ITAD Ruling No. 024-04

March 11, 2004 ITAD RULING NO. 024-04 Arts. 5, 7 & 12, RP-Switzerland Arts. 5, 7 & 12; RP-Singapore BIR Ruling No. ITAD DA 39-03 Sycip Gorres Velayo & Co. 6760 Ayala Avenue 1226 Makati City Attention: A. C. Tionko Tax Division Gentlemen : This refers to your letter dated November 17, 2003 on behalf of your client, Panalpina World Transport (Phils.) Inc. (P-Philippines), requesting confirmation of the following: (1) The compensation to be paid by P-Philippines to Panalpina Management AG (P-Switzerland) and Panalpina World Transport (Singapore) Pte. Ltd. (P-Singapore) for business services and IT services, respectively, under Business Service Agreement and IT Service Agreement (Agreements) are considered as compensation for services and not royalties; and (2) Since P-Switzerland and P-Singapore do not have permanent establishments in the Philippines as defined under the RP-Switzerland and RP-Singapore tax treaties, the compensation for services received from P-Philippines shall not be subject to withholding tax in the Philippines under the Article on Business Profits as provided for in the said treaties. It is represented that P-Switzerland is a nonresident foreign corporation duly organized and existing under the laws of Switzerland with office address at Viadukstrasse 42, Basel, Switzerland 4051; that P-Singapore is a nonresident foreign corporation duly organized and existing under the laws of Singapore with office address at # 1 Pickering Street, # 08-01 Singapore 048659; that both companies are not registered either as a corporation or as a partnership and have not been licensed to do business in the Philippines per certifications both dated November 13, 2003 issued by the Securities and Exchange Commission (SEC); that P-Philippines is a domestic corporation duly organized and existing under the laws of the Philippines with office address at Zealcor Business Center, Sta. Agueda Ave., Pascor Drive, Sto. Nio, Paraaque City; that it is engaged in the freight forwarding business; that on January 1, 2003, it entered into a Business Service Agreement with P-Switzerland and an IT Services Agreement with P-Singapore; that under the Business Service Agreement, P-Switzerland shall render business services to P-Philippines consisting of, but not limited to: 1. Information Technology 2. Finance Corporate Credit Control Corporate Controlling and Agent Relations Corporate Financial Reporting and Tax Management Accounting Corporate Treasury 3. Global Accounts 4. Executive Board Corporate Business Development Human Resources Corporate Secretary Internal Duties Corporate Audit 5. General Projects Local Supports Training that under the IT Services Agreement, on the other hand, P-Singapore shall provide P-Philippines Information Technology services in the areas of Corporate Information Management, Management Information System and Process Development; that IT services relate to forwarding systems, Internet Systems, SAP, systems and communications, infrastructure, customer and logistics systems as well as data centers; that the business and IT services are largely to be performed abroad and that any Philippine services shall only last for a short duration of time, which will not exceed 6 months or 183 days in any twelve-month period; that for their services, P-Switzerland and P-Singapore shall bill P-Philippines for total cost directly incurred in rendering the services determined on the basis of the Cost Allocation Keys outlined in the Panalpina Transfer Pricing Manual. In reply, please be informed this Office's opinion on the above issues are as follows: 1. The service fees are not in the nature of royalties . Article 12(3) of the RP-Switzerland and the RP-Singapore tax treaties, respectively, provides that: "RP-Switzerland "Article 12 Royalties xxx xxx xxx 3. The term "royalties" as used in this Article means payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematographic films and films and tapes for television or radio broadcasting, any patent, trademark, design or model, plan, secret formula, or process, or for information concerning industrial, commercial or scientific experience. "xxx xxx xxx." RP-Singapore "Article 12 Royalties xxx xxx xxx 3. The term "royalties" as used in this Article means payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work, including cinematographic films or tapes for television or broadcasting, any patent, trade mark, design or model, plan, secret formula or process, or for the use of, or the right to use, industrial, commercial or scientific equipment, or for information concerning industrial, commercial or scientific experience. aHCSTD "xxx xxx xxx." Both tax treaties define " royalties " to include " payments of any kind received as a consideration for information concerning industrial, commercial or scientific experience ." According to the commentaries of the ORGANISATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT (OECD) Committee on Fiscal Affairs on the Model Tax Convention [par. 11, Commentary on Article 12 (royalties), 1998, p. 151), such information alludes to the concept of " know-how ". The definition of know-how, which has been adopted by the said Committee, is " all the undivulged technical information, whether capable of being patented or not, that is necessary for the industrial reproduction of a product or process, directly and under the same conditions; inasmuch as it is derived from experience, know-how represents what a manufacturer cannot know from mere examination of the product and mere knowledge of the progress of technique ." In the know-how contract, one of the parties agree 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. ( BIR