DECISION

BAUTISTA, J p:
The Case
Before the Court En Banc are two Petitions for Review pursuant to Section 18 of
Republic Act No. 1125, as amended by Section 11 of Republic Act No. 9282. The first petition
docketed as C.T.A. EB No. 206 filed by the Commissioner of Internal Revenue seeks the
reversal of the Decision dated February 23, 2006 and the Resolution dated July 18, 2006 of
the Second Division of this Court ("Court in Division") in C.T.A. Case No. 6782 captioned
Smart Communications, Inc. vs. Commissioner of Internal Revenue, which ordered the
Commissioner of Internal Revenue to pay Smart Communications, Inc. the amount of
P3,989,456.43 representing overpaid final withholding taxes for the month of August 2001.
On the other hand, the second petition docketed as C.T.A. EB No. 207 was filed by
Smart Communications, Inc. praying that this Court render judgment granting its Petition that
the payment for services provided for in the Service Download Manager Agreement ("SDM
Agreement") be classified as business profits of Prism Transactive (M) Sdn Bhd ("Prism") and
as such not subject to tax here in the Philippines since Prism is not engaged in business in the
Philippines through a permanent establishment. In effect, Smart Communications, Inc. is
praying that its entire claim for the refund or issuance of tax credit certificate in the amount of
P7,008,840.43 be granted.
Since both Petitions for Review involve the same parties and subject matter, this Court
deemed it necessary to consolidate the aforementioned petitions.
Antecedent Facts
As summarized by the Court in Division, the facts are:
"In their 'Joint Stipulation of Facts', the parties submitted the following:
'1.02.
Petitioner is a corporation organized and existing under Philippine law with
principal office at the Smart Tower, Ayala Avenue, 1226 Makati Avenue.
1.03. Respondent is the duly appointed Commissioner of Internal Revenue (CIR)
vested with authority to exercise the functions of said office, including inter alia, the power to
refund any internal revenue tax erroneously or illegally assessed or collected, or of any penalty
claimed to have collected without authority, or any sum alleged to have been excessively or in
any manner wrongfully collected, and holding office at the BIR National Office Building,
Diliman, Quezon City, where he may be served with summons and other legal processes of
this Honorable Court (ANSWER, par. 1).
1.04. SMART is an enterprise duly registered with the Board of Investment (BOI) on a
preferred non-pioneer status, having been issued the following BOI Certificates:
BOI Certificate of Registration No.
Registered Activity
94-034 dated March 8, 1994
New operator of a nationwide enhanced
Cellular Mobile Telephone System (CMTS)
94-628 dated December 29, 1994
New operator of International Gateway
Facility ("IGF")
97-117 dated August 26, 1997 Expanding Operator of Nationwide
Cellular Mobile Telephone System
(CMTS)
2001-066 dated May 3, 2001
Expanding Operator of Telecommunication

Systems (Nationwide Cellular Mobile

Telephone Services Global System
for Mobile Communication (GSM) Network
2001-102 dated July 12, 2001 New IT Service Firm in the Field of Information
Technology Service (Payment Infrastructure
System)
1.05. In line with its Bespoke Project and the launching of its mCommerce service such
as Smart Banking, Smart Money and ZED Mobile service initiatives, SMART entered into three
(3) Agreements for Programming and Consultancy Services (collectively the 'Agreements') with
Prism Transactive (M) Sdn Bhd, Inc. ('Prism'). ADSIaT
1.06. Prism is a non-resident corporation duly organized and existing under the laws of
Malaysia.
1.07.
SMART withheld and paid to the BIR withholding taxes totaling Seven
Million Eight Thousand Eight Hundred Forty and 43/100 Pesos (P7,008,840.43) applying the
tax rate of 25%, as follows:
Particulars Amount
Tax Base
US$547,822.45
Multiply by: Withholding Tax rate 25%
Final Withholding Tax
US$136,955.61
Multiply by: Prevailing Exchange 51.176
Rate
FWT remitted to the BIR P7,008,840.43
1.08. SMART filed its Monthly Remittance of Final Income Taxes Withheld (BIR Form
No. 1601-F) for the month of August 2001 on September 25, 2001.
1.09. On September 23, 2003, SMART formally filed a claim with the BIR, through the
International Tax Affairs Division ('ITAD'), for the refund of its overpaid or erroneously paid final
withholding tax for the month of August 2001.
1.10. Respondent Commissioner has not acted upon or granted said written claim for
refund. Thus, SMART filed the instant Petition to forestall the running of the prescriptive
period.'
In his answer, respondent alleged by way of special and affirmative defenses:
'4.
The 'Agreements' attached as Annexes 'I-K' of the petition are unnotarized
documents. Respondent, thus has no way of checking the veracity of the scope of obligations
of both parties under the agreements.
5.
Further, the Completion of Work Certificate given by PRISM TRANSACTIVE (M)
SDN, BHD. ('Prism') is unauthenticated by the Malaysian Embassy. Reliance cannot be had on
the said certification absent authentication by the Malaysian Embassy or the Philippine
Consulate Office in Malaysia.
6.
The billing statement relied upon to prove payment to Prism does not in any way
show proof that the payment was made thereon. It does not show that remittance was made to
Prism in the stated amount.
7.
Petitioner is not the party-in-interest in this case to recover the amount it paid to
the respondent. In fact, petitioner is deemed as the agent of the government in collecting the
Seven Million Eight Thousand Eight Hundred Forty Pesos and Three Centavos
(Php7,008,840.03), constituting final tax on passive income of royalty to Prism. Even under the
cited 'RP-Malaysia' Tax Treaty, it is Prism who is the proper party-in-interest to seek for the

refund of said amount as it is deemed to be the one to have been prejudiced by the
withholding of the tax on royalty payment. Thus, herein petitioner SMART is not the proper
party-in-interest in this case. Clearer still, it is not entitled to the reliefs of the treaty provision as
it is not a Malaysian Company entitled to privileges under the treaty.
8.
Assuming in grantia arguenti that petitioner is the proper party in interest, it
cannot rely its claim for refund on the treaty provisions:
a.
Petitioner failed miserably to establish that what were paid were business profits.
Assuming that the payment for services rendered are not royalty payments, petitioner still
failed to prove that what were remitted to Prism were business profits. Petitioner cannot rely on
implications that since the payments were not royalty payments, they are business profits and
thus covered by the treaty. An exemption from common burdens cannot he made to rely on
vague implications (Asiatic Petroleum Co. {P.I.} v. Llanes, 49 Phil. 466),
b.
The interpretation by the Organization for Economic Cooperation and
Development Committee on Fiscal Affairs through the Technical Advisory Group on Treaty
Characterization of Electronic Commerce Payments is likewise not the authority on the matter.
In a dispute between the petitioner and respondent, petitioner cannot rely on the construction
of international agreements, which are not treaty provisions between the Philippines and
Malaysia. These international agreements are not parts of the law of the land. In this claim for
refund the governing authority is the ordinary meaning of royalties, as this is the one being
used by the Philippine Government for taxation purposes. Royalties as generally used in this
jurisdiction mean 'payment of any kind received as a consideration of the use of, or the right to
use, any copyright of literary, artistic or scientific work including . . . any patent, trademark,
design or model, plan, secret formula or process, or for the use of, or the right to use,
industrial, commercial or scientific equipment, or for information concerning industrial,
commercial or scientific experience'. From this general definition of royalties, it is perfectly lucid
that the payments made by petitioner to Prism are royalty payments. This position is
buttressed by recent Revenue Memorandum Circular No. 77-2003 issued by the respondent.
Thus, petitioner could not be deemed to be in error in its payment of the amount being claimed
for refund in this petition.
9.
Petitioner's claim for refund is subject to administrative investigation/examination
by the respondent. However, due to its act of belated filing, one day before the expiry of the
two-year period, it deprived the respondent of reasonable opportunity to act on its claim for
refund.
10. In an action for refund, the burden of proof is on the taxpayer to establish its right
to refund. Failure to sustain the burden is fatal to the claim for refund/credit. This is so because
exemptions from tax are highly disfavored in law, and he who claims exemption must be able
to justify his claim by the clearest grant of organic or statutory law.
11. Claims for refund are construed strictly against the claimant, for the same
partake the nature of exemption from taxation.'
Petitioner presented Rina Lorena R. Manuel and Jose Crisanto B. Magno, as
witnesses, and submitted its Formal Offer of Evidence, which was admitted by the Court,
subject to a final evaluation as regards their probative value.
On the other hand, at the hearing on May 18, 2005, respondent manifested that he will
no longer present evidence, and moved that the parties be given thirty (30) days therefrom
within which to file their simultaneous memoranda, which the Court granted.
Both parties having complied thereto, the case was deemed submitted for decision."

