ITAD BIR Ruling No. 181-12

May 3, 2012 ITAD BIR RULING NO. 181-12 Articles 5 & 7, Philippines-Korea Tax Treaty; BIR Ruling No. ITAD-134-11 Roxas de Los Reyes Laurel Rosario & Leagogo Law Offices 19/F BDO Plaza, 8737 Paseo de Roxas Makati City, 1226 Attention: Atty. Valerie Anne D. Gonzales Gentlemen : This refers to your Tax Treaty Relief Application ("TTRA") filed on June 29, 2011, on behalf of Korea Exchange, Inc. ("KRX"), requesting confirmation that its income from Capital Market Integrity Corporation ("CMIC") is exempt from Philippine income tax pursuant to the Convention between the Republic of the Philippines and the Republic of Korea for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income ("Philippines-Korea tax treaty") . It is represented that KRX, with address at Nulwon Building, 825-3, Beomil-dong, Dong-gu, Busan, Korea, is a resident of Korea per Certificate of Business Registration issued by the Head Busanjin District Tax Office dated June 3, 2011; that KRX is not registered either as a corporation or as a partnership in the Philippines as shown in the Certification of Non-Registration of Corporation/Partnership issued by the Securities and Exchange Commission on June 6, 2011; and that, on the other hand, CMIC is a corporation organized and existing under Philippine laws, with principal address at 2nd Floor PSE Plaza, Ayala Triangle, Ayala Avenue, Makati City. It is further represented that KRX and CMIC entered into a License and Project Implementation Agreement for the Development of CMIC's New Surveillance System ("License Agreement") on May 3, 2011 that will monitor unfair market practices, misconduct, rules violation and other types of infringement in the capital market; that under the License Agreement, KRX shall design, develop, deliver, test and commission a Surveillance System, including all necessary licensed software 1 for CMIC; identify technical specifications for Equipment 2 and Third Party Software; 3 provide Implementation Services; 4 and provide Maintenance Services; 5 that KRX agrees that CMIC shall have all the rights, title and interest (including ownership of copyright and/or any other Intellectual Property Right) in any product (that may constitute an Intellectual Property Right), created during the term of the License Agreement, only if CMIC does not use it commercially or does not transfer it to a Third Party, except that any agreement for the direct or indirect use of such rights, titles, and interests by the Philippine Stock Exchange or its subsidiaries or affiliates shall be allowed, under the condition that such subsidiaries or affiliates shall not transfer such rights, titles and interest to a Third Party; that the total fee payable by CMIC to KRX for the provision of the Software and Services shall be Seven Hundred Fifty Thousand US Dollars (US$750,000.00) and the Maintenance Fees of US$97,500 per year; that the payment milestones are subject to the acceptance criteria clauses as specified in Schedule 10 of the License Agreement; that maintenance should be limited only to 13% of the cost of the Software & Service Fee in accordance with the payment schedule below: Project Milestones Terms of Payment Amount Month Signing of 30% of US$650K US$195,000 0 Implementation Agreement Installation of software 20% of US$650K after successful installation US$130,000 10 for UAT of software in the CMIC test environment Completion of User 20% of US$650K after successful completion US$130,000 12 Acceptance Test of Documentation, Training and acceptance of Internal User Acceptance Test Go-Live Completion of 20% of US$650K upon successful migration US$130,000 12 + 1 migration to production to production and audit certification is week awarded Acceptance Test Completion of 10% of US$650K after the stabilization US$65,000 13 stabilization period After Warranty Period US$20,000 25 After 1st year of US$20,000 37 Maintenance Amount to be waived, only if SEC enters into an agreement with KRX on the same Software After 2nd year of & Services, before the 'completion of the US$20,000 49 Maintenance stabilization' After 3rd year of US$20,000 61 Maintenance After 4th year of US$20,000 73 Maintenance that based on the certification issued by CMIC, KRX sent representatives who rendered services for a total aggregate period of 16 days for 2011, and that for the year 2012, it is expected to send representatives in the Philippines for an aggregate period of 118 days. Finally, it is represented that the transaction subject of the herein request for ruling is not under investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings, or a judicial appeal