ITAD Ruling No. 060-05

June 17, 2005 ITAD RULING NO. 060-05 Article 5 & 7, Philippines-Japan tax treaty BIR Ruling No. 69-04; VAT Ruling 95-99 Punongbayan & Araullo 20th Floor, Tower 1 The Enterprise Center 6766 Ayala Avenue 1200 Makati City Attention: Maria Victoria C. Espao Tax Partner Gentlemen : This refers to your letter dated March 9, 2005, on behalf of your client, T&H Furnishing Industries, Inc. (T&H), requesting confirmation that the service fees it paid to T&H to Tsuneishi Forestry Construction Co., Ltd. (TFC) (formerly Tsuneishi Enterprise Co., Ltd) under a Support Service Agreement are not subject to Philippine income tax pursuant to the Philippines-Japan tax treaty, and value-added tax (VAT). It is represented that TFC is a nonresident foreign corporation organized and existing under the laws of Japan with registered head office address at 1083 Oaza Tsuneishi Numakuma-cho, Numakuma-gun, Hiroshima-ken, Japan; that it is not registered either as a corporation or as a partnership licensed to do business in the Philippines per certification issued by the Securities and Exchange Commission dated January 18, 2005; that T & H is a corporation organized and existing under the laws of the Philippines with office address at Mactan Economic Zone (MEZ) II, Lapu-lapu City, Cebu; that it is an enterprise engaged in the manufacture of ship furniture and fixtures and the provision of outfitting services for ships; that T&H is registered with the Philippine Economic Zone Authority (PEZA) as an export enterprise and currently operating at Mactan Economic Zone II (MEZ); that on April 1, 2004, T&H and TFC entered into a Support Services Agreement whereby TFC shall provide to T&H the following services outside the Philippines: "1. Assistance in the procurement of raw materials and supplies in Japan with regard to quality and specifications; TADCSE "2. Undertakes after sales services of the ship furniture sold in Japan; "3. Undertake information dissemination and promotion of T&H's product in Japan; and "4. Undertake other management and advisory services as deemed necessary in connection with the T&H's ship furniture and outfitting activities;" that the services shall in no case involve the transfer of TFC's technology, know-how or other intellectual property rights; that TFC shall exclusively perform the aforementioned services in Japan or in other countries outside the Philippines; that in cases where it would be necessary for TFC to send its employees to the Philippines, the stay of these individuals in the Philippines shall not, in any case, exceed six (6) months; that in consideration for the services performed by TFC, T&H shall pay a monthly fee of Japanese Yen: Three Million Five Hundred (JPY3,500,000.00) only; and that the monthly fee to be charged by TFC shall be evaluated and agreed upon by both parties. In reply, please be informed that Article 7 of the Philippines-Japan tax treaty provides, viz : "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. Moreover, Article 5 of the said treaty provides, viz : "Article 5 "1. For the purposes of this Convention, the term 'permanent establishment' means a fixed place of business through which the business of an enterprise is wholly or partly carried on. ASTcEa "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. However, if the furnishing of such services is effected under an agreement between the Governments of the two Contracting States regarding economic or technical cooperation, that enterprise shall, notwithstanding any provisions of this Article, not deemed to have a permanent establishment in that other Contracting State. "xxx xxx xxx" Based on the aforementioned provisions, it is clear that if a corporation which is a resident of Japan carries on business in the Philippines through a permanent establishment situated therein, the profits of the same shall be subject to Philippine income tax, but only so much of the profits as is attributable to that permanent establishment. For this purpose, a corporation which is a resident of Japan may be deemed to have a permanent establishment in the Philippines if, among others, the furnishing of consultancy or supervisory services by such corporation, through its employees, continue within the Philippines for a period or periods aggregating more than six months in any taxable year, except when the furnishing of such services is effected under an agreement between the Governments of Japan and Philippines regarding economic or technical cooperation, in which case, the corporation shall not be deemed to have a permanent establishment in the Philippines. Considering that the furnishing of the services under the Support Services Agreement is to be performed by TFC for T&H in Japan or in other countries outside the Philippines, and that should it be necessary for TFC to send its employees to the Philippines, the stay of these individuals shall not in any case exceed six (6) months, TFC is not deemed to have a permanent establishment in the Philippines to which its business profits may be attributed to. Therefore, the income derived by TFC from services rendered to T&H under the Support Service Agreement are not subject to Philippine income tax, pursuant to Article 7 (1) in relation to Article 5 of the Philippines-Japan tax treaty. (DA-ITAD Ruling No. 69-04 dated July 13, 2004) Moreover, Section 108 of the Tax Code of 1997 states that, "sale or exchange of services" is subject to VAT. Under current revenue regulations, the sale of services to an Ecozone Enterprise may be considered effectively zero-rated for VAT purposes but subject to the limitation that the sale of service is made to persons or entities who enjoy indirect tax exemption [Section 4.102-2 (c) Revenue Regulations No. 7-95]. Since there is no express provision under Republic Act No. 7916 (PEZA law) granting exemption from indirect taxes to Ecozone Enterprise, the recognition of zero-rated sale of services is made to rest on the Cross Border Doctrine or Destination Principle of the VAT system, viz "the country taxes all value-added, at home and abroad, for goods that have as their destination the consumers of that country. Exports are exempt, imports are taxable. . . ." (VAT Ruling No. 009-99 dated January 21, 1999) DACTSH The same principle is applicable to the case at hand. It should be noted that the herein sale of services is in connection with the manufacture of products for export. However, instead of the zero-rating which is not available to nonresident suppliers, the provision for exempt transactions under Section 109 of the Tax Code of 1997 which provides VAT exemption for transactions which are exempt under special laws, e.g., Republic Act No. 7916 or PEZA law, is particularly applicable to the instant case. In the case of payment of service fees to a nonresident service provider, the responsibility for withholding the VAT and paying the same rests on the payor. However, since PEZA-registered export enterprises may not be passed on with nor claim input VAT, then service fees paid to a nonresident service provider, such as TFC should be, as it is hereby confirmed to be, exempt from VAT (VAT Ruling No. 095-99 date September 4, 1999). 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.) JAMES H. ROLDAN Assistant Commissioner Legal Service