ITAD BIR Ruling No. 098-13

April 8, 2013 ITAD BIR RULING NO. 098-13 Articles 5 (Permanent Establishment), 7 (Business Profits) and 23 (Non-Discrimination), Philippines-Malaysia tax treaty Ilao and Ilao Law Offices Unit 15-B, ACT Tower 135 Sen. Gil Puyat Avenue Makati City Attention: Atty. Gina V. Ilao Gentlemen : This refers to your tax treaty relief application ("TTRA") filed on August 26, 2011 requesting confirmation that service fees paid by UEM-Mara Philippines Corporation ("UEM-Mara Philippines") to RTS Technology Sdn. Bhd. ("RTS Technology") (formerly Redflex Transportation Systems (M) Sdn. Bhd.) are exempt from income tax pursuant to 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 ("Philippine-Malaysia tax treaty"). Facts RTS Technology is a foreign corporation and a resident of Malaysia based on its Memorandum and Articles of Association and on the Certificate of Residence issued by the Inland Revenue Board of Malaysia on July 14, 2011. RTS Technology is located at 11-5-2 Cheras Business Centre, Jalan 4/101C, Batu 5 Jala Cheras, Kuala Lumpur, Malaysia. RTS Technology 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 January 25, 2011. On the other hand, UEM-Mara Philippines is a domestic corporation located at 1st Floor, Corporate Business Centre, 151 Paseo de Roxas, Legaspi Village, Makati City, Philippines. On October 14, 2008, UEM-Mara Philippines and RTS Technology entered into (1) a Contract for the On-Shore Supply of Services Manila-Cavite Toll Expressway R1 Extension Manual Toll Collection System and (2) a Contract for the Off-Shore Supply of Products and Services Manila-Cavite Toll Expressway R1 Extension Manual Toll Collection System where RTS Technology agreed to provide products and services to UEM-Mara Philippines relating to its Manual Toll Collection System ("MTCS") at its toll plazas in the Manila-Cavite Expressway R1 Extension. MTCS is a cash collection system which does not use the Electronic Toll Collection System (the use of electronic cards and electronic passes) and which can co-exist with the later system provided the proper devices are installed at the toll plazas. In consideration for the On-Shore Supply of Services Agreement, UEM-Mara Philippines will pay RTS Technology the sum of $166,474.00, broken down as follows: (a) preliminary cost (insurance, office and storage facilities, security, project management, freight, etc.): $33,531.00; (b) toll plaza equipment installation cost (lane processors, toll collector terminal, magnetic card reader, lone civil works, toll plaza equipment, power supply, cabling, lightning surge protection, closed-circuit televisions, etc.): $102,107.00; and (c) training cost (operational training for equipment installed, training of maintenance staff): $30,836.00. aHICDc In consideration for the Off-Shore Supply of Products and Services Agreement, UEM-Mara Philippines will pay RTS Technology the sum of $1,253,526.00, broken down as follows: (a) preliminary cost (insurance, office and storage facilities, security, project management, freight, etc.): $103,705.00; (b) provisional sum (prototype inspection at place of manufacturer, additional works due to site constraints and additional operation requirements, local agencies and authorities fee for the purpose of liaison, application, approval, clearance, etc.): $13,334.00; (c) Application System Design and Software Development (preparation and approval of Final Functional Specification, development, installation and configuration of System Software, pre-installation of System and Application Software): $158,665.00; (d) toll plaza equipment installation cost (lane processors, toll collector terminal, magnetic card reader, lone civil works, toll plaza equipment, power supply, cabling, lightning surge protection, closed-circuit televisions, etc.): $920,987.00; (e) system documentation cost (functional specification, design documentation, construction drawings, user and maintenance documentation, as-built drawings, training manuals): $22,647.00; and (f) spares, test equipment and consumables (recommended holding of spare components, special tools and test equipment, consumables): $34,188.00. The amounts under the two Agreements will be paid as follows: a) 30 percent downpayment upon signing of the Agreement; b) 20 percent upon factory acceptance of the equipment; c) 20 percent upon delivery of the equipment and the provision services; d) 20 percent upon installation of the equipment and site acceptance tests; and e) 10 percent after six months of installation and site acceptance. Each interim payment is due within one month after receipt of a statement of billing from RTS Technology. Both Agreements took effect on October 14, 2008 and will remain in effect up to the completion of the project. CADSHI Based on the Certification issued by UEM-Mara Philippines on August 23, 2011, RTS Technology sent its personnel (Tan Wee yo, Mohd Salleh Bin Md Yusoff, Ahmad Fakhruddin Bin Yusoff, Wong Set Leng) to the Philippines in 2010 and 2011 to perform services to UEM-Mara Philippines under the Agreements, for an aggregate period of 45 days. Ruling In reply, please be informed that payments made