ITAD Ruling No. 016-05

February 24, 2005 ITAD RULING NO. 016-05 Articles 5 (Permanent Establishment) and 8 (Business Profits) Philippines-United States of America tax treaty BIR Ruling No. 191-87 BIR Ruling UN-030-1-16-95 BIR Ruling No. DA-ITAD 14-03 Laya Mananghaya & Co. Certified Public Accountants and Management Consultants 22nd Floor, Philamlife Tower 8767 Paseo de Roxas Street Makati City Attention: Atty. Raymund S. Gallardo Partner Atty. Melea Solis-Cruz Manager Tax and Corporate Services Gentlemen : This refers to your letter dated December 10, 2004 requesting for the tax treatment of service fees to be paid by the United States Agency for International Development (USAID) to Development Alternatives, Inc. (Development Alternatives) under the pertinent provisions of the Philippines-United States of America (United States or U.S.A.) tax treaty. It is represented that Development Alternatives (formerly, The Development Corporation ) is a foreign company organized and existing under the laws of the United States with principal office at 7250 Woodmont Avenue, Suite 200, Bethesda, Maryland 20814, U.S.A., as confirmed by the relevant Certificate issued by Development Alternatives ' Corporate Secretary on March 3, 2004, certified as a public document by a notary public in the County of Montgomery, State of Maryland on March 3, 2004 and by the Secretary of the State of Maryland on March 25, 2004; that Development Alternatives is engaged in (1) assisting individuals, corporations and government instrumentalities who are involved or considering involvement in developing nations (a) to understand the political, economic, and cultural environment of such nations, and (b) to devise and implement programs relating to their involvement in the context of social and political changes in those nations, and (2) assisting individuals, corporations and government instrumentalities involved or considering involvement in social and economic problems of the United States; that Development Alternatives is licensed to establish a representative office in the Philippines (Representative Office), as confirmed by the License issued to Development Alternatives by the Securities and Exchange Commission on September 17, 1992 numbered AFO92-000057; that the Representative Office's functions are to liaise with potential customers in the Philippines and to undertake activities (like information dissemination and sales promotion), for Development Alternatives ; that the Representative Office's address is at Unit 2007, 20th Floor, Jollibee Plaza Condominium, Emerald Avenue, Ortigas Center, Pasig City, Philippines; that on September 27, 2004, the USAID contracted Development Alternatives to provide technical assistance in the implementation of the Environmental Governance 2 Project (Project); that the Project is pursuant to (1) the Memorandum of Understanding between the United States of America (through the USAID ) and the Republic of the Philippines (through the National Economic and Development Authority) for the Protection of Productive and Life-Sustaining Natural Resources dated May 30, 2002, (2) the Strategic Objective Grant Agreement between the Republic of the Philippines and the United States of America for Protection of Productive and Life-Sustaining Natural Resources through Improved Environmental Management and Enforcement dated August 22, 2001, and (3) the Economic and Technical Cooperation Agreement between the Government of the United States of America and the Government of the Philippines signed on April 27, 1951 and entered into force on May 21, 1951, whereby the United States government agreed to provide to and for the Philippine government technical assistance, among others; that the objectives of the Project are to strengthen the capacities of the Department of Environment and Natural Resources (DENR), local government units (LGUs), and local institutions to improve the management of forests, coastal marine and water resources, and promote integrated solid waste management by LGUs through effective environmental governance; that the Project calls for a seven-year completion and that for the first five years, Development Alternatives is expected to have achieved the following targets: (1) 80 institutions (e.g., DENR, Department of the Interior and Local Government (DILG, LGUs) meeting environmental good governance index benchmarks; (2) 150,000 hectares of forest cover placed under improved management; (3) 800 hectares of coastal areas placed under improved management, 20 marine protected areas established covering 300 hectares and the management of 60 existing marine protected areas (covering about 750 hectares); (4) 25% of waste diverted to recycling and composting in 90 LGUs; and (5) 20 LGUs investing in sanitation facilities; that Development Alternatives has the following responsibilities for the Project: (1) Functional co-management arrangements established between, and among, local and national government agencies, communities and other stakeholders in the project sites to enable them to implement forest, coastal and marine resource management plans, to carryout waste reduction schemes, and