ITAD BIR Ruling No. 069-11

March 1, 2011 ITAD BIR RULING NO. 069-11 Articles 5 and 7, Philippines-Japan tax treaty; Section 109 (K), Tax Code of 1997; BIR Ruling No. ITAD-061-10; BIR Ruling No. DA-ITAD-101-00 Sycip Gorres Velayo & Co. 6760 Ayala Avenue 1226 Makati City Attention: Fabian K. delos Santos Partner, Tax Services Gentlemen : This refers to your tax treaty relief application filed on July 20, 2010, on behalf of your client TAIYO NIPPON SANSO CORPORATION ("TNSC"), requesting confirmation that: IASTDE 1) The service fees to be received by TNSC from H.R.D. Singapore Pte. Ltd. Philippine branch ("HRD") are not subject to Philippine income tax pursuant to Articles 5 and 7 of 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"), as amended by a Protocol; 1 and 2) The service fees are exempt from the 12% value-added tax (VAT). It is represented that TNSC, with address at 3-26 Koyama 1-chome, Shinagawa Ward, Tokyo, is a corporation duly incorporated in July 19, 1918 under the laws of Japan under Corporate Registration No. 0107-01-015826, as shown in the Certificate of all registered items in the commercial register issued by the Registrar of the Tokyo Legal Affairs Bureau, Shinagawa Liaison Office dated April 13, 2010; that it is a resident of Japan under the provisions of the Philippines-Japan tax treaty based on the Certificate of Residence issued by the District Director of Ebara Tax Office dated May 21, 2010; that it is not registered as a corporation or as a partnership in the Philippines per Certification of Non-Registration of Company issued by the Securities and Exchange Commission (SEC) dated May 26, 2010; that HRD, on the other hand, is a duly licensed branch office in the Philippines of H.R.D. Singapore Pte. Ltd. under Amended SEC License No. A199601192; that it is a Philippine Economic Zone Authority (PEZA)-registered enterprise in the Philippines under Certificate of Registration No. 96-078 dated June 27, 1996, licensed to engage in export of technical service (on-site) among others: (a) assembling process of all housing parts and components; (b) process control system; (c) safety control system; (d) quality control system; (e) time and scheduling control system and (f) accounting and inventory monitoring and control system, etc., as shown in the SEC License Certificate dated February 27, 2001. It is also represented that sometime in July 2010, an Individual Transaction Contract ("Contract") was entered into by and between TNSC and HRD, with TNSC as a seller and HRD as a buyer, under the following terms: TNSC shall deliver and complete "The System", described in the Contract as follows: 1) One set of Gas Supply System; 2) One set of Abatement and Filter System for PECVD; As contract price, HRD shall pay to TNS a total amount of JPY489,000,000, broken down as follows: 1) One set of Gas Supply System JPY121,000,000; and 2) One set of Abatement and Filter System for PECVD JPY368,000,000; TNSC shall deliver and complete "The System" inside the Solar Cell Factory located in Cavite Economic Zone, Rosario, Philippines, which is designated by HRD; caEIDA TNSC shall deliver and complete "The System" at the aforesaid place of delivery no later than July 30, 2010; and The period of service to be rendered in the Philippines shall not be more than 5 months in any case. It is finally represented, per the Certification issued by HRD dated July 7, 2010, that the issue subject of the above request is not under any investigation or on-going audit, administrative protest, claim for refund or issuance of tax credit certificate, collection proceedings, or a judicial appeal. In reply, please be informed that profits derived in the Philippines by a nonresident corporation, like TNSC in the instant case, are generally subject to tax under Section 28 (B) (1) of the National Internal Revenue Code of the Philippines of 1997, as amended (Tax Code of 1997). It provides, viz. : "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 . . . profits and income , . . .: Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)." (Emphasis supplied) xxx xxx xxx" However, said income derived by a nonresident foreign corporation may be exempt or partially exempt pursuant to a treaty obligation to which the Philippine government is bound. Thus, Section 32 (B) (5) of the Tax Code of 1997 provides, 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: 2 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." STHAaD In the instant case which involves income derived within the Philippines by a resident of Japan, the Philippines-Japan tax treaty, as amended, appropriately applies. Hence, Article 7 (1) of the Philippines-Japan tax treaty provides: "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. xxx xxx xxx" Based on the above, 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 that is attributable to that permanent establishment. Applying this to the instant case, the service fees received by TNSC for services rendered in the Philippines under the Contract shall be taxable in the Philippines only if it has a permanent establishment in the Philippines in connection with the activities giving rise to such income. In relation thereto, Article 5 of the same tax treaty defines a permanent establishment, 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. 