ITAD Ruling No. 170-02

October 2, 2002 ITAD RULING NO. 170-02 Articles 5 & 8, RP-US tax treaty Sections 27 & 108, NIRC of 1997 BIR Ruling No. ITAD-182-00 Punongbayan & Araullo Ernst and Young International 20th Floor, Tower 1 The Enterprise Center 6766 Ayala Avenue, 1200 Makati City Attention: Marivic C. Espao Tax Partner Gentlemen : This refers to your application for relief from double taxation dated December 6, 2001, on behalf of your clients, Intel Philippines Manufacturing, Inc. (IPMI) and Intel Technology Phils. Inc. (ITPI), requesting confirmation of your opinion that: 1) any business profits to be derived by Intel Corporation (IC) and Intel Semiconductor Limited (ISL), from the proposed sales structure hereunder described, are not taxable due to the absence of a permanent establishment in accordance with the provisions of the RP-US tax treaty; 2) the sale, respectively, of goods by IC to ISL and by ISL to enterprises located in special economic zones are exempt from VAT; 3) the net income derived by IPMI and ITPI from picking, packing and shipping services to be provided to ISL will be subject to the normal corporate income tax at 32% tax rate; and 4) the sale of these services by IPMI and ITPI are zero-rated for VAT purposes. It is represented that IC is a non-resident foreign corporation duly organized and existing under the laws of the United States of America (USA); that IC was licensed to establish its regional or area headquarters (RHQ) in the Philippines per Certificate of Registration and License dated January 23, 1978 issued by the Securities and Exchange Commission (SEC); that the activities of the RHQ shall be limited to acting as supervision, communications and coordination center for its affiliates, subsidiaries or branches in the Asia-Pacific Region; that IC decided not to operate the RHQ and as such, it has not performed any business activity; that IC consigns goods to IPMI and ITPI for assembly and test processing; that IPMI and ITPI are domestic corporations registered with the Philippine Securities and Exchange Commission; that for incentives purposes, IPMI is registered with the Board of Investments, while ITPI is registered with the Philippine Economic Zone Authority, to engage in the assemble/test of microprocessor electronic integrated circuits (PENTIUM); that IPMI and ITPI are value-added taxpayers per Certificate of Registration issued by Revenue District Offices 48 and 54, respectively; that under each of the separate service agreements of IC with ITPI and IPMI. IC retains ownership over the raw materials consigned to IPMI and ITPI; that IPMI and ITPI do not have the power to contractually bind IC in any manner; that all decisions and strategies relating to the sale of the finished goods remain with IC; that for the assembly and testing of goods, IC pays IPMI and ITPI the agreed service fees; that after the consigned goods have been assembled and tested by IPMI and ITPI, IC sells these goods to its foreign affiliates, which the latter subsequently sell to third-party customers; that the compensation to be paid by IC to ITPI and IPMI for assembly and testing services is set at arm's length; that one of the affiliates to which IC sells the goods assembled and tested by ITPI and IPMI is ISL, a non-resident foreign corporation duly organized and existing under the laws of the USA; that ISL is not registered either as a corporation or as a partnership and has not been licensed to do business in the Philippines per certificate dated March 5, 2002 issued by the Securities and Exchange Commission; that for goods intended to be sold to customers in the Philippines, ISL requires IC to export the goods to affiliates either in Hongkong or Singapore for warehousing; that ISL then instructs these affiliates to deliver back the goods to customers in the Philippines; that ISL finds this current practice to be not cost-efficient for the customers who ultimately bear, as part of the purchase price, the unnecessary expenses arising from the movement of goods from and to the Philippines; that ISL is considering modifying the process by having the goods it purchased from IC delivered directly to PEZA-registered customers located in the Philippines; that for this purpose, ISL plans to contract IPMI and ITPI to handle the picking, packing and shipping of the goods, for which both companies will be compensated by ISL at cost plus 10% mark-up; that the service fees to be paid to IPMI and ITPI shall be in acceptable foreign currency and accounted for in accordance with the rules and regulations of the Bangko Sentral ng Pilipinas; that under this scheme, ITPI and IPMI are not dependent agents of ISL since they do not have the power to contractually bind ISL in any manner so much so that the Philippine customers will transact directly with ISL and will have no legal recourse against either IPMI or ITPI; that from the viewpoint of third-party customers, payments for the goods shall be made directly to ISL since they consider the same as importations; that under the proposed arrangement, ISL will not maintain a fixed place of business in the Philippines nor send employees or other personnel in the Philippines for a period aggregating more than 183 days; that ISL retains ownership over the goods acquired from IC until they