ITAD BIR Ruling No. 114-16

June 27, 2016 ITAD BIR RULING NO. 114-16 Article 14 (Independent Personal Services), Philippines-Japan tax treaty, as amended Viovicente & Perez-Viovicente Law Offices Unit 810 One Corporate Center Julia Vargas corner Meralco Avenue Attention: Atty. Ernesto L. Viovicente Gentlemen : This refers to your tax treaty relief application (TTRA) dated December 29, 2011 requesting confirmation that the service fees derived by Hashimoto Yukio Design Studio, Inc. ("Hashimoto") and Taisei Corporation ("Taisei") , collectively referred to as Team Hashimoto , from All Green Holdings, Inc. ("All Green") 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 1 ("Philippines-Japan tax treaty") . It is represented that Hashimoto and Taisei are foreign corporations organized and existing under the laws of Japan with principal business addresses at 3-38-5 Jingu-mae, Shibuya-ku, Tokyo, Japan and 1-25-1, Nishi Shinjuku Shinjuku-ku, Tokyo, Japan, respectively, based on the Certifications issued by the District Director of Shibuya Tax Office on February 3, 2012; that Hashimoto and Taisei are not registered either as a corporation or partnership based on the Certification of Non-Registration of Company issued by the Securities and Exchange Commission on January 30, 2012; that on the other hand, All Green is a domestic corporation with principal address at KPMG Center 687 Ayala Avenue, Makati City. It is further represented that on October 26, 2011, an Agreement was entered into whereby Hashimoto and Taisei formed a Joint Venture for the purpose of preparing the conceptual, schematic and interior design for All Green's Project located in Bonifacio Global City for the design and construction of a mixed-use high-rise structure, with a total gross floor area of more or less 69,615.00 square meters; that for and in consideration of the said services, payment shall be made in Japanese Yen and fees shall be computed as follows: Phase Service Fee Initial Payment after fifteen days from the 10% of the Service Fee 35,500,000 TTRA Conceptual Design Stage 20% of the Service Fee 71,000,000 Schematic Design Stage 40% of the Service Fee 142,000,000 Design Development Stage 20% of the Service Fee 71,000,000 Construction Stage 10% of the Service Fee 35,500,000 Total of Service Fee excluding all taxes and duties under Philippine laws 355,000,000 that the initial payment of 10% design fee shall be made at least 15 days after the filing of the TTRA; that the design fee is the minimum payment under the Agreement and subsequent payments for services shall be based on the above schedule; that for payment of each phase except initial payment and construction stage, the 50% of the agreed amount shall be paid on commencement of each stage and the other 50% upon approval of deliverables of each stage; that for the payment at construction stage, 50% of the agreed amount shall be paid on commencement of the stage and the other 50% upon substantial completion of the stage; and that based on the Sworn Declaration of the Treasurer of All Green dated December 3, 2012, All Green has not made any payment to Hashimoto and/or Taisei under the Agreement . aDSIHc In reply, please be informed that under Section 28 (B) (1) of the National Internal Revenue Code of 1997 ("Tax Code") , as amended, the payments made to Team Hashimoto 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 Code, such payments may be exempt from income tax or subject to a reduced rate to the extent required by any treaty obligation on the Philippines, thus: "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." For this purpose, you invoke Article 14 (Independent Personal Services) of the Philippines-Japan tax treaty provides: "Article 14 1. Income derived by a resident of a Contracting State in respect of professional services or other activities of an independent character shall be taxable only in that Contracting State unless he has a fixed base regularly available to him in the other Contracting State for the purpose of performing his activities or he is present in that other Contracting State for a period or periods exceeding in the aggregate 120 days in the calendar year concerned. If he has such a fixed base or remains in that other Contracting State for the aforesaid period or periods, the income may be taxed in that other Contracting State but only so much of it as is attributable to that fixed base or is derived in that other Contracting State during the aforesaid period or periods. 2. The term 'professional services' includes, especially, independent scientific, literary, artistic, educational or teaching activities as well as the independent activities of physicians, lawyers, engineers, architects, dentists and accountants." ETHIDa The term "professional services" generally includes all personal services performed by an individual for his own account, whether as a sole proprietor or as a partner, where the individual receives the income and bears the risk of loss arising from the services. 2 Pursuant to Article 14, remuneration derived by Team Hashimoto , being a resident of Japan, from furnishing technical assistance to All Green may be taxed in the Philippines if (1) Team Hashimoto has a fixed base in the Philippines regularly available to Team Hashimoto for the purpose of performing its activities; or (2) Team Hashimoto is present in the Philippines for a period or periods exceeding in the aggregate 120 days in the calendar year involved. As regards the first criterion, Team Hashimoto may be considered to have a fixed base for the purpose of performing its activities if Team Hashimoto has permanently set up in the Philippines an office or a workplace that will be regularly available to Team Hashimoto to furnish technical assistance to persons resident in this country. 