ITAD BIR Ruling No. 202-14

October 3, 2014 ITAD BIR RULING NO. 202-14 Articles 5 (Permanent Establishment) and 7 (Business Profits) Philippines-Australia tax treaty Bank of the Philippine Islands BPI Head Office Building Ayala Avenue corner Paseo de Roxas Makati City Attention: Pilar Bernadette C. Marquez Senior Vice President Gentlemen : This refers to your tax treaty relief application filed on December 11, 2012 requesting confirmation that the payments made by Bank of the Philippine Islands ("BPI") to Fraudwatch International Pty Ltd ( "Fraudwatch" ) are not subject to Philippine income tax, pursuant to the provisions 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" ). It is represented that Fraudwatch is a corporation registered under the laws of Australia as evidenced by its Certificate of Registration, with principal office address at the Ground Floor, 20 Albert Street Blackburn Victoria, Australia based on its Certificate of Residency issued by the Australian Taxation Office on December 6, 2011; that Fraudwatch is not registered either as a corporation or as a partnership in the Philippines as evidenced by the Certification of Non-Registration of Corporation/Partnership dated December 3, 2012, issued by the Philippine Securities and Exchange Commission; that on the other hand, BPI is a domestic corporation with principal office located at BPI Head Office Building, Ayala Avenue corner Paseo de Roxas, Makati City. It is further represented that on October 22, 2012, Fraudwatch and BPI entered into an Anti-Phishing Solution Subscriber Agreement ( "Agreement" ) whereby Fraudwatch will provide 24-hour monitoring of the internet to detect: (a) phishing incidents and cases of brand abuse (b) malware incidents, (c) fraudulent sites and contents, and (d) unauthorized mobile applications, targeting BPI 's brands; that upon detection and confirmation, Fraudwatch will create an incident in BPI portal, and work on removing a phishing activity from the internet; that Fraudwatch shall immediately notify and communicate the same to BPI; that for and in consideration of the said services, BPI shall pay Fraudwatch a fee of PhP1,300,000 and an additional take down fee of PhP13,000 per incident; that the fees shall be invoiced at the end of each month and shall be payable within 30 days from invoice; that the services are not to be performed in the Philippines, unless otherwise required due to exceptional circumstances based on the Certification issued by BPI on November 9, 2012; and that the first payment of the service fees under the Agreement was made on December 20, 2012 based on the telegraphic transfer issued by the Bank of Philippine Islands on even date. TCASIH It is finally represented that the issue or transaction subject of the above application 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 based on the Certification issued by BPI on November 9, 2012. In reply, please be informed that Section 28 (B) (1) of the National Internal Revenue Code (Tax Code) of 1997, as amended by Republic Act No. 9337, applies in general to income received by a nonresident foreign corporation from all sources within the Philippines. It provides: "Section 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): n Provided, That effective January 1, 2009, at the rate of income tax shall be thirty percent (30%). xxx xxx xxx" However, Section 32 (B) (5) of the Tax Code of 1997, provides: "Section 32. Gross Income. xxx xxx xxx (B) Exclusions from Gross Income. The following items shall not be included in gross 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. SIcCTD xxx xxx xxx" Since Fraudwatch is a resident of Australia pursuant to Article 4 of the Philippines-Australia tax treaty, the provisions of said treaty may be used to determine the taxability of its income under the Agreement. To distinguish between payments for the supply of services and payments for know-how, the following commentaries of the Organisation for Economic Cooperation and Development ( "OECD" ) Model Tax Convention on Income and on Capital (Condensed Version, July 2010) mention: "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 recognized 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 that 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. HTcDEa 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. 11.4. Examples of payments which should therefore not be considered to be received as consideration for the provision of know-how but, rather, for the provision of services, include: payments obtained as consideration for after-sales service, payments for services rendered by a seller to the purchaser under a warranty, payments for pure technical assistance, payments for a list of potential customers, when such a list is developed specifically for the payer out of generally available information (a payment for the confidential list of customers to which the payee has provided a particular product or service would, however, constitute a payment for know-how as it would relate to the commercial experience of the payee in dealing with these customers), payments for an opinion given by an engineer, an advocate or an accountant, and payments for advice provided electronically, for electronic communications with technicians or for accessing, through computer networks, a trouble-shooting database such as a database that provides users of software with non-confidential information in response to frequently asked questions or common problems that arise frequently. " (Pages 225-226) underscoring supplied. In this case, since the services to be performed under the Agreement includes purely technical assistance such that said services are provided electronically, then the same is a contract for supply of services and not that of know-how. In this regard, Article 7, and in relation hereto, Article 5 of the Philippines-Australia tax treaty provide: TAacHE "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. xxx xxx xxx 4. An enterprise shall be deemed to have a permanent establishment in one of the Contracting States and to carry on business through that permanent establishment if substantial equipment is being used in that State for more than six months by, for or under contract with the enterprise. (emphasis supplied) xxx xxx xxx" Based on the above provisions, the profits of an enterprise which is a resident of Australia shall be taxable only in Australia unless such enterprise carries on business in the Philippines through a permanent establishment situated therein. If the enterprise which is a resident of Australia carries on business as aforesaid, the profits of such enterprise may be taxed in the Philippines but only so much of such profits as is attributable to that permanent establishment. Applying this to the instant case, the income payments received by Fraudwatch from BPI for the services rendered under the subject Agreement shall be taxable in the Philippines only if it has a permanent establishment in the Philippines in connection with the activities giving rise to such income. Inasmuch as it has been represented that the services shall be performed by Fraudwatch in Australia through the internet, and in the event that such services shall be required to be performed in the Philippines under exceptional circumstances for an aggregate period not exceeding 183 days, then Fraudwatch is deemed not to have a permanent establishment in the Philippines. Thus, the income payments received by Fraudwatch from the services it rendered or will render to BPI shall not be subject to Philippine income tax and consequently from withholding tax. acHITE However, services performed by Fraudwatch in the Philippines will be subject to value-added tax ( "VAT" ) pursuant to Section 108 (A) of the Tax Code, 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, 1 raise the rate of value-added tax 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 . . ." 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. 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.