ITAD Ruling No. 152-04

December 20, 2004 ITAD RULING NO. 152-04 Philippines-United States Tax Treaty Articles 5, 8 and 16; Tax Code of 1997 Sections 28 (B) (1), 42 (A) (3) and 108 BIR Ruling No. DA-ITAD-38-03 BIR Ruling No. DA-ITAD-96-02 BIR Ruling No. DA-ITAD-38-02 Bernaldo Mirador Law Offices Unit 1807 Cityland Condominium 10-Tower 1 6815 Ayala Avenue corner H.V. Dela Costa Sts. Makati City Attention: Atty. Rosario S. Bernaldo Managing Partner Gentlemen : This refers to your letter dated May 6, 2004, on behalf of your client, Technology Exports Services Corporation (TESCO), requesting confirmation of the following: (1) the consultancy fees paid by TESCO to TNG Enterprises, Inc. (TNG) for consultancy services under the Consultancy Agreement are considered as compensation for services rendered outside the Philippines pursuant to Section 42(C)(3) of the National Internal Revenue Code of 1997 (Tax Code), hence, not subject to income tax pursuant to Section 28(B)(1) of the Tax Code, and consequently to expanded withholding tax; (2) the consultancy fees paid by TESCO to TNG for services performed by the latter are ordinary and necessary business expense of TESCO which are allowed as a deduction from its gross income pursuant to Section 34(A)(1) of the Tax Code; and (3) the consultancy fees received by TNG from TESCO for services rendered abroad are not subject to ten percent (10%) value-added tax (VAT) pursuant to Section 108 of the Tax Code. It is represented that TNG is a nonresident foreign corporation duly organized and existing under the laws of the United States of America, with principal address at 10018 Sagegate, Houston, Texas; that TNG is not registered either as a corporation or as a partnership licensed to do business in the Philippines per certification issued by Securities and Exchange Commission dated June 3, 2004; that TESCO is a corporation duly organized and existing under the laws of the Philippines with principal office at RMT Industrial Complex, Tunasan, Muntinlupa City; that TESCO is engaged in the business of providing geothermal energy services; that on December 15, 2003, TESCO and TNG entered into an Equipment Lease Contract, whereby TNG, being the absolute owner of a Smith Geothermal Well Repair Unit, Geopak Valve Change Unit and Post Weld Heat Treat Equipment (Equipment), leases said Equipment to TESCO; that said Lease Contract shall be valid and binding from January 2004 to December 2004; that pursuant to said Contract, TESCO shall use the Equipment in a careful and proper manner subject to the approval of TNG and provided that the TNG appointed consultant is present; that on December 15, 2004, TESCO and TNG likewise entered into a Consultancy Agreement whereby TNG, representing and warranting to have technical expertise and know-how in providing consultancy services related to geothermal energy works, covenants to provide consultancy services to operate and supervise the use of its leased equipment to TESCO; that in consideration for the above consultancy services, TESCO shall pay TNG consultancy fee on a per project basis, payable in US dollars subject to the rules and regulations of the Bangko Sentral ng Pilipinas on remittance of foreign exchange; and that the lease on the Equipment shall be based on its actual use as may be agreed upon by the parties which shall be invoiced in US Dollars. In reply, please be informed as follows: 1) Whether the consultancy fees paid by TESCO to TNG under the Consultancy Agreement are considered as compensation for services rendered outside the Philippines . ECDaTI Sections 28(B)(1), 42(A)(3), and 42(C)(3) of the Tax Code provides, viz : "SEC. 28. Rates of Income Tax on Foreign Corporations . xxx xxx xxx "(B) Tax on Nonresident Foreign Corporations. "(I) 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 interests, 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); 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%)." "SEC. 42. Income from Sources Within the Philippines . "(A) Gross Income From Sources Within the Philippines. xxx xxx xxx "(3) Services. Compensation for labor or personal services performed in the Philippines; xxx xxx xxx "(C) Gross Income from Sources Without the Philippines. xxx xxx xxx "(3) Compensation for labor or personal services performed without the Philippines; Based on the foregoing, a nonresident foreign corporation, in general, shall be subject to income tax at the rate of thirty-two percent (32%) only when its income is derived from sources within the Philippines. Thus, when the income is derived from sources without the Philippines (e.g., compensation for labor or personal services performed without the Philippines), the same shall not be subject to the income tax rate. In connection, Article 8 and, in relation thereto, Article 5 of the Philippines-United States tax treaty respectively states that: "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." "Article 5 "PERMANENT ESTABLISHMENT "1. For the purposes of this Convention, the term 'permanent establishment' means a fixed pace of business through which a resident of one of the Contracting States engages in a trade or business. "2. The term 'fixed place of business' includes but is not limited to: "xxx xxx xxx "j) The furnishing of services, including consultancy services, by a resident of one of the Contracting States through employees or other personnel, provided activities of that nature continue (for the same or a connected project) within the other Contracting State for a period or periods aggregating more than 183 days ." (Emphasis supplied) It is clear from the above-quoted provisions that if a corporation which is