ITAD Ruling No. 074-04

July 23, 2004 ITAD RULING NO. 074-04 Art. 12, Philippines-Finland tax treaty Art. 12, Philippines-Singapore tax treaty Section 108, NIRC BIR Ruling No. DA-ITAD-163-02 BIR Ruling No. DA-ITAD-39-03 BIR Ruling No. DA-ITAD-63-03 Sycip Gorres Velayo & Co 6760 Ayala Avenue 1226 Makati City Attention: Veronica A . Santos Tax Division Gentlemen : This refers to your letter dated May 17, 2004 requesting confirmation that the Service Fee payments of your client, Wireless Service Asia, Inc (WSA) , to Oy Wireless Service Europe, Ltd . (OWSE) and Wireless Service Asia Pte . Ltd . (WSS) , under two separate Service Agreements, are not subject to Philippine income tax and value-added tax (VAT). It is represented that OWSE is a nonresident foreign corporation duly organized and existing under the laws of Finland with principal address at Itamerenkatu 5, 2nd Floor, 00180 Helsinki, Finland; that WSS is a nonresident foreign corporation duly organized and existing under the laws of Singapore with principal address at 80 Raffles Place, UOB Plaza 1, No. 35-26 Singapore; that OWSE and WSS are not registered either as corporations or as partnerships licensed to do business in the Philippines per certifications issued by the Securities and Exchange Commission dated December 11, 2003; that the WSA is a corporation duly organized and existing under the laws of the Republic of the Philippines with principal place of business at 11th Floor, NOL-Tower, Commerce Avenue, Madrigal Business Park, Ayala Alabang, Muntinlupa City; that on December 15, 2002, OWSE and WSA entered into a Services Agreement whereby OWSE shall market, within Europe, products and services of WSA, specifically, those that carry the trademarks "Mbox" and "Gamechannel"; that on December 15, 2002, WSA and WSS also executed a similar Services Agreement whereby WSS will market the same WSA's products and services within the Asian Region; that in both Agreements, the services include, but are not limited to the following: a. Market Development b. Provision of information on potential customers for WSA c. Liaison with WSA's potential customers and dispersing information on WSA's products and services; d. Liaison with customers for obtaining feedback on behalf of WSA; e. Exploration of expansion of WSA's product and services lines It is further represented that in consideration for the abovementioned services, WSA shall pay OWSE and WSS an annual service fee in the amount of Ninety Thousand Euros (Euro90,000.00) and Four Hundred Twenty Thousand Singapore Dollars (S$420,000.00), respectively; that in both Service Agreements, WSA is given the option to pay an Annual Bonus Fee; that neither of the above Service Agreements involves the grant of a license for the use of any proprietary rights or transfer of technology; and that both Agreements contemplate the performance of services entirely outside the Philippines. In reply, this Office is of the opinion and so holds that: 1. The service fees payable by WSA to OWSE and WSS are ordinary business profits and not royalties . Article 12 of the Philippines-Finland and Philippines-Singapore tax treaties define the term "royalties", as follows: Philippines-Finland tax treaty "Article 12 ROYALTIES "xxx xxx xxx "3. The term "royalties" as used in this Article means payments of any kind received as a consideration a) for the use of, or the right to use, any copyright of literary, artistic or scientific work; b) for the use of, or the right to use, any patent, trade mark, design or model, plan, secret formula or process, or any industrial, commercial, or scientific equipment; c) for information concerning industrial, commercial or scientific experience. "xxx xxx xxx" Philippines-Singapore tax treaty "Article 12 ROYALTIES "xxx xxx xxx "3. 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 of literary, artistic or scientific work, including cinematographic films or tapes for television or broadcasting, any patent, trade mark, 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. TcHEaI "xxx xxx xxx" The above tax treaties define " royalties " to include "payment of any kind received as a consideration for information concerning industrial, commercial or scientific experience." According to the commentaries of the ORGANISATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT (OECD) Committee on Fiscal Affairs on the Model Tax Convention [par. 11, Commentary on Article 12 (royalties), 1998, p. 151), such information alludes to the concept of "know-how". The definition of know-how, which has been adopted by the said Committee, is "all the undivulged technical information, whether capable of being patented or not, that is necessary for the industrial reproduction of a product or process, directly and under the same conditions; inasmuch as it is derived from experience, know-how represents what a manufacturer cannot know from mere examination of the product and mere knowledge of the progress of technique." In