Ruling No. DA-ITAD 49-02 dated April 15, 2002 ) Furthermore, in the case of Philippine Refining Company (PRC) vs. CIR, CTA case No. 2872 dated January 15, 1986 , the Court of Tax Appeals had an occasion to rule on the distinction of service fees from royalties, to wit: "To distinguish between compensation for service and royalty payments, one must inquire on whether the payee has proprietary interest in the property giving rise to the income. If the payee has none, then the payment is a compensation for personal services, if the payee has proprietary interest then the payment is royalty." Based on the above, the subject payments under the Business Service and the IT Service Agreements are not within the definition of royalties under Article 12(3) of the RP-Switzerland and RP-Singapore tax treaties. Nothing in the said Agreements would require transfer in the Philippines of "know-how" or any property of which the payee has proprietary interest. 2. The service fees are business profits not subject to Philippine tax . Article 5 of the RP-Singapore tax treaty provides: "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 specially 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; j) A workshop; g) A warehouse, in relation to a person providing storage facilities for others; h) A mine, quarry, or other place of extraction of natural resources; i) A building site or construction or assembly project or installation project or supervisory activities in connection therewith, provided such site, project or activity continues for a period 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. "xxx xxx xxx." In relation thereto, Article 7 of the RP-Singapore tax treaty also provides: "Article 7 BUSINESS PROFITS 1. The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on or has carried 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. "xxx xxx xxx." On the other hand, Article 7 of RP-Switzerland tax treaty provides: "Article 5 PERMANENT ESTABLISHMENT 1. For the purposes of this Convention, the term "permanent establishment" means a fixed place of business through 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; j) a mine, an oil or gas well, a quarry or any other place of extraction of natural resources; g) a building site, a construction, assembly or installation project or supervisory activities in connection therewith, but only where such site, project or activity continues for a period of more than six months; h) the furnishing of services, including consultancy services, by an enterprise through employees or other personnel engaged by the enterprise for such purpose, but only where activities of that nature continue (for the same or a connected project) within the country for a period or periods aggregating more than six months within any twelve-month period. "xxx xxx xxx." In relation thereto, Article 7 of the same tax treaty states: "Article 7 BUSINESS PROFITS 1. The profits of an enterprise of a Contracting State shall be taxable only in that 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 the other State but only so much of them as is attributable to that permanent establishment. "xxx xxx xxx." It is clear from the aforequoted provisions that if a corporation which is a resident of Singapore or Switzerland does not carry on business in the Philippines through a permanent establishment situated therein, the profits of such corporation shall not be subject to Philippine income tax. For this purpose, a corporation which is a resident of Singapore or Switzerland may be deemed to have a permanent establishment in the Philippines if, among others, the furnishing of services through its employees continue (for the same or a connected project) within the Philippines for a period or periods aggregating more than 183 days. aACEID Inasmuch as it has been represented that the business and IT services will be performed by the P-Singapore and P-Switzerland outside the Philippines, and that any services to be performed in the Philippines shall not exceed 6 months or 183 days in any twelve-month period, P-Singapore and P-Switzerland cannot be considered to have a permanent establishment in the Philippines. Hence, the herein service fees are considered income derived from sources outside the Philippines pursuant to Section 42(C)(3) of the Tax Code of 1997 and are, therefore, not subject to Philippine income tax and consequently to the withholding tax under Section 28(B)(1) of the same Code. ( BIR Ruling No. DA-ITAD 39-03 dated March 4, 2003 ) 3. On Value-Added Tax Moreover, while the compensation for services rendered outside the Philippines is not subject to the 10% VAT, however, the fees paid for that portion where the services of P-Singapore and P-Switzerland are rendered in the Philippines are subject to the 10% VAT pursuant to Section 108(a) of the Tax Code of 1997. Accordingly, P-Philippines, 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 P-Singapore and P-Switzerland. In remitting the VAT withheld, P-Philippines shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Fax 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 P-Philippines upon filing its own VAT Return, if it is a VAT-registered taxpayer. In case P-Philippines 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, P-Philippines is required to issue the Certificate of Final Tax Withheld at Source (BIR Form 2306) in quadruplicate upon request of P-Singapore and P-Switzerland, the first three copies thereof to be given to P-Singapore and P-Switzerland and the fourth copy to be retained by P-Philippines 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 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