ITAD Ruling No. 060-04

June 8, 2004 ITAD RULING NO. 060-04 Articles 5 (Permanent Establishment), 7 (Business Profits), 12 (Royalties), 15 (Dependent Personal Services) and 24 (Elimination of Double Taxation) Philippines-Norway tax treaty BIR Ruling Nos. DA-ITAD-169-02, 16-04 and 28-04 Ramon F. Garcia Company Certified Public Accountants 30th Floor, Burgundy Corporate Tower 252 Sen. Gil Puyat Ayala Avenue Makati City Attention: Ms. Nhorie L. Paguio Gentlemen : This refers to your letter dated February 5, 2004 requesting confirmation that service fees and royalties paid by Reime Philippines, Inc. (Reime Philippines) to Reime Network Implementation Services AS (Reime NIS) are subject to preferential tax treatments under the existing Philippines-Norway tax treaty. It is represented that Reime NIS is a foreign company organized and existing under the laws of Norway with principal office at Jarlsovelen 45, N-3124 Tonsberg, Norway; that Reime NIS 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 the Certification of Non-Registration of Corporation/Partnership issued by the Securities and Exchange Commission on September 23, 2003; that, on the other hand, Reime Philippines is a domestic company organized and existing under the laws of the Philippines with principal office at Unit 906, Raffles Corporate Center, Ortigas Center, Pasig City, Philippines; that Reime Philippines is a subsidiary of Reime NIS , and both are engaged in the provision of cellular towers and specialized designs of such towers, of services related to installation of cellular towers, and of tools, equipment, and supplies related to such installation; that, on June 15, 2003, Reime Philippines and Reime NIS entered into an Inter Company Agreement (Agreement) for the provision of license and services, where Reime NIS grants Reime Philippines the license to sell the former's products and to use the know-how on such products, and where Reime NIS shall provide Reime Philippines support services related to the license; that the Agreement complies with the specific provisions of the Intellectual Property Code (Republic Act No. 8923) on Voluntary Licensing as confirmed by the Certificate of Compliance No. 5-2003-00095 issued by the Intellectual Property Office on December 11, 2003; that these products and know-how are: Products The ' Reime Compact Site' all designs The full range of steel lower and mast designs (JAT, S5, SR5, LS, Panel, ST-A, ST-B, BT-A, BT-B triangular and square guyed masts) The ' Reime Shelter' solutions, inclusive of complete interior solution specter inclusive of the alarm system units Generator solutions inclusive of PLC The full range of standard accepted telecommunications products designed and supplied by third parties, where prices and delivery terms are negotiated by Reime NIS Know-how Product documentation and design drawings Manuals, flowcharts, procedures and routines developed by Reime NIS Quality management and manuals Roll out management skills, reporting standards and information technology applications Financial management skills, reporting standards and information technology applications Logistic management skills, reporting standards and information technology applications Project management Site supervision Technical standards designs, drawings, technical solutions, specification interpretations and analysis skills; that, as compensation, Reime Philippines shall remit to Reime NIS a five percent (5%) royalty based on the former's accounted revenue from the sale of the products; that, on the other hand, the support services and their corresponding per-hour costs in U.S. dollars are: Place of service Philippines Abroad 1. Management monitoring and support 240.00 140.00 2. Project management support 130.00 80.00 3. Technical/Structural supervision 110.00 80.00 4. Marketing and sales support 150.00 80.00 5. Product technical support 120.00 70.00 6. Quality control and audits 150.00 90.00 7. Logistic support 120.00 70.00 8. Finance and information technology support 130.00 80.00 and, that these services will be performed almost entirely abroad, and if such services will be performed in the Philippines, they will be carried out for only a period of less than six months. In reply, with regard to the royalties paid by Reime Philippines to Reime NIS for the subject licenses, please be informed that Article 12 of the Philippines-Norway tax treaty provides: "Article 12 ROYALTIES "1. Royalties arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State if such resident is the beneficial owner of the royalties. "2. Such royalties may also be taxed in the Contracting State in which they arise, and according to the law of that State. However, when the royalties are taxable in the other Contracting State, the tax so charged shall not exceed a) in Norway, 10 per cent of the gross amount of the royalties including rentals or the rates referred to in subparagraph 2(b)(ii) below, and b) in the Philippines, (i) 25 per cent of the gross amount of the royalties, including 25 per cent of the gross rentals or amount paid for the use of, or the right to use, motion picture films, films or tapes for radio or television broadcasting; (ii) 7.5 per cent of the gross rentals or amount paid for the use of or the right to use containers, or (iii) the lowest rate of the Philippine tax that may be imposed on royalties of the same kind paid in similar circumstances to a resident of a third State. "3. Notwithstanding the provisions of paragraph 2, the amount of tax imposed by the Philippines on the royalties paid by a company, being a resident of the Philippines, registered with the Board of Investments and engaged in preferred pioneer areas of investment under the investment incentives laws of the Philippines to a resident of Norway, who is the beneficial owner of the royalties, shall not exceed 10 per cent of the gross amount of the royalties. "4. 