ITAD BIR Ruling No. 092-16

May 12, 2016 ITAD BIR RULING NO. 092-16 Articles 5 and 7, Philippines-Japan tax treaty Sumisetsu Philippines, Inc. 8th Floor, G.C. Corporate Plaza 150 Legaspi Street, Legaspi Village Makati City Attention: Atty. Marilou I. Ababa-Premediles Assistant Manager Finance Accounting Division Gentlemen : This refers to your tax treaty relief application filed on April 27, 2011 requesting confirmation that service fees paid by Sumisetsu Philippines, Inc. ("Sumisetsu Philippines") to Misuzu Erie Company Ltd. ("Misuzu Erie") are exempt from 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 Facts Misuzu Erie is a foreign corporation and a resident of Japan based on its amended Articles of Incorporation and Residence Certificate issued by the Yokkaichi Tax Office in Japan on August 18, 2010. Misuzu Erie is located at 3-8-13, Hinagahigashi, Yokkaichi, Mie, Japan. 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 August 11, 2010. On the other hand, Sumisetsu Philippines is a domestic corporation located at 8th Floor, G.C. Corporate Plaza, 150 Legaspi Street, Legaspi Village, Makati City, Philippines. On May 12, 2010, Sumisetsu Philippines (as main contractor in a project) and Misuzu Erie (as subcontractor in the project) entered into a Construction Basic Subcontract Agreement where Misuzu Erie agreed to carry out works in the project as requested by Sumisetsu Philippines . For this purpose, Sumisetsu Philippines shall issue the necessary purchase orders to Misuzu Erie , which the latter shall confirm. Misuzu Erie shall issue separate drawings, plans, or other specifications to the project. Misuzu Erie or its site representative shall, with regard to individual work, stay at the work site, handles all matters relating to the work site and accepts full responsibility. Upon completion of the individual work, Misuzu Erie shall give notice to Sumisetsu Philippines and the completion inspection and verification shall be conducted within twenty days from such notice with the presence of both parties. Mode of payment and period of payment of the contract price of the individual work shall be pursuant to the provisions of the purchase order and order confirmation. Misuzu Erie , after passing the inspection of individual work and passing it to Sumisetsu Philippines , may claim the payment of the contract price to Sumisetsu Philippines. To date, the following purchase orders were issued by Sumisetsu Philippines to Misuzu Erie in relation to certain works to be carried out by Misuzu Erie in the Philippines: Purchase Date of Nature of Service Fee Delivery Date Payment Order No. Purchase Work (in US Terms Order Dollars) 11-000105 Mar. 24, 2011 Electrical 2,800.00 Jan. 3-31, 2011 100 percent subcontractor billing upon works for the completion. modification of waster water I/L SO4 and SO5 11-000107 Mar. 23, 2011 Electrical 65,000.00 Jan. 3-31, 2011 100 percent subcontractor billing upon works for the completion. IPI- coordination panels of production machine 10-004466 Mar. 23, 2011 Electrical 8,300.00 Dec. 15-30, 100 percent subcontractor 2010 billing upon works for completion. ATS-MPC 1, 2 remote control 10-004465 Mar. 24, 2011 Electrical 52,000.00 Dec. 15-30, 100 percent subcontractor 2010 billing upon works for the completion. operation monitor for drill, laser area 10-001629 Mar. 23, 2011 Electrical 20,000.00 Jul. 1-31, 2010 100 percent subcontractor billing upon works for the completion. additional B- net system at substation D4 10-003957 Mar. 23, 2011 Electrical 132,000.00 Nov. 2- Dec. 100 percent subcontractor 30, 2010 billing upon works for the completion. remote central operation systems network organization Total 280,100.00 ========= Based on the Certifications issued by Sumisetsu Philippines on May 17 and April 19, 2013, and April 26, 2011, the works are connected with the Ibiden Control System project where Sumisetsu Philippines is a general contractor. Misuzu Erie has only sent one personnel, Mr. Takashi Kitagawa, to provide consultancy services and other related works to the project. His length of stay in the country is as follows: ETHIDa Personnel 2010 2011 Jul. Aug. Sep. Oct. Nov. Dec. Jan. Feb. Mar. Apr. May Jun. Takashi Kitagawa 10- 1-8 - - 9-11 3-31 1-31 1-19, 1-21 - - - 31 28 Total 22 8 - - 3 29 31 20 21 Grand Total 134 days Based on the Application for Foreign Remittance submitted by Sumisetsu Philippines to Bank of Tokyo-Mitsubishi UFJ Manila Branch 2 on May 20, 2011 and the Statement of Account issued by this bank on May 31, 2011, the service fees were remitted in lump sum by Sumisetsu Philippines to Misuzu Erie , to wit: Date of Amount Remitting Bank Reference Receiving Bank Remittance Number May 20, 2011 