ITAD BIR Ruling No. 141-13

May 21, 2013 ITAD BIR RULING NO. 141-13 Articles 5 and 7, Philippines-Australia tax treaty; Sections 28 (B) (1), 32 (B) (5), 108 (A) (1) and (3) of the Tax Code of 1997, as amended Mr. Alfonso S. Sta. Clara, CPA 92 P. Banzon Street, BF Homes Sucat, Paraaque City Sir : This refers to your tax treaty relief application filed on December 29, 2011, requesting for confirmation that the income payments by Bangko Sentral ng Pilipinas ("BSP") to CCK Financial Solutions Ltd. ("CCK-Australia") for the purchase of certain software from and the provision of related services are exempt from income tax pursuant to Article 7 (Business Profits) in relation to Article 5 (Permanent Establishment) of the Agreement between the Government of the Republic of the Philippines and the Government of Australia for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income ("Philippines-Australia tax treaty") . ICAcTa It is represented that CCK-Australia is a non-resident foreign corporation, organized and existing under the laws of Australia and a resident thereof with principal business address at Level 3, 12 Street Geroges Terrace Perth WA 6000 as evidenced by the Certificate of Residency issued by the Delegate of the Deputy Commissioner of the Australian Taxation Office on November 25, 2011; that CCK-Australia is not registered either as a corporation or partnership in the Philippines based on the Certification of Non-Registration of Company issued by the Philippine Securities and Exchange Commission on December 19, 2011; that on the other hand, BSP is the central bank of the Republic of the Philippines with principal business address at A. Mabini Street, Malate, Manila. It is further represented that on January 16, 2012, CCK-Australia and BSP entered into a Software License Agreement ("Agreement") whereby CCK-Australia grants to BSP the right to use the Software Package 1 in connection with its existing business, or in connection with the existing business of a related party of BSP, and authorize a related party to use the Software Package solely for its existing business or the existing business of BSP or another related party of BSP for the License Term 2 and in accordance with the Agreement; that BSP must not make any copies of the Software Package except in machine readable form and only for the purposes of: (a) archive, emergency restart or back up of the Software Product, (b) testing the software, and (c) replacing a defective copy or verifying a programming error in the Software Product, and BSP must ensure that only the minimum number of copies necessary for these purposes exist at any one time; that the initial number of users shall be 30 concurrent users; that for and in consideration of the License granted, BSP shall pay CCK-Australia the following: (1) Basic Fee of PhP33,750,000; (2) Maintenance Fee of PhP7,470,000 (being PhP6,750,000 in respect of the Basic Fee and PhP720,000 in respect of interfaces) if BSP elects to subscribe to the Gold Level of Maintenance or PhP8,217,000 (being P7,425,000 in respect of the Basic Fee and PhP792,000 in respect of interfaces if BSP elects to subscribe to the Platinum level of Maintenance; that the additional user fee in respect of users of the software product exceeding the initial number of users; that all sums payable by BSP to CCK-Australia must be paid in full; that based on the Certifications issued by CCK and BSP on May 29, 2012 and May 25, 2012, respectively, payments were to be made based on the following schedule: Activity Payment Date Kick-off May 25, 2012 Business Review June 8, 2012 Guava Database Build June 15, 2012 User Training June 22, 2012 User Acceptance Testing September 15, 2012 Data Migration December 15, 2012 Live Date February 15, 2013 On-site Support Post Live May 15, 2013 and that the actual payment was made on December 21, 2012 for the initial or partial payment for the services rendered based on the Certification issued by the authorized representative of CCK-Australia on March 22, 2013. It is further represented that the following employees of CCK-Australia were sent to the Philippines to furnish services pursuant to the Agreement : TaDIHc Name January February March April May June 2012 2012 2012 2012 2012 2012 Jennifer 3-31 1-25 and 27 1-31 10-30 1-31 1-30 Treadwell Helen 14, 15, 26, 16-21 14-17 and 12-15 Glastras 27, 28 21-22 Mukhtiar 5-15 27-31 1-8 Singh Frank Cavaleri Stephen 6-17 Platell Jay Khaw 19-28 25-30 21-31 1-2 Total 29 28 31 21 31 30 ====== ====== ===== ===== ===== ==== Grand Total 170 Financial Year 2012 July 1, 2012 to June 30, 2013 Name July August September October November December Jan Feb 2012 2012 2012 2012 2012 2012 2013 2013 Jennifer 1-19 and 1-30 1-13 and 1-25 4-28 3-21 2-24 4-6 and Treadwell 24-31 23-30 