ITAD Ruling No. 084-05

August 23, 2005 ITAD RULING NO. 084-05 Articles 5, 7 & 12 of Philippines-Australia tax treaty; Philippines-Indonesia tax treaty; Philippines-Malaysia tax treaty; and Philippines-Singapore tax treaty; Articles 5 & 7 of Philippines-Japan tax treaty; Section 28 (B) (1) & Section 42 (A) (3) of the Tax Code of 1997; BIR Ruling No. DA-ITAD 24-04; BIR Ruling No. DA-ITAD 13-05; BIR Ruling No. DA-ITAD 129-03; BIR Rulings No. DA-145-97 Punongbayan & Araullo 20th Flr., Tower 1 The Enterprise Center 6766 Ayala Avenue, Makati City Attention: Benedicta Du-Baladad Tax Partner Gentlemen : This refers to your letter dated December 23, 2004, filed on behalf of your client, Philippine Computer Associates International, Inc. (PCAII),requesting confirmation of your opinion as follows, to wit: 1. That the service fees paid by PCAII to its "Foreign Affiliates" namely, Computer Associates PTY Ltd. of Australia (CAPL-Australia);PT CA Indonesia of Indonesia (PTCA-Indonesia);Computer Associates (Malaysia) Sdn Bhd (CA-Malaysia) and Computer Associates Pte Ltd. of Singapore (CAPL-Singapore),are in the nature of business profits under the provisions of applicable tax treaties where Philippines is a signatory, and therefore, not subject to Philippine income tax and consequently to withholding tax; aDcEIH 2. That the service fees paid by PCAII to Computer Associates International Ltd. of Hongkong (CAIL-Hongkong), also a foreign Affiliate, are exempt from Philippine income tax pursuant to Section 28(B)1) in relation to Section 42(A)(3), both of the Tax Code of 1997 and consequently to withholding tax; 3. That the service fees paid to affiliates under (1) and (2),are exempt from the 10% VAT if rendered outside the Philippines; 4. That the reimbursement of costs paid by PCAII to Computer Associates Japan Ltd. (CA-Japan) is not subject to income tax, to withholding tax and to 10% VAT; and 5. That the fees paid in connection with (1) and (2) above are valid deductions from gross income for purposes of determining the income tax liability of PCAII. It is represented that: 1. CAPL-Australia is a nonresident foreign corporation duly organized and existing under the laws of Australia with its principal office address at 407 Pacific Highway, Artarmon, NSW, Australia; 2. PTCA-Indonesia is a nonresident foreign corporation duly organized and existing under the laws of Indonesia with principal office address at Wisma 46, Kota BNI, Level 34-05/06, Jl. Jend. Sudirman Kav. l, Jakarta 10220, Indonesia; IDTcHa 3. CA-Malaysia is a nonresident foreign corporation duly organized and existing under the laws of Malaysia with principal office address at Level 69, Tower 2, Petronas Twin Towers, KLCC, 50088, Kuala Lumpur, Malaysia; 4. CAPL-Singapore is a nonresident foreign corporation duly organized and existing under the laws of Singapore with principal office address at 9 Temasek Boulevard, #10-01/03 Suntec Tower 2, Singapore; 5. CA-Japan is a nonresident foreign corporation duly organized and existing under the laws of Japan with principal office address at 39/F Mitsui Bldg.,Shinjuku Tokyo, Japan; and 6. CAIL-Hong Kong is a nonresident foreign corporation duly organized and existing under the laws of Hong Kong with principal office address at 21/F World Trade Center, 280 Gloucester Road, Causeway Bay, Hong Kong. that these Foreign Affiliates 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 August 4, 2004 and November 4, 2004; that PCAII, on the other hand, is domestic corporation duly organized and existing under the laws of the Philippines with principal office address at 30/F Philam Life Tower, 8767 Paseo de Roxas, Salcedo Village, Makati City; that PCAII is registered with Board of Investments (BOI) under Certificate of Authority No. 2117 dated July 6, 1990; that it is primarily engaged in software licensing, and providing maintenance support, technical and professional services related to the software licensed from Computer Associates International, Inc. of Delaware, US; that the Foreign Affiliates entered into a separate service agreements with PCAII for management consultancy and support services; that the specific services and the scope of services to be rendered by the Foreign Affiliates throughout the term of their contracts are governed by their respective service agreement; that like most multi-national companies, the consultancy and support services of the Foreign Affiliates are provided within the Computer Associates Group worldwide; that the services include information and technology support and consultancy services, including providing regional pre-sales technical support and regional professional services in the implementation and installation of the licensed CA software; that the Foreign Affiliates shall provide these services outside the Philippines, except only in respect of activities that its personnel will conduct for specific services, which require highly qualified and experienced personnel for short periods of time not exceeding 183 days; that for the consultancy and