ITAD BIR Ruling No. 236-11

October 25, 2011 ITAD BIR RULING NO. 236-11 Articles 5 (Permanent Establishment), 7 (Business Profits), Philippines-Canada tax treaty Castillo Laman Tan Pantaleon & San Jose 2nd, 5th and 9th Floors, The Valero Tower 122 Valero Street, Salcedo Village Makati City 1227 Attention: Atty. Joseph Gregson A. Castillo Gentlemen : This refers to your tax treaty relief application dated May 10, 2010, on behalf of your client, Cirque Du Soleil, Inc. ("Cirque") , requesting confirmation that commissions to be paid by Hoopla, Inc. ("Hoopla") to Cirque are not subject to income tax in the Philippines pursuant to the Convention between the Philippines and Canada for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income ("Philippines-Canada tax treaty") . Facts It is represented that Cirque is a foreign corporation organized and existing under the laws of Canada and is resident thereof based on its Certificate of Amalgamation and on the Certification of Canadian Residency issued by the Canada Revenue Agency on January 11, 2011; that Cirque is situated at 8400, 2nd Avenue, Montreal, Quebec, Canada; that Cirque is not registered as a corporation or partnership in the Philippines based on the Certification of Non-Registration of Company issued by the Securities and Exchange Commission on February 25, 2011; and that, on the other hand, Hoopla is a corporation organized and existing under the laws of the Philippines, situated at 650 Jesus Extension, Pandacan, Manila, Philippines. It is further represented that on February 25, 2011, Cirque and Hoopla entered into a Ticket Sales and Distribution Agreement ("Agreement") where Hoopla assigned to Cirque all the Tickets available for sale for the Show ( "Tickets" ) during the Performance Period; that Show means a circus-style live production entitled Varekai to be presented by Cirque Du Soleil Shows B.V. ("Cirque Netherlands" ) of the Netherlands; that Performance Period means the period from June 22 to July 24, 2011 and for 40 performances (each a ("Performance") ; that Hoopla shall provide Cirque with accurate seating plans and seat contingent for all the Performances to go on advance sale; that Cirque shall act as an intermediary and agent for Hoopla in selling and distributing the Tickets; that Cirque shall use the Network it operates and maintains for such purpose and shall: TcDHSI a) Make all arrangements with a call centre providing Cirque with the exclusive services of its call centre which is connected to the Network ("Call Centre") for the sale of the Tickets; b) Conclude all necessary and appropriate agreements and make all arrangements to provide and maintain an internet site with the web address "www.cirquedusoleil.com" which is connected to the Network for the sale of the Tickets; c) Provide Hoopla with a web link to the Network transaction site. It shall be Hoopla's responsibility to activate the said link with its own internet site at www.hoopla.ph. For this purpose, Cirque internet site and Hoopla internet site shall hereinafter collectively be referred to as "Internet Sites" ; and d) Through its affiliate Cirque Netherlands, operate the on-site box-office ("Box Office"). That Network means the computer assisted ticket sales network throughout the world in order to offer advance ticket sales for events that take place worldwide; that Hoopla shall provide staff members available at all times during the regular business hours of the Box Office to serve ticket-buying customers and allow "Care of Box Office" customers to pick up their tickets; that Hoopla's assigned staff shall work under the supervision of Cirque Netherlands Box Office; that Hoopla authorizes Cirque to collect the amount of all proceeds generated from the sale of the Tickets sold through the Network; that in consideration, Hoopla shall pay Cirque a commission equal to eight percent (8%) of the Ticket Revenues generated through the Network, whether through the Call Centre, the Internet Sites, or the Box-Office; that Ticket Revenues means proceeds generated from the sale of the Tickets through the Network as evidenced by the sales reports generated by the Network; that the Ticket Revenues collected by Cirque from customers shall be in Philippine pesos; that the local cash proceeds collected at the Box Office shall be remitted to Hoopla directly on site and on a daily basis; and that Hoopla acknowledges and agrees that the Ticket Revenues (except for local cash) shall be immediately converted into United States dollars by a third party hired by Cirque for the processing of the transactions and shall be deposited at Cirque's bank account in United States dollars. It is finally represented that the income subject of this ruling is not under investigation, on-going audit, administrative protest, claims for refund or issuance of a tax credit certificate, collection proceedings, or judicial appeal, based on the Sworn Statement issued by the President of Hoopla on April 8, 2011. Ruling In reply, please be informed that income derived in the Philippines by Cirque, a foreign corporation not engaged in trade or business in the Philippines, is subject to income tax at the rate of 30 percent. Section 28 (B) (1) of the National Internal Revenue Code of 1997 ("Tax Code") , as amended, provides: "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): Provided, That, effective January 1, 2009, the rate of income tax shall be thirty percent (30%). EHSCcT xxx xxx xxx However, such income may be exempt