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, patent, trademark, 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" Based on the abovequoted paragraph 4, payments made by Reime Philippines to Reime NIS for the license to sell the latter's products and to use the know-how on such products are payments for the use or the right to use of a design or model and for the use or the right to use of information concerning, commercial or scientific experience , and as such are to be considered as royalties for purposes of the Philippines-Norway tax treaty. Based on the abovequoted paragraphs 2 and 3, royalties arising in the Philippines and paid to a resident of Norway are subject to a preferential tax rate of (a) 25 percent; (b) 10 percent based on the gross amount of royalties if the company paying the royalties is registered with the Philippine Board of Investments and engaged in preferred pioneer areas of investment under the investment incentives laws of the Philippines; or (c) the lowest rate of Philippine income tax that may be imposed on royalties of the same kind paid under similar circumstances to a resident of a third State (also known as the most-favored-nation tax treatment on royalties). With respect to the most favored-nation tax treatment on royalties, the Supreme Court, in Commissioner of Internal Revenue vs. S. C. Johnson and Son Inc. and Court of Appeals (G.R. No. 127105 dated June 25, 1999), has cited two conditions in order for royalties arising in the Philippines and derived by a resident of another country (in this case, Norway) to be subject to the most-favored-nation tax treatment (in this case, a rate lower than 25 percent) as that granted by the Philippines to a resident of a third country under an existing tax treaty. First, the Court noted that the royalties arising and subject to tax in the Philippines and derived by a resident of Norway must be of the same nature as those derived by a resident of the third country. Second, the Court stressed that the mechanism for relieving double taxation of income employed by Norway with respect to royalties arising in the Philippines and derived by a resident of Norway must be the same as that employed by the third country with respect to royalties arising in the Philippines and derived by a resident of the third country. In looking for an existing Philippine tax treaty that provides a most-favored-nation tax treatment on royalties, it is worthy to take into account and use as basis the Philippines-China tax treaty. Under the Royalties article of this treaty, royalties for the use or the right to use of a design or model and for the use or the right to use of information concerning, commercial or scientific experience (to which royalties paid by Reime Philippines to Reime NIS for the subject licenses are categorized as) arising in the Philippines and derived by a resident of China are subject to an income tax rate not exceeding 10 percent of the gross amount of the royalties. On the other hand, under the Relief from Double Taxation article of the Philippines-China tax treaty, the mechanism for relieving double taxation of income (specifically, royalties) arising in the Philippines and derived by a resident of China is the ordinary credit method , similar with that of Norway. Under this method, only income taxes actually paid by a resident taxpayer with respect to income derived from foreign sources are allowed as credit against the taxpayer's taxable income subject to certain limitations. Such being the case, this Office is of the opinion and so holds that royalties paid by Reime Philippines to Reime NIS for the subject licenses under the Agreement shall be subject to a preferential tax rate of 10 percent based on the gross amount thereof. ( BIR Ruling No. DA-ITAD 16-04 dated February 20, 2004 ) On the other hand, with regard to the service fees paid by Reime Philippines to Reime NIS for the subject support services, please be informed that such fees are business profits subject to tax under Article 7 of the Philippines-Norway tax treaty: "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" Based on the abovequoted paragraph 1, business profits arising in the Philippines and derived by an enterprise of Norway is subject to Philippine income tax if the same 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 5 (Permanent Establishment) of the Philippines-Norway tax treaty, means, generally, 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. Aside from a fixed place of business, a permanent establishment includes also the furnishing of services in a Contracting State by an enterprise of the other Contracting State