ITAD BIR Ruling No. 206-11

August 3, 2011 ITAD BIR RULING NO. 206-11 Articles 5 & 7, Philippines-Japan tax treaty, as amended; BIR Ruling No. 068-88; BIR Ruling No. ITAD-101-00; BIR Ruling No. ITAD-091-01; BIR Ruling No. ITAD-078-02; BIR Ruling No. ITAD-184-02 F. Tech R & D Philippines, Inc. F. Tech Annex Bldg. 123 North Science Avenue Laguna Technopark, Bian, Laguna Attention: Yukimitsu Nakakura President, FRDP Gentlemen : This refers to your letter dated January 22, 2009 requesting confirmation that the fees for services rendered by F. Tech, Inc. (hereinafter referred to as "FTI") to F. Tech R & D Philippines, Inc. (hereinafter referred to as "FRDP") are not subject to Philippine income tax and value-added tax 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 (hereinafter referred to as the "Philippines-Japan tax treaty"). It is represented that FTI is a nonresident foreign corporation organized and existing under the laws of Japan with principal office address at 19 Showanuma, Shobu-machi, Minami Saitama-gun, Saitama, Japan per Residence Certificate issued on December 15, 2008 by the Kasukabe Tax Office; that FTI is not registered either as a corporation or as a partnership in the Philippines as shown in the Certification of Non-Registration issued by the Securities and Exchange Commission on December 15, 2008; that FTI is engaged in research and development activities and related improvement process of mechanical and electromechanical nature towards the enhancement and modification of vehicular support components, including automotive underbody products such as but not limited to suspensions, subframes, and pedals in a unique integrated system, either for itself, affiliates and third parties under acceptable outsourcing arrangements; that FRDP, on the other hand, is a domestic corporation with office address located at F. Tech Annex Bldg., 123 North Science Avenue, Laguna, Technopark, Bian, Laguna; and that FRDP is duly registered with the Philippine Economic Zone Authority (PEZA) as an ecozone export enterprise at the Laguna Technopark-Special Economic Zone under Certificate of Registration No. 08-44 issued on August 14, 2008. It is further represented that on October 1, 2008, FRDP and FTI entered into a Support Service Agreement (hereinafter referred to as "Service Agreement" ) that shall continue to be valid unless terminated by either Party at any time before the end of one (1) year period by giving at least sixty (60) days prior written notice to the other Party; that under the Service Agreement, FTI shall provide the following support services to FRDP: A. Management and Administration: (i) Assist in defining and implementing FRDP's business strategies and policies; (ii) Provide data on international business trends; (iii) Assist in improving management and administration system and provide solutions to problems encountered by FRDP in its operations on an on-going basis; (iv) Assist in foreign exchange management as well as procurement of financial support and facilities from both local and offshore sources and; (v) Evaluation of capital investment and risk management. B. Marketing (i) Review and advise on FRDP's marketing and promotional plans; aIHSEc (ii) Organize and participate in promotional activities; (iii) Analyze potential market, clients, competitive factors, etc.; (iv) Prepare brochures and other advertising/promotional materials; study and assist in the coordination of advertising campaigns; (v) Provide marketing financial analysis and assist FRDP in developing and implementing pricing and marketing strategies; (vi) Advise and assist in the framework of contracts with the clients and with the regional, national and international organization; and (vii) Assist in the negotiation with potential customers for possible supply agreement. It is finally represented that based on the Service Agreement, the above services shall be performed by FTI outside the Philippines, primarily in Japan; but that, however, in certain isolated cases and upon request of FRDP, FTI may agree to provide services in the Philippines for a period of up to one week if necessary; that in consideration for the services rendered, FRDP agrees and undertake to pay FTI an annual fee of Fifteen Million One Hundred Ninety-Four Thousand Forty Japanese Yen (15,194,040.00) for the services; that for the services rendered in the Philippines, the fee will be billed separately as agreed upon by both parties, FTI and FRDP; and that the issues or transactions subject of the above request for ruling are 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 taxpayer/s involved. 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 earned by a nonresident foreign corporation. 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 . . ., profits and income . . .: Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%). 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" In connection thereto, Article 7 of the Philippines-Japan tax treaty provides: "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." Based on the foregoing, the profits of an enterprise which is a resident of the Japan shall be taxable only in Japan unless such enterprise carries on business in the Philippines through a permanent establishment situated therein. If the Japan 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 FTI 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. In relation thereto, Article 5 of the same tax treaty provides: CHTcSE "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." 