ITAD Ruling No. 187-02

October 22, 2002 ITAD RULING NO. 187-02 Article 7 and 5, RP-Singapore Article 8 and 5, RP-US Article 7 and 5, RP-Korea Article 7 and 5, RP-Japan Sec. 12, R.A. 7227 Sec. 24, R.A. 7916 Sec. 28 (B) (1), 42 (E), 56, 57 (B) Tax Code of 1997 000-00 Sycip Gorres Velayo & Co. 6760 Ayala Avenue 1226 Makati City Attention: Mr. R.R. Rubio Tax Division Gentlemen : This refers to your letter dated August 8, 2001, requesting for a ruling confirming your position that the sale of goods by foreign suppliers who are residents of Japan, Korea, Singapore, United States of America, Hongkong and Taiwan to Toshiba Information Equipment (Phils.), Inc. (hereinafter called "TIP") under a proposed delivery and sales arrangement between them shall not be taxable in the Philippines. It is represented that TIP is a Philippine Economic Zone Authority (PEZA) registered enterprise; that TIP would like manage the inventory level of raw materials to be purchased from the foreign suppliers; that TIP is proposing an arrangement with the foreign suppliers where the raw materials will be delivered to TIP's warehouses without the foreign suppliers recognizing sales upon delivery, that the foreign suppliers will only recognize sales and will issue invoice upon withdrawal by TIP for production purposes; that TIP in turn will not recognize as its inventories the raw materials stored in its warehouse until actual withdrawal for production purposes are made. On the basis of the above proposed arrangements, TIP would like to resolve the following issues: (a) Whether the foreign suppliers are deemed to have a permanent establishment (PE) in the Philippines or are deemed to be doing business in the Philippines for storing goods in the warehouse maintained by TIP and subsequently selling the same to TIP upon withdrawal therefrom; and, b) Whether the sale of goods by the foreign suppliers to TIP is a taxable transaction in the Philippines. In reply, please be informed of the pertinent provisions of Article 7 and Article 5 of the RP-Japan, RP-Singapore and RP-Korea tax treaties and Articles 8 and 5 of the RP-US tax treaty which provide, viz : Article 7 of the RP-Japan, RP-Singapore and RP-Korea tax treaties: "BUSINESS PROFITS "1. The profits of an enterprise of a Contracting State shall be taxable only in that Contracting 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 that other Contracting State but only so much of them as is attributable to that permanent establishment" Article 5 of the RP-Japan tax treaty: "PERMANENT ESTABLISHMENT "1. For the purposes of this Convention, the term "permanent establishment" means a fixed place of business through which the business of an enterprise is wholly or partly carried on. "2. The term 'permanent establishment' includes especially: xxx xxx xxx f) a warehouse; xxx xxx xxx Article 5 of the RP-Singapore tax treaty: "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: xxx xxx xxx g) A warehouse, in relation to a person providing storage facilities for others; xxx xxx xxx Article 5 of the RP-Korea tax treaty: "PERMANENT ESTABLISHMENT "1. For the purposes of this Convention, the term 'permanent establishment' means a fixed place of business through which the business of an enterprise is wholly or partly carried on. "2. The term 'permanent establishment' includes especially: xxx xxx xxx b) a warehouse, in relation to a person providing storage facilities for others xxx xxx xxx Article 8 of the RP-US tax treaty: "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 is attributable to the permanent establishment." Article 5 of the RP-US tax treaty: "PERMANENT ESTABLISHMENT "1. For the purposes of this Convention, the term 'permanent establishment' means a fixed place 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 g) a warehouse; xxx xxx xxx Based on the aforequoted provisions of the Philippines' tax treaties with US, Singapore, Korea and Japan, the business profits of the foreign suppliers of TIP shall be taxable in the Philippines if they have a permanent establishment situated in the Philippines and only so much of them as is attributable to that permanent establishment. A warehouse is considered a permanent establishment if the business of an enterprise of one of the Contracting States is wholly or partly carried on through it. In the instant case, the subject warehouse is being utilized by its owner, TIP, for storing raw materials delivered to the latter by foreign suppliers in accordance with the Just-In-Time (JIT) arrangement as proposed by TIP. As represented, foreign suppliers will deliver raw materials to TIP's warehouse but sales will be recognized only upon actual withdrawal of such raw materials by TIP for production purposes. Based on this arrangement, it is clear that the use of the warehouse is for the benefit of TIP and not for the purpose of establishing a fixed place through which the business of the foreign suppliers are to be wholly or partly carried on. If any, the relation between the warehouse and the foreign suppliers under the arrangement is merely to attain the ultimate objective of carrying out the JIT proposal of TIP. The American