ITAD Ruling No. 223-02

December 27, 2002 ITAD RULING NO. 223-02 RP-Japan, Art. 5 & 7 BIR Ruling No. ITAD-91-01 BIR Ruling No. ITAD-166-02 PNOC Petrochemical Development Corp. 11/F BA Lepanto Building 8747 Paseo de Roxas 1227 Makati, Metro Manila Attention: Dionisia L. Mascardo Manager-Finance & Treasury Department Gentlemen : This refers to your letter dated June 28, 2002 requesting confirmation of your opinion that the consultancy service fees to be paid by PNOC Petrochemical Development Corp. (PPDC) to Toyo Engineering Corp. (TEC) are not subject to Philippine income tax pursuant to Articles 5 and 7 of the RP-Japan tax treaty. It is represented that TEC is a corporation organized and existing under the laws of Japan with principal office address at Kasumigaseki Bldg., 2-5 3-Chome, Kasumigaseki, Chiyoda Ku, Tokyo, Japan; 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 June 17, 2002 issued by the Securities and Exchange Commission; that PPDC is a corporation organized and existing under the laws of the Philippines; that on April 9, 2002, TEC and PPDC entered into a Technical Consultancy Service Agreement (Agreement) whereby TEC will undertake a detailed feasibility study of the Philippine Cracker Project to fully determine its viability; that the Agreement will have a duration of ninety (90) calendar days from the commencement of work until the submission of final report on July 1, 2002; that while the Agreement is for 90 days, the actual stay and engagement of TEC's personnel in the Philippines in connection with the Agreement is only for sixteen (16) days; that in consideration for the said services, PPDC agreed to pay TEC professional fees and reimbursement cost broken down as follows: a.) Professional Fees To be performed in the Philippines US$30,000.00 To be performed outside the Philippines 201,000.00 b.) Reimbursement Cost (supported by receipts) 17,000.00 US$248,000.00 =========== In reply, please be informed that with respect to the professional fees derived from consultancy services rendered within the Philippines, Article 7 of the RP-Japan tax treaty provides: "Article 7 "(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. "xxx xxx xxx" Moreover, paragraphs (1) and (6) of Article 5 of the said treaty provide, viz: "Article 5 "(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. "xxx xxx xxx" "(6) An enterprise of a Contracting State shall be deemed to have a permanent establishment in the other Contracting State if it furnishes in that other Contracting State consultancy services, or supervisory services in connection with a contract for a building, construction or installation project through employees or other personnel other than an agent of an independent status to whom paragraph (7) applies provided that such activities continue (for the same project or two or more connected projects) for a period or periods aggregating more than six months within any taxable year. However, if the furnishing of such services is effected under an agreement between the Governments of the two Contracting States regarding economic or technical cooperation, that enterprise shall, notwithstanding any provisions of this Article, not be deemed to have a permanent establishment in that other Contracting State. ESTcIA "xxx xxx xxx" Based on the aforequoted provisions, it is clear that if a corporation which is a resident of Japan carries on business in the Philippines through a permanent establishment situated therein, the profits of the same shall be subject to Philippine income tax, but only so much of them as is attributable to that permanent establishment. For this purpose, a corporation which is a resident of Japan may be deemed to have a permanent establishment in the Philippines if, among others, the furnishing of consultancy or supervisory 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 six months in any taxable year except when the furnishing of such services is effected under an agreement between the Governments of Japan and Philippines regarding economic or technical cooperation, in which case, the corporation shall not be deemed to have a permanent establishment in the Philippines. Considering that the furnishing of consultancy services in the Philippines by TEC's personnel will not exceed an aggregate period of six months, TEC is not deemed to have a permanent establishment in the Philippines to which its business profits may be attributed to. Therefore, the consultancy income in the form of professional fees derived by TEC from services rendered in the Philippines is not subject to Philippine income tax pursuant to Article 7(1) in relation to Article 5(1) and (6) of the RP-Japan tax treaty. ( BIR Ruling No. ITAD-91-01 dated October 8, 2001 ) As regards the professional fees from services rendered by TEC outside the Philippines, it is noteworthy that the RP-Japan tax treaty will find no application as the transaction does not result in double taxation for which a tax treaty relief may be sought. Such fees are considered income derived from sources outside the Philippines, which shall be governed by Section 28(B)(1), in relation to Section 42(A)(3), both of the 1997 Tax Code, to wit: "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 shall be thirty-three percent (33%); and effective January 1, 2000 and thereafter, the rate shall be thirty-two percent (32%). (Emphasis supplied) "xxx xxx xxx" "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" It is clear from the aforequoted provisions that a non-resident foreign corporation is taxable only on income derived from sources within the Philippines. Hence, since the services to be rendered by TEC to PPDC shall be performed entirely in Japan, the fees to be remitted by SCPI are considered income derived from sources outside the Philippines and therefore are not taxable in the Philippines. ( BIR Ruling No. DA ITAD 166-02 dated September 23, 2002 ) However, the fees paid by PPDC for the services rendered within the Philippines by TEC shall be subject to the 10 percent value added tax (VAT) pursuant to Section 108(A)(1) and (3) of the Tax Code of 1997. Accordingly, PPDC, being the payor in control of the payment, shall be responsible for the withholding of VAT on such fees on behalf of TEC by filing a separate VAT return for and on behalf of TEC using 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 sufficient basis for the claim of input tax to be applied against the output tax that may be due from PPDC. In addition, PPDC is required to issue the Certificate of Creditable Tax Withheld at Source (BIR Form 2307) in quadruplicate upon request of TEC, the first three copies thereof to be given to TEC and the fourth copy to be retained by PPDC as its file copy. In fine, the professional fees derived from consultancy services rendered within and outside the Philippines shall not be subject to Philippine income tax pursuant to Article 7(1) in relation to Article 5(1) and (6) of the RP-Japan tax treaty and to Section 28(B)(1) in relation to Section 42(A)(3) of the Tax Code of 1997, respectively. However, the same fees for services rendered within the Philippines shall be subject to VAT pursuant to Section 108 of the Tax Code of 1997. 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