ITAD Ruling No. 130-05

November 14, 2005 ITAD RULING NO. 130-05 Articles 5 (Permanent Establishment), 8 (Business Profits) and 16 (Dependent Personal Services) Philippines-United States of America tax treaty BIR Ruling Nos. DA-ITAD 47-05 and 112-05 Sycip Gorres Velayo & Co . 6760 Ayala Avenue 1226 Makati City Attention: Atty. R.C. Vinzon Tax Services Gentlemen : This refers to your letter dated February 24, 2005 requesting our opinion on the tax treatment of inspection service fees to be paid by Samsung Electronic Philippines Manufacturing Corporation (Samsung Philippines) to Underwriters Laboratories, Inc. (Underwriters Laboratories) under the pertinent provisions of the Philippines-United States of America tax treaty. It is represented that Underwriters Laboratories is a nonresident foreign corporation, organized and existing under the laws of the United States of America, with principal office at 333 Pfingsten Road, Northbrook, Illinois 60062, United States of America; that Underwriters Laboratories is not registered either as a corporation or as a partnership licensed to engage in business in the Philippines, as confirmed by the relevant Certificate of Non-Registration of Corporation/Partnership issued by the Securities and Exchange Commission dated February 11, 2005; that, on the other hand, Samsung Philippines is a corporation organized and existing under the laws of the Philippines, with principal office at Block 6, Calamba Premiere International Park, Barangay Batino, Calamba City, Laguna, Philippines; that Samsung Philippines is engaged in the design, manufacture, and sale, generally for export, of electronic products like optical disk drives and their components and parts; that Samsung Philippines is registered with the Philippine Economic Zone Authority, with Registration Certificate No. 01-011 dated February 9, 2001; that on June 25, 2002, Underwriters Laboratories and Samsung Philippines entered into an Agreement for Environmental Management System Assessment Services, whereby Underwriters Laboratories will evaluate Samsung Philippines' environmental management systems for compliance with the International Organization for Standardization (ISO) 14001, Series of Standards and/or other published standards for the evaluation of environmental management systems like BS7750; that for this purpose, Underwriters Laboratories will conduct preassessment meetings with Underwriters Laboratories and will make preliminary assessments, registration assessments, and continuous assessments of Samsung Philippines ' environmental management systems; that for preliminary assessments on June 25, 2002 for two (2) days, Samsung Philippines paid Underwriters Laboratories a service fee of US$2,000 and an initial annual fee of US$665 for maintaining Samsung Philippines' name in Underwriters Laboratories' Directory of Registered Firms; that at the conclusion of registration assessment, Underwriters Laboratories' audit team will make a recommendation concerning registration and when such registration is achieved, continuous assessment (surveillance assessment) visits will be conducted normally every six months per site per registration as part of an ongoing program designed to confirm Samsung Philippines' registered firm status; that, normally, over a two-year period (four continuous assessments) the entire environmental management system will be reevaluated; that Samsung Philippines agrees that Underwriters Laboratories' may permit any accreditor of Underwriters Laboratories to audit the assessment reports and supporting documents and that Samsung Philippines shall, upon request, provide reasonable cooperation to such accreditor and Underwriters Laboratories; and that if Samsung Philippines chooses to add the mark of the accreditor to its Certificates of Registration, there is an additional charge to be paid to the accreditor. aCIHAD In reply, please be informed that the inspection service fees to be paid by Samsung Philippines to Underwriters Laboratories , which include all fees for preliminary assessment, registration assessment, and continuous assessment, and the annual fee for maintaining Samsung Philippines ' name in Underwriters Laboratories ' Directory of Registered Firms, are business profits taxable under paragraph 1, Article 8 (Business Profits) of the Philippines-United States of America tax treaty: "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. xxx xxx xxx" Paragraph 1 states that the service fees are taxable in the Philippines if they are attributable to a permanent establishment which Underwriters Laboratories has in the Philippines. In relation, a permanent establishment , as defined in paragraphs 1 and 2, Article 5 (Permanent Establishment) of the Philippines-United States of America tax treaty, means "a fixed place of business through which a resident of one of the Contracting States engages in a trade or business", and includes a seat of management, a branch, an office, a store or other sales outlet, a factory, and other fixed places of business. A permanent establishment also includes the furnishing of services by a resident of one of the Contracting States through employees or other personnel within the other Contracting State for a period or periods aggregating more than 183 days. Accordingly, since Underwriters Laboratories does not have an office, a branch, or any other fixed place of business in the Philippines, as confirmed by the relevant Certificate issued by the Securities and Exchange Commission, and since it will carry out the activity of evaluating Samsung Philippines ' environmental management systems for only a very short period of four (4) days in every year, which will not exceed the required 183 days, Underwriters Laboratories , in either case, is not deemed to have a permanent establishment in the Philippines. This being so, the inspection service fees to be paid by Samsung Philippines to Underwriters Laboratories are therefore exempt from Philippine income tax. (BIR Ruling No. DA-ITAD 47-05 dated May 31, 2005) On the other hand, the remuneration of the representatives of Underwriters Laboratories who will personally carry out the activity of evaluating Samsung Philippines ' environmental management systems are generally subject to Philippine income tax, unless the conditions set forth in paragraph 2, Article 16 (Dependent Personal Services) of the Philippines-United States of America tax treaty, quoted below, are all complied with: "Article 16 DEPENDENT PERSONAL SERVICES 1. Except as provided in Article 20 (Governmental Functions), wages, salaries, and similar remuneration derived by an individual who is a