ITAD Ruling No. 174-03

November 20, 2003 ITAD RULING NO. 174-03 Articles 5.7.12 of the RP-Singapore Tax Treaty BIR Ruling No. DA-ITAD 39-03 Punongbayan & Araullo 20th Floor Tower I, The Enterprise Center 6766 Ayala Avenue, 1200 Makati City Attention: Romeo H . Duran Tax Principal Gentlemen : This refers to your letter dated September 29, 2003, on behalf of your client, AZURE TECHNOLOGIES PHILIPPINES, INC. (Azure Phils.), requesting confirmation of your opinion that the service fees paid by Azure Phils. to VANDA SYSTEMS (Singapore) PTE. LTD. (Vanda Systems) are not subject to Philippine income tax pursuant to the RP-Singapore tax treaty. It is represented that Vanda Systems is a non-resident foreign corporation duly organized and existing under the laws of Singapore with office address at 50 Kallang Avenue 09-02 Noel Corporate Bldg., Singapore 339505; that it is not registered either as a corporation or as a partnership and has not been licensed to do business in the Philippines per certification dated September 24, 2003 issued by the Securities and Exchange Commission (SEC); that Azure Phils. is a domestic corporation duly organized and existing under the laws of the Philippines with office address at 12/F Liberty Center 104 H.V. de la Costa cor. San Agustin Sts., Salcedo Village, Makati City; that it is primarily engaged in the wholesale business of distributing products of IBM to sub-distributors and providing support services for said products; that on January 31, 2002, Azure Phils. entered into an agreement designated as "Agreement for Service Fees Chargeable by Vanda Systems (Singapore) Pte. Ltd. to Azure Technologies Philippines Inc." with Vanda Systems, whereby the latter shall provide the following services to Azure Phils., to wit: (1) Review of weekly cashflow, AR aging analysis, Stock aging analysis, fortnightly management reports and monthly financial package; (2) Consolidation of monthly financials; (3) Quarterly performance review; (4) Co-ordination of bi-annual internal audit; (5) Consolidation and review of bi-annual HK reporting package; (6) Annual budget and audit review; (7) Consolidation and annual review of Singapore Reporting and HK Reporting package; (8) Arrangement of IBM credit facilities; (9) Arrangement for banking facilities, corporate guarantee and co-ordination with corporate secretarial relating to the execution of board and shareholders' resolution and any other costs associated with such arrangement; (10) Printing of Vanda Group annual reports; (11) Marketing efforts including printing of corporate flyers, brochures, advertising and maintenance of Vanda Group's website; (12) Any other ad-hoc requests as and when required; that the above-mentioned services will be performed by Vanda Systems in Singapore; that nothing in the Agreement would require the transfer of technology, equipment, or other property, where the payee has proprietary interest, or would otherwise permit Vanda Systems to impart to Azure Phils. its special knowledge and experience which remain unrevealed to the public; that in consideration for the services performed by Vanda Systems, Azure Phils. shall pay an annual service charge of S$144,000 (S$12,000 per month); that the Agreement shall take effect from April 1, 2002 and will be subject to review annually. In reply, please be informed of this Office's ruling on the following issues as follows: 1. The service fees are not in the nature of royalties . Article 12(3) of the RP-Singapore tax treaty provides that: "Article 12 Royalties xxx xxx xxx 3. The term 'royalties' as used in this Article means payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work, including cinematographic films or tapes for television or broadcasting, any patent, trade mark, design or model, plan, secret formula or process, or for the use of, or the right to use, industrial, commercial or scientific equipment, or for information concerning industrial, commercial or scientific experience. xxx xxx xxx" The above tax treaty defines " royalties " to include "payments of any kind received as a consideration for information concerning industrial, commercial or scientific experience ." According to the commentaries of the ORGANISATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT (OECD) Committee on Fiscal Affairs on the Model Tax Convention [par. 11, Commentary on Article 12 (royalties), 1998, p. 151), such information alludes to the concept of "know-how" . The definition of know-how, which has been adopted by the said Committee, is "all the undivulged technical information, whether capable of being patented or not, that is necessary for the industrial reproduction of a product or process, directly and under the same conditions; inasmuch as it is derived from experience, know-how represents what a manufacturer cannot know from mere examination of the product and mere knowledge of the progress of technique." In the know-how contract, one of the parties agree to impart to the other, so that he can use them for his own account, his special knowledge and experience which remain unrevealed to the public. (BIR Ruling DA-ITAD No . 