ITAD BIR Ruling No. 119-12

March 14, 2012 ITAD BIR RULING NO. 119-12 Articles 5 (Permanent Establishment) and 7 (Business Profits); Philippines-Israel tax treaty; BIR Ruling No. ITAD 85-11 Mendoza and Pangan Room 1105, Antel Corporate Center 121 Valero Street, Salcedo Village 1227 Makati City Attention: Ferdinand D. Tolentino Mikhail G. Romulo Gentlemen : This refers to your tax treaty relief application ("TTRA") filed on April 26, 2011 requesting confirmation that service fees paid by Globe Telecom, Inc. ("Globe") to Cvidya 2010 Ltd. ("Cvidya") (formerly, Ectel Ltd. ) are exempt from income tax pursuant to the Convention between the Government of the Republic of the Philippines and the Government of the State of Israel for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income ("Philippines-Israel tax treaty"). Facts Cvidya is a corporation organized and existing under the laws of Israel and is a resident thereof, based on its Articles of Incorporation and on the Certificate of Fiscal Residence issued by the Israel Tax Authority on January 12, 2011. Cvidya is situated at 3 Sapir Street, Ampa Building, Herzliya, Israel. Cvidya is not registered as a corporation or partnership in the Philippines based on the Certificate of Non-Registration of Company issued by the Securities and Exchange Commission on March 4, 2011. On the other hand, Globe is a domestic corporation situated at Globe Telecom Plaza, Pioneer corner Madison Street, Mandaluyong City, Philippines. On March 31, 2011, Cvidya and Globe entered into a General Services Engagement Agreement for the planning, design, development, testing, deployment, integration and full implementation of the Software Applications, for the delivery and installation of Cvidya 's Software, the Specified Equipment and for the provision of other related Services and Deliverables identified as Project Armor ("Project") for the exclusive use of Globe. Services means the delivery, installation, design, development, deployment, integration, acceptance testing, full implementation of the Project or other relevant supervisory services, installation, modifications, technical support, repair, training and other similar tasks, performed by Cvidya. Software Applications means the computer programs, modules, applications and coding, and their documentation, to be developed by Globe under the Project. Specified Equipment means Cvidya 's proprietary hardware items to be provided to Globe. Deliverables means all tangible items that are to be provided by Cvidya to Globe , including the Software Applications and their documentation, the Specified Equipment and other written reports, documents and results pertaining to the Services. Phase 1 of the Project calls for the creation by Cvidya of a Fraud Management System, which began on August 23, 2010 up to March 4, 2011. The services to be delivered on Data Source Coverage consist of the following: Usage Data Source Source System Voice GHP Prepaid Voice ENODE TM Prepaid Voice ENODE GHP Postpaid Voice HP OVCSU-MD Roaming TAP3 HP OVCSU-MD Roaming NRTRDE HP OVCSU-MD WAP/Internet/Browsing GPRS Postpaid EMM GPRS Prepaid EMM Roaming HUR HUR Reports Various partners SMS SMS Aggregate TDW/Messaggio M-Commerce G-Cash Transaction Utiba/OBAMA Topup/Reloads GHP Prepaid ENODE TM Prepaid ENODE PPAS TM Call Cards NSN IVR GHP Call Cards PNS PNS SAL RUDOLPH Gcash2load G-Cash Amax Autoload/Max Rewards Altair Toolbox Registration Platform New Frontier FUN2 Trigger IN Balance GHP Prepaid Balance NSN-IN Touch Mobile Balance Ericsson IN Wireless Customer Information GHP (Postpaid and CCB Prepaid Account Info) TM Account Info CCB-David G-Cash Wallet Info Utiba/OBAMA Phase 2 of the Project calls for the creation by Cvidya of a Wireline Voice and Wireline Data/Internet. The services to be delivered on Data Source Coverage consist of the following: Usage Data Source Source System Wireline PSTN (Voice) Connery, switch (legacy and NGN) Settlement Traffic Inopac NGN soft Switch ZTE SS or ICCBS or Inopac Broadband AAA Server WIMAX Wimax Wireline Customer Information Wireline ICCBS/Connery The contract price for Phase 1 of the Project is US$720,000.00. The contract price for Phase 2 of the Project is US$175,000.00. The contract price for maintenance and support services after the warranty period of the Project is US$431,200.00. The service fees are payable in installments, based on the amount of completion of work that Cvidya made on the Project. Globe will pay Cvidya within 30 days from receipt of the invoice. The Agreement commenced on August 23, 2010 up to March 31, 2012. cITaCS Based on the Certification of Duration of Service issued by the Chief Financial Officer of Globe on April 20, 2011, Cvidya performed the following services in the Philippines pursuant to the Agreement: Date