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 taxable year. 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. ScaEIT xxx xxx xxx" Paragraph 6 of Article 5 provides that an enterprise of Japan shall be deemed to have a permanent establishment in the Philippines if it furnishes in the Philippines 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 taxable year. The documents submitted to this Office show that the five (5) personnel of TNSC rendered services in the Philippines pursuant to the Contract from January to August 2010 totaling an aggregate period of 171 days, which is a period not exceeding 183 days within a twelve-month period. Thus, TNSC is not deemed to have a permanent establishment by virtue of the rendition of said services in the Philippines to which its profits could be attributable. In view thereof, this Office is of the opinion and so holds that the profits derived by TNSC from the rendition of services under the Contract shall not be subject to Philippine income tax pursuant to Article 7 (1) in relation to Article 5 of the Philippines-Japan tax treaty, as amended. (BIR Ruling No. ITAD-16-10 dated August 11, 2010; BIR Ruling No. DA-ITAD-101-00 dated August 7, 2000) As regards the imposition of the VAT on the rendition of services of TNSC, please be informed further that Section 108 of the Tax Code of 1997 3 provides as follows: "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%) 4 of gross receipts derived from the sale or exchange of services, including the use or lease of properties. 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 supplied) Thus, in general, the VAT is imposed on services rendered by TNSC in the Philippines. On every payment of service fees, HRD is required to withhold such VAT and treat the same as a "passed on" VAT, pursuant to Section 4.110-3 (b) of Revenue Regulations No. 7-95 as amended [now Section 4.114-2 (b) of Revenue Regulations No. 16-05]. However, in Commissioner of Internal Revenue vs. Seagate Technology (Philippines) (G.R. No. 153866, February 11, 2005), the Supreme Court held, viz. : CcADHI "Special laws may certainly exempt transactions from the VAT. 5 However, the Tax Code provides that those falling under PD 66 are not. PD 66 is the precursor of RA 7916 the special law under which respondent was registered. The purchase transactions it entered into are, therefore, not VAT-exempt. These are subject to the VAT; respondent is required to register. xxx xxx xxx Since the purchases of respondent are not exempt from the VAT, the rate to be applied is zero. Its exemption under both PD 66 and RA 7916 effectively subjects such transactions to a zero rate, because the ecozone within which it is registered is managed and operated by the PEZA as a separate customs territory. This means that in such zone is created the legal fiction of foreign territory. Under the cross-border principle of the VAT system being enforced by the Bureau of Internal Revenue (BIR), no VAT shall be imposed to form part of the cost of goods destined for consumption outside of the territorial border of the taxing authority. If exports of goods and services from the Philippines to a foreign country are free of the VAT, then the same rule holds for such exports from the national territory except specifically declared areas to an ecozone. xxx xxx xxx 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: . . ., 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. IATSHE 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. xxx xxx xxx" Based on the foregoing, the sale of goods and services to persons or entities exempt from VAT, by reason of PD 66 and RA 7916, is effectively zero-rated. However, instead of zero-rating which is not available to nonresident suppliers, the provision for exempt transactions under Section 109 (K) of the Tax Code of 1997, as amended, which provides VAT exemption for transactions that are exempt under special laws, e.g. , Republic Act No. 7916 or PEZA Law, is particularly applicable to the instant case. Such being the case, the payment of services fees by HRD, being a PEZA-registered enterprise, to TNSC under the subject Contract should be, as it is hereby confirmed to be, 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 facts are different, then this ruling shall be without force and effect insofar as the herein parties are concerned. Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes 1. Effective January 1, 2009. 2. Title II Tax on Income. 3. This cited provision has been retained by Republic Act (RA) No. 9337, although with the modification as to the applicable rate when the circumstances so warrant. 4. Effective February 1, 2006, the rate shall be 12%. 5. Referring to the old Section 109 (q) of the Tax Code of 1997 [now Section 109 (K), as amended by RA No. 9337.