ITAD BIR Ruling No. 317-14

November 24, 2014 ITAD BIR RULING NO. 317-14 Articles 5 (Permanent Establishment) and 7 (Business Profits) Philippines-Netherlands tax treaty Manabat Sanagustin and Co. Certified Public Accountants and Management Consultants 9th Floor, The KPMG Centre 6787 Ayala Avenue Makati City Attention: Atty. Maria Myla S. Maralit Partner, Tax Gentlemen : This refers to your tax treaty relief application filed on November 22, 2011 requesting confirmation that service fees paid by Philippine American Life and General Insurance Company ("Philam Life") to ReMark International BV ("ReMark") (formerly Reinsurers Marketing BV) are exempt from income tax pursuant to the Convention between the Kingdom of the Netherlands and the Republic of the Philippines for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income ("Philippines-Netherlands tax treaty"). Facts ReMark is a foreign corporation and a resident of the Netherlands based on its amended Articles of Association and Declaration of Residence issued by the Tax Administration of Rivierenland in Netherlands on July 29, 2011. ReMark is located at Zuidplein 214, 1077 XV, Amsterdam, Netherlands. It 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 July 21, 2011. On the other hand, Philam Life is a domestic corporation located at Philamlife Building, United Nations Avenue, Ermita, Manila, Philippines. On May 5, 2011, Philam Life and ReMark entered into a Direct Marketing Agreement where ReMark agreed to perform direct marketing services to the strategic life assurance joint venture between Philam Life and the Bank of the Philippine Islands which was formed on November 27, 2009, namely: 1. Marketing advice including designing and recommending marketing techniques and customer propositions; 2. Planning and strategy of marketing campaigns including distribution strategy and direct marketing/telemarketing channel development; 3. Design, management and implementation of marketing campaigns; 4. Assistance and advice on product development, design and pricing; EHSTDA 5. Recommendation of selected providers (data processing, printing, telemarketing, etc.); 6. Data enhancement and recommending the appropriate selection of Philam Life's customers to be included in the marketing campaign; 7. Production of marketing materials and arranging art (designing) and copywriting, producing telemarketing scripts and online communications; 8. Providing marketing campaign information and conducting post-marketing campaign analysis. ReMark will provide the necessary materials, facilities and personnel to perform the services. In consideration, Philam Life will pay the following fees to ReMark: a) Onshore service fee. Equivalent to 6 percent of the premium received by Philam Life for every policy issued as a result of the marketing campaigns. This fee is payable beginning on the second month of the effectivity of the Agreement. b) Offshore service fee. Equivalent to 6 percent of the premium received by Philam Life for every policy issued as a result of the marketing campaigns. This fee is payable beginning on the second month of the effectivity of the Agreement. c) ReMark Proprietary Policy Administration System fee (also known as RAPID fee ). Equivalent to 5 percent of the premium received by Philam Life for every policy issued as a result of the marketing campaigns. These fees are payable as long as the policies and any renewals or continuations thereof generate premiums to Philam Life, and are due within thirty days from receipt of invoice from ReMark. The Agreement took effect on May 5, 2011 for an initial period of three years; thereafter, the parties may renew the Agreement. The Agreement was amended on October 28, 2011. Based on the Affidavit issued by ReMark on November 1, 2011, March 22, 2012, June 28, 2013, and March 6, 2014, as of January 2014, ReMark, has sent personnel to the Philippines and provided services on the following dates: 2011 May Jun. Jul. Aug. Sep. Oct. Nov. Dec. 3-6, 1-3, 1-8, 1-6, 1-2, 3-7, 23-25 6-8 9-14, 6-10, 12-22, 8-10, 5-8, 11-13, 25, 15-18, 25-31 17-19, 13-15, 18-20, 26, 20-24, 23-26, 18-22, 24-27 30, 31 28-30 31 26-28 14 20 26 19 17 15 3 3 2012 Jan. Feb. Mar. Apr. May Jun. Jul. Aug. Sep. Oct. Nov. Dec. 10-12, 8-10, 1-2, 10-13, 7-10, 4-7, 2-6 1, 21- 4-7, 2-5, 1, 26- 11-14 16-18, 14-17, 19-22, 24-27 21-25 12-15, 24-27 24 10-14, 29-31 29 25-27 28-29 27-30 18-22, 30-31 24-27 25-28 9 9 10 8 9 17 11 5 17 7 5 4 2013 Jan. Feb. Mar. Apr. May Jun. Jul. Aug. Sep. Oct. Nov. Dec. 8-11, 4-7, 5-8, 1-5, 1-3, 24-28 - - 4-6, 2-4, 18-21 16-18 22-25 19-22 12-15 15-19, 27-28 9-13, 16-18, 29-30 18-20 29-31 8 8 8 12 6 5 0 0 11 9 14 3 2014 Jan. 21-23 3 The aggregate number of days for each twelve-month period did not exceed 