are sold to customers; that the goods will stay with IPMI and ITPI for a brief period of time enough for them to be packed and shipped to the customers; that thereafter, the goods are immediately sent to designated delivery points by ISL; that upon advice that the goods have been assembled and tested by ITPI and IPMI, ISL sends purchase instructions to IC and in the same instance, ISL directs ITPI and IPMI to pick, pack and deliver the finished goods to ready customers in the Philippines (located in ECOZONES) and in other countries in the Asia Pacific region; and that ISL does not keep an inventory of goods in the Philippines. It is further represented that, presently, the exportation of the consigned goods to Hongkong and Singapore by IPMI and ITPI and their delivery back to the Philippines entail expenses for shipment, brokerage, insurance and other incidental charges; that all these expenses are ultimately imputed in the price charged by ISL on the goods sold to the customers located in special economic zones in the Philippines, most of which are exporters of semi-conductor products; that with higher costs of parts for production, the ability of these ecozone enterprises to offer their products in the international market at competitive rates is hampered; that recognizing the inefficiency in this set-up, ISL is considering modifying the current manner of delivering the goods to these customers; that rather than exporting them first out of the Philippines and having them imported back by these customers, the proposal is to arrange for their direct delivery from IPMI and ITPI to these customers; that while ISL may still pass on to the customers the cost of picking, packing and shipping services of IPMI and ITPI, these costs are expected to be lower than the expenses arising from the existing arrangement. In reply, please be informed of the following: Whether the business profits to be derived by IC and ISL from the proposed sales structure, as above described, are not taxable in the Philippines due to absence of a permanent establishment in accordance with the provisions of the RP-US tax treaty. Article 8 of the RP-US tax treaty provides as follows, viz : "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. "(2) Where a resident of one of the Contracting States has a permanent establishment in the other Contracting State, there shall in each Contracting State be attributed to the permanent establishment the business profits which would reasonably be expected to have been derived by it if it were an independent entity engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the resident of which it is a permanent establishment. "(3) There may also be attributed to that permanent establishment the business profits derived from the sale of goods or merchandise of the same or similar kind as those sold, or from other business activities of the same or similar kind as those effected, through that permanent establishment if the sale or activities had been resorted to in order to avoid taxation. "xxx xxx xxx." Article 5 of the same tax treaty provides as follows, viz : "Article 5 "PERMANENT ESTABLISHMENT "(1) For the purpose of this Convention, the term 'permanent establishment' means a fixed place of business through which a resident of one of the Contracting State engages in a trade or business." "(2) The term 'fixed place of business' includes but is not limited to: (a) A seat of management; (b) A branch; (c) An office; (d) A store or other sales outlet; (e) A factory; (f) A workshop; (g) A warehouse; (h) A mine, quarry, or other place of extraction of natural resources; (i) A building site or construction or assembly project or supervisory activities in connection therewith, provided such site, project or activity continues for a period of more than 183 days; and (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 connected project) within the other Contracting State for a period or periods aggregating more than 183 days. "xxx xxx xxx "(4) A person acting in one of the Contracting States on behalf of a resident of the other Contracting State, other than an agent of an independent status to whom paragraph (5) applies, shall be deemed to give rise to a permanent establishment in the first-mentioned Contracting State if (a) Such person has, and habitually exercises in the first-mentioned Contracting State, an authority to conclude contracts in the name of that resident, unless the exercise of such authority is limited to the purchase of goods or merchandise for that resident; or (b) He has no such authority, but habitually maintains in the first-mentioned State a stock of goods or merchandise from which he regularly delivers goods and merchandise on behalf of the resident. DaTISc "(5) A resident of one of the Contracting States shall not be deemed to have a permanent establishment in the other Contracting State merely because such resident carries on business in that other Contracting State through a broker, general commission agent, or any other agent of an independent status, where such broker or agent is acting in the ordinary course of his business. However, when the activities of such an agent are devoted wholly or almost wholly on behalf of that resident, he shall not be considered an agent of independent status within the