a know-how contract, one of the parties agrees to impart to the other, so that he can use them for his own account, his special knowledge and experience which remain unrevealed to the public. (BIR Ruling No. DA-ITAD No. 163-02 dated September 23, 2002) Further, in the case of Philippine Refining Company vs . CIR , CTA Case No. 2872 dated January 15, 1986, the Court of Tax Appeals had an occasion to rule on the distinction of service fees from royalties, to wit: "To distinguish between compensation for service and royalty payments, one must inquire on whether the payee has proprietary interest in the property giving rise to the income. If the payee has none, then the payment is a compensation for personal services, if the payee has proprietary interest then the payment is royalty." Applying the above discussions to the instant case, there is nothing in the above Service Agreements that would require transfer into the Philippines of technology, equipment or other property where either OWSE or WSS has proprietary interest or would otherwise permit OWSE or WSS to impart to WSA their special knowledge and experience which remain unrevealed to the public. Likewise, inasmuch as OWSE and WSS shall render the services using their respective customary skills, then the compensation to be received therefor shall not constitute as 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 transfer of technology. Accordingly, the service fees to be paid by the WSA to OWSE and WSS are not within the purview of the definition of "royalties" but rather, shall constitute as ordinary business profits derived from sources outside the Philippines. (BIR Ruling No. DA-ITAD-39-03 dated March 4, 2003) 2. The service fees being derived from sources outside the Philippines shall be exempt from Philippine income tax . Inasmuch as it has been represented that the subject services are to be performed by OWSE and WSS outside the Philippines, then the Philippines-Finland and Philippines-Singapore tax treaties do not apply as the herein transactions do not result in a case of double taxation for which a tax treaty relief is sought. (BIR Ruling No. DA-ITAD-63-03 dated April 15, 2003). In this regard, Section 28(B)(1), in relation to Section 42(A)(3), both of the National Internal Revenue Code (NIRC) provide, viz : "SEC. 28. Rates of Income Tax on Foreign Corporations . "xxx xxx xxx" "(B) Tax on Nonresident Foreign Corporation . "(1) In General . Except as otherwise provided in this Code, a foreign corporation not engaged in trade or business in the Philippines shall pay a tax equal to thirty-five percent (35%) of the gross income received during each taxable year from all sources within the Philippines, such as interests, dividends, rents, royalties, salaries, premiums (except reinsurance premiums), annuities, emoluments or other fixed or determinable annual, periodic or casual gains, profits and income, and capital gains, except capital gains subject to tax under subparagraphs 5(c): Provided, That effective January 1, 1998, the rate of income tax shall be thirty-four percent (34%); effective January 1, 1999, the rate shall be thirty-three percent (33%); and, effective January 1, 2000 and thereafter, the rate shall be thirty-two percent (32%). "SEC. 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" Under the afore-cited provisions, a nonresident foreign corporation is taxable only on income derived from sources within the Philippines. Considering that the aforementioned services under the two Service Agreements are to be performed by OWSE and WSS outside the Philippines, the subject service fees are income derived from sources outside the Philippines. Accordingly, the service fees (consisting of the annual service fees and annual bonus fees, if any) by WSA to OWSE and WSS under the subject Service Agreements are considered income derived from sources outside the Philippines and are, therefore, not subject to Philippine income tax and consequently to withholding tax, pursuant to Section 28(B)(1) of the NIRC. 3. Since the subject services will be performed outside the Philippines, the said service fees are not subject to Philippine income tax and the 10% value-added tax . In defining the phrase "sale or exchange of services" subject to 10% VAT, Section 108 of the NIRC provides: "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, . . . " (emphasis supplied) Clearly, the VAT imposed under Section 108 of the NIRC applies only to services performed in the Philippines and not to services rendered outside the Philippines. Accordingly, since the services by OWSE and WSS are to be performed outside the Philippines, then the subject service fees by WSA to OWSE and WSS are not subject to VAT. ( BIR Ruling No. DA-ITAD 39-03 dated March 4, 2003 ) This ruling is issued on the basis of the foregoing facts as represented. However, if upon investigation it shall be disclosed or discovered 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