183 days as shown below: Beginning Ending Month Number of Beginning Ending Month Number of Month Days Month Days May 2011 Apr 2012 153 Apr 2012 Mar 2013 107 Jun 2011 May 2012 148 May 2012 Apr 2013 111 Jul 2011 Jun 2012 145 Jun 2012 May 2013 108 Aug 2011 Jul 2012 130 Jul 2012 Jun 2013 96 Sep 2011 Aug 2012 116 Aug 2012 Jul 2013 85 Oct 2011 Sep 2012 116 Sep 2012 Aug 2013 80 Nov 2011 Oct 2012 108 Oct 2012 Sep 2013 74 Dec 2011 Nov 2012 110 Nov 2012 Oct 2013 76 Jan 2012 Dec 2012 111 Dec 2012 Nov 2013 75 Feb 2012 Jan 2013 110 Jan 2013 Dec 2013 74 Mar 2012 Feb 2013 109 Feb 2013 Jan 2014 69 Onshore activities performed by ReMark include: a) Provided business opportunity assessment and business proposal development; HAICcD b) Identified and assessed business opportunities with client by conducting user requirement gathering workshops with BPI Philam Life 's Operations Team of Underwriting, Policy Administration, Product, Actuary, Treasury, Accounting, Claims and IT; c) Conducted product assessment, development and finalization; d) Provided recommendation of selected third party providers including call centers inspection and selection; e) Developed critical key performance indicators to measure the productivity and sales performance of the team; f) Conducted site visit to shortlisted third party call center before proposing the selected call center; g) Provided recommendations on all templates of reports to be developed by the selected call center for all BPI Philam Life 's campaigns; h) Conducted various thorough user-acceptance testing at selected call center before going live to ensure smooth transition of the operations; i) Successfully migrated all campaigns from Tele-performance to the selected call center; j) Provided on floor call management training to the call center manager and supervisors who do not have much outbound experience; k) Conducted site visit at Shore Solution and provided detailed audit report and recommendations to BPI Philam Life ; and l) Reviewed and proposed changes to the report template to be developed by third party call center. Offshore activities performed by ReMark include: a) Detailed documentation of the user requirements collected during the workshops conducted in the onshore activities to be used for planning the service; b) Provided marketing advice on the design and recommended marketing techniques and customer propositions on the Credit Secure Telemarketing campaign and the Accidental Protection Plan. c) Planned the distribution strategy of direct mail and telemarketing programs and multichannel developments; d) Designed, managed and implemented marketing campaigns; e) Provided advice on product development, design and pricing; f) Compiled and reviewed various third party call centers in terms of costing and experience in handling insurance campaign; g) Provided advice on product development, pricing and strategies for launching Savings Protector Plan product targeting at BPI Philam Life depositors' account with free personal accident provided over the counter when a customer opens a new deposit account; aCHDAE h) Assisted in reviewing the costing and process efficiency of various courier companies before providing advice on the shortlisted company for marketing campaigns; i) Compiled and reviewed all cancellation data to develop retention program; j) Provided advice on the product development, design and pricing of the Critical Illness Plan; k) Assisted BPI Philam Life to assess and review other third party call centers; l) Conducted post campaign analysis using data analytic tools such as predictive modeling. Also, based on the said affidavits, the Direct Marketing Agreement between Philam Life and ReMark is still in effect, and that, to date, no payment has been made by Philam Life to ReMark under the agreement. Ruling In reply, please be informed that under Section 28 (B) (1) of the National Internal Revenue Code of 1997, as amended ( "Tax Code" ), profits derived in the Philippines by a foreign corporation not engaged in trade or business is subject to income tax at the rate of 30 percent, 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%)." However, under Section 32 (B) (5) of the Tax Code, such profits are 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-Netherlands tax treaty provides relief to profits derived by an enterprise resident of the Netherlands, thus: "Article 7 Business Profits 1. The profits of an enterprise of one of the States shall be taxable only in that State unless the enterprise carries on business in the other 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." DcTaEH Under this article, the profits may be taxed in the Philippines if attributable to a permanent establishment which the enterprise has