meaning of this paragraph if the transactions between the agent and the resident were not made under arm's length conditions. "xxx xxx xxx." Based on the above-quoted provisions, the income of IC and ISL shall be taxable in the Philippines only if they have a permanent establishment situated in the Philippines. As a rule, in order that a permanent establishment may be deemed to exist, a resident of one Contracting State much conduct business through a fixed place of business situated in the other Contracting State. Paragraph 2 of Article 5 of the RP-US tax treaty enumerates certain examples of a permanent establishment, while paragraph 3 enumerates what are excluded therefrom. Paragraph 2 contains a list, by no means exhaustive, of examples, each of which constitutes a permanent establishment. As these examples are to be seen against the background of the general definition given in paragraph 1, it is assumed that the Contracting States ( i.e. , the Philippines and the United States of America) interpret the terms listed in such a way that such places of business constitute permanent establishments only if they meet the requirements or conditions of paragraph 1, to wit: (1) the existence of a "place of business," i.e., a facility such as premises; (2) this place of business must be "fixed," i.e. , it must be established at a distinct place with a certain degree of permanence; (3) the carrying on of the business of the enterprise through this fixed place of business. 1 IC is not considered as having a permanent establishment in the Philippines because the requirements or conditions of paragraph 1 of Article 5 of the RP-US tax treaty as above-stated are not present and IC's situation does not fall under subparagraph (j) of paragraph 2 of the same Article. Accordingly, the income of IC under the proposed sale structure as above described, shall not be subject to income tax in the Philippines, pursuant to Article 8 in relation to Article 5 of the RP-US tax treaty. As regards ISL, the latter is also not considered as having a permanent establishment situated in the Philippines because the requirements or conditions of paragraph 1 of Article 5 of the RP-US tax treaty as above-stated are not present and ISL's situation does not fall under subparagraph (j) of paragraph 2 of the same Article. IPMI and ITPI will not be considered permanent establishments of ISL under paragraph 4 because they do not have the authority to conclude contracts with customers in the name or on behalf of ISL. Neither IPMI nor ITPI, both in the Philippines, habitually maintain a stock of goods or merchandise from which either IPMI or ITPI may regularly deliver goods or merchandise on behalf of ISL, a circumstance that would otherwise constitute IPMI and ITPI as a permanent establishment of ISL, pursuant to paragraph 4(b) of Article 5 of the RP-US tax treaty. (BIR Ruling No. ITAD-182-00 dated December 6, 2000) For purposes of paragraph 5 of the same Article 5 which applies only to independent agents, IPMI and ITPI cannot be considered permanent establishments thereunder because they are neither brokers nor agents of ISL, as the services to be performed by IPMI and ITPI are limited only to picking, packing and shipping, on behalf of ISL. Thus, the income of ISL under the proposed sale structure shall not be subject to income tax in the Philippines, pursuant to Article 8 in relation to Article 5 of the RP-US tax treaty. Whether the sale of goods by IC to ISL and ISL to enterprises located in special economic zones is exempt from VAT The Philippines' Value-Added Tax (VAT) law adheres to the rule that no VAT shall form part of the cost component of products which are destined for consumption outside of the territorial border of the Philippines. Hence, actual export of goods and services from the Philippines to a foreign country must be free from the imposition of VAT. Conversely, those destined for use or consumption within the Philippines shall be subject to the ten percent (10%) VAT. Thus, although Section 105 of the Tax Code of 1997 subjects to VAT any person who, in the course of trade or business, sells, barters, exchanges, leases goods or properties, such person may not be subject to the payment thereof if the said goods or properties are destined for consumption outside the territorial borders of the Philippines. In view thereof, and since the goods to be sold by IC to ISL, who are both non-residents, will ultimately be sold to PEZA-registered enterprises located in ECOZONES, whose sales are destined for export to foreign countries, the sale of IC to ISL and the sales by ISL to PEZA-registered enterprises, under the said proposed sale structure, shall be exempt from VAT. If, however, ISL sells the goods to customers located in the customs territory, i.e. , outside the ECOZONES, the same is subject to VAT. It is the understanding of this Office, as you have represented, that there is no immediate plan for ISL to sell the goods to customers located in the customs territory. Once there is a definite plan to do so, the parties concerned are hereby advised to secure another ruling on the tax treatment of such arrangement, and the administrative requirements imposed on such requirements, in order to ensure compliance with the requirements of the Tax Code of 1997 and