The Ruling of the Court in Division

In a Decision promulgated on February 23, 2006, the Court in Division ruled that as the
withholding agent, petitioner Smart Communications, Inc. was the proper party to file the claim
for refund.
As regards the SDM Agreement between petitioner and Prism, the Court in Division
found that payments to Prism for the installation of the SDM are royalties, as contemplated
under Article 12, paragraph 4 of the RP-Malaysia Tax Treaty 1 since the SDM remained to be
the intellectual property of Prism. Therefore, the same are taxable as such.
With respect to the payments to Prism relative to the Channel Manager Agreement
("CM Agreement") and the SIM Applications Agreement, the Court in Division held that such
payments are not royalties. They are business profits within the meaning of the RP-Malaysia
Tax Treaty, which are taxable in the Philippines only if they are attributable to a permanent
establishment in the Philippines, pursuant to Article 7 in relation to Article 5 of the said Treaty.
Considering that petitioner was able to prove that Prism did not establish a permanent
establishment in the Philippines, then said payments are not taxable.
Since petitioner was able to show that it remitted and paid the amount of
P7,008,840.43 representing final withholding taxes and considering that only the amount of
$236,000.00 representing payment for the SDM Agreement is taxable under the Treaty, the
Court in Division declared that petitioner was entitled to a refund in the reduced amount of
P3,989,456.43.
The fallo of the aforementioned Decision reads as follows:
"WHEREFORE, premises considered, the instant petition is hereby partially
GRANTED. Accordingly, respondent Commissioner of Internal Revenue is hereby ORDERED
to REFUND or ISSUE a TAX CREDIT CERTIFICATE to petitioner Smart Communications, Inc.
in the amount of P3,989,456.43, representing overpaid final withholding taxes for the month of
August 2001.
SO ORDERED."
Smart Communications, Inc. filed a Motion for Partial Reconsideration of the
aforementioned Decision of the Court in Division on March 22, 2006. The Commissioner of
Internal Revenue likewise filed his Motion for Partial Reconsideration on March 21, 2006.
In a Resolution dated July 18, 2006, the Court in Division denied both Motions for
Reconsideration for lack of merit.
Hence, both respondent Commissioner of Internal Revenue and petitioner Smart
Communications, Inc. filed their respective Petitions for Review with the Court of Tax Appeals
En Banc (hereafter "this Court") on September 7, 2006. The appeal by the Commissioner of
Internal Revenue was docketed as C.T.A. EB No. 206 while Smart Communications, Inc.'s
appeal was docketed as C.T.A. EB No. 207. In a Resolution dated February 8, 2007, this Court
ordered the consolidation of C.T.A. EB No. 206 with C.T.A. EB No. 207. Considering that both
parties are petitioners and respondents at the same time, they shall be referred to by their
respective names throughout the rest of this Decision. Thus, the term "Commissioner" shall
refer to the Commissioner of Internal Revenue and the name "Smart" shall refer to Smart
Communications, Inc.
The Issues
The following are the issues raised by the parties in their respective Petitions for
Review:
C.T.A. EB No. 206

Commissioner of Internal Revenue vs. Smart Communications, Inc.

1.
WHETHER OR NOT RESPONDENT IS ENTITLED TO A REFUND EVEN IF IT
BROUGHT THE CLAIM FOR REFUND, INDEPENDENT OF, AND WITHOUT AUTHORITY,
FROM THE TAXPAYER FROM WHOM THE TAXES WERE WITHHELD;
2.
WHETHER OR NOT THE PAYMENTS MADE BY PETITIONER TO PRISM ARE
CONSIDERED ROYALTY REMITTANCES SUBJECT TO FINAL WITHHOLDING TAX, AND
ARE THUS, NOT COVERED BY THE TAX TREATY PROVISIONS ON BUSINESS PROFITS;
AND
3.
WHETHER OR NOT A TAX CREDIT CERTIFICATE CAN BE ISSUED IN THE
NAME OF RESPONDENT, DESPITE THE FACT THAT IT IS NOT THE PARTY
ECONOMICALLY PREJUDICED BY WITHHOLDING OF THE TAXES.
C.T.A. EB No. 207
Smart Communications, Inc. vs. Commissioner of Internal Revenue
1.
THE SECOND DIVISION OF THE CTA ERRED IN PARTIALLY DENYING THE
PETITIONER'S CLAIM FOR REFUND IN THE AMOUNT OF FIFTY NINE THOUSAND US
DOLLARS (US$59,000.00) EQUIVALENT TO THREE MILLION NINETEEN THOUSAND
THREE HUNDRED EIGHTY FOUR PESOS (P3,019,384.00) REPRESENTING OVERPAID
25% FINAL WITHHOLDING TAX ON PAYMENT MADE BY PETITIONER TO PRISM ON THE
SDM AGREEMENT FOR THE MONTH OF AUGUST 2001; AND
2.
THE SECOND DIVISION OF THE CTA ERRED IN RULING THAT PAYMENTS
MADE BY PETITIONER IN RESPECT OF THE SDM AGREEMENT WERE CONSIDERED AS
ROYALTIES INSTEAD OF PAYMENTS FALLING UNDER THE RULES OF BUSINESS
PROFITS.
THE COMMISSIONER'S ARGUMENTS IN C.T.A. EB No. 206
The Commissioner avers that Smart, in all its representations before the BIR, and this
Court, is prosecuting the claim for refund in its own name, and never in behalf of its supposed
principal, Prism. In addition, there is no indication that the economic incidents of the refund will
redound to Prism. The cases cited by the Court in Division are inappropriate as the withholding
agents therein are also wholly owned subsidiaries of the payees. Thus, in said cases, the
economic incidence of the refund will ultimately redound to the benefit of the payees of the
remittances. In the instant case, Smart and Prism are unrelated. Their relationship was
occasioned only by the contracts between them. It was thus erroneous for the Court in Division
to rule that Smart is an agent of Prism for purposes of the prosecution of this claim for refund.
The Commissioner also argues that the claim for refund in the instant case is based on
the provisions of the RP-Malaysia Tax Treaty on royalties and business profits. Thus, it should
be Prism, a Malaysian company, which should be the principal party in the case. Smart can
never bring an action in its own name citing treaty provisions to which it is not entitled.
The Commissioner likewise contends that all the payments made by Smart to Prism
pursuant to the SDM and CM Agreements are in the nature of royalty payments since Prism
retained intellectual property rights over the programs. Hence, such payments are subject to
final withholding tax under the National Internal Revenue Code ("NIRC"), and not as business
profits under the Treaty.
Lastly, the Commissioner posits that since tax refunds are in the nature of tax
exemptions, they are construed strictly against the person or entity claiming the exemption.
Accordingly, Smart has the burden of proof to establish the factual and legal bases of its claim

for refund, as well as its right to file the subject claim for refund as a party in interest. As Smart
fell short of proving its entitlement to the refund, its claim should be denied in its entirety.
SMART'S ARGUMENTS IN C.T.A. EB No. 207
Smart asserts that the payments it made to Prism pursuant to the SDM Agreement
should not be considered royalties but business profits using the criteria set by paragraph 29 of
the OECD Commentary, 2 to wit:
"29. The Group recognizes that the distinction between payments for services
rendered and payments for the supply of know-how may sometimes raise practical difficulties.
It considers that the following criteria, developed in a ruling by the Australian Tax Office, may
be useful in that respect.

under a contract for the supply of know-how:

(a) a "product" (i.e. knowledge, information, technique, formula, skills, process, plan,
etc.) which has already been created or developed or is already in existence is transferred;
(b) the product which is the subject of the contract is transferred for use by the buyer
(i.e. it is supplied); and
(c) except in the case of a disposition where the seller divests himself completely of
any further interest in the product, the property in the product remains with the seller. All that is
obtained by the buyer is the right to use the product. Subject to the terms of the contract, the
seller retains the right to use the product himself and to transfer it to others.

by contrast, in a contract involving the performance of services:

(d) the contractor undertakes to perform services which will result in the creation,
development, or the bringing into existence of a product (which may or may not be know-how);
(e) in the course of developing a product, the contractor would apply existing
knowledge, skill and expertise there is not a transfer (i.e. supply) of know-how from the
contractor to the buyer as such but a use by the contractor of his knowledge for his own
purposes; and
(f)
the product created as a result of the services belongs to the buyer for him to use
without having to obtain any further rights in respect of the product. . . ."
Based on the foregoing, Smart submits that payments it made pursuant to the SDM
Agreement are payments for a contract for services, viz:
"(a) the contractor (Prism) undertakes to perform services which will result in the
creation, development or the bringing into existence of a product, i.e., SDM Application, which
is software application (see Annex 'N');
(b) in the course of developing a product, the contractor (Prism) would apply existing
knowledge, skill and expertise there is not a transfer (i.e. supply) of know-how from the
contractor to the buyer as such but a use by the contractor of his knowledge for his own
purposes (see Annex 'N'); and
(c) the product created as a result of the services belongs to the buyer (Smart) for
him to use without having to obtain any further rights in respect of the product. However, in the
course of rendering services, the contractor would, in most cases, also produce as a byproduct a work (e.g. plan, design, specification, report, etc., which could contain knowledge,
etc. not otherwise known to the buyer and which may or may not be protected by patents,
etc..) in which copyright subsist. Unless specifically agreed otherwise, the contractor is the
owner of such copyright and the buyer or any other person is, by law, precluded from using the
property in which the copyright subsists for any purpose other than the purpose for which it
was originally designed without first obtaining the approval of the contractor. This would not