to establish sanitation and solid waste management facilities; (2) Technical, financial, policy support and other governance tools put in place to sustain the efforts of local and national government agencies, communities and other stakeholders in the project sites to improve environmental management; (3) An index for Good Environmental Governance developed and advocated to be adopted by participating national and local government agencies. In relation, baseline information shall be established and procedures in place for annual monitoring; (4) Appropriate financing options identified, developed and made accessible to project partners to support community-based natural resource management and water pollution control projects. Public-private alliances shall be encouraged to mobilize investments for implementing improved environmental management practices; (5) Training provided to government and non-government law enforcement agencies in the project sites, (e.g., Bantay Dagat (Protect the Ocean)/Bantay Gubat (Protect the Forest)/ Bantay Basura (Solid Waste Management) volunteers, PEDOs, Judges, Office of the Environmental Ombudsman and prosecutors) on environmental laws and alternative dispute resolution techniques. A national environmental law enforcement protocol developed and best efforts exerted to facilitate its adoption by concerned government and non-government agencies; (6) Local service providers such as local academic institutions and other non-profit groups identified and strengthened to provide technical assistance to LGUs, other government agencies and communities; (7) A small-grants program established to support community-based natural resource management and water pollution abatement actions. This includes a monitoring system done in partnership with local and national government agency partners; and (8) LGU leagues, sectoral, and professional associations strengthened to promote environmental good governance and implement public awareness campaign on environmental issues; and that the estimated cost of the Project, exclusive of service fees, is $17,873,909 for the base period (years 1 to 5) and $4,282,714 for the extension period (years 6 to 7), and that the service fees of Development Alternatives are $1,126,034 for the base period and $262,973 for the extension period. In reply, please be informed that the service fees to be paid by the USAID to Development Alternatives are business profits taxable under the provisions of paragraph 1, Article 8 (Business Profits) of the Philippines-United States tax treaty below: "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. "xxx xxx xxx" According to paragraph 1, the service fees are subject to Philippine income tax only if they are attributable to a permanent establishment which Development Alternatives has in the Philippines. A permanent establishment, as defined in paragraphs 1 and 2, Article 5 (Permanent Establishment) of the same tax treaty, means "a fixed place of business through which a resident of one of the Contracting States engages in trade or business," and includes, for example, "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, which continues for a period or periods aggregating more than 183 days." In the first instance, where it is required that there be a fixed place of business and with respect to the representation that Development Alternatives has an office in the Philippines (Representative Office), the same can constitute a permanent establishment if the activities carried out therein are not preparatory and auxiliary in character and if the Representative Office has a certain degree of permanency. As regards examples of activities that have a preparatory and auxiliary character, paragraph 3, Article 5 of the tax treaty mentions: "3. Notwithstanding paragraphs 1, 2, and 4, a permanent establishment shall be deemed not to include any one or more of the following: a) The use of facilities solely for the purpose of storage, display, or occasional delivery of goods or merchandise belonging to the resident; b) The maintenance of a stock of goods or merchandise belonging to the resident solely for the propose of storage, display, or occasional delivery; c) The maintenance of a stock of goods or merchandise belonging to the resident solely for the purpose of processing by another person; d) The maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise, or for collecting information, for the resident; e) The maintenance of a fixed place of business solely for the purpose of advertising, for the supply of information, for scientific research, or for similar activities which have a preparatory or auxiliary character, for the resident; or f) The furnishing of services, including the provision of equipment, in one of the Contracting States by a resident of the other Contracting State, including consultancy firms, in accordance with, or in the implementation of an agreement between the Contracting States regarding technical cooperation." Where it is represented that the Representative Office's functions are to liaise with potential customers in the Philippines and to undertake activities (like information