ITAD Ruling No. 129-05

November 11, 2005 ITAD RULING NO. 129-05 Articles 5 (Permanent Establishment) and 7 (Business Profits) Philippines-Singapore tax treaty; Philippines-Thailand and Philippines-China tax treaty BIR Ruling No. DA-ITAD 62-05; BIR Ruling No. DA-ITAD 54-03 Aranas Consunji Barleta Unit 106, Ground Floor, Le Metropole Building 326 Tordesillas corner De La Costa Streets Salcedo Village, Makati City Attention: Atty. Jesus Clint O. Aranas Gentlemen : This refers to your letter dated July 26, 2005 received by this Office on August 4, 2005 requesting confirmation that business profits from the sale of raw materials by TR Formac Pte Ltd (TR Formac-Singapore), Soode Nagano (Thailand) Co. Ltd. (Soode-Thailand) and Donaldson (WUX) Filter Co. Ltd (Donaldson-China) who are residents of Singapore, Thailand and China, respectively, to Hitachi Global Storage Technologies Philippines, Pte Ltd. (Hitachi-Philippines) under a Vendor Management Inventory Arrangement (VMIA) as embodied Participatory Agreements, shall not be taxable in the Philippines under the pertinent provisions of the Philippines-Singapore, Philippines-Thailand and the Philippines-China tax treaties. It is represented that TR Formac-Singapore, Soode-Thailand and Donaldson-China are nonresident foreign corporations, organized and existing under the laws of Singapore, Thailand and China, respectively; that TR Formac-Singapore's business office address is at 57, Senoko Road Singapore 758121, as confirmed by the Information Resources issued by the Accounting and Regulatory Authority (ACRA) of Singapore; that Soode-Thailand's business office address is at Banwa Duty Freezone, Hi-Tech Industrial Estate, 180 Moo.1, T. Banlen, Phranakorn Sri-Ayutthava, 13160 as confirmed by its Amended Article of Incorporation; that Donaldson-China's business office address is at Lot 235, 236, 252 Standard Factory, Wuxi Singapore Industry Park, Wuxi, Jiangsu, China, as confirmed by the Business License For Enterprises as Legal Entities issued by Wuxi Administration for Industry & Commerce of Jiangsu Province on December 28, 2004; that TR Formac-Singapore, Soode-Thailand and Donaldson-China are not registered either as corporations or as partnerships engaged in business in the Philippines as confirmed by the respective Certificates of Non-Registration of Corporation/Partnership dated March 11, 2005 and April 13, 2005 issued by the Securities and Exchange Commission; that, on the other hand, Hitachi-Philippines is a corporation organized and existing under the laws of the Philippines, with principal office at Special Export Processing Zone, Laguna Technopark, Bian, Laguna, Philippines; that Hitachi Philippines, (the Buyer),entered into separate Participation Agreements (PA) with TR Formac-Singapore, Soode-Thailand and with Donaldson-China (the Suppliers),pursuant to existing Vendor Management Inventory Arrangements between Hitachi-Philippines and TR Formac-Singapore, Hitachi-Philippines and Soode-Thailand and Hitachi-Philippines and Donaldson-China; that each of the PA adopts and incorporates by reference all of the terms and conditions of the relevant Goods Agreement (GA) and Statement of Works (SOW);that the respective PA does not adopt and incorporate any amendments to the GA and SOW unless agreed to in writing by the parties; that the respective parties to the PA agree that purchases and sales of the Deliverables, Products or Services, as defined in the GA, will be conducted in accordance with, and be subject to the terms and conditions of the PA, the SOW and any Work Authorization (WA);that the respective parties under the PA are bound by a Vendor Management Inventory Arrangement (VMI);that VMI operates on a pull process as defined in the GA and SOW; that the products are delivered to a VMI Warehouse owned and utilized by Hitachi Philippines; that the Suppliers agree that Hitachi Philippines is not responsible to pull any inventory not required by the latter; that the Suppliers shall deliver the identified parts by their numbers (Products) under the Buyer's Purchase Orders (PO) to VMI warehouse; that the products that Suppliers will deliver are for the exclusive benefit of Hitachi-Philippines; and that the process of order and payment shall comply with the applicable provisions contained in the GA and SOW. EACIcH In reply, please be informed that payments derived by TR Formac-Singapore, Soode-Thailand and Donaldson-China from the sale of their raw materials to Hitachi Philippines under their respective Participation Agreements are business profits of TR Formac-Singapore, Soode-Japan and Donaldson-China, taxable under the respective paragraphs 1, Article 7 (Business Profits) of the Philippines-Singapore, Philippines-Thailand and Philippines-China tax treaties, to wit: Singapore : "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 of them as is attributable to that permanent establishment." Thailand : "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." China : "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." The respective paragraphs 1 above state that the payments in question are subject to Philippine income tax if they are attributable to permanent establishments which TR Formac Singapore, Soode-Thailand and