ITAD BIR Ruling No. 272-11

November 15, 2011 ITAD BIR RULING NO. 272-11 Articles 5 (Permanent Establishment) and 7 (Business Profits) Philippines-Spain tax treaty International Technical Assistance Consultants, SL Foreign Assisted Project Office c/o Department of Environment and Natural Resources Visayas Avenue, Diliman, Quezon City Attention: Mr. Ricardo Garcia Leandro Director Gentlemen : This refers to your application for tax treaty relief dated December 13, 2010 on the service fees paid by the DEPARTMENT OF ENVIRONMENT AND NATURAL RESOURCES ("DENR") to INTERNATIONAL TECHNICAL ASSISTANT CONSULTANTS, SL ("ITAC") (in Spanish, INTERNACIONAL DE TECHNOLOGIA ASISTENCIA Y CONSULTORIA, SOCIEDAD LIMITADA) are exempt from income tax pursuant to the Convention between the Republic of the Philippines and Spain for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income ("Philippines-Spain tax treaty") . It is represented that ITAC is a foreign corporation resident of Spain, based on its Articles of Incorporation and on its Residence Certificate issued by the Tax Authorities of Bizkaia in Spain on November 8, 2010; that ITAC is situated at Plentzia, Urbanizacion Isuskiza 144, Bizkaia, Spain; that ITAC is not registered as a corporation or partnership in the Philippines based on the Certification of Non-Registration issued by the Securities and Exchange Commission on November 12, 2010; and that, on the other hand, DENR is a government agency in the Philippines situated at Visayas Avenue, Diliman, Quezon City, Philippines. cCESTA It is further represented that on October 6, 2010, the DENR and ITAC, in association with Techniplan SpA, IPA Energy + Water Economics ("IPA") and Associated Pacific Corporation, agreed to provide consulting services to the DENR for Innovative Financing Mechanisms and Market-Based-Incentives under the GEF-Manila Third Sewerage Project (" Grant No. TF057296 PH ") Components 3 and 4, as shown in the duly notarized Certification issued by the Project Manager of the Manila Third Sewerage Project on December 10, 2010; that the development objective of the Project is to create an enabling environment to scale up priority investments in sewerage and sanitation in the Laguna Lake-Pasig River-Manila Bay watershed area through (i) upgrading of sector plans and policies based on environmental and economic principles; and (ii) piloting of innovative financial mechanisms to facilitate private sector investment: that the Innovative Financing Component will assist DENR and the Manila Water Sewerage System in preparing an action plan and a sewerage and sanitation investment program for the whole watershed area, which would substantially reduce water pollution in the Manila Bay; that the improvement of the mathematical models currently in use in the watershed under the GEF project will help assess medium and long-term allowable pollution loads that would bring the Laguna-Pasig River-Manila Bay watershed area in compliance with the Clean Water Act and define the investments needed to result in substantial improvement of the environmental conditions of the Manila Bay; that the Market-Based-Incentives Component will assess the possibility of using innovative financial mechanisms to try and attract investors into financing sewerage and sanitation; that such mechanisms include (i) World Bank and Asian Development Bank Guarantee Programs; (ii) improving the Local Government Unit Guarantee Corporation ("LGU-GC"); and (iii) improving an Local Government Unit financing mechanism for non-revenue generating projects; that will also help the Laguna Lake Development Authority improve its EUF System; that Component 3 of the Project is composed of the following tasks: 1) Comparative study of LGU financing in developing countries. 2) Evaluation of the different incentive mechanisms, incentive schemes/packages in existing financing programs and propose appropriate schemes for sewerage and sanitation projects. 3) Formulation, designing and proposal of innovative financing mechanisms, including proposed incentive schemes, appropriate for sewerage and sanitation projects outside the concession areas. ISAcHD 4) Drafting of policy framework and policy measures to support recommended innovative financing mechanisms. 5) Preparation of an action plan and a sewerage and sanitation investment program. 6) Piloting the test proposed innovative financing schemes for sewerage and sanitation sector to attract private sector investments and the LGUs for two selected areas. 7) Capacity building and training. 8) Stakeholders' consultation. That Component 4 of the Project is composed of the following tasks: 1) Compile available reports on and review/evaluate applicable existing market-based instruments, locally and internationally. 2) Improve the use of market-based instruments. 3) Undertake a review of the fees which have not been changed in more than four years. The principle should be to maintain a fixed but low fee to avoid being accused of selling a license to pollute and a variable and high to be an effective deterrent to polluters. 4) Focus efforts on non-compliant industries. 5) Draft policy framework and policy measures to support recommended improvements on market-based instruments. 6) Capacity building and training which shall form an integral part of the consulting assignment. 7) Stakeholders' consultation. That in consideration, DENR shall pay ITAC the amount of US$599,800.00, inclusive of local taxes, according to the following schedule: (a) First payment Mobilization Fee ISCaDH 10 percent of the Contract Price mobilization fee shall be paid upon the DENR's receipt of copy of the contract signed by both parties with a Notice to Proceed. (b) Second Payment Inception Report 20 percent of the lump-sum amount shall be paid upon submission and acceptance by the DENR of the inception report (end of first month of the contract assignment). (c) Third payment Mid-Term Report 30 percent of the lump-sum amount shall be paid upon submission and acceptance by the DENR of the mid-term report. (d) Fourth payment Draft Policy Framework 20 percent of the lump-sum amount shall be paid upon submission and acceptance by the DENR of the report. (e) Fifth payment Project Completion 20 percent of the lump-sum amount shall be paid upon approval of the final report. It is further represented that the Project involving ITAC and the other consultants will have a duration of 16 months from October 2010 to January 2012, based on the Certifications issued by the Project Manager of the DENR on December 10, 2010, February 16, 2011, and March 30, 2011; that based on the Certification issued by the Deputy Project Manager of GEF Manila Third Sewerage Project on March 30, 2011, and based on the approved work plan, Mr. Ricardo Leandro Garcia , Team Leader/Financial Analyst of ITAC and Mr. Stuart King, Environmental Economist of