support services, PCAII pays the Foreign Affiliates with the exception of CA-Japan, on a cost-plus basis with a mark-up of 10% based on total costs incurred by the affiliates; that in the case of CA-Japan, the arrangement is purely on a cost reimbursement basis; and that PCAII receives billings or invoices from the Foreign Affiliates which serve as proof of the amount of service fees to be paid by PCAII. In reply, this Office is of the opinion and so holds that: 1. Payments made by PCAII to its Foreign Affiliates for services rendered abroad under their respective Service Contracts, are exempt from Philippine income tax and consequently to withholding tax under their respective tax treaties with the Philippines . Philippines-Australia tax treaty "Article 5 PERMANENT ESTABLISHMENT "1. For the purposes of this Agreement, the term 'permanent establishment' means a fixed place of business through which the business of an enterprise is wholly or partly carried on. "2. The term 'permanent establishment' shall include especially xxx xxx xxx k) a place in one of the Contracting States through which an enterprise of the other Contracting State furnishes services, including consultancy services, for a period or periods aggregating more than six months in any taxable year or year of income, as the case may be, in relation to a particular project, or to any project connected therewith. "xxx xxx xxx" "Article 7 BUSINESS PROFITS "1. The profits of an enterprise of one of the Contracting States 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 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 a) that permanent establishment; or "xxx xxx xxx." Philippines-Indonesia tax treaty "Article 5 PERMANENT ESTABLISHMENT "1. For the purposes of this Agreement, the term "permanent establishment" means a fixed place of business through which the business of the enterprise is wholly or partly carried on SEHTAC "2. The term 'permanent establishment' includes especially: xxx xxx xxx m) the furnishing of services, including consultancy services by an enterprise through an employee or other personnel where activities of that nature continue (for the same or connected project) for a period or periods aggregating more than 183 days within any twelve-month period. "xxx xxx xxx" "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: a. that permanent establishment; or "xxx xxx xxx." Philippines-Malaysia tax treaty "Article 5 PERMANENT ESTABLISHMENT "1. For the purposes of this Agreement, the term 'permanent establishment' means a fixed place of business in which the business of the enterprise is wholly or partly carried on. "xxx xxx xxx." "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 business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much thereof as is attributable to that permanent establishment. "xxx xxx xxx." Philippines-Singapore tax treaty "Article 5 PERMANENT ESTABLISHMENT "1. For the purposes of this convention, the term 'permanent establishment' means a fixed place of business in which the business of the enterprise is wholly or partly carried on. IcAaEH "2. The term 'permanent establishment' includes specially but is not limited to: "xxx xxx xxx" j) The furnishing of services, including consultancy services, by a resident of one of the Contracting States through employees or other personnel, provided activities of that nature continue (for the same or a connected project) within the other Contracting State for a period or periods aggregating more than 183 days. "xxx xxx xxx." "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 there as is attributable to that permanent establishment. "xxx xxx xxx." Based on the abovequoted provisions, the income of these Foreign Affiliates shall be taxable in the Philippines only if they are deemed to have a permanent establishment situated in the Philippines as defined under the above Philippine tax treaties. Inasmuch as it is represented that the consultancy and support services to be rendered by these Foreign Affiliates for PCAII are to be performed outside of the Philippines except in respect of activities that their respective personnel will conduct for specific services, which require highly qualified and experienced personnel for short periods of time, not exceeding 183 days, the furnishing of said services by these Foreign Affiliates through their respective employees or other personnel shall not constitute carrying of business through a permanent establishment in the Philippines. Such being the case, income derived by these Foreign Affiliates which are in the nature of business profits are not subject to Philippine tax as defined under the above Philippine tax treaties. (BIR Ruling No. DA-ITAD 24-04 dated March 11, 2004) 2. That the service fees paid by PCAII to CAIL-Hong Kong, also a foreign affiliate, are exempt from Philippine income tax pursuant to Section 28(B)(1) in relation to Section 42(A)(3), both of the Tax Code of 1997 and consequently to withholding tax . In reply, please be informed that Section 28(B)(1) of the Tax