alter the nature of the contract which would remain one for the performance of services (see
Annex 'N')."
Thus, considering that the payment to Prism is not in the nature of "royalties," such
payment constitutes "business profits," which is taxable in the Philippines only if it is
attributable to a permanent establishment in the Philippines pursuant to Article 7 of the RPMalaysia Tax Treaty. Since Prism does not maintain any permanent establishment in the
Philippines, and considering further that its consultants stayed in the Philippines for less than
six (6) months, the payment to Prism is therefore not subject to Philippine taxes.
Smart likewise asseverates that pursuant to OECD Commentaries, 3 it can be
concluded that payments made for partial transfer of rights would represent royalties in very
limited circumstances, such as, where the transferor is the author of the software and placed
part of his rights at the disposal of a third party to enable the latter to exploit the software itself
commercially. However, if the acquisition of the software is for the personal or business use of
the purchaser, the payment will be considered as commercial income subject to the rules on
Article 7 on business profits. Moreover, where the payments are made for the transfer of full
ownership, the payment cannot represent royalty and the provisions on Article 12 (Royalties)
are not applicable. In the present case, the acquisition by Smart of the SDM is for its internal
business use, not for commercial distribution or exploitation and there is full transfer of
ownership. Hence, payments made for its acquisition should not be considered as royalties,
but instead commercial income.
Lastly, Smart opines that based on Revenue Memorandum Circular ("RMC") No. 442005, even assuming without admitting that payments for SDM are considered as royalties, the
Court in Division failed to consider that a portion of such payment for the customization of such
SDM is payment for provision of services rendered. Hence, such portion should be treated as
income from services and taxable as such. CSTDEH
The Ruling of the Court En Banc
The petition is bereft of merit.
A withholding agent
can file a claim for
refund
This Court shall first discuss the issue of whether Smart is the proper party in interest
to claim the subject refund.
The Court in Division, in holding that Smart is a party in interest, made the following
disquisition:
"The issue of whether or not a withholding agent is the proper party to claim for the
refund of overpayment of withholding tax is not novel, as the issue had, in a number or so of
cases, been previously ruled upon by the Supreme Court.
In Commissioner of Internal Revenue vs. Wander Philippines, Inc., 160 SCRA 577, the
Supreme Court said that Wander Philippines, as the Philippine counterpart, is the proper party
who should claim for the refund, and ruled as follows:
'In any event, the submission of petitioner that Wander is but a withholding agent of the
government and therefore cannot claim reimbursement of the alleged overpaid taxes, is
untenable. It will be recalled, that said corporation is first and foremost a wholly owned
subsidiary of Glaro. The fact that it became a withholding agent of the government which was
not by choice but by compulsion under Section 53 (b) of the Tax Code, cannot by any stretch
of the imagination be considered as an abdication of its responsibility to its mother company.

Thus, this Court construing Section 53 (b) of the Internal Revenue Code held that "the
obligation imposed thereunder upon the withholding agent is compulsory." It is a device to
insure the collection by the Philippine Government of taxes on incomes, derived from sources
in the Philippines, by aliens who are outside the taxing jurisdiction of this Court (Commissioner
of Internal Revenue vs. Malayan Insurance Co., Inc., 21 SCRA 944). In fact, Wander may be
assessed for deficiency withholding tax at source, plus penalties consisting of surcharge and
interest (Section 54, NLRC). Therefore, as the Philippine counterpart, Wander is the proper
entity who should claim for the refund or credit of overpaid withholding tax on dividends paid or
remitted by Glaro.'
In Commissioner of Internal Revenue vs. Procter and Gamble Philippine Manufacturing
Corporation, 204 SCRA 384-387, the Supreme Court, in its Resolution granting Procter and
Gamble Philippine Manufacturing Corporation's Motion For Reconsideration and setting aside
the decision of the Second Division promulgated on April 15, 1988, ruled that a withholding
agent is properly regarded as a 'taxpayer' within the meaning of Section 309 of the NIRC, and
is impliedly authorized to file the claim for refund and the suit to recover such claim, as follows:
xxx
xxx
xxx
Then, in Commissioner of Internal Revenue vs. The Court of Tax Appeals, G.R. No.
93901, February 11, 1992, which involved the issue of whether or not Hawaiian Philippines Co.
has legal capacity to file a claim for refund of withholding tax on behalf of its non-resident U.S.
stockholders, the Supreme Court ruled that a withholding agent has sufficient legal interest to
bring an action to recover tax overpayment.
The foregoing rulings treated the withholding agent as a taxpayer in view of its direct
and independent liability under the withholding tax system. Pursuant to the aforequoted
decisions of the Supreme Court, the withholding agent is the agent of both the government and
the taxpayer. With respect to the filing of the necessary income tax return and the actual
payment of the tax which includes the authority to file a claim for refund and to bring an action
for recovery of such claim, he is the agent of the taxpayer, and with respect to the collection
and/or withholding of the tax, he is the Government's agent (Principles and Remedies, 2nd ed.
2005, pp. 190-191, by Justice Japar B. Dimaampao).
Consequently, We rule that herein petitioner, as the withholding agent, is the proper
party to file the present claim for refund."
The Commissioner's contention that the aforementioned cases cited by the Court in
Division are inapplicable to this case as the withholding agents therein are wholly owned
subsidiaries of the payees, whereas in this case, Smart and Prism are unrelated corporations,
is untenable.
Section 2, Rule 3 of the 1997 Rules of Civil Procedure defines a party in interest as
follows:
"SEC. 2.
Parties in interest. A real party in interest is the party who stands to be
benefited or injured by the judgment in the suit, or the party entitled to the avails of the suit.
Unless otherwise authorized by law or these Rules, every action must be prosecuted or
defended in the name of the real party in interest."
Smart, a party to the subject Agreements with Prism, is the resident withholding agent
and payor in control of payment that shall be responsible for payments that may arise in
relation to said Agreements pursuant to Section 57 (A) of the National Internal Revenue Code
("NIRC") of 1997, as amended, considering that Prism is a non-resident foreign corporation.
Moreover, under Section 2.57 (A) in relation to Section 57-1 (I) (I) of Revenue Regulations No.

2-98, as amended, implementing said provision of law, Smart, as the withholding agent, has
the responsibility to withhold and remit said final withholding tax to the Philippine government.
Section 2.57 (A) provides:
"SECTION 2.57. Withholding of Tax at Source
(A) Final Withholding Tax. Under the final withholding tax system the amount of
income tax withheld by the withholding agent is constituted as a full and final payment of the
income tax due from the payee on the said income. The liability for payment of the tax rests
primarily on the payor as a withholding agent. Thus, in case of his failure to withhold the tax or
in case of under withholding, the deficiency tax shall be collected from the payor/withholding
agent. The payee is not required to file an income tax return for the particular income.
"(Emphasis supplied)
Based on the foregoing, failure on the part of the withholding agent to withhold and
subsequently remit said final tax would constitute liability on the instituted withholding agent, in
this case, Smart. Given the said responsibility and liability to withhold and remit said tax, there
is legal basis to make the said withholding agent a real party in interest entitled to a refund for
erroneously withheld tax.
While it is true that Smart and Prism are unrelated entities, such circumstance does not
affect the status of Smart as a party in interest in the instant claim for refund. It is a party in
interest based on its direct and independent liability under the withholding tax system, as
correctly pointed out by the Court in Division.
Royalties vs. Business Profits
At this juncture, this Court will delve into the characterization of the payments under the
three (3) Agreements between Smart and Prism. Necessarily, since Prism is a resident of
Malaysia, this Court shall refer to the pertinent provisions of the RP-Malaysia Tax Treaty, viz:
"Article 7
BUSINESS PROFITS
1.
The profits of an enterprise of a Contracting State shall be taxable only in that
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 the other State but only on so much thereof as is
attributable to that permanent establishment. . . ."
"Article 5
PERMANENT ESTABLISHMENT
1.
For the purposes of this agreement, the term 'permanent establishment' means a
fixed of business in which the business of the enterprise is wholly or partly carried on.
2.
The term 'permanent establishment' shall include especially:
(a) a place of management;
(b) a branch;
(c) an office;
(d) a factory;
(e) a workshop;
(f)
a mine, an oil or gas well, a quarry or other place of extraction of natural
resources including timber or other forest produce;
(g) a farm or plantation; a building site or construction, installation or assembly
project which exists for more than 6 months. DcaCSE
xxx
xxx
xxx