through employees or other personnel thereof, where such activity is carried out for a period of more than six months within a twelve-month period. Accordingly, since Reime NIS does not have a fixed place of business in the Philippines, as confirmed by the relevant Certification from the Securities and Exchange Commission, Reime NIS is not considered to have a permanent establishment in the Philippines. Similarly, since Reime NIS will provide the subject support services almost entirely abroad, and that should such services be performed in the Philippines they be carried out only for a period of less than six months, no permanent establishment of Reime NIS is created under the Philippines-Norway tax treaty. Thus, in the instant case where the service fees paid by Reime Philippines to Reime NIS for the subject support services cannot be made attributable to a permanent establishment of the latter in Philippines, this Office is of the opinion and so holds that such fees are not subject to Philippine income tax. ( BIR Ruling No. ITAD 28-04 dated March 29, 2004 ) It should be noted that the service fees exempt from income tax in this case refers only to the amount representing the income of Reime NIS itself; the amount which represents the remuneration of the personnel who will furnish the subject support services in the Philippines should be distinguished from the income of Reime NIS , and is governed by Article 15 of the Philippines-Norway tax treaty, and not by Article 7 thereof. Article 15 provides: "Article 15 DEPENDENT PERSONAL SERVICES "1. Subject to the provisions of Articles 16, 17, 18, 19 and 20, salaries, wages and other similar remuneration derived by a resident of a Contracting State in respect of an employment shall be taxable only in that State unless the employment is exercised in the other Contracting State. If the employment is so exercised, such remuneration as is derived therefrom may be taxed in that other State. "2. Notwithstanding the provisions of paragraph 1 remuneration derived by a resident of a Contracting State in respect of an employment exercised in the other Contracting State shall be taxable only in the first-mentioned State if: a) the recipient is present in that other State for a period or periods not exceeding in the aggregate 183 days in any twelve-month period; and b) the remuneration is paid by, or on behalf of, an employer who is a resident of the State of which the recipient is a resident, and whose business activities do not wholly or mainly consist of hiring out of labour; and c) the remuneration is not reasonably connected with the activities of a permanent establishment or a fixed base which the employer has in that other State. "However, to the extent that the above-mentioned remuneration is exempt from tax in the first-mentioned State, or upon the application of this Article will be exempt from tax in that State, the remuneration may be taxed in the other State. "xxx xxx xxx" Based on the abovequoted paragraph 1, the remuneration of the concerned personnel are generally subject to Philippine income tax where the subject support services are performed in the Philippines. However, such remuneration, according to the abovequoted paragraph 2, can be exempt if (a) the concerned personnel is present in the Philippines for less than 183 days within any twelve-month period, and (b) the remuneration is paid by, or on behalf of, an employer who is a resident of Norway whose business activities do not wholly or mainly consist of hiring out of labour, and (c) the remuneration is not reasonably connected with the activities of a permanent establishment which the employer ( Reime NIS ) has in Philippines, and, more importantly , (d) if such remuneration is taxed in Norway, as emphasized by the last sentence: "to the extent that the remuneration is exempt from tax in the first-mentioned State (i.e., Norway), or upon the application of this Article will be exempt from tax in that State, the remuneration may be taxed in the other State (i.e., the Philippines)." Whether such remuneration is taxed in Norway can be determined by taking into account the methods of eliminating double taxation of income employed by Norway with respect to income arising in the Philippines and derived by a Norwegian resident, as outlined in Article 24 of the Philippines-Norway tax treaty below: "Article 24 ELIMINATION OF DOUBLE TAXATION "In Norway: "1. Where a resident of Norway derives income or owns capital which, in accordance with the provisions of this Convention, may be taxed in the Philippines, Norway shall, subject to the provisions of paragraphs 2 and 3, exempt such income or capital from tax. "2. Where a resident of Norway derives items of income which, in accordance with the provisions of Articles 8, 10, 11, 12, 16 and 22 may be taxed in the Philippines, Norway shall allow as a deduction from the tax on the income of that person an amount equal to the tax paid in the Philippines. Such deductions shall not, however, exceed that part of the tax, as computed before the deduction is given, which is attributable to such items of income derived from the Philippines . . . . "3. Notwithstanding the provisions of paragraph 2 of this Article, dividend paid by a company which is a resident of the Philippines