ITAD BIR Ruling No. 231-12

June 5, 2012 ITAD BIR RULING NO. 231-12 Sections 23 (F), 42 (A) (3) and 108 (A) National Internal Revenue Code of 1997, as amended; Article 12 (Royalties); Philippines-Malaysia tax treaty; BIR Ruling No. ITAD 297-11 S.E. Industries (Philippines), Inc. 12-C, 1st Avenue corner Sta. Teresita Drive Bagumbayan, Taguig City Attention: Necita G. Doyugan Finance and Administrative Manager Gentlemen : This refers to your Tax Treaty Relief Application ("TTRA") filed and received on July 30, 2009 requesting confirmation that payments made by S.E. Industries (Philippines), Inc. ("S.E. Industries") to Super Enterprise Holdings Bhd. ("Super Enterprise") are subject to preferential treatment pursuant to the Agreement between the Government of the Republic of the Philippines and the Government of Malaysia for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income ("Philippine-Malaysia tax treaty") . Facts Super Enterprise is a corporation organized and existing under the laws of Malaysia based on its Memorandum and Articles of Association. Super Enterprise is situated at Lot 9, Jalan E1/1, Kawasan Perusahaan Taman Ehsan, 52100 Kepong, Kuala Lumpur, Malaysia. Super Enterprise is not registered as a corporation or partnership in the Philippines based on the Certification of Non-Registration of Corporation/Partnership issued by the Securities and Exchange Commission on June 2, 2009. On the other hand, S.E. Industries is a domestic corporation situated at 12-C, 1st Avenue corner Sta. Teresita Drive Bagumbayan, Taguig City, Philippines. On April 1, 2006, S.E. Industries and Super Enterprise entered into a Management Fee Agreement where Super Enterprise agreed to provide the following services to S.E. Industries : a) Technical Transfer and Human Resources Development Super Enterprise will provide technical assistance to S.E. Industries on product development and transfer of printing technology. Super Enterprise will also develop the skills of technicians and printers of S.E. Industries to ensure that they acquire knowledge on new printing techniques. SHADEC b) Machinery Procurement and Maintenance Super Enterprise will develop advanced machinery profiles and provide related information to S.E. Industries . Super Enterprise will assist S.E. Industries in the procurement and installation of new machinery upon request, and will offer adequate training program on machine operation and maintenance thereof. c) Operational Improvement Super Enterprise will impart various tools and techniques on quality improvement to ensure that S.E. Industries receives a quality assurance certification from Underwriters Laboratories, Inc. d) Corporate Guarantee Super Enterprise will provide corporate guarantee in respect of banking facilities granted to S.E. Industries to enable it to acquire more facilities to expand and increase its sales. In consideration, S.E. Industries will pay the following fees to Super Enterprise : April 1, 2006 April 1, 2007 April 1, 2008 April 1, 2009 -March 31, -March 31, -March 31, -March 31, 2007 2008 2009 2010 a) Fee for technical transfer 7,200.00 7,280.00 12,940.00 11,640.00 and human resources development b) Fee for machinery 5,400.00 5,460.00 9,700.00 8,730.00 procurement and maintenance c) Fee for operational improvement 3,230.00 3,270.00 5,820.00 5,240.00 d) Fee for corporate guarantee 2,150.00 2,180.00 3,890.00 3,494.00 Total per month (in Malaysian Ringgit) 17,980.00 18,190.00 32,350.00 29,104.00 ======== ======== ======== ======== In addition, Super Enterprise may impose interest on the late payment on such fees at the rate of 5 percent per annum. The Agreement took effect on April 1, 2006 and had an initial term of one year up to March 31, 2007. Based on the Letters of Renewal dated April 1, 2007, the Agreement was renewed for three consecutive years and extended up to March 31, 2008, March 31, 2009, and March 31, 2010. Based on the Affidavit issued by S.E. Industries on August 27, 2010, Super Enterprise did not send any personnel to the Philippines to perform services to S.E. Industries . aTHASC Ruling Fees for machinery procurement and maintenance, for operational improvement, and for corporate guarantee Please be informed that with respect to the fees for machinery procurement and maintenance , for operational improvement , and for corporate guarantee , inasmuch as the services or activities that give rise to these fees are not carried out by Super Enterprise in the Philippines but in Malaysia (since it did not send any personnel to the Philippines for this purpose), the situs 1 of these incomes is not the Philippines under Section 42 (A) (3) of the National Internal Revenue Code of 1997 ("Tax Code") , as amended, to wit: "Section 42. Income from Sources Within the Philippines . (A) Gross Income From Sources Within the Philippines . The following items of gross income shall be treated as gross income from sources within the Philippines : xxx xxx xxx (3) Services . Compensation for labor or personal services performed in the Philippines ;" (Emphasis ours) Relative thereto, under Section 23 (F) of the Tax Code, a foreign corporation, whether or not engaged in trade or business in the Philippines, is taxable only on income derived from sources in the Philippines , to wit: "SEC. 23. General Principles of Income Taxation in the Philippines . Except when otherwise provided in this Code: xxx xxx xxx (F) A foreign corporation , whether engaged or not in trade or business in the Philippines, is taxable only on income derived from sources within the Philippines ." (Emphasis ours) CSaIAc Accordingly, since the situs of the fees (for machinery procurement and maintenance, for operational improvement, and for corporate guarantee) is not the Philippines, such fees (including interest on