ITAD BIR Ruling No. 300-12

July 27, 2012 ITAD BIR RULING NO. 300-12 Articles 5 & 7, Philippines-UAE tax treaty Smart Communications Smart Tower, Ayala Avenue Makati City Attention: Rina R. Manuel Tax Department Head Gentlemen : This refers to your tax treaty relief application filed on December 1, 2010, on behalf of Delta Partners FZ-LLC (Delta Partners) , requesting confirmation that service fees paid by Smart Communications, Inc. (Smart) to Delta Partners are exempt from income tax, pursuant to the Agreement between the Government of the Republic of the Philippines and the Government of the United Arab Emirates for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and on Capital ("Philippines-UAE tax treaty") . It is represented that Delta Partners, with address at Media One Building, 29th Floor, Dubai Internet City, United Arab Emirates, PO Box 502428, and with License No. 20381, is a resident of the United Arab Emirates under the provisions of the Philippines-UAE tax treaty per Tax Residence Certificate issued by the Executive Director for International Finance Relations of the Ministry of Finance on September 30, 2010; that Delta Partners is not registered either as a partnership or a corporation in the Philippines pursuant to a Certification of Non-registration of Company issued by the Philippine Securities and Exchange Commission dated October 6, 2010; and that, on the other hand, Smart is a corporation duly organized and existing under and by virtue of the laws of the Philippines, with office address at 6799 Ayala Avenue, Makati 1226. It is further represented that on August 29, 2010, Delta Partners and Smart and/or Smart Group ; 1 entered into a Professional Services Agreement (PSA) and Supplementary Agreement ("SA") ; that under the SA, Delta Partners shall provide the following professional services to Smart: 1. Perform an in depth operational performance assessment of Smart's Marketing, Sales and Network groups; 2. Enhance Smart's "Analytics Based Management" (ABM) capabilities; 3. Assess/validate business opportunities by looking at the market, industry and competitive landscape, with special focus on implications to traditional and broadband business; 4. Review current segmentation model and adjust it to ensure an optimal approach to market; 5. Review and adjust Smart's current strategy for the traditional business to ensure its adequacy to maximize Smart's value in a saturated market; 6. Adjust Smart's current broadband strategy to "Accelerate" take up and maximize market share, ensure there is a solid economic and business model, optimize impact in the traditional business, and integrated approach to market ( e.g. , mobile business and fixed business); TASCDI 7. Identify necessary adjustments in Smart's extended value proposition to ensure that Smart's strategy is properly segmented and adequate to maximize value extraction from the target segments; 8. Provide guidance to Smart Group in the Information Cellular Telecommunication (ICT) arena by leveraging on ICT Syndicated Research led by Delta Partners and with the participation of vendors and operators, from both mature and emerging markets; and 9. Explore and assess the possibility for Smart PLDT to participate in the Telefonica Strategic Alliance program and potentially support in the closure of a partnership. Moreover, it is represented, based on the SA, that Delta Partners shall deploy six (6) Full Time Equivalents 2 led by an engagement partner and support from Delta Partners subject matter expert, leadership team and the intelligence and ABM Units to perform the services; that the total number of days that Delta Partners' personnel will perform the services in the Philippines will not exceed twelve (12) weeks; and that the term of the PSA shall be for a period of (12) months from executing unless renewed by mutual written agreement or otherwise earlier terminated; and the SA, on the other hand, is 12 weeks from August 29, 2010 or until November 26, 2010; and that the fees remitted by Smart to Delta Partners for the services rendered by the latter amounted to a total of US$ Nine Hundred Ninety-nine Thousand (US$999,000.00) and was paid thru Customer Credit Transfer of Deutsche Bank AG Manila on December 14 and 17, 2010. Finally, it is represented that the transaction subject of the herein request for ruling is not under investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings, or a judicial appeal of the taxpayers involved per the Sworn Statement issued by Smart dated December 1, 2010. In reply, please be informed that Section 28 (B) (1) of the National Internal Revenue Code of 1997 ("Tax Code of 1997") , as amended, applies in general, to profits derived in the Philippines by a nonresident foreign corporation. It provides: "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 . . ., royalties, . . . profits and income, . . .: Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%). xxx xxx xxx" However, Section 32 (B) (5) of the Tax Code of 1997, as amended, provides that any income may be exempt from tax to the extent required by any treaty obligation binding upon the Philippine Government, thus: "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" With respect to a treaty, what you invoke for this purpose is the