ITAD BIR Ruling No. 112-16

June 22, 2016 ITAD BIR RULING NO. 112-16 Articles 5 and 7, Philippines-Japan tax treaty, as amended Update Management and Research Center (UMRC), Inc. Unit 1904 Cityland Herrera Tower Rufino cor. Valero Streets, Salcedo Village 1227 Makati City Attention: Ms. Armi S. Linsangan Gentlemen : This refers to your tax treaty relief application filed on May 30, 2014 , requesting confirmation that service fees paid by ASIGA GREEN ENERGY CORPORATION ("AGEC") to CHODAI, CO., LTD. ("CHODAI") under the Service Agreement Regarding Support of Supervision of Construction 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") , as amended by a Protocol 1 effective January 1, 2009. It is represented that CHODAI is a corporation organized and existing under the laws of Japan and a resident thereof based on the Certificate of Residence issued by the Nihonbashi Tax Office in Japan on January 23, 2014. CHODAI is engaged into, among others, design and supervision of civil works, construction, machinery and electrical facilities as well as consulting services; activities connected with the study and design for town planning and regional planning; activities connected with environmental measurement, various surveying and soil/geological surveys; activities connected with data processing by computer, with research and development of software, and services offering information; sale and leasing of computer software and computer systems and production/sale of commodities related to soil/geological surveys and civil works; activities connected with medical and welfare services; research and development of soil/geological surveys, substructures and construction method; and design and construction implementation of disaster prevention work and construction work regarding ground disaster. CHODAI has Representative Office in the Philippines under the name of CHODAI CO., LTD. MANILA REPRESENTATIVE OFFICE as shown in the Certification of Non-Registration of Company issued by the Securities and Exchange Commission on March 10, 2014. On the other hand, AGEC is a domestic corporation organized and existing under the laws of the Philippines and is engage in the exploration, development, utilization, operation and maintenance of new and renewable energy resources; managing and maintaining bulk water reservoir and treatment plants; and all classes of construction and erosion works both public and private or integral part thereof. It is further represented that on October 11, 2012, CHODAI entered into a Service Agreement Regarding Support of Supervision of Construction ("Service Agreement") with AGEC , Equi-Parco Construction Company ("EPCC") , Twinpeak Hydro Resources Corporation ("THRC") , and Resources Management and Consultancy, Inc. ("HRMCI") , all of which corporations are duly organized and existing under the laws of the Philippines, regarding the exploration, development and utilization of the hydropower resources in Asiga, (referred to as "Asiga Project" ). Under said Service Agreement , CHODAI will study and analyze the supervision services of EPCC, THRC and HRMCI, and advise AGEC on the following: (1) Quality Control Method of construction and management of the power generation facility to maintain the quality of the facility and equipments, and amendment of such method in response to changes of various conditions. (2) Management of Construction Schedule a) Method of preparation and contents of the schedule of the construction plan; b) Method of effective management of progress by way of visualization, synchronizing and setting priorities with due consideration to various uncertainty. (3) Management of Safe Environment Method of management of safe environment of workers, facilities, buildings and equipments, and method of management of environment based upon the standards of the Environmental Compliance Certificate. (4) Management of Costs Method of management of proper allocation of manpower, and method to shorten work periods by way of prevention of delay and rationalization of construction technique. The foregoing Services include the preparation of reports, certificates, designs, notices, contracts and other documents related to the Services to be submitted by CHODAI to AGEC, in English language. It shall also provide any extra services as it may require and accepted by AGEC in excess of, but in connection with the Services. CHODAI shall be entitled to rely on the data, information and documents provided by AGEC, EPCC, THRC or HRMCI, and shall not be required to conduct any independent investigation to confirm the completeness or the accuracy thereof. CHODAI shall not bear any responsibility or liability whatsoever arising from the incompleteness or inaccuracies of the data, information or documents provided by AGEC, EPCC, THRC or HRMCI. The Service Agreement shall be in effect for the period of three (3) years. In consideration of the performance of the said Services, AGEC shall pay CHODAI PHP500,000.00 per month as stipulated in the Supplement to Service Agreement Construction Supervision dated March 12, 2013. Under the same Supplement, it is also stipulated that services that will be rendered in the Philippines shall not be for a period or periods aggregating more than six (6) months