ITAD BIR Ruling No. 124-16

June 29, 2016 ITAD BIR RULING NO. 124-16 Articles 5 (Permanent Establishment), 7 (Business Profits) and 22 (Non-Discrimination) Philippines-Switzerland tax treaty; Article 14 (Personal Services), Philippines-Italy tax treaty Aerotech Industries Philippines, Inc. NCP Compound Pasong Tamo Extension Western Bicutan Taguig City Attention: Ms. Teresa C. Parian Chief Operating Officer Gentlemen : This refers to your tax treaty relief applications ("TTRAs") both filed on November 19, 2009 requesting confirmation that service fees paid by Aerotech Industries Philippines, Inc. ("Aerotech Philippines") to Aerotech SA ("Aerotech") and salaries and other remuneration paid by Aerotech to Mr. Cesare Pepe ("Mr. Pepe") are subject to preferential tax treatment pursuant to the Convention between the Republic of the Philippines and the Swiss Confederation for the Avoidance of Double Taxation with Respect to Taxes on Income ("Philippines-Switzerland tax treaty") and the Convention between the Government of the Republic of the Philippines and the Government of the Republic of Italy for the Avoidance of Double Taxation with Respect to Taxes on Income and to Prevent Fiscal Evasion ("Philippines-Italy tax treaty") . Facts Aerotech is a foreign corporation in Switzerland based on its Articles of Incorporation. Aerotech is located at Via Lambertenghi 5, Lugano, Switzerland. It is not registered as a corporation or partnership in the Philippines based the Certification of Non-Registration of Company issued by the Securities and Exchange Commission on September 2, 2009. Mr. Pepe is a resident of Italy based on its Residence Certificate issued by the Civil Registrar of Preganziol in Italy on April 7, 2009. He is a resident of Via PO3, Preganziol, Italy. The business name Cesare Pepe is not registered with the Department of Trade and Industry based on a Negative Certification issued on August 28, 2009. On the other hand, Aerotech Philippines is a domestic corporation with representative office at NCP Compound, Pasong Tamo Extension, Western Bicutan, Taguig City, Philippines, and with main office and aircraft service station at Building, 7242 Civil Aviation Complex, Clark Freeport Zone, Clarkfield, Pampanga, Philippines. On January 2, 2008, Aerotech Philippines and Aerotech entered into an Aircraft Maintenance/Repair Servicing Technical and Assistance Agreement where Aerotech agreed to provide Aerotech Philippines technical hardware, instrumentation, and manpower which includes technical personnel and test pilots time for the purpose of providing overall technical supervision for the 1500-hour mandatory inspection with major structural inspection of the S-211 aircraft of the Philippine Air Force and the SF260F Program of the Department of National Defense, the Armed Forces of the Philippines and the Philippine Air Force. The services will be supplied from January 2, 2008 to May 31, 2009. In consideration, Aerotech Philippines will pay service fees to Aerotech amounting to $17,000.00 and payable in installment of $1,000.00 every month. On June 1, 2009, Aerotech Philippines and Aerotech entered into another Aircraft Maintenance/Repair Servicing Technical and Assistance Agreement where Aerotech agreed to continue to provide Aerotech Philippines the same technical hardware, instrumentation, and manpower for a period of two years. In consideration, Aerotech Philippines will pay annual service fees to Aerotech amounting $12,000.00 and payable in installment of $1,000.00 every month. Based on the letters issued by Aerotech to Aerotech Philippines on February 1, 2008 and June 1, 2009, Aerotech will send these personnel to the Philippines to provide services to Aerotech Philippines-Silvano Cervelin (Program Manager and Overall Technical Supervisor), Cesare Pepe (Senior Technical Consultant and Escape System Specialist), and Raffaele Cifaldi (Senior Technical Consultant and Quality Inspector for Aircraft Maintenance and their length of stay in the country is as follows: Personnel Days of Physical Presence 2008 2009 2010 2011 Silvano Cervelin March 30- January 11- January 11- January 9- December 31 December 18 December 12 June 29 Cesare Pepe June 29- January 1-July 4, January 1- - December 31 August 1- February 13, December 31 February 19- July 30, 2010 Raffaele Cifaldi - May 10-August 7, January 1- January 9- September 24- December 14 August 31 December 31 Total 277 days 365 days 348 days 235 days ======= ======= ======= ======= Ruling In reply, please be informed that the service fees paid by Aerotech Philippines to Aerotech are exempt from income tax if they are not attributable to a permanent establishment which Aerotech has in the Philippines, under paragraph 1, Article 7 of the Philippines-Switzerland 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 