ITAD Ruling No. 128-05

November 10, 2005 ITAD RULING NO. 128-05 Arts. 5 & 7, Philippines-Japan tax treaty BIR Ruling No. DA-ITAD 24-04; VAT Review Committee Ruling No. 005-2003 Punongbayan & Araullo Certified Public Accountants Unit 807, 8th Floor Ayala Life-FGU Center Mindanao Avenue Corner Biliran Road Cebu Business Park, Cebu City Attention: Marivic C. Espao Partner Tax Advisory and Compliance Gentlemen : This refers to your letter dated April 18, 2005 requesting confirmation that the management fees paid by Blaze Manufacturing Corporation (Blaze) to Yoshi Corporation (Yoshi) are exempt from Philippine income tax and from value-added tax (VAT) pursuant to the pertinent sections of the National Internal Revenue Code of 1997 (Tax Code) and the Philippines-Japan tax treaty. It is represented that Yoshi is a nonresident foreign corporation organized and existing under the laws of Japan with business address at 5-48-5-302, Hinominami, Konan-Ku, Yokohama City, Japan; that Yoshi is not registered either as a corporation or as a partnership licensed to engage in business in the Philippines as confirmed by the Certificate of Corporate Filing/Information issued by the Securities and Exchange Commission on March 1, 2005; that Blaze (formerly Yamago Philippines Corporation),on the other hand, is a domestic company organized and existing under the laws of the Philippines with principal office at Lot 1, Blk. 4, Ph 2, Mactan Economic Zone II (SEZ),Basak, Lapu-Lapu City, Cebu; that it is registered with the Philippine Economic Zone Authority (PEZA) as an export enterprise and currently operating at Mactan Economic Zone II (MEZ),Basak, Lapu-Lapu City, Cebu Province; that Blaze is engaged in the manufacture of high quality blocks made of mortar with ducts inserted in it; that on September 1, 2003, Blaze entered into a Management Agreement (Agreement) with Yoshi; that under the said Agreement Yoshi shall provide services to Blaze in the following areas: 1. Monthly financial review of the operation; 2. Training of the employees of Blaze to attain skills in the manufacturing of products and to improve productivity; 3. Assistance in the procurement and shipment of good quality raw materials and supplies in Japan; and 4. Promotion of Blaze's product in Japan. cTEICD that in general, Yoshi shall perform the aforementioned services in Japan or in other countries outside the Philippines; that in cases where it would be necessary for Yoshi to send employees to the Philippines, the stay of these individuals in the Philippines shall not, in any case, exceed six (6) months in a year; that in consideration for the services, Blaze will pay Yoshi a fixed monthly fee, as indicated in the Agreement; and that the Agreement shall be effective for a twelve-month term commencing on September 11, 2003 until September 10, 2004, subject to an automatic renewal for another twelve-month term, unless the other party serves a written notice of nonrenewal not later than one (1) month prior to the expiration of the current term. In reply, please be informed that paragraph 1 of Article 7 of the Philippines-Japan tax treaty provides: "Article 7 "1. The profits of an enterprise of a Contracting State shall be taxable only in that Contracting 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 that other Contracting State but only so much as is attributable to that permanent establishment." In view of the foregoing, the profits of an enterprise of a Contracting State shall be taxable only in that Contracting 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 that other Contracting State but only so much of them that is attributable to that permanent establishment. Applying this to the instant case, the management fees received by Yoshi for the services rendered in the Philippines shall be taxable in the Philippines only if it has a permanent establishment in the Philippines in connection with the activities giving rise to such income. In relation thereto, Article 5 of the same tax treaty defines a permanent establishment, 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. "2. The term 'permanent establishment' includes especially: 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 the 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." EaIcAS "xxx xxx xxx." Inasmuch as it has been represented that the services will generally be performed by Yoshi outside the Philippines and that its employees will not stay in the Philippines for a period or periods aggregating more than six months within any taxable year in the course of their rendition of services to Blaze, Yoshi may be considered as not having a permanent establishment in the Philippine. In other words, Yoshi is deemed not to have a permanent establishment for as long as its employees do not stay in the Philippines for a period or periods aggregating more than six months within any taxable year in the course of their rendition of services to Blaze. (BIR Ruling No. DA-ITAD 24-04 dated March 11, 2004) In such a case, the income derived by Yoshi from services rendered to Blaze shall not be subject to Philippine income tax and, as such, shall likewise be exempt from withholding tax. Finally, as PEZA registered enterprise, Blaze is subject to "5% special tax regime, in lieu of all taxes". Hence, its payments for the services rendered by Yoshi are exempt from VAT, consequently, from the creditable VAT withholding prescribed under Section 114 (C), NIRC of 1997. (VAT Review Committee Ruling No. 005-2003) 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