ITAD BIR Ruling No. 393-12

December 11, 2012 ITAD BIR RULING NO. 393-12 Articles 5 & 7, Philippines-Japan Tax Treaty, as amended Asia Pacific Business Legal Consulting 2nd Floor Bldg. B. Mactan Marina Mall Mactan Economic Zone 1 Ibo, Lapulapu City 6015, Cebu City Attention: Ma. Cristina L. Latonio Partner Hisao Yagi President, NEC Telecom Software Phils., Inc. Gentlemen : This refers to your tax treaty relief application filed on August 26, 2011, on behalf of NEC Communication Systems, Ltd. ("NCOS"), requesting confirmation that its income from NEC Telecom Software Philippines, Inc. ("NSP") is exempt from Philippine income tax pursuant to the amended Philippines-Japan Tax Treaty, as amended. 1 It is represented that NCOS, with address at 1-4-28, Mita, Minato-ku, Tokyo, 108-0073, Japan, is a corporation organized and existing under the laws of Japan and a resident of Japan per Residence Certificate issued by the District Director of Shiba Tax Office on July 29, 2011; that NCOS is not registered either as a corporation or as a partnership in the Philippines as shown in the Certification of Non-Registration of Corporation/Partnership issued by the Securities and Exchange Commission on August 19, 2011; and that NSP, on the other hand, is a domestic corporation duly organized and existing under the laws of the Philippines with office address located at E-Office One, Asia Town I.T. Park Apas, Cebu City; that it is a Philippine Economic Zone Authority (PEZA)-registered enterprise in the Philippines under Certificate of Registration No. 01-018-IT dated March 23, 2007, licensed to engage in the development and export of operation management software for telecommunication equipment and transmission systems and system engineering such as, but not limited to, fiber optic transmission system (multiplexer), high performance internet routers, cable as shown in the Certificate issued by the PEZA dated August 2, 2011. It is also represented that on July 4, 2011, a Service Agreement ("Agreement") was entered into by and between NCOS and NSP, whereby NCOS shall render to NSP consultation activities as Appraisal, SCAMPI Team Training and Readiness Review; that the Agreement shall remain in force from July 4, 2011 to May 31, 2012; that in the rendition of the consultancy services, NCOS shall send personnel/staff in the Philippines for an aggregate period of seventeen (17) days for the entire duration of the Agreement per Certification issued by NSP dated August 18, 2011; that the payments for service was paid to NCOS on August 31, January 30, May 29 and August 2, 2012 as evidenced by application for telegraphic transfer of funds of Metro Bank. It is finally represented, per the Certification issued by NSP dated August 18, 2011, that the issue subject of the above request is not under any investigation or on-going audit, administrative protest, claim for refund or issuance of tax credit certificate, collection proceedings, or a judicial appeal. CSIDEc In reply, please be informed that profits derived in the Philippines by a nonresident corporation, like NCOS in the instant case, are generally subject to tax under Section 28 (B) (1) of the National Internal Revenue Code of the Philippines of 1997 (Tax Code of 1997), as amended. It provides, viz. : "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 . . . profits and income, . . .: Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)." (Emphasis supplied) xxx xxx xxx" However, said income derived by a nonresident foreign corporation may be exempt or partially exempt pursuant to a treaty obligation to which the Philippine government is bound. Thus, Section 32 (B) (5) of the Tax Code of 1997, as amended provides, viz. : "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: 2 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." aAHDIc In the instant case which involves income derived within the Philippines by a resident of Japan, Article 7 (1) of the Philippines-Japan tax treaty, as amended, appropriately applies. It provides: "Article 7 1. The profits of an enterprise of a Contracting State shall be taxable only in that Contracting 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 that other Contracting State but only so much of them as is attributable to that permanent establishment. xxx xxx xxx" Based on the above, the profits of an enterprise of Japan shall be taxable only in Japan unless the enterprise carries on business in the Philippines through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in Philippines but only so much of them that is attributable to that permanent establishment. Applying this to the instant case, the service fees received by NCOS for services rendered in the Philippines under the Contract shall be taxable in the Philippines only if it has a permanent establishment in the Philippines in connection with the activities giving rise to such income. In relation thereto, Article 5 of the same tax treaty defines a permanent establishment, as follows: "Article 5 1. For the purposes of this Convention, the term 'permanent establishment' means a fixed place of business through which the business of an enterprise is wholly or partly carried on. xxx xxx xxx 6. An enterprise of a Contracting State shall be deemed to have a permanent establishment in the other Contracting State if it furnishes in that other Contracting State consultancy services, or supervisory services in connection with a contract for a building, construction or installation project through employees or other personnel other than an agent of an independent status to whom paragraph 7 applies provided that such activities continue (for the same project or two or more connected projects) for a period or periods aggregating more than six months within any taxable year. However, if the furnishing of such services is effected under an agreement between the Governments of the two Contracting States regarding economic or technical cooperation, that enterprise shall, notwithstanding any provisions of this Article, not be deemed to have a permanent establishment in that other Contracting State. aICcHA xxx xxx xxx" Paragraph 6 of Article 5 provides that an enterprise of Japan shall be deemed to have a permanent establishment in the Philippines if it furnishes in the Philippines consultancy services, or supervisory services