4.
An enterprise of a Contracting State shall be deemed to have a permanent
establishment in the other Contracting State if:
(a) it carries on supervisory activities in that other State for more than 6 months in
connection with a construction, installation or assembly project which is being undertaken in
that other State; or
(b) substantial equipment is in that other State being used or installed by, for or
under contract with, the enterprise."
"Article 12
ROYALTIES
1.
Royalties arising in a Contracting State and paid to a resident of the other
Contracting State may be taxed in that other State, if such resident is the beneficial owner of
the royalties.
2.
Such royalties may also be taxed in the contracting State in which they arise, and
according to the laws of that State. However, if the recipient is the beneficial owner of the
royalties:
a.
...
b.
in the case of the Philippines:
the tax so charged shall not exceed:
(i)
15 per cent of the gross amount of the royalties where the royalties are paid by a
registered enterprise as well as royalties defined in paragraph 4(a)(ii); and
(ii)
25 per cent of the gross amount of the royalties in all other cases.
xxx
xxx
xxx"
Under the foregoing treaty provisions, if the service fees paid by Smart to Prism are
business profits and not royalties and Prism carries on business in the Philippines through a
permanent establishment, such profits may be taxed in the Philippines but only so much of
them as are attributable to such permanent establishment. In other words, if the income is in
the form of business profits, the same will only be subject to Philippine income tax if a
permanent establishment is created in the Philippines. Conversely, if there is no permanent
establishment, there will he no tax consequences in the Philippines.
Hence, it is essential to differentiate between business profits and royalties. Under
Article 12 (paragraph 4) of the RP-Malaysia Tax Treaty, the term "royalties" is defined as
follows:
"4. (a) The term 'royalties' as used in this Article means payments of any kind
received as consideration for:
(i)
the use of, or the right to use, any patent, trade mark, design or model, plan,
secret formula or process, any copyright of literary, artistic or scientific work, or for the use of,
or the right to use, industrial, commercial, or scientific equipment, or for information concerning
industrial, commercial or scientific experience;
(ii)
the use of, or the right to use, cinematograph films, or tapes for radio or television
broadcasting."
The treaty defines "royalties" to include "payment of any kind received as a
consideration for information concerning industrial, commercial or scientific experience."
In relation thereto, the Bureau of Internal Revenue ("BIR") has consistently applied the
rule that in order for service fees to be considered as royalties, there must he a transfer in the
Philippines of scientific, technical, industrial or commercial knowledge or information or other
property where the payee has proprietary interest in the property giving rise to the income. 5

Such rule has also been recognized by the Honorable Court of Tax Appeals. 6 Moreover, the
International Tax Affairs Division ("ITAD") of the BIR explained in one ruling that such
knowledge or information refers to the concept of "know-how." 7 To quote:
"According to the commentaries of the ORGANIZATION FOR ECONOMIC
COOPERATION AND DEVELOPMENT (OECD) Committee on Fiscal Affairs on the Model Tax
Convention [par. 11 and 12, Commentary on Article 12 (Royalties), 2003, p. 175], such
information alludes to the concept of 'know-how'. The definition adopted by the said Committee
is, 'all the undivulged technical information, whether capable of being patented or not, that is
necessary for the industrial reproduction of a product or process, directly and under the same
conditions, inasmuch as it is derived from experience, know-how represents what a
manufacturer cannot know from mere examination of the product and mere knowledge of the
progress of technique.' In a know-how contract, one of the parties agrees to impart to the other,
so that he can use them for his own account, his special knowledge and experience which can
remain unrevealed to the public. (BIR Ruling DA-ITAD No. 57-05 dated June 17, 2005)"
It is settled that the interpretation of an administrative government agency like the BIR,
which is tasked to implement a statute, is accorded great respect and ordinarily controls the
construction of the courts. The reason behind this rule was explained in Nestle Philippines, Inc.
vs. Court of Appeals in this wise: "The rationale for this rule relates not only to the emergence
of the multifarious needs of a modern or modernizing society and the establishment of diverse
administrative agencies for addressing and satisfying those needs; it also relates to the
accumulation of experience and growth of specialized capabilities by the administrative agency
charged with implementing a particular statute." 8
On the concept of business profits, generally speaking, such profits (or industrial and
commercial profits) include payments for the supply of goods, for the supply of services, and
for the lease of personal properties. In this regard, the Court of Tax Appeals has ruled as
follows: 9
"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."
Guided by the foregoing discussion, this Court shall proceed to examine the provisions
of each of the 3 Agreements between Smart and Prism.
Payments under the CM
Agreement are business
profits under the Treaty
Paragraphs 1 and 1.4 of the Programming Services (Schedule A) of the CM Agreement
10 provide:
"1. CHANNEL MANAGER
The Channel Manager ('CM') will provide the content interface to the WIB via DP5.
There are two CM platforms defined. One will provide ZED functionality and the other would
provide Mobile Banking and Smart Money transactions to the SIM.
The ZED version of CM will be delivered first and must be in place when the first SIMs
are released to the market. The Mobile Banking and Smart Money applications are hidden
when the SIM is released and as such, the CM that enables these services will he provided
after the ZED CM.

The ZED Channel Manager will be developed as Enterprise Java Beans ('EJB') to be
run on the Netscape iPlanet application server. A set of servlets will receive the SIM requests
via DP5 and then hand the transaction request to the EJB components. The SMART
Money/MBS Channel Manager will be developed under the PHP development environment.
xxx
xxx
xxx
1.4 Intellectual Property Rights (IPR)
The IPR of all components of the CM belong to the Client with the exception of the
following components, which are provided, without technical or commercial restraints or
obligations:

ConfigurationException.java

DataStructures (DbLinkedList.java, DblListNode.java, List

EmptyException.java,ListFullException.java, ListNodeNotFoundException.java,
QueueEmptyException.java, QueuFullException.java, QueueList.java, QueuListEx.java, and
QueueNodeNotFoundException.java)

Field MappedObject.java

LogFileEx.java

Logging (BaseLogger.java and Logger.java)

PrismGeneric Exception.java

PrismGenericObject.java

ProtocollBuilders/CIMD2 (Alive.java, Base MessageData.java,

DeliverMessage.java, Login.java, Logout.java, Nack.java, SubmitMessage.java,

TemplateManagement (FileTemplateDataBag.java, TemplateDataBag.java,

TemplatgeManagerExBag.java, and TemplateParserExBag.java)

Template Manager.class

TemplateServer.class

TemplateServer$RequestThread.class

Template Server_skel.class

TemplateServer_stub.class

Template Service.class

Prism Crypto Server module for PHP4

xxx
xxx
xxx"
(Emphasis and italics supplied)
According to the Court in Division, under the CM Agreement, Prism applied existing
knowledge, skills and expertise in the development of the CM. The product or software created
as a result of the services belongs to Smart. There is no existing product that Smart is availing
from Prism. Thus, the Court in Division concluded that payments to Prism with respect to the
CM Agreement are payments for professional services which are considered business profits
within the meaning of the RP-Malaysia Tax Treaty.
This Court agrees with the said ruling of the Court in Division. Moreover, the cited
provisions of the CM Agreement clearly show that Prism does not have any interest or right to
whatever is the result of services performed. The results of all of the services rendered by
Prism are owned by Smart. Prism has no proprietary interest or right to them. Furthermore, the
payments by Smart to Prism are business profits, since there is nothing in the CM Agreement
which would require the transfer into the Philippines of technology, equipment or other property

where Prism has proprietary interest or would otherwise permit Prism to impart to Smart its
special knowledge and experience which remain unrevealed to the public.
As previously discussed, such business profits will be taxable in the Philippines if it is
attributable to a permanent establishment in the Philippines. This Court concurs with the
findings of the Court in Division that Smart was able to show that Prism has no permanent
establishment in the Philippines based on the Completion of Work Certificate No. SM0102 11
relating to the CM Agreement which showed that the consultants and employees of Prism
stayed in the Philippines from July 23, 2001 to November 2, 2001 or for less than six (6)
months from the time of the engagement until the CM Agreement was completed.
Consequently, payments under the CM Agreement are not taxable in the Philippines.
Payments under the SIM
Applications Agreement
are business profits
under the Treaty
Paragraphs 1 and 1.3 of the Programming Services (Schedule A) of the SIM
Applications Agreement 12 provide:
"1. SMART MONEY AND MOBILE BANKING SERVICE SIM APPLICATIONS
In order to deliver the advanced level of SIM application that the Client requires in the
timeframes requested, Prism will perform the WIB script development on the SIM, concluding
with the 64k WIB script code referred to later.
The activities to be performed will be:

Proof of concept and demonstration

Several iterations of requirement analyses rapid turnaround prototyping

SIM application development and debugging

Backend simulation development for application requirements refinement,

application testing and functional/technical/performance evaluation for marketing acceptance
sign-off.
1.1 Terms of Reference
The general terms of reference for the SIM Applications are set out below.
xxx
xxx
xxx
1.3 Intellectual Property Rights (IPR)
The Client shall own the IPR for the Specifications and the Source Code for the SIM
Applications. PRISM shall develop an executable compiled code (the 'Executable Version') of
the SIM Applications for use on the aSIMetric card which, however, shall only be for the
Client's use. The Executable Version may not be provided by PRISM to any third parties
without the prior written consent of the Client. It is further recognized that the Client anticipates
licensing the use of the SIM Applications, but it is agreed that no license fee will be charged to
PRISM or to a licensee of the aSIMetrix card from PRISM when SIMs are supplied to the
Client." (Emphasis and italics supplied) ESCTIA
The Court in Division ruled that, under the SIM Applications Agreement, Prism applied
existing knowledge, skills and expertise in the development of the SIM Applications. The
product or software created as a result of the services belongs to Smart. There is no existing
product that Smart is availing from Prism. Thus, the Court in Division concluded that payments
to Prism with respect to the SIM Applications Agreement are payments for professional
services which are considered business profits within the meaning of the RP-Malaysia Tax
Treaty.

