ITAD BIR Ruling No. 094-16

May 16, 2016 ITAD BIR RULING NO. 094-16 Articles 5 (Permanent Establishment) and 8 (Business Profits), Philippines-United States tax treaty Sycip Gorres Velayo and Co. 6760 Ayala Avenue Makati City Attention: Atty. Ma. Fides A. Balili Principal, Tax Services Gentlemen : This refers to your tax treaty relief application filed on July 19, 2013 requesting confirmation that income payments to Sasaki Associates, Inc. ("Sasaki") (originally Sasaki, Walker and Associates, Inc. ; then Sasaki, Dawson, De May Associates, Inc. ) in consideration for services it rendered to Science Park of the Philippines, Inc. ("Science Park") and Pueblo De Oro Corporation ("Pueblo") are exempt from income tax pursuant to the Convention between the Government of the Republic of the Philippines and the Government of the United States of America with Respect to Taxes on Income ("Philippines-United States tax treaty"). Facts Sasaki is a foreign corporation and resident of the United States based on its amended Articles of Organization and Certificate of Residence Issued by the Internal Revenue Service on August 20, 2012. It is located at 64 Pleasant Street, Watertown, Massachusetts, United States. Sasaki is engaged in architecture, interior design, planning, urban design, landscape architecture, graphic design, and civil engineering, as well as financial planning and software development. It is founded by the late Hideo Sasaki in 1953, who was internationally respected as a landscape architect, planner, teacher, and mentor. The company 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 July 10, 2013. On the other hand, Science Park and Pueblo are domestic corporations with same principal office address at 17th Floor, Robinson's Summit Center, 6783 Ayala Avenue, Makati City, Philippines. Both are created to purchase, acquire, invest in or sell lands, buildings, improvements and any other real properties. On June 14, 2013, Science Park and Pueblo entered into a Contract for Master Planning Services with Sasaki for the creation of a cutting edge new industrial estate in the Light Industry and Science Park IV ( "LISP IV Project" or "project" ) at Malvar, Batangas, Philippines. Sasaki will create a plan for the project with efficient layout and contemporary landscape. The project ensures the right mix of program in its development and must create spaces that create a sense of activity and vibrancy to attract potential tenants, residents and visitors. Sasaki is drawn to the project not only because it is an interesting design challenge, but more importantly because of what it means for the future of these types of mixed program developments throughout the Philippines and the larger region. The project is divided into four phases with substantial deliverables in each phase, as follows: Phase Scope Key Deliverables Duration 1 Discovery and Site - Regional context plan, showing the science 3 weeks Analysis park in relation to urban centers, airports and from Worksession No. 1: other transportation and population hubs. notice to Philippines Also includes a thorough analyses of existing proceed Worksession No. 2: access, circulation, and transit connections to from the Online meeting the site. client - Transportation and circulation analysis, at a suitable scale, showing both regional and local conditions. - Ecological considerations diagrams, including watersheds, drainage, vegetation, and other environmental issues and attributes. 2 Strategic - Planning and design precedents, illustrating 2 weeks Programming and solutions for analogous planning concepts of from Initial Land Use Plan other successful industrial parks, innovation client's Worksession No. 3: districts, mixed-use centers, and new approval Online meeting communities from around the world. of Phase 1 - Recommended development program and diagrammatic charts illustrating site areas, gross floor areas, etc. - Site capacity study, at an appropriate scale, depicting the general organization of basic land uses and their strategic adjacencies to each other on the site based on the agreed upon development program. 3 Draft Master Plan - Draft Illustrative Master Plan, at 1:2,500 or 4 weeks Worksession No. 4: other suitable scale, showing layout of key from Philippines planning concepts, the overall landscape client's strategy, conceptual building footprints and approval massing, circulation networks, land uses, and of Phase 2 the open space program of the site. - Draft Land Use Plan, at 1:2,500 or other suitable scale, indicating use, area, density and development program. - Draft Landscape and Open Space Plan, at 1:2,500 or other suitable scale, depicting landscape program and amenities including parks, natural areas, and recreational spaces. 4 Final Master Plan - Final Illustrative Urban Design and 4 weeks Documentation and Landscape Plan, at 1:2,500 or other suitable from Visualization scale, showing layout of key planning client's Worksession No. 5: concepts, the overall landscape strategy, approval Philippines conceptual building footprints and massing, of Phase 3 circulation networks, land uses, and the open space program of the site. - Final Land Use Plan, at 1:2,500 or other suitable scale, indicating use, area, density and development program. - Final Landscape and Open Space Plan, at 1:2,500 or other suitable scale, depicting landscape program and amenities including parks, natural areas, and recreational spaces. Total 13 weeks ======= The project has a contract price of US$400,000.00 to include labor, materials, and expenses including travel expenses for persons going to the Philippines. Invoices will be prepared for each payment, including the initial payment. Payment is due within twenty business days after the invoice is rendered with the exception of the initial payment, which will be paid not later than thirty days from the issuance of the client's notice to proceed. TIADCc Based on a sworn statement issued by Science Park and Pueblo on February 26, 2014, Sasaki completed the project in thirteen weeks. A Certificate of Acceptance for this purpose was issued to Sasaki on February 26, 2014 by Science Park and Pueblo . Based on the same sworn statement, the following personnel of Sasaki were sent to the Philippines for the project: (1) Dennis Pieprz (Principal for Urban Design); (2) Michael Grove (Principal for Planning and Landscape Architecture); (3) Lachlan Hicks (Planner and Project Manager); (4) Anthony Fettes (Landscape Ecologist); and (5) Tao Zhang (Landscape Architect and Ecologist). Their length of stay in the country is tabulated below: The following amounts were remitted to Sasaki through bank transfer: Date Purpose Amount (in US Dollars) Aug. 5, 2013 Payments 1 and 2 as described in the Contract. 