ITAD Ruling No. 039-03

March 4, 2003 ITAD RULING NO. 039-03 Articles 5, 7, 12 of the RP-Singapore Tax Treaty & Articles 5, 8, 13 of the RP-USA Tax Treaty BIR Ruling No. DA-ITAD 49-02 BIR Ruling No. DA-ITAD 101-02 Laya Mananghaya & Co. 22/F Philamlife Tower, 8767 Paseo de Roxas Makati City 1226 Attention: Francisco G. Tagao & Charlene O. Ang Gentlemen : This refers to your letter dated January 9, 2003, on behalf of your client, EGL Eagle Global Logistics Philippines Inc. (EGL Phils.), requesting confirmation of your opinion that the service fees paid by EGL Phils. to EGL Asia Pacific Holdings Co. Pte. Ltd. (EGL Singapore) and EGL Global Logistics LP (EGL USA) are ordinary business profits and not royalties and since these services will be performed outside the Philippines, the same are not subject to Philippine income tax, the withholding tax, and the 10% value-added tax. EaCDAT It is represented that EGL Singapore is a non-resident foreign corporation duly organized and existing under the laws of Singapore with office address at 15 Changi South Street 2 Singapore 486068; that EGL USA is a limited partnership duly organized and existing under the laws of the State of Delaware, USA with office address at 15350 Vickery Drive, Houston, Texas, USA 77032; that they 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 December 17, 2002 issued by the Securities and Exchange Commission (SEC); that EGL Phils. is a domestic corporation duly organized and existing under the laws of the Philippines with office address at EGL Building, Pascor Drive cor. Johann St., Bo, Ibayo, Sto. Nio, Paraaque City; that it is primarily engaged in the business of freight forwarding, logistics and supply chain management services; that due to the nature of its business and its lack of capacity to provide a full range of services to its customers, its business and its personnel, EGL Phils. entered into a separate Intercompany Service Agreements (ISA) with EGL Singapore and EGL USA, both dated January 1, 2002, whereby the latter shall provide routine, non-technical day-to-day support services to EGL Phils.; that under the ISA with EGL Singapore, the latter shall provide the following services within the Asia and Pacific Region (ASPAC) , excluding the Philippines, to wit: (1) Advice and assistance on EGL Phils. current freight forwarding and logistics operations in the ASPAC region; (2) Administrative support services which include but not limited to the following; a) notification of forwarding space available for freight destined in the ASPAC region; b) coordination with internationally affiliated shipping and airlines for freight destined to the ASPAC region; c) project handling, publicity and promotion, financing and financial coordination and coordinating the implementation of group policy and procedures in the ASPAC region; d) advice on maintaining and administering proper accounting procedures, ledgers, payroll processing and other bookkeeping records; e) advice on establishing, maintaining and updating computer systems and data capture and control procedures for freight destined to and from the ASPAC region; f) monitoring compliance with general group treasury and management and administrative policies; g) legal, tax, accounting, restructuring, and auditing services; and h) advice on Information Systems including hardware, software and personnel requirements; (3) Advertising, marketing, sales support and various bids to increase the freight forwarding and logistics business for EGL Phils., including but not limited to: a) market research requirements and questionnaire structure/content; b) packaging design; c) media material content; d) media planning; e) promotional campaign requirements and structure; f) structure of logistics distribution systems; (4) Update new developments with respect to freight forwarding business; that under the ISA with EGL USA, the latter shall provide worldwide administrative support services including but not limited to the following services: (1) Advice and assistance on EGL Phils. current freight forwarding and logistics operations outside of ASPAC; (2) Administrative support services shall include but are not limited to the following: a) notification of forwarding space available for freight outside of ASPAC; b) coordination with internationally affiliated shipping and airlines for freight outside of ASPAC; c) project handling, publicity and promotion, financing and financial coordination and coordinating the implementation of group policy and procedures outside of ASPAC; d) advice on establishing, maintaining and updating computer systems and data capture and control procedures outside of ASPAC; (3) Advertising, marketing, sales support and various international worldwide bids to increase the freight forwarding and logistics business for EGL Phils., including but not limited to the following services: a) market research requirements and questionnaire structure/content; b) packaging design; c) media material content; d) media planning; e) promotional campaign requirements and structure; f) structure of logistics distribution systems; (4) Provide advice on Information Systems including hardware, software and personnel requirements; (5) Provide worldwide support for specialist customer support in tracking of packages and freight; (6) Provide worldwide legal, tax, accounting, restructuring, and auditing services that cannot be provided from ASPAC or from local internal providers; that the above-mentioned services will be performed by EGL