accordingly, since Electrolux is not engaged in trade or business in the Philippines to which a branch, an office, or other fixed place of business is necessary, and that it did not furnish services in the Philippines for more than 183 days, but for a period of seven days only, Electrolux shall not be deemed to have a permanent establishment in the Philippines pursuant to paragraphs 1 and 2, Article 5 of the Philippines-Singapore tax treaty. Therefore, service fees paid to Electrolux by Electrolux Philippines under a Service Agreement effective on January 1, 2011 are exempt from income tax pursuant to paragraph 1, Article 7 of the same treaty. Furthermore, on the classification of service fees as business profits (which are exempt from income tax if not attributable to a permanent establishment) as against payment for know-how or royalties (which are subject to reduced rate of income tax), the following commentaries of the Organisation for Economic Co-operation and Development Model Tax Convention on Income and on Capital (Condensed Version, July 22, 2010) mention that: aDSIHc "11.1 In the know-how contract, one of the parties agrees to impart to the other, so that he can use them for his own account, his special knowledge and experience which remain unrevealed to the public. It is recognised that the grantor is not required to play any part himself in the application of the formulas granted to the licensee and that he does not guarantee the result thereof. 11.2 This type of contract thus differs from contracts for the provision of services, in which one of the parties undertakes to use the customary skills of his calling to execute work himself for the other party. Payments made under the latter contracts generally fall under Article 7. 11.3 The need to distinguish these two types of payments, i.e., payments for the supply of know-how and payments for the provision of services, sometimes gives rise to practical difficulties. The following criteria are relevant for the purpose of making that distinction: Contracts for the supply of know-how concern information of the kind described in paragraph 11 that already exists or concern the supply of that type of information after its development or creation and include specific provisions concerning the confidentiality of that information. In the case of contracts for the provision of services, the supplier undertakes to perform services which may require the use, by that supplier, of special knowledge, skill and expertise but not the transfer of such special knowledge, skill or expertise to the other party. In most cases involving the supply of know-how, there would generally be very little more which needs to be done by the supplier under the contract other than to supply existing information or reproduce existing material. On the other hand, a contract for the performance of services would, in the majority of cases, involve a very much greater level of expenditure by the supplier in order to perform his contractual obligations. For instance, the supplier, depending on the nature of the services to be rendered, may have to incur salaries and wages for employees engaged in researching, designing, testing, drawing and other associated activities or payments to sub-contractors for the performance of similar services." (Pages 225-226) Based on the commentaries, in a contract for the supply of know-how, there would generally be very little more which needs to be done by the supplier other than to supply existing information or reproduce existing material. On the other hand, in a contract for the performance of services, this involves, in a majority of cases, a very much greater level of expenditure by the supplier in order to perform his contractual obligations to the other party, such as salaries and wages for employees engaged in researching, designing, testing, drawing and other associated activities or payments to subcontractors for the performance of similar services. Accordingly, since the Service Agreement does not call for Electrolux to supply existing information or reproduce existing material to Electrolux Philippines , but to provide services to Electrolux Philippines , the agreement is clearly a contract for the performance of services and not for the supply of know-how or other royalty-bearing property. The services cover areas in regional management, human resources, communication, information technology, marketing and branding, product development, manufacturing support and regional distribution center. Moreover, by reason that the services are performed by employees of Electrolux , the latter will incur certainly a greater level of expenditure ( e.g. , salaries and other remuneration of the personnel) in fulfilling its contractual obligations to Electrolux Philippines . This being the case, the service fees paid by Electrolux Philippines to Electrolux constitute clearly as business profits and not royalties. Finally, the service fees paid to Electrolux for rendering