This Court concurs with the said ruling of the Court in Division. Moreover, the cited
provisions of the SIM Applications Agreement clearly show that Prism does not have any
interest or right to whatever is the result of services performed. The results of all of the
services rendered by Prism are owned by Smart. Prism has no proprietary interest or right to
them. Furthermore, the payments by Smart to Prism are business profits, since there is
nothing in the SIM Applications Agreement which would require the transfer into the Philippines
of technology, equipment or other property where Prism has proprietary interest or would
otherwise permit Prism to impart to Smart its special knowledge and experience, which remain
unrevealed to the public.
As previously discussed, such business profits will be taxable in the Philippines if it is
attributable to a permanent establishment in the Philippines. This Court agrees with the
findings of the Court in Division that Smart was able to show that Prism has no permanent
establishment in the Philippines based on the Completion of Work Certificate No. SM0101 13
relating to the SIM Applications Agreement, which shows that the consultants and employees
of Prism stayed in the Philippines from June 1, 2001 to July 27, 2001 or for a period of less
than six (6) months from the time of the commencement of the engagement until the SIM
Applications Agreement was completed. Consequently, payments under the SIM Applications
Agreement are also not taxable in the Philippines.
Payments under the SDM
Agreement are royalties
under the Treaty
Paragraph 1 of the Programming Services Schedule A of the SDM Agreement
provides: 14
"1. SERVICE DOWNLOAD MANAGER
The Service Download Manager ("SDM") provides the functionality to manage WIB
applications on the SIM. It allows application to be downloaded to the SIM in a queue fashion
and integrates with Smart Trust's DP5 platform in this regard. It also performs the required
cryptographic operations on the download instructions prior to sending the message to the
SIM. The SDM is the intellectual property of PRISM.
1.1 SDM Functions
The functions that the SDM perform include:

Updating a database of the available applications that can be downloaded to a

SIM

Updating a database of the current status of the SIM with respect to installed
applications, available space for applications etc.

Providing a SIM update service for non-application updates to the SIM eg. List
updates

Formatting the Prism SIM specific application update WML to byte code

Logging all SIM updates performed either successful or unsuccessful

Queuing all requested SIM updates and ensuring that all SIM update requests
are attempted within a specific period of time
1.2 Deliverables
The deliverables to the Client, which shall also be subject to Acceptance Testing
as set out in Clause (3), shall comprise the following:

Successful User Acceptance Testing ("UAT") of all abovementioned functions

Delivery of SDM API specifications


1.3

Delivery of SDM runtimes with installation documentation

Intellectual Property Rights (IPR)
The SDM shall be installed by PRISM, including the SDM Libraries, the IPR of
which shall be retained by PRISM. PRISM, however, shall provide the Client the APIs for the
SDM at no cost to the Client. The Client shall be permitted to develop programs to interface
with the SDM or the SDM Libraries, using the related APIs as appropriate." (Emphasis and
italics supplied)
Relative to the foregoing, the Court in Division ruled as follows:
"Under the above provision of the Programming Services, it is clear that the SDM is the
intellectual property of PRISM. It further provides that the SDM shall be installed by PRISM,
including the SDM Libraries, the intellectual property right of which shall be retained by PRISM.
Petitioner availed an already existing program "SDM" from PRISM, contrary to its
statement that PRISM is to undertake to perform service which will result in the creation,
development or bringing into existence of a product, like SDM. Thus, payments to PRISM for
the installation of the SDM are clearly royalties and are therefore taxable." TADcCS
This Court affirms the aforementioned ruling of the Court in Division. It bears stressing
that the cited provisions of the SDM Agreement evidently reveal that Prism has a proprietary
interest or right to the SDM as it retains the intellectual property rights thereto. For this reason,
the payments by Smart to Prism are royalties, since the SDM Agreement required the transfer
into the Philippines of technology, equipment or other property where Prism has proprietary
interest and permitted Prism to impart to Smart its special knowledge and experience which
remain unrevealed to the public.
Smart cited the following criteria recommended by the OECD Commentaries in
distinguishing between payments for services which constitute business profits and payments
for know-how which constitute royalties:
"29. The Group recognizes that the distinction between payments for services
rendered and payments for the supply of know-how may sometimes raise practical difficulties.
It considers that the following criteria, developed in a ruling by the Australian Tax Office, may
be useful in that respect.

under a contract for the supply of know-how:

(a) a "product" (i.e. knowledge, information, technique, formula, skills, process, plan,
etc.) which has already been created or developed or is already in existence is transferred;
(b) the product which is the subject of the contract is transferred for use by the buyer
(i.e. it is supplied); and
(c) except in the case of a disposition where the seller divests himself completely of
any further interest in the product, the property in the product remains with the seller. All that is
obtained by the buyer is the right to use the product. Subject to the terms of the contract, the
seller retains the right to use the product himself and to transfer it to others."

by contrast, in a contract involving the performance of services:

(d) the contractor undertakes to perform services which will result in the creation,
development, or the bringing into existence of a product (which may or may not be know-how);
(e) in the course of developing a product, the contractor would apply existing
knowledge, skill and expertise there is not a transfer (i.e. supply) of know-how from the
contractor to the buyer as such but a use by the contractor of his knowledge for his own
purposes; and

(f)
the product created as a result of the services belongs to the buyer for him to use
without having to obtain any further rights in respect of the product. . . ." (Emphasis supplied)
Applying the foregoing criteria, this Court finds that payments made by Smart pursuant
to the SDM Agreement are indeed royalties:
(a) a "product" i.e., the SDM which has already been created, developed and is
already in existence is transferred by Prism to Smart;
(b) the SDM which is the subject of the contract is transferred for use by Smart (i.e.,
it is supplied); and
(c) the property in the SDM remains with the Prism. All that is obtained by Smart is
the right to use the product. ICTcDA
Smart also relied on the provisions of RMC No. 44-2005 in arguing that assuming that
payment for SDM is considered as royalties, a portion of such payment for the customization of
such SDM is payment for provision of services rendered. Hence, such portion should be
treated as income from services and taxable as such.
RMC No. 44-2005 15 (Taxation of Payments of Software) dated September 1, 2005
took effect on September 8, 2005 16 and its effectivity clause provides that it shall cover
software payments paid or payable starting said effectivity date. It is apparent therefore, that
RMC No. 44-2005 cannot be applied to the payment under the SDM Agreement as based on
the records, the same is dated May 25, 2001 and the fee pursuant thereto was paid in August
2001.
In fine, this Court finds no compelling reason to reverse the assailed Decision
promulgated on February 23, 2006 and the Resolution dated July 18, 2006.
WHEREFORE, the instant petition is hereby DISMISSED. Accordingly, the assailed
Decision and Resolution are hereby AFFIRMED.
SO ORDERED.
(SGD.) LOVELL R. BAUTISTA
Associate Justice
Ernesto D. Acosta, P.J., Juanito C. Castaeda, Jr., Erlinda P. Uy, Caesar A. Casanova
and Olga Palanca-Enriquez, JJ., concur.
Footnotes
1. Agreement between the Government of the Philippines and the Government of
Malaysia for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with
Respect to "Taxes on Income, January 1, 1985. HacADE
2. The Organization for Economic Cooperation and Development ("OECD")
Committee on Fiscal Affairs through the Technical Advisory Group (TAG) on Treaty
Characterization of Electronic Commerce Payments released a document describing 26
categories of e-commerce transactions and presenting the preliminary conclusions of the
Group, and their analysis, on how the payments arising from these transactions should be
classified for tax treaty purposes.
3. The Commentaries of the Organization for Economic Cooperation and
Development (OECD) Committee on fiscal Affairs on the Model Tax Convention, par. 12-17,
Commentary on Article 12 (Royalties), 1998, pp. 152-153.
4. Unilever Philippines, Inc. v. Commissioner of Internal Revenue, C.T.A. Case No.
6517, July 26, 2006.
5. BIR Ruling No. 036-90 dated March 27, 1990, BIR Ruling No. [DA-148-98] dated
April 20, 1998, and BIR Ruling No. [DA-037-04] dated February 2, 2004.

