ITAD Ruling No. 056-04

May 31, 2004 ITAD RULING NO. 056-04 Articles V (Permanent Establishment) and VII (Business Profits), Philippines-Canada tax treaty BIR Ruling Nos. DA-ITAD 28-04 and 32-04 Bearing Point Unit 1007, 10th Floor, The Orient Square Emerald Avenue, Ortigas Center Pasig City Attention: Ms. Nide Marie S. Bombay Project Director Policy, Training and Technical Assistance Facility Gentlemen : This refers to your letter dated February 17, 2004 requesting for an opinion on the taxation of service fees paid by Bearing Point (formerly, KPMG Consulting LP (Canada) ) to Mediagrif Interactive Technologies, Inc . It is represented that Bearing Point is a foreign private corporation organized and existing under the laws of Canada with principal office in that country and a representative office in the Philippines at Unit 1007, 10th Floor, The Orient Square Emerald Avenue, Ortigas Center, Pasig City, Philippines; that on November 6, 1998, the Government of the Republic of the Philippines (through the National Economic and Development Authority) and the Government of Canada (through the Canadian International Development Agency (CIDA)) entered into a Memorandum of Understanding Concerning the Policy, Training and Technical Assistance Facility (PTTAF) Phase II (the Facility), the objective of which is to assist selected key government departments and agencies of the Philippines to develop their self-sustaining capacities to formulate, plan, implement, monitor and evaluate socio-economic and administrative policies and reform programs; that CIDA contracted Bearing Point to implement and oversee the Facility and authorized the latter to negotiate, implement and sign agreements on its (CIDA) behalf with the various government departments and agencies of the Philippines for the development and implementation of programs under the Facility; that on May 2, 2001, the Department of Budget and Management (DBM) (a government department with principal address at Mabini Hall, Gate 7, Malacaang Compound, J.P. Laurel Street, San Miguel, Manila, Philippines) and Bearing Point entered into a Memorandum of Agreement relative to the Organizational Streamlining and Electronic Procurement System Development (Phase II) Project (the Project); that the objective of the Project is, among others, to assist, the DBM Procurement Service in assessing/reviewing its present organizational structure, systems, and processes (e.g., Electronic Procurement System (EPS), establishment of a Procurement Service supermarket), vision of its officials (e.g., increased income), and needs of its clients (e.g., efficient and effective delivery of goods and services); that CIDA's contribution to the Project will be 350,000 Canadian dollars (to cover for project design and conceptualization, consultants' fees and expenses, capability building/training, and management monitoring and evaluation), and P1,000,000.00 (to cover for EPS marketing activities and materials); that DBM's contribution will be 420,000 Canadian dollars (or its equivalent in Philippine pesos) (to cover for the one-year extension of the EPS operation/services), and P2,640,000.00 and P2,200,000.00 (to cover for the one-year maintenance and operation of the EPS Customer Service Area and for the EPS Personnel concerned, respectively); that as regards the software, EPS, Bearing Point contracted Mediagrif Interactive Technologies, Inc. (Mediagrif) to develop the same in Canada through the Internet, and Bearing Point will pay Mediagrif service fees in consideration for said services; and that Mediagrif is a foreign private corporation organized and existing under the laws of Canada with principal office in that country, and is not registered either as a corporation or as a partnership and has not been licensed to engage in business in the Philippines as confirmed by both the Certification of Non-Registration issued by the Securities and Exchange Commission on May 17, 2004 and the letter dated May 17, 2004 of the DBM-Procurement Service to the Bureau of Internal Revenue-Legal and Inspection Group. In reply, please be informed that Section 23(F) of the National Internal Revenue Code of 1997 (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, the service fees paid by Bearing Point to Mediagrif are subject to Philippine income tax if they are derived from sources within the Philippines; otherwise, such fees are exempt. In the case of furnishing of services, income derived from this activity is deemed derived from sources within the Philippines if it is undertaken in the Philippines, in accordance with Section 42(A)(3) 1 of the Tax Code. Since Mediagrif, being a foreign corporation, will develop the software EPS entirely in Canada through the Internet so that income arising therefrom is not deemed derived from sources within the Philippines , service fees paid to Mediagrif by Bearing Point for this purpose are exempt from Philippine income tax. ( BIR Ruling No. DA-ITAD 32-04 dated April 2, 2004 ) In addition, paragraph 1, VII (Business Profits) of the Philippines-Canada tax treaty states: "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: a) that permanent establishment; or xxx xxx xxx" Based on the above paragraph 1, business profits arising in the Philippines and derived by an enterprise of Canada shall be subject to Philippine income tax if they are attributable to a permanent establishment which the enterprise has in the Philippines; otherwise such profits are exempt. The term "permanent establishment," as defined in paragraphs 1 and 2, Article V (Permanent Establishment) of the Philippines-Canada tax treaty, means a fixed place of business through which the business of an enterprise is wholly or partly carried on, and includes, for example, a place of management, a branch, and an office. cAEDTa Assuming that Mediagrif developed the EPS in the Philippines and not in Canada, the service fees paid to Mediagrif by Bearing Point for this purpose will still not be subject to Philippine income tax since Mediagrif does not have a fixed place of business in the Philippines, as confirmed by both the relevant Certification from the Securities and Exchange Commission and the relevant letter from the DBM-Procurement Service, so as to constitute its permanent establishment in the country. This conclusion is even buttressed by the fact that, unlike the majority of other Philippine tax treaties, the Philippines-Canada tax treaty (particularly the Permanent Establishment article thereof), apparently, however, does not have a provision on the furnishing of services as constituting a permanent establishment for the foreign enterprise undertaking it in a situs country for a sufficient duration like 183 days. ( BIR Ruling No. ITAD 28-04 dated March 29, 2004 ) Finally, the subject service fees 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 . . ." The above definition states that in order for receipts or payments for the sale or exchange of services to be subject to VAT, the services must be undertaken in the Philippines, similar to the requirement of subjecting such receipts or payments to income tax where the services concerned are performed in the Philippines. Accordingly, since Mediagrif will develop the EPS entirely in Canada, service fees paid to it by Bearing Point shall be exempt from VAT. 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. HICSaD Very truly yours, Commissioner of Internal Revenue By: (SGD.) JOSE MARIO C. BUAG Deputy Commissioner Legal and Inspection Group 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