ITAD Ruling No. 034-03

February 13, 2003 ITAD RULING NO. 034-03 Arts. 6 & 8, RP-US Tax Treaty Secs. 28 & 42 of the Tax Code of 1997 DA-ITAD-231-02 Bernaldo Mirador Law Offices U-1810-11 Cityland Condominium 10-Tower I, 6815 Ayala Avenue North, Makati City Attention: Atty. Rosario S. Bernaldo Managing Partner Gentlemen : This refers to your application for relief from double taxation dated April 30, 2002, on behalf of your client, Caterpillar Financial Services Philippines, Inc. (CFSPI), requesting confirmation of your opinion that the service fees paid by CFSPI to its foreign affiliate, Caterpillar Financial Services Corporation (CFSC), in consideration for services performed outside the Philippines are considered as income from sources outside the Philippines and, therefore, not subject to Philippine income tax, expanded withholding tax and value-added tax and that CFSPI shall be allowed to claim such service fees as deduction for income tax purposes. It is represented that CFSC is a corporation organized and existing under the laws of USA with business address at 2120 West End Ave., Nashville, TN 37203; that it is not registered either as a corporation or as a partnership and has not been licensed to do business in the Philippines per certification issued by the Securities and Exchange Commission dated May 13, 2002; that CFSPI is a corporation organized and existing under the laws of the Philippines with business address at 150 E. Rodriguez, Jr. Ave., 1110 Libis, Quezon City; that on April 1, 1998, CFSPI entered into a Service Agreement with CFSC; that under the said Agreement, the services to be rendered by CFSC to CFSPI are the following: (1) accounting support services relating to accounting functions (2) credit evaluation services (3) marketing service assistance (4) treasury support services (5) personnel services (6) legal services (7) other related services as the parties may agree; that CFSC shall provide service either by utilizing its own personnel or the services of third parties who possess the necessary expertise and experience; that Caterpillar Financial Services Asia (CFSA) is a corporation duly organized and existing under the laws of Singapore; that CFSA is the Asian regional hub for CFSC with overview responsibilities for CFSC's business activities in Asia; that CFSC and CFSA entered into a sub-contracting agreement whereby CFSA will render most of the services required by CFSPI; that for this purpose the staff of CFSA have been deployed to the Philippines; that CFSC also renders services directly to CFSPI, specifically in the areas of treasury, accounting support and legal services; that all the services rendered by CFSPI pursuant to the Service Agreement shall be performed outside the Philippines; that should it be necessary for CFSC to send its employees to the Philippines, the period of stay in the Philippines for all employees of CFSC will be limited to 182 days; and that on the other hand, CFSA shall charge CFSC for the services it rendered to CFSPI, and therefrom, CFSC will oncharge CFSPI for the Singapore service cost plus whatever services CFSC renders directly to CFSPI. In reply, please be informed that Articles 8 and 5 of the RP-US tax treaty provide: "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" "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: caEIDA (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) "xxx xxx xxx" Based on the aforequoted provisions, it is clear that a corporation which is a resident of the USA 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, for the same or a connected project, continue within the Philippines for a period or periods aggregating more than 183 days. Considering that the above-mentioned services will be performed by CFSC's staff or its sub-contractor's personnel either in Singapore or in the US, and should it be necessary for CFSC to send its employees or its sub-contractor's personnel to the Philippines, the length of stay shall be limited to 182 days, then CFSC cannot be considered to have a permanent establishment in the Philippines. Moreover, Section 28(B)(1) in relation to Section 42(C)(3) of the National Internal Revenue Code of 1997 (NIRC) 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 interests, dividends, rents, royalties, salaries, premiums (except reinsurance premiums), annuities, emoluments or other fixed or determinable annual, periodic or casual gains, profits and income, and capital gains, except capital gains subject to tax under subparagraphs 5(c) and (d): Provided, That effective January 1, 1998, the rate of income tax shall be thirty-four percent (34%); effective January 1, 1999, the rate shall be thirty-three percent (33%); and, effective January 1, 2000 and thereafter, the rate shall be thirty-two percent (32%). (Emphasis supplied) "SEC. 42. Income from Sources Within the Philippines . "(C) Gross Income From Sources Without the Philippines . The following items of gross income shall be treated as income from sources without the Philippines: xxx xxx xxx "(3) Compensation for labor or personal services performed without the Philippines;" Based on the afore-cited provisions, a nonresident foreign corporation is taxable only on income derived from sources within the Philippines so that if a nonresident foreign corporation furnishes and performs services in the Philippines, the service fees therefrom is taxable in the Philippines. Considering that the services of CFSC to CFSPI under the said Agreement is rendered outside the Philippines, the service fees to be paid by CFSPI to CFSC are considered income from sources outside the Philippines. ( BIR Ruling No. DA-ITAD 231-02 dated December 27, 2002 ) In view thereof, since the above-mentioned services shall be subcontracted by CFSC to CFSA or should it be necessary for CFSC to send its employees to the Philippines, their length of stay shall be limited to 182 days, CFSC is not deemed to have a permanent establishment in the Philippines to which its business profits may be attributed to. Hence, this Office confirms your opinion and so holds that the service fees derived by CFSC from CFSPI are not subject to Philippine tax pursuant to Article 8(1) in relation to Article 5(2)[j] of the RP-US tax treaty and Section 28(B)(1) in relation to Section 42(C)(3) of the NIRC of 1997. However, the fees paid by CFSPI to CFSC for the services rendered in the Philippines are subject to the 10% value-added tax pursuant to Sec. 108 of the Tax Code of 1997. Accordingly, CFSPI, 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 fees before making any payment to CFSC. In remitting the VAT withheld, CFSPI 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 CFSPI upon filing its own VAT Return, if it is a VAT-registered taxpayer. In case CFSPI 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, CFSPI is required to issue the Certificate of Final Tax Withheld at Source (BIR Form 2306) in quadruplicate upon request of CFSC, the first three copies thereof to be given to CFSC and the fourth copy to be retained by CFSPI 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 ] As regards the issue whether the subject fees are considered deductible business expenses under Section 34(a)(1) of the Tax Code, as amended, please be informed that we decline to rule on the matter considering the factual nature of the issue raised. ( BIR Ruling No. DA-ITAD-101-02 dated May 28, 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