140,020.00 Aug. 16, 2013 Payment 3 as described in the Contract. 100,020.00 Sep. 2, 2013 Payment 4 as described in the Contract. 100,020.00 Jan. 7, 2014 Payment 5 as described in the Contract. 59,128.88 Total 399,188.88 Ruling In reply, please be informed that under Section 28 (B) (1) of the National Internal Revenue Code of 1997, as amended ("Tax Code") , income payments 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." In this regard, paragraph 1, Article 8 of the Philippines-United States tax treaty, provides relief to business or commercial profits derived by an enterprise of the United States from sources in the Philippines, to wit: "Article 8 Business Profits 1. Business profits of a resident of one of the Contracting States shall be taxable only in that State unless the resident has a permanent establishment in the other Contracting State. If the resident has a permanent establishment in that other Contracting State, tax may be imposed by that other Contracting State on the business profits of the resident but only on so much of them as are attributable to the permanent establishment." Under this article, such profits are subject to income tax in the Philippines if they are attributable to a permanent establishment which the enterprise has therein. Otherwise, the profits are exempt. In relation thereto, paragraphs 1 and 2, Article 5 of the treaty defines a permanent establishment as follows: "Article 5 Permanent Establishment 1. For the purposes of this Convention, the term 'permanent establishment' means a fixed place of business through which the business of the enterprise is wholly or partly carried on. 2. The term 'permanent establishment' shall include especially: a) a seat of management; b) a branch; AIDSTE c) an office; d) a store or other sales outlet; e) a factory; f) a workshop; g) a warehouse; h) a mine, quarry, or other place of extraction of natural resources; i) a building site or construction or assembly project or supervisory activities in connection therewith, where such site, project or activity continues for a period of 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, and includes especially, a seat of management, a branch, an office, a store or other sales outlet, a factory, and a workshop. In the case of the furnishing of services, a permanent establishment exists if this activity by a foreign enterprise (through employees or other personnel thereof) is carried out in a State for an aggregate period of more than 183 days. Accordingly, since Sasaki 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 it did not render services in the country for more than 183 days but for six days only to carry out the LISP IV Project, Sasaki is not deemed to have a permanent establishment under paragraphs 1 and 2, Article 5 of the Philippines-United States tax treaty. Therefore, payments made to Sasaki for the project are exempt from income tax under paragraph 1, Article 8 of the treaty. On the characterization of payments for services as business profits rather than payments for know-how or royalties , 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: "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 and as a general rule, 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 sub-contractors for the performance of similar services. Accordingly, since the Contract did not call for Sasaki to supply existing information or reproduce existing material to Science Park and Pueblo , but to provide actual services to Science Park and Pueblo by preparing the master plan of the LISP IV Project, the contract is one for the performance of services and not supply of know-how or other intangible property. Moreover, on account that Sasaki has employed personnel to make a thorough analysis of the project site and to prepare the appropriate illustrative master plan, land use, plan, and landscape and open space plan of the project, which activities were done mostly in the United States and a few in the Philippines, Sasaki had incurred substantial and recurring expenditures in fulfilling its contractual obligations or deliverables to Science Park and Pueblo . These expenditures include primarily the salaries and allowances of the personnel involved in the project. On the other hand, under Section 108 (A) of the Tax Code, payments to Sasaki for services rendered in the Philippines are subject to value-added tax ("VAT") , to wit: AaCTcI "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, 1 raise the rate of value-added tax to twelve percent (12%). . ." In paying VAT, Science Park (who had control of payments) shall withhold VAT on the payments at the rate of twelve percent before remitting them to Sasaki and, for this purpose, use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld). This duly filled-up form and accompanying proof of payment shall serve as documentary evidence for Science Park 's claim of input VAT on the payments; otherwise, if Science Park is not a VAT-registered taxpayer, it may treat the VAT as an asset or expense, whichever applicable. VAT withheld shall be remitted within ten days following the end of the month the withholding was made. 2 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. 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. 2. 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: (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." 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.