April 25, 1986

REVENUE AUDIT MEMORANDUM ORDER NO. 01-86

1.

SUBJECT :

Procedure for Tax Audit of Philippine Branches of

Foreign Corporations.

TO

All Internal Revenue Officers and Others Concerned.

Background
1.1

Some branches of foreign corporations engage in business in the

Philippines by soliciting orders from local importers. These
branches are called "liaison offices or branches." Sales made
from such solicitations are not reported by these branches as
their own sales purportedly because the branch office merely
relays to its head office abroad purchase orders from local
importers and it is purportedly its head office that actually
consummates the sales. At the end of the taxable period, the
branch office simply reports for income tax purposes its
purported share of the income generated from sales but the
allocation of this purported share is left entirely at the discretion
of its head office. The revenue service is completely at the
mercy of multi-national companies.
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1.2

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Some branches engage in business in the Philippines by

soliciting orders from local importers and relays this
information to its head office abroad. The head office in turn
solicits prospective exporters for a compensation. At the end of
the taxable period, the head office allocates a certain portion of
the compensation to its branch in the Philippines. The branch in
turn reports its purported share for income tax purposes but
does not pay the commercial broker's tax thereon purportedly
because the compensation was received from its head office and
purportedly because the branch cannot be legally considered a
commercial broker in relation to its head office since the branch
and its head office possess only a single legal personality
(PHILIPP
BROTHERS
OCEANIC,
INC.
vs.
COMMISSIONER OF INTERNAL REVENUE, CTA Case No.

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3140, March 8, 1984).

Again, in this second situation, allocation of the
compensation is left at the discretion of the head office the
revenue service also left at the mercy of these multi-national
companies.
2.

Legal Consequences
2.1

The foregoing scope of activities of these branch offices is

considered under R.A. 5455 as business acts. "'Doing business'
shall include soliciting orders, purchases, service contracts
opening offices, whether called 'liaison' offices or branches. . .
. any other act or acts that imply a continuity of commercial
dealings or arrangements, and contemplate to that extent the
performance of acts or works, or the exercise of some of the
functions normally incident to, and in progressive prosecution
of, commercial gain or of the purpose and object of the business
organization." (SEC. 1 (1), R.A. 5455).

2.2

These branch offices, like any other businesses, are required by

law to account for their business operations in accordance with
generally accepted accounting practices (SEC. 38, NIRC).
Thus, a branch office although not possessing a separate and
distinct juridical personality is, however, considered under
generally accepted accounting practices as a distinct character,
a separate business unit and should be "supplied by the home
office with cash and merchandise and such other assets as may
be needed" (Advance Accounting by Simons and Karrenbrock,
4th ed., p. 202). Generally accepted accounting practices also
dictate that income and expenses of the branch shall be
segregated from those of the home office in order to clearly
reflect their respective operating results (ibid).
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2.3

The doctrine on corporate fiction is not absolute the veil of

corporate fiction may be legally pierced should it be used to
subvert just application of laws.
". . . Where the corporate form or organization is adopted or a
corporate entity is asserted in an endeavor to evade a statute or to
modify its intent, courts will disregard the corporation or its entity.
This has been applied to violations of . . . tax laws, . . ."
(FLETCHER, 170-171, Commentaries and Jurisprudence on the
Commercial Laws of the Philippines by Agbayani, Vol. 3, 1970 ed., p.

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21).
". . . Where a corporation is a dummy, is unreal or a sham and
serves no business purposes and is intended only as a blind, the
corporate form may be ignored for the law cannot countenance a
form that is bald and a mischievous fiction." (LIDDEL & CO. v.
COLLECTOR OF INTERNAL REVENUE, L-9687, June 30, 1961,
citing Gregory v. Helvering, 293 US 465, L. ed. 596-599; Higgins v.
Smith, 1940, 308 US 406 L. ed., cited in p. 20, Commentaries and
Jurisprudence on the Commercial Laws of the Philippines by
Agbayani, Vol. 3, 1970 ed.).
". . . To allow a taxpayer to deny tax liability on the ground
that the sales were made through another and distinct corporation
when it is proved that the latter is virtually owned by the former or
that they are practically one and the same is to sanction a
circumvention of our tax laws." (ibid).

Corporate fiction may be inquired upon where there is "inadequacy of

capital . . ., confusion of affairs . . . and direct intervention in
management causing inequitable results (Ballantine, 314; Rorhlick,
417-422).
3.