resident of one of the Contracting States from labor or personal services performed as an employee, including income from services performed by an officer of a corporation, may be taxed by that Contracting State. Except as provided by paragraphs 2 and 3 and in Articles 20 (Governmental Functions), 21 (Teachers), and 22 (Students and Trainees), such remuneration derived from sources within the other Contracting State may also be taxed by that other Contracting State. CITSAc 2. Remuneration described in paragraph 1 derived by an individual who is a resident of one of the Contracting States shall be exempt from tax by the other Contracting State if a) He is present in that other Contracting State for a period or periods aggregating less than 90 days in the taxable year; b) He is an employee of a resident of, or of a permanent establishment maintained in, the first-mentioned Contracting State; and c) The remuneration is not borne as such by a permanent establishment which the employer has in that other Contracting State. xxx xxx xxx" Accordingly, the remuneration of the representatives (taken individually) are exempt from Philippine income tax by reason that the above conditions are all present in their case: (a) their length of stay in the Philippines did not or would not exceed ninety (90) days, (b) they are employees of Underwriters Laboratories , who is a resident of the United States of America, and (c) their remuneration is not borne by a permanent establishment which Underwriters Laboratories has in the Philippines, since Underwriters Laboratories has no permanent establishment in the Philippines to begin with. (BIR Ruling No. DA-ITAD 47-05 dated May 31, 2005) Further, the inspection service fees to be paid by Samsung Philippines to Underwriters Laboratories , which include all fees for preliminary assessment, registration assessment, and continuous assessment, and the annual fee for maintaining Samsung Philippines ' name in Underwriters Laboratories ' Directory of Registered Firms, are subject to ten percent (10%) value-added tax (VAT) under Section 108(A) 1 of National Internal Revenue Code of 1997 (Tax Code): "SEC. 108. Value-added Tax on Sale of Services and Use or Lease of Properties. (A) Rate and Base of Tax. There shall be levied, assessed and collected, a value-added tax equivalent to ten percent (10%) of gross receipts derived from the sale or exchange of services, including the use or lease of properties. xxx xxx xxx" However, Section 109(q) 2 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: 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; HIACac xxx xxx xxx Concerning special laws relevant to Samsung 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 Samsung Philippines (Section 105, Tax Code), Samsung 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 Underwriters Laboratories to shoulder the payment of VAT on the inspection service fees. This is further supported by PEZA Certificate No. 2005-429 dated January 20, 2005 issued to Samsung Philippines which states that suppliers of goods, properties, and services to Samsung Philippines, being a PEZA-registered enterprise, are entitled to zero percent (0%) VAT for sales made to Samsung Philippines and by VAT Ruling No. 100-99 dated September 16, 1999, the dispositive portion of which provides: " In the case of payment for royalties to a non-resident owner, the responsibility for withholding the VAT and paying the same rests on the payor. However, since PEZA-registered export enterprise may not be passed on with nor claim input VAT, then payment of royalties to a non-resident lessor, . . . , should be as it is hereby confirmed to be, exempt from VAT. " (BIR Ruling Nos. DA-ITAD 62-05 dated June 27, 2005 and DA-ITAD 112-05 dated September 30, 2005) Finally, where Samsung Philippines agrees that the assessment reports and supporting documents prepared by Underwriters Laboratories ' will be audited by an accreditor permitted by Underwriters Laboratories and where Samsung Philippines opts to add the accreditor's service mark to its Certificates of Registration so that an additional charge will be paid to the accreditor, the additional charge will constitute as royalties. If the accreditor is a nonresident foreign corporation, organized and existing under the laws of a foreign country which has an existing tax treaty with the Philippines, the reduced tax rates on royalties may apply to the additional charge to be paid to the accreditor, and for which a separate ruling will be issued upon application for tax treaty relief by the proper party and submission of complete documentary requirements enumerated in BIR Form 0901. Otherwise, depending on whether the accreditor is a domestic corporation or a nonresident foreign corporation, organized and existing under the laws of a foreign country without an existing tax treaty with the Philippines, the tax rates on royalties under the Tax Code of 1997 shall apply to the additional charge. HSIADc 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 Footnotes 1. Republic Act No. 9337 (An Act Amending Sections 27, 28, 34, 106, 107, 108, 109, 110, 111, 112, 113, 114, 116, 117, 119, 121, 148, 151, 151, 236, 237 And 288 Of The National Internal Revenue Code Of 1997, As Amended, And For Other Purposes), which was signed into law on May 24, 2005, modifies Section 108 (A) to read as: "SEC. 106. Value-added Tax on Sale of Services and Use or Lease of Properties. (A) Rate and Base of Tax. There shall be levied, assessed and collected, a value-added tax equivalent to ten percent (10%) of gross receipts derived from the sale or exchange of services, including the use or lease of properties: Provided, that the President, upon the recommendation of the Secretary of Finance, shall, effective January 1, 2006, raise the rate of value-added tax to twelve percent (12%), after any of the following conditions has been satisfied: (i) Value-added tax collection as a percentage of Gross Domestic Product (GDP) of the previous year exceeds one and one-half percent (1 1/2%); or (ii) National government deficit as a percentage of GDP of the previous year exceeds one and one-half percent (1 1/2%). xxx xxx xxx" 2. Republic Act No. 9337 renumbers Section 109(q) to Section 109(K) and modifies the same to read as: "SEC. 109. Exempt Transactions. (1) Subject to the provisions of Subsection (2) hereof, the following transactions shall be exempt from the value-added: xxx xxx xxx" (K) Transactions which are exempt under international agreements to which the Philippines is a signatory or under special laws, except those under Presidential Decree No. 529; xxx xxx xxx"