ITAD Ruling No. 106-05

September 21, 2005 ITAD RULING NO. 106-05 Philippines-United States tax treaty, Articles 5 & 8 NIRC of 1997, Section 28, 57 & 105 Revenue Regulations No. 2-98; 13-2007 BIR Ruling No. ITAD-182-00; BIR Ruling No. DA-062-99; BIR Ruling No. 136-98 Sycip Gorres Velayo & Co . 6760 Ayala Avenue 1226 Makati City Attention: Atty. C.P. Noel Tax Division Gentlemen : This refers to your letters dated January 12, 2001 and May 25, 2004, on behalf of your client, Tupperware Products Inc. (TPI), requesting confirmation of your opinion on the following: 1) that TPI does not have a permanent establishment (PE) in the Philippines in accordance with the provisions of the Philippines-United States tax treaty; 2) that since TPI does not have a PE in the Philippines, TPI is not subject to Philippine income tax and consequently to the withholding tax pursuant to the same tax treaty; and 3) that TPI or Tupperware Philippines, Inc. (TWP) as the Commissionaire will not be subject to the 1% creditable withholding tax on the sale of goods to customers in the Philippines. It is represented that TPI is a nonresident foreign corporation duly organized and existing under and by virtue of the laws of the United States of America (USA) with principal office address at 14901 S. Orange Blossom Trail, Orlando, Florida 32837 USA; that TPI is engaged in the manufacture and sale of Tupperware products which includes plastic wares, kitchen and household effects; that TPI 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 February 13, 2001; that Dart Philippines Inc. (DPI) and TWP are domestic corporations existing under the laws of the Philippines; that in line with the worldwide Tupperware reorganization, TPI is formed in the United States to act as the regional trading company for the Asia Pacific region; that the Tupperware operations in the Philippines will involve DPI as the manufacturing entity and TWP, the new company which resulted in the spin-off of the marketing division of DPI, as the marketing entity; that under proposed commissionaire agent structure, the mainstream transaction flow involves TWP receiving orders from the distributors; that upon receipt of the orders, TWP forwards the orders to TPI for acceptance as TWP has no authority to conclude contracts on behalf of TPI; that once orders are accepted, TPI purchases the ordered items from DPI; that DPI maintains the finished products only for a reasonable period of time for the necessary inspection to maintain the quality assurance of the products; that upon purchase, title to the DPI goods is transferred from DPI to TPI the moment the goods leave DPI's premises; that upon instructions of TPI to DPI, the finished goods are transported to unrelated distributors via an independent third party transportation contractor; and that upon delivery, title to the goods passes from TPI to the distributor. TICAcD It is further represented that TWP, as the commissionaire, is an agent of an independent status; that it shall market and sell the goods purchased by TPI from DPI and will deal with the Philippine customers in its own name; that since TPI does not have presence in the Philippines, TWP shall use its own invoice in billing the customers for the goods sold to the latter; that payments for the goods sold by TPI are collected and received by TWP on behalf of TPI; that as far as the Philippine customers are concerned, they are only dealing with TWP, with TPI as the undisclosed principal; that TWP's principal responsibilities as commissionaire of TPI include, (a) cultivation and expansion of the Tupperware sales Network (Home Party Plan),(b) production of product catalogs, (c).promotion of Tupperware products, (d) processing of orders, (e) recommending distributor margins, dealer commission and product prices, (f) monitoring the shipments and distribution of Tupperware products and (g) filing of VAT return on behalf of TPI for goods sold within the Philippines; that TWP will also be selling non-Tupperware products for its own account as a wholesaler; that for its services as commissionaire, TWP will charge an arm's length commission fee to TPI; that for this purpose, TPI has commissioned independent experts to undertake transfer pricing studies to identify the market rates paid for comparable services by independent parties dealing at arm's length, in the context of the same facts and circumstances; that in the case of DPI, it owns and operates the facilities, plant and the machinery/equipment; and that TPI is the legal owner of all the imported and locally sourced raw materials being used in the production of the finished products which DPI sells to TPI. In reply, please be informed that Article 8 of the Philippines-United States tax treaty provides as follows: "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. "(2) Where a resident of one of the Contracting States has a permanent establishment in the other Contracting State, there shall in each Contracting State be attributed to the permanent establishment the business profits which would reasonably be expected to have been derived by it if it were an independent, entity engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the resident of which it is a permanent establishment. "(3) There may also be attributed to that permanent establishment the business profits derived from the sale of goods or merchandise of the same or similar kind as those sold, or from other business activities of the same