Production and Inventory Control Society (APICS) defines JIT as follows: " a philosophy of manufacturing based on planned elimination of all waste and continuous improvement of productivity. It encompasses the successful execution of all manufacturing activities required to produce a final product, from design engineering to delivery and including all stages of conversion from raw materials onward. The primary elements include having only the required inventory when needed; to improve quality to zero defects; to reduce lead time by reducing setup times, queue lengths and lot sizes; to incrementally revise the operations themselves, and to accomplish these things at minimum cost ." As the definition implies, upon the adoption of JIT, TIP eliminates the stocking of inventory, reduces order scheduling and eliminates excess material spoilage. It also reduces production and delivery lead times, manufacturing related costs through the elimination of excess material handling, inspections, and storage of parts and also eliminates the use of warehouse. All the foregoing considered, the business profits to be derived by the foreign suppliers in the Philippines from the sale of raw materials to TIP are not taxable in the Philippines since the foreign suppliers do not maintain a permanent establishment in the Philippines to which their profits as such may be attributed. However, since the Philippines has no existing tax treaties with Hongkong and Taiwan, the suppliers from these two countries will be classified as non-resident foreign corporations and any income they derive from sources within the Philippines is subject to Philippine tax under Section 28(B)(1) of the Tax Code of 1997. Section 42(E) of the same Code states what are considered as income from Philippine sources: ". . . Gains, profits and income derived from the purchase of personal property within and its sale without the Philippines, or from the purchase of personal property without and its sale within the Philippines shall be treated as derived entirely from sources within the country in which sold: Provided, however, That gain from the sale of shares of stock in a domestic corporation shall be treated as derived entirely from sources within the Philippines regardless of where the said shares are sold . . ." As regards your opinion that the foreign suppliers from Hongkong and Taiwan may, nonetheless, be exempted from Philippine taxation since the proposed arrangement has basically the same concept with that of the Just-In-Time buffer stock program sponsored by SBDMC, you have cited BIR Ruling No. 172-99 where the BIR ruled as follows: "Being a separate customs territory, the provisions of the Tax Code, imposing and prescribing regular taxes upon persons and entities in the Customs Territory would not be applicable to the SBF and SBMA administered zones insofar as the same will conflict with the provisions of Republic Act (R.A.) 7227. Such being the case, the so-called Just-In-Time buffer stock program being sponsored by SBDMC is entirely within the jurisdiction and administration of the Subic Bay Metropolitan Authority. However, in proper cases, this Office remains with jurisdiction to look into the books of accounts of SBF companies, such as ACER and Circle Freight, for the purpose of determining the veracity of declared income upon which the special tax rate is based. "With respect to foreign suppliers participating under the JIT program, such as IBM, we hold that they are still subject to the jurisdiction of SBMA since, as represented, their transaction would be restricted to the introduction of materials or merchandise within the confines of the Subic Bay Freeport, there to be disposed of in the manner outlined under the JIT program, i.e., for subsequent consumption by Acer, an SBF registered enterprise. "It bears stressing that the SBMA exercises authority and jurisdiction over all economic activity within the SBF (Section 11, Rules Implementing R.A. 7227). Thus, the rules, policies and regulations imposed by SBMA shall govern in this regard provided, however, that the activities of the said foreign suppliers do not extend outside of the freeport zone and into the customs territory, for which the SBF incentives and SBMA regulations do not apply. Consequently, IBM and other foreign suppliers concerned exporting their materials under the said JIT program of Acer, as approved by the SBMA, do not come within the meaning of non-resident foreign corporations deriving taxable income within the Philippines. Therefore, its subsequent deliveries of products from the third-party warehouse and/or its receipts of payment therefor remain not subject to tax imposed under the Tax Code of 1997." While it is conceded that the TIP proposed arrangement has basically the same concept with that of the JIT buffer stock program sponsored by the SBDMC and, therefor, can be used to support TIP's proposal, however, this office is of the opinion and so holds that the cited BIR Ruling No. 172-99 has no legal basis in saying that the foreign suppliers concerned "do not come within the meaning of non-resident foreign corporations deriving taxable income within