ITAD Ruling No. 048-04

May 7, 2004 ITAD RULING NO. 048-04 Principle of Sovereign Immunity BIR Ruling No. ITAD-16-03 BIR Ruling No. 080-97 Embassy of the Federal Republic of Germany 6/F PS Bank Center 777 Paseo de Roxas, Makati City Attention: Dietmar Wenger Head of Administration German Embassy Manila Gentlemen : This refers to your letter dated March 11, 2004 seeking clarification on whether or not the Embassy of the Federal Republic of Germany (Embassy) may be required to withhold five percent (5%) tax on its monthly rental payments pursuant to a lease contract entered into by the Embassy. It is represented that the Embassy is planning to relocate its offices in RCBC Plaza along Ayala Avenue, Makati City within the year; that the lease contract with the lessor stipulates that the lessee (Embassy) should withhold and remit to this Bureau a 5% tax from its monthly rental payments; that to your knowledge, diplomatic missions are exempt from direct taxes as provided under Article 34 of the Vienna Convention on Diplomatic Relations; and that according to the Foreign Office in Berlin, the Philippine Embassy in Germany is not required to remit taxes due from the lease of its office space. In reply; please be informed that the subject 5% tax on monthly rental payments stipulated in the lease contract pertains to the creditable income tax of the lessor, and not an income tax imposed on the lessee Embassy. To shed light on the matter, Section 2.57.2 of Revenue Regulations No. 2-98, as amended by Revenue Regulations No. 14-02, provides as follows: "SEC. 2. Income payments subject to creditable withholding tax and rates prescribed thereon. Section 2.57.2 of Revenue Regulations No. 2-98, as amended, is hereby further amended to read as follows: "Sec. 2.57.2. Except as herein otherwise provided, there shall be withheld a creditable income tax at the rates herein specified for each class of payee from the following items of income payments to persons residing in the Philippines: "xxx xxx xxx" "(C) Rentals "(1) Real properties. On gross rental for the continued use or possession of real property used in business which the payor or obligor has not taken or is not taking title, or in which he has no equity Five percent (5%);" "xxx xxx xxx" Based on the afore-cited provisions, the lessee of real properties is constituted as a withholding agent with the obligation to withhold and remit to this Bureau a creditable income tax of 5% on the monthly rental fees to be paid to the lessor. In other words, the lessee, before making the monthly rental payments to the lessor, shall deduct, withhold and remit to this Bureau the 5% creditable withholding tax of the lessor. Accordingly, the 5% tax on the monthly rental payments stipulated in the lease contract is not a tax obligation/imposition on the Embassy but rather a tax obligation of the lessor for income derived from their lease of property which is to be withheld by the lessee. It is noteworthy that in the case of CIR vs. CA , 1 the Supreme Court held that "codal provisions on withholding tax are mandatory and must be complied with by the withholding agent." Hence, unless there is a law or agreement duly entered into which specifically provides that an entity is exempt from withholding tax obligation, such entity has a legal duty to make the necessary deductions on its income payments subject to withholding tax. ( BIR Ruling No. ITAD-16-03 dated January 24, 2003 ) Be that as it may, the lessee Embassy cannot be constituted as a withholding agent for the reason that the Embassy is not subject to the jurisdiction of the Philippines under the generally accepted principles of international law of sovereign immunity. Relative thereto, Article II, Section 2 of the Philippine Constitution provides, viz : "The Philippines renounces war as an instrument if national policy, adopts the generally accepted principles of international law as a part of the law of the land and, adheres to the policy of peace, equality, justice, freedom, cooperation and amity with all nations." (emphasis supplied) The above provision has expressly placed international law in the same category as the other components of Philippine law, i . e . , the New Civil Code of the Philippines and the Tax Code of 1997. Under the principle of sovereign immunity in international law, a state enjoys and is granted immunity from the exercise of jurisdiction by another state for any activity or property in connection with the governmental acts ( acta jure imperii ) of the former. 2 Corollarily, a diplomatic agent is immune from the civil, criminal and administrative jurisdiction of the receiving state except under certain cases. 3 The immunity contemplated herein includes but is not limited to the obligation to withhold Philippine taxes on all income payments subject to withholding tax or being constituted as withholding agent for the purpose of withholding the corresponding taxes, creditable or final, on all its income payments subject thereto, as mandated by the Tax Code of 1997 and its implementing Revenue Regulations. Moreover, by fiction of international law, the embassy is deemed an extension of the territorial jurisdiction of a sending state in a host state for the purpose of conferring the exclusive sovereignty within the embassy premises to the sending state. As the power of taxation may be exercised only within the territorial jurisdiction of the taxing authority, 4 it necessarily follows that power to obligate the withholding of the tax is also limited by the same principle of territoriality. ( BIR Ruling No. 080-97 dated July 11, 1997 ) Such being the case, the Embassy cannot be constituted as a withholding agent as defined under the Philippine tax laws and regulations pursuant to the generally accepted principles of international law. Consequently, the Embassy is not required to withhold and remit to this Bureau the 5% withholding tax as lessee of real property under Section 2.57.2 of Revenue Regulations No. 2-98, as amended by Revenue Regulations No. 14-02. 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. CIHTac Very truly yours, Commissioner of Internal Revenue By: (SGD.) JOSE MARIO C. BUAG Deputy Commissioner Legal and Inspection Group Footnotes 1. CIR vs. CA , 102 SCRA 134 (199) citing CIR vs. Malayan Insurance , 129 Phil. 165, 170 (1967). 2. Jovito R. Salonga, "Public International Law," 1998, p. 127 . 3. Article 31, Vienna Convention on Diplomatic Relations. 4. Jose C. Vitug and Ernesto D. Acosta, "Tax Law and Jurisprudence", 2000 p. 10.