Philippines-Switzerland tax treaty define a permanent establishment as follows: "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 building site, a construction, assembly or installation project or supervisory activities in connection therewith, but only where such site, project or activity continues for a period of more than six months; h) the furnishing of services, including consultancy services, by an enterprise through employees or other personnel engaged by the enterprise for such purpose, but only where activities of that nature continue (for the same or a connected project) within the country 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, and includes especially, a place of management, a branch, an office, a factory, and a workshop. It includes also the furnishing of services, including consultancy services, by an enterprise of Contracting State (through employees or other personnel thereof) in the other Contracting State where such activity continues (for the same or a connected project) within a period or periods aggregating more than six months within any twelve-month period. Accordingly, since Aerotech had furnished services in the Philippines for periods aggregating more than six months within any twelve-month period , that is, 277 days in 2008, 365 days in 2009, 348 days in 2010 , and 235 days in 2011 , Aerotech is deemed to have a permanent establishment in the Philippines, under paragraph 2 (h), Article 5 of the Philippines-Switzerland tax treaty. This being the case, the service fees paid by Aerotech Philippines to Aerotech shall be subject to income tax in the Philippines, under paragraph 1, Article 7 of the treaty. Furthermore, under paragraph 3, Article 7 and paragraph 2, Article 22 of the Philippines-Switzerland tax treaty, Aerotech , in view of having a permanent establishment, shall be allowed to deduct expenses it incurred including executive and general administrative expenses and it shall not be treated less favorably than domestic enterprises carrying on the same activities in the Philippines, to wit: "3. In determining the profits of a permanent establishment, there shall be allowed as deduction expenses which are incurred for the purposes of the permanent establishment, including executive and general administrative expenses so incurred, whether in the State in which the permanent establishment is situated or elsewhere." "Article 22 Non-Discrimination xxx xxx xxx 2. The taxation on a permanent establishment which an enterprise of a Contracting State has in the other Contracting State shall not be less favourably levied in that other State than the taxation levied on enterprises of that other State carrying on the same activities. This provision shall not be construed as obliging a Contracting State to grant to residents of the other Contracting State any personal allowances, reliefs and reductions for taxation purposes on account of civil status or family responsibilities which it grants to its own residents." In view of the foregoing, Aerotech shall be treated as a resident foreign corporation and subject to income tax at the rate of 35 percent (before January 1, 2009) and 30 percent (beginning January 1, 2009) based on its taxable income 1 derived from sources in the Philippines, under Section 28 (A) (1) of the National Internal Revenue Code of 1997 ("Tax Code") , as amended, to wit: "SEC. 28. Rates of Income Tax on Foreign Corporations. (A) Tax on Resident Foreign Corporation . (1) In General . Except as otherwise provided in this Code, a foreign corporation organized, authorized, or existing under the laws of any foreign country, engaged in trade or business within the Philippines, shall be subject to an income tax equivalent to thirty-five percent (35%) of the taxable income derived in the preceding taxable year from all sources within the Philippines: Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)." On the other hand, with respect to the salaries and other remuneration paid by Aerotech to one of its personnel, Mr. Pepe , they are exempt from income tax if the following conditions laid down in paragraph 2, Article 14 of the Philippines-Italy tax treaty are all satisfied by Mr. Pepe , to wit: "Article 14 Personal Services 1. Subject to the provisions of Articles 15, 17 and 18, salaries, wages and other similar remuneration or income for personal (including professional) services derived by a resident of a Contracting State, shall be taxable only in that State unless the services are performed in the other Contracting State. If the services are so performed, such remuneration or income as is derived therefrom may be taxed in that other State. 