6. Commissioner of Internal Revenue v. Cyanamid Philippines, Inc., CA-G.R. SP

No. 39933, February 4, 1999.
7. DA ITAD BIR Ruling No. 056-06 dated May 22, 2006.
8. 203 SCRA 504 [1991].
9. Philippine Refining Co., Inc. v. Commissioner of Internal Revenue, CTA Case No.
2872, January 15, 1986 citing Ingram vs. Bowers, 5 F 2d 65 and Oppenhein vs. Commissioner
of Internal Revenue, 31 BTA 563.
10. Pages 251 to 252, CTA Records, CTA Case No. 6782.
11. Exhibit "N'', page 276, CTA Records, CTA Case No. 6782.
12. Pages 270 to 271, Ibid.
13. MISSING
14. MISSING
15. This RMC substantially amended RMC No. 77-2003 (Classification of Payments
for Software For Income Tax Purposes) which mandated the observance of its provisions
regarding the taxation of software payments made on November 18, 2003 up to September 7,
2005.
16. DA-ITAD BIR Ruling No. 17-07 dated February 9. 2007.
December 7, 2015
ITAD BIR RULING NO. 335-15
Article 7 Business Profits, Philippines-Canada tax treaty
CalEnergy International Services, Inc.
24th Floor, 6750 Building
Ayala Avenue
1226 Makati City
Attention: Trinity S. Gatuz
Vice President
Gentlemen :
This refers to your tax treaty application ("TTRA") filed on June 11, 2013 requesting
confirmation that service fees to be paid by CalEnergy International Services, Inc. (CalEnergy)
to KAWA Engineering LTD. (KAWA) are exempt from income tax pursuant to the Convention
between the Government of the Republic of the Philippines and the Government of Canada
with respect to Taxes on Income, ("Philippines-Canada tax treaty"). EATCcI
It is represented that KAWA is a non-resident foreign corporation organized and
existing under the laws of Canada with principal address at Suite 400, 510 West Hastings St.,
Vancouver, Canada V6B 1D8; that it is not registered as a corporation or partnership in the
Philippines per certificate of non-registration issued by the Securities and Exchange
Commission on May 16, 2013; and that CalEnergy is a regional operating headquarters duly
organized and existing under the laws of the Republic of the Philippines with office address at
24th Floor, 6750 Building, Ayala Avenue, Makati City.
It is also represented that on May 2, 2013, CalEnergy entered into a Service
Agreement (agreement) with KAWA; that KAWA agreed to provide services in identifying
potential projects for investment in South East Asia, Asia and elsewhere that is considered
acceptable to CalEnergy; that for and in consideration of the services to be rendered by
KAWA, CalEnergy shall pay the total service fee based on the hourly rates indicated in 2013

Rate Sheet of KAWA 1 and in any amendments as may subsequently be agreed upon by both
parties; that CalEnergy shall pay KAWA such other fees and expenses as may be approved by
CalEnergy; that the service fees, other fees and expenses shall be payable every month and
not later than thirty (30) days from receipt of the detailed invoice or billing from KAWA for
services rendered the previous month; that under the service agreement KAWA performed due
diligence and consulting services for the review of a potential investment in a hydroelectric
power project located in Myanmar; that these services were rendered by the personnel of
KAWA in Canada and Switzerland; and that there were no actual services performed in the
Philippines based on the certification issued by the Vice President of CalEnergy on May 2,
2014. ISHCcT
Consequently, CalEnergy paid the amount of $58,378.78 on August 13, 2013 to KAWA
for services rendered in Canada and Switzerland under its contract for the provision of due
diligence and other consulting services to CalEnergy.
It is further represented, per Certification issued by CalEnergy dated June 10, 2013,
that the issue subject of the above request is not under any investigation or on-going audit,
administrative protest, claim for refund or issuance of tax credit certificate, collection
proceedings, or a judicial appeal.
In reply, please be informed that profits derived in the Philippines by a nonresident
corporation, like KAWA in the instant case, are generally subject to tax under Section 28 (B) (1)
of the National Internal Revenue Code of the Philippines of 1997 (Tax Code of 1997), as
amended. It provides, 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 . . . profits and income. Provided, That effective January 1, 2009, the rate
of income tax shall be thirty percent (30%)." (Emphasis supplied)
xxx
xxx
xxx"
However, said income derived by a nonresident foreign corporation may be exempt or
partially exempt pursuant to a treaty obligation to which the Philippine government is bound.
Thus, Section 32 (B) (5) of the Tax Code of 1997, as amended provides, viz.:
"SEC. 32. Gross Income.
xxx
xxx
xxx
(B) Exclusions from Gross Income. The following items shall not be included in
gross income and shall be exempt from taxation under this Title.
xxx
xxx
xxx
(5) Income Exempt under Treaty. Income of any kind, to the extent required by
any treaty obligation binding upon the Government of the Philippines." DHITCc
In the instant case, Article 7 (1) of the Philippines-Canada tax treaty appropriately
applies. It provides:
Article 7
Business Profits
1.
The profits of an enterprise of a Contracting State shall be taxable only in that
State unless the enterprise carries on business in the other Contracting State through a

permanent establishment situated therein. If the enterprise carries on or has carried on

business as aforesaid, the profits of the enterprise may be taxed in the other State but only so
much of them as is attributable to:
a)
that permanent establishment; or
b)
sales of goods or merchandise of the same or similar kind as those sold, or from
other business activities of the same or similar kind as those affected, through that permanent
establishment.
xxx
xxx
xxx
Based on the foregoing, the profits of an enterprise of Canada shall be taxable only in
Canada unless the enterprise carries on business in the Philippines through a permanent
establishment situated therein. If the enterprise carries on business as aforesaid, the profits of
the enterprise may be taxed in the Philippines but only so much of them that is directly or
attributable to that permanent establishment. Applying this to the instant case, the service fees
received by KAWA for services rendered in the Philippines under the Agreement shall be
taxable in the Philippines only if it has a permanent establishment in the Philippines in
connection with the activities giving rise to such income.
In relation thereto, paragraphs 1 and 2 of Article 5 of the treaty define a permanent
establishment as follows:
"Article 5
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" shall include especially:
a)
a place of management;
b)
a branch; CAacTH
c)
an office;
d)
a factory;
e)
a workshop;
f)
a mine, quarry or other place of extraction of natural resources;
g)
a building or construction site or supervisory activities in connection therewith,
where such activities continue for a period more than six months;
h)
an assembly or installation project which exists for more than three months;
i)
premises used as a sales outlet;
j)
a warehouse, in relation to a person providing storage facilities for others.
xxx
xxx
xxx"
Accordingly, since KAWA is not engaged in trade or business in the Philippines to
which an office or a branch is necessary, then KAWA is considered to have no permanent
establishment in the Philippines. This being the case, the consultancy service fees paid by
CalEnergy to KAWA under the agreement shall be exempt from income tax.
This ruling is issued on the basis of the facts as represented. However, if upon
investigation it shall be disclosed that the actual facts are different, then this ruling shall be
without force and effect insofar as the herein parties are concerned.
Very truly yours,
(SGD.) KIM S. JACINTO-HENARES
Commissioner of Internal Revenue
Footnotes

1.

Attachment 2 of the Service Contract X.

June 2, 2015
ITAD BIR RULING NO. 172-15
Articles 5 (Permanent Establishment) and 7 (Business Profits), Philippines-Australia tax
treaty
Fujitsu Philippines, Inc.
2nd Floor, United Life Building
837 A. Arnaiz Avenue
Legaspi Village, Makati City
Attention: Mr. Peter G. Tan
President
Atty. Rodolfo R. Nicolas, Jr., CPA
In-house Legal Counsel
Gentlemen :
This refers to your tax treaty relief application filed on September 20, 2011, requesting
confirmation that service fees paid by Fujitsu Philippines, Inc. ("Fujitsu Philippines") to Fujitsu
Australia Ltd. ("Fujitsu Australia") are exempt from income tax pursuant to the Agreement
between the Government of the Republic of the Philippines and the Government of Australia
for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to
Taxes on Income ("Philippines-Australia tax treaty").
Facts
Fujitsu Australia is a foreign corporation resident of Australia based on the company's
constitution and on Certificate of Residency issued by the Australian Taxation Office on June 9,
2011. It is situated at 2 Julius Avenue, North Ryde, New South Wales, Australia. Fujitsu
Australia is engaged in the sale of computer products (servers storage; client computing
devices; peripheral devices; software; car audio/video systems; air conditioners) and in
providing IT services (application services; business services; managed infrastructure
services; telecommunications; financial services). Fujitsu Australia is not registered as a
corporation or partnership in the Philippines based on the Certification of Non-registration of
Company issued by the Securities and Exchange Commission on September 22, 2011. On the
other hand, Fujitsu Philippines is a domestic corporation situated at 2nd Floor, United Life
Building, 837 A. Arnaiz Avenue, Legaspi Village, Makati City, Philippines. It is engaged in the
sale of computer products (computing products; software; telecommunications;
microelectronics and electronic devices; OEM products) and in providing IT services (systems
integration; IT infrastructure services; managed services; software services). HSAcaE
On November 5, 2010, Fujitsu Philippines and Fujitsu Australia entered into an OffShore Services Agreement where Fujitsu Australia agreed to provide services to Fujitsu
Philippines to be done entirely in Australia. The services consist of two parts. The first part
pertains to Asset Management Coordination and Administration, which includes facilitation of
IT procurement (hardware and software) using existing customer processes and existing
vendor relationships; maintenance of software license tracking register; IT hardware asset
tracking; IT hardware forecasting; and management of the leasing cycle of personal
computers. The second part pertains to Tier 1/Level 2 Onsite Support, which includes
assistance in transition activities requested by Fujitsu Philippines' customers for the

onboarding of new service providers; performance of onsite support in Kuala Lumpur,