to RTS Technology under the Agreements are subject to relief, that is, exempt from income tax, if these payments are not attributable to a permanent establishment which it has in the Philippines, under paragraph 1, Article 7 of the Philippines-Malaysia tax treaty, to wit: "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." In relation to a permanent establishment, paragraphs 1, 2 and 4, Article 5 of the treaty define it as follows: "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; SETaHC 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. xxx xxx xxx 4. An enterprise of a Contracting State shall be deemed to have a permanent establishment in the other Contracting State if: a) it carries on supervisory activities in that other State for more than 6 months in connection with a construction, installation or assembly project which is being undertaken in that other State; or b) substantial equipment is in that other State being used or installed by, for or under contract with, the enterprise." 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. A permanent establishment includes the furnishing of supervisory activities for more than six months in connection with a construction, installation or assembly project which is being undertaken in a Contracting State, and the use or installation of substantial equipment in that State by, for, or under a contract with, an enterprise of the other Contracting State. IEHTaA Accordingly, since RTS Technology had installed substantial equipment in the Philippines to implement the Manual Toll Collection System of the toll plazas operated by UEM-Mara Philippines in the Manila-Cavite Expressway R1 Extension, RTS Technology is deemed to have a permanent establishment under paragraph 4 (b), Article 5 of the Philippines-Malaysia tax treaty. This being the case, all payments made by UEM-Mara Philippines to RTS Technology under the two Agreements shall be subject to income tax in the Philippines, under paragraph 1, Article 7 of the treaty. Moreover, under paragraph 3, Article 7, and paragraph 2, Article 23, of the Philippines-Malaysia tax treaty, RTS Technology, by reason of having a permanent establishment, shall be allowed to deduct executive and general administrative expenses from all amounts it receives from UEM-Mara Philippines, and, as a foreign enterprise, it shall not be treated less favorably than domestic enterprises carrying on the same activities in the Philippines, to wit: "Article 7 Business Profits xxx xxx xxx 3. In determining the profits of a permanent establishment, there shall be allowed as deductions all expenses including executive and general administrative expenses, which would be deductible if the permanent establishment were an independent enterprise, insofar as they are reasonably allocable to the permanent establishment, whether incurred in the State in which the permanent establishment is situated or elsewhere." "Article 23 Non-Discrimination xxx xxx xxx 2. The taxation on a permanent establishment which an enterprise of a Contracting State has in the other Contracting State shall not be less favourably levied in that State than the taxation levied on enterprises of that other State carrying on the same activities." ECDaTI This being the case, RTS Technology shall, for purposes of income taxation, be treated as a foreign corporation engaged in trade or business in the Philippines under Section 28 (B) (1) of the National Internal Revenue Code of 1997 ("Tax Code") , to wit: "SEC. 28. Rates of Income Tax on Foreign Corporations. (A) Tax on Resident Foreign Corporation. (1) In General. Except as otherwise provided in this Code, a foreign corporation organized, authorized, or existing under the laws of any foreign country, engaged in trade or business within the Philippines, shall be subject to an income tax equivalent to thirty-five percent (35%) of the taxable income 1 derived in the preceding taxable year from all sources within the Philippines: Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)." Finally, under Section 108 (A) of the Tax Code, the amounts payable to RTS Technology, being payments for the supply of services in the Philippines, are subject to value-added tax ("VAT"), thus: "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, 2 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. AICEDc 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, UEM-Mara Philippines shall withhold VAT on the payments at the rate of 12 percent before remitting them to RTS Technology . UEM-Mara 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 UEM-Mara Philippines ' claim of input tax on the payments; 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. 3 Please be guided accordingly. Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes 1. "SEC. 31. Taxable Income Defined. The term 'taxable income' means the pertinent items of gross income specified in this Code, less the deductions and/or personal and additional exemptions, if any, authorized for such types of income by this Code or other special laws." 2. 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. 3. 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."