ITAD Ruling No. 012-03

January 27, 2003 ITAD RULING NO. 012-03 Arts. 5, 8, 16 & 20, RP-US tax treaty Secs. 28, 42 & 108, NIRC BIR Ruling No. DA ITAD-169-02 BIR Ruling No. DA ITAD-190-02 Office of the Governor Province of Marinduque Provincial Capitol Santos, Boac, Marinduque Attention: Hon. Carmencita O. Reyes Provincial Governor Gentlemen : This refers to your letter dated January 20, 2003 requesting confirmation of your opinion on the following: 1) that the salaries paid to United States Geological Survey (USGS) personnel by USGS while conducting their studies in the Philippines is not subject to Philippine income tax; 2) that payments made by the Provincial Government of Marinduque to Futures Group International, Inc. (FGI) are not subject to Philippine tax and; 3) that said payments by PGM to FGI are not subject to value-added tax. It is represented that USGS is an agency of the Department of Interior of the United States of America (USA); that FGI is a non-resident foreign corporation duly organized and existing under the laws of USA; that the Provincial Government of Marinduque (PGM) and USGS, in collaboration with the Department of Environment and Natural Resources (DENR) and the Department of Health (DOH), entered into an agreement whereby USGS will undertake technical management and oversight of the consortium of experts from the Armed Forces Institute of Pathology, University of Arizona and Geochimica, Inc.; that under the agreement, the USGS consortium will conduct a study on the geological, biological, health and safety aspects of the mines waste disaster resulting from Marcopper mining operations which has affected the environment and ecological system of Marinduque; that the study will cover a period of 18 months with most if not all of the work to be done in the United States; that some of the USGS personnel may arrive in the Philippines but will not be staying for more than 180 days in the aggregate in a given year; that the funds for the Study shall be provided by the President's Social Fund which shall be released by the Office of the President to PGM thru the DENR; that FGI is the nominated agent of USGS that will undertake the fiscal management aspect of the study; that the payments to USGS are made by Provincial Government of Marinduque through FGI. In reply, this Office is of the opinion and so holds: 1. Whether the income paid to USGS personnel while conducting their studies in the Philippines is subject to Philippine income tax. While it is true that the subject agreement is between the instrumentality of the Philippines and United States, Article 20 (Government Functions) of the RP-US tax treaty will find no application. To illustrate our position, Article 20 of the treaty is reproduced as follows: "Article 20 GOVERNMENT FUNCTIONS Wages, salaries and similar remuneration, including pensions, annuities, or similar benefits, paid from public funds of one of the Contracting States. a) To a citizen of that Contracting State, or b) To a citizen of a State other than a Contracting State who comes to the other Contracting State expressly for the purpose of being employed by the first-mentioned Contracting State for labor or personal services, performed as an employee of the national Government of that Contracting State, or any agency thereof, in the discharge of functions of a governmental nature shall be exempt from tax by the other Contracting State. A cursory reading of the above will show that such provisions are intended only to cover services which are governmental in nature paid by public funds of a State, and which services are rendered in the other State. Since the study is both funded by the Philippine government and rendered in the Philippines, it will not fall within the purview of governmental functions. In this connection, it is Article 16 of the RP-US tax treaty that covers the subject transaction, which reads, viz : "Article 16 DEPENDENT PERSONAL SERVICES 1. Except as provided in Article 20 (Governmental Functions), wages, salaries, and similar remuneration derived by an individual who is a resident of one of the Contracting States from labor or personal services performed as an employee, including income from services performed by an officer of a corporation, may be taxed by that Contracting State. Except as provided by paragraphs (2) and (3) and in Articles 20 (Governmental Functions), 21 (Teachers), and 22 (Students and Trainees), such remuneration derived from sources within the other Contracting State may also be taxed by that other Contracting State. 2. Remuneration described in paragraph (1) derived by an individual who is a resident of one of the Contracting States shall be exempt from tax by the other Contracting State if a) He is present in that other Contracting State for a period or periods aggregating less than 90 days in the taxable year; b) He is an employee of a resident of, or of a permanent establishment maintained in, the first-mentioned Contracting State; and c) The remuneration is not borne as such by a permanent establishment which the employer has in that other Contracting State. 