dissemination and sales promotion) for Development Alternatives , said activities (without more) can be regarded as preparatory and auxiliary, in accordance with subparagraphs (a) and (d) above. However, if the liaising with potential customers and sales promotion extend to negotiation and/or signing of sales contracts and/or to after-sales services, the same are regarded as being beyond preparatory and auxiliary and as such can deem the Representative Office a permanent establishment. As regards permanency, where it is represented that the Representative Office has been in existence immediately after it was given license by the Securities and Exchange Commission on September 17, 1992 and it continues to be so at present or for more than twelve years now, the Representative Office is considered as already having acquired a certain degree of permanency. Hence, considering that the activities carried out in the Representative Office are merely preparatory and auxiliary, although the Representative Office, over time, has already acquired a certain degree of permanency, the Representative Office does not yet constitute a permanent establishment of Development Alternatives . In the second instance, with respect to furnishing of services and where it is represented, that Development Alternatives (through its personnel or employees) will provide technical assistance for the Project in the Philippines for five years and for not less than 183 days, said activity will generally be considered as constituting a permanent establishment for Development Alternatives . However, subparagraph (f) of the above-quoted paragraph 3, excludes from the concept of a permanent establishment " the furnishing of services, including the provision of equipment, in one of the Contracting States by a resident of the other Contracting State, including consultancy firms, in accordance with, or in the implementation of an agreement between the Contracting States regarding technical cooperation ." In other words, even if the furnishing of services exceeds the allowed period of 183 days, the same cannot be regarded as giving rise to a permanent establishment if said activity is carried out in pursuance of a technical cooperation agreement between the Philippines and the United States. Where it is represented that the provision of technical assistance by Development Alternatives is pursuant to a technical cooperation agreement between the Philippines and the United States (namely, (1) the Memorandum of Understanding between the United States of America (through the USAID ) and the Republic of the Philippines (through the National Economic and Development Authority) for the Protection of Productive and Life-Sustaining Natural Resources dated May 30, 2002, (2) the Strategic Objective Grant Agreement between the Republic of the Philippines and the United States of America for Protection of Productive and Life-Sustaining Natural Resources through Improved Environmental Management and Enforcement dated August 22, 2001, and (3) the Economic and Technical Cooperation Agreement between the Government of the United States of America and the Government of the Philippines signed on April 27, 1951 and entered into force on May 21, 1951), said activity is covered by the exclusion from the concept of a permanent establishment in subparagraph (f). By mentioning the phrase "including consultancy firms," subparagraph (f) extends the exclusion to other entities (like Development Alternatives ) whom the United States may assign or delegate to fulfill its obligations to the Philippines under the relevant technical cooperation agreement/s. This being so, the service fees to be paid by the USAID to Development Alternatives for the provision of technical assistance for the Project are exempt from Philippine income tax. (BIR Ruling No. 191-87 dated July 2, 1987 and BIR Ruling UN-030-1-16-95 dated December 16, 1994) Finally, the service fees to be paid by USAID to Development Alternatives , being payments for the performance of services in the Philippines, are generally subject to 10 percent value-added tax (VAT) under Section 108(A) of the Tax Code below: "Section 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. '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 . . . " However, since VAT is an indirect tax and the amount of tax may be shifted or passed on to the buyer, transferee or lessee (Section 105, Tax Code), the USAID , in this case, and not Development Alternatives , will ultimately shoulder the payment of VAT on the service fees. But in view of the existing VAT Exemption Certificate No. 2004-109 dated December 16, 2003 issued to the Embassy of the United States of America (to which the USAID is a part and is working dependently) valid until December 31, 2004 and renewable every year, the USAID cannot be obliged to shoulder the VAT on the subject service fees. Thus, the service fees to be paid by the USAID to Development Alternatives are exempt from VAT. (BIR Ruling No. DA-ITAD 14-03 dated January 27, 2003) EIAHcC 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.) JOSE MARIO C. BUAG Deputy Commissioner Legal and Inspection Group