ITAD Ruling No. 042-02

April 5, 2002 ITAD RULING NO. 042-02 Article 7 (1) & 5 (6) RP-Japan Tax Treaty BIR Ruling No. ITAD 159-00 Reyes Francisco & Associates Law Office Unit 1909 Cityland 10 Tower 1 H.V. dela Costa Street, Salcedo Village Makati City, Metro Manila Attention: Atty. Edgar B. Francisco Gentlemen : This refers to your application for relief from double taxation dated February 21, 2001, on behalf of Unico International Corporation (Unico), requesting confirmation of your opinion that the consultancy fees to be paid by PNOC Petrochemical Development Corporation (PPDC) to Unico are not subject to Philippine income/withholding taxes pursuant to Articles 7(1) and 5(6) of the RP-Japan tax treaty. It is represented that PPDC is a corporation duly organized and existing under Philippine laws with principal office at 11th Floor, BA Lepanto Bldg., 8747 Paseo de Roxas, Makati City, Philippines; that PPDC was mandated to take the lead role in organizing a consortium that will put up the first Naphtha Cracker Plant in the Philippines known as the Bataan Naphtha Cracker Plant Project (BNC Project); that Unico is a corporation organized and existing under the laws of Japan, with business address at Konishi Bldg., 6-3 Nihonbashi Hon-Cho, 2-Chome Chou-Ku Tokyo 1103-0023 Japan; that as there was a need to fast-track the integration and implementation of the BNC Project, PPDC entered into a contract for engineering consultancy services with Unico on January 19, 2001, wherein Unico shall provide PPDC the necessary technical, engineering and project execution expertise during the Pre-FEED phase of the BNC Project; that under the contract, Unico shall act as consultant for a maximum period of four (4) months; that PPDC shall pay Unico composed of the Japanese Yen portion of Thirty Million Two Hundred Forty Thousand Yen (JY30,240,000) and the Peso portion of Five Million Pesos (PHP5,000,000); that the agreed contract amount for all the consultancy services shall be divided into off-shore consultancy services amounting to Seventeen Million Five Hundred Fifty Thousand Yen (JY17,550,000) and on-shore consultancy services amounting to Twelve Million Six Hundred Ninety Thousand Yen (JY12,690,000) and Five Million Pesos (PHP5,000,000); that the off-shore portion is divided into fixed remuneration cost amounting to Fifteen Million Nine Hundred Sixty Thousand Yen (JY15,960,000) and reimbursable cost amounting to One Million Five Hundred Ninety Thousand Yen (JY1,590,000); that the on-shore portion in Japanese Yen is divided into fixed remuneration cost amounting to Ten Million Six Hundred Forty Thousand Yen (JY10,640,000) while the on-shore portion in Philippine Peso is divided into reimbursable cost amounting to Two Million One Hundred Sixty Thousand Pesos (P2,160,000) and Other Cost amounting to Two Million Eight Hundred Forty Thousand Pesos (P2,840,000); that in effect, the total consideration of the contract, which is payable in four equal payments with the first payment to be made at the end of the first month from the Commencement Date (i.e., February 1, 2001), amounts to Twenty Six Million Six Hundred Thousand Yen (JY26,600,000) and Two Million Eight Hundred Forty Thousand Pesos (P2,840,000); that within fifteen (15) days from the issuance of the Notice to Proceed, PPDC shall pay Unico an advance payment for mobilization equivalent to 20% of the total consideration of the contract in Japanese Yen and Philippine Peso; that this advance payment shall be repaid by Unico by deducting from the first and second monthly payments fifty per cent (50%) each of the value of the advance payment for mobilization; that the foreign and local reimbursable costs shall be paid to Unico within thirty (30) days after receipt of monthly invoice issued by Unico and submission by the latter of the appropriate supporting documents and vouchers. In reply, please be informed that Article 7(1) in relation to Article 5(6) of the RP-Japan tax treaty provides: "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." "Article 5 "xxx xxx xxx "(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. . . " While Unico earns business profits for the consultancy services it renders to PPDC, such services shall be rendered in the Philippines for a period not exceeding six (6) months during the entire duration of the contract (the consultancy period will only involve four (4) months from February 1, 2001 ending May 31, 2001). Thus, Unico is deemed not to have a permanent establishment in the Philippines to which business profits can be attributed. (BIR Ruling No. ITAD 159-00) Such being the case, this Office is of the opinion and so holds that the service fees to be paid by PPDC to Unico are not subject to Philippine income tax and withholding tax pursuant to Article 7(1) in relation to Article 5(6) of the RP-Japan tax treaty: However, the fees to Unico for the services rendered in the Philippines shall be subject to the ten percent (10%) value-added tax (VAT) pursuant to Sections 107(A) and 108(A) of the Tax Code of 1997. Accordingly, PPDC being the payor in control of the payment shall be responsible for the withholding of VAT on such fees on behalf of Unico by filing a separate VAT return for on behalf of Unico using 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 sufficient basis for the claim of input tax to be applied against the output tax that may be due from PPDC if it is a VAT-registered taxpayer. In case PPDC is a non-VAT registered taxpayer, the passed-on VAT withheld shall form part of the cost of the service purchased or treated as expense, whichever is applicable. In addition, PPDC is required to issue the Certificate of Creditable Tax Withheld at Source (BIR form 2307) in quadruplicate upon request of Unico, the first three copies thereof to be given to Unico and the fourth copy to be retained by PPDC as its file copy. As regards your third query, whether the subject royalty payments 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. This ruling is issued on the basis of the foregoing facts as represented. However, if upon investigation it shall be disclosed that the facts are different, then this ruling shall be considered null and void. Very truly yours, Commissioner of Internal Revenue By: (SGD.) MILAGROS V. REGALADO Assistant Commissioner Legal Service