Singapore's and EGL USA's personnel based in Singapore and US, respectively, who will liaise with EGL Phils. staff; that none of these services will be provided in the Philippines; that these services shall not involve the provision or licensing of any know-how to EGL Phils.; that in consideration for the effort and tasks performed by EGL Singapore and EGL USA, EGL Phils. shall pay a service fee for: a) costs directly attributable to EGL Phils.; b) all costs arising from performance of the services and are specifically identifiable with EGL Phils. will be charged directly to EGL Phils.; c) a fair and equitable method of apportionment for all other indirectly allocable costs will be used; that the payment of the service fees shall be made to EGL Singapore and EGL USA within thirty (30) days after EGL Phils.' receipt of the relevant invoices issued by EGL Singapore and EGL USA under these Agreements. In reply, please be informed of this Office's ruling on the following issues as follows: 1. The service fees are not in the nature of royalties . Article 12(3) of the RP-Singapore tax treaty provides that: " Article 12 Royalties 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. xxx xxx xxx" Article 13 of the RP-US tax treaty also provides: " Article 13 ROYALTIES 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 films or tapes used for radio or television broadcasting, any patent, trade mark, design or model, plan, secret formula or process, or other like right or property, or for information concerning industrial, commercial or scientific experience. The term 'royalties' also includes gains derived from the sale, exchange or other disposition of any such right or property which are contingent on the productivity, use, or disposition thereof." 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 ORGANIZATION 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 DA-ITAD No. 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." Applying the above discussions to the case at hand, it is clear in the Intercompany Service Agreement that the service fees are not within the definition of "royalties" under Article 12 of RP-Singapore and Article 13 of the RP-USA tax treaties. Specifically, nothing in the Agreements would require transfer into the Philippines of technology, equipment or other property where the payee has proprietary interest or would otherwise permit EGL Singapore and EGL USA to impart to EGL Phils. their special knowledge and experience which remain unrevealed to the public. Inasmuch as EGL Singapore and EGL USA shall render these services using only their customary skills, then the compensation to be received therefor shall not constitute as consideration for the use of, or the right to use, any copyright, patent, trademark, design or model, plan, secret formula or process, or for the transfer of technology. Thus, the service fees paid to EGL Singapore and EGL USA shall not be considered as royalties but shall constitute as business profits derived from sources outside the Philippines. EacHCD 2. The service fees are business profits not subject to Philippine taxation. 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; f) 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 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 5 of the RP-US 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 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; 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 8 of the same tax treaty states: " 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" It is clear from the aforequoted provisions that if a corporation which is a resident of Singapore or USA does not carry on business in the Philippines through a permanent establishment situated therein, the profits of the corporation shall not be subject to Philippine income tax. For this purpose, a corporation which is a resident of Singapore or USA 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. Inasmuch as it has been the representation that these services will be performed by the EGL Singapore and EGL USA outside the Philippines, who will liaise with EGL Phils. staff, and that in case it would be necessary for EGL Singapore and EGL USA to conduct regular visits in the Philippines, their stay here will not be more than 183 days in a calendar year, EGL Singapore and EGL USA cannot be considered to have a permanent establishment in the Philippines. Hence, the 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 DA-ITAD No. 101-02 dated May 28, 2002) 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 EGL Singapore and EGL USA are rendered in the Philippines are subject to the 10% VAT pursuant to Section 108(a) of the Tax Code of 1997. Accordingly, EGL Phils., 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 EGL Singapore and EGL USA. In remitting the VAT withheld, EGL Phils. 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 EGL Phils. upon filing its own VAT Return, if it is a VAT-registered taxpayer. In case EGL Phils. 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, EGL Phils. is required to issue the Certificate of Final Tax Withheld at Source (BIR Form 2306) in quadruplicate upon request of EGL Singapore and EGL USA, the first three copies thereof to be given to EGL Singapore and EGL USA and the fourth copy to be retained by EGL Phils. 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. EAHDac Very truly yours, Commissioner of Internal Revenue By: (SGD.) MILAGROS V. REGALADO Assistant Commissioner Legal Service