or similar kind as those effected, through that permanent establishment if the sale or activities had been resorted to in order to avoid taxation. caIDSH "xxx xxx xxx." In relation, Article 5 of the same tax treaty provides, viz: "Article 5 "PERMANENT ESTABLISHMENT "(1) For the purposes of this Convention, the term 'permanent establishment' means a fixed place of business through which a resident of one of the Contracting State engages in a trade or business. "(2) The term 'fixed place of business' includes but is not limited to: (a) A seat of management; (b) A branch; (c) An office; (d) A store or other sales outlet; (e) A factory; (f) A workshop; (g) A warehouse; (h) A mine, quarry, or other place of extraction of natural resources; (i) A building site or construction or assembly project or supervisory activities in connection therewith, provided such site, project or activity continues for a period of more than 183 days; and (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 connected project) within the other Contracting State for a period or periods aggregating more than 183 days. "xxx xxx xxx "(4) A person, acting in one of the Contracting States on behalf of a resident of the other Contracting State, other than an agent of an independent status to whom paragraph (5) applies, shall be deemed to give rise to a permanent establishment in the first-mentioned Contracting State if (a) Such person has, and habitually exercises in the first-mentioned Contracting State, an authority to conclude contracts in the name of that resident, unless the exercise of such authority is limited to the purchase of goods or merchandise for that resident, or (b) He has no such authority, but habitually maintains in the first-mentioned State a stock of goods or merchandise from which he regularly delivers goods and merchandise on behalf of the resident. CcTIAH "(5) A resident of one of the Contracting States shall not be deemed to have a permanent establishment in the other Contracting State merely because such resident carries on business in that other Contracting State through a broker, general commission agent, or any other agent of an independent status, where such broker or agent is acting in the ordinary course of his business. However, when the activities of such an agent are devoted wholly or almost wholly on behalf of that resident, he shall not be considered an agent of independent status within the meaning of this paragraph if the transactions between the agent and the resident were not made under arm's length conditions. "xxx xxx xxx." Based on the above-quoted provisions, the income of TPI shall be taxable in the Philippines only if it has a permanent establishment situated in the Philippines. As a rule, in order that a permanent establishment may be deemed to exist, a resident of one of the Contracting States must conduct business through a fixed place of business situated in the other Contracting State. Paragraph 2 of Article 5 of the Philippines-United States tax treaty enumerates certain examples of a permanent establishment, while paragraph 3 enumerates what are excluded therefrom. Paragraph 2 contains a list, by no means exhaustive, of examples, each of which constitutes a permanent establishment. As these examples are to be seen against the background of the general definition given in paragraph 1, it is assumed that the Contracting States (i.e.,the Philippines and the United States of America) interpret the terms listed in such a way that such places of business constitute permanent establishments only if they meet the requirements or conditions of paragraph 1, to wit: (1) the existence of a "place of business," i.e.,a facility such as premises or, in certain instances, machinery and equipment; (2) this place of business must be "fixed," i.e.,it must be established at a distinct place with a certain degree of permanence; (3) the carrying on of the business of the enterprise through this fixed place of business. 1 Paragraph 4 enumerates instances when a person acting on behalf of a resident of the other Contracting State, other than an agent of an independent status shall be deemed to give rise to a PE. In paragraph 5, however, an agent of an independent status is deemed not to give rise to a PE. TWP and DPI are not to be considered as permanent establishments of TPI under paragraph 2 of Article 5. Likewise, they cannot be considered as TPI's permanent establishment under paragraph 4 because they do not have the authority to conclude contracts with customers in the name or on behalf of TPI. Neither TWP nor TPI, both in the Philippines, habitually maintain a stock of goods or merchandise from which either may regularly deliver goods or merchandise on behalf of TPI, a circumstance that would also otherwise constitute TWP and DPI as a permanent establishments of TPI, pursuant to paragraph 4(b) of Article 5 of the Philippines-United States tax treaty. (BIR Ruling No. ITAD-182-00 dated December 6, 2000) For purposes of paragraph 4(a) of Article 5, neither TWP nor DPI has the authority to conclude contracts in the name of TPI. As a toll manufacturer, DPI operates its own facilities, plant and machinery for the processing of the raw and packing materials belonging to TPI. DPI has no authority to accept orders from distributors and will only process tupperware products based on orders placed by TPI. On the other hand, a critical feature of TWP is its inability to contractually bind TPI. TWP will