ITAD BIR Ruling No. 091-16

May 4, 2016 ITAD BIR RULING NO. 091-16 Articles 5 (Permanent Establishment) and 7 (Business Profits), Philippines-Australia tax treaty Team Sual Corporation CTC Building 2232 Roxas Boulevard Pasay City Attention: Ms. Taryn F. Uberita Tax Manager Gentlemen : This refers to your tax treaty relief application ("TTRA") filed on October 20, 2011 requesting confirmation that service fees paid by Team Sual Corporation ("Team Sual") to Howden Australia Pty. Ltd. ("Howden") 1 are exempt from income tax pursuant to the Agreement between the Government of the Republic of the Philippines and the Government of Australia for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income ("Philippines-Australia tax treaty"). Facts Howden is a foreign corporation and a resident of Australia based on its amended Memorandum of Association, amended Certificate of Registration, and Certificate of Residency issued by the Australian Taxation Office on September 1, 2010. Howden is located at Unit 23, 38-46 South Street, Rydalmere, New South Wales, Australia. Howden 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 June 10, 2011. On the other hand, Team Sual is a domestic corporation with its main office and power plant respectively located at CTC Building, 2232 Roxas Boulevard, Pasay City, and at Pangascasan, Sual, Pangasinan, Philippines. On August 25, 2010, Team Sual (through Team Energy Corporation ) 2 entered into a Contract with Howden offering the latter to provide a suitably qualified and experienced Specialist Engineer, local labor and tools for the inspection and overhauling of Unit 2 air Preheater A and B at Team Sual's power plant. The Specialist Engineer shall perform a complete inspection and repair of the unit, main support bearing inspection and repair, rectifying defects, supervision, mobilization and demobilization. The duration of the work will be for a period of 50 days (or earlier) and from September 10 to November 10, 2010 (or from any agreed date). On August 25, 2010, Howden issued a response letter to Team Sual accepting such proposal. Pursuant to the Contract, Howden sent a Specialist Engineer who worked at the site for a period at least eight hours a day and six days a week. The service fee for such period of 59 days, viz. : Name Nationality Inclusive Dates Mr. James P. Turnbull British Sep. 9-Nov. 6, 2010 Total 59 days In consideration of Howden's services, it was a service fees on October 27, 2011 in the amount of Aus$141,278.63. Details of this payment is as follows: Date of Amount Remitting Bank Reference Receiving Bank Remittance Number Oct. 27, 2011 Aus$141,278.63 Mizuho Corporate OTT749697397 HSBC Bank Bank Ltd. Manila Australia Pty. Ltd. 4 Branch 3 Ruling In reply, please be informed that under Section 42 (A) (3) of the National Internal Revenue Code of 1997 ("Tax Code"), as amended, payments for services are considered derived within the Philippines if the services are performed therein, to wit: "SEC. 42. Income from Sources within the Philippines. (A) Gross Income from Sources within the Philippines. The following items of gross income shall be treated as gross income from sources within the Philippines: xxx xxx xxx (3) Services. Compensation for labor or personal services performed in the Philippines;" Moreover, payments for services derived in the Philippines and made to a foreign corporation not engaged in trade or business in the Philippines are 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: n Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)." Relative thereto, Article 7 of the Philippines-Australia tax treaty provide relief on business profits as follows: "Article 7 Business Profits 1. The profits of an enterprise of one of the Contracting States 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 of them as is attributable to a) that permanent establishment, or" Under Article 7, profits derived by Howden from sources in the Philippines may be taxed in the Philippines if the profits are attributable to a permanent establishment situated therein. Article 5 defines permanent establishment as follows: "Article 5 Permanent Establishment 1. For the purposes of this Agreement, the term 'permanent establishment' means a fixed place of business through which the business of an enterprise is wholly or partly carried on. EcTCAD 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, oil or gas well, quarry or other place of extraction of natural resources; g) an agricultural, pastoral or forestry property; h) a building site or construction, installation or assembly project, or supervisory activities in connection therewith where such site, project or activity continues for more than six months; i) premises used as a sales outlet; j) a warehouse, in relation to a person providing storage facilities for others; k) a place in one of the Contracting States through which an enterprise of the other Contracting State furnishes services, including consultancy services, for a period or periods aggregating more than six months in any taxable year or year of income, as the case may be, in relation to a particular project, or to any project connected therewith." 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 place of management, a branch, an office, a factory and a workshop. It includes also a place in the Philippines through which an enterprise of Australia furnishes services, including consultancy services, for a period or periods aggregating more than six months in any taxable year or year of income, as the case may be, in relation to a particular project, or to any project connected therewith. Accordingly, since Howden is not engaged in trade or business in the Philippines to which a fixed place of business like an office or a branch is necessary, and since it did not furnish services in the Philippines for more than six months in any taxable year, but for an aggregate of 59 days only, Howden is not deemed to have a permanent establishment in the Philippines, pursuant to paragraphs 1 and 2, Article 5 of the Philippines-Australia tax treaty. This being so, the service fees paid by Team Sual to Howden shall be exempt from income tax pursuant to paragraph 1, Article 7 of the treaty. On the characterization of the service fees as business profits (which are generally exempt from income tax if not attributable to a permanent establishment) rather than payments for know-how or royalties (which are generally subject to a 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: "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 agreement between Team Sual and Howden did not call for Howden to supply existing information or reproduce existing material to Team Sual, but for Howden to provide actual services to Team Sual by inspecting and overhauling the preheater unit at Team Sual's power plant, these documents are clearly contracts for the performance of services and not for the supply of know-how or other royalty-bearing property. Moreover, by reason that the services are rendered in the Philippines (for 59 days) by a designated personnel of Howden (Mr. James P. Turnbull), it is certain that Howden incurred a greater level of expenditure (such as salaries and other remuneration paid to this personnel) in fulfilling its contractual obligations to Team Sual. This being the case, the service fee paid by Team Sual to Howden constitute business profits rather than payments for know-how or royalties. However, the service fees paid to Howden (a nonresident foreign person) for such services are subject to value-added tax ("VAT"), pursuant to Section 108 (A) in relation to Section 105 of the Tax Code, 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, 5 raise the rate of value-added tax to twelve percent (12%). . ." "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. HSAcaE 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, Team Sual shall withhold VAT on the service fee at the rate of 12 percent before remitting it to Howden. Team Sual 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 Team Sual's claim of input VAT on the fees; otherwise, if it is not a VAT-registered taxpayer, Team Sual may treat the 'passed-on' VAT as an asset or expense, whichever is applicable. VAT withheld shall be remitted within 10 days following the end of the month the withholding was made. 6 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.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes 1. Originally, Vacu-Blast (Australia) Ltd.; then Vacu-Blast (Australia) Pty. Ltd.; then Howden Group Australia Pty. Ltd. 2. A domestic corporation located at CTC Building, 2232 Roxas Boulevard, Pasay City. 3. Located at 26th Floor, Citibank Tower, Valero corner Villar Streets, Salcedo Village, Makati City, Philippines. 4. Located at Exchange Centre, 28 Bridge Street, Sydney, Australia. 5. 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. 6. Pursuant to Section 4.112-2 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 corporation, individuals, estates and trust, whether large or non-large taxpayers, shall withhold twelve percent (12%) VAT, starting February 1, 2006, with respect to the following payments: xxx xxx xxx (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." n Note from the Publisher: Copied verbatim from the official document. The phrase "and (d) above" no longer appears in RA 9337, the law amending this provision.