Donaldson-China have or might have in the Philippines. A permanent establishment ,as defined in the respective paragraphs 1 and 2, Article 5 (Permanent Establishment) of the relevant tax treaties, means "a fixed place of business through or in which the business of an or the enterprise is wholly or partly carried on," and includes, for example, "a place of management, a branch, an office, a factory, a workshop, a store or other sales outlet, and a warehouse." In the contractual arrangements between Hitachi-Philippines and TR Formac-Singapore; Hitachi-Philippines and Soode-Thailand and between Hitachi Philippines and Donaldson-China where Hitachi Philippines shall permit TR Formac-Singapore, Soode-Japan and Donaldson-China to use its (Hitachi Philippines) warehouse to store their raw materials prior to its fuse of the raw materials, such a warehouse which will be utilized (in whole or in part) by them can be considered a permanent establishment if the general requisites of a permanent establishment are attendant in the use of the warehouse. TIEHSA In relation, the 2003 Organization for Economic Cooperation and Development (OECD) Model Tax Convention Commentary (pages 85-91) gives guidance as to when a facility such as a warehouse can become a permanent establishment, as it explains: "Paragraph 1 gives a general definition of the term "permanent establishment" which brings out its essential characteristics of a permanent establishment in the sense of the Convention (tax treaty),i.e.,a distinct "situs",a "fixed place of business".The paragraph defines the term "permanent establishment" as a fixed place of business through which the business of an enterprise is wholly or partly carried on. This definition, therefore, contains the following conditions: the existence of a "place of business",i.e.,a facility such as premises or, in certain instances, machinery or equipment; this place of business must be "fixed",i.e.,it must be established at a distinct place with a certain degree of permanence; the carrying on of the business of the enterprise through this fixed place of business. This means usually that persons who, in one way or another, are dependent on the enterprise (personnel) conduct the business of the enterprise in the State in which the fixed place is situated." (Paragraph 2) "The term 'place of business' covers any premises, facilities or installations used for carrying on the business of the enterprise whether or not they are used exclusively for that purpose. A place of business may also exist where no premises are available or required for carrying on the business of the enterprise and it simply has a certain amount of space at its disposal. It is immaterial whether the premises, facilities or installations are owned or rented or are otherwise at the disposal of the enterprise. A place of business may thus be constituted by a pitch in a market place, or by a certain permanently used area in a customs depot (e.g.,for the storage of dutiable goods).Again the place of business may be situated in the business facilities of another enterprise. This may be the case for instance where the foreign enterprise has at its constant disposal certain premises or a part thereof owned by the other enterprise." (Paragraph 4) "As noted above, the mere fact that an enterprise has a certain amount of space at its disposal which is used for business activities is sufficient to constitute a place of business. No formal legal right to use that place is therefore required. Thus, for instance, a permanent establishment could exist where an enterprise illegally occupied a certain location where it carried on its business." (Paragraph 4.1) "Whilst no formal legal right to use a particular place is required for that place to constitute a permanent establishment, the mere presence of an enterprise at a particular location does not necessarily mean that the location is at the disposal of that enterprise. These principles are illustrated by the following examples where representatives of one enterprise are present on the premises of another enterprise. A first example is that of a salesman who regularly visits a major customer to take orders and meets the purchasing director in his office to do so. In that cases, the customer's premises are not at the disposal of the enterprise for which the salesman is working and therefore do not constitute a fixed place of business through which the business of that enterprise is carried on (depending on the circumstances, however, paragraph 5 of the Article could apply to deem a permanent establishment to exist)." (Paragraph 4.2) "A second example is that of an employee of a company who, for a long period of time, is allowed to use an office in the headquarters of another company (e.g.,a newly acquired subsidiary) in order to ensure that the latter company complies with its obligations under contracts concluded with the former company. In that case, the employee is carrying activities related to the business of the former company and the office that is at his disposal at the headquarters of the other company will constitute a permanent establishment of his employer, provided that the office is at his disposal for a sufficiently long period of time so as to constitute