ITAD Ruling No. 185-03

November 28, 2003 ITAD RULING NO. 185-03 Articles 28, 42 & 108 of the Tax Code of 1997 BIR Ruling No. DA-ITAD 79-03 Sycip Gorres Velayo & Co . 6760 Ayala Avenue 1226 Makati City, Philippines Attention: E.C. Alcantara Tax Division Gentlemen : This refers to your letter dated October 2, 2003, on behalf of your client, Sithe Hong Kong Power Services Ltd. (Sithe Hong Kong) requesting confirmation of your opinion that the pre-operation and consultation fees paid to Sithe Hong Kong by San Roque Power Corporation (SRPC) under the Operation and Maintenance Consulting Agreement (Consulting Agreement) are not royalties as defined under Section 42(A)(4) of the Tax Code of 1997 but are fees which constitute compensation for services performed outside the Philippines, and are not subject to Philippine income tax and 10% value-added tax. It is represented that Sithe Hong Kong is a non-resident foreign corporation duly organized and existing under the laws of Hong Kong with office address at 42/F Cheung Kong Center, No. 2 Queen's Road Central, Hong Kong; that it is not registered either as corporation or as a partnership and has not been licensed to do business in the Philippines per certification issued by the Securities and Exchange Commission dated September 25, 2003; that SRPC is a corporation organized and existing under the laws of the Philippines with principal address at Brgy. San Roque, San Manuel, Pangasinan; that on October 27, 1998, Sithe Hong Kong and SRPC entered into a Consulting Agreement with respect to the San Roque Multipurpose Power Project whereby SRPC retained the consultation and advisory services of Sithe Hong Kong with regard to the operation and maintenance of the Power Station; that as specifically outlined in Schedule 1 attached to the Agreement, the scope of services to be rendered by Sithe Hong Kong throughout the term of the agreement are, to wit: 1) Pre-Mobilization and Mobilization and Start-Up Services; 2) Operational Period Services; 3) Presentation of the following Plans: a. Annual O & M Plan; b. Annual Operations Program; c. Annual Maintenance Program; d. Annual Budget; e. Annual Report; f. Standards and Practices and Safety Plan; g. Preparedness, Prevention and Contingency Plan; h. Plant Activity Plans; 4) Review of Plans; that Sithe Hong Kong shall provide these services outside the Philippines save only in respect of activities that its personnel will conduct at the Project Site; that in consideration for the said services, Sithe Hong Kong shall be paid a monthly Pre-Operation Fee of $50,000.00 and an annual consulting fee of $750,000.00. cDHAES 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 42(A)(4) of the Tax Code of 1997, as amended, provides an enumeration on what are considered royalties for Philippine tax purposes, viz : "Section 42. Income from Sources Within the Philippines . (A) Gross Income From Sources Within the Philippines . xxx xxx xxx (4) Rentals and Royalties . xxx xxx xxx (a) The use of or the right or privilege to use in the Philippines any copyright, patent, design or model, plan, secret formula or process, goodwill, trademark, trade brand or other like property or right; (b) The use of or the right to use in the Philippines any industrial, commercial, or scientific equipment; (c) The supply of scientific, technical, industrial, or commercial knowledge or information; (d) The supply of any assistance that is ancillary and subsidiary to, and is furnished as a means of, enabling the application or enjoyment of, any such property or right as is mentioned in paragraph (a), any such equipment as is mentioned in paragraph (b), or any such knowledge or information as is mentioned in paragraph (c); (e) The supply of services by a nonresident person or his employee in connection with the use of property or rights belonging to, or the installation or operation of any brand, machinery, or other apparatus purchased from, such nonresident person; (f) Technical advice, assistance, or services rendered in connection with technical management or administration of any scientific, industrial, or commercial undertaking, venture, project, or scheme; and (g) The use of or the right to use: (i) Motion picture films; (ii) Films or video tapes for use in connection with television and; (iii) Tapes for use in connection with radio broadcasting." Also, Section 2.1 of Chapter Two of the Agreement provides in part that: "The Parties understand and agree that Consultant is providing consulting services only , and the actual operation and maintenance of the Power Station and the Facilities shall be performed by Owner's personnel or Owner's contractors. . . . 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 Consulting Agreement that the service fees are not within the definition of "royalties" under Article 42(A)(4) of the Tax Code of 1997. Specifically, nothing in the Agreement would require transfer into the Philippines of technology, equipment or other property where the payee has proprietary interest or would otherwise permit Sithe Hong Kong to impart to SRPC their special knowledge and experience which remain unrevealed to the public. Inasmuch as Sithe Hong Kong 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 Sithe Hong Kong shall not be considered as royalties but shall constitute as business profits derived from sources outside the Philippines. (BIR Ruling No. DA-ITAD 79-03 dated June 11, 2003) As such, the business profits are governed by Section 28(B)(1), in relation to Section 42(A)(3), both of the Tax Code of 1997 which provide, viz : "Sec. 28. Rates of Income Tax on Foreign Corporations . xxx xxx xxx "(B) Tax on Nonresident Foreign Corporation . "(1) 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) and (d): Provided, That effective January 1, 1998, the rate of income tax shall be thirty-four percent (34%); effective January 1, 1999, the rate of income tax shall be thirty-three percent (33%); and, effective January 1, 2000 and thereafter, the rate shall be thirty-two percent (32%). SIcEHD "Sec. 42. Income from Sources Within the Philippines . "(A) Gross Income From Sources Within the Philippines . The following items of gross income shall be treated as 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" Under the afore-cited provisions, a nonresident foreign corporation is taxable only on income derived from sources within the Philippines so that if a nonresident foreign corporation furnishes and performs services in the Philippines, the service fees therefrom are taxable in the Philippines. Considering that the services of Sithe Hong Kong to SRPC under the Consulting Agreement are rendered outside the Philippines, the payments by SRPC to Sithe Hong Kong are considered income derived from sources outside the Philippines. In view thereof, this Office is of the opinion as it hereby holds that payments of SRPC to Sithe Hong Kong pursuant to the Consulting Agreement are considered income derived from sources outside the Philippines pursuant to Section 42(A)(3) of the Tax Code of 1997 and are, therefore, not subject to Philippine income tax under Section 28(B)(1) of the said Code. 2. On Value-Added Tax Moreover, 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 Sithe Hong Kong are rendered in the Philippines, with respect to activities conducted by its personnel at the Project Site, are subject to the 10% VAT pursuant to Section 108(a) of the Tax Code of 1997. Accordingly, SRPC, 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 Sithe Hong Kong. In remitting the VAT withheld, SRPC 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 SRPC upon filing its own VAT Return, if it is a VAT-registered taxpayer. In case SRPC 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, SRPC is required to issue the Certificate of Final Tax Withheld at Source (BIR Form 2306) in quadruplicate upon request of Sithe Hong Kong, the first three copies thereof to be given to Sithe Hong Kong and the fourth copy to be retained by SRPC 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