ITAD BIR Ruling No. 169-13

June 19, 2013 ITAD BIR RULING NO. 169-13 Articles 5, 7 and 24, Philippines-Japan tax treaty Sycip Gorres Velayo and Co . 6760 Ayala Avenue 1226 Makati City Attention: Maria Victoria A. Villaluz Tax Services Gentlemen : This refers to your tax treaty relief application filed on February 24, 2009 requesting confirmation, primarily, that Hitachi-Omron Terminal Solutions Corporation ("Hitachi-Omron") does not have a permanent establishment in the Philippines 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") . 1 TEIHDa Facts Hitachi-Omron is a foreign corporation and a resident of Japan based on the Certificate of Status of Taxable Person issued by the Shinagawa Tax Office in Japan on October 2, 2008. It is located at 1-6-3, Osaki, Shinagawa-ku, Tokyo, Japan, and engaged primarily in the manufacture and sale of electric and electronic products. It is not registered as a corporation or partnership in the Philippines based on the Certification of Non-Registration of Corporation/Partnership issued by the Securities and Exchange Commission on October 14, 2008. On April 15, 2006, Hitachi-Omron and Hitachi Terminals Mechatronics Philippines Corporation ("Hitachi Terminals Philippines") (formerly, TOP Mechatronics Corporation ) entered into a Basic Purchase Agreement where Hitachi-Omron contracted Hitachi Terminals Philippines to manufacture electric and electronic products for Hitachi-Omron . Hitachi Terminals Philippines is a domestic corporation located at Block E-1, Subic Techno Park, Boton Area, Subic Bay Freeport Zone, Philippines. Under the Agreement, Hitachi-Omron will supply Hitachi Terminals Philippines the necessary materials, tools, dies, gauges, and equipment to manufacture the products. The products will be manufactured in accordance with the specifications given by Hitachi-Omron and Hitachi Terminals Philippines will not make any changes thereon to affect the form, fit, function, or spare parts of the products. Hitachi Terminals Philippines will manufacture the products based on purchase orders issued by Hitachi-Omron . Hitachi Terminals Philippines will invoice Hitachi-Omron of the price of the products to include therein the costs for packaging, hauling, storage and transportation. Hitachi Terminals Philippines will mark the boxes that contain these products with Hitachi-Omron 's order number, quantity, product name, and serial number. Hitachi Terminals Philippines will reserve space on a first-class ocean-going vessel or on a first-class airplane to transport the products. The Agreement took effect on April 15, 2006, for an initial term of three years. The Agreement will be automatically extended thereafter for successive periods of one-year. Based on a Summary Report prepared by Hitachi Terminals Philippines , for the years 2006 to 2009 alone, Hitachi Terminals Philippines had manufactured electric and electronic products for Hitachi-Omron , which were subsequently delivered to Hitachi-Omron in Japan and to the following customers thereof: Customer Address 1. Advanced Modules Private Ltd. 2 Jurong East Street, IMM Building, Singapore 2. Aures Technologies 63 Rue Du Bois Chaland, Lisses, France 3. CRC Grossbeeren GmbH AM Wall 5, Grossbeeren Germany 4. Flextronics America LLC 1000 Technology Drive, West Columbia, South Carolina, United States of America 5. Getronics Computer Solutions 6 Maskit Street, Herzilya Pituach, Ltd. Israel 6. Hitachi East Asia Ltd. 4th Floor, North Tower, World Finance Centre, Harbour City Canton Road, Tsimshatsui, Kowloon, Hongkong 7. Hitachi-Omron Terminal Wegalaan 71, JD Hoofdorp, Solutions Europe Netherlands 8. Hwasung I and T Corporation 405 Daeryung Techno Town 488 Gasan-Dong, Geumcheon-Gu, Seoul, Korea 9. Joint Binaric System Ltd. 49 Hasivim Street, Park Yanai Kiryat Matalon, Petah-Tikva Israel 10. Mostyle Corporation 3rd Floor, No. 50 Chow-Tze Street, Nei-Hu, Taipei, Taiwan 11. Nautilis Hyosung, Inc. 52 Cheongdam-dong, Kangnam- ku, Seoul, Korea 12. NCR Financial Equipment 22 Hong-DA North, BDA, Beijing, System Company, Ltd. China 13. NCR Global Solutions Ltd. Block 1, Unit 180, Airside Business Park, Dublin, Ireland 14. NCR Global Solutions Ltd. Group Ltd., Kingsway West Hungary Dundee, Scotland 15. Omron Electronics 55 Commerce Drive, Suite B Components LLC Schaumburg, Illinois, United States of America 16. Omron Electronics Pty. Ltd. 71 Epping Road, North RYD Sydney, Australia 17. Procomp Industria AV Torres de Oliveira, 407 Electronica Ltda. Jaguare, Sao Paulo, Brazil 18. Regenersis GmbH AV Torres de Oliveira, 407 Jaguare, Sao Paulo, Brazil 19. Sejin Electron, Inc. 60-19 Kasan-Dong Keumchon- Ku, Seoul, Korea 20. Toshiba Tec Singapore Pte. Ltd. 2 Ang Mo Kio Street, Singapore 21. Wincor Nixdorf International Gebaeuded Rampe D28, Heinz GmbH Nixdorf-Ring, Paderbon, Germany 22. Wincor Nixdorf Logistics c/o Arvato Technology ELC GmbH GmbH, Willi-Bleicher-Strasse, Dueren, Germany 23. Wincor Nixdorf Pte. Ltd. 2 Kailang Sector, Singapore 24. Wincor Nixdorf Pte. Ltd. GDC Singapore, 2 Kailang GDC Singapore Sector, Singapore 25. Wincor Nixdorf Retail and Block 70, 36 Yi Wei Road, Banking Systems Waigaoqiao Free Trade Zone (Shanghai) Company, Ltd. Shanghai, China Ruling In reply, please be informed that profits derived by Hitachi-Omron from the sale of the said products to its customers worldwide may be taxed in the Philippines if attributable to a permanent establishment which Hitachi-Omron has in the Philippines, pursuant to paragraph 1, Article 7 of the amended Philippines-Japan tax treaty, thus: IEcaHS "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." In relation to a permanent establishment, paragraphs 1, 2, 5 and 7, Article 5 of the treaty define it 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. xxx xxx xxx 5. Where a person other than an agent of an independent