6. An enterprise of a Contracting State shall be deemed to have a permanent establishment in the other Contracting State if it furnishes in that other Contracting State consultancy services, or supervisory services in connection with a contract for a building, construction or installation project through employees or other personnel other than an agent of an independent status to whom paragraph 7 applies, provided that such activities continue (for the same project or two or more connected projects) for a period or periods aggregating more than six months within any taxable year . However, if the furnishing of such services is effected under an agreement between the Governments of the two Contracting States regarding economic or technical cooperation, that enterprise shall, notwithstanding any provisions of this Article, not be deemed to have a permanent establishment in that other Contracting State. Please be informed further that this Article 5 has been amended under Article I of a Protocol 1 amending the Philippines-Japan tax treaty which took effect on January 1, 2009, Article III of which reads as follows: Paragraph (6) of Article 5 of the Convention shall be deleted and replaced by the following: "(6) An enterprise of a Contracting State shall be deemed to have a permanent establishment in the other Contracting State if it furnishes in that other Contracting State consultancy services, or supervisory services in connection with a contract for a building, construction or installation project through employees or other personnel other than an agent of an independent status to whom paragraph (7) applies, provided that such activities continue (for the same project or two or more connected projects) for a period or periods aggregating more than six months within any twelve-month period. However, if the furnishing of such services is effected under an agreement between the Governments of the two Contracting States regarding economic or technical cooperation, that enterprise shall, notwithstanding any provisions of this Article, not be deemed to have a permanent establishment in that other Contracting State." Based on the foregoing, in order for FTI to be considered to have a permanent establishment to which said business profits may be attributed, it must satisfy the following conditions: 2 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." Accordingly, a resident corporation of Japan may be deemed to have a permanent establishment in the Philippines if, among others, the furnishing of services through its employees, in the same or connected project, continues within the Philippines for a period or periods aggregating more than six months period within any twelve month period. Since it appears, based on the SEC Certification, that FTI is not registered either as a corporation or as a partnership in the Philippines, and that FTI does not have a place of business at its disposal which is fixed or established at a distinct place with a certain degree of permanence in the Philippines through which it may use for carrying on its business, FTI is deemed as not having a permanent establishment to which said business profits may be attributed. CSTHca Thus, for as long as FTI is deemed not to have a permanent establishment in the Philippines to which its profits may be attributable, FTI's business profits shall be exempt from income tax and consequently from withholding tax. Considering that the above-mentioned services shall be mostly performed outside the Philippines and in some cases, shall be performed in the Philippines but not for a period exceeding six (6) months as provided for in Article 2, par. 2.2 of the Service Agreement, and for as long as the services for the renewal of the Service Agreement do not exceed more than six (6) months within any twelve-month period, FTI shall not be deemed to have a permanent establishment in the Philippines to which its business profits may be attributed. Therefore, the income derived by FTI from the services rendered to FRDC shall not be subject to Philippine income tax, pursuant to Article 7 (1) in relation to Article 5 of the Philippines-Japan tax treaty. (BIR Ruling No. 068-88 dated March 3, 1988; BIR Ruling No. DA-ITAD-101-00 dated August 7, 2000; BIR Ruling No. DA-ITAD-091-01 dated October 18, 2001; BIR Ruling No. DA-ITAD-078-02; BIR Ruling No. DA-ITAD-184-02 dated October 17, 2002) However, payment for services rendered in the Philippines shall be subject to value-added tax (VAT) under Section 108 of the Tax Code of 1997, as amended. It provides: "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%) 3 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, raise the rate of value-added tax to twelve percent (12%), after any of the following conditions has been satisfied: (1) The lease or the use of or the right or privilege to use any copyright, patent, design or model plan, secret formula or process, goodwill, trademark, trade brand or other like property or right; xxx xxx xxx" With regard to the procedure for the withholding and the payment of VAT, pursuant to Sections 4 and 6 of Revenue Regulations (RR) No. 4-2002, Section 3 of RR No. 8-2002, and Section 7 of RR No. 14-2002, Section 4.114.2 of RR No. 16-05 as last amended by RR No. 4-07, FRDP shall be responsible for the withholding of VAT on the service fees before remitting it to FTI. In remitting to the Bureau of Internal Revenue the VAT withheld, FRDP shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax & Other Percentage Taxes Withheld). If it is a VAT-registered taxpayer, FRDP may use as documentary substantiation for its claim of input VAT the duly filed BIR Form No. 1600 and the proof of payment accompanying such form. On the other hand, if it is a non-VAT-registered taxpayer, FRDP may include as part of the cost of the service fees to it by FTI, the VAT consequently shifted or passed on to it. In addition, FRDP is required to issue the Certificate of Final Tax Withheld at Source (BIR Form No. 2306) in quadruplicate, the first three copies for FTI and the fourth copy for FRDP as its file copy. 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. DTAESI Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes 1. 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. 2. Organization for Economic Cooperation and Development (OECD), 2005 edition, paragraph 2, pages 85-91. 3. The VAT rate was increased to 12% on 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.