Activity Number of Days September 13-15, 2010 Project Kick-off Meeting 3 days October 11-21, 2010 Data Gathering and 11 days Information December 6-17, 2010 Oracle installation and 12 days third party installation February 7-18, 2011 Training 12 days February 28-March 19, SAT/UAT/Fixes 20 days 2011 installation March 27-April 1, 2011 SAT/UAT/Fixes 6 days installation Total 64 days ===== These services were rendered by the following personnel of Cvidya: 1. Yuval Hirshel Harel 2. Yosef Dolgoy 3. Asaf Tsiklag 4. Ruslan Kit 5. Asen Demitrov 6. Sandra Monteiro 7. Atanas Petkov Ruling Relative thereto, please be informed that under Section 14 of Revenue Memorandum Order No. 72-2010 (Guidelines on the Processing Tax Treaty Relief Applications (TTRA) Pursuant to Existing Philippine Tax Treaties) ("RMO 72-2010"), effective November 4, 2010, and which covers income derived or accrued on that date and onwards, any availment of tax treaty relief (exemption from income tax or reduction of tax) shall be preceded by an application filed at the International Tax Affairs Division of this Bureau before the intended transaction or payment of income, to wit: "Filing should always be made BEFORE the transaction. Transaction for purposes of filing the TTRA shall mean before the occurrence of the first taxable event. Failure to properly file the TTRA with ITAD within the period prescribed herein shall have the effect of disqualifying the TTRA under this RMO." (Emphasis ours) Also, under Section III (2) of Revenue Memorandum Order No. 1-00 (Procedures for Processing Tax Treaty Relief Application) ("RMO 1-2000"), which covers income earned before November 4, 2010, any availment of tax treaty relief shall be preceded by an application filed at ITAD at least 15 days before the intended transaction or payment of income, thus: "III. Policies: In order to achieve the above-mentioned objectives, the following policies shall be observed: xxx xxx xxx 2. Any availment of the tax treaty relief shall be preceded by an application by filing BIR Form No. 0901 (Application for Relief from Double Taxation) with ITAD at least 15 days before the transaction i.e. payment of dividends, royalties, etc.,accompanied by supporting documents justifying the relief ..." (Emphasis ours) acHETI This condition was emphasized by the Court of Tax Appeals in Mirant (Philippines) Operations Corporation vs. Commissioner of Internal Revenue (C.T.A. Case No. 6382 dated June 7, 2005) where it ruled: "However, it must be remembered that a foreign corporation wishing to avail of the benefits of the tax treaty should invoke the provisions of the tax treaty and prove that indeed the provisions of the tax treaty applies to it, before the benefits may be extended to such corporation. In other words, a resident or non-resident foreign corporation shall be taxed according to the provisions of the National Internal Revenue Code, unless it is shown that the treaty provisions apply to the said corporation, and that, in cases the same are applicable, the option to avail of the tax benefits under the tax treaty has been successfully invoked. Under Revenue Memorandum Order 01-2000 of the Bureau of Internal Revenue, it is provided that the availment of a tax treaty provision must be preceded by an application for a tax treaty relief with its International Tax Affairs Division (ITAD). This is to prevent any erroneous interpretation and/or application of the treaty provisions with which the Philippines is a signatory to. The implementation of the said Revenue Memorandum Order is in harmony with the objectives of the contracting state to ensure that the granting of the benefits under the tax treaties are enjoyed by the persons or corporations duly entitled to the same. The Court notes that nowhere in the records of the case was it shown that petitioner indeed took the liberty of properly observing the provisions of the said order. Petitioner quotes various BIR, as well as ITAD, Rulings issued to several foreign corporations seeking for a tax relief from the office of the respondent. However, not any one of these rulings pertains to the petitioner. It must be stressed that BIR rulings are issued based on the facts and circumstances surrounding particular issue/issues in question and are resolved on a case-to-case basis. It would be thus erroneous to invoke the ruling of the respondent in specific cases, which have no bearing to the case of petitioner." (Emphasis ours) This decision was also upheld by the Supreme Court in a Resolution (G.R. No. 168531) dated February 18, 2008. Furthermore, the necessary requirement laid down in RMO 1-2000 is reiterated in subsequent rulings of the Court of Tax Appeals: Deutsche Bank AG Manila Branch vs. Commissioner of Internal Revenue (C.T.A. Case No. EB 456 dated May 29, 