ITAD BIR Ruling No. 301-14

October 13, 2014 ITAD BIR RULING NO. 301-14 Articles 5 (Permanent Establishment) and 8 (Business Profits) Philippines-United States of America 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 ("TTRA") filed on July 21, 2011 requesting confirmation that service fees paid by First Philippine Industrial Corporation ("First Philippine") to Spec Services, Inc. ("Spec") (formerly Spec Services ) are exempt from income tax pursuant to the Convention between the Government of the Republic of the Philippines and the Government of the United States of America with Respect to Taxes on Income ("Philippines-United States tax treaty"). Facts Spec is a foreign corporation and a resident of the United States based on its amended Articles of Incorporation and Certificate of Residence issued by the Internal Revenue Service of the United States on June 20, 2011. Spec is located at 17101 Bushard Street, Fountain Valley, California, United States. 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 May 11, 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 February 9, 2011, First Philippine issued a letter to Spec with the subject Consulting Work for First Philippine Industrial Corporation Pipelines where First Philippine confirmed that Spec agreed to be the former's consultant on the engineering and design of the replacement for the existing pipelines owned and operated by First Philippine in the Philippines. First Philippine owns and operates the sole, largest commercial oil pipelines in the country, transporting crude and refined petroleum products from Batangas to Metro Manila. For 40 years, First Philippine has transported more than 150 billion liters of gasoline, diesel, jet fuel, fuel oil and other petroleum products belonging to Shell Petroleum Corporation and Chevron Philippines, Inc. As consultant, Spec will IaAHCE 1. Develop material and construction specifications for the pipeline replacements; 2. Provide project cost estimates for materials and construction; 3. Provide general engineering guidance on alternative pipeline routes, construction methodologies and specifications; 4. Make a site visit to look at the segments of the pipeline identified for replacement; and 5. Render reports and other relevant documentation on the foregoing. The services will be performed from February 1 to June 1, 2011. The services will be rendered mostly in the United States. In consideration, First Philippine will pay service fees to Spec based on the hourly rates of the personnel employed and equipment utilized for this purpose. Spec assigned primarily Mr. Bud Pingree and Mr. Omar Estrada to carry out this project, each with an hourly rate of $173.00. Based on the Sworn Statement issued by First Philippine on April 25, 2013, the personnel mentioned performed services as follows: Personnel Dates Present in Nature of Services Rendered the Philippines Bud Pingree February 17-24, 2011 Held business meetings and onsite inspection of pipeline segment, but all contracted services such as opinions and reports were done outside the Philippines Omar Estrada Did not perform services Plan and design in the Philippines First Philippine paid service fees to Spec as follows: Invoice Invoiced Invoiced Date of Remitting Bank Receiving Bank Number Amount Amount Payment (Spec) (in US Plus Bank Dollars) Charges (in US Dollars) 30823 13,305.27 13,305.27 Sep. 2, Union Bank of the Wells Fargo Bank N.A. 2011 Philippines 30824 49,953.72 49,953.72 Sep. 2, Union Bank of the Wells Fargo Bank N.A. 2011 Philippines 4983-1 1,395.81 1,424.81 Mar. 9, Bank of the Wells Fargo Bank N.A. 2012 Philippine Islands 31796 8,109.50 8,138.50 Aug. 2, Bank of the Wells Fargo Bank N.A. 2012 Philippine Islands 4983-2 646.89 675.89 Sep. 28, Bank of the Wells Fargo Bank N.A. 2012 Philippine Islands Ruling In reply, please be informed that since the TTRA was filed on July 21, 2011, and the first payment of the service fees subject thereof was made later on September 2, 2011, such fees paid on that date and onwards shall be subject to relief (exemption from income tax or reduction of tax) pursuant to Section 14 of Revenue Memorandum Order No. 72-2010 (Guidelines on the Processing of Tax Treaty Relief Applications (TTRA) Pursuant to Existing Philippine Tax Treaties), to wit: IDAESH " SECTION 14. When and Where to File the TTRA . All tax treaty relief applications (updated BIR Forms No. 0901-D, 0901-I, 0901-R, 0901-P, 0901-S, 0901-T, 0901-O and 0901-C) relative to the implementation and interpretation of the provisions of Philippine tax treaties shall only be submitted to and received by the International Tax Affairs Division (ITAD). If the forms or any necessary documents are submitted to any other BIR Office, the application shall be considered as improperly filed. Filing should always be made BEFORE the transaction. Transaction for purposes of filing the TTRA shall mean before the occurrence of the first taxable event . " (Emphasis ours) Article 8 of the Philippines-United States tax treaty provides relief