ITAD BIR Ruling No. 283-12

July 17, 2012 ITAD BIR RULING NO. 283-12 Articles 5 (Permanent Establishment) and 7 (Business Profits); Philippines-United Kingdom of Great Britain and Northern Ireland tax treaty Isla Lipana and Co. 29th Floor, Philamlife Tower 8767 Paseo de Roxas Makati City Attention: Alexander B. Cabrera Managing Partner, Tax Services Gentlemen : This refers to your tax treaty relief application ("TTRA") filed on June 3, 2009 1 requesting confirmation that service fees paid by Lowe, Inc. ("Lowe") to Lowe and Partners Worldwide Ltd. ("Lowe and 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 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") . Facts Lowe and Partners is a foreign corporation and a resident of the United Kingdom based on its Certificate of Residence issued by the Revenue and Customs of the United Kingdom on July 24, 2008. Lowe and Partners is located at 60 Sloane Avenue, London, England, United Kingdom. It 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 September 19, 2008. On the other hand, Lowe is a domestic corporation located at 15th to 17th Floors, Rufino Pacific Tower, 6784 Ayala Avenue, Makati City, Philippines. On January 1, 2002, Lowe and Lowe and Partners entered into a Service Agreement where Lowe and Partners agreed to provide services to Lowe on multinational client coordination, fostering and developing creativity, new business targeting, public relations, strategic planning, media support, financial administration, human resources management, information technology and business. The services will be rendered in the United Kingdom and the Philippines. In consideration, Lowe will pay service fees to Lowe and Partners based on the cost of providing the services plus a profit element of 5 percent. The service fees are payable in British sterling pounds and due within 30 days after the receipt of invoice for each quarter. The Agreement took effect on January 1, 2002 and remains in effect indefinitely. Based on the Certifications issued by Lowe on January 12, 2012, Lowe and Partners sent the following personnel to the Philippines to provide services to Lowe pursuant to the Agreement, to wit: ACaTIc Personnel Dates Number of Days 2008 Charuvarn Vanasin February 12-13 2 September 21-23 3 2009 Charuvarn Vanasin February 26-27 2 Erlyn de Rosales April 11-15, 22-23 7 May 13-17 5 October 22-25 4 November 17-18 2 December 19-31 13 2010 Charuvarn Vanasin January 1-10, 18-21, 30-31 16 Erlyn de Rosales February 7 1 Ian Andrew Courts March 7-10, 21-30 14 Robert Gordon Marsh May 19-22 4 Richard W. Welch June 18-20 3 August 7-9, 13-17 8 October 23-25 3 December 18-31 14 2011 Charuvarn Vanasin January 1-3, 9-13, 19-20 20 Erlyn de Rosales February 18-20 3 Ian Andrew Courts March 15-17 3 Aniruddha Deb April 13-17 5 Ricardo Turcios July 15-17 3 Sandeep Kumar Puri August 16-17 2 September 16-17 2 October 21-24, 27-31 9 November 1-6 6 A computation of the number of days for each twelve-month period from 2008 to 2011 yields the following result: Twelve-Month Number Twelve-Month Number Twelve-Month Number Period of Days Period of Days Period of Days Jan. 08-Dec. 08 5 Jan. 09-Dec. 09 33 Jan. 10-Dec. 10 63 Feb. 08-Jan. 09 5 Feb. 09-Jan. 10 49 Feb. 10-Jan. 11 67 Mar. 08-Feb. 09 5 Mar. 09-Feb. 10 48 Mar. 10-Feb. 11 69 Apr. 08-Mar. 09 5 Apr. 09-Mar. 10 62 Apr. 10-Mar. 11 58 May 08-Apr. 09 10 May 09-Apr. 10 55 May 10-Apr. 11 63 Jun. 08-May 09 15 Jun. 09-May 10 54 Jun. 10-May 11 59 Jul. 08-Jun. 09 15 Jul. 09-Jun. 10 57 Jul. 10-Jun. 11 56 Aug. 08-Jul. 09 15 Aug. 09-Jul. 10 57 Aug. 10-Jul. 11 59 Sept. 08-Aug. 09 15 Sept. 09-Aug. 10 65 Sept. 10-Aug. 11 53 Oct. 08-Sept. 09 14 Oct. 09-Sept. 10 68 Oct. 10-Sept. 11 55 Nov. 08-Oct. 09 18 Nov. 09-Oct. 10 68 Nov. 10-Oct. 11 61 Dec. 08-Nov. 09 20 Dec. 09-Nov. 10 62 Dec. 10-Nov. 11 67 Jan. 11-Dec. 11 53 Ruling Relative thereto, please be informed that 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 fifteen 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. .." (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 . cEaCTS 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 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) . In view of the foregoing, since the subject TTRA was filed on June 3, 2009 and the Service Agreement that gives rise to the service fees has been in effect since January 1, 