11-14 Helen 9-12, 1-2 and 10-13 8-11 6-8 3-6 3-4 11-14 Glastras 16-17, 30 13-15 Mukhtiar Singh Frank 2-9 7-17 Cavaleri Stephen 30 1-9 20-24 Platell Jay Khaw 5-30 1-8 and 1-14 11-28 4-21 23-30 Total 27 30 21 25 25 19 23 7 ===== ===== ===== ===== ===== ====== ===== ===== Grand Total 177 based on the Certification of duration issued by the authorized representative of CCK-Australia . Clearly, the services performed do not exceed an aggregate period of six months in any taxable year or year of income as the duration of the services performed in the Philippines pursuant to the Agreement are 170 days for the first taxable year and 177 days for the second taxable year. It is finally represented that the issue or transaction subject of this request is not subject of investigation, on-going audit, administrative protest, claims for refund or issuance of a tax credit certificate, collection proceedings, or judicial appeal, based on the Certification issued by the Director of BSP on December 22, 2011. In reply, please be informed that concerning software payments, Revenue Memorandum Circular (RMC) No. 44-2005 3 provides the tax treatment of software payments, either as (1) business income, (2) royalties, (3) rental income, or (4) capital gains, depending on the nature of the transaction out of which such payments are made. Software payments are treated as royalties only if the transaction does not constitute a sale or exchange and not all substantial rights in the software have been transferred, but are merely for the transfer of copyright rights in the software. It provides: "Section 5. Characterization of Transactions . The character of payments received in a transaction involving the transfer of computer software depends on the nature of the rights that the transferee acquires under the particular arrangement regarding the use and exploitation of the program. AETcSa a. Transfer of copyright rights. A transfer of software is classified as a transfer of a copyright right if as a result of the transaction, a person acquires any one or more of the rights described below: i. The right to make copies of the software for purposes of distribution to the public by sale or other transfer of ownership, or by rental, lease or lending; ii. The right to prepare derivative computer programs based upon the copyrighted software; iii. The right to make a public performance of the software; iv. The right to publicly display the computer program; or v. Any other rights of the copyright owner, the exercise of which by another without his authority shall constitute infringement of said copyright. The determination of whether a transfer of a copyright right in a software is a sale or exchange of property is made on the basis of whether, taking into account all facts and circumstances, there has been a transfer of all substantial rights in the copyright. A transaction that does not constitute a sale or exchange because not all substantial rights have been transferred will be classified as a license generating royalty income. When only copyright rights are transferred, payments made in consideration therefor are royalties. On the other hand, when copyright ownership is transferred, payments made in consideration therefor are business income. b. Transfer of copyrighted articles. A copyrighted article incorporating a software includes a copy of the software from which the work can be perceived, reproduced, or otherwise communicated, either directly or with the aid of a machine or device. The copy of the software may be fixed in the magnetic medium of a floppy disk or a CD-ROM, or in the main memory or hard drive of a computer, or in any other medium. If a person acquires a copy of a software but does not acquire any of the rights described above (or only acquires a de minimis grant of such rights), and the transaction does not involve the provision of services or of know-how, the transfer of the copy of the software is classified solely as a transfer of a copyrighted article and payments for which constitute business income. xxx xxx xxx" Under the provisions of the above-quoted Circular, license fee is treated as business income (or business profits) and taxable as such, as described above. Accordingly, the license fees paid or payable to CCK-Australia by BSP for the latter's use of the Licensed Software, are subject to income tax only if the same are attributable to a permanent establishment which CCK-Australia has in the Philippines, under paragraph 1, Article 7 in relation to Article 5 of the Philippines-Australia tax treaty, to wit: IScaAE "Article 7 Business Profits 1. The profits of an enterprise of one of the Contracting States 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 (a) that permanent establishment; or (b) sales within