ITAD BIR Ruling No. 294-14

October 10, 2014 ITAD BIR RULING NO. 294-14 Articles 5 (Permanent Establishment) and 7 (Business Profits) Philippines-Singapore tax treaty First Philippine Industrial Corporation Ground Floor, Benpres Building Exchange Road corner Meralco Avenue Ortigas Center, Pasig City Attention: Ms. Ana Maria S. del Rosario Vice President and Comptroller Gentlemen : This refers to your tax treaty relief application filed on May 24, 2011 requesting confirmation that service fees paid by First Philippine Industrial Corporation ("First Philippine") to SGS Testing and Control Services Singapore Pte. Ltd. ("SGS Testing") are exempt from income tax pursuant to the Convention between the Republic of the Philippines and the Republic of Singapore for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income ("Philippines-Singapore tax treaty"). Facts SGS Testing is a foreign corporation and a resident of Singapore based on its Memorandum and Articles of Association; Certificate of Incorporation of Private Company issued by the Registrar of Companies and Businesses in Singapore on August 6, 1994; and Certificate of Residence issued by the Inland Revenue Authority of Singapore on May 31, 2011. SGS Testing is located at 26 Ayer Rajah Cresent, 03-07 Ayer Rajah Industrial Estate, Singapore. It 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 April 12, 2011. On the other hand, First Philippine is a domestic corporation located at Ground Floor, Benpres Building, Exchange Road corner Meralco Avenue, Ortigas Center, Pasig City, Philippines. On March 15, 2011, SGS Testing issued Quotation Invoice No. 113/11 to First Philippine (which was subsequently acknowledged and accepted by the latter) concerning services to be provided by SGS Testing to First Philippine in the inspection of pipelines procured by First Philippine abroad. The services consist of: llcd 1. Visual inspection of the pipelines to check if they are in accordance with the API 5L requirements. 2. UTG check for wall thickness. Sampling size to be determined after visual inspection. 3. Dimensional and roundness check. 4. Review of supplier test records and certificates and advise if they conform with the API 5L x 52 PSL 2 material. In consideration, First Philippine will pay SGS Testing a service fee equivalent to 900.00 Singapore dollars per day of work rendered, from Monday to Friday and from 08:30 to 17:30. Overtime work will be charged an additional 100.00 Singapore dollars per hour. The work will be done mostly in Singapore. Based on the Certification issued by First Philippine on September 19, 2011 and the invoices issued by SGS Testing, the inspection of pipelines was carried out in March to May 2011 for a total of 18 man-days 16 days in Singapore and Indonesia and 2 days in the Philippines. The service fee per day is 9,000.00 Singapore dollars or totaling 16,200.00 Singapore dollars for 18 days. Based on the computer generated notification issued by Union Bank of the Philippines, 1 the fee amounting 16,200.00 Singapore dollars was remitted by First Philippine to SGS Testing on July 15, 2011. Instead of sending personnel to the Philippines, SGS Testing contracted SGS Philippines, Inc. ("SGS Philippines) to undertake the work where it supervised the unsealing of the containers containing the pipelines and the unloading and inspection of these pipelines in Batangas Province and Pandacan, Manila. SGS Philippines is a domestic corporation located at Alegria Building, Chino Roces Avenue, Makati City, Philippines. Ruling In reply, please be informed that under Section 28 (B) (1) of the National Internal Revenue Code of 1997, as amended (" Tax Code "), income derived in the Philippines by a foreign corporation not engaged in trade or business in the Philippines is subject to income tax at the rate of 30 percent, to wit: STEacI "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%)." However, under Section 32 (B) (5) of the Tax Code, such income is exempt or partially exempt to the extent required by any treaty obligation on the Philippines, to wit: "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." For this purpose, paragraph 1, Article 7 of the Philippines-Singapore tax treaty provides relief to income derived by an enterprise which is a resident of Singapore, to wit: "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 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 that permanent establishment." AHcDEI Under this article, the income may be taxed in the Philippines if it is attributable to a permanent establishment which the enterprise has in the Philippines; otherwise, such income is exempt. In relation 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' includes specially but is not limited to: a) A seat of management; b) A branch; c) An office; d) A store or other sales outlet; e) A factory; f) A workshop; g) A warehouse, in relation to a person providing storage facilities for others; h) A mine, quarry, or other place of extraction of natural resources; i) A building site or construction or assembly project or installation project or supervisory activities in connection therewith, provided such site, project or activity continues for a period more than 183 days; and j) The furnishing of services, including consultancy services, by a resident of one of the Contracting States through employees or other personnel, provided activities of that nature continue (for the same or a connected project) within the other Contracting State for a period or periods aggregating more than 183 days." aHTEIA As defined, 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 seat of management, a branch, an office, a store or other sales outlet, a factory, and a workshop. It also includes the furnishing of services by an enterprise of Singapore (through employees or other personnel thereof) which continues in the Philippines for an aggregate period of 183 days. Accordingly, since SGS Testing is not engaged in trade or business in the Philippines to which a branch, an office, or other fixed place of business is relevant, and since it did not furnish services in the Philippines for more than 183 days, but for two days only, SGS Testing is not deemed to have a permanent establishment in the Philippines under paragraphs 1 and 2, Article 5 of the Philippines-Singapore tax treaty. This being the case, the service fees paid by First Philippine to SGS Testing for inspecting the pipelines procured by First Philippine from abroad are exempt from income tax, pursuant to paragraph 1, Article 7 of the treaty. Furthermore, on the classification of the service fees as business profits rather than 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 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: SIDEaA 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 subcontractors for the performance of similar services. Accordingly, since the Quotation Agreement did not call for SGS Testing to supply existing information or reproduce existing material to First Philippine, but to provide services to First Philippine by inspecting the pipelines procured by First Philippine to check if they are in accordance with the required specifications, this agreement is clearly a contract for the performance of services rather than the supply of know-how or other royalty-bearing property. Moreover, by reason that there were personnel who carried out the inspection, SGS Testing incurred a greater level of expenditure (such as salaries and other remuneration of these personnel) to fulfil its contractual obligations to First Philippine. This being the case, the service fees paid by First Philippine to SGS Testing clearly constitute as business profits rather than and royalties. TEHIaA Finally, under Sections 108 (A) and 105 of the Tax Code, the inspection of the pipelines in the Philippines by SGS Testing (through SGS Philippines ) 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." cACTaI Relative thereto, First Philippine shall withhold VAT on the service fees (but only those attributable to services done in the Philippines and done by SGS Philippines ) at the rate of 12 percent before remitting them to SGS Testing. First Philippine 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 VAT on the fees; otherwise, if not a VAT-registered taxpayer, the passed-on VAT withheld shall form part of the cost of purchased services which may be treated by First Philippine 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. Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner Bureau of Internal Revenue Footnotes 1. Located at UnionBank Plaza, Meralco Avenue corner Onyx and Sapphire Roads, Ortigas Center, Pasig City, Philippines. 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 4.114-2 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." Footnotes n Note from the Publisher: The phrase "and (d) above" no longer appears in RA 9337, the law amending this provision.