sell the tupperware goods in its capacity as consignee independent agent and will invoice the customers in its own name pursuant to its status as an independent agent. It will have no ability to conclude contracts with customers in the name of, or on behalf of, TPI. Neither TWP nor DPI habitually maintains a stock of goods or merchandise from which either TWP of DPI may regularly deliver goods or merchandise on behalf of TPI pursuant to Article 5(4)(b).Upon purchase of TPI, title to the DPI goods is transferred from DPI to TPI the moment the goods leave DPI's premises. And upon delivery to the distributors, title to the goods passes from TPI to the distributors. Needless to state, DPI maintains the finished products only for a reasonable period of time for the necessary inspection and quality assurance of the products. aEIcHA While TPI will enter into an agreement relating to the provision of toll processing and other services with DPI and will also enter into a commissionaire agreement with TWP, they will not constitute permanent establishments since DPI and TWP have separate and distinct personalities from TPI and since their activities will not be devoted wholly or almost wholly to TPI and will be done in the ordinary course of their business under arm's length conditions. For purposes of Article 5(5),DPI and TWP are not dependent agents of TPI. Rather, they are independent entities that merely provide services to TPI in return for an arm's length consideration, acting in the ordinary course of their trades or businesses. DPI, having its own machineries and equipment, has the freedom and autonomy to carry out its business operations without any immediate interference or control from TPI. Both TWP and DPI are not subject to control of TPI and are free to run their operations based upon their own decisions. The independent status of DPI and TWP is likewise supported by the fact, as represented herein, that their respective transactions with TPI will be compensated on an arm's length basis. With the payment of arm's length service fees, DPI and TWP cannot be considered a permanent establishment of TPI. Premises considered, this Office is of the opinion and so holds that TPI is deemed not to have a permanent establishment in the Philippines under the proposed sales structure. Moreover, since TPI will not have a permanent establishment in the Philippines, then the business profits to be derived by TPI, in particular, the income from the sale of tupperware goods to customers in the Philippines, shall not be subject to Philippine income tax and shall be subject to tax only in the United States pursuant to Article 8 of the above treaty. Be that as it may, all income derived from the Philippines by DPI and TWP from the proposed sales structure will be subject to Philippine income tax. (BIR Ruling No. ITAD-182-00 dated December 6, 2000) Finally, under Section 57 of the Tax Code of 1997, the income tax imposed therein shall be withheld by the payor-corporation and/or person. Implementing this provision, Revenue Regulations (RR) No. 2-98 dated April 17, 1998, as amended, provides, among others, that income payments made by any of the top ten thousand (10,000) corporations, as determined by the Commissioner, to their local supplier of goods shall be subject to a 1% creditable withholding tax. (Sec. 2.57.2(M), Revenue Regulations No. 2-98 as amended by Revenue Regulations No. 17-2003) However, Sec. 2.57.5(B) of the same Regulations provides that the withholding of creditable withholding tax prescribed therein shall not apply to income payments made to persons enjoying exemption from payment of income taxes pursuant to the provisions of any law, general or special. In this regard, since TPI does not have a permanent establishment in the Philippines and will not be subject to tax on the business profits it derives from the sale of goods to the customers in the Philippines, it follows that the payments to TPI shall not be subject to any withholding tax under Section 57 of the Tax Code, including the 1% creditable tax to be withheld on income payments made by any of the top 10,000 corporations to their local supplier of goods. (BIR Ruling No. DA-062-99 dated February 5, 1999; 136-98 dated September 24, 1998). For the same reason, TPI shall not be required to withhold the same tax (1% creditable withholding tax) when making payments to local suppliers of raw and packing materials. Likewise, TWP shall not be subject to the creditable withholding tax on the sale of goods belonging to TPI because it merely sells as an independent agent. ACTISE In fine, your opinion that TPI is not deemed to have a permanent establishment in the Philippines under the proposed structure pursuant to Articles 8 in relation to Article 5 of the Philippines-United States tax treaty and as such will not be subject to Philippine income tax on the business profits or income to be derived on the sale of goods to customers in the Philippines, and that TPI will not be subject to the 1% creditable withholding tax on the sale of goods to customers in the Philippines, and that TPI will also not be required to withhold the same tax on payments to local suppliers of raw and packing materials, is hereby confirmed. 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.) JOSE MARIO C. BUAG OIC-Commissioner Footnotes 1. Commentary on Article 5 (Permanent Establishment),Model Tax Convention On Income and Capital, January 2003, Condensed Version OECD 2002.