Malaysia; assistance in preparing regular reports; and providing recommendations on service
improvements applicable in sustaining support requirements by customers. In consideration,
Fujitsu Philippines will pay service fee to Fujitsu Australia based on the following schedule:
Scope of Work
Period Number of Monthly Fee Total
months
Both parts Nov 5-Dec 31,
1
AUD30,392.71
AUD30,392.71
2010
First part
Jan 1-Dec 31,
12
8,445.92
101,351.04
2011
Second part Jan 1-Dec 31,
12
8,116.00
97,392.00
2011
Based on the Certificate of Completion and Acceptance duly signed by Fujitsu
Philippines and Fujitsu Australia on October 16, 2014, both parties agreed that the services
contemplated in the Agreement were delivered completely by Fujitsu Australia to Fujitsu
Philippines.
Based on a certification issued by Mizuho Corporate Bank Ltd. Manila Branch 1 on
October 28, 2014, Fujitsu Philippines remitted a total of AUD252,834.32 to Fujitsu Australia on
November 10, 2011, December 12, 2011 and February 8, 2012.
Ruling
In reply, please be informed that under Section 28 (B) (1) of the National Internal
Revenue Code of 1997, as amended ("Tax Code"), business profits derived in the Philippines
by a foreign corporation not engaged in trade or business is subject to income tax at the rate of
30 percent, 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
subparagraph 5(c) and (d) above: * Provided, That effective January 1, 2009, the rate of
income tax shall be thirty percent (30%)."
However, under Section 32 (B) (5) of the Tax Code, the profits are exempt or partially
exempt to the extent required by any treaty obligation on the Philippines, to wit:
"SEC. 32. Gross Income.
xxx
xxx
xxx
(B) Exclusions from Gross Income. The following items shall not be included in
gross income and shall be exempt from taxation under this Title:
xxx
xxx
xxx
(5) Income Exempt under Treaty. Income of any kind, to the extent required by
any treaty obligation binding upon the Government of the Philippines."
In this connection, paragraph 1, Article 7 of the Philippines-Australia tax treaty provides
relief to profits derived by an Australian enterprise, to wit:

"Article 7
Business Profits
1.
The profits of an enterprise of one of the Contracting States shall be taxable only
in that 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 the other State, but only so much of them as is
attributable to
a)
that permanent establishment; or"
Under this article, such profits may be taxed in the Philippines if attributable to a
permanent establishment which the enterprise has in the Philippines. On the question of
permanent establishment, paragraphs 1 and 2, Article 5 of the treaty defines this term below:
"Article 5
Permanent Establishment
1.
For the purposes of this Agreement, 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' shall include especially
a)
a place of management;
b)
a branch;
c)
an office;
d)
a factory;
e)
a workshop;
f)
a mine, oil or gas well, quarry or other place of extraction of natural resources;
g)
an agricultural, pastoral or forestry property;
h)
a building site or construction, installation or assembly project, or supervisory
activities in connection therewith where such site, project or activity continues for more than six
months;
i)
premises used as a sales outlet;
j)
a warehouse, in relation to a person providing storage facilities for others;
k)
a place in one of the Contracting States through which an enterprise of the other
Contracting State furnishes services, including consultancy services, for a period or periods
aggregating more than six months in any taxable year or year of income, as the case may be,
in relation to a particular project, or to any project connected therewith."
As defined, a permanent establishment means a fixed place of business through which
the business of an enterprise is wholly or partly carried on, and includes especially, a place of
management, a branch, an office, a factory and a workshop. In the case of furnishing of
services, this activity constitutes a permanent establishment if the concerned enterprise
furnishes services, including consultancy services, in the Philippines for a period or periods
aggregating more than six months in any taxable year or year of income, as the case may be,
in relation to a particular project, or to any project connected therewith.
Accordingly, since Fujitsu Australia is not engaged in trade or business in the
Philippines to which a fixed place of business like an office or a branch is necessary, and it did
not furnish services in the Philippines but elsewere, Fujitsu Australia is not deemed to have a
permanent establishment in the Philippines pursuant to paragraphs 1 and 2, Article 5 of the
Philippines-Australia tax treaty. This being so, the service fees paid by Fujitsu Philippines to
Fujitsu Australia under the Off-Shore Services Agreement, for undertaking and completing the

asset management coordination and administration (first part) and onsite support (second part)
of the project, are exempt from income tax pursuant to paragraph 1, Article 7 of the
Philippines-Australia treaty.
On the characterization of the service fees as business profits (which are generally
exempt from income tax) rather than payments for know-how or royalties (which are generally
subject to a reduced income tax), the following commentaries of the Organization for Economic
Co-operation and Development Model Tax Convention on Income and on Capital (Condensed
Version, July 22, 2010) mention that:
"11.1 In the know-how contract, one of the parties agrees to impart to the other, so that
he can use them for his own account, his special knowledge and experience which remain
unrevealed to the public. It is recognised that the grantor is not required to play any part
himself in the application of the formulas granted to the licensee and that he does not
guarantee the result thereof.
11.2 This type of contract thus differs from contracts for the provision of services, in
which one of the parties undertakes to use the customary skills of his calling to execute work
himself for the other party. Payments made under the latter contracts generally fall under
Article 7.
11.3 The need to distinguish these two types of payments, i.e., payments for the
supply of know-how and payments for the provision of services, sometimes gives rise to
practical difficulties. The following criteria are relevant for the purpose of making that
distinction:

Contracts for the supply of know-how concern information of the kind described
in paragraph 11 that already exists or concern the supply of that type of information after its
development or creation and include specific provisions concerning the confidentiality of that
information.

In the case of contracts for the provision of services, the supplier undertakes to
perform services which may require the use, by that supplier, of special knowledge, skill and
expertise but not the transfer of such special knowledge, skill or expertise to the other party.

In most cases involving the supply of know-how, there would generally be very
little more which needs to be done by the supplier under the contract other than to supply
existing information or reproduce existing material. On the other hand, a contract for the
performance of services would, in the majority of cases, involve a very much greater level of
expenditure by the supplier in order to perform his contractual obligations. For instance, the
supplier, depending on the nature of the services to be rendered, may have to incur salaries
and wages for employees engaged in researching, designing, testing, drawing and other
associated activities or payments to sub-contractors for the performance of similar services."
(Pages 225-226)
Based on the commentaries, in a contract for the supply of know-how, there would
generally be very little more which needs to be done by the supplier other than to supply
existing information or reproduce existing material. On the other hand, in a contract for the
performance of services, this involves, in a majority of cases, a very much greater level of
expenditure by the supplier in order to perform his contractual obligations to the other party,
such as salaries and wages for employees engaged in researching, designing, testing, drawing
and other associated activities or payments to subcontractors for the performance of similar
services.

Accordingly, since the Agreement does not call for Fujitsu Australia to supply existing
information or reproduce existing material to Fujitsu Philippines, but for the former to provide
actual services to Fujitsu Philippines as described above, this agreement is clearly a contract
for the performance of services and not for the supply of know-how or other royalty-bearing
property. Moreover, by reason that the services were rendered continuously for more than one
year (November 2010 to December 2011) by designated personnel of Fujitsu Australia at its
facilities and that Fujitsu Australia utilized its resources for this purpose, it is certain that a
greater level of expenditure (such as salaries and other remuneration of personnel) was
incurred by Fujitsu Australia to fulfil its contractual obligations to Fujitsu Philippines. This being
the case, the service fees paid to Fujitsu Australia constitute business profits and not payments
for know-how or royalties.
Furthermore, under Section 108 (A) of the Tax Code the service fees paid for services
rendered by Fujitsu Australia entirely outside the Philippines are exempt from value-added tax
("VAT"), to wit:
"SEC. 108. Value-added Tax on Sale of Services and Use or Lease of Properties.
(A) Rate and Base of Tax. There shall be levied, assessed and collected, a valueadded tax equivalent to ten percent (10%) of gross receipts derived from the sale or exchange
of services, including the use or lease of properties: Provided, that the President, upon the
recommendation of the Secretary of Finance, shall, effective January 1, 2006, 2 raise the rate
of value-added tax to twelve percent (12%). . ."
The phrase 'sale or exchange of services' means the performance of all kinds of
services in the Philippines for others for a fee, remuneration or consideration. . ."
Under the cross-border or destination principle, the sale of services is subject to VAT
only if the services are performed in the Philippines.
This ruling is issued on the basis of the facts as represented. However, if upon
investigation it shall be disclosed that the actual facts are different, then this ruling shall be
without force and effect insofar as the herein parties are concerned.
Very truly yours,
(SGD.) KIM S. JACINTO-HENARES
Commissioner of Internal Revenue
Footnotes
1. Situated at 26th Floor, Citibank Tower, Valero corner Villar Streets, Salcedo
Village, Makati City, Philippines.
2. The VAT rate was increased to 12 percent beginning February 1, 2006, in
accordance with the Memorandum of the Executive Secretary to the Secretary of Finance
dated January 31, 2006, as circularized by Revenue Memorandum Circular No. 7-2006
(Publishing the Full Text of the Memorandum from Executive Secretary Eduardo R. Ermita
dated January 31, 2006 Approving the Recommendation of the Secretary of Finance to
Increase the Value Added Tax Rate from Ten Percent to Twelve Percent) dated January 31,
2006.
March 4, 2016
ITAD BIR RULING NO. 007-16
Articles 5 (Permanent Establishment), 7 (Business Profits) and Protocol PhilippinesGermany tax treaty

Yung Sung Industrial Philippines, Inc.

