Sycip Gorres Velayo and Co.

October 23, 2018 ITAD BIR RULING NO. 106-18 Articles 5 (Permanent Establishment), 7 (Business Profits) and 15 (Dependent Personal Services) Philippines- China tax treaty Sycip Gorres Velayo and Co. 6760 Ayala Avenue 1226 Makati City Attention: AAA _______________ Gentlemen : This refers to your tax treaty relief application filed on April 27, 2012 requesting confirmation that service fees paid by Philippine Associated Smelting and Refining Corporation ("PASAR") to China Nerin Engineering Company Ltd. ("China Nerin") and remuneration paid by China Nerin to its employees are exempt from income tax pursuant to the Agreement between the Government of the Republic of the Philippines and the Government of the People's Republic of China for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income ("Philippines-China tax treaty") . HTcADC FACTS China Nerin is a foreign corporation organized and existing under the laws of China and a resident thereof based on its amended Articles of Association and the Business License issued by the Administration for Industry and Commerce of Jiangxi in China and the Certificates of Tax Registration issued by the Local Taxation Bureau of Nanchang in China. China Nerin is engaged in engineering design, consultation, general contracting and construction supervision. China Nerin is not registered as a corporation or partnership in the Philippines based on the Certification of Non-Registration issued by the Securities and Exchange Commission. On the other hand, PASAR is a domestic corporation registered with the Philippine Economic Zone Authority ("PEZA") . Based on certification issued by PEZA in 2011, PASAR is registered originally with the then Export Processing Zone Authority ("EPZA") on September 23, 1982. EPZA was succeeded by PEZA under Republic Act No. 7916. 1 PASAR 's production plant is located in Leyte Industrial Development Estate in Isabel, Leyte, Philippines. The registered activities of PASAR are as follows: 1. Manufacture of copper cathodes, gold in dore, silver in dore, selenium blister copper (containing copper, gold and silver) and sulfuric acid; 2. Increase in the production capacity of its original activity [ i.e. , the manufacture of copper cathodes (main product), gold in dore, selenium blister copper and sulfuric acid and other by-products (expansion project with base figure)]; 3. Production of bismuth bisulfate using molecular recognition technology; 4. Additional by-products: copper anode, selenium powder granulated slag, electrostatic precipitator dust, magnetite concentrate, palladium, platinum, gypsum, antimonial lead and decopperized gold and silver slime and copper telluride; 5. Blending of different materials to produce metallurgical products (amendment); 6. Replacement of tankhouse's precast concrete cells with polymer cells to improve product quality and operating efficiency in manufacturing 99.99% copper cathodes (expansion); and 7. Production of by-product 'Trof slag.' On April 9, 2012, PASAR and China Nerin entered into a Contract where China Nerin agreed to provide services to PASAR in connection with the installation, testing and commissioning of a 240,000 Nm3/hr 2 wet electrostatic precipitator equipment at PASAR 's production plant in Leyte. Electrostatic precipitators are used to separate small particles (pollutants) from gas streams. In wet electrostatic precipitators, charged particles are collected onto the collectors. As particles accumulate on the collector, a liquid, typically water, runs down the plates and collects and removes the particles from the plates. 3 China Nerin will provide the following services in the Philippines: 1. Mobilization and demobilization of employees, tools and equipment at the site; 2. Installation works; 3. Electrical and instrumentation works; 4. No-load test and pre-commissioning procedures; 5. Testing and commissioning supervision; 6. Training of operating maintenance employees; and 7. Site cleanup during performance and after completion of works. The project cost is $__________ payable in installment: 25% within three working days after filing the relevant tax treaty relief application with the Bureau of Internal Revenue, and 75% within thirty working days after signing of the contract. On May 18, 2012, PASAR and China Nerin entered into a Supplemental Contract where PASAR again engaged the services of China Nerin to install an additional 80,000 NM3/hr wet electrostatic precipitator equipment at PASAR 's production plant. The project cost is $__________. The Supplemental Contract is governed by the same terms and conditions of the original contract. aScITE Based on certifications issued by PASAR , all works pursuant to the original and supplemental contracts, including training of PASAR 's operating maintenance employees and site cleanup, were carried out by China Nerin 's employees on May 2 to September 9, 2012, for a total of 131 days. Those employees and their length of stay in the Philippines were as follows: May 2012 June 2012 July 2012 August 2012 September 2012 Total number of days of individual BBB 12-31 1-30 1-31 1-31 1-9 121 CCC 12-31 1-30 1-31 1-31 1-9 121 DDD 29-31 1-30 1-31 1-31 1-9 104 EEE 2-31 1-30 1-31 1-31 1-9 131 FFF 29-31 1-30 1-31 1-31 1-9 104 GGG 12-31 1-30 1-31 1-31 1-9 121 HHH 2-31 1-30 1-31 1-31 1-9 131 III 2-31 1-30 1-31 1-31 1-9 131 JJJ 2-31 1-30 