ITAD Ruling No. 114-04

October 26, 2004 ITAD RULING NO. 114-04 Art. 5, 7, 12 of Philippines-Korea Tax Treaty BIR Ruling No. 068-88 Samsung Electro-Mechanics Philippines Corp . Blk. 5, Calamba Premiere International Park Brgy. Prinza Calamba, Laguna Attention: Mr . Dae Sik Choi General Manager Gentlemen : This refers to your application for relief from double taxation dated July 29, 2003, requesting for a ruling that the service fees paid by Samsung Electro-Mechanics Philippines Corporation (Samsung-Phil) to Samsung Electro-Mechanics Co., Ltd. (Samsung-Korea) under a Management Support Agreement and Information Services Agreement are not subject to Philippine income tax pursuant to the Philippines-Korea tax treaty. It is represented that Samsung-Korea is a nonresident foreign corporation organized and existing under the laws of Korea with principal address at 314 Maetan 3-Dong, Suwon-Si, Kyunggi-Do, Korea; that it is not registered either as a corporation or as a partnership and has not been licensed to do business in the Philippines per certification issued by the Securities and Exchange Commission dated August 18, 2003; that Samsung-Phil is a subsidiary of Samsung-Korea and is a PEZA-registered corporation organized and existing under the laws of the Philippines with principal address at Blk. 5 Calamba Premiere International Park, Brgy. Batino Prinza, Calamba Laguna; that on January 1, 2002, Samsung-Korea and Samsung-Phil entered into a Management Support Agreement under which the former will provide the latter various management supports and services, including but not limited to the following support: (1) Consulting or audit, (2) Development, installation, and maintenance of management systems, (3) Installation, upgrade, maintenance of production line or equipment, (4) Audit or improvement of quality or process, (5) Training of leaders for 6-Sigma program, and (6) Other supports requested by Samsung-Phil with respect to its formation and operation including, but not limited to, production, technology, research, development, sales, purchasing, and/or administration; that Samsung-Phil shall pay Samsung-Korea fees and expenses for such Management Support and under the Agreement as follows: (a) Per Diem in accordance with the current standard of Samsung-Korea, (b) Lodge in accordance with the then current standard of Samsung-Korea (Company may first pay the lodge for Samsung-Korea personnel, in this case Samsung-Korea will not invoice the lodge in duplicate), (c) Airfare or other expenses allowed in accordance with the then current standard of Samsung-Korea, including but not limited to local transportation, communication, and (d) Fees in accordance with following table: Fee Personnel US$300/day Director or higher level, who takes charge of group level organization US$200/day Manager or higher level US$150/day Assistant manager or lower level US$400/day Any level of personnel of Samsung-Korea's Tooling & Die Division and that in the event that only part of the journey of Samsung-Korea's personnel is involved in the management support hereunder, Samsung-Phil will share a part of his/her trip expenses and fees as follows: (a) Pro rata portion of fees and expenses for lodge, per diem and other expenses (excluding airfare) paid by Samsung-Korea on the basis of number of days involved in the management support hereunder among his/her total trip and, (b) Half of the total airfare incurred during his/her trip; that the fees and expenses shall be charged and paid on a quarterly basis. DcCHTa It is further represented that on January 1, 2001, Samsung-Phil and Samsung-Korea entered into an Information Services Agreement under which Samsung-Korea will provide Samsung-Phil the following Information Services: (1) Access to Samsung-Korea's Network Server, (2) Connection of Samsung-Korea's Network Server to Samsung-Phils', (3) Software License, (4) Continuous Development and upgrades of Information System, and (5) Technical assistance for Network operation and maintenance; and that in consideration for the said Information Services, Samsung-Phil shall pay the following fees: (1) Server Access Fee (Pro rata payment of Server access fees to be paid by Samsung-Phil based on Dialog Steps), (2) Network Access Fee (The fee charged for the route between Gwachon Network Center and Company), (3) Software License Fee (Pro rata payment of Software License Fees to be paid by Samsung-Phil based on Number of users); (4) System Development Fee (Fee calculated by the actual person-day input utilized for development of specific system based on the cost table with reference of cost table issued by KAIST in 2001), and (5) Service Fee (Fee calculated by the actual person-day input provided by trip to Company based on the following rates: (a)US$500/person-day, general manager, (b)US$300/person-day, manager level, and (c) US$200/person-day, associate level. In reply, please be informed that