therein; otherwise, the profits are exempt. Relative thereto, paragraphs 1 and 2, Article 5 of the tax 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 especially: a) a place of management; b) a branch; c) an office; d) a factory; e) a workshop; f) a mine, quarry or other place of exploration or extraction of natural resources; g) a building site or construction or assembly project or supervisory activities in connection therewith, where such site, project or activity continues for a period of more than 183 days; h) the furnishing of services including consultancy services by an enterprise through an employee or other personnel where activities of that nature continue (for the same or a connected project) for a period or periods exceeding in the aggregate 183 days within any twelve-month period." 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 place of management, a branch, an office, a factory and a workshop. It also includes the furnishing of services including consultancy services which continues (for the same or a connected project) for a period or periods exceeding in the aggregate 183 days within any twelve-month period. Accordingly, since ReMark 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 an aggregate of 183 days within any twelve-month period, ReMark is not deemed to have a permanent establishment in the Philippines under paragraphs 1 and 2, Article 5 of the Philippines-Netherlands tax treaty. This being so, the fees payable to ReMark by Philam Life under the Direct Marketing Agreement are exempt from income n pursuant to paragraph 1, Article 7 of the same tax treaty. On the characterization of the offshore and onshore 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: HEDSCc "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. Accordingly, since the Direct Marketing Agreement does not call for ReMark to supply existing information or reproduce existing material to Philam Life but to provide services to Philam Life, this is clearly a contract for the performance of services rather than for the supply of know-how or other intangible property. Moreover, on account that ReMark has employed personnel to provide direct marketing insurance services to Philam Life in the Philippines and abroad and on a continuous basis, it is certain that ReMark incurred a greater level of expenditure (such as salaries and wages of these personnel) to fulfill its contractual obligations to Philam Life. This being the case, the service fees paid therefor constitute business profits rather than payments for know-how or royalties. ISDCaT In the same manner, the RAPID fee for the use of the RAPID software by Philam Life likewise constitutes business profits rather than payments for know-how or royalties , as explained in Section 5 of Revenue Memorandum Circular No. 44-2005 (Taxation of Payments of Software) ("RMC 44-2005") below: " Section 5. Characterization of Transactions. The character of payments received in a transaction involving the transfer of computer software depends on the nature of the rights that the transferee acquires under the particular arrangement regarding the use and exploitation of the program. a. Transfer of copyright rights. A transfer of software is classified as a transfer of copyright right if, as a result of the transaction, a person acquires any one or more of the rights described below: i. The right to make copies of the software for purposes of distribution to the public by sale or other transfer of ownership, or by rental, lease or lending; ii. The right to prepare derivative computer programs based upon the copyrighted software; iii. The right to make a public performance of the software; iv. any other rights of the copyright owner, the exercise of which by another without his authority shall constitute infringement of said copyright; The determination of whether a transfer of a copyright in a software is a sale or exchange of property is made on the basis of whether, taking into account all facts and circumstances, there has been a transfer of all substantial rights in the copyright. A transaction that does not constitute a sale or exchange because not all substantial rights have been transferred will be classified as a license generating royalty income. When only copyright rights are transferred, payments made in consideration thereof are royalties. On the other hand, when copyright ownership is transferred, payments made in consideration therefor are business income . b. Transfer of copyrighted articles . A copyrighted article incorporating a software includes a copy of the software from which the work can be perceived, reproduced, or otherwise communicated, either directly or with the aid of a machine or device. The copy of the