within any twelve (12) month period. Below is the summary of the onshore services performed by Mr. Suwa Seiji and Mr. Hikonari Maeda of CHODAI in the Philippines for the rendition of the support of supervision of construction from 2012 to 2014, as shown in the Gantt charts on an annual basis: Summary of the Duration of Stays in the Philippines in the Performance of the Onshore Services For the year 2012 Support of Supervision of Construction Task Month Oct-12 Nov-12 Dec-12 Period 18-31 10-17 1-19 5-30 6-26 13-19 "S" stands for Mr. Suwa Person "M" stands for Mr. Maeda in M S M S M S charge 1 Collecting and Organizing Off-sh Results of Existing Surveys On-sh 3 3 2 3 2 Checking Existing Construction Off-sh Supervision Plan On-sh 3 2 3 3 2 3 Site Investigation Off-sh 1 1 1 On-sh 4 Conference Off-sh 1 1 1 Name of Personnel Description of Services Year Month/s Total No. of Days Mr. Suwa Seiji and Mr. Hikonari Maeda 2012 1. Collecting and Organizing October 3 Results of Existing Surveys November 5 December 3 2. Checking Existing October 3 Construction Supervision Plan November 2 December 5 Total 21 === For the year 2013 Support of Supervision of Construction Name of Personnel Description of Services Year Month/s Total No. of Days Mr. Suwa Seiji and Mr. Hikonari Maeda 2013 1. Collecting and Organizing January 5 Results of Existing Surveys February 3 March 2 April 2 May 1 June 2 July 4 August 2 September 2 October 3 November 1 December 2 2. Checking Existing January 3 Construction Supervision Plan February 5 March 5 April 5 May 5 June 6 July 4 August 5 September 4 October 5 November 5 December 4 3. Advice for Improvement February 2 March 3 April 3 May 4 June 2 August 3 September 4 October 2 November 2 December 4 Total 114 === For the year 2014 Support of Supervision of Construction Name of Personnel Description of Services Year Month/s Total No. of Days Mr. Suwa Seiji and Mr. Hikonari Maeda 2014 1. Management of Safe May 3 Environment June 3 July 2 August 4 September 1 October 5 November 5 December 6 2. Management of Costs October 1 November 2 December 1 Total 107 === It is finally represented that the service fees subject of this ruling are not under investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings, or judicial appeal, based on the Sworn Statement issued by the President of AGEC on February 10, 2014. In reply, please be informed that generally, under Section 28 (B) (1) of the National Internal Revenue Code of 1997 ("Tax Code") , as amended, the service fees payable to nonresident foreign corporation 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 fees may be exempt from income tax or subject to a reduced rate 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 On the other hand, the taxation of service fees paid by AGEC to CHODAI would depend if CHODAI has a permanent establishment in the Philippines to which these fees are attributable, under paragraph 1, Article 7 of the Philippines-Japan tax treaty, 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." Based on paragraph 1, the profits of an enterprise of Japan shall be taxable only in Japan unless the enterprise carries on business in the Philippines through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the Philippines but only so much of them that is attributable to that permanent establishment. Relative thereto, under paragraphs 1, 2, 3 and 6, Article 5 of the same treaty, a permanent establishment is defined 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. 3. A building site or construction or installation project constitutes a permanent establishment only if it lasts more than six months. 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." Based on the foregoing paragraphs, CHODAI is deemed to have a permanent establishment if it has a fixed place of business in the Philippines through which its business is wholly or partly carried on, such as, a store or other sales outlet, a branch, an office, a factory, a workshop, and a warehouse, or if it undertakes activities relating to a mine, an oil or gas well, a quarry or other place of extraction of natural resources, or a building site or construction or installation which continues for more than six months, or if it furnishes consultancy services, or supervisory services in connection with a contract for a building, construction or installation project for a period or periods aggregating more than six months within any twelve-month period. A perusal of the records shows that CHODAI has a Representative Office here in the Philippines Chodai Co., Ltd. Manila Representative Office . A Representative Office promotes the products and/or services of the Company it represents, but cannot conclude contracts with local entities on behalf of its parent company. Its activities are limited to the promotion and dissemination of information about the Company's products and/or services. By the nature of the activities allowed of a Representative Office, it cannot derive income from the Philippines. The test of whether an office is a representative office or not, is whether it derives income from its operations. A representative office has no income from operations and, therefore, has no income tax liability. As to whether the service fees paid by AGEC to CHODAI