2009), CBK Power Company Ltd. vs. Commissioner of Internal Revenue (C.T.A. Case Nos. 6699, 6844 and 7166 dated March 29, 2010) and Manila North Tollways Corporation vs. Commissioner of Internal Revenue (C.T.A. Case No. 7864 dated April 12, 2011). ECHSDc In view of the foregoing, since the General Services Engagement Agreement between Cvidya and Globe for the planning, design, development, testing, deployment, integration and full implementation of the Project took effect on August 23, 2010 up to March 31, 2012 (the expected date of completion of the Project),and service fees therefor are payable in installments, based on the amount of work completed by Cvidya over time, but since the subject TTRA was filed on April 26, 2011, this Office hereby DENIES relief on such fees paid by Globe to Cvidya on or before April 26, 2011, pursuant to RMO 72-2010 and RMO 1-2000. Consequently, said fees shall be subject to income tax at the rate of 30 percent under Section 28 (B) (1) of the National Internal Revenue Code ("Tax Code"), as amended, 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: Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)." On the other hand, the taxation of service fees paid by Globe to Cvidya on April 27, 2011 and thereafter, depends if Cvidya has a permanent establishment in the Philippines to which these fees are attributable, under paragraph 1, Article 7 of the Philippines-Israel 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 of them as is attributable to that permanent establishment." In relation thereto, paragraphs 1 and 2, Article 5 of the treaty provide: "Article 5 PERMANENT ESTABLISHMENT 1. For the purposes of this Convention, the term 'permanent establishment' means a fixed place of business through which the business of the 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; f) a mine, an oil or gas well, a quarry or any other place of extraction of natural resources; g) a place of exploration of natural resources; h) a building site or construction project or supervisory activities in connection therewith, where such site, project or activity continues for a period of more than six months; i) an assembly or installation project which exists for more than six months; j) the furnishing of services, including consultancy services by an enterprise through employees or other personnel where activities of that nature continue (for the same or a connected project) within a State for a period or periods aggregating more than six months within any twelve-month period;" As defined, a permanent establishment means a fixed place of business through which the business of an enterprise is wholly or partly carried on. With respect to the furnishing of services, an enterprise furnishing services in the Philippines is deemed to have a permanent establishment if it has a branch or an office in the Philippines [subparagraphs (b) and (c)] or if it undertakes this activity for an aggregate period of six months within any twelve-month period. [subparagraph (j)]. Accordingly, since Cvidya is not engaged in trade or business in the Philippines to which an office or a branch is necessary, and since it did not furnish services in the Philippines relating to the Project for an aggregate period of six months within any twelve-month period but, to date, for an aggregate period of 64 days only, Cvidya is not deemed to have a permanent establishment with respect to services it rendered to the Project. This being the case, and provided Cvidya has no permanent establishment up to the completion of the Project, service fees paid by Globe to Cvidya on April 27, 2011 and thereafter under the Agreement shall be exempt from income tax pursuant to paragraph 1, Article 7, in relation to paragraphs 1 and 2, Article 5, of the Philippines-Israel tax treaty. (BIR Ruling No. 85-11 dated March 11, 2011) However, under Section 108 (A) of the Tax Code, the service fees, being payments for the supply of services in the Philippines, are subject to value-added tax ("VAT"), thus: HaTDAE "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, 1 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, Globe shall withhold VAT on the payments at the rate of 12 percent before remitting them to Cvidya. Globe shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld).If Globe is a VAT-registered taxpayer, the duly filed BIR Form No. 1600 and its accompanying proof of payment shall serve as documentary substantiation for Globe' 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. 2 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. 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. 2. 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 corporations, individuals, estates and trusts, 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."