3 Accordingly, the profits of a corporation which is a resident of Japan are taxable only in Japan, unless the Japanese corporation carries on business in the Philippines through a permanent establishment situated therein. In the instant case, though Taisei has a Philippine branch, it has been represented that Taisei-Philippine branch has no participation whatsoever directly or indirectly, in the subject Agreement entered into by Team Hashimoto with All Green , and that the income derived by Team Hashimoto from the said Agreement is neither attributable to the branch nor paid or coursed through the latter since any payment is directly remitted to Team Hashimoto based on the Certification issued by the authorized representative in the Philippines of Taisei Corporation . In the case of Marubeni vs. CIR 4 it was 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 that the branch becomes 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 of 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." Hence, income derived by Team Hashimoto under the contract shall be considered as income of Team Hashimoto independently and not connected with Taisei-Philippine Branch. As regards the second criterion, the days counted for this purpose are all days of physical presence of personnel of Team Hashimoto in the Philippines which include: a partial day, the day of arrival, the day of departure, and all other days spent in the Philippines including Saturdays and Sundays, national holidays, holidays before, during, and after the activity, periods of training, strikes, lock-out and delays, days of sickness, and days attributable to death or sickness in the family. 5 In this case, the following schedule shows the estimated duration of service to be performed in the Philippines under the Agreement pursuant to the Amended Estimated Schedule of Service in the Philippines issued by Team Hashimoto notarized on March 27, 2012: Year 2010 2011 2012 2013 2014 Total Activity Conceptual Design Schematic Contract Supervision Number of Design/Design Days in the Development Philippines Total: 3 17 15 12 9 56 days Team Hashimoto Hence, the total estimated number of days, being 56 days only, or less than the threshold of 120 days, Team Hashimoto 's presence in the Philippines does not create a permanent establishment for purposes of the Philippines-Japan. On the characterization of the service fees as business profits and not 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. cSEDTC 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 sub-contractors for the performance of similar services. Accordingly, since the Agreement does not call for Team Hashimoto to supply existing information or reproduce existing material to All Green , but to actually provide design services and engineering and architectural review services to All Green in connection with the Project, this Agreement is clearly a contract for the performance of services and not for the supply of know-how or other royalty-bearing property. Moreover, by reason that the services are rendered on a continuing basis by designated personnel of Team Hashimoto , it is certain that a greater level of expenditure (such as salaries and wages of the personnel) is incurred by the latter to fulfil its contractual obligations to All Green . This being the case, the service fees paid therefor constitute business profits and not payments for know-how or royalties . And since the total estimated number of days of service to be performed in the Philippines being 56 days only, or less than the threshold of 120 days, Team Hashimoto 's presence in the Philippines does not create a permanent establishment for purposes of the Philippines-Japan. Thus, this Office is of the opinion and so holds that the payments under the Agreement are exempt from income tax pursuant to the Philippines-Japan tax treaty, as amended. Finally, with respect to value-added tax (VAT), Sections 105 and 108 of the Tax Code provide: SDAaTC " 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. xxx xxx xxx 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, 6 raise the rate of value-added tax to twelve percent (12%). . . The phrase 'sale or exchange of services' means the performance of all kinds of services in the Philippines for others for a fee, remuneration or consideration. . ." (underscoring supplied) In this case, the services rendered in the Philippines under the Agreement shall be subject to 12 percent VAT based on the foregoing provisions. As regards the procedures for withholding and paying the VAT, Sections 4 and 6 of Revenue Regulations 4-2000, Section 3 of Revenue Regulations 8-02, and Section 7 of Revenue Regulations 14-2002 altogether state that All Green , the resident withholding agent and payor in control of the salaries, shall be responsible for the withholding of the 12 percent VAT on such salaries before paying them to Team Hashimoto . In remitting the VAT withheld to the Bureau, All Green shall use BIR Form 1600 (Monthly Remittance Return of VAT and Other Percentage Taxes Withheld). If a VAT-registered taxpayer, All Green may use as documentary substantiation for its claim of input VAT the duly filed BIR Form 1600 and the proof of payment accompanying it. If not a VAT-registered taxpayer, All Green may include as part of the cost of the technical assistance furnished to it by Team Hashimoto , the VAT consequently shifted or passed on to it by Team Hashimoto and may treat such VAT either as expense or asset, whichever is applicable. In addition, upon Team Hashimoto 's request, All Green is required to issue in quadruplicate the relevant Certificate of Final Tax Withheld at Source (BIR Form 2306), the first, second and third copies to be kept by All Green and the fourth copy by Team Hashimoto . This ruling is issued on the basis of the facts as represented. However, if upon investigation it shall be disclosed that the 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. Income Tax Treaties of the United States, Peter H. Blessing, Copyright 1996, Chapter 13, Page 21. 3. Pages 31-34, Ibid. 4. G.R. No. 76573 dated September 14, 1989. 5. Model Tax Convention on Income and on Capital, OECD Committee on Fiscal Affairs, Copyright June 1996, Pages 171-172. 6. 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. 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.