ITAD BIR Ruling No. 075-11

March 10, 2011 ITAD BIR RULING NO. 075-11 Articles 7, 5 and 14, Philippines-Malaysia tax treaty; BIR Ruling No. DA-ITAD-134-06; BIR Ruling No. 179-95; BIR Ruling No. DA-ITAD-51-08; BIR Ruling No. DA-ITAD-121-04 Isla Lipana & Co. 29th Floor Philamlife Tower 8767 Paseo de Roxas 1226 Makati City Attention: Atty. Malou P. Lim Partner, Tax Services Gentlemen/Ladies : This refers to your letter dated June 24, 2008, on behalf of SINCLAIR KNIGHT MERZ SDN BHD (hereinafter referred to as "SKM Malaysia" ), requesting confirmation of the following: IHCSET 1. That the service fees received by SKM Malaysia from its Service Agreement with SINCLAIR KNIGHT MERZ (PHILIPPINES), INC. (hereinafter referred to as "SKM Philippines" ) constitute business profits which are exempt from Philippine income tax under the Agreement between the Government of the Republic of the Philippines and the Government of Malaysia for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income (hereinafter referred to as the "Philippines-Malaysia tax treaty" ), provided there is no permanent establishment in the Philippines; and 2. That the fees paid to SKM-Malaysia within the Philippines are subject to 12% value-added tax ("VAT") pursuant to Section 108 of the National Internal Revenue Code (Tax Code) of 1997. It is represented that SKM Malaysia, with office address at Level 15, Block E, Plaza Mont' Kiara, 2 Jalan Kiara, 50480 Kuala Lumpur, Malaysia, is a resident of Malaysia for income tax purposes for the Year of Assessment 2008, as certified by the Deputy Director, Department of International Tax, Inland Revenue Board Malaysia, on May 8, 2008; that SKM Malaysia is not registered as a corporation or as a partnership in the Philippines, but that, however, there is a similarly named entity registered in the Philippines, SINCLAIR KNIGHT MERZ PTY LIMITED PHILIPPINE BRANCH with SEC Registration No. FS200512354, as evidenced by a Certification of Non-registration of Corporation/Partnership issued by the Securities and Exchange Commission (SEC); that said Philippine branch is a branch of a proprietary company organized and existing under the laws of Australia named SINCLAIR KNIGHT MERZ PTY LIMITED and not a branch of SKM-Malaysia in the Philippines and hence, has no direct relationship with SKM-Malaysia; and that, on the other hand, SKM Philippines is a corporation organized and existing under the laws of the Philippines, with office address at 35/F The Orient Square Bldg., No. 26 Don Francisco Ortigas, Jr., Ortigas Center, Pasig City. It is further represented that on October 1, 2007, a Service Agreement was entered into by and between SKM Malaysia and SKM Philippines whereby SKM Philippines, keen to expand its business in the Philippines and wishing to strengthen its managerial capability as well as acquiring support in growing its business in the various sectors such as infrastructure, power generation, heavy industries and resource mining, engaged SKM Malaysia to provide the services as described below, but which services may be revised, modified, amended, supplemented or restated from time to time by mutual written agreement between the two parties: Management Provide general management advice Provide legal and commercial expertise Provide general finance and accounting support Provide training and employee development support Provide human resources expertise and advice Business Development Assist in business development efforts in and outside of India Assist in providing recommendations to SKM Malaysia's global clients Provide market and industry data Provide information on SKM Malaysia's and its affiliates' technical capabilities Provide general support in SKM Philippine's bids and proposals Special Projects Assist in office set up and commencement of operations Assist with project registration, internal control systems and to ensure compliance CHIScD Assist with capital expenditure, and these are properly documented and managed Assist in selection and recruitment of local teams Other Support Provide advice on any issues that arises on a general basis or adhoc basis Prepare and handover roles and responsibilities to the local team Other on-going general support, on a day-to-day basis As to where the services will be performed, it is represented that, in general, SKM Malaysia will perform the work at its Kuala Lumpur-based office, but that upon request, SKM Malaysia will supply its personnel to perform the work in the Philippines; that the duration and nature of assignments in the Philippines will be mutually agreed upon prior to assignment of SKM Malaysia's personnel, but shall not exceed six months in any given year; that SKM Malaysia will provide guidance to SKM Philippines in its initial period of operations and that such direction or guidance by SKM Malaysia shall be provided by SKM Malaysia's personnel deputized to and located at SKM Malaysia's facilities in Malaysia and other countries outside the Philippines; that in case SKM Philippines needs some SKM Malaysia experts in the Philippines for training of personnel in the Philippines and overseeing the work, SKM Malaysia will deputize these experts to the Philippines for short durations and their expense on traveling, boarding and lodging in Philippines will be borne by SKM Philippines. As to the service fees, terms of payment and duration of the Service Agreement, it is represented that the fees are calculated based on the 1.8% of sales 1 of SKM Philippines; that SKM Malaysia will issue two invoices to SKM Philippines for the payment of support fees on a monthly basis, one invoice for services rendered outside the Philippines and the other invoice for services rendered within the Philippines; and that the duration of the work is for 12 months until October 31, 2008, but can be extended on a month-to-month basis, based on written mutual consent. Finally, it is represented that the transaction subject of the above request for ruling is not under investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings, or a judicial appeal of the taxpayers involved per the Sworn Statement of the President of SKM Philippines dated March 25, 2008. In reply, please be informed as follows: On Income Tax Profits derived within the Philippines by a nonresident foreign corporation are, in general, subject to tax and shall be governed by Section 28, paragraph B, sub-paragraph 1 of the Tax Code of 1997, as amended. It provides: "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, as amended, provides: "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 TSHIDa 