ITAD Ruling No. 145-02

August 21, 2002 ITAD RULING NO. 145-02 Section 42 (A) (4), Section 28 (B) (1) and Section 108 (A) of the NIRC of 1997 DA 076-99 Follosco Morallos & Herce Suite 1506, 15th Floor, 88 Corporate Center 141 Valero Street Corner Sedeo Street Salcedo Village, Makati City 1229 Attention: Atty. Rachel P. Follosco Gentlemen : This refers to your letter dated February 7, 2001 to the Commissioner of Internal Revenue, which was forwarded to this Office by the Deputy Commissioner, Legal and Inspection Group on February 12, 2002, for and on behalf of your client, Oakwood Management Services (Philippines) Inc. (Oakwood Phils.),stating that it is a corporation duly organized and existing under Philippine laws and engaged in the business of managing and operating service apartments in the Philippines; that on January 15, 2001, Oakwood Phils. entered into a Service Agreement with Oakwood Asia Pacific Limited (Oakwood Asia),a non-resident foreign private limited company duly incorporated in Labuan, Malaysia; that under the Service Agreement, Oakwood Asia undertakes to perform the following services for Oakwood Phils.: General consultation and management (e.g. assist in strategic planning and forecasting) Training and personnel development (e.g. give advice on standards for recruitment of executive staff); Financial and budgetary planning (e.g. budget review, financial projection and analysis);and Marketing services (e.g. give advice on marketing strategies, business development, and marketing analysis). that all the foregoing services will be performed by Oakwood Asia in Malaysia or in some other jurisdiction outside of the Philippines; that from time to time, Oakwood Asia may have to send personnel to the Philippines for short periods which should not, in aggregate, exceed 183 days in any given year; and that under the Service Agreement, in consideration of the foregoing services, Oakwood Phils. shall pay Oakwood Asia a fixed monthly fee, in addition to bearing out-of-pocket expenses which are separately reimbursable to Oakwood Asia at their actual cost. In reply, this Office is of the opinion and so holds as follows: 1. Whether the Service Fees payable to Oakwood Asia constitute compensation for labor or personal services rendered outside of the Philippines as they are not within the contemplation of "rentals and royalties" as defined under Section 42(A)(4) of the Tax Code of 1997 or the term "royalties" as defined under Article XII of the tax treaty between the Philippines and Malaysia (RP-Malaysia tax treaty). DaAETS In BIR Ruling No. DA-076 dated February 8, 1999, it was held that fees payable under a Marketing Support Agreement to a nonresident foreign corporation which will render offshore services in connection with (a) Public and Promotional Affairs (b) Consultancy services on Treasury and Legal Matters; (c) Insurance; and (d) Travel, Accommodation and Carriage are not to be construed as royalties. In the same ruling, fees payable under Marketing and Business Development Agreement to a non-resident foreign corporation for services rendered to a domestic corporation were not construed as royalties. To be considered as royalties, there must be a transfer into the Philippines of technology, equipment or other property, where the payee has proprietary interest. In BIR Ruling 93-89, this Office held that, to constitute royalties, specifically, there must be transfer of scientific, technical, industrial or commercial knowledge or information. The Court of Tax Appeals also had the occasion to discuss the distinction between realties and service fees in the Philippine Refining Company, (PRC) vs. Commercial of Internal Revenue (CIR) ,CTA Case No. 2872 dated January 15, 1986 (Annex "D").In said case, PRC entered into an agreement with Unilever Limited of England (Limited) whereby the latter will provide the following services: a) Training; b) Research; c) Availability of Services and Advisory Departments Buying of Raw Materials; d) Trademarks; and e) Communication of Patents, Secret Patents, Secret Processes, etc. The CTA ruled that the legal and advisory fees (i.e.,services a, b and c above) are services fees and not royalties. The CTA expressed the opinion, that "To distinguish between compensation for service and royalty payments, one must inquire on whether the payee has proprietary interest in the property giving rise to the income .If the payee has none, then the payment is a compensation for personal services, if the payee has proprietary interest then the payment is royalty. An examination of the records satisfies us that far be it from a comedy of errors, "In all these undertakings, Unilever Ltd.,does not have any interest or right to whatever is the result of services performed." The results of all these