software may be fixed in the magnetic medium of a floppy disk or a CD-ROM, or in the main memory of hard drive of a computer, or in any other medium. If a person acquires a copy of a software but does not acquire any of the rights described above (or only acquires a de minimis grant of such rights), and the transaction does not involve the provision of services or of know-how, the transfer of the copy of the software is classified solely as a transfer of a copyrighted article and payments for which constitute business income." (Underscoring ours) IDaCcS RMC 44-2005 distinguishes between payment for the use of copyright rights in a software and payment for the use of a copyrighted article embedding a software. Under this circular, if a person merely acquires a copy of a software but does not acquire any copyright rights in the software (or only acquires a de minimis grant of such rights), this transfer is classified as a transfer of a copyrighted article where payment therefor constitutes business income or business profits. On the other hand, if a person acquires copyright rights in a software, such as the right to make copies of the software for public distribution by sale or other transfer of ownership, or by rental, lease or lending; the right to prepare derivative computer programs based upon the software; the right to make a public performance of the software; and the performance of any act relating to the software which would otherwise constitute an infringement without prior authority from the developer or owner of the software. On the use of the RAPID software by Philam Life, based on the agreement, Philam Life is not given the right to exploit the copyright rights in the software ( i.e., the right to make copies for public distribution; the right to prepare derivative computer programs; the right to make public performance; and the right to perform other acts on the software). At most, Philam Life as an end-user automatically acquires the right to copy the software from a disk containing it or from a computer disk or a server containing a copy of the same via a modem or an internet connection onto the servers or hard disks of Philam Life 's computer network, to enable Philam Life to operate the programs contained in the software, and the right to make a copy of the software for archival or back-up purposes. This act of copying is considered a de minimis right and not a right to exploit the copyright or economic rights in the software, and allowed under Section 189 of the Intellectual Property Code, 1 to wit: "Section 189. Reproduction of Computer Program. 189.1. Notwithstanding the provisions of Section 177, the reproduction in one (1) backup copy or adaptation of a computer program shall be permitted, without the authorization of the author of, or other owner of copyright in, a computer program, by the lawful owner of that computer program; Provided, That the copy or adaptation is necessary for: (a) The use of the computer program in conjunction with a computer for the purpose, and to the extent, for which the computer program has been obtained; and (b) Archival purposes, and, for the replacement of the lawfully owned copy of the computer program in the event that the lawfully obtained copy of the computer program is lost, destroyed or rendered unusable." Where Philam Life is not granted authority/right to exploit the copyright rights in the RAPID software, the RAPID fee payable to ReMark by Philam Life clearly constitutes as business profits rather than royalties. Finally, under Section 108 (A) of the Tax Code, payments made to ReMark for the use of the RAPID Software and for the provision of related services are subject to 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%) . . . THEcAS Relative thereto, Philam Life shall withhold VAT on the fees for services performed in the Philippines at the rate of 12 percent before remitting them to ReMark. Philam Life 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 Philam Life 's claim of input tax on the fees; otherwise, if it 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. Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner Bureau of Internal Revenue Footnotes 1. Republic Act No. 8293 entitled An Act Prescribing the Intellectual Property Code and Establishing the Intellectual Property Office, Providing for Its Powers and Functions, and for Other Purposes. 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: xxx xxx xxx "SEC. 4.114-2. Withholding of VAT on Government Money Payments and Payments to Non-Residents. (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 nonresidents; 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." n Note from the Publisher: Copied verbatim from the official copy.