late payment of these fees, if any) paid by S.E. Industries to Super Enterprise under the Agreement, for the period April 1, 2006 to March 31, 2010 , shall be exempt from income tax pursuant to Section 23 (F), in relation to Section 42 (A) (3), of the Tax Code. (BIR Ruling No. 464-93 dated November 19, 1993; BIR Ruling No. 219-88 dated May 27, 1988) Fee for technical transfer and human resources development However, with respect to the fee for technical transfer and human resources development , this is Super Enterprise's compensation for the provision of technical assistance to S.E. Industries on product development and on the transfer of printing technology to S.E. Industries in order to develop the skills of S.E. Industries' technicians and printers and to ensure that they acquire knowledge on new printing techniques. This fee cannot be regarded merely as compensation for services but as royalties , being payments for the supply of scientific, technical, industrial or commercial knowledge or information ("know-how") , and the situs of which is the Philippines under Section 42 (A) (4) (c) of the Tax Code, to wit: "Section 42. Income from Sources Within the Philippines . (A) Gross Income from Sources Within the Philippines. The following items of gross income shall be treated as gross income from sources within the Philippines : xxx xxx xxx (4) Rental and Royalties . Rentals and royalties from property located in the Philippines or from any interest in such property, including rentals or royalties for (c) The supply of scientific, technical, industrial or commercial knowledge or information ;" (Emphasis ours) Under paragraph 2 (b), in relation to paragraph 4 (a) and (c), Article 12 of the Philippines-Malaysia tax treaty, royalties arising in the Philippines and paid to a resident of Malaysia may be taxed in the Philippines at a rate not to exceed (a) 15 percent if the royalties are paid by an enterprise registered with the Board of Investments and engaged in preferred areas of activities, or if the royalties are for the use of, or the right to use, cinematograph films, or tapes for radio or television broadcasting; and (b) 25 percent in all other cases, thus: TEcADS "Article 12 ROYALTIES xxx xxx xxx 2. Such royalties may also be taxed in the Contracting State in which they arise, and according to the laws of that State. However, if the recipient is the beneficial owner of the royalties: xxx xxx xxx b) in the case of the Philippines: the tax so charged shall not exceed: (i) 15 per cent of the gross amount of the royalties where the royalties are paid by a registered enterprise as well as royalties defined in paragraph 4 (a) (ii); and (ii) 25 per cent of the gross amount of the royalties in all other cases. 4. a) The term 'royalties' as used in this Article means payments of any kind received as consideration for: (i) the use of, or the right to use, any patent, trade mark, design or model, plan, secret formula or process, any copyright of literary, artistic or scientific work, or for the use of, or the right to use, industrial, commercial, or scientific equipment, or for information concerning industrial, commercial or scientific experience; (ii) the use of, or the right to use, cinematograph films, or tapes for radio or television broadcasting." xxx xxx xxx c) The term 'registered enterprise' as used in this Article means an enterprise registered with the Philippine Board of Investments and engaged in preferred areas of activities." ACIDSc However, in relation to the filing of TTRAs, under Section III (2) of Revenue Memorandum Order No. 1-00 (Procedures for Processing Tax Treaty Relief Application) ("RMO 1-2000") , any availment of tax treaty relief (exemption from income tax or reduction of tax) shall be preceded by an application filed at the International Tax Affairs Division ("ITAD") of this Bureau at least 15 days before the intended transaction or payment of income, thus: "III. Policies: In order to achieve the above-mentioned objectives, the following policies shall be observed: xxx xxx xxx 2. Any availment of the tax treaty relief shall be preceded by an application by filing BIR Form No. 0901 (Application for Relief from Double Taxation) with ITAD at least 15 days before the transaction i.e., payment of dividends, royalties, etc., accompanied by supporting documents justifying the relief . . ." 2 (Emphasis ours) In view of the foregoing, since the fee for technical transfer and human resources development, as royalties, was paid every month throughout the term of the Agreement on April 1, 2006 to March 31, 2010 , but the subject TTRA was filed on July 30, 2009 , this Office hereby DENIES relief on the fees paid by S.E. Industries to Super Enterprise before August 14, 2009 , in violation of the fifteen-day prior application rule under RMO 1-2000. These fees (including any interest on late payment thereon) shall be subject to income tax under Section 28 (B) (1) of the Tax Code, 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: Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)." cTCEIS On the other hand, the fees (including interest on late payment thereon) paid by S.E. Industries to Super Enterprise on August 14, 2009 and thereafter shall be subject to income tax at the rate of 25 percent of the gross amount thereof under paragraph 2 (b) (ii), Article 12 of the Philippines-Malaysia tax treaty. (BIR Ruling No. ITAD 297-11 dated November 25, 2011) Value-added tax Finally, with respect to value-added tax ("VAT"), the fees for machinery procurement and maintenance, for operational improvement, and for corporate guarantee (including interest on late payment of these fees, if any), being payments for services not performed in the Philippines, shall be exempt from 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, 