2002, this Office hereby DENIES relief on service fees for services rendered in the Philippines and paid by Lowe to Lowe and Partners before June 18, 2009, pursuant to Section III (2) of RMO 1-2000. Accordingly, said fees shall be subject to income tax 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: Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)" On the other hand, the fees paid to Lowe and Partners on June 18, 2009 and thereafter are subject to relief under paragraph 1, Article 7, in relation to paragraphs 1, 2 and 3, Article 5, of the Philippines-United Kingdom tax treaty, which provide: "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." "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; c) an office; d) a factory; e) a workshop; f) a mine, oil well, quarry or other place of extraction of natural resources; g) an installation or structure used for the exploration of natural resources; h) a building site or construction or assembly project which exists for more than 183 days. 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." CTEDSI Under Article 7, profits of an enterprise of the United Kingdom may be taxed in the Philippines if the enterprise carries on business in the Philippines through a permanent establishment situated therein. Under Article 5, with respect to the furnishing of services including consultancy services, an enterprise is deemed to have a permanent establishment if it has a branch or an office in the Philippines, or if it furnished such services (through employees or other personnel thereof) for a period exceeding in the aggregate 183 days within any twelve-month period. Accordingly, since Lowe and Partners 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 from 2008 to 2011, it is not deemed to have a permanent establishment with respect to those services it rendered in the Philippines for Lowe pursuant to the Agreement. This being the case, the service fees paid by Lowe to Lowe and Partners on June 18, 2009 and thereafter are exempt from income tax, under paragraph 1, Article 7, in relation to paragraphs 1, 2 and 3, Article 5, of the Philippines-United Kingdom tax treaty. On the characterization of the service fees as business profits and not payments for know-how or royalties, 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: "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. 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 sub-contractors for the performance of similar services. EIAScH Accordingly, since the Service Agreement did not call for Lowe and Partners to supply existing information or reproduce existing material to Lowe, but actually to provide services to Lowe on multinational client coordination, fostering and developing creativity, new business targeting, etc.,this Agreement is a contract for the performance of services and not for the supply of know-how. Moreover, on account that the services are rendered on a continuing basis by designated personnel of Lowe and Partners, it is certain that a greater level of expenditure (such as salaries and wages of the personnel) is incurred by Lowe and Partners to fulfil its contractual obligations to Lowe under the Agreement. This being the case, the service fees paid therefor constitute business profits and not payments for know-how or royalties. Finally, under Section 108 (A) of the Tax Code, in relation to Section 105 of the Tax Code, the service fees for services rendered in the Philippines by Lowe and Partners, a nonresident foreign person, 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, 2 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. 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, Lowe shall withhold VAT on the fees at the rate of 10 percent before February 1, 2006, and 12 percent beginning February 1, 2006, before remitting them to Lowe and Partners. Lowe 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 Lowe 's claim of input tax on the payments; otherwise, if Lowe 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. 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. IEAaST Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes 1. Originally filed at the Law Division of this Bureau on October 7, 2008. 2. 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. 3. 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."