status to whom paragraph 7 applies is acting in a Contracting State on behalf of an enterprise of the other Contracting State, that enterprise shall be deemed to have a permanent establishment in the first-mentioned Contracting State in respect of any activities which that person undertakes for the enterprise, if: a) that person has, and habitually exercises in the first-mentioned Contracting State, an authority to conclude contracts in the name of the enterprise, unless his activities are limited to those mentioned in paragraph 4 which, if exercised through a fixed place of business, would not make this fixed place of business a permanent establishment under the provisions of that paragraph; or IDASHa b) that person regularly secures orders in the first-mentioned Contracting State wholly or almost wholly for the enterprise itself or for the enterprise and other enterprises which control or are controlled by that enterprise; or c) that person maintains in the first-mentioned Contracting State a stock of goods or merchandise belonging to the enterprise from which he regularly fills orders on behalf of the enterprise. xxx xxx xxx 7. An enterprise of a Contracting State shall not be deemed to have a permanent establishment in the other Contracting State merely because it carries on business in that other Contracting State through a bona fide broker, general commission agent or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business." Under Article 5, a permanent establishment means a fixed place through which the business of an enterprise is wholly or partly carried on, and includes especially, a store or other sales outlet, a branch, an office, a factory and a workshop (paragraphs 1 and 2) . With respect to the delivery of a stock of goods or merchandise by a person in a Contracting State for or on behalf of an enterprise of the other Contracting State, this activity constitutes a permanent establishment if such person maintains such stock belonging to the enterprise from which it regularly fills orders on behalf of that enterprise [paragraph 5 (c)] . Accordingly, since under the Agreement, Hitachi Terminals Philippines manufactures electric and electronic products for Hitachi-Omron and delivers them for or on behalf of Hitachi-Omron, Hitachi Terminals Philippines constitutes a permanent establishment of Hitachi-Omron , under paragraph 5 (c), Article 5 of the Philippines-Japan tax treaty. On the condition of ownership , the fact that the necessary materials, tools, dies, gauges, and equipment to manufacture the products are supplied by Hitachi-Omron , and, in pricing these products, Hitachi Terminals Philippines will include only the costs for packaging, hauling, storage and transportation of these products, such products clearly belong to Hitachi-Omron . On the condition of maintenance , the fact that the products are stored within the premises of Hitachi Terminals Philippines after production and Hitachi Terminals Philippines incurs storage cost in the process shows that Hitachi Terminals Philippines maintains or stores these products for Hitachi-Omron . On the condition of filling orders or delivering regularly , the fact that in 2006 to 2009 alone, Hitachi Terminals Philippines has delivered the products it manufactured to several customers of Hitachi-Omron worldwide proves that Hitachi Terminals Philippines regularly fills orders or delivers these products for or on behalf of Hitachi-Omron . CSaHDT On the other hand, we take note that under paragraph 7 of Article 5, Hitachi-Omron will not be deemed to have a permanent establishment merely because it carries on business in Philippines through a bona fide broker, general commission agent or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business. On whether this paragraph applies to Hitachi Terminals Philippines , a toll manufacturer and an independent contractor and which is not involved in the actual negotiation and conclusion of the sale of the products in question, we believe that this is not the case for Hitachi Terminals Philippines . We support our answer as follows. In Philippine Fund, Inc. vs. Commissioner of Internal Revenue (CTA Case No. 4461 dated May 13, 1994), the Court of Tax Appeals applied the ejusdem generis principle in considering any other agent of an independent status as referred to in tax treaties to refer only to a person whose business activities are the same or similar to those rendered by a broker or a commission agent to the general public. The pertinent portion of this ruling reads: " Petitioner would like this Court to believe that it has no permanent establishment in the Philippines considering that its agent in the Philippines is of independent status. We do not believe so. Pursuant to the requirement of paragraphs 4(a) and 5 of Article 5 of RP-US Tax Treaty, you may be considered as having a permanent establishment if there is a person acting in one of contracting states on behalf of a resident of the other contracting state and such person has habitually exercised an authority to conclude contracts in the name of that resident. This situation will not apply if such representative is a broker, general commission agent or any other agent of an independent status, where such broker or agent is acting in the ordinary course of his business . The agent shall not be considered independent if the activities of such agent are devoted wholly or almost wholly on behalf of that resident. xxx xxx xxx Thus the agents representing the petitioner are with authority to conclude contracts as they are specifically authorized to execute documents under the power of attorney and therefore could qualify as a permanent establishment. They could not qualify as an independent agent. This court believes that the agents referred to in the tax treaty are those in the same category