from income tax or subject to a reduced rate to the extent required by any treaty obligation on the Philippines. Section 32 (B) (5) of the Code provides: "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: 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." With respect to a treaty, you invoke the Philippines-Canada tax treaty. Under tax treaties in general, payments for services are considered business profits unless they are otherwise treated as royalties when the contract out of which the services are rendered involves primarily the use or lease of an intangible property like know-how. In this regard, the following commentaries of the Organisation for Economic Cooperation and Development Model Tax Convention on Income and on Capital (Condensed Version, July 22, 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 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: DHSaCA 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. 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), aSCDcH 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 nonconfidential information in response to frequently asked questions or common problems that arise frequently." (Pages 225-226) Applying these commentaries, the commissions payable to Cirque are not royalties but business profits since: 1. The Agreement between Cirque and Hoopla concerns primarily the supply of services and not the lease by Cirque to Hoopla of any intangible property like know-how. 2. To perform services to Hoopla, Cirque will merely use its special knowledge, skill and expertise on the subject, and not the transfer of such special knowledge, skill or expertise to Hoopla. 3. To fulfill its contractual obligations, Cirque will actually perform services to Hoopla, particularly selling and distributing the Tickets by using the Network, and not simply supply existing information or material to Hoopla. As business profits, the commissions may be taxed in the Philippines if attributable to a permanent establishment which Cirque has in the Philippines. Paragraph 1, Article 7 of the Philippines-Canada tax treaty provides: "Article VII 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 or has carried 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 of goods or merchandise of the same or similar kind as those sold, or from other business activities of the same or similar kind as those affected, through that permanent establishment." With regard to a permanent establishment, paragraphs 1 and 2, Article 5 of the treaty provide: IaESCH Article V 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; c) an office; d) a factory; e) a workshop; f) a mine, quarry or other place of extraction of natural resources; g) a building or construction site or supervisory activities in connection therewith, where such activities continue for a period more than six months; h) an assembly or installation project which exists for more than three months; i) premises used as a sales outlet; j) a warehouse, in relation to a person providing storage facilities for others. As defined, a permanent establishment means a fixed place of business in 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; a workshop; a mine, quarry or other place of extraction of natural resources; a building or construction site or supervisory activities in connection therewith, where such activities continue for a period more than six months; an assembly or installation project which exists for more than three months; premises used as a sales outlet; and a warehouse, in relation to a person providing storage facilities for others. Accordingly, with respect to services rendered by Cirque to Hoopla under the Agreement, since Cirque is not engaged in trade or business in the Philippines, and since the services of selling and distributing the Tickets will be carried out by Cirque through the Call Centre, it is remote for Cirque to have a fixed place of business in the Philippines for this purpose such as an office, a branch, or premises used as a sales outlet that can constitute a permanent establishment. This being so, the commissions to be paid by Hoopla to Cirque for these services are exempt from income tax, pursuant to paragraph 1 Article 7, in relation to paragraphs 1 and 2, Article 5, of the Philippines-Canada tax treaty. Furthermore, the commissions at hand, being payments for the performance of services in the Philippines (since the Tickets will be issued in the Philippines and the Show will be performed in the Philippines), are subject to value-added tax ("VAT"). Section 108 (A) of the Tax Code, as amended, provides: aEDCSI "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%). . ." Accordingly, Hoopla, the resident withholding agent, shall withhold VAT on the commission to be paid to Cirque, the nonresident supplier of services, at the rate of 12 percent . Section 4.112-2 of Revenue Regulations No. 16-2005, 2 as amended by Revenue Regulations No. 4-2007, 3 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 'expense' or 'asset', whichever is applicable, of the resident withholding agent. TEAaDC VAT withheld under this Section shall be remitted within ten (10) days following the end of the month the withholding was made." 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. Entitled Consolidated Value-Added Tax Regulations of 2005 . 3. Entitled Amending Certain Provisions of Revenue Regulations No. 16-2005, as Amended, Otherwise Known as the Consolidated Value-Added Tax Regulations of 2005) .