1-31 1-31 1-9 131 KKK 12-31 1-30 1-31 1-31 1-9 121 LLL 12-31 1-30 1-31 1-31 1-9 121 MMM 29-31 1-30 1-31 1-31 1-9 104 NNN 12-31 1-30 1-31 1-31 1-9 121 OOO 12-31 1-30 1-31 1-31 1-9 121 PPP 29-31 1-30 1-31 1-31 1-9 104 QQQ 12-31 1-30 1-31 1-31 1-9 121 RRR - 25-30 1-31 1-31 1-9 77 SSS 2-31 1-30 1-31 1-31 1-9 131 TTT 2-31 1-30 1-31 1-31 1-9 131 UUU 12-31 1-30 1-31 1-31 1-9 121 VVV 12-31 1-30 1-31 1-31 1-9 121 WWW 2-31 1-30 1-31 1-31 1-9 131 XXX 29-31 1-30 1-31 1-31 1-9 104 YYY 12-31 1-30 1-31 1-31 1-9 121 ZZZ 12-31 1-30 1-31 1-31 1-9 121 AAAA 12-31 1-30 1-31 1-31 1-9 121 BBBB - 25-30 1-31 1-31 1-9 77 CCCC - 25-30 1-31 1-31 1-9 77 DDDD 2-31 1-30 1-31 1-31 1-9 131 EEEE - 25-30 1-31 1-31 1-9 77 FFFF 29-31 1-30 1-31 1-31 1-9 104 GGGG 12-31 1-30 1-31 1-31 1-9 121 HHHH 29-31 1-30 1-31 1-31 1-9 104 IIII 12-31 1-30 1-31 1-31 1-9 121 JJJJ - 25-30 1-31 1-31 1-9 77 KKKK 12-31 1-30 1-31 1-31 1-9 121 LLLL 12-31 1-30 1-31 1-31 1-9 121 Based on the Certificates of Project Completion and Acceptance issued by PASAR, China Nerin completed the installation of the first equipment on May 15, 2012 and the second equipment on August 6, 2012. Based on bank certifications, PASAR remitted partial payments to China Nerin on May 8, 2012 ($__________) and August 8, 2012 ($__________). Based on a sworn statement issued by PASAR , the income subject of this ruling is not under investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceeding, or judicial appeal. RULING In reply, please be informed that under Section 28 (B) (1) of the National Internal Revenue Code of 1997 ("Tax Code") , as amended, income derived by a foreign corporation not engaged in trade or business is subject to income tax at the rate of 30%, 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 income is exempt to the extent required by any treaty obligation on the Philippine government, 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 7 of the Philippines-China tax treaty provides: " 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 of them as is attributable to that permanent establishment." aDSIHc Under Article 7, income derived by an enterprise of a Contracting State in the other Contracting State may be taxed in the other State if it carries on business in that State through a permanent establishment situated therein. The term permanent establishment is defined in paragraphs 1, 2 and 3, Article 5 of the tax treaty below: " 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. 2. The term 'permanent establishment' includes especially: a) a place of management; b) a branch; c) an office; d) a factory; e) a workshop; and f) a mine, an oil or gas well, a quarry or any other place of extraction of natural resources. 3. The term 'permanent establishment' likewise encompasses: a) a building site, a construction, assembly or installation project or supervisory activities in connection therewith, but only where such site, project or activities continue for a period of more than 6 months." Under Article 5, a permanent establishment means a fixed place 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 building site, a construction, assembly or installation project, or supervisory activities in connection therewith, which are for more than six months. In determining the duration of a site, which applies to building site, construction, assembly, or installation project, the relevant commentaries of the Organisation for Economic Co-operation and Development Model Tax Convention on Income and on Capital (July 15, 2014) mention that a site continues to exist until the work is completed or permanently abandoned, thus: "19. A site exists from the date on which the contractor begins his work, including any preparatory work, in the country where the construction is to be established, e.g., if he installs a planning office for the construction. In general, it continues to exist until the work is completed or permanently abandoned . . ." (Page 102) (Emphasis ours) Accordingly, since China Nerin is not engaged in trade or business in the Philippines, and it does not have a branch, an office, or other fixed place of business in the Philippines, and it has completed the installation projects for 131 days only, which did not exceed six months or 180 days, China Nerin is not deemed to have a permanent establishment under paragraphs 1, 2 and 3, Article 5 of the Philippines-China tax treaty. This being so, service fees paid by PASAR to China Nerin for the installation, testing and commissioning of the two wet electrostatic precipitator equipment at PASAR 's production plant in Leyte are exempt from income tax pursuant to paragraph 1, Article 7 of the treaty. With regard to remuneration of China Nerin 's employees, the taxation of this income is governed by Article 15 of the Philippines-China tax treaty, to wit: " Article 15 DEPENDENT PERSONAL SERVICES 1. Subject to the provisions of Articles 16, 18, 19, 20 and 21, salaries, wages and other similar remuneration derived by a resident of a Contracting State in respect of an employment shall be taxable only in that State unless the employment is exercised in the other Contracting State. If the employment is so exercised, such remuneration as is derived therefrom may be taxed in that other State. 