ITAD BIR Ruling No. 213-14

October 8, 2014 ITAD BIR RULING NO. 213-14 Article 7 Business Profits Philippines-UAE tax treaty Smart Communications, Inc. 26th Floor, Smart Tower 6799 Ayala Avenue 1226 Makati City Attention: Ms. Rina R. Manuel Tax Department Head Gentlemen : This refers to your Tax Treaty Relief Application (TTRA) filed on May 5, 2011 on behalf of Delta Partners FZ-LLC (Delta Partners), requesting confirmation that service fees paid by Smart Communications, Inc. (SMART) to Delta Partners are exempt from income tax pursuant to the Convention between the Government of the Republic of the Philippines and the Government of the United Arab Emirates with respect to Taxes on Income, ("Philippines-UAE tax treaty"). It is represented that Delta Partners is a non-resident foreign corporation organized and existing under the laws of United Arab Emirates (UAE) with principal address at Media One Building, 29th Floor, Dubai Internet City, United Arab Emirates; that it is engaged in the business of providing professional consulting and technical services to entities providing communication services to end users; that it is not registered as a corporation or partnership in the Philippines per certificate of non-registration issued by the Securities and Exchange Commission on October 6, 2010. On the other hand, SMART is a domestic corporation engaged in the operation of integrated telecommunications services throughout the Philippines with principal place of business at 26th Floor, Smart Tower, Ayala Avenue, Makati City. It is represented that on January 1, 2011, SMART entered into a Professional Services Agreement (agreement) with Delta Partners; that Delta Partners agreed to provide strategic management consulting services to SMART and shall deploy during the term of the agreement from January 1 to June 30, 2011 a minimum base team of 5.5 Full Time Equivalents ("FTE") consultants which includes the Engagement Partner at a part-time basis; and that in compliance with the agreement, Delta Partners sent three personnel in the Philippines as per certification of duration of stay and certified copies of the passports of the said personnel for a total of seventy four (74) days with inclusive dates as follows: AEIcSa Also under the agreement, Delta Partners shall invoice SMART in respect of each calendar month (the "Monthly Invoice"). The Monthly Invoice shall cover fees for all Professional Services plus project expenses rendered in that calendar month under a Supplementary Agreement. The Monthly Invoices shall be submitted no earlier than the first day of the succeeding calendar month. The Monthly Invoices will be payable in US Dollars, based on the rate prevailing at the time of settlement. In return, SMART shall pay the Monthly Invoice within fifteen (15) days of receipt of the complete and correct invoice. The fees for the services to be provided by Delta Partners are provided as follows: Base Team shall be charged at 2,900 USD per day per FTE (equivalent to USD 68,300 monthly per FTE). Same rate applies to the Engagement Partner. There will be no charge regarding the Leadership Team. Intelligence Unit ("IU") and Analytical-Based Management ("ABM") Unit's support shall be charged at 1,000 USD per day per resource (equivalent to monthly USD 22,000 per resource). In addition, Delta Partners hereby commits to deliver one workshop on a relevant topic at no charge, if required. The Engagement Steering Committee shall decide when and to whom the workshops will be delivered. DIEACH The total fees for any given month shall be established in each Supplementary Agreement and will be the result of applying the frame agreement fees to the agreed team for the month. Project expenses regarding travelling, accommodation and other administrative expenses will be charged separately as follows: For the Base Team (including Engagement Partner) and ABM/IU unit resources expenses will be charged at 15% of the total monthly fees and added to the monthly invoice; For the Leadership Team, reasonable actual and documented project expenses for travelling, accommodation and other administrative expenses will be charged separately and provided that these actual and documented expenses were made with the prior written approval of SMART. Consequently, on May 6, 2011, SMART made its first payment to Delta Partners in the amount of US$1,419,330 as evidenced by a certification issued by the Tax Department Head of SMART on July 4, 2013 with an attached proof of remittance of the said amount. It is further represented, per the Certification issued by SMART dated June 28, 2011, that the issue subject of the above request is not under any investigation or on-going audit, administrative protest, claim for refund or issuance of tax credit certificate, collection proceedings, or a judicial appeal. In reply, please be informed that profits derived in the Philippines by a nonresident corporation, like Delta Partners in the instant case, are generally subject to tax under Section 28 (B) (1) of the National Internal Revenue Code of the Philippines of 1997 (Tax Code of 1997), as amended. It provides, viz. : EcIDaA "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 . . . profits and income. Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)." (Emphasis supplied) xxx xxx xxx" However, said income derived by a nonresident foreign corporation may be exempt or partially exempt pursuant to a treaty obligation to which the Philippine government is bound. Thus, Section 32 (B) (5) of the Tax Code of 1997, as amended provides, viz. : "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. ATICcS 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 the instant case, Article 7 (1) of the Philippines-UAE tax treaty appropriately applies. It provides: 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 of UAE shall be taxable only in UAE unless the enterprise carries on business in the Philippines through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the Philippines but only so much of them that is directly or indirectly attributable to that permanent establishment. Applying this to the instant case, the service fees received by Delta Partners for services rendered in the Philippines under the 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. In relation thereto, paragraphs 1 and 2 of Article 5 of the treaty define a permanent establishment as follows: TaCDAH "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 the 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 or exploration of natural resources; g) a farm or plantation; h) a building site, a construction assembly or installation project or supervisory activities in connection therewith, but only where such site, project or activity continues for a period of more than six months; i) the furnishing of services, including consultancy services, by an enterprise through employees or other personnel engaged by the enterprise for such purpose, but only where activities of that nature continue in the territory of the other Contracting State for a period or periods aggregating more than six months during any taxable year. xxx xxx xxx" Accordingly, since Delta Partners is not engaged in trade or business in the Philippines to which an office or a branch is necessary and the number of days of stay in the Philippines of the personnel sent by Delta Partners is less than six months or 183 days, then Delta Partners is considered to have no permanent establishment in the Philippines. This being the case, the consultancy service fees paid by SMART to Delta Partners under the agreement shall be exempt from income tax. CHDaAE Finally, under Section 108 (A), in relation to Section 105 of the Tax Code, the consultancy service fees paid by SMART to Delta Partners, a non-resident foreign corporation are subject to 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, 1 raise the rate of value-added tax to twelve percent (12%). . ." "SEC. 105. Persons Liable. Any person who, in the course of trade or business, sells, barters, exchanges, leases goods or properties, renders services, and any person who imports goods shall be subject to the value-added tax (VAT) imposed in Sections 106 to 108 of this Code. The value-added tax is an indirect tax and the amount of tax may be shifted or passed on to the buyer, transferee or lessee of the goods, properties or services. This rule shall likewise apply to existing contracts of sale or lease of goods, properties or services at the time of the effectivity of Republic Act No. 7716. The phrase 'in the course of trade or business' means the regular conduct or pursuit of a commercial or an economic activity, including transactions incidental thereto, by any person regardless of whether or not the person engaged therein is a non-stock, nonprofit private organization (irrespective of the disposition of its net income and whether or not it sells exclusively to members or their guests), or government entity. EcTaSC The rule of regularity, to the contrary notwithstanding, services as defined in this Code rendered in the Philippines by nonresident foreign persons shall be considered as being rendered in the course of trade or business ." (Emphasis ours) Relative thereto, SMART shall withhold VAT on the service fees at the rate of twelve percent (12%) before remitting them to Delta Partners. SMART shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld). The duly filed BIR Form No. 1600 and its accompanying proof of payment shall serve as documentary substantiation for SMART's claim of input tax on the fees; otherwise, if it is not a VAT-registered taxpayer, it may treat the VAT as an asset or expense, whichever is applicable. VAT withheld shall be remitted within ten days following the end of the month the withholding was made. 2 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. 2. Pursuant to Section 4.112-2 of Revenue Regulations No. 16-2005 (Consolidated Value-Added Tax Regulations of 2005), as amended by Revenue Regulations No. 4-2007 (Amending Certain Provisions of Revenue Regulations No. 16-2005, As Amended, Otherwise Known as the Consolidated Value-Added Tax Regulations of 2005), which provides: "SEC. 4.114-2. Withholding of VAT on Government Money Payments and Payments to Non-Residents. xxx xxx xxx (b) The government or any of its political subdivisions, instrumentalities or agencies including GOCCs, as well as private corporation, individuals, estates and trust, whether large or non-large taxpayers, shall withhold twelve percent (12%) VAT, starting February 1, 2006, with respect to the following payments: (1) Lease or use of properties or property rights owned by non-residents; and (2) Other services rendered in the Philippines by non-residents. In remitting VAT withheld, the withholding agent shall use BIR Form No. 1600 Remittance Return of VAT and Other Percentage Taxes Withheld. VAT withheld and paid for the non-resident recipient (remitted using BIR Form No. 1600), which VAT is passed on to the resident withholding agent by the non-resident recipient of the income, may be claimed as input tax by said VAT-registered withholding agent upon filing his own VAT Return, subject to the rule on allocation of input tax among taxable sales, zero-rated sales and exempt sales. The duly filed BIR Form No. 1600 is the proof or documentary substantiation for the claimed input tax or input VAT. Nonetheless, if the resident withholding agent is a non-VAT taxpayer, said passed-on VAT by the non-resident recipient of the income, evidenced by the duly filed BIR Form No. 1600, shall form part of the cost of purchased services, which may be treated either as an 'asset' or 'expense', whichever is applicable, of the resident withholding agent. VAT withheld under this Section shall be remitted within ten (10) days following the end of the month the withholding was made.