as commission agent or broker. This is in accordance with the principle of ejusdem generis. Under this principle on statutory construction where general terms follow the designation of particular things or classes of persons or subjects, the general terms will be construed to include those things or person of the same class of the same nature as those specifically enumerated (Handbook on Statutory Construction by Ruperto G. Martin, 1973 ed. p. 70). This conclusion is supported by the fact that the treaty provision requires this agent to be 'acting in the ordinary course of his business'. So the business of this person or entity are commission agent or broker and they are acting as such to the general public. The agents of the petitioner in our case could not qualify as an agent of independent status considering that they are employees of a banking institution whose duties are entirely different from the assigned task as agent of the petitioner. For instance, Mrs. Hernandez runs the credit and marketing department of the bank. She admitted that the administration of the assets of the petitioner is an additional function and in fact she is designated there in her individual capacity. She is neither a commission agent, a broker nor an independent agent acting in the pursuit of such business. The independency is even questionable inasmuch as the company where she is employed indirectly owned 100% of petitioner. Granting that she is an independent agent, it appears that her activities as an agent are devoted wholly or almost wholly on behalf of that resident and as explained in the next paragraph the transaction between the agent and the petitioner does not seem to be under arm's length condition. Therefore, she could not be considered as an agent with independent status pursuant to Article 5 of the said tax treaty . " (Emphasis added) In Income Tax Treaties of the United States (Copyright 1996 by Peter H. Blessing), the view that the other agent of an independent status as referred to in tax treaties must be involved in the negotiation of sales contracts with third parties (whether or not the agent binds his principal) is supported by the very concept of a broker or a general commission agent and its historical origins. The pertinent commentaries thereon mention: THIECD "Paragraph 6 of the Permanent Establishment article of the U.S. and OECD Model Treaties (Article 5(6)), dealing with independent agents, seems, on its face, at least to a common law reader, to set forth an exception to paragraph 5 for a 'broker, general commission agent or any other agent of an independent status.' A question that has been debated concerns whether paragraph 6 in fact does set forth an exception or whether, instead, it only covers situations in which the agent does not habitually exercise a power to bind the principal by contract ( i.e., situations that are not reached by paragraph 5). The more conventional, majority view (at least in common-law countries) is that paragraph 6 in fact is intended to set forth an exception to paragraph 5. Under that view, an independent agent includes an agent that can bind its principal by contract. The catchall term 'any other agent of an independent status' is not to be limited under the ejusdem principle to agents of the same type as commission agents or brokers. Further, as used in paragraph 6, those terms arguably should be construed by reference to their common-law meanings, since paragraph 6 ultimately was derived, through a circuitous route, from a 1925 U.K. statute. The French terms 'commissionaire' (a person who contracts in his own name) and 'courtier' (a person who only brings parties together and does not bind them by contract) may be considered under this view to be erroneous translations of the English counterparts (or at least as not determinative of the meaning of paragraph 6 in a common-law country, the English terms encompass agents having the authority to bind their principals by contract." This being the case, the profits derived by Hitachi-Omron from the sale to its customers worldwide of electric and electronic products manufactured and delivered by Hitachi Terminals Philippines for or on behalf of Hitachi-Omron shall be subject to income tax in the Philippines, pursuant to paragraph 1, Article 7 of the Philippines-Japan tax treaty. Moreover, under paragraph 3, Article 7, and paragraph 2, Article 24, of the Philippines-Japan tax treaty, Hitachi-Omron shall be allowed to deduct executive and general administrative expenses from such profits, and, as a foreign enterprise, it shall not be treated less favorably than domestic enterprises carrying on the same activities in the Philippines, to wit: "Article 7 xxx xxx xxx 3. In determining the profits of a permanent establishment, there shall be allowed as deductions expenses which are incurred for the purposes of the permanent establishment, including executive and general administrative expenses so incurred, whether in the Contracting State in which the permanent establishment is situated or elsewhere." ISADET "Article 24 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 Contracting State than the taxation levied on enterprises of that other Contracting 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." This being the case, Hitachi-Omron shall, for purposes of income taxation, be treated as a foreign corporation engaged in trade or business in the Philippines under Section 28 (B) (1) of the National Internal Revenue Code of 1997, 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 2 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%)." Please be guided accordingly. Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes 1. As amended by the 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. ''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."