in connection with a contract for a building, construction or installation project through employees or other personnel other than an agent of an independent status to whom paragraph 7 applies provided that such activities continue (for the same project or two or more connected projects) for a period or periods aggregating more than six months within any taxable year. Accordingly, in as much as the services performed in the Philippines pursuant to the Agreement totaled an aggregate period of 17 days, which is a period not exceeding 183 days within a twelve-month period, then NCOS is not deemed to have a permanent establishment by virtue of the rendition of said services in the Philippines to which its profits could be attributable. In view thereof, this Office is of the opinion and so holds that the profits derived by NCOS from the rendition of services under the Agreement shall mot be subject to Philippine income tax pursuant to Article 7 (1) in relation to Article 5 of the Philippines-Japan Tax Treaty, as amended. As regards the imposition of the VAT on the rendition of services of NCOS, please be informed further that Section 108 of the Tax Code of 1997, 3 as amended provides, as follows: "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%) 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 of services in the Philippines for others for a fee, remuneration or consideration, . . ." (Emphasis supplied) Thus, in general, the VAT is imposed on services rendered by NCOS in the Philippines. On every payment of service fees, NSP is required to withhold such VAT and treat the same as a "passed on" VAT, pursuant to Section 4.110-3 (b) of Revenue Regulations No. 7-95, as amended [now Section 4.114-2 (b) of Revenue Regulations No. 16-05]. ECaScD However, in Commissioner of Internal Revenue vs. Seagate Technology (Philippines) (G.R. No. 153866, February 11, 2005), the Supreme Court held, viz. : "Special laws may certainly exempt transactions from the VAT. 5 However, the Tax Code provides that those falling under PD 66 are not. PD 66 is the precursor of RA 7916 the special law under which respondent was registered. The purchase transactions it entered into are, therefore, not VAT-exempt. These are subject to the VAT; respondent is required to register. xxx xxx xxx Since the purchases of respondent are not exempt from the VAT, the rate to be applied is zero. Its exemption under both PD 66 and RA 7916 effectively subjects such transactions to a zero rate, because the ecozone within which it is registered is managed and operated by the PEZA as a separate customs territory. This means that in such zone is created the legal fiction of foreign territory. Under the cross-border principle of the VAT system being enforced by the Bureau of Internal Revenue (BIR), no VAT shall be imposed to form part of the cost of goods destined for consumption outside of the territorial border of the taxing authority. If exports of goods and services from the Philippines to a foreign country are free of the VAT, then the same rule holds for such exports from the national territory except specifically declared areas to an ecozone. xxx xxx xxx Applying the special laws we have earlier discussed, respondent as an entity is exempt from internal revenue laws and regulations. This exemption covers both direct and indirect taxes, stemming from the very nature of the VAT as a tax on consumption, for which the direct liability is imposed on one person but the indirect burden is passed on to another. Respondent, as an exempt entity, can neither be directly charged for the VAT on its sales nor indirectly made to bear, as added cost to such sales, the equivalent VAT on its purchases. Ubi lex non distinguit, nec nos distinguere debemus . Where the law does not distinguish, we ought not to distinguish. Moreover, the exemption is both express and pervasive for the following reasons: cTSDAH . . ., R.A. 7916 states that 'no taxes, local and national, shall be imposed on business establishments operating within the ecozone'. Since this law does not exclude the VAT from the prohibition, it is deemed included. Exceptio firmat regulam in casibus non exceptis . An exception confirms the rule in cases not excepted; that is, a thing not being excepted must be regarded as coming within the purview of the general rule. Moreover, even though the VAT is not imposed on the entity but on the transaction, it may still be passed on and, therefore, indirectly imposed on the same entity a patent circumvention of the law. That no VAT shall be imposed directly upon business establishments operating within the ecozone under R.A. 7916 also means that no VAT may be passed on and imposed indirectly. Quando aliquid prohibetur ex directo prohibetur et per obliquum . When anything is prohibited directly, it is also prohibited indirectly. xxx xxx xxx" Based on the foregoing, the sale of goods and services to persons or entities exempt from VAT, by reason of PD 66 and RA 7916, is effectively zero-rated. However, instead of zero-rating which is not available to nonresident suppliers, the provision for exempt transactions under Section 109 (K) of the Tax Code of 1997, as amended, which provides VAT exemption for transactions that are exempt under special laws, e.g. , Republic Act No. 7916 or PEZA Law, is particularly applicable to the instant case. Such being the case, the payment of service fees by NSP, being a PEZA-registered enterprise, to NCOS under the subject Contract should be, as it is hereby confirmed to be, exempt from VAT. This ruling is issued on the basis of the facts as represented. However, if upon investigation it shall be disclosed that the facts are different, then this ruling shall be without force and effect insofar as the herein parties are concerned. IcCDAS Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes 1. Convention between the Republic of the Philippines and Japan for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income. 2. Effective January 1, 2009. 3. This cited provision has been retained by Republic Act (RA) No. 9337, although with the modification as to the applicable rate when the circumstances so warrant. 4. Effective February 1, 2006, the rate shall be 12%. 5. Referring to the old Section 109 (q) of the Tax Code of 1997 [now Section 109 (K), as amended by RA No. 9337.