a "fixed place of business" and that the activities that are performed there go beyond the activities referred to in paragraph 4 of the Article." (Paragraph 4.3) HIaSDc "A third example is that of a road transportation enterprise which would use a delivery dock at a customer's warehouse every day for a number of years for the purpose of delivering goods purchased by that customer. In that case, the presence of the road transportation enterprise at the delivery dock would be so limited that that enterprise could not consider that place as being at its disposal so as to constitute a permanent establishment of that enterprise." (Paragraph 4.4) "A fourth example is that of a painter who, for two years, spends three days a week in the large office building of its main client. In that case, the presence of the painter in that office building where he is performing the most important functions of his business (i.e.,painting) constitute a permanent establishment of that painter." (Paragraph 4.5) "According to the definition, the place of business has, to be a 'fixed' one. Thus in the normal way there has to be a link between the place of business and a specific geographical point. ..." (Paragraph 5) "For a place of business to constitute a permanent establishment the enterprise using it must carry on its business wholly or partly through it. The activity need not be of a productive character. Furthermore, the activity need not be permanent in the sense that there is no interruption of operation, but operations must be carried out on a regular basis." (Paragraph 7) "The business of an enterprise is carried on mainly by the entrepreneur or persons who are in paid-employment relationship with the enterprise (personnel).This personnel includes employees and other persons receiving instructions from the enterprise (e.g. dependent agents).The powers of such personnel in its relationship with third parties are irrelevant. It makes no difference whether or not the dependent agent is authorized to conclude contacts if he works at the fixed place of business. ..." (Paragraph 10) Accordingly, the subject warehouse can constitute a permanent establishment if (1) it is a place of business at the disposal of TR Formac-Singapore, Soode-Thailand and Donaldson-China, (2) it is fixed, or established at a distinct place with a certain degree of permanence, and (3) it is used for carrying on the businesses of TR Formac-Singapore, Soode-Thailand and Donaldson-China where personnel dependent on them conduct businesses on their behalf at the warehouse. (Paragraph 3, Commentary.) Concerning requirement number (1),the subject warehouse owned by Hitachi-Philippines can become a place of business at the disposal of TR Formac-Singapore, Soode-Thailand and Donaldson-China if the warehouse will be used for a sufficiently long period of time and if the activities that will be performed in the warehouse go beyond preparatory and auxiliary activities. (Paragraph 4.3, Ibid .) As to whether or not the warehouse will be used for a sufficiently long period, the fact that the relevant Participation Agreements do not contain therein a fixed term of at most six months for TR Formac-Singapore, Soode-Thailand and Donaldson-China to deliver raw materials to Hitachi Philippines and to use the warehouse to store the raw materials there is no conclusive proof that the warehouse will be used for a sufficiently long period of time, unless proven otherwise. As to whether or not the activities that will be performed in the warehouse go beyond preparatory and auxiliary activities, the respective subparagraphs (a) and (b), paragraphs 4 and 3, Article 5 of the Philippines-Singapore, Philippines-Thailand and Philippines-China tax treaties provide that "the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise" and "the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery" by themselves are activities of a preparatory and auxiliary character. The fact that that the activities of storing and delivering the raw materials are of a preparatory and auxiliary character, the warehouse for this purpose cannot be regarded as a place of business that will constitute a permanent establishment of TR Formac-Singapore, Soode-Thailand and Donaldson-China. DaESIC Concerning requirement number (2),the fact that the warehouse is established at a distinct place in the Philippines with a certain degree of permanence makes it a fixed place of business. Concerning requirement number (3),although not expressly mentioned in the relevant Participation Agreements, the fact that Hitachi-Philippines will store the raw materials in its warehouse prior to its use thereof for its own account and that Hitachi-Philippines personnel will be responsible for the storage, inventory and security of the raw materials, is sufficient to consider these personnel as dependent on TR Formac-Singapore, Soode-Thailand and Donaldson-China who conduct businesses on their behalf. In view of the foregoing, this Office is of the opinion and so holds that the subject warehouse, although a fixed place of business through which the businesses of TR Formac-Singapore, Soode-Thailand and Donaldson-China can be wholly or partly carried on, is not a permanent establishment because the activities