ITAD Ruling No. 069-04

July 13, 2004 ITAD RULING NO. 069-04 Article 5 & 7, RP-Japan tax treaty ITAD Ruling No. 184-02 Punongbayan & Araullo 20th Floor, Tower 1 The Enterprise Center 6766 Ayala Avenue, Makati City Attention: Ms. Benedicta Du-Baladad Tax Partner Gentlemen : This refers to your letter dated May 12, 2004, requesting confirmation of your opinion that the service fees paid by your client, Yamaki Philippine Corporation (YPC), to Yamaki Electric Corporation (YEC), are not subject to Philippine income tax, pursuant to the Philippines-Japan tax treaty, and that such service fees, being compensation for services abroad and rendered to a Philippine Economic Zone Authority (PEZA) company, are not subject to value-added tax. It is represented that YEC is a foreign corporation duly organized and existing under the laws of Japan, with principal office at 7-22 3 Chroume, Shimomeguro, Meguroku, Tokyo, Japan; that it is not registered either as a corporation or as a partnership licensed to do business in the Philippines as evidenced by Certification dated February 10, 2004 issued by the Securities and Exchange Commission; that YPC is a PEZA-registered corporation organized and existing under the laws of the Philippines with principal office at MEPZ II, Basak, Lapu-lapu City, Cebu; that it is registered with the PEZA as an Export Enterprise under Certificate of Registration No. 95-137; that YPC is engaged in the business of manufacturing various kinds of electrical and electronic devices as well as communication equipment while YEC operates the business of manufacturing in Japan as well as providing managerial, training, and administrative supports to YPC; that on August 1, 2002, YPC and YEC entered into a Management Agreement wherein: "1. YEC shall conduct a monthly financial review of the operation of YPC. YPC will send monthly reports to YEC in Japan. If necessary, YEC may recommend some improvements in relation to the financial reporting of YPC and other areas; "2. YEC shall train selected employees of YPC to attain skills in the manufacture of the latter's products and to improve productivity; "3. YEC shall assist YPC in the procurement and shipment of good quality raw materials and supplies in Japan; and "4. YEC shall promote the products manufactured by YPC." that during the term of agreement, YEC shall hire necessary personnel to perform the services; that the employees and personnel of YEC shall exclusively perform the services for YPC in Japan or in other countries outside the Philippines, and should it be necessary for YEC to send its employees to the Philippines, the stay of these individuals shall not in any case exceed six (6) months; that as a compensation for the service performed by YEC, YPC shall pay YEC a monthly fee equal to Eight Hundred Ten Thousand Japanese Yen (810,000), covering the period from August 1, 2002 to July 31, 2003; and that the said Service Agreement shall be effective for a twelve-month term commencing on August 1, 2002 until July 31, 2003, subject to automatic renewal for another twelve-month term, unless one of the parties serves a written notice of non-renewal to the other party not later than one (1) month prior to the expiration of the current term. In reply, please be informed that Article 7 of the Philippines-Japan tax treaty provides as follows: "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. "xxx xxx xxx" 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. "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 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 all agreement between the Governments of the two Contracting States regarding economic or technical cooperation, that enterprise shall, notwithstanding any provisions of this Article, not be deemed to have a permanent establishment in that other Contracting State. "xxx xxx xxx" Based on the aforequoted 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 them 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 or other personnel, in the same or connected project, 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 services is performed by YEC in its office in Japan or in other countries outside the Philippines and that although the above-mentioned services are performed in the Philippines, the length of stay of personnel of YEC shall not exceed six (6) months, YEC 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 YEC from services rendered to YPC are not subject to Philippine income tax, pursuant to Article 7(1) in relation to Article 5 of the Philippines-Japan tax treaty. ( BIR Ruling No. ITAD-184-02 dated October 17, 2002 ) Moreover, Section 108 of the Tax Code of 1997 states that, "sale or exchange of services" is subject to VAT. Under current regulations, the sale of services to Ecozone Enterprises 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 the PEZA law granting exemption from indirect taxes to Ecozone Enterprises, 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 ) The same principle is applicable to the case at hand. It should be noted that the sale of services is in connection with the manufacture of products for export. However, instead of the zero-rating which is not available to non-resident 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 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 rest 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 YEC should be, as it is hereby confirmed to be, exempt from VAT. ( VAT Ruling No. 095-99 dated September 14, 1999 ) This ruling is issued on the basis of the foregoing facts as represented. However, if upon investigation, it will be disclosed that the facts are different, then this ruling shall be without force and effect insofar as the herein parties are concerned. aIcCTA Very truly yours, Commissioner of Internal Revenue By: (SGD.) MILAGROS V. REGALADO Assistant Commissioner Legal Service