Article 7 in relation to Article 5, both of the Philippines-Korea tax treaty provides: "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 of them as is attributable to that permanent establishment. "xxx xxx xxx" "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. "2. The term 'permanent establishment' includes especially 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" Based on the foregoing, it is clear that when a corporation which is a resident of Korea does not carry on business in the Philippines through a permanent establishment situated therein, the profits derived in the Philippines shall not be subject to Philippine income tax. For this purpose, a Korean corporation may be deemed to have a permanent establishment in the Philippines if, among others, the furnishing of services by such corporation through its employees or other personnel continue for the same or a connected project within the Philippines for a period or periods aggregating more than 183 days. However, the certification issued by Samsung-Phil shows that in the year 2002, the length of stay of personnel/employees of Samsung-Korea who rendered services in the Philippines, under the Management Support Services Agreement, exceeded 183 days during the year, and the furnishing of the said services shall constitute carrying of business through a permanent establishment in the Philippines. Such being the case, the income derived by Samsung-Korea under the Management Support Services Agreement in 2002 which are in the nature of business profits are subject to Philippine income tax and consequently to withholding tax under Section 28(B)(1) of the Tax Code of 1997. On the other hand, services rendered by Samsung-Korea to Samsung-Phil under the Information Service Agreement and for the year 2003 under the Management Support Services Agreement do not constitute the carrying on of a business through a permanent establishment, since the length of stay of Samsung-Korea personnel/employees in the Philippines, to perform the said services, do not exceed 183 days. Thus, fees received in consideration for said services by Samsung-Korea from Samsung-Phil are not subject to Philippine income tax. HAICTD Furthermore, please be informed that the software license granted by Samsung-Korea to Samsung-Phil under the Information Services Agreement should be treated as royalties in accordance with the meaning of "royalty", taxed at the following rates under the Philippines-Korea tax treaty: "Article 12 "Royalty "1. Royalties arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State if such resident is the beneficial owner of the royalties. "2. However, such royalties may be taxed in the Contracting State in which they arise, and according to the laws of that State, but if the recipient is the beneficial owner of the royalties the tax so charged shall not exceed 15 per cent of the gross amount of the royalties. "3. Notwithstanding the provisions of paragraph 2 hereof, the amount of tax imposed by the Philippines, registered with the Board of Investments and engaged in preferred pioneer areas of investment under the investment incentives laws of the Philippines to a resident of Korea, who is the beneficial owner of the royalties, shall not exceed 10 per cent of the gross amount of the royalties. "4. 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, any patent, trademark, 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, and includes payments of any kind in respect of motion picture films and works on films or videotapes for use in connection with television or tapes for the use of radio broadcasting. "xxx xxx xxx" Therefore, Software License Fees paid by Samsung-Phil to Samsung-Korea for the Software License under the Information Services Agreement shall be subject to a fifteen percent (15%) preferential tax rate, based on the gross amount of royalties, pursuant to the Philippines-Korea tax treaty. Moreover, Section 108 of the Tax Code of 1997 states that the lease or use of any trademark, trade brand or other like property or right is embraced within the definition of "sale or exchange of services" and is subject to value-added tax (VAT). However, under the 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 enjoyed 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) This ruling is issued on the basis of the facts as represented and is rendered only for the purpose of determining whether Samsung-Korea is entitled to the benefits of the Philippines-Korea tax treaty. The determination on whether your request for tax refund should be given due course is upon the Office which will be conducting the investigation for that purpose. Thus, the docket pertaining thereto (including a copy of this ruling) shall be endorsed to the proper office for processing and investigation. Very truly yours, Commissioner of Internal Revenue By: (SGD.) MILAGROS V. REGALADO Assistant Commissioner Legal Service