the payment of the correct taxes thereon. Whether the net income derived by IPMI and ITPI from picking, packing and shipping services to be provided to ISL will be subject to the normal corporate income tax at 32% tax rate Section 27 of the Tax Code of 1997 provides as follows, viz : "SEC. 27. Rates of Income Tax on Domestic Corporations . "(A) In General. Except as otherwise provided in this Code, an income tax of thirty-five percent (35%) is hereby imposed upon the taxable income derived during each taxable year from all sources within and without the Philippines by every corporation, as defined in Section 22(B) of this Code and taxable under this Title as a corporation, organized in, or existing under the laws of the Philippines; 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%) xxx xxx xxx "(E) Minimum Corporate Income Tax on Domestic Corporations. "(1) Imposition of Tax. A minimum corporate income tax of two percent (2%) of the gross income as of the end of the taxable year, as defined herein, is hereby imposed on a corporation taxable under this Title, beginning on the fourth taxable year immediately following the year in which such corporation commenced its operations, when the minimum income tax is greater than the tax computed under Subsection (A) of this Section for the taxable year. "xxx xxx xxx." In view of the foregoing provisions, IPMI and ITPI shall pay the Minimum Corporation Income Tax (MCIT) whenever it is greater than the regular or normal corporate income tax. Thus, the corporate income tax to be paid by IPMI and ITPI shall be either the two percent (2%) of their respective gross income, as defined by the Tax Code of 1997, or the thirty two (32%) of their respective taxable income, whichever is higher. The comparison between the normal income tax payable by the corporation and the MCIT shall be made at the end of the taxable year. The foregoing rule applies as regards ITPI, notwithstanding its PEZA registration which would normally result in the imposition of five percent (5%) tax on its gross income from its registered activities under the PEZA law, since the PEZA registration of ITPI pertains only in engaging in the assembly and testing of microprocessor electronic integrated circuits (PENTIUM) and does not cover income derived from picking, packing and shipping services. Whether the sale of the above services by IPMI and ITPI rendered for IC and ISL are zero-rated for VAT purposes, pursuant to Section 108(B)(2) of the Tax Code of 1997 Section 108 of the Tax Code of 1997 provides as follows, viz : "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 "(B) Transactions Subject to Zero Percent (0%) Rate. The following services performed in the Philippines by VAT-registered persons shall be subject to zero percent (0%) rate: "(1) Processing, manufacturing or repacking goods for other persons doing business outside the Philippines which goods are subsequently exported, where the services are paid for in acceptable foreign currency and accounted for in accordance with the rules and regulations of the Bangko Sentral ng Pilipinas (BSP); "(2) Services other than those mentioned in the preceding paragraph, the consideration for which is paid for in acceptable foreign currency and accounted for in accordance with the rules and regulations of the Bangko Sentral ng Pilipinas (BSP); 'xxx xxx xxx." In view of the foregoing provisions, services rendered by a VAT-registered person shall be subject to zero percent (0%) VAT rate if: (a) pursuant to Section 108(B)(1) of the Tax Code of 1997, (1) the services rendered by the VAT-registered person are the processing, manufacturing or repacking of goods, (2) such goods are subsequently exported, (3) such services are performed for other persons doing business outside the Philippines, and (4) such services are paid for in acceptable foreign currency and accounted for in accordance with the rules and regulations of the BSP; or (b) pursuant to Section 108(B)(2) of the same Code, (1) the services rendered by the VAT-registered person are other than the processing, manufacturing, or repacking of goods, and (2) such services are paid for in acceptable foreign currency and accounted for in accordance with the rules and regulations of the BSP. The services to be rendered by IPMI and ITPI fall under the above-mentioned provisions of the Tax Code of 1997. It must be stressed that although some of the goods are sold to Philippine residents located in ECOZONES, the same are deemed "subsequently exported" since products manufactured or produced within the ECOZONES are destined for export to other countries. In view thereof, the supply of the above services ( i.e., picking, packing and shipping for and on behalf of ISL) by IPMI and ITPI are zero-rated for VAT purposes. This ruling is issued on the basis of the foregoing facts as represented. However, if upon investigation it shall be disclosed or discovered that the facts are different, then this ruling shall be without force and effect insofar as the parties herein are concerned. Very truly yours, (SGD.) EDMUNDO P. GUEVARA Deputy Commissioner Legal and Inspection Group Footnotes 1. Paragraphs 12 & 2, Commentary on Article 5 (Permanent Establishment), Model Tax Convention On Income and Capital, June 1998, Condensed Version OECD 1998.