ITAD Ruling No. 171-00

November 7, 2000 ITAD RULING NO. 171-00 Articles 5 & 7, RP-Malaysia Tax Treaty Section 22 (H) (1), NIRC of 1997 Agustin Chiong Agustin Suite 317, Third Floor, Calvo Building Escolta Street, Binondo Manila Attention: Atty . Ira Carlota Chiong Agustin Gentlemen : This refers to your letter dated April 17, 1999, requesting for a ruling regarding, and or behalf of your client, ISC Technology Sdn Bhd (hereinafter referred to as "ISC"). It is represented that ISC is a foreign corporation based in the Republic of Malaysia and is engaged in selling computer application which includes hardware, software and maintenance services; that it maintains a representative office in the Philippines and has been issued a License To Transact Business dated October 1, 1998 by the Securities and Exchange Commission under SEC License No. A199814939; that ISC plans to sell computer applications in the Philippines; and that such sale of computer application shall be in two parts, to wit: ISC will sell the hardware and software part while the maintenance service shall be performed by the representative office as allowed under the SEC license. Under the said License, the representative office is established for the purpose of conducting marketing research, post sales functions without earning income, information dissemination, promotion, and advertisements of the products of ISC. Based on the foregoing, you are now requesting for a ruling on the following queries: "1. What is the status of ISC Technology Sdn Bhd? Is it a resident or non-resident foreign corporation? "2. What is the status of representative office of ISC Technology Sdn Bhd? Is it liable for taxes even if no income shall be derived within the Philippines considering that all operational expenses shall be handled by the headquarter in Malaysia? CaDSHE "3. As to the income payment for ISC Technology Sdn Bhd-Malaysia for the hardware which shall be delivered and paid here in the country, how should it be treated? "4. If the representative office charges service fees for the maintenance services, how should the same fees be treated? "5. Can the provisions of the RP-Malaysia Tax Treaty apply to ISC Technology Sdn Bhd, especially on the elimination of double taxation (re query nos. 3 & 4 apply)?" In reply, please be informed as follows: 1. Under Section 79 of the National Internal Revenue Code of 1997: "xxx xxx xxx (H) The term 'resident foreign corporation' applies to foreign corporation engaged in trade or business within the Philippines. (I) The term 'nonresident foreign corporation' applies to a foreign corporation not engaged in trade of business within the Philippines. cTIESa xxx xxx xxx" There is no criterion as to what constitutes "doing" or "engaging in" or "transacting" business. Each case must be judged in the light of its peculiar circumstances. The term implies continuity of commercial dealings and arrangements, and contemplates to that extent, the performance of acts or works or the exercise of some of the functions normally incident to, and in progressive prosecution of, commercial gain or for the purpose and object of the business organization. In order that a foreign corporation may be regarded as doing business within the State, there must be continuity of conduct and intention to establish a continuous business, such as the appointment of a local agent, and not one of a temporary character. ( Commissioner of Internal Revenue v . British Overseas Airways Corporation and Court of Tax Appeals Nos . L-65773-74, April 30, 1987, 149 SCRA 395 ) A casual business activity in the Philippines by a foreign corporation does not amount to engaging in trade or business in the Philippines for income tax purposes. (N.V. Reederij "Amsterdam" and Royal Interocean Lines v. Commissioner of Internal Revenue, No. L-46029, June 23, 1988, 162 SCRA 487) Thus, since the intention of ISC is to sell computer applications here in the Philippines, ISC is to be regarded as a resident foreign corporation once it commences such activity. Until such commencement, ISC remains a nonresident foreign corporation. 2. The representative office of ISC is deemed a resident foreign corporation. Under the License, said representative office is tasked to perform certain activities the exercise of which are normally incident to, and are in progressive pursuit of, the purpose and object of ISC. Hence, such representative office is considered doing or engaged in trade or business within the Philippines. The representative office, therefore, is subject to income tax as a resident foreign corporation on its income from sources within the Philippines. 3. The income payment to ISC from the sale of its hardware, which shall be delivered and paid in the Philippines, should be treated as income from sources within the Philippines as this is a sale of personal property pursuant to Section 42 (A)(6) of the Tax Code of 1997. The tax base will depend on whether ISC is deemed a resident foreign corporation or a nonresident foreign corporation, as defined above. If ISC qualities as a resident foreign corporation, it shall pay a tax equal to 33% of the taxable income derived for taxable year 1999 from all sources within the Philippines, and effective January 1, 2000 and thereafter, the tax rate shall be 32%. On the other hand, if it is considered as a nonresident foreign corporation, ISC shall be subject to the same rates but based on the gross income received from all sources within the Philippines. However, Article 5 of the RP-Malaysia Tax Treaty provides: "Article 5 PERMANENT ESTABLISHMENT 1. For the purpose of this Agreement the term 'permanent establishment' means a fixed place of business in which the business of the enterprise is wholly or partly carried on. 2. The term 'permanent establishment' shall include especially: (a) a place of management; DSEIcT (b) a branch; (c) an office; xxx xxx xxx" Further, Article 7 of the same Treaty provides: "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 on so much thereof as is attributable to that permanent establishment. 2. Subject to the provisions of paragraph 3, where an enterprise of a Contracting State carries on business in the other Contracting State through a permanent establishment situated therein, there shall in each Contracting State be attributed to that permanent establishment the profits which it might be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which is a permanent establishment. CHcESa 3. In determining the profits of a permanent establishment, there shall be allowed as deductions all expenses including executive and general administrative expenses, which would be deductible if the permanent establishment were an independent enterprise, insofar as they are reasonably allocable to the permanent establishment, whether incurred in the State in which the permanent establishment is situated or elsewhere." In view of the foregoing, ISC is deemed to have a permanent establishment in the Philippines. Such being the case, the income which are or may be derived by ISC may be taxed in the Philippines but only so much thereof as is attributable to the representative office. 4. The fees should be treated as gross income from sources within the Philippines, as these are compensation for labor or personal services performed in the Philippines, pursuant to Section 42 (A)(3) of the Tax Code of 1997. Thus, the representative office, being a resident foreign corporation, is subject to income tax equivalent to 33% of its taxable income derived for taxable year 1999 from all sources within the Philippines, and effective January 1, 2000 and thereafter, the tax rate shall be 32%, pursuant to the Tax Code of 1997 and the RP-Malaysia Tax Treaty. In addition to income tax, such representative office is also subject to the value-added tax (VAT) of 10% if it is a VAT-registered enterprise, otherwise it is subject to the percentage tax of 3%. 5. The RP-Malaysia Tax Treaty is applicable (Please refer to nos. 3 & 4 above.) Please be guided accordingly. Very truly yours, (SGD.) DAKILA B. FONACIER Commissioner of Internal Revenue