2. Notwithstanding the provisions of paragraph 1, remuneration or income derived by a resident of a Contracting State in respect of personal (including professional) services performed 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 taxable 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." As stated, salaries and remuneration paid to Mr. Pepe are exempt from income tax if (a) he is present in the Philippines for a period or periods not exceeding in the aggregate 183 days in any taxable year, (b) the remuneration is paid by, or on behalf of, an employer who is not a resident of the Philippines, and (c) the remuneration is not borne by a permanent establishment which the employer has in the Philippines. Accordingly, since Mr. Pepe had been present in the Philippines for periods aggregating more than 183 days in any taxable year , that is, 186 days in 2008 (June 29-December 31), 338 days in 2009 (January 1-July 4, August 1-December 31), and 206 days in 2010 (January 1-February 13, February 19-July 30), such salaries and other remuneration paid to him by Aerotech shall be subject to income tax in the Philippines, under paragraph 2 (a), Article 14 of the Philippines-Italy tax treaty. In view of his stay in the country for more than 180 days in any taxable year, Mr. Pepe shall be taxed as a nonresident alien engaged in trade or business in the Philippines under Section 25 (A) (1), in relation to Section 24 (A) (1), of the Tax Code, to wit: "SEC. 25. Tax on Nonresident Alien Individual. (A) Nonresident Alien Engaged in Trade or Business within the Philippines . (1) In General . A nonresident alien individual engaged in trade or business in the Philippines shall be subject to an income tax in the same manner as an individual citizen and a resident alien individual, on taxable income received from all sources within the Philippines. A nonresident alien individual who shall come to the Philippines and stay therein for an aggregate period of more than one hundred eighty (180) days during any calendar year shall be deemed a 'a nonresident alien doing business in the Philippines' , Section 22(G) of this Code notwithstanding." "SEC. 24. Income Tax Rates. (A) Rates of Income Tax on Individual Citizen and Individual Resident Alien of the Philippines . (1) An income tax is hereby imposed. (a) On the taxable income defined in Section 31 of this Code, other than income subject to tax under Subsections (B), (C) and (D) of this Section, derived for each taxable year from all sources within and without the Philippines by every individual citizen of the Philippines residing therein; (b) On the taxable income defined in Section 31 of this Code, other than income subject to tax under Subsections (B), (C) and (D) of this Section, derived for each taxable year from all sources within the Philippines by an individual citizen of the Philippines who is residing outside of the Philippines including overseas contract workers referred to in Subsection (C) of Section 23 hereof; and (c) On the taxable income defined in Section 31 of this Code, other than income subject to tax under Subsections (B), (C) and (D) of this Section, derived for each taxable year from all sources within the Philippines by an individual alien who is a resident of the Philippines. The tax shall be computed in accordance with and at the rates established in the following schedule: Not over P10,000 5% Over P10,000 but not over P30,000 P500 + 10% of the excess over P10,000 Over P30,000 but not over P70,000 P2,500 + 15% of the excess over P30,000 Over P70,000 but not over P140,000 P8,500 + 20% of the excess over P70,000 Over P140,000 but not over P250,000 P22,500 + 25% of the excess over P140,000 Over P250,000 but not over P500,000 P50,000 + 30% of the excess over P250,000 Over P500,000 P125,000 + 32% of the excess over P500,000" Finally, under Section 108 (A) of the Tax Code, the service fees paid by Aerotech Philippines to Aerotech 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%). . ." Relative thereto, Aerotech Philippines shall withhold VAT on the service fees at the rate of 12 percent before remitting them to Aerotech . Aerotech Philippines shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld). The duly filed BIR Form and its accompanying proof of payment shall serve as documentary substantiation for Aerotech Philippines ' claim of input tax on the fees; otherwise, if is not a VAT-registered taxpayer, Aerotech Philippines 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 Please be guided accordingly. Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes 1. "SEC. 31. Taxable Income Defined. The term 'taxable income' means the pertinent items of gross income specified in this Code, less the deductions and/or personal and additional exemptions, if any, authorized for such types of income by this Code or other special laws." 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."