ITAD Ruling No. 080-05

August 8, 2005 ITAD RULING NO. 080-05 Articles 5 (Permanent Establishment) and 8 (Business Profits) Philippines-United States of America tax treaty Laya Mananghaya & Co . Certified Public Accountants and Management Consultants 22nd Floor, Philamlife Tower 8767 Paseo de Roxas Street Makati City Attention: Atty. Francisco G. Tagao Principal Manuel P. Salvador III Director, Tax and Corporate Services Gentlemen : This refers to your application for relief from double taxation dated September 9, 2004, requesting confirmation that: (1) the monthly equipment rentals and the one time transportation expense which constitute as additional rental paid by the National Power Corporation (NPC) to GE Energy Rentals, Inc . (GE U.S.A.) are not subject to income tax and consequently to the withholding tax of 7.5% imposed on the rentals derived by nonresident lessors of equipment under Section 28(B)(4) of the National Internal Revenue Code (Tax Code) of 1997, pursuant to the Philippines-United States of America tax treaty; and (2) the same monthly equipment rentals and one time transportation expenses are subject to a withholding value-added tax of 10%. It is represented that GE U.S.A. (formerly, Showpower, Inc .) is a nonresident foreign corporation organized and existing under the laws of the U.S.A.,with registered office at 1209 Orange Street, Wilmington, Delaware 19801, County of New Castle, U.S.A.,as confirmed by the Restated Certificate of Incorporation issued by GE U.S.A. on November 30, 2001 certified by the Government of the State of Georgia on July 30, 2004; that GE U.S.A. is not registered either as a corporation or as a partnership in the Philippines as confirmed by the Certification of Non-Registration issued by the Securities and Exchange Commission on July 6, 2004; that GE U.S.A. has a subsidiary company in the Philippines, General Electric Philippines, Inc. (GE Philippines) ,a domestic company organized and existing under the laws of the Philippines with principal office at 2291 Don Chino Roces Avenue Extension, 1231 Makati City, Philippines; that NPC is a government-owned and controlled corporation of the Philippines, organized and existing under the laws of the Philippines, with principal office at NPC Office Building Complex, Quezon Avenue corner Agham Road, East Triangle, Diliman, Quezon City, Philippines; that GE U.S.A.,GE Philippines and NPC are all engaged primarily in the business of generating power; that GE U.S.A. and GE Philippines entered into two separate Contracts of Lease (both dated February 13, 2004) of Modular Generating Set for Mindoro Island and for Palawan Island, respectively, where GE U.S.A. agreed to lease to GE Philippines complete modular diesel generator sets capable of supplying continuous power to Mindoro Island and to Palawan Island; that for Mindoro, the generator sets shall be capable of continuous operation with net generating total capacity output of 25 MW at 69 KV and/or 13.8 KV high voltage and at 60 hertz, and that for Palawan, the generator sets shall be capable of continuous operation with net generating total capacity output of 15 MW at 69 KV high voltage and at 60 hertz; that for Mindoro, the generator sets must be on commercial operation on April 8, 2004 for the first 15 MW and on April 18, 2004 for the additional 10 MW, and that for Palawan, the generator sets must be on commercial operation not later than March 7, 2004; that the lease for each of the contracts is one year, but may be renewed upon the consent of the parties; that under the same Contracts of Lease, GE U.S.A. was authorized to assign to GE Philippines ,with the consent of NPC, all the rights and obligations of GE U.S.A. regarding the mobilization, operation and maintenance, and demobilization of the generator sets; that on February 11, 2004, GE U.S.A. and GE Philippines entered into two separate Assignment Agreements, where GE U.S.A. agreed to assign to GE Philippines the mobilization, operation and maintenance, and demobilization of the generator sets after being transported to the Philippines by GE U.S.A. ;that GE Philippines shall not be subject to the detailed instructions or to the comprehensive control of GE U.S.A. in the performance of the mobilization, operation and maintenance, and demobilization of the generator sets; that the purpose of the Assignment Agreements executed between GE U.S.A. and GE Philippines is to transfer to GE Philippines ,all the rights and obligations of GE U.S.A. pertaining to the mobilization, operation, maintenance and demobilization of the generating sets; that GE U.S.A. has nothing more to do with respect to the assigned portion of the contract; that GE Philippines steps into the shoes of GE U.S.A. with respect to the assigned portion vis--vis NPC; that under the Contracts of Lease, NPC agreed to pay GE U.S.A. and GE Philippines ,the amounts of US$ 6,088,000.00 for Mindoro and US$ 3,421,485.00 for Palawan, broken down as follows: for Mindoro : GE U.S.A. (US$) GE Philippines (US$) Transportation 617,515.00 Mobilization 432,248.00 Equipment rental 3,455,498.80 Operations and 1,493,638.20 (payable monthly at maintenance (payable 287,958.23 for 12 monthly at 124,469.85 months) for 12 months) Demobilization 89,100.00 Total 4,073,013.80 