ITAD Ruling No. 129-03

August 18, 2003 ITAD RULING NO. 129-03 Secs. 28, 34 & 42, NIRC BIR Ruling No. DA-ITAD-80-03 BIR Ruling No. DA-384-98 Tam-Yap & Associates Unit 408, Ferros Bel-Air Tower 30 Polaris cor Durban Streets Bel-Air, Makati City Attention: Teresa R. Tam-Yap Ryan Jan G. Cruz Gentlemen : This refers to your letter dated December 19, 2002 on behalf of your client, SKF, Philippines, requesting confirmation of your opinion that: (1) The reimbursement by SKF Philippines of the administration expenses incurred by Aktiebolaget SKF (AB SKF), including the 5% mark-up, is not subject to Philippine withholding tax, pursuant to the RP-Sweden tax treaty; and (2) The subject reimbursement, including the 5% mark-up, qualifies as a tax deductible item in computing SKF Philippines net income subject to income tax. It is represented that AB SKF is a corporation organized and existing under the laws of Sweden, with registered office address at 415 50 Gteborg, Sweden; 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 (SEC) dated June 3, 2003; that AB SKF provides professional expertise to all SKF companies in the areas of accounting and financing, international legal matters, personnel matters, organization, communication, public relations, quality development, business development, purchasing, logistics, information technology, manufacturing, marketing and sales; that this function is exercised through certain controlling and coordinating activities; that the controlling and coordinating activities are required by SKF Philippines, Inc. (SKF Philippines) for extensive regional and international connections; that SKF Philippines is a corporation organized and existing under and by virtue of Philippine laws, with office address at U-302 Alegria Bldg., 2229 Chino Roces Avenue, Makati City; that SKF Philippines is a member of the SKF Group; that the SKF Group is one of the largest rolling bearing suppliers in the world; that AB SKF provides routine non-technical day-to-day administration services within the SKF Group worldwide; that it is neither practical nor economical to provide these services in each country and are therefore provided on a centralized basis; that with this arrangement, SKF Philippines, like other subsidiaries of AB SKF, entered into a Service Agreement (Agreement) with AB SKF for reimbursement on a periodic basis, of routine non-technical day-to-day administration expenses incurred by AB SKF and the regional headquarters concerned (SKF South East Asia and Pacific Pte. Ltd., Singapore [SKF SEAP]) in providing the management services; that the calculation of the amount to be reimbursed includes reference to actual expenses incurred by SKF SEAP directly applicable to SKF Philippines, and a proportion of the actual routine non-technical day-to-day administration expenses incurred by AB SKF in rendering the aforesaid administration services; and that there is also a five percent (5%) arm's length profit mark-up based on actual cost of administrative expenses ("Mark-up") to be charged by AB SKF. In reply, this Office is of the opinion and so holds as follows: 1. Whether the reimbursement by a SKF Philippines of the administration expenses incurred by AB SKF, including the 5% mark-up, is not subject to Philippine withholding tax, pursuant to the RP-Sweden tax treaty. By its very nature, reimbursement of expenses is not income but merely a return of capital. Accordingly, said reimbursement is not subject to withholding tax. (BIR Ruling No. DA-384-98 dated August 24, 1998) In the instant case, therefore, the reimbursement by SKF Philippines of the administration expenses incurred by AB SKF is not subject to withholding tax. However, the 5 % mark-up to be charged by AB SKF to SKF Philippines, in addition to the actual amount of administrative expenses herein reimbursed, constitutes business profits of AB SKF which is taxable if AB SKF has a permanent establishment in the Philippines to which such profits are attributable. Considering that AB SKF has no permanent establishment in the Philippines to which its business profits may be attributed to, and more importantly, considering the representation that the herein services rendered by AB SKF are performed outside the Philippines, the tax treatment of the abovementioned 5% mark-up is governed by Section 28(B)(1) in relation to Section 42(A)(3) of the National Internal Revenue Code of 1997 (NIRC) which state as follows: "SEC 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 interest, 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%). (Emphasis supplied) "SEC. 42. Income from Sources Within the Philippines. "(A) Gross 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;" As afore-cited, a nonresident foreign corporation is taxable only on income derived from sources within the Philippines so that if a nonresident foreign corporation furnishes and performs services in the Philippines, the service fees therefrom are taxable in the Philippines. Considering that the services of AB SKF to SKF Philippines under the said Service Agreement are rendered outside the Philippines, the 5% mark-up is considered income derived from sources outside the Philippines and is, therefore, not taxable. 2. Whether the reimbursement by SKF Philippines of administration expenses incurred by AB SKF and SKF SEAP, including the 5% mark-up, will qualify as a tax deductible item in computing SKF Philippines' net income subject to income tax, pursuant to Section 34(A)(1)(a) of the NIRC. As to whether the above reimbursement of administration expenses will qualify as tax deductible item in computing SKF Philippines' net income pursuant to Section 34(A)(1)(a) of the NIRC, please be informed that 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 NIRC. ( BIR Ruling No. DA-ITAD-80-03 dated June 11, 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.) MILAGROS V. REGALADO Assistant Commissioner Legal Service