US$280,100.00 Bank of Tokyo- 69TTTS04276500 Bank of Tokyo- Mitsubishi UFJ Mitsubishi UFJ Manila Branch Yokkaichi 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, under Section 28 (B) (1) of the Tax Code, payments for services 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%). " However, under Section 32 (B) (5) of the Tax Code, such payments 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." Relative thereto, Article 7 of the Philippines-Japan tax treaty provides relief to service fees paid to Misuzu Erie , to wit: cSEDTC "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." Under Article 7, profits derived by an enterprise of Japan from sources in the Philippines may be taxed in the Philippines if such profits are attributable to a permanent establishment which the enterprise has therein; otherwise, such profits are exempt. In relation thereto, Article 5 of the 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. 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. 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." As defined, a permanent establishment means a fixed place 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 (paragraphs 1 and 2) . It includes also the furnishing of services in the Philippines by an enterprise of Japan, particularly, consultancy services, or supervisory services in connection with a contract for a building, construction or installation project, through employees or other personnel of that enterprise, provided 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 (paragraph 6) . Accordingly, since Misuzu Erie 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 since it did not furnish services in the Philippines in connection with a building, construction or installation project for a period or periods aggregating more than six months (180 days) within any twelve-month period, but for 134 days only , Misuzu Erie shall not be deemed to have a permanent establishment in the Philippines pursuant to paragraphs 1, 2 and 6, Article 5 of the Philippines-Japan tax treaty. This being the case, the service fees paid by Sumisetsu Philippines to Misuzu Erie in connection with electrical installation works performed by the latter for the Ibiden Control System project shall be exempt from income tax in the Philippines 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: SDAaTC 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 Construction Basic Subcontract Agreement did not call for Misuzu Erie to supply existing information or reproduce existing material to Sumisetsu Philippines , but for Misuzu Erie to provide actual services to Nidec Subic by providing consultancy services to Sumisetsu Philippines relating to electrical installation works carried out by Sumisetsu Philippines on the Ibiden Control System project, this agreement is clearly a contract for the performance of services rather than for the supply of know-how or other royalty-bearing property. Moreover, by reason that the services are rendered continuously in the Philippines by a single designated personnel of Misuzu Erie (Takashi Kitagawa), it is certain that a greater level of expenditure (such as salaries and other remuneration of this personnel) was incurred by Misuzu Erie to fulfil its contractual obligations to Sumisetsu Philippines . This being the case, the service fees paid by Sumisetsu Philippines to Misuzu Erie constitute business profits rather than payments for know-how or royalties . On the other hand, the services rendered in the Philippines by Misuzu Erie , a nonresident foreign person, are subject to value-added tax ("VAT") pursuant to Section 108 (A) of the Tax Code, as amended, 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, 4 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. 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, Sumisetsu Philippines shall withhold VAT on the service fees at the rate of 12 percent before remitting them to Misuzu Erie . Sumisetsu 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 Sumisetsu Philippines' claim of input VAT on the fees; otherwise, if it is not a VAT-registered taxpayer, it may treat the VAT as an asset or expense, whichever is applicable. VAT withheld shall be remitted within ten days following the end of the month the withholding was made. 5 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. acEHCD Very truly yours, (SGD.) KIM S. JACINTO-HENARES 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. 2. Located at 15th Floor, 6788 Ayala Avenue, Makati City, Philippines. 3. Located at 5-7 Suwa-cho, Yokkaichi City, Mie, Japan. 4. 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. 5. 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.