services in the Philippines are subject to value-added tax ("VAT") under Section 108 (A) of the Tax Code, which provides: " 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, 2 raise the rate of value-added tax to twelve percent (12%) . . . " Under Section 105 of the Tax Code, services performed by a nonresident foreign person like Electrolux are considered performed in the course of trade or business for the purpose of imposing VAT, to wit: TIADCc " SEC. 105. Persons Liable . Any person who, in the course of trade or business, sells, barters, exchanges, leases goods or properties, renders services, and any person who imports goods shall be subject to the value-added tax (VAT) imposed in Sections 106 to 108 of this Code. The value-added tax is an indirect tax and the amount of tax may be shifted or passed on to the buyer, transferee or lessee of the goods, properties or services. This rule shall likewise apply to existing contracts of sale or lease of goods, properties or services at the time of the effectivity of Republic Act No. 7716. The phrase 'in the course of trade or business' means the regular conduct or pursuit of a commercial or an economic activity, including transactions incidental thereto, by any person regardless of whether or not the person engaged therein is a non-stock, nonprofit private organization (irrespective of the disposition of its net income and whether or not it sells exclusively to members or their guests), or government entity. The rule of regularity, to the contrary notwithstanding, services as defined in this Code rendered in the Philippines by nonresident foreign persons shall be considered as being rendered in the course of trade or business." Relative thereto, Electrolux Philippines shall withhold VAT on the service fees at the rate of 12% before remitting them to Electrolux . Electrolux Philippines shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld). The duly filed BIR Form No. 1600 and its accompanying proof of payment shall serve as documentary substantiation for Electrolux Philippines ' claim of input tax on the fees; otherwise, if it is not a VAT-registered taxpayer, Electrolux Philippines may consider the passed-on VAT as part of the cost of services provided by Electrolux . VAT withheld shall be remitted within 10 days following the end of the month the withholding is made. 3 cSEDTC 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. Inclusive dates of Electrolux's employees in the Philippines: 2011 Total February March April May June July August 7, 8, 9, 10 - - - - - 27, 25, 29 7 days 2. The VAT rate was increased to 12 percent beginning February 1, 2006 , in accordance with the Memorandum of the Executive Secretary to the Secretary of Finance dated January 31, 2006, as circularized by Revenue Memorandum Circular No. 7-2006 (Publishing the Full Text of the Memorandum from Executive Secretary Eduardo R. Ermita dated January 31, 2006 Approving the Recommendation of the Secretary of Finance to Increase the Value Added Tax Rate from Ten Percent to Twelve Percent) dated January 31, 2006. 3. Pursuant to Section 4.114-2 of 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) , which provides: " SEC. 4.114-2. Withholding of VAT on Government Money Payments and Payments to Non-Residents . xxx xxx xxx (b) The government or any of its political subdivisions, instrumentalities or agencies including GOCCs, as well as private corporations, individuals, estates and trusts, whether large or non-large taxpayers, shall withhold twelve percent (12%) VAT, starting February 1, 2006, with respect to the following payments: (1) Lease or use of properties or property rights owned by non-residents; and (2) Services rendered to local insurance companies with respect to reinsurance premiums payable to non-residents; and (3) Other services rendered in the Philippines by non-residents. In remitting VAT withheld, the withholding agent shall use BIR Form No. 1600 Remittance Return of VAT and Other Percentage Taxes Withheld. VAT withheld and paid for the non-resident recipient (remitted using BIR Form No. 1600), which VAT is passed on to the resident withholding agent by the non-resident recipient of the income, may be claimed as input tax by said VAT-registered withholding agent upon filing his own VAT Return, subject to the rule on allocation of input tax among taxable sales, zero-rated sales and exempt sales. The duly filed BIR Form No. 1600 is the proof or documentary substantiation for the claimed input tax or input VAT. Nonetheless, if the resident withholding agent is a non-VAT taxpayer, said passed-on VAT by the non-resident recipient of the income, evidenced by the duly filed BIR Form No. 1600, shall form part of the cost of purchased services, which may be treated either as an 'asset' or 'expense,' whichever is applicable, of the resident withholding agent. VAT withheld under this Section shall be remitted within ten (10) days following the end of the month the withholding was made."