Code provides: "Section 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) and (d): 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." Furthermore, Section 23(F) of the Tax Code of 1997 provides: "Section 23. General Principles of Income Taxation in the Philippines . Except when otherwise provided in this Code: xxx xxx xxx (F) A foreign corporation, whether engaged or not in trade or business in the Philippines, is taxable only on income derived from sources within the Philippines. aCSHDI "xxx xxx xxx" According to Section 23(F), foreign corporations like CAIL-Hong Kong are taxable only on income derived from sources within the Philippines. In the case of income from the provision of services, such income is considered derived from sources within the Philippines if the services are performed in the Philippines, as stated in Section 42(A)(3) of the Tax Code below: "Section 42. 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" Accordingly, since the subject services will be carried out outside the Philippines, service fees therefor to be paid by PCAII to CAIL-Hong Kong, being income not derived from sources within the Philippines by foreign corporations, are therefore exempt from Philippine income tax. (BIR Ruling No. DA-ITAD 13-05 dated February 16, 2005) IASCTD 3. That the service fees paid to affiliates under (1) and (2),are exempt from the 10% VAT if rendered outside the Philippines . Similarly, the subject fees are not subject to ten percent (10%) Value-Added Tax (VAT) imposed under Section 108(A) of the Tax Code below: "Section 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 ..." Section 108(A) clearly states that the sale or exchange of services subject to VAT include only those services that are performed in the Philippines. Accordingly, the service fees to be paid by PCAII to these Foreign Affiliates to the extent that subject services are not performed in the Philippines are therefore exempt from VAT. (BIR Ruling No. DA-ITAD 24-04 dated March 11, 2004) On the other hand, the fees to be paid by PCAII to these Foreign Affiliates for the portion of services actually rendered in the Philippines are subject to 10% value-added tax (VAT). Accordingly, PCAII, being the resident withholding agent and payor in control of payment shall be responsible for the withholding of the 10% final VAT on such fees before making any payment to these Foreign Affiliates. In remitting the VAT withheld, PCAII shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax & Other Percentage Taxes Withheld). The duly filed BIR Form No. 1600 and proof of payment thereof shall serve as documentary substantiation for the claim of input tax to be applied against the output tax that may be due from PCAII if it is a VAT-registered taxpayer. In case PCAII is a non-VAT registered taxpayer, the passed-on VAT withheld shall form part of the cost of the service purchased or treated as "expense" or "asset", whichever is applicable. In addition, PCAII is required to issue the Certificate of Creditable Withheld at Source (BIR Form No. 2307) in quadruplicate upon request of these Foreign Affiliates, the first three copies thereof be given to these Foreign Affiliates, respectively, and the fourth copy to be retained by PCAII. (Sections 4 & 6, Revenue Regulations (RR) No. 4-2002; Section 3 of RR 8-2002; Section 7 of RR 14-2002) 4. That royalty fees for the use of the licensed CA Software, for which services under the subject Service Contracts are rendered, are subject to income tax under the Tax Code or relevant tax treaties, as applicable, and to the value-added tax . 5. That the reimbursement of costs paid by PCAII to Computer Associates Japan Ltd. (CA-Japan) is not subject to income tax, to withholding tax and to 10% VAT . In reply, please be informed that mere reimbursements of actual expenses/costs without any mark-up or profit clement do not constitute income payments and are, therefore, not subject to Philippine income taxes. (BIR Ruling No. DA-145-97) However, should the payments constitute business profits, the same shall be exempt from Philippine income taxes if CA-Japan does not have a permanent establishment in the Philippines pursuant to Article 5 in relation to Article 7 of the Philippines-Japan tax treaty, quoted as follows: "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 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 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." 6. That the issue on the deductibility of the fees under numbers (1) and (2) above is a factual issue which this Office cannot rule upon . This Office declines to rule on the matter considering the factual nature of the issue. However, this does not preclude the taxpayer to treat it as a deductible item, the allowability of which is subject to the findings of an investigation pursuant to the substantiation requirements under Section 34(A)(1)(b) of the National Internal Revenue Code. (BIR Rulings No. DA-ITAD 129-03 dated August 18, 2003) CAETcH 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