the Philippines." The exemption from national and local taxes granted under Section 12 of R.A. No. 7227 and Section 24 of R.A. No. 7916, as amended, pertains only to business enterprises operating within the ECOZONES and, therefore, does not in any way grant tax exemption privileges to non-resident foreign corporations or suppliers dealing with business enterprises operating within the ECOZONES. In fact, Section 43 of the Rules Implementing R.A. No. 7227 (issued by the Subic Bay Metropolitan Authority) and Section 6 of Revenue Regulations No. 1-95 1 is explicit that only SBF Enterprises 2 or "registered enterprises" 3 shall be exempt from national and local taxes, and in lieu of paying taxes, said Enterprises shall pay a final tax of five percent (5%) of gross income earned. In like manner, nothing in the provisions of R.A. No. 7916 and the rules and regulations implementing the same states that the tax exemption privileges granted to business establishments operating within the ECOZONE extend to their non-resident foreign suppliers. It is true that under the Rules implementing R.A. No. 7227, the SBMA exercises authority and jurisdiction over all economic activity within the SBF. This authority, however, does not include the granting of tax exemption privileges to the said non-resident corporations or suppliers as the said law never intends it to be. As a matter of fact, while the registered enterprises shall pay only a final tax of five percent in lieu of national and local taxes, it is clear that the term "national taxes" shall, however, not include withholding taxes on salaries of employees or on income payments to persons other than a registered ECOZONE enterprise , subject to the withholding tax at source under Section 50(b) [now Section 57(B) of the Tax Code, as amended]. (Section 2(h) of Revenue Regulations No. 12-97 4 dated August 1, 1997) In addition, under Section 6(e) of Revenue Regulations No. 1-95, it is stated that: "SEC. 6. TAXES AND FISCAL OBLIGATIONS. "Obligations and Liabilities. "xxx xxx xxx "e. A registered enterprise operating within the Secured Area shall be constituted as withholding agent for the government (i) . . ., or (ii) . . ., (iii) if it makes payment remittance of certain income subject to the final withholding tax under Sec. 50(a) [now Section 57(A)] in relation to Section 51 (now Section 56 of the NIRC)." Claims for tax exemption are regarded as derogation of sovereign authority and to be construed strictissimi juris against the person or entity claiming the exemption. The burden of proof rests upon the party claiming the exemption to prove that it is in fact covered by the exemption so claimed, for exemptions from taxation are not favored in law, nor are they presumed. They must be expressed in the clearest and most unambiguous language and not left to mere implication. In view thereof, it was not justified by the clearest grant of organic or statute law that the foreign suppliers who are residents of Hongkong and Taiwan under the proposed delivery and sales arrangement with TIP are exempt from tax imposed under the Tax Code of 1997 on their sale to enterprises operating within the ECOZONES. In this regard, since TIP takes title upon withdrawal, the sale is deemed to have occurred in the Philippines, thus from Philippine sources and subject to tax. In fine, herein foreign suppliers pursuant to the proposed delivery and sales arrangement with TIP who are residents of Japan, Korea, Singapore and US are exempt from Philippine income tax. On the other hand, similar suppliers who are residents of Hongkong and Taiwan will be taxed as non-resident foreign corporations under Section 28(B)(1) of the NIRC of 1997 as the Philippines has no existing tax treaties with Hongkong and Taiwan. Nonetheless, the sale of goods to TIP by these foreign suppliers, whether residents of tax treaty partner countries or not, are exempt from the value added tax. All the above considered, BIR Ruling No. 172-99 is hereby revoked. This ruling is issued on the basis of the foregoing 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 , (SGD.) GUILLERMO L. PARAYNO, JR. Commissioner of Internal Revenue Footnotes 1. Rules and Regulations to Implement the Tax Incentives Provisions under paragraphs (b) and (c) of Section 12, Republic Act No. 7227 otherwise known as the Bases Conversion and Development Act of 1992. 2. Under Section 3(g) of the Rules Implementing R.A. No. 7227, "SBF Enterprises" refers to any business entity or concern within the Subic Bay Freeport (SBF) duly registered with and/or licensed by the SBMA to operate any lawful economic activity within the SBF. 3. Under Section 3(k) of Revenue Regulations No. 1-95, "registered enterprise" refers to any corporation registered with the SBMA to do business in the Secured Area of the Zone. 4. Regulations Implementing Sections 12(c) and 15 of Republic Act No. 7227 and Sections 24(b)(c) of Republic Act No. 7916 Allocating Two Percent (2%) of the Gross Income Earned by All Businesses and Enterprises within the SUBIC, CLARK, JOHN HAY, PORO POINT SPECIAL ECONOMIC ZONES and other SPECIAL ECONOMIC ZONES under PEZA To All LGUs Concerned.