to the fees as follows: "Article 8 Business Profits 1. Business profits of a resident of one of the Contracting States shall be taxable only in that State unless the resident has a permanent establishment in the other Contracting State. If the resident has a permanent establishment in that other Contracting State, tax may be imposed by that other Contracting State on the business profits of the resident but only on so much of them as are attributable to the permanent establishment." Under this article, profits derived by an enterprise of the United States from sources in the Philippines may be taxed in the Philippines if attributable to a permanent establishment which the enterprise has therein; otherwise, such profits are exempt. In relation to a permanent establishment, Article 5 of the treaty defines this term as follows: "Article 5 Permanent Establishment 1. For the purposes of this Convention, the term 'permanent establishment' means a fixed place of business through which a resident of one of the Contracting States engages in a trade or business. 2. The term 'fixed place of business' includes but is not limited to: a) A seat of management; b) A branch; aTCADc c) An office; d) A store or other sales outlet; e) A factory; f) A workshop; g) A warehouse; h) A mine, quarry, or other place of extraction of natural resources; i) A building site or construction or assembly project or supervisory activities in connection therewith, provided such site, project or activity continues for a period of 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." 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, including consultancy services, in the Philippines by an enterprise of the United States (through employees or other personnel thereof), where such activities continue (for the same or a connected project) for a period or periods aggregating more than 183 days. Accordingly, since Spec 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, but for a period of eight days only (February 17 to 24, 2011), to visit the segments of First Philippine 's pipelines identified for replacement, Spec shall not be deemed to have a permanent establishment in the Philippines under these circumstances, pursuant to paragraph 2, Article 5 of the Philippines-United States tax treaty. This being the case, the service fees paid by First Philippine to Spec for rendering consultancy services on the engineering and design of the replacement for First Philippine 's existing pipelines shall be exempt from income tax in the Philippines, pursuant to paragraph 1, Article 8 of the treaty. IaESCH Furthermore, on the classification of the service fees as business profits (which are generally exempt from income tax if not attributable to a permanent establishment) as against payments for know-how or royalties (which are generally subject to income tax at a reduced rate), 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: 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) SAHaTc 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 Letter Agreement did not call for Spec to supply existing information or reproduce existing material to First Philippine, but to provide services to First Philippine by developing material and construction specifications for pipeline replacements, providing project cost estimates for materials and construction, and making a site visit at the segments of the pipeline identified for replacement, among others, the Letter Agreement in question is clearly a contract for the performance of services and not for the supply of know-how or other royalty-bearing property. Moreover, by reason that the services are rendered on a considerable period by designated personnel of Spec, it is certain that a greater level of expenditure (such as salaries and other remuneration of these personnel) is incurred by Spec to fulfil its contractual obligations to First Philippine. This being the case, the service fees paid by First Philippine to Spec constitute clearly as business profits and not royalties. Finally, under Section 108 (A) in relation to Section 105 of the National Internal Revenue Code of 1997, as amended, the service fees paid to Spec, a nonresident foreign person, for service it rendered in the 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, 1 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. HIaAED 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, First Philippine shall withhold VAT on the service fees at the rate of 12 percent before remitting them to Spec. 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 First Philippine 's claim of input tax on the fees; otherwise, if it is not a VAT-registered taxpayer, First Philippine may treat the VAT as an asset or expense, whichever is applicable. VAT withheld shall be remitted within 10 days following the end of the month the withholding was made. 2 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. 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. 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."