3. Notwithstanding the preceding provisions of this article, remuneration derived by an employee of a resident of one of the Contracting States for labor or personal services performed as a member of the regular complement of a ship or aircraft operated in international traffic by a resident of that Contracting State may be taxed only by that Contracting State." Based on the aforecited provisions, remuneration derived by USGS personnel in conducting the study shall be exempt from Philippine income tax if the following conditions concur: (a) he is present in the Philippines for a period not exceeding an aggregate of 90 days in a taxable year; (b) that he is an employee of USGS; and (c) the remuneration is not borne by a permanent establishment of USGS in the Philippines. Accordingly, if all the preceding conditions are satisfied, the income of the USGS personnel shall not be subject to Philippine income tax, otherwise, such remuneration may be taxed in the Philippines. (BIR Ruling No. ITAD-169-02 dated September 26, 2002) 2. Whether the payments made by the Provincial Government of Marinduque (PGM) to Futures Group International, Inc. (FGI) are not subject to Philippine income tax Under the proposed agreement, it is USGS that actually conducts the study. FGI merely receives the payment from PGM on behalf of USGS. Therefore, the payments by PGM to FGI is in reality a payment to USGS, FGI being an agent of the latter. In this regard, Article 8 in relation to Article 5 of the RP-US tax treaty provides 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." CAacTH "xxx xxx xxx" "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; 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. " (emphasis supplied) Based on the aforequoted provisions, it is clear that if an enterprise which is a resident of the United States does not carry on business in the Philippines through a permanent establishment situated therein, the profits of the same shall not be subject to Philippine income tax. For this purpose, an enterprise which is a resident of the United States 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, in the same or connected project, continue within the Philippines for a period or periods aggregating more than 183 days. Considering that in the furnishing of services in the Philippines, USGS personnel will not stay in the Philippines for more than 180 days in the aggregate in a year, USGS is not deemed to have a permanent establishment in the Philippines to which its business profits may be attributed to. Therefore, the payments by PGM received by FGI on behalf of USGS for services rendered in the Philippines by USGS is not subject to Philippine income tax pursuant to Article 8(1) in relation to Article 5(2) of the RP-US tax treaty. (BIR Ruling No. ITAD-190-02 dated October 25, 2002) As regards the portion of the payments for services rendered by USGS outside the Philippines, it is noteworthy that the RP-US tax treaty will find no application as the transaction does not result in double taxation for which a tax treaty relief may be sought. Such fees are considered income derived from sources outside the Philippines, and therefore, are not subject to Philippine income tax. ( Section 28(B)(1) in relation to Section 42(A)(3), NIRC ) EHACcT 3. Whether the payments of PGM to FGI are not subject to Value-added Tax The payments by PGM for the services actually rendered within the Philippines by USGS shall, however, be subject to the 10 percent value added tax (VAT) pursuant to Section 108(A)(1) and (3) of the Tax Code of 1997. Accordingly, PGM, being the resident withholding agent and payor in control of the payment shall be responsible for the withholding of the 10% final VAT on such service fees before making any payment to USGS. In remitting the VAT withheld, PGM shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld). The duly filed BIR Form 1600 and proof of payment thereof shall serve as documentary substantiation for the claim of input tax by PGM upon filing its own VAT Return, if it is a VAT-registered taxpayer. In case PGM is a non-VAT registered taxpayer, the passed-on VAT withheld shall form part of the cost of the service purchased which may be treated as "expense" or "asset" whichever is applicable. In addition, PGM is required to issue the Certificate of Final Tax Withheld at Source (BIR Form 2306) in quadruplicate upon request of USGS, the first three copies thereof to be given to USGS and the fourth copy to be retained by PGM 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 facts are different, then this ruling shall be without force and effect insofar as the herein parties are concerned. Very truly yours, Commissioner of Internal Revenue By: (SGD.) MILAGROS V. REGALADO Assistant Commissioner Legal Service