49-02 dated April 15, 2002) Furthermore, in the case of Philippine Refining Company (PRC) vs . CIR, CTA Case No . 2872 dated January 15, 1986 , the Court of Tax Appeals had an occasion to rule on the distinction of service fees from royalties, to wit: "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." Applying the above discussions to the case at hand, it is clear in the Service Agreement that the service fees are not within the definition of "royalties" under Article 12 of RP-Singapore tax treaty. Inasmuch as Vanda Systems shall render these services using only their customary skills, then the compensation to be received therefor shall not constitute as consideration for the use of, or the right to use, any copyright, patent, trademark, design or model, plan, secret formula or process, or for the transfer of technology. Thus, the service fees paid to Vanda Systems shall not be considered as royalties but shall constitute as business profits derived from sources outside the Philippines. 2. The service fees are business profits not subject to Philippine taxation . Since the services enumerated under the Services Agreement are performed by Vanda Systems in Singapore, the service fees paid by Azure Phils. to Vanda Systems are considered income from sources outside the Philippines pursuant to Section 43(C)(3) of the Tax Code of 1997. Accordingly, the service fees are not subject to Philippine income tax since foreign corporations are taxable only on their income from Philippine sources. Consequently, since the service fees are not subject to Philippine income tax, the same are likewise not subject to withholding tax under Section 28(B)(1) of the said Code. ISCDEA However, Article 5 of the RP-Singapore tax treaty provides: "Article 5 PERMANENT ESTABLISHMENT 1. For the purposes of this Convention, 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' includes specially 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, in relation to a person providing storage facilities for others; h) A mine, quarry, or other place of extraction of natural resources; e) A building site or construction or assembly project or installation project or supervisory activities in connection therewith, provided such site, project or activity continues for a period more than 183 days; and f) 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. xxx xxx xxx" In relation thereto, Article 7 of RP-Singapore tax treaty also 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 or has carried on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is attributable to that permanent establishment. xxx xxx xxx" Based on the aforequoted provisions, a corporation which is a resident of Singapore may be deemed to have a permanent establishment in the Philippines when, among others, the furnishing of services in the Philippines by that corporation, through its employees or other personnel, continue (for the same or connected project) for a period or periods aggregating more than 183 days. Considering that the services will be performed by Vanda Systems outside the Philippines, that is, in Singapore, and that, in case it would be necessary for Vanda Systems personnel to conduct occasional visits in the Philippines, these shall be of short duration and shall in no case exceed an aggregate of 183 days during the period of the Service Agreement, Vanda Systems is not deemed to have a permanent establishment in the Philippines. Hence, the service payments made by Azure Phils. to Vanda Systems are not subject to Philippine income tax. 3. On Value-Added Tax The situs for taxing services rendered is the place where the service is performed regardless of the place of payment. In connection with this, Section 108 (A) of the Tax Code of 1997 provides that: "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, while the compensation for services rendered outside the Philippines is not subject to the 10% VAT, however, the fees paid for that portion where the services of Vanda Systems are in the Philippines are subject to the 10% VAT pursuant to the above-quoted provision of the Tax Code of 1997. Accordingly, Azure Phils., being the resident withholding agent and payor in control of the payment, shall be responsible for the withholding of the 10% final VAT on such service fees before making any payment to Vanda Systems. In remitting the VAT withheld, Azure Phils. shall use 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 documentary substantiation for the claim of input tax by Azure Phils. upon filing its own VAT Return, if it is a VAT-registered taxpayer. In case Azure Phils. 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, Azure Phils. is required to issue the Certificate of Final Tax Withheld at Source (BIR Form 2306) in quadruplicate upon request of Vanda Systems, the first three copies thereof to be given to Vanda Systems and the fourth copy to be retained by Azure Phils. as its file copy. [Sections 4 & 6, Revenue Regulations (RR) No. 4-2002; Section 3 of RR 8-2002; Section 7 of RR 14-2002] 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.) MILAGROS V. REGALADO Assistant Commissioner Legal Service