ITAD BIR Ruling No. 234-13

August 15, 2013 ITAD BIR RULING NO. 234-13 Articles 5 (Permanent Establishment) and 7 (Business Profits), Philippines-United Kingdom of Great Britain and Northern Ireland tax treaty Maynilad Water Services, Inc. MWSS Compound Katipunan Road, Balara Quezon City Attention: Mr. Randolph T. Estrellado Chief Finance Officer Gentlemen : This refers to your tax treaty relief application ("TTRA") filed on May 10, 2011 requesting confirmation that service fees paid by Maynilad Water Services, Inc. ("Maynilad") to JD7 Ltd. ("JD7") are exempt from income tax pursuant to the Convention between the Government of the Republic of the Philippines and the Government of the United Kingdom of Great Britain and Northern Ireland for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital Gains ("Philippines-United Kingdom tax treaty") . CSDcTA Facts JD7 is a foreign corporation and a resident of the United Kingdom based on its Memorandum and Articles of Association, Certificate of Incorporation, and Certificate of Residence issued by Her Majesty's Revenue and Customs of the United Kingdom on March 7, 2011. JD7 is located at Unit 8, Masons Place Business Park, Nottingham Road, Derby, England, United Kingdom. It is not registered as a corporation or partnership in the Philippines based on the Certificate of Non-Registration of Corporation/Partnership issued by the Securities and Exchange Commission on February 18, 2011. On the other hand, Maynilad is a domestic corporation. It is the water and wastewater services provider for the seventeen cities and municipalities that comprise the West Zone of the greater Metro Manila area in the Philippines. It was granted a twenty-five year exclusive concession by the Philippine Government, through the Metropolitan Waterworks and Sewerage System, to operate, maintain and invest in the water and sewerage system in these areas. On March 30, 2011, Maynilad and JD7 entered into a Contract for Live Mains Investigations on Pipelines (Potable Water) where JD7 agreed to inspect Maynilad 's pipelines for potable water using its (JD7) pipeline inspection technology and employing a support team for this purpose. In consideration, Maynilad will pay fees to JD7. Payment will be made within twenty-eight days after the receipt of the relevant invoice from JD7. The fees will be in United States dollars and remitted to JD7's designated bank in the United Kingdom. Based on the Affidavit issued by Maynilad on March 18, 2013, Maynilad engaged the services of JD7 to demonstrate the use of the latter's products, namely, LDS1000 and LDS2012, in inspecting and testing Maynilad 's primary pipelines that are located in certain parts of its service area. The services were carried out in the Philippines by the following personnel of JD7: Ta DI Personnel Inclusive Dates Daniel Poyntz February 14-April 2, 2012 Clive Webster Adam Rustom Daniel Krywyj Total 49 days ============== The service fees paid by Maynilad to JD7 for such services amounted to US$150,000.00 and were remitted as follows: Date of Remittance Amount Remitted Remitting Bank Receiving Bank (in US Dollars) November 19, 2010 52,500.00 Banco de Oro Royal Bank of June 16, 2011 22,500.00 Universal Bank Scotland June 16, 2011 75,000.00 Total 150,000.00 ========= Ruling Relative thereto, please be informed that under Section 14 of Revenue Memorandum Order No. 72-2010 (Guidelines on the Processing of Tax Treaty Relief Applications (TTRA) Pursuant to Existing Philippine Tax Treaties) ("RMO 72-2010") , which covers income derived or accrued on November 4, 2010 and thereafter , 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 before the intended transaction or payment of income, to wit: HASDcC " SEC. 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 ours) This condition is 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. EcHaAC 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 is upheld by the Supreme Court in Resolution G.R. No. 168531 dated February 18, 2008. Furthermore, the necessary requirement 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) . In view of the foregoing, since the service fees subject of the TTRA were first paid by Maynilad to JD7 on November 19, 2010 , but the TTRA was filed only on May 10, 2011 , this Office hereby DENIES relief on such fees paid on or before May 10, 2011 , pursuant to Section 14 of RMO 72-2010. Accordingly, said fees shall be subject to income tax at the rate of 30 percent under Section 28 (B) (1) of the National Internal Revenue Code of 1997 (" Tax Code "), as amended, 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: n Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)." TAaIDH On the other hand, the fees paid to JD7 on May 11, 2011 and thereafter are subject to relief under Article 7 of the Philippines-United Kingdom tax treaty, which 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 directly or indirectly attributable to that permanent establishment." Under Article 7, profits derived by an enterprise of the United Kingdom from sources in the Philippines may be taxed in the Philippines if the profits are attributable to a permanent establishment of the enterprise situated in the Philippines. Relative thereto, Article 5, of the treaty defines a permanent establishment as follows: "Article 5 Permanent Establishment 