Branch Operation and Consequences

3.1

The Philippine branch solicits purchase orders from local

buyers, relays the information to its home office abroad, and
the home office purportedly directly makes the sale.
In this type of operation: (i) Sales purportedly
consummated abroad by the home office shall be treated as
sales constructively consummated in the Philippines and made
by the branch office, hence, income therefrom shall be
considered income from sources within the Philippines; (ii) the
branch shall record and report the gross selling price of
commodities sold thru its home office; and (iii) report for
income tax purposes its net income therefrom. (iv) Since under
this situation, the import taxes, duties and charges have already
been paid by the local buyers, the same shall not anymore be
chargeable against the branch.
Under this paragraph, these transactions are treated sales
constructively consummated by the branch office in accordance
with generally accepted accounting practices required under
Section 38 of the Tax Code since the branch solicitations are

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actually trading acts. Accordingly, the home office is obligated

to supply its branch with merchandise in pursuing its trading
business in the Philippines. Hence, sales purportedly made
directly by its home office shall be considered no more than
merely a constructive supplying of the merchandise to its
branch which eventually constructively sells the same to
Philippine buyers.
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3.2

The branch solicits purchase orders from local buyers, relays

the information to its home office, the home office solicits
prospective sellers abroad and eventually receives
compensation for services rendered.
In this second type of operation: (i) the branch shall be
considered "a commercial broker" or indentor; (ii) its share
from compensation as allocated by its home office shall be
subject to commercial broker gross receipts tax; (iii) the branch
shall provide itself with the corresponding fixed tax as a
commercial broker; and (iv) pay income tax on its share of the
compensation.
Under this paragraph, the branch office shall be
considered a commercial broker since its activities is well
within the ambit of the term "broker". Brokers are ". . . those
who are engaged for others in the negotiation of contracts
relative to property with the custody of which they have no
concern. They act as negotiators in bringing other persons
together to bargain; generally, they ought not to sell in their
own names, have no implied authority to receive payment, are
not entrusted with the physical possession of the principal's
goods when engaged to buy or sell, and have no special
property therein or lien thereon." (8 Am. Jur. 889-890, cited in
Philipp Brothers Oceanic, Inc. v. The Commissioner of Internal
Revenue, CTA Case No. 3140, March 8, 1984).

4.

Audit Procedure
4.1

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For constructive trading by branch office

(a)

Determine gross sales generated from branch's

constructive trading (from solicitations made by the
branch);

(b)

Require

the

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Philippine

branch

Philippine Taxation Encyclopedia 2013

to

submit

duly
4

authenticated (i) income statement; and (ii) statement of

cost of sales re worldwide operation of the entire
corporation during the taxable year;
(c)

Extract the gross income generated from such

constructive sales by applying against the gross
constructive sales the gross profit rate shown in the cost
of sale statement referred to in paragraph (b) (ii) above.
Illustration: Assume that the gross profit ratio, based
on worldwide statement of cost of sales, is 20% and the gross
constructive sales amounts to P1,000,000. Gross income
therefrom shall be computed as follows:
Gross sales

P1,000,000

Gross income therefrom

(20% G/P rate)

(d)

P200,000

Check from the records of the Bureau of Customs all

shipments coming from the branch's home office during
the taxable year in determining the branch's constructive
sales in the Philippines.
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(e)
4.2

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Require the branch to reconcile computations of its

constructive sales in the Philippines.

For broker activity by branch office

(a)

Verify veracity of the amount of compensation allocated

to the branch by its home office;

(b)

Require submission of sworn declaration from home

office on the correctness of the allocated share of the
branch office and cross check this declaration in
connection with the branch records re extent of
solicitations undertaken in the Philippines during the tax
year;

(c)

Require the branch to pay the corresponding fixed tax as

a commercial broker;

(d)

Require the branch to pay the corresponding commercial

broker's gross receipts tax, based on its total share from
compensation derived for services rendered in the
Philippines; and

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(e)

5.

Determine also the branch income tax obligation for the

said income which is being considered income from
sources within the Philippines.

Implementation
Strict enforcement of this Revenue Audit Memorandum Order
is enjoined.

6.

Effectivity
This Order shall take effect immediately.

7.

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Publication
The Bureau shall give this Order as wide a publicity as possible
for proper guidance of multi-national companies doing business in the
Philippines under a branch-head office relationship; and for strict
enforcement by revenue personnel.

(SGD.) BIENVENIDO A. TAN, JR.

Commissioner

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