Total 2,014,986.20 for Palawan: GE U.S.A. (US$) GE Philippines (US$) Transportation 253,800.00 Mobilization 198,333.00 Equipment rental 2,315,224.81 Operations and 565,027.19 (payable monthly at maintenance (payable 192,935.40 for 12 monthly at 47,085.60 months) for 12 months) Demobilization 89,100.00 Total 2,569,024.81 Total 852,460.19 In reply, please be informed as follows: A. Rentals for the lease and payments for the transportation of the generator sets to be made by Napocor to GE U.S.A. are not subject to Philippine income tax . Being business profits, rentals for the lease 1 and payments for the transportation of the generator sets to be made by NPC to GE U.S.A. are subject to Philippine income tax only if they are attributable to a permanent establishment which G.E. U.S.A. has in the Philippines, as mentioned in paragraphs 1, Article 8 (Business Profits) of the Philippines-U.S.A. tax treaty below: Article 8 BUSINESS PROFITS 1. Business profits of a resident of one of the Contracting States shall be taxable only in that State unless the resident has a permanent establishment in the other Contracting State. If the resident has a permanent establishment in that other Contracting State, tax may be imposed by that other Contracting State on the business profits of the resident but only on so much of them as are attributable to the permanent establishment. CAaEDH xxx xxx xxx A permanent establishment ,as defined in paragraphs 1 and 2, Article 5 (Permanent Establishment) of the same tax treaty, means "a fixed place of business through which a resident of one of the Contracting States engages in trade or business," and includes, for example, "a seat of management, a branch, an office, a store or other sales outlet, a factory, and a workshop." Thus, GE U.S.A. can have a permanent establishment in the Philippines if it has in the Philippines a branch, an office, or any of the fixed places of business mentioned, or, as mentioned in the following OECD Commentary, if the leased generator sets constitute as such a permanent establishment: ...Whether or not gaming and vending machines and the like set up by an enterprise of a State in the other State constitute a permanent establishment thus depends on whether or not the enterprise carries on a business activity besides the initial setting up of the machines. A permanent establishment does not exist if the enterprise merely sets up the machines and then leases the machines to other enterprises. A permanent establishment may exist, however, if the enterprise which sets up the machines also operates and maintains them for its own account. This also applies if the machines are operated and maintained by an agent dependent on the enterprise. 2 With respect to the criteria of having a fixed place of business, GE U.S.A. is deemed not to have in the Philippines a branch, an office, or any other fixed place of business to constitute for it a permanent establishment, in view of the relevant Certificate of Non-Registration issued by the Securities and Exchange Commission. In the case of the leased generator sets, the above Commentary, by analogy, considers the same as constituting a permanent establishment if GE U.S.A. or any dependent agent thereof operates and maintains the generator sets. Inasmuch as it is represented that GE U.S.A. shall not be the entity which will operate and maintain the generator sets, the latter may not constitute as permanent establishment of GE U.S.A. Neither will GE Philippines be considered as a dependent agent of GE U.S.A. since GE Philippines shall not be subject to the detailed instructions or to the comprehensive control of GE U.S.A. in the performance of the operation and maintenance of the generator sets. Thus, GE Philippines may not also constitute as a permanent establishment of GE U.S.A. In addition, Section 2 of Revenue Regulation No. 19-86 provides as follows, viz : SEC. 2. Reporting of Income and Deductions by a Lessor or a Vendor . 2.01 Lessor if a contract is a lease The amount paid for the use of property under an agreement which is determined under these regulations to be a lease shall be considered as rental (and therefore includible in gross income) of the lessor. ... If, under the agreement, the lessee pays to the lessor a stipulated rental, and in addition pays certain other expenses which are properly payable by the lessor, the lessor is deemed to have received as rental income not only the stipulated rental but also the amount of such other expenses paid by the lessee to, or for the account of, the lessor .