IPA will go to the Philippines on the following dates to do field works, conduct trainings/workshops, prepare and submit project reports and other deliverables or milestone: October 7-14, 2010 (8 days) December 9-17, 2010 (9 days) March 7-17, 2011 (11 days) EICDSA April 27-May 10, 2011 (14 days) June 20-July 6, 2011 (17 days) September 1-14, 2011 (14 days) October 24-November 5, 2011 (12 days) December 8-20, 2011 (13 days) January 23-31, 2012 (9 days) It is finally represented that the service fees subject of this ruling are not under investigation, on-going audit, administrative protest, claim for refund or issuance of tax credit certificate, collection proceedings, or judicial appeal, based on the Certification issued by the Chief Accountant of the DENR on February 15, 2011. In reply, please be informed that Section 28 (B) (1) of the National Internal Revenue Code of 1997 (" Tax Code "), as amended, provides that that the service fees paid to ITAC are subject to income tax as follows: "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 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%) . IDAaCc xxx xxx xxx" (Emphasis Supplied) However, Section 32 (B) (5) of the Code provides that such fees may be exempt from income tax or subject to reduced rate to the extent required by any treaty obligation on the Philippines, viz.: "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" (Emphasis ours) For this purpose, you invoke the Philippines-Spain tax treaty. Paragraph 1, Article 7 thereof provides: SEIDAC "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 are attributable to that permanent establishment or are derived within such other Contracting State from sales of goods or merchandise of the same or similar kind as those sold, or from other business transactions of the same or similar kind as those effected through the permanent establishment. The competent authorities of the Contracting States shall consult each other on the similarity of goods sold or business transactions. xxx xxx xxx." Based on the aforequoted provision, the profits of an enterprise of Spain shall be taxable only in Spain unless it carries on business in the Philippines through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of that enterprise may be taxed in the Philippines to the extent they are attributable to that permanent establishment. In relation thereto, paragraphs 1 and 2, Article 5 of the tax treaty define 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. aHIEcS 2. The term 'permanent establishment' includes, but is not limited to: a) a place of management; b) a branch; c) an office; d) a factory; e) a workshop; f) a warehouse, in relation to a person providing storage facilities for others; g) a store or premises where sales are performed; h) a mine, an oil-well, quarry or other place of extraction of natural resources; i) a building site or construction, installation or assembly project or supervisory activities in connection therewith, where such site, project or activity continues for more than six months; j) the furnishing of services including consultancy services by an enterprise through an employee or other personnel provided where activities of that nature (for the same or connected project) within the other Contracting States continue within a Contracting State for a period or periods exceeding 180 days within any twelve-month period. xxx xxx xxx." Based on the aforequoted provision, the term "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; a workshop; a warehouse in relation to a person providing storage facilities for others; a store or premises where sales are performed; a mine, an oil-well, quarry or other place of extraction of natural resources; a building site or construction, installation or assembly project or supervisory activities in connection therewith, where such site, project or activity continues for more than six months; and the furnishing of services including consultancy services by an enterprise through an employee or other personnel provided where activities of that nature (for the same or connected project) within the other Contracting States continue within a Contracting State for a period or periods exceeding 180 days within any twelve-month period. HTCESI Accordingly, since ITAC is not engaged in trade or business in the Philippines, and since it will not furnish services in the Philippines for more than 183 days within any twelve-month period (in fact, for the duration of the Project from October 2010 to January 2012, ITAC and the other consultants will provide the services for a total of 107 days only), ITAC is not deemed to have a permanent establishment in the Philippines with respect to activities it undertakes for the Project. This being the case, the service fees to be paid by the DENR to ITAC for services furnished related to the Project, beginning December 1, 2010 , 1 are exempt from income tax, provided that ITAC at all times does not have a permanent establishment in the Philippines for the duration of the Project. However, service fees, being payments for services performed in the Philippines are subject to value-added tax ("VAT") at the rate of 12 percent. Section 108 (A) of the Tax Code, as amended, 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%) 2 of gross receipts derived from the sale or exchange of services, including the use or lease of properties selling price or gross value in money of the goods or properties sold, bartered or exchanged, such tax to be paid by the seller or transferor: 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: (i) Value-added tax collection as a percentage of Gross Domestic Product (GDP) of the previous year exceeds two and four-fifth percent (2 4/5%); or (ii) National government deficit as a percentage of GDP of the previous year exceeds one and one-half percent (1 1/2%). HCaEAT xxx xxx xxx" With regard to the procedures for the withholding and payment of VAT, DENR shall withhold VAT on the service fees at the rate of 12 percent before remitting them to ITAC and the other consultants. In remitting to the Bureau of Internal Revenue the VAT withheld, DENR shall use BIR Form No. 1600 (Monthly Remittance Return of VAT and Other Percentage Taxes Withheld). In addition, DENR is required to issue in quadruplicate the Certificate of Final Tax Withheld at Source (BIR Form No. 2306), the first three copies for ITAC and the other consultants and the fourth copy for DENR as its file copy. 3 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. Pursuant to Revenue Memorandum Order No. 72-2010 (Prescribes the Guidelines on the processing of the Tax Treaty Relief Applications pursuant to existing Philippine Tax Treaties). 2. 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. 3. Pursuant to Revenue Regulations No. 16-2005 (Consolidated Value-Added Tax Regulations of 2005), as amended.