that other Contracting State of goods or merchandise of the same or a similar kind as those sold, or other business activities of the same or a similar kind as those carried on through that permanent establishment if the sale or the business activities had been made or carried on in that way with a view to avoiding taxation in that other State. xxx xxx xxx" "Article 5 Permanent Establishment 1. For the purposes of this Agreement, 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' shall include especially xxx xxx xxx" (k) a place in one of the Contracting States through which an enterprise of the other Contracting State furnishes services, including consultancy services, for a period or periods aggregating more than six months in any taxable year or year of income, as the case may be, in relation to a particular project, or to any project connected therewith. xxx xxx xxx" Based on the foregoing, in order for CCK-Australia to be considered to have a permanent establishment to which said business profit may be attributed, it must satisfy the following conditions: SCaTAc the existence of a "place of business", i.e., a facility such as premises or, in certain instances, machinery or equipment; this place of business must be "fixed", i.e., it must be established at a distinct place with a certain degree of permanence; the carrying on of the business of the enterprise through this fixed place of business. This means usually that persons who, in one way or another, are dependent on the enterprise (personnel) conduct the business of the enterprise in the State in which the fixed place is situated." 4 Since it appears, based on the Certificate issued by CCK Financial Solutions (Philippines), Inc. , that the fees subject of this application are not effectively connected with therewith, CCK Financial Solutions (Philippines), Inc. cannot be deemed as CCK's permanent establishment to which said business profit may be attributed. Thus, for as long as CCK-Australia is deemed not to have a permanent establishment in the Philippines to which its profits may be attributable, the subject fees constituting business profits shall be exempt from income tax and consequently from withholding tax. As regards the maintenance fee and other service fees paid in relation to the Agreement which are represented to be rendered outside the Philippines and in cases of the services rendered in the Philippines by employees of CCK-Australia , for as long as such stay in the Philippines will not exceed an aggregate period of six (6) months, Article 7 in relation to Article 5 of the Philippines-Australia tax treaty shall apply. In this case, inasmuch the duration of services performed in the Philippines pursuant to the Agreement are 170 days for the first financial year and 177 days for the second financial year, based on the relevant Certification issued by the authorized representative of CCK-Australia , then CCK-Australia is deemed not to have a permanent establishment in the Philippines. IAEcaH Finally, fees paid for the services of CCK-Australia are subject to value-added tax (VAT) at the rate of 12 percent pursuant to Section 108 of the Tax Code of 1997. Accordingly, BSP being the resident withholding agent and payor in control of the payments, shall be responsible for the withholding of the final VAT before respectively making any payment to CCK-Australia . In remitting the VAT withheld, BSP shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld). The duly filed BIR Form 1600 and proof of payment thereof shall serve as documentary substantiation for the claim of input tax by CCK-Australia upon filing its own VAT Return, if it is a VAT-registered taxpayer. In case BSP is a non-VAT registered taxpayer, the passed-on VAT withheld shall form part of the cost of the service purchased which may be treated as "expense" or "asset", whichever is applicable. In addition, BSP is required to issue the respective Certificate of Final Tax Withheld at Source (BIR Form 2306) in quadruplicate upon request of BSP, the first three copies thereof to be given to CCK-Australia and the fourth copy to be retained by BSP as its file copy. [Sections 4 & 6, Revenue Regulations (RR) No. 4-2002; Section 3 RR No. 8-2002; Section 7 of RR No. 14-2002] 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. Includes Guava Suite Treasury, System incorporating Guava Dealer, Guava Risk, Guava Ops and Guava Reporter, Money Market Module, Fixed Income Module, Foreign Exchange Module, and Derivative Module. 2. Means the period from the License Commencement Date until the License is terminated. 3. Entitled, "Taxation of Payments for Software" dated September 1, 2005. 4. Organization for Economic Cooperation and Development (OECD), 2005 edition, paragraph 2, pages 85-91.