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 the instant case which involves income derived within the Philippines by a resident of Malaysia, the Philippines-Malaysia tax treaty appropriately applies. Hence, Articles 7 (1) and 5 of the Philippines-Malaysia tax treaty provide: "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 business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much thereof as is attributable to that permanent establishment." "Article 5 PERMANENT ESTABLISHMENT 1. For the purposes of this Agreement, 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' shall include especially: a) a place of management; b) a branch; c) an office; d) a factory; e) a workshop; f) a mine, an oil or gas well, a quarry or other place of extraction of natural resources including timber or other forest produce; g) a farm or plantation; h) a building site or construction, installation or assembly project which exists for more than 6 months." Based on the foregoing, the Philippines may tax the business profits of an enterprise which is a resident of Malaysia if such enterprise has a fixed place of business in the Philippines, but only so much of the profits as may be attributable to such fixed place of business. Inasmuch as the representations show that SKM Malaysia does not have a fixed place of business in the Philippines which would constitute as its permanent establishment in the Philippines, the service fees it receives from SKM Philippines for the services rendered by the former under the herein Service Agreement are not subject to Philippine income tax. (BIR Ruling No. DA-ITAD-134-06 dated October 27, 2006; BIR Ruling No. 179-95 dated November 16, 1995; BIR Ruling No. DA-ITAD-51-08 dated July 9, 2008) However, insofar as the representation that SKM Malaysia personnel will be deputized in the Philippines to render services, the remuneration paid to said personnel is generally subject to tax, unless the conditions set forth in paragraph 2, Article 14 of the Philippines-Malaysia tax treaty are all complied with, to wit: "Article 14 PERSONAL SERVICES 1. Subject to the provisions of Articles 15, 17, 18, 19 and 20, salaries, wages and similar remuneration or income derived by a resident of a Contracting State in respect of professional services or other activities of a similar character, shall be taxable only in that State unless the services or activities are exercised or performed in the other Contracting State. If the employment, services or activities are so exercised or performed, such remuneration or income as is derived therefrom may be taxed in the other State. cCaIET 2. Notwithstanding the provisions of paragraph 1, remuneration or income derived by a resident of a Contracting State in respect of an employment, services or activities exercised or performed in any calendar year in the other Contracting State shall be taxable only in the first-mentioned State, if: a) the recipient is present in that other State for a period or periods not exceeding in the aggregate 183 days in the calendar year concerned, and b) the services or activities are exercised or performed for or on behalf of a person who is a resident of the first-mentioned State, and c) the remuneration or income is not borne by a permanent establishment which the person paying the remuneration has in the other State. xxx xxx xxx" Based on the above provision, the subject remuneration will be exempt from tax if: (a) the personnel who shall come to the Philippines shall not stay therein for an aggregate period of more than 183 days in the calendar year concerned, (b) the services or activities are performed for or on behalf of an employer who is a resident of Malaysia and (c) the remuneration is not borne by a permanent establishment which the employer has in the Philippines. Applying this to the instant case, all the aforementioned requirements are satisfied considering that (a) the length of stay in the Philippines of the personnel of SKM Malaysia, as represented, shall not exceed a period of six months; (b) the services are performed for or on behalf of SKM Malaysia, who is a resident of Malaysia; (c) the remuneration is not borne directly by a permanent establishment which SKM Malaysia has in the Philippines. In view thereof, the said remuneration is not subject to Philippine income tax. (BIR Ruling No. DA-ITAD-121-04 dated November 3, 2004) On VAT The value-added tax (VAT) on the fees paid to SKM Malaysia for services performed in the Philippines shall be governed by Section 108 of the Tax Code of 1997, as amended. It 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%) 3 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%), after any of the following conditions has been satisfied: xxx xxx xxx The phrase 'sale or exchange of services' means the performance of all kinds of services in the Philippines for others for a fee, . . ." (Emphasis supplied) With regard to the procedure for withholding and paying the VAT, SKM Philippines, being the resident withholding agent and payor in control of payment shall be responsible for the withholding of the final VAT on such fees before making any payment to SKM Malaysia. In remitting the VAT withheld, SKM Malaysia shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax & Other Percentage Taxes Withheld). The duly filed BIR Form No. 1600 and the proof of payment thereof shall serve as documentary substantiation for the claim of input tax to be applied against the output tax that may be due from SKM Philippines if it is VAT-registered. In case SKM Philippines is not VAT-registered, the passed-on VAT withheld shall form part of the cost of the service purchased and may treat such VAT as an "expense" or as an "asset", whichever is applicable. In addition, SKM Philippines is required to issue a Certificate of Final Tax Withheld at Source (BIR Form No. 2306) in quadruplicate, the first three copies for SKM Malaysia and the fourth copy for SKM Philippines. (Sections 4 & 6, Revenue Regulations (RR) No. 4-2002; Section 3 of RR 8-2002; Section 7 of RR 14-2002) This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it will be disclosed that the actual facts are different, then this ruling shall be without force and effect insofar as the herein parties are concerned. cDCaHA Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes 1. Sale/s is defined as invoiced sales duly paid by the client(s) of SKM Philippines. Client(s) comprised Pilipinas Shell Petroleum Corporation. 2. TITLE II TAX ON INCOME. 3. The VAT rate was increased to 12% on 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.