to a company being resident of Norway which controls directly or indirectly at least 10 per cent of the capital of the company paying the dividends shall be exempt in Norway from tax mentioned in subparagraphs (ii), (iii) and (iv) of paragraph 3 of Article 2. Where, in the cases mentioned in this paragraph, dividends are subject to national income tax in Norway, then such tax shall not exceed 27.8 per cent of the gross amount of the dividends. "4. Where in accordance with any provision of the Convention income derived or capital owned by a resident of Norway is exempt from tax in Norway, Norway may nevertheless, in calculating the amount of tax on the remaining income or capital of such resident, take into account the exempted income or capital. "xxx xxx xxx" A perusal of the Article reveals that Norway, in fact, employs two methods of eliminating double taxation, the ordinary credit method 1 (as specified in the abovequoted paragraph 2) and the exemption with progression method 2 (as specified in the abovequoted paragraphs 1, 3 and 4). The ordinary credit method applies to (1) shipping and air transport income (Article 8), (2) dividends (Article 10), except dividends exempted under paragraph 3, (3) interest (Article 11), (4) royalties (Article 12), (5) directors' fees (Article 16), and (6) offshore activities income (Article 22). On the other hand, the exemption with progression method applies to items of income to which the ordinary credit method is not relevant, which certainly includes dependent personal services income under Article 15 of the tax treaty, among others. This being the case, this Office is of the opinion and so holds that remuneration derived by the concerned personnel of Reime NIS from the furnishing of the subject support services for Reime Philippines are subject to Philippine income tax, where such activity is exercised in the Philippines. The rate of tax is 25 percent based on the remuneration received as that imposed on income of a nonresident alien not engaged in business in the Philippines under Section 25(B) of the National Internal Revenue Code of 1997 (Tax Code). ( BIR Ruling No. DA-ITAD-169-02 dated September 26, 2002 ) Finally, Section 108(A)(1) of the Tax Code states that "the use of or the right or privilege to use of design or model" and "the supply of any assistance that is ancillary and subsidiary and is furnished as a means of enabling the application or enjoyment of such design or model" both fall within the definition of sale or exchange of services subject to 10 percent value-added tax (VAT). Accordingly, the subject license fees and the subject service fees (for services actually performed in the Philippines) paid by Reime Philippines to Reime NIS are both subject to 10 percent VAT. ( BIR Ruling Nos. DA-ITAD-16-04 dated February 20, 2004 and DA-ITAD-28-04 dated March 29, 2004 ) SEIaHT With regard to the procedures for withholding and paying the VAT, Sections 4 and 6 of Revenue Regulations No. 4-2000, Section 3 of Revenue Regulations No. 8-2002, and Section 7 of Revenue Regulations No. 14-2002 provide that the resident person making the payments ( Reime Philippines ) to a nonresident person ( Reime NIS ), shall be responsible for the withholding of the 10 percent VAT on such payments before remitting them to Reime NIS . In remitting to the Bureau of Internal Revenue the VAT withheld on such payments, Reime Philippines shall use BIR Form No. 1600 (Monthly Remittance Return of VAT and Other Percentage Taxes Withheld). If a VAT-registered taxpayer, Reime Philippines may use as documentary substantiation for its claim of input VAT the duly filed BIR Form No. 1600 and the proof of payment accompanying it. If not a VAT-registered taxpayer, Reime Philippines may include as part of the cost of the license granted and the services furnished to it by Reime NIS , the VAT consequently shifted or passed on to it and may treat such VAT either as expense or asset , whichever is applicable. In addition, upon Reime NIS ' request, Reime Philippines is required to issue in quadruplicate the relevant Certificate of Final Tax Withheld at Source (BIR Form No. 2306), the first three copies to be given to Reime NIS and the fourth copy to be retained by Reime Philippines as its file copy. 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 Footnotes 1. Under the ordinary credit method , the residence State (Norway) calculates a taxpayer's tax on the basis of its total income including the income from the source State (Philippines) which, according to the tax treaty, may be taxed in that other State. The residence State then allows a deduction from the taxpayer's own tax for the tax paid in the source State, but the deduction is restricted to that part of the tax which is appropriate to the income which may be taxed in the source State. 2. Under the exemption with progression method , the residence State (Norway) does not tax the taxpayer's income which, according to the tax treaty, may be taxed in the source State (Philippines). However, when determining the tax to be imposed on the rest of the taxpayer's income ( i.e. , income from the residence State and from third States), the residence State retains the right to take into consideration the exempted income in the source State.