ITAD Ruling No. 197-02

November 8, 2002 ITAD RULING NO. 197-02 Art. 5&8, RP-US tax treaty Section 108, NIRC BIR Ruling No. 174-92 VAT Ruling No. 516-88 Sycip Gorres Velayo & Co. 6760 Ayala Avenue 1226 Makati City Attention: J.A. Osana Tax Division Gentlemen : This refers to your letter dated February 1, 2001 requesting confirmation of your opinion that Robert Gilchrist Engineering, LLC (RGE), a subcontractor of your client, Shell Philippines Exploration, B.V. (SPEX), a petroleum service contractor to the Republic of the Philippines, is exempt from Philippine taxes pursuant to the RP-US tax treaty, including the 8% tax on gross income imposed under Presidential Decree No. 1354 and from value added tax (VAT). It is represented that SPEX is a corporation formed and organized under the laws of the Netherlands and operates in the Philippines through a branch duly licensed by the Securities and Exchange Commission; that SPEX is a petroleum service contractor of the Government of the Philippines under Service Contract No. 38 covering an area in Offshore Northwest Palawan; that RGE is a non-resident foreign corporation duly organized and existing under the laws of the United States of America with principal office address at 557 Country Road 182-R, Westcliffe, CO 81252; 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 certificate dated January 30, 2001 issued by the Securities and Exchange Commission; that in connection with its Pipeline End Structure (PLES) installation, SPEX subcontracted RGE to provide consultancy services which include a review of particulars including, but not limited to, installation, path, pipe bending load and others for the PLES being constructed; that RGE shall render service from November 20, 2000 to December 10, 2000; that in the performance of the said services, Mr. Robert Gilchrist was the only RGE personnel who arrived in the Philippines and stayed for a period of 7 days only; and that in consideration for the said services, SPEX shall pay RGE a fee in the amount of Fifteen Thousand US Dollars (US$15,000). In reply, please be informed that Article 8, paragraph 1, of the RP-US tax treaty provides, 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." "xxx xxx xxx" Moreover, Article 5 of the above treaty provides: " Article 5 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. ScCDET 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 for 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." (emphasis supplied) Based on the aforequoted provisions, it is clear that if a corporation which is a resident of the United States does not carry on business in the Philippines through a permanent establishment situated therein, the profits of the same shall not be subject to Philippine income tax. For this purpose, a corporation which is a resident of the United States may be deemed to have a permanent establishment in the Philippines if, among others, the furnishing of services by such corporation, through its employees or other personnel, in the same or connected project, continue within the Philippines for a period or periods aggregating more than 183 days. Considering your representation that RGE performed consultancy services in the Philippines from November 20, 2000 to December 10, 2000, and that Mr. Robert Gilchrist, personnel of RGE, arrived and stayed in the Philippines in connection thereto for a period of 7 days only, RGE cannot be deemed to have established in the Philippines a permanent establishment to which its business profits may be attributed. Hence, this Office holds that Robert Gilchrist Engineering, LLC (RGE) is exempt from Philippine income tax, specifically from the 8% final income tax on gross income imposed under Presidential Decree No. 1354. ( BIR Ruling No. 174-92 dated May 29, 1992 ) As regards the value-added tax, Presidential Decree No. 1354 provides that subcontractors of petroleum service contractors in the Philippines are subject to a final withholding tax of 8% on their gross income, in lieu of all taxes , whether national or local, except those income derived from other sources, in which case, they shall be subject to the taxes imposed under the National Internal Revenue Code. Consequently, since the 8% final income tax is in lieu of all national and local taxes, exemption therefrom shall carry with it exemption from all other taxes, such as the 10% VAT. Therefore, in addition to the exemption from the payment of the 8% final income tax under PD 1354 pursuant to the RP-US tax treaty, RGE is likewise exempt from VAT. A contrary interpretation of subjecting the services of the subcontractor to the 10% VAT will nullify the intent to provide for a preferential and simple tax regime to petroleum subcontractors under Presidential Decree No. 1354. (VAT Ruling No. 516-88 dated November 16, 1988) Also, a similar interpretation will result in the absurd situation where petroleum subcontractors who are granted relief from the payment of 8% final income tax under the treaty are consequently subjected to a more burdensome taxation for being exposed to the payment of VAT and would run counter therefore to the principle that tax treaties are meant to provide relief to the taxpayer. In the light of the preceding paragraph, it is important to note that the non-discrimination article found in Article 24 of the RP-US tax treaty generally prevents one Contracting State from imposing taxation on nationals or permanent establishments of the other Contracting State that is additional or more burdensome that the Contracting State imposes on its own nationals or enterprises. For purposes of Article 24 of the treaty, paragraph 4 thereof provides that the term "taxes" or "taxation" means " taxes or taxation of every kind imposed at the national, state, or local level ." Therefore, the imposition of VAT, a kind of tax imposed at the national level, on RGE as a result of his exemption from income tax pursuant to the treaty will result in RGE being discriminated from other subcontractors who remain exempt from VAT, a situation not intended by the RP-US tax treaty. In fine, RGE is exempt from Philippine income tax, specifically from the 8% final income tax on gross income imposed under Presidential Decree No. 1354, and from VAT imposed under Section 105 of the Tax Code of 1997. ( BIR Ruling No. 174-92 dated May 29, 1992 ) 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 parties herein are concerned. Very truly yours, (SGD.) GUILLERMO L. PARAYNO, JR. Commissioner of Internal Revenue