of the taxpayers involved per the Sworn Statement issued by CMIC dated July 18, 2011. In reply, please be informed that Section 28 (B) (1) of the National Internal Revenue Code (Tax Code) of 1997, as amended, applies, in general, to income received by a nonresident foreign corporation which provides: "Section 28. Rates of Income Tax on Foreign Corporations. xxx xxx xxx (B) Tax on Nonresident Foreign Corporation. xxx xxx xxx (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 subject to tax under subparagraphs 5(c): Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%). HCaDET xxx xxx xxx" However, Section 32 (B) (5) of the Tax Code of 1997, as amended, provides: "Section 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. xxx xxx xxx" With respect to a treaty, what you invoke for this purpose is the Philippines-Korea tax treaty. Article 7 thereof provides as follows: "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. xxx xxx xxx" Based on the foregoing, the profits of an enterprise which is a resident of the Korea shall be taxable only in Korea unless such enterprise carries on business in the Philippines through a permanent establishment situated therein. If the Korea enterprise carries on business as aforesaid, the profits of such enterprise may be taxed in the Philippines but only so much of them as is attributable to that permanent establishment. Applying this to the instant case, the service fees received by KRX for the services rendered in the Philippines shall be taxable in the Philippines only if it has a permanent establishment in the Philippines to which said fees may be attributable. DEcSaI In relation thereto, Article 5 of the same tax treaty provides: "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 an 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) premises used as a sales outlet; and h) a warehouse, in relation to a person providing storage facilities for others; i) a building site or construction, installation or assembly project or supervisory activities in connection therewith, constitute a permanent establishment only if such site, project or activity continues for a period of more than six months; j) the furnishing of services including consultancy services by an enterprise through an employee or other personnel constitutes a permanent establishment only if activities of that nature continues within a Contracting State for a period or periods exceeding in the aggregate 183 days within any twelve-month period; and HAEDIS k) a place of exploration of natural resources constitutes a permanent establishment only if it exists for more than six months." It is clear from the aforequoted provision that a corporation which is a resident of Korea may be deemed to have a permanent establishment in the Philippines if, among others, the furnishing of services through its employees continue within the Philippines for a period or periods aggregating 183-days within any twelve month period. Relative thereto, however, please be informed that Section 14 of Revenue Memorandum Order No. ("RMO") 72-2010, published in Manila Bulletin on October 20, 2010, and effective November 4, 2010, provides as follows: Section 14. When and Where to File the TTRA. All tax treaty relief applications (updated BIR Forms No. 0901-D, 0901-I, 0901-R, 0901-P, 0901-S, 0901-T, 0901-O and 0901-C) relative to the implementation and interpretation of the provisions of Philippine tax treaties shall only be submitted to and received by the International Tax Affairs Division (ITAD). If the forms or any necessary documents are submitted to any other BIR Office, the application shall be considered as improperly filed. 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 supplied) In view thereof, since the TTRA was filed on June 29, 2011 , after the date of effectivity of the Agreement which was on May 3, 2011 , this Office hereby DENIES relief on income payments made before filing of the TTRA on June 29, 2011, being in violation of the requirement under RMO 72-2010 that filing of the TTRA should be made BEFORE the transaction, that is the payment of software and service fees. Accordingly, said payments shall be subject to tax at the rate provided in Section 28 of the aforementioned Tax Code of 1997, as amended. SCADIT On the other hand, the payments by CMIC to KRX from the time of filing of this application on June 29, 2011 , under the License Agreement, are entitled to relief under the tax treaty. Considering that the services to be performed by KRX employees in the Philippines are expected to be more or less 120-days within twelve-month period per certificate issued