is considered to have been made through a permanent establishment in the Philippines, the commentaries of the Organization for Economic Cooperation and Development ("OECD") Model Tax Convention on Income and on Capital 1 are relevant: ". . . the right to tax of the State where the permanent establishment is situated does not extend to profits that the enterprise may derive from that State but that are not attributable to the permanent establishment. This is a question on which there have historically been differences of view, a few countries having some time ago pursued a principle of general "force of attraction" according to which income such as other business profits, dividends, interest and royalties arising from sources in their territory was fully taxable by them if the beneficiary had a permanent establishment therein even though such income was clearly not attributable to that permanent establishment. Whilst some bilateral tax conventions include a limited anti-avoidance rule based on a restricted force of attraction approach that only applies to business profits derived from activities similar to those carried on by a permanent establishment, the general force of attraction approach described above has now been rejected in international tax treaty practice. The principle that is now generally accepted in double taxation conventions is based on the view that in taxing the profits that a foreign enterprise derives from a particular country, the tax authorities of that country should look at the separate sources of profit that the enterprise derives from their country and should apply to each permanent establishment test, subject to the possible application of other Articles of Convention. This solution allows simpler and more efficient tax administration and compliance, and is more closely adapted to the way in which business is commonly carried on. . . ." In the same context, the Supreme Court in the case of Marubeni Corporation vs. Commissioner of Internal Revenue and Court of Tax Appeals 2 held that: "The general rule that a foreign corporation is the same juridical entity as its branch office in the Philippines cannot apply here. This rule is based on the premise that the business of the foreign corporation is conducted through its branch office, following the principal-agent relationship theory. It is understood the branch become its agent here. So that when the foreign corporation transacts business in the Philippines independently of its branch, the principal-agent relationship is set aside. The transaction becomes one of the foreign corporation, not the branch. Consequently, the taxpayer is the foreign corporation, not the branch or the resident foreign corporation. Corollarily, if the business transaction is conducted through the branch office, the latter becomes the taxpayer, and not the foreign corporation." Therefore, based on the above rationalization, the income paid to the head office of a foreign corporation which has a Representative office in the Philippines shall not be subject to the preferential tax rate if the income is not effectively connected to the said Representative office. However, if the business transactions that created the income came from a separate and independent transaction from the Representative Office in the Philippines, then such income shall be subject to the preferential tax rate under the tax treaty. In the case at hand, it is represented that the rights and obligations of CHODAI arising from the service agreement in AGEC are solely for the account of CHODAI and are not in any way effectively connected with the business activity of Chodai Co., Ltd. Manila Representative Office . Therefore, applying the rules enunciated above, such service fees paid by AGEC to CHODAI cannot be considered as effectively connected with Chodai Co., Ltd. Manila Representative Office . Accordingly, since CHODAI did not provide the services in the Philippines for a period or periods aggregating more than six months within any twelve-month period, (in fact, CHODAI rendered onshore services in the Philippines for 21 days in 2012, 114 days in 2013 and 107 days in 2014), CHODAI is not deemed to have a permanent establishment with respect to such services. This being the case, the service fees to be paid by AGEC to CHODAI are exempt from income tax, pursuant to paragraph 1, Article 7, in relation to paragraphs 1, 2, 3 and 6, Article 5, of the Philippines-Japan tax treaty, as amended. However, under Section 108 (A) of the Tax Code, the service fees in question, 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. 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, AGEC shall withhold VAT on the payments at the rate of 12 percent before remitting them to CHODAI. AGEC shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld). If AGEC is a VAT-registered taxpayer, the duly filed BIR Form No. 1600 and its accompanying proof of payment shall serve as documentary substantiation for AGEC's claim of input tax on the payments; otherwise, it may treat such 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 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. 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: (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.