ITAD Ruling No. 032-04

April 2, 2004 ITAD RULING NO. 032-04 Articles 5 and 7, Philippines-Japan tax treaty Sections 23 (F) and 108 (A), National Internal Revenue Code of 1997 BIR Ruling No. DA-ITAD 152-03 Sycip Gorres Velayo & Co. 6th Floor, Ayala Life FGU Center Mindanao Avenue corner Biliran Road Cebu Business Park, Cebu City 6000 Cebu Attention: Atty. Lauris L. dela Pea Tax Service s Gentlemen : This refers to your letter dated January 7, 2004 requesting confirmation that commissions for 'design-in' activities paid by Taiyo Yuden (Philippines), Inc. (Taiyo Yuden-Philippines) to Taiyo Yuden Company, Ltd. (Taiyo Yuden-Japan) are exempt from Philippine income tax pursuant to Section 28(B)(1) of the National Internal Revenue Code of 1997 (Tax Code) and Articles 5 and 7 of the Philippines-Japan tax treaty. It is represented that Taiyo Yuden-Japan is a company organized and existing under the laws of Japan, with principal office at 6-16-20 Ueno, Taito-ku, Tokyo, Japan; that Taiyo Yuden-Japan is engaged primarily in the manufacture and sale of electronic and electric machinery and apparatus and materials related thereto; that Taiyo Yuden-Japan has a representative office in the Philippines, the Taiyo Yuden Company, Ltd. (Manila Representative Office) , at Unit 901, Antel 2000 Corporate Centre, 121 Valero Street, Salcedo Village, Makati City; that, on the other hand, Taiyo Yuden-Philippines is a company organized and existing under the laws of the Philippines, with principal office at Mactan Export Processing Zone, Lapu-lapu City, Cebu; that, on December 16, 2003, Taiyo Yuden-Japan and Taiyo Yuden-Philippines , entered into a Design-in Service Agreement, where Taiyo Yuden-Japan shall carry out the following activities in Japan for Taiyo Yuden-Philippines : 1. Collection and analysis of information on manufacturers in Japan targeted for the Design-in Activity (Target Users) and on market trends; 2. Introduction of Taiyo Yuden-Philippines ' products to Target-Users in Japan for adoption by the Target-Users of the former's electric devices; 3. Activity for Taiyo Yuden-Philippines ' products to acquire certifications under certain standards; 4. Assistance to Taiyo Yuden-Philippines in case of trouble on the quality of its products; 5. Negotiation on the price and on the share allocation of Taiyo Yuden-Philippines ' products, etc.; and 6. Any other activity that may be requested by Taiyo Yuden-Philippines . aSCHIT That Taiyo Yuden-Japan shall periodically report to Taiyo Yuden-Philippines the details and progress of such activities; and that, as consideration, Taiyo Yuden-Philippines shall pay Taiyo Yuden-Japan , in U.S. dollars and within sixty (60) days from the date of receipt of the invoice, commissions computed using this formula: Commission = Sales Proceeds to Target Users x Taiyo Yuden-Japan's Contribution Rate x Commission Rate. In reply, please be informed that Section 23(F) of the Tax Code provides: "Section 23. General Principles of Income Taxation in the Philippines . Except when otherwise provided in this Code: xxx xxx xxx (F) A foreign corporation, whether engaged or not in trade or business in the Philippines, is taxable only on income derived from sources within the Philippines." Applying Section 23(F) to the instant case, commissions for 'design-in' activities paid by Taiyo Yuden-Philippines to Taiyo Yuden-Japan are subject to Philippine income tax if such commissions are derived from sources within the Philippines; otherwise, such commissions are exempt. In the case of furnishing of services, income arising from this activity is deemed derived from sources within the Philippines if it is carried out in the Philippines, in accordance with Section 42(A)(3) 1 of the Tax Code. Since Taiyo Yuden-Japan , being a foreign corporation, will carry out the subject activities entirely in Japan so that income arising therefrom is not deemed derived from sources within the Philippines , commissions paid to Taiyo Yuden-Japan by Taiyo Yuden-Philippines for such activities are exempt from Philippine income tax. Also, paragraph 1, Article 7 of the Philippines-Japan tax treaty mentions: "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" Applying paragraph 1 to the instant case, the subject commissions are subject to Philippine income tax if they are attributable to a permanent establishment which Taiyo Yuden-Japan has in the Philippines; otherwise, they are exempt. In the case of furnishing of services, this activity is deemed to give rise to a permanent establishment if, generally speaking, it is carried out in the Philippines for a period or periods aggregating more than six months within any taxable year, in accordance with paragraph 6, 2 Article 5 of the tax treaty. Since the subject activities will be carried out by Taiyo Yuden-Japan entirely in Japan so that there is no instance that they may give rise to a permanent establishment in the Philippines, commissions paid to Taiyo Yuden-Japan by Taiyo Yuden-Philippines for such activities are exempt from Philippine income tax. ( BIR Ruling No. DA-ITAD 152-03 dated October 9, 2003 ) Finally, in the same manner, the subject commissions are not subject to the 10 percent value-added tax (VAT) under Section 108(A) of the Tax Code, which mentions: "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 . . . " It is clear from the above definition of " sale or exchange of services " that in order for the subject commissions to be subject to VAT, the 'design-in' activities giving rise to such commissions must be carried out in the Philippines. On the contrary, however, such activities are carried out by Taiyo Yuden-Japan entirely in Japan. 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. HcDSaT Very truly yours, Commissioner of Internal Revenue By: (SGD.) MILAGROS V. REGALADO Assistant Commissioner, Legal Service Footnotes 1. Section 42. Income from Sources Within the Philippines. (A) Gross Income from Sources Within the Philippines. The following items of gross income shall be treated as gross income from sources within the Philippines: xxx xxx xxx (3) Services. Compensation for labor or personal services performed in the Philippines: xxx xxx xxx 2. 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 . . .