services and the products manufactured by PRC to which there are integrated are owned by PRC. Unilever has no interest or right to them." (Emphasis ours) In case of Oakwood Asia, there is no transfer of technology but simply the rendition of services enumerated above where Oakwood Asia will have no interest or right to whatever is the result of the services. Accordingly, the Service Fees are not royalties but compensation for labor or personal services. In yet another BIR Ruling (DA-148 dated April 20, 1998), this Office confirmed that the fees due to Sony Asia, a non-resident foreign corporation, pursuant to a Services Agreement constitute compensation for labor and personal services rendered outside of the Philippines rather than royalties. Under the Services Agreement, Sony Asia is to render to Sony RP, a domestic corporation, services and assistance relative to the latter's production planning, procurement of raw materials, transportation, handling and labelling of products, management training programs, personnel policies, budget control and marketing strategies, which services shall be performed by Sony Asia in Hong Kong except for occasional visits or consultations with Sony RP of short duration. The services to be rendered by Oakwood Asia to Oakwood Phils. are akin to the services rendered by Sony Asia to Sony Phils. The ruling of the BIR in the case of Sony should apply on all fours to the present case of Oakwood. There being no transfer of technology, that Service Fees should not be construed as royalties but compensation for labor or personal services. 2. Whether the Service Fees payable to Oakwood Asia are exempt from Philippine income tax, hence Oakwood Phils. is not required to withhold income tax upon its remittance of such Service Fees. Pursuant to Section 28(B)(1) of the Tax Code of 1997, non-resident foreign corporation are subject to income tax only on income derived from all sources within the Philippines. Consequently, Oakwood Asia, being a non-resident foreign corporation is not subject to income tax on income derived from sources outside the Philippines. 3. Whether the service fees and reimbursement are not subject to value-added tax in view of the fact that the services herein being remunerated are performed outside of the Philippines and the reimbursements pertain to such services so rendered. Inasmuch as it has been the representation that the abovementioned services will be performed by Oakwood Asia in Malaysia or in some other jurisdiction outside the Philippines and from time to time, Oakwood Asia may have to send its personnel to the Philippines, for short periods which should not, in aggregate, exceed 183 days in any calendar year, the fees paid by Oakwood Phils. for services rendered in the Philippines are subject to the 10% value-added tax pursuant to Section 108 of the Tax Code of 1997. Accordingly, Oakwood Phils. being the payor in control of the payment shall be responsible for the withholding of VAT on such fees on behalf of Oakwood Asia by filing a separate VAT return for and on behalf of Oakwood Asia using BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld). The duly filed BIR Form 1600 and proof of payment thereof shall serve as sufficient basis for the claim of input tax to be applied against the output tax that may be due from Oakwood Phils., if it is a VAT-registered taxpayer. In case Oakwood Phils. is a non-VAT registered taxpayer, the passed-on VAT withheld shall form part of the cost of the service purchased or treated as expense, whichever is applicable. In addition, Oakwood Asia Phils. is required to issue the Certificate of Creditable Tax Withheld at Source (BIR Form 2307) in quadruplicate upon request of Oakwood Asia, the first three copies thereof to be given to Oakwood Asia and the fourth copy to be retained by Oakwood Phils. as its file copy. [ Sections 4 & 6, Revenue Regulation No. 4-2002 ] It will be noted that the Philippines has an existing treaty with Malaysia for the avoidance of double taxation. However, inasmuch as all the subject services will be performed by Oakwood Asia outside of the Philippines, as represented, the said RP-Malaysia tax treaty will have no application as the transaction does not give rise to a case of double taxation. Under the Tax Code of 1997, non-resident foreign corporations are taxable only for income derived in the Philippines. Relative thereto, compensation, for labor or personal services performed outside the Philippines are not income from sources within the Philippines. This ruling is issued on the basis of the foregoing 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 parties herein are concerned. Very truly yours, Commissioner of Internal Revenue By: (SGD.) MILAGROS V. REGALADO Assistant Commissioner Legal Service