(Emphasis supplied) ADHaTC xxx xxx xxx Thus, although the payments for the transportation of the generator sets are per se not rentals for the generator sets, the same are deemed rental income of GE U.S.A . Based on the aforequoted provision and in view of the fact that GE U.S.A. is deemed not to have a permanent establishment in the Philippines, rentals for the lease and payments for the transportation of the generator sets to be made by NPC to GE U.S.A. are therefore exempt from Philippine income tax and consequently to the 7.5% withholding tax imposed under Section 28(B)(4) of the Tax Code of 1997, pursuant to paragraph 1, Article 8 of the Philippines-U.S.A. tax treaty. It must be emphasized, however, that the income to be derived by GE Philippines in the mobilization, operation, maintenance and demobilization of the generating sets shall be subject to tax in accordance with the following provisions of the Tax Code of 1997, viz : SEC. 27. Rates of Income Tax on Domestic Corporations . (A) In General . Except as otherwise provided in this Code, an income tax of thirty-five percent (35%) is hereby imposed upon the taxable income derived during each taxable year from all sources within or without the Philippines by every corporation, as defined in Section 22(B) of this Code and taxable under this Title as a corporation, organized in, or existing under the laws of the Philippines: 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%). xxx xxx xxx (E) Minimum Corporate Income Tax on Domestic Corporations . (1) Imposition of Tax . A minimum corporate income tax of two percent (2%) of the gross income as of the end of the taxable year, as defined herein, is hereby imposed on a corporation taxable under this Title, beginning on the fourth taxable year immediately following the year in which such corporation commenced its business operations, when the minimum income tax is greater than the tax computed under Subsection (A) of this Section for the taxable year. xxx xxx xxx SEC. 105. Persons Liable . Any person who, in the course of trade or business, sells, barters, exchanges, leases goods or properties, renders services , and any person who imports goods shall be subject to the value-added tax (VAT) imposed in Sections 106 to 108 of this Code. (Emphasis supplied) IcHTCS xxx xxx xxx SEC. 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. ...(Emphasis supplied) xxx xxx xxx B. Rentals for the lease and payments for the transportation of the generator sets to be made by Napocor to GE U.S.A. are subject to 10 percent value-added tax (VAT) . Furthermore, being payments for the performance of services in the Philippines, rentals for the lease and payments for the transportation of the generator sets to be made by NPC to GE U.S.A. are subject to 10 percent value-added tax (VAT) under Section 108 and 114, both of the Tax Code of 1997, viz : xxx xxx xxx Lease of properties shall be subject to the tax herein imposed irrespective of the place where the contract of lease or licensing agreement was executed if the property is leased or used in the Philippines. xxx xxx xxx SEC. 114. Return and Payment of Value-added tax . xxx xxx xxx (C) Withholding of Creditable Value-added Tax . ... Provided, further ,That the payment for lease or use of properties or property rights to nonresident owners shall be subject to ten percent (10%) withholding tax at the time of payment. For this purpose, the payor or person in control of the payment shall be considered as the withholding agent. CSHDTE The value-added tax withheld under this Section shall be remitted within ten (10) days following the end of the month the withholding was made. xxx xxx xxx 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 to a nonresident person, NPC, shall be responsible for the withholding of the 10 percent VAT on such payments before remitting them to the nonresident person, GE U.S.A .In remitting to this Bureau the VAT withheld on such payments, NPC shall use BIR Form No. 1600 (Monthly Remittance Return of VAT and Other Percentage Taxes Withheld).If a VAT-registered taxpayer, NPC 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 a non-VAT-registered taxpayer, NPC may include as part of the cost of the services provided to it by GE U.S.A. 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 GE U.S.A. 's request, NPC is required to issue in quadruplicate the relevant Certificate of Final Tax Withheld at Source (BIR Form No. 2306),the first three copies for GE U.S.A. and the fourth copy for NPC 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, (SGD.) JOSE MARIO C. BUAG OIC-Commissioner of Internal Revenue Footnotes 1. Generally, rentals for the lease of industrial, scientific, or commercial equipment like the subject generator sets are royalties under tax treaties and taxable as such. However, the definition of "royalties" in paragraph 3, Article 13 (Royalties) of the Philippine-U.S.A. tax treaty below exclude therein such rentals for the lease of equipment: "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 films or tapes used for radio or television broadcasting, any patent, trade mark, design or model, plan, secret formula or process, or other like right or property, or for information concerning industrial, commercial or scientific experience. The term "royalties" also includes gains derived from the sale, exchange or other disposition of any such right or property which are contingent on the productivity, use, or disposition thereof. " On the other hand, such rentals for the lease of equipment are considered business profits under paragraph 6, Article 8 (Business Profits) of the same tax treaty: "6. The term "business profits" means income derived from any trade or business whether carried on by an individual, corporation or any other person, or group of persons, including the rental of tangible personal (movable) property ." 2. OECD Model Tax Convention on Income and on Capital (January 2003),Paragraph 10, P. 91.