Philippines-UAE tax treaty. Its Article 7 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 attributable to that permanent establishment." Based on the foregoing, the profits of an enterprise which is a resident of the UAE shall be taxable only in UAE unless such enterprise carries on business in the Philippines through a permanent establishment situated therein. If the UAE enterprise carries on business as aforesaid, the profits of such enterprise may be taxed in the Philippines but only so much of them as is attributable to that permanent establishment. Applying this to the instant case, the service fees received by Delta Partners for the services rendered in the Philippines shall be taxable in the Philippines only if it has a permanent establishment in the Philippines to which said fees may be attributable. CETIDH In relation thereto, Article 5 of the Philippines-UAE tax treaty provides: "Article 5 PERMANENT ESTABLISHMENT 1. For the purposes of this Agreement, the term "permanent establishment" means a fixed place of business through which the business of the enterprise is wholly or partly carried on. 2. The term "permanent establishment" includes especially: a) a place of management; b) a branch; c) an office; d) a factory; e) a workshop; f) a mine, an oil or gas well, a quarry or any other place of extraction or exploration of natural resources; g) a farm or plantation; h) a building site, a construction assembly or installation project or supervisory activities in connection therewith, but only where such site, project or activity continues for a period of more than six months; i) the furnishing of services, including consultancy services, by an enterprise through employees or other personnel engaged by the enterprise for such purpose, but only where activities of the nature continue in the territory of the other Contracting State for a period or periods aggregating more than six months during any taxable year." It is clear from the aforequoted provision, that a corporation which is a resident of the UAE may be deemed to have a permanent establishment in the Philippines if, among others, the furnishing of services by such corporation, through its employees or other personnel, constitutes within the Philippines for a period or periods more than six months during any taxable year. Inasmuch as it is represented that the employees of Delta Partners did not stay in the Philippines for a period or periods not more than six months during the taxable year in the course of rendition of service to Smart, the income derived by Delta Partners from services rendered to Delta Partners shall not be subject to Philippine income tax and, consequently, to withholding tax pursuant to the Philippines-UAE tax treaty. Moreover, as provided in Section 108 of the NIRC of 1997, the said service fees are subject to value-added tax (VAT): "SEC. 108. 3 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%) 4 of gross receipts derived from the sale or exchange of services, including the use or lease of properties. The phrase 'sale or exchange of services' means the performance of all kinds or services in the Philippines for others for a fee, remuneration or consideration, . . . ." As to the procedure for the withholding and the payment of VAT, Smart, being the resident withholding agent and payor in control of payment shall be responsible for the withholding of the final VAT on such service fees before making any payment to Delta Partners. In remitting the VAT withheld, Smart shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax & Other Percentage Taxes Withheld). The duly filed BIR Form No. 1600 and the proof of payment thereof shall serve as documentary substantiation for the claim of input tax to be applied against the output tax that may be due from Smart if it is a VAT-registered taxpayer. In case Smart is a non-VAT-registered taxpayer, the passed-on VAT withheld shall form part of the cost of the service purchased and may treat such VAT as an "expense" or as an "asset", whichever is applicable. In addition, Smart is required to issue in quadruplicate a Certificate of Final Tax Withheld at Source (BIR Form No. 2306) in quadruplicate, the first three copies for Delta Partners and the fourth copy for Smart as its file copy. [Sections 4 & 6, Revenue Regulations (RR) No. 4-2002; Section 3 of RR 8-2002; Section 7 of RR 14-2002] 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. SaHcAC Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes 1. "Smart Group" shall mean Smart and its Subsidiaries and Associated Companies. 2. "Full Time Equivalents or FTE's" shall mean the consultants deployed by Delta Partners to perform the services under this Agreement or any Supplementary Agreement. 3. Section 108 was amended by Republic Act No. 9337 (An Act Amending Sections 27, 28, 34, 106, 107, 108, 109, 110, 111, 112, 113, 114, 116, 117, 119, 121, 148, 151, 236, 237 and 288 of the National Internal Revenue Code of 1997, as Amended, and for Other Purposes), which was signed into law on May 24, 2005 and became effective on November 1, 2005, to read as: "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, 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%). xxx xxx xxx 4. 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.