ITAD BIR Ruling No. 172-15

June 2, 2015 ITAD BIR RULING NO. 172-15 Articles 5 (Permanent Establishment) and 7 (Business Profits) Philippines-Australia tax treaty Fujitsu Philippines, Inc. 2nd Floor, United Life Building 837 A. Arnaiz Avenue Legaspi Village, Makati City Attention: Mr. Peter G. Tan President Atty. Rodolfo R. Nicolas, Jr., CPA In-house Legal Counsel Gentlemen : This refers to your tax treaty relief application filed on September 20, 2011, requesting confirmation that service fees paid by Fujitsu Philippines, Inc. (" Fujitsu Philippines ") to Fujitsu Australia Ltd. (" Fujitsu Australia ") are exempt from income tax pursuant to 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 "). Facts Fujitsu Australia is a foreign corporation resident of Australia based on the company's constitution and on Certificate of Residency issued by the Australian Taxation Office on June 9, 2011. It is situated at 2 Julius Avenue, North Ryde, New South Wales, Australia. Fujitsu Australia is engaged in the sale of computer products (servers storage; client computing devices; peripheral devices; software; car audio/video systems; air conditioners) and in providing IT services (application services; business services; managed infrastructure services; telecommunications; financial services). Fujitsu Australia is not registered as a corporation or partnership in the Philippines based on the Certification of Non-registration of Company issued by the Securities and Exchange Commission on September 22, 2011. On the other hand, Fujitsu Philippines is a domestic corporation situated at 2nd Floor, United Life Building, 837 A. Arnaiz Avenue, Legaspi Village, Makati City, Philippines. It is engaged in the sale of computer products (computing products; software; telecommunications; microelectronics and electronic devices; OEM products) and in providing IT services (systems integration; IT infrastructure services; managed services; software services). On November 5, 2010, Fujitsu Philippines and Fujitsu Australia entered into an Off-Shore Services Agreement where Fujitsu Australia agreed to provide services to Fujitsu Philippines to be done entirely in Australia. The services consist of two parts. The first part pertains to Asset Management Coordination and Administration, which includes facilitation of IT procurement (hardware and software) using existing customer processes and existing vendor relationships; maintenance of software license tracking register; IT hardware asset tracking; IT hardware forecasting; and management of the leasing cycle of personal computers. The second part pertains to Tier 1/Level 2 Onsite Support, which includes assistance in transition activities requested by Fujitsu Philippines' customers for the onboarding of new service providers; performance of onsite support in Kuala Lumpur, Malaysia; assistance in preparing regular reports; and providing recommendations on service improvements applicable in sustaining support requirements by customers. In consideration, Fujitsu Philippines will pay service fee to Fujitsu Australia based on the following schedule: Scope of Work Period Number of Monthly Fee Total months Both parts Nov 5-Dec 31, 1 AUD30,392.71 AUD30,392.71 2010 First part Jan 1-Dec 31, 12 8,445.92 101,351.04 2011 Second part Jan 1-Dec 31, 12 8,116.00 97,392.00 2011 Based on the Certificate of Completion and Acceptance duly signed by Fujitsu Philippines and Fujitsu Australia on October 16, 2014, both parties agreed that the services contemplated in the Agreement were delivered completely by Fujitsu Australia to Fujitsu Philippines . Based on a certification issued by Mizuho Corporate Bank Ltd. Manila Branch 1 on October 28, 2014, Fujitsu Philippines remitted a total of AUD252,834.32 to Fujitsu Australia on November 10, 2011, December 12, 2011 and February 8, 2012. Ruling In reply, please be informed that under Section 28 (B) (1) of the National Internal Revenue Code of 1997, as amended (" Tax Code "), business profits derived in the Philippines by a foreign corporation not engaged in trade or business is subject to income tax at the rate of 30 percent, 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: 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 Tax Code, the profits are exempt or partially exempt to the extent required by any treaty obligation on the Philippines, to wit: "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." In this connection, paragraph 1, Article 7 of the Philippines-Australia tax treaty provides relief to profits derived by an Australian enterprise, to wit: "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" Under this article, such profits may be taxed in the Philippines if attributable to a permanent establishment which the enterprise has in the Philippines. On the question of permanent establishment, paragraphs 1 and 2, Article 5 of the treaty defines this term below: " 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 a) a place of management; b) a branch; c) an office; d) a factory; e) a workshop; f) a mine, oil or gas well, quarry or other place of extraction of natural resources; g) an agricultural, pastoral or forestry property; h) a building site or construction, installation or assembly project, or supervisory activities in connection therewith where such site, project or activity continues for more than six months; i) premises used as a sales outlet; j) a warehouse, in relation to a person providing storage facilities for others; 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." 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. In the case of furnishing of services, this activity constitutes a permanent establishment if the concerned enterprise furnishes services, including consultancy services, in the Philippines 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. Accordingly, since Fujitsu Australia is not engaged in trade or business in the Philippines to which a fixed place of business like an office or a branch is necessary, and it did not furnish services in the Philippines but elsewere, Fujitsu Australia is not deemed to have a permanent establishment in the Philippines pursuant to paragraphs 1 and 2, Article 5 of the Philippines-Australia tax treaty. This being so, the service fees paid by Fujitsu Philippines to Fujitsu Australia under the Off-Shore Services Agreement, for undertaking and completing the asset management coordination and administration (first part) and onsite support (second part) of the project, are exempt from income tax pursuant to paragraph 1, Article 7 of the Philippines-Australia treaty. On the characterization of the service fees as business profits (which are generally exempt from income tax) rather than payments for know-how or royalties (which are generally subject to a reduced income tax), the following commentaries of the Organization for Economic Co-operation and Development Model Tax Convention on Income and on Capital ( Condensed Version, July 22, 2010 ) mention that: "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. 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 subcontractors for the performance of similar services. Accordingly, since the Agreement does not call for Fujitsu Australia to supply existing information or reproduce existing material to Fujitsu Philippines , but for the former to provide actual services to Fujitsu Philippines as described above, 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 were rendered continuously for more than one year (November 2010 to December 2011) by designated personnel of Fujitsu Australia at its facilities and that Fujitsu Australia utilized its resources for this purpose, it is certain that a greater level of expenditure (such as salaries and other remuneration of personnel) was incurred by Fujitsu Australia to fulfil its contractual obligations to Fujitsu Philippines . This being the case, the service fees paid to Fujitsu Australia constitute business profits and not payments for know-how or royalties . Furthermore, under Section 108 (A) of the Tax Code the service fees paid for services rendered by Fujitsu Australia entirely outside the Philippines are exempt from value-added tax ("VAT"), to wit: "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%). . ." 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. . ." Under the cross-border or destination principle, the sale of services is subject to VAT only if the services are performed in the Philippines. 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. Situated at 26th Floor, Citibank Tower, Valero corner Villar Streets, Salcedo Village, Makati City, Philippines. 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. n Note from the Publisher: The phrase "and (d) above" no longer appears in RA 9337, the law amending this provision.