2. Notwithstanding the provisions of paragraph 1, remuneration derived by a resident of a Contracting State in respect of an employment exercised in the other Contracting State shall be taxable only in the first-mentioned State if: a) the recipient is present in the other State for a period or periods not exceeding in the aggregate 183 days in the calendar year concerned; and b) the remuneration is paid by, or on behalf of, an employer who is not a resident of the other State; and c) the remuneration is not borne by a permanent establishment or a fixed base which the employer has in the other State." Under Article 15, remuneration derived by a resident of a Contracting State in respect of employment exercised in the other Contracting State shall be taxable only in the first-mentioned State if (a) the recipient is present in the other State for a period or periods not exceeding in the aggregate 183 days in the calendar year concerned; (b) the remuneration is paid by, or on behalf of, an employer who is not a resident of the other State; and (c) the remuneration is not borne by a permanent establishment or a fixed base which the employer has in the other State. Those conditions concurred with China Nerin 's employees. First, no employee stayed in the Philippines for more than 183 days; the longest period certain individuals stayed was 131 days only. Second, China Nerin , the employer, is not a resident of the Philippines but China. Third, the remuneration is not borne by a permanent establishment since China Nerin , as explained, does not have a permanent establishment in the Philippines. Accordingly, remuneration paid by China Nerin to its employees involved in the projects is exempt from income tax pursuant to Article 15 of the Philippines-China tax treaty. ETHIDa Finally, with respect to value-added tax ("VAT") , Section 108 (A) of the Tax Code provides that services rendered in the Philippines are subject to VAT at the rate of 12%, 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, raise the rate of value-added tax to twelve percent (12%). . ." However, since PASAR is a PEZA-registered enterprise and entitled to fiscal incentives under Republic Act No. 7916, the Supreme Court, in Commissioner of Internal Revenue vs. Seagate Technology (Philippines) (G.R. No. 153866 dated February 11, 2005), ruled that: " Applying the special laws we have earlier discussed, respondent as an entity is exempt from internal revenue laws and regulations. This exemption covers both direct and indirect taxes, stemming from the very nature of the VAT as a tax on consumption, for which the direct liability is imposed on one person but the indirect burden is passed on to another. Respondent, as an exempt entity, can neither be directly charged for the VAT on its sales nor indirectly made to bear, as added cost to such sales, the equivalent VAT on its purchases . Ubi lex non distinguit, nec nos distinguere debemus. Where the law does not distinguish, we ought not to distinguish . Moreover, the exemption is both express and pervasive for the following reasons: First, RA 7916 states that 'no taxes, local and national, shall be imposed on business establishments operating within the ecozone.' Since this law does not exclude the VAT from the prohibition, it is deemed included . Exceptio firmat regulam in casibus non exceptis. An exception confirms the rule in cases not excepted; that is, a thing not being excepted must be regarded as coming within the purview of the general rule . Moreover, even though the VAT is not imposed on the entity but on the transaction, it may still be passed on and, therefore, indirectly imposed on the same entity a patent circumvention of the law. That no VAT shall be imposed directly upon business establishments operating within the ecozone under RA 7916 also means that no VAT may be passed on and imposed indirectly . Quando aliquid prohibetur ex directo prohibetur et per obliquum. When anything is prohibited directly, it is also prohibited indirectly ." Applying the ruling to the instant case, since the installation of the two wet electrostatic precipitator equipment at PASAR 's production plant in Leyte is directly connected with PASAR 's performance of its registered activities (namely, producing copper cathodes, gold in dore, silver in dore, selenium blister copper, sulfuric acid, and other metallurgical products and by-products), where the equipment removes pollutants arising from the production of those products, PASAR cannot be imposed VAT on transactions related to its activities. Directly, PASAR cannot be treated as a regular VAT-registered taxpayer with respect to its registered activities, and indirectly, PASAR cannot be shifted or passed-on VAT on purchase of goods and services related to those activities. 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.) CAESAR R. DULAY Commissioner of Internal Revenue Footnotes 1. Entitled An Act Providing for the Legal Framework and Mechanism for the Creation, Operation, Administration, and Coordination of Special Economic Zones in the Philippines, Creating for this Purpose, the Philippine Economic Zone Authority (PEZA), and for Other Purposes , as amended. 2. Nm3/hr means normal cubic meter per hour . 3. Information came from University of Michigan College of Engineering at http://encyclopedia.che.engin.umich.edu/Pages/SeparationsMechanical/ElectrostaticPrecipitators/ElectrostaticPrecipitators.html . n Note from the Publisher: Copied verbatim from the official document.