by CMIC June 28, 2011, and for as long as the services for the License Agreement do not exceed 183-days within any twelve-month period such that KRX will not be deemed to have a permanent establishment in the Philippines to which its business profits may be attributed, any income to be derived by KRX shall not be subject to Philippine income tax, pursuant to Article 7 (1), in relation to Article 5, of the Philippines-Korea tax treaty. Finally, on VAT, Sections 107 (A) and 108 (A) of the Tax Code of 1997, as amended, provide: "SEC. 107. Value-added Tax on Importation of Goods. (A) In General. There shall be levied, assessed and collected on every importation of goods a value-added tax equivalent to ten percent (10%) 6 based on the total value used by the Bureau of Customs in determining tariff and customs duties, plus customs duties, excise taxes, if any, and other charges, such tax to be paid by the importer prior to the release of such goods from customs custody: . . . . xxx xxx xxx" "Section 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 per cent (10%) now (12%) of the gross receipt of derived from the sale or exchange of services, including the use or lease of properties: . . . xxx xxx xxx 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. . . ." xxx xxx xxx" Accordingly, the compensation for the supply of equipment [being treated as importation of goods under Section 107 (A)], and the compensation for the services rendered in the Philippines, technical services rendered in the Philippines, guarantee of loans, training services, rental of tools, equipment and materials, and other services [being treated as sale of services and use or lease of properties under Section 108 (A)], to be paid by CMIC to KRX under the License Agreement, are subject to VAT. SEAHID With regard to the procedures for the withholding and the payment of the VAT on the compensations mentioned, Sections 4 and 6 of Revenue Regulations No. 4-2000, Section 3 of Revenue Regulations No. 8-2002, and Section 7 of Revenue Regulations No. 14-2002, provides that CMIC, being the payor in control of the payment will be responsible for the withholding of the VAT on the compensation before remitting them to KRX, the portion of the fees to be paid by CMIC to KRX for whatever portion of services to be rendered in the Philippines under the Agreement are subject to the 10% (now 12%) VAT pursuant to Section 108 of the Tax Code of 1997, as amended. Accordingly, CMIC in withholding the VAT on such fees shall file a separate VAT return for and on behalf of KRX using 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 sufficient basis for the claim of input tax to be applied against the output tax that may be due from CMIC, if it is a VAT-registered taxpayer. In case CMIC is a non-VAT registered taxpayer, the passed-on VAT withheld shall form part of the cost of the service purchased or treated as an "expense" or an "asset", whichever is applicable. In addition, CMIC is required to issue a Certificate of Final Tax Withheld at Source (BIR Form No. 2306) in quadruplicate, the first three copies thereof to be given to KRX upon its request, and the fourth copy to be retained by CMIC as its file copy. [Section 4.110-3 (b), Revenue Regulations (RR) No. 7-95, as amended by RR Nos. 4-02, 8-02, and 14-02 (now Section 4, 114-2 (b), RR No. 16-05)]. This ruling is issued on the basis of the foregoing 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. "Licensed Software" means the software products describe in Schedule 1 licensed by KRX to CMIC and where applicable, shall include the documentation and user manuals relating to the Licensed Software. 2. "Equipment" means the hardware specified in Schedule 2 including all electronic devices, electromechanical parts and associated components and any software package therein. 3. "Third Party Software" means any other software licensed from a third party required for the operation for the Surveillance System, as described in Schedule 2 and where applicable, shall include the documentation and user manuals relating to the Third Party Software. 4. "Implementation Services" means the service provided by KRX to CMIC as amended and/or included to the scope to develop, deliver, test and commission the Surveillance System and any other obligations of KRX. 5. "Maintenance Services" means the maintenance of services to be provided or procured by KRX to/for CMIC in respect of the Licensed Software, Customisations and Developed Applications, Equipment, Third Party Software or any other component of the Surveillance System as described in the Maintenance Agreement. 6. Now "12%".