3 raise the rate of value-added tax to twelve percent (12%) . . . aTICAc 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 . . ." (Emphasis ours) On the other hand, the fee for technical transfer and human resources development, being payments for the lease of an intangible property (know-how) in the Philippines , are subject to VAT pursuant to Section 108 (A) (3) of the Tax Code, to wit: ". . . The phrase 'sale or exchange of services 'shall likewise include: (3) The supply of scientific, technical, industrial or commercial knowledge or information ;" (Emphasis ours) Relative thereto, S.E. Industries shall withhold VAT on the fee (for technical transfer and human resources development) at the rate of 12 percent before remitting it to Super Enterprise. S.E. Industries 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 S.E. Industries' claim of input tax on the fee. Otherwise, if S.E. Industries is not a VAT-registered taxpayer, it may treat such 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. 4 DEcITS 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. Under paragraph 1, Article 7, in relation to paragraphs 1, 2 and 4, Article 5, of the Philippines-Malaysia tax treaty, the exemption or relief sought for will come into play only if the situs of income is the Philippines by reason, for example, in the case of income from the provision of services, the services are performed in the Philippines and the enterprise concerned has no permanent establishment in the Philippines so that such income will not be taxed therein, thus: "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 thereof as is attributable to that permanent establishment ." "Article 5 PERMANENT ESTABLISHMENT 1. For the purposes of this Agreement, the term 'permanent establishment' means a fixed place of business in which the business of the 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, an oil or gas well, a quarry or other place of extraction of natural resources including timber or other forest produce; g) a farm or plantation; h) a building site or construction, installation or assembly project which exists for more than 6 months. xxx xxx xxx 4. An enterprise of a Contracting State shall be deemed to have a permanent establishment in the other Contracting State if: a) it carries on supervisory activities in that other State for more than 6 months in connection with a construction, installation or assembly project which is being undertaken in that other State; or b) substantial equipment is in that other State being used or installed by, for or under contract with, the enterprise." 2. This condition was emphasized by the Court of Tax Appeals in Mirant (Philippines) Operations Corporation vs. Commissioner of Internal Revenue (C.T.A. Case No. 6382 dated June 7, 2005) where it ruled: " However, it must be remembered that a foreign corporation wishing to avail of the benefits of the tax treaty should invoke the provisions of the tax treaty and prove that indeed the provisions of the tax treaty applies to it, before the benefits may be extended to such corporation . In other words, a resident or non-resident foreign corporation shall be taxed according to the provisions of the National Internal Revenue Code, unless it is shown that the treaty provisions apply to the said corporation, and that, in cases the same are applicable, the option to avail of the tax benefits under the tax treaty has been successfully invoked. Under Revenue Memorandum Order 01-2000 of the Bureau of Internal Revenue, it is provided that the availment of a tax treaty provision must be preceded by an application for a tax treaty relief with its International Tax Affairs Division (ITAD). This is to prevent any erroneous interpretation and/or application of the treaty provisions with which the Philippines is a signatory to. The implementation of the said Revenue Memorandum Order is in harmony with the objectives of the contracting state to ensure that the granting of the benefits under the tax treaties are enjoyed by the persons or corporations duly entitled to the same . The Court notes that nowhere in the records of the case was it shown that petitioner indeed took the liberty of properly observing the provisions of the said order. Petitioner quotes various BIR, as well as ITAD, Rulings issued to several foreign corporations seeking for a tax relief from the office of the respondent. However, not any one of these rulings pertains to the petitioner. It must be stressed that BIR rulings are issued based on the facts and circumstances surrounding particular issue/issues in question and are resolved on a case-to-case basis. It would be thus erroneous to invoke the ruling of the respondent in specific cases, which have no bearing to the case of petitioner." (Emphasis ours) This decision was also upheld by the Supreme Court in a Resolution (G.R. No. 168531) dated February 18, 2008. Furthermore, the necessary requirement laid down in RMO 1-2000 is reiterated in subsequent rulings of the Court of Tax Appeals: Deutsche Bank AG Manila Branch vs. Commissioner of Internal Revenue (C.T.A. Case No. EB 456 dated May 29, 2009), CBK Power Company Ltd. vs. Commissioner of Internal Revenue (C.T.A. Case Nos. 6699, 6844 and 7166 dated March 29, 2010) and Manila North Tollways Corporation vs. Commissioner of Internal Revenue (C.T.A. Case No. 7864 dated April 12, 2011) . 3. 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. 4. 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 corporations, individuals, estates and trusts, 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) Services rendered to local insurance companies with respect to reinsurance premiums payable to non-residents, and (3) 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."