a resident of United States does not carry on business in the Philippines through a permanent establishment situated therein, the profits of that corporation shall not be subject to Philippine income tax. For this purpose, a corporation which is a resident of United States may be deemed to have a permanent establishment in the Philippines if, among others, the furnishing of services through its employees continue (for the same or a connected project) within the Philippines for a period or periods aggregating more than 183 days. It is worthy to note that under the scope of services of the said Consultancy Agreement, TNG agreed to provide consultancy services " to operate and supervise the use of TNG leased equipment ". Since under the Lease Contract, TESCO may use the leased equipment only when " the TNG appointed consultant is presen t," it may be inferred that the presence of TNG's consultant in the Philippines for the entire duration of the said contracts is very much necessary to operate the leased equipment. Thus, the said services rendered by TNG (through its employees) for TESCO would constitute a permanent establishment of TNG in the Philippines inasmuch as these services will be furnished in the Philippines for a period exceeding 183 days within the twelve-month period considering that the term of the Lease Contract is one year, based on the provisions of the related Consultancy Agreement. Such being the case and since the services are performed within the Philippines, the business profits/income attributable to the rendering of subject services will be subject to Philippine income tax, and consequently to withholding tax, pursuant to Article 8 and 5 of the Philippines-United States tax treaty in relation to Section 28(B)(1) and Section 42(A)(3) of the Tax Code. (BIR Ruling No. DA-ITAD-38-03 dated February 21, 2003) Moreover, Article 16 of the same treaty provides: "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. "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 Based on the above provision, remuneration derived by an individual who is a resident of the United States is not taxable in the Philippines if all three conditions are met: a) his presence in the Philippines is merely for less than 90 days in a year , b) he is an employee of a company which is a resident of the United States; and c) his remuneration or income is not borne by a permanent establishment which his employer has in the Philippines. The documents submitted (i.e., Lease Contract and Consultancy Agreement between TESCO and TNG) show that TNG consultant/s will be staying in the Philippines for a period exceeding 90 days. This considering, said consultant/s shall be treated as nonresident alien doing business in the Philippines pursuant to Section 25(A)(1) of the Tax Code. As such, they shall be subject to the graduated tax rate of 5% to 32%, in the same manner as an individual Filipino citizen, pursuant to Section 24(A)(l)(c) of the Tax Code. Accordingly, their remuneration derived within the Philippines shall be subject to creditable withholding tax on compensation income pursuant to Section 57 of the Tax Code as implemented by Revenue Regulations No. 2-98 as amended, specifically Section 2.78 thereof. (BIR Ruling No. DA-ITAD-96-02 dated May 21, 2002) 2) Whether the consultancy fees paid by TESCO to TNG for services performed by TNG are ordinary and necessary business expense of TESCO which are allowed as a deduction from its gross income pursuant to Section 34(A)(1) of the Tax Code . DAaIHT As regards your opinion that the consultancy fees paid by TESCO to TNG qualify as deductible expense under Section 34(A)(1)of the Tax Code, please be informed that we decline to rule on the matter considering the factual nature of the issue raised. (BIR Ruling No. DA-ITAD-38-02 dated March 14, 2002) 3) Whether the consultancy fees received by TNG from TESCO for services rendered abroad are not subject to ten (10%) percent value-added tax (VAT) pursuant to Section 108 of the Tax Code . Section 108(A) of the Tax Code provides, as follows: 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. DIEAHc "The phrase ` sale or exchange of services ' means the performance of all kinds of services in the Philippines for others for a fee, remuneration or consideration, . . . " (Emphasis supplied) Thus, the payment for the lease of equipment and the services rendered by TNG in the Philippines are subject to the 10% VAT pursuant to Section 108 of the Tax Code. Accordingly, TESCO being the resident withholding agent and the payor in control of the payment shall be responsible for the withholding of 10% VAT on such fees before making any payment to TNG. In remitting the VAT withheld, TESCO shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld). The duly filed BIR Form No. 1600 and proof of payment thereof shall serve as documentary substantiation for the claim of input tax by TESCO upon filing its own VAT return, if it is a VAT-registered taxpayer. In case TESCO is a non-VAT registered taxpayer, the passed on VAT withheld shall form part of the cost of the service purchased which may be treated as "expense" or "asset" whichever is applicable. In addition, TESCO is required to issue the Certificate of Final Tax Withheld at Source (BIR Form No. 2306) in quadruplicate upon request of TNG, the first three copies thereof to be given to TNG and the fourth copy to be retained by TESCO as its file copy. [Section 4&6, Revenue Regulations (RR) No. 4-2002; Section 3, RR No. 8-2002; Section 7, RR No. 14-2002] Very truly yours, Commissioner of Internal Revenue By: (SGD.) MILAGROS V. REGALADO Assistant Commissioner Legal Service