ITAD BIR Ruling No. 108-16

June 22, 2016 ITAD BIR RULING NO. 108-16 Articles 5 and 7, Philippines-Japan tax treaty, as amended 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 June 24, 2010 requesting confirmation that service fees paid by Sumisetsu Philippines, Inc. ("Sumisetsu Philippines") to Sumitomo Densetsu Company Ltd. ("Sumitomo Densetsu") 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 , as amended by a protocol ("Philippines-Japan tax treaty") . 1 Facts Sumitomo Densetsu is a foreign corporation and a resident of Japan based on its amended Articles of Incorporation and Residence Certificate issued by the Nishi Tax Office in Japan on January 7, 2010. Sumitomo Densetsu is located at 12-15, Mita-3-chome, Minato-ku, Tokyo, Japan. Based on the Certificate of Corporate Filing/Information issued by the Securities and Exchange Commission on February 9, 2010, Sumitomo Densetsu was registered previously with the Commission, but its license has been withdrawn already on April 23, 2003. 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 January 4, 2010, Sumisetsu Philippines and Sumitomo Densetsu entered into a Technical Assistance Agreement where Sumitomo Densetsu agreed to provide services to Sumisetsu Philippines in connection with the electrical works on the Ibiden project. For this purpose, Sumitomo Densetsu will send Mr. Hiroyuki Tainaka , a senior electrical engineer, who will be in the country from January 8 to April 30, 2010. In consideration, Sumisetsu Philippines will pay service fees to Sumitomo Densets mounting 1,015,500.00 a month or 33,850.00 a day. Based on the Certification issued by Sumisetsu Philippines on April 6, 2011, Mr. Tainaka has been in the Philippines on the following dates: Personnel Taxable Year 2011 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Hiroyuki Tanaka 8-31 1-28 1-31 1-6, 10-30 - - - - - - - - Total 24 28 31 27 - - - - - - - - === === === === 110 days The service fees were remitted by Sumisetsu Philippines and Sumitomo Densetsu on several dates and by telegraphic transfer thru Bank of Tokyo-Mitsubishi UFJ Manila Branch, 2 to wit: CAIHTE Invoice Number Invoice Date Date of Payment Amount 09206 Jan. 29, 2010 Mar. 25, 2010 101,550.00 09206-1 Mar. 1, 2010 Mar. 25, 2010 1,110,000.00 09209 Mar. 31, 2010 Jun. 28, 2010 1,024,101.00 10200 Apr. 30, 2010 Sep. 29, 2010 1,021,052.00 10203 May 31, 2010 Sep. 29, 2010 651,331.00 Total 3,908,034.00 =========== Ruling In reply, please be informed that under Section 28 (B) (1) of the National Internal Revenue Code of 1997, as amended ("Tax Code") , profits derived by a foreign corporation not engaged in trade or business in the Philippines are subject to income tax at the rate of 30 percent: "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 profits are exempt or partially exempt to the extent required by any treaty obligation on the Philippines: "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 connection, paragraph 1, Article 7 of the Philippines-Japan tax treaty provides relief to profits derived by an enterprise resident of Japan from sources in the Philippines, to wit: "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, such profits may be taxed in the Philippines if attributable to a permanent establishment which the enterprise has therein; otherwise, the profits are exempt. Paragraphs 1, 2 and 6, 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; j) 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." DETACa 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. It also includes the furnishing of consultancy services by an enterprise (through employees or other personnel thereof), or supervisory services in connection with a contract for a building, construction or installation project, which continue for more than an aggregate of six months within any twelve-month period. Accordingly, since Sumitomo Densetsu 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 furnish services in the Philippines for more than an aggregate of six months within any twelve-month period, but for an aggregate of 110 days only in connection with the electrical works on the Ibiden project, Sumitomo Densetsu does not 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, service fees paid by Sumisetsu Philippines to Sumitomo Densetsu for such works are exempt from income tax under paragraph 1, Article 7 of the treaty. Furthermore, on the classification of the service fees as business profits (which are fully exempt from income tax if not attributable to a permanent establishment) rather than payments for know-how or royalties (which are partially exempt), 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 Technical Assistance Agreement did not call for Sumitomo Densetsu to supply existing information or reproduce existing material to Sumisetsu Philippines , but to provide actual services to the latter in connection with the electrical works on the Ibiden 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 Sumitomo Densetsu has sent a personnel to the Philippines to carry out the services which lasted for 110 days, Sumitomo Densetsu had incurred a greater level of expenditure ( e.g. , salary and other allowances of the personnel) in fulfilling its contractual obligations to Sumisetsu Philippines . This being the case, the service fees paid to Sumitomo Densetsu are clearly in the nature of business profits rather than royalties. aDSIHc Finally, under Sections 105 and 108 (A) of the Tax Code, the service fees are subject to value-added tax ("VAT"), 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, 3 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 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 Sumitomo Densetsu . 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 tax on the fees; otherwise, if it is not a VAT-registered taxpayer, Sumisetsu Philippines 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. 4 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. 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. 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 dated January 31, 2006. 4. 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, insirumentalities 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.