1. For the purposes of this Convention, 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; ASHECD c) an office; d) a factory; e) a workshop. xxx xxx xxx 3. An enterprise of a Contracting State shall likewise be deemed to have a permanent establishment in the other Contracting State if: a) it carries on supervisory activities within that other Contracting State for more than 183 days in connection with a building site, or a construction or assembly project which is being undertaken, in that other Contracting State; or b) it furnishes services, including consultancy services, in that other Contracting State through its employees or other personnel (other than agents of an independent status within the meaning of paragraph 7 of this Article) for a period exceeding in the aggregate 183 days within any twelve-month period." Under Article 5, a permanent establishment means a fixed place of business through which the business of an enterprise is wholly or partly carried on, and includes especially, a place of management, a branch, an office, a factory, and a workshop. It also includes the furnishing of services, including consultancy services, in a Contracting State by an enterprise of the other Contracting State (through employees or other personnel thereof) for a period exceeding an aggregate of 183 days within any twelve-month period. Accordingly, since JD7 is not engaged in trade or business in the Philippines to which a branch, an office, or other fixed place of business is necessary, and since it did not furnish services in the Philippines for more than 183 days within any twelve-month period, but for 49 days only to inspect Maynilad 's pipelines for potable water and to demonstrate to Maynilad the relevant technological products thereto developed by JD7, JD7 shall not be deemed to have a permanent establishment in the Philippines under these circumstances, pursuant to paragraphs 1, 2 and 3, Article 5 of the Philippines-United Kingdom tax treaty. This being the case, the service fees paid therefor by Maynilad to JD7 on May 11, 2011 and thereafter shall be exempt from income tax, pursuant to paragraph 1, Article 7 of the treaty. TCcDaE Furthermore, on the classification of the service fees as business profits (which are exempt from income tax if not attributable to a permanent establishment) and not as payments for know-how or royalties (which are subject to reduced rate of income tax), the following commentaries of the Organisation for Economic Co-operation and Development Model Tax Convention on Income and on Capital (Condensed Version, July 22, 2010) mention that: "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 recognised 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 the 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. aEcDTC 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." (Pages 225-226) Based on the commentaries, in a contract for the supply of know-how, there would generally be very little more which needs to be done by the supplier other than to supply existing information or reproduce existing material. On the other hand, in a contract for the performance of services, this involves, in a majority of cases, a very much greater level of expenditure by the supplier in order to perform his contractual obligations to the other party, such as salaries and wages for employees engaged in researching, designing, testing, drawing and other associated activities or payments to subcontractors for the performance of similar services. Accordingly, since the Contract did not require JD7 to supply existing information or reproduce existing material to Maynilad, but to provide services Maynilad by inspecting its pipelines for potable water and demonstrating to Maynilad the relevant technological products, the Contract in question is clearly a contract for the performance of services and not for the supply of know-how or other royalty-bearing property. Moreover, by reason that the services are rendered for a considerable period of 49 days by designated personnel of JD7, it is certain that a greater level of expenditure (such as salaries and other remuneration of these personnel) was incurred by JD7 to fulfil its contractual obligations to Maynilad. This being the case, the service fees paid by Maynilad to JD7 constitute clearly as business profits and not royalties. ADcEST Finally, under Section 108 (A) in relation to Section 105 of the Tax Code, the service fees paid to JD7, a nonresident foreign person, for services it rendered 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 (irreSGS Testingtive of the disposition of its net income and whether or not it sells exclusively to members or their guests), or government entity. 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." Relative thereto, Maynilad shall withhold VAT on the service fees at the rate of 12 percent before remitting them to JD7. Maynilad 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 its claim of input tax on the fees; otherwise, if it is not a VAT-registered taxpayer, Maynilad 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 ScHAIT 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) 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." n Note from the Publisher: The phrase "and (d) above" no longer appears in RA 9337, the law amending this provision.