that are performed therein are merely of a preparatory and auxiliary character. This is buttressed by the fact that TR Formac-Singapore, Soode-Thailand and Donaldson-China are not licensed to engage in business in the Philippines as confirmed by the relevant certificates issued by the Securities and Exchange Commission which support the conclusion that TR Formac-Singapore, Soode-Thailand and Donaldson-China do not have other fixed places of business in the Philippines which may be constituted as their permanent establishments. Hence, for the reason that activities performed by TR Formac-Singapore, Soode-Thailand and Donaldson-China in connection with the subject warehouse are merely preparatory and auxiliary, payments received by TR-Formac-Singapore, Soode-Thailand and Donaldson-China from the sale of their raw materials to Hitachi Philippines under their respective Participation Agreements are exempt from Philippine income tax. (BIR Ruling No. DA-ITAD 62-05 dated June 27, 2005) However, where provisions of the relevant GAs and SOWs as adopted and incorporated in the PAs give rise to a permanent establishment of TR Formac-Singapore, Soode-Thailand and Donaldson-China under the Philippines-Singapore, Philippines-Thailand and Philippines-China tax treaties, said income shall be subject to Philippine income tax pursuant to relevant provisions of the Tax Code of 1997. Further, Section 107 of National Internal Revenue Code of 1997 (Tax Code) provides that the importation of the raw materials by Hitachi Philippines is subject to ten percent (10%) value-added tax (VAT): "Section 107. Value-added Tax on Importation of Goods. "(A) In General. There shall be levied, assessed and collected on every importation of goods a value-added tax equivalent to ten percent (10%) based on the total value used by the Bureau of Customs in determining tariff and customs duties, plus customs duties, excise taxes, if any, and other charges, such tax to be paid by the importer prior to the release of such goods from customs custody. .." However, Section 109(q) of the Tax Code exempts from VAT transactions which are exempt under international agreements or under special laws: "SEC. 109. Exempt Transactions. The following shall be exempt from the value-added tax: EATCcI "xxx xxx xxx "(q) Transactions which are exempt under international agreements to which the Philippines is a signatory or under special laws, except those under Presidential Decree Nos. 66, 529 and 1590;" "xxx xxx xxx" Concerning special laws relevant to Hitachi-Philippines and other PEZA-registered enterprises, Section 24 of Republic Act No. 7916 (An Act Providing for the Legal Framework and Mechanism for the Creation, Operation, Administration, and Coordination of Special Economic Zones in the Philippines, Creating for this Purpose, the Philippine Economic Zone Authority (PEZA), and for Other Purposes) and Section 1, Rule XIV (Incentives to ECOZONE Developers/Operators) of the Rules and Regulations to Implement this Act are worth mentioning: "Section 24. Exemption from Taxes Under the National Internal Revenue Code . Any provision of existing laws, rules and regulations to the contrary notwithstanding, no taxes, local and national, shall be imposed on business establishments operating within the ECOZONE. In lieu of paying taxes, five percent of the gross income earned by all business and enterprises within the ECOZONE shall be remitted to the national government. . ." "Section 1. ECOZONE Developers/Operators. ECOZONE Developers/Operators shall be entitled to the following incentives: A. Exemption from National and Local Taxes and Licenses. An ECOZONE Developer/Operator shall to the extent of its construction and operation, be exempt from payment of all national internal revenue taxes and local government impost, fees, licenses or taxes, including but not limited to the following: 1. Internal revenue taxes such as gross receipts tax, value-added tax, ad valorem and excise taxes; 2. Franchise, common carrier or value added taxes and other percentage taxes on public and service utilities and enterprises. xxx xxx xxx" Accordingly, since VAT is an indirect tax and the amount of tax may be shifted or passed on to Hitachi-Philippines (Section 105, Tax Code), Hitachi-Philippines, on the other hand, by reason that it is exempt from national internal revenue taxes like VAT under Section 24 of Republic Act No. 7916, cannot be obliged by TR Formac-Singapore, Soode-Thailand and Donaldson-China to shoulder the payment of VAT on the imported raw materials. This is further supported by PEZA Certificate No. 2005-261 dated January 17, 2005 issued to Hitachi-Philippines which states that suppliers of goods, properties, and services to Hitachi-Philippines, being a PEZA-registered enterprise, are entitled to zero percent (0%) VAT for sales made to Hitachi-Philippines. However, since PEZA-registered export enterprises may not be passed on nor claim input VAT, then payments by Hitachi-Philippines to TR Formac-Singapore, Soode-Thailand and Donaldson-China are exempt from VAT. (BIR Ruling No. DA-ITAD 54-03 dated April 15, 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. HIEASa Very truly yours, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service