E-1901B, Philippine Stock Exchange Centre
Exchange Road, Ortigas Complex
Pasig City
Attention: Mr. Victor Antonio C. Cruz
Special Projects Manager
Gentlemen :
This refers to your tax treaty relief application filed on July 4, 2011, requesting
confirmation that service fees paid by the Bangko Sentral ng Pilipinas ("BSP") to Giesecke and
Devrient GmbH ("Giesecke") are exempt from income tax pursuant to the Agreement between
the Republic of the Philippines and the Federal Republic of Germany for the Avoidance of
Double Taxation with Respect to Taxes on Income and Capital ("Philippines-Germany tax
treaty").
Giesecke is a foreign corporation and a resident of Germany based on the document
issued by the Registration Court in Munich, Germany, on January 18, 2011, and the Certificate
on Fiscal Registration issued by the Internal Revenue Office in Munich, Germany, on February
9, 2011. Giesecke is located at Prinzregentenstrasse 159, Munich, Germany. It is not
registered as a corporation or partnership in the Philippines based on the Certification of NonRegistration of Company issued by the Securities and Exchange Commission on June 27,
2011. Giesecke was issued Taxpayer Identification Number ("TIN") 409-465-051 by the Bureau
of Internal Revenue ("BIR") Revenue District Office ("RDO") No. 39 (South Quezon City). On
the other hand, BSP is the central bank of the Philippines and the country's central monetary
authority. Its primary objective is to maintain price stability conducive to a balanced and
sustainable economic growth, and to promote and preserve monetary stability and the
convertibility of the national currency. 1 It is located at A. Mabini corner P. Ocampo Sr. Streets,
Malate, Manila, Philippines.
On August 31, 2010, BSP and Giesecke entered into a Full Service and Maintenance
Contract where Giesecke agreed to provide BSP with regular service and maintenance
activities for the operation of two units of Banknote Processing System (BPS 1040SB-30) at
the BSP Security Plant Complex in East Avenue, Diliman, Quezon City, Philippines. Giesecke
will provide, among others, the daily presence on-site of two skilled and qualified local
engineers and technicians duly trained by Giesecke to perform the required full service and
operational assistance and maintenance work. These personnel will be present on-site all day
on a single shift basis for five days (Monday to Friday) from 9:00 AM to 6:00 PM with one hour
lunch break. In consideration, BSP will pay service fees to Giesecke equivalent to 21,300.00
Euros every month or 255,600.00 Euros every year. The fees are computed and payable
quarterly. The Contract took effect on July 4, 2010 up to July 3, 2011.
Based on the Certificate issued by Giesecke on June 4, 2011, Giesecke appointed
Yung Sung Industrial Philippines, Inc. ("Yung Sung") as sole distributor of all Banknote
Processing Systems in the Philippines. Yung Sung will be responsible for supplying spare
parts, accessories and related items, and after sales service for these systems for a period of
at least ten years from the date of its acceptance. Yung Sung is a domestic corporation located
at E-1901B, Philippine Stock Exchange Centre, Exchange Road, Ortigas Complex, Pasig City,
Philippines.
Based on the Certification issued by Giesecke on September 2, 2011, Yung Sung is
responsible for providing local engineers in connection with servicing the two units of Banknote

Processing System (BPS 1040SB-30) installed at the Cash Department, BSP Security Plant
Complex in Quezon City, Philippines.
Ruling
In reply, please be informed that under Article 7 of the Philippines-Germany tax treaty,
the profits derived by an enterprise of Germany from sources in the Philippines may be taxed
in the Philippines if they are attributable to a permanent establishment which the enterprise
has therein, to wit:
"Article 7
Business Profits
1.
The profits of an enterprise of a Contracting State shall be taxable only in that
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 the other State but only so much of them as is
attributable to that permanent establishment."
In relation thereto, Article 5 of the treaty and the Protocol thereto defines a permanent
establishment as follows:
"Article 5
Permanent Establishment
1.
For the purposes of this Agreement 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' shall include especially:
a)
a place of management;
b)
a branch;
c)
an office;
d)
a factory;
e)
a workshop;
f)
a warehouse, in relation to a person providing storage facilities for others;
g)
a mine, quarry or other place of extraction of natural resources;
h)
a building site or construction or assembly project or supervisory activities in
connection therewith, where such site, project or activity continues for a period of more than
six months."
"PROTOCOL
2.
In relation to Article 5, if an enterprise of a Contracting State carries out activities
in the other Contracting State by furnishing services, including consultancy services, through
an employee or other personnel, it shall be considered to have a permanent establishment in
that Contracting State only if such services continue (for the same or a connected project)
within that Contracting State for a period or periods aggregating more than six months within
any twelve-month period.
No permanent establishment is assumed if the services, including the provision
of equipment, are furnished in a Contracting State by enterprises of the other Contracting
State, including consultancy firms, in accordance with, or in the implementation of, an
agreement between the Contracting States regarding technical cooperation."
As defined, a permanent establishment means a fixed place of business through which
the business of an enterprise is wholly or partly carried on, and includes especially, a place of
management, a branch, an office, a factory, and a workshop. Also, a permanent establishment
includes the furnishing of services, including consultancy services, by an enterprise of a

Contracting State (through employees or other personnel thereof), where such activities
continue (for the same or a connected project) within the other Contracting State for a period
or periods aggregating more than six months within any twelve-month period, except if these
activities were undertaken in accordance with, or in the implementation of, an agreement on
technical cooperation between the Contracting States.
Accordingly, since the Full Service and Maintenance Contract between BSP and
Giesecke would call for Giesecke agreed to provide BSP with regular service and maintenance
activities for the operation of two units of Banknote Processing System at the BSP Security
Plant Complex in Quezon City, Philippines, for a continuous period of at least twelve months,
Giesecke shall be deemed to have a permanent establishment in the Philippines, pursuant
to Article 5 of the treaty and the Protocol. This is regardless of the fact that Giesecke
subcontracted the said services to a domestic company, Yung Sung, who will provide the
required engineers on-site throughout the period. These subcontracted engineers would
nonetheless constitute as Giesecke's "other personnel" contemplated in the protocol.
The same analogy applies to a permanent establishment in the form of a building site
or construction or assembly project. According to the commentaries of the Organisation for
Economic Co-operation and Development Model Tax Convention on Income and on Capital
(Condensed Version, July 2010), in counting the period of a permanent establishment arising
from this activity, the period spent by a subcontractor would be counted as that spent by the
general contractor, to wit:
"19. . . . If an enterprise (general contractor) which has undertaken the performance
of a comprehensive project subcontracts parts of such a project to other enterprises
(subcontractors), the period spent by a subcontractor working on the building site must be
considered as being time spent by the general contractor on the building project. The
subcontractor himself has a permanent establishment at the site if his activities there last more
than twelve months." (Page 100) (Emphasis ours)
Since Giesecke has a permanent establishment, the service fees paid to it by BSP
amounting to 21,300.00 Euros every month (255,600.00 Euros every year) shall be subject to
income tax pursuant to paragraph 1, Article 7 of the Philippines-Germany tax treaty.
Relative thereto, under paragraph 3 of the same Article 7, in computing the taxable
profits of Giesecke, reasonable expenses should be deducted from such profits and which are
incurred for the purpose of providing services to BSP, to wit:
"3. In the determination of the profits of a permanent establishment, there shall be
allowed as deductions expenses which are incurred for the purposes of the permanent
establishment including executive and general administrative expenses so incurred, whether in
the State in which the permanent establishment is situated or elsewhere."
Since Giesecke did not send its own employees or personnel to the Philippines but
subcontracted the services to Yung Sung, a local company, nor it maintains any branch or
office in the Philippines, the question arises what reasonable expenses could be allowed to
Giesecke to compute its taxable profits. Overall, there is no need for Giesecke to send its own
employees or personnel to the Philippines since the same services could be performed by
Yung Sung which has the same technical capability to provide such services to BSP. It is more
costly to Giesecke and BSP for Giesecke to send its own people to the Philippines since their
salaries should be at least identical with those they received in Germany. Moreover, Giesecke
or BSP would provide these individuals the usual accommodation and other allowances during
their stay which is at least one year. This being so, we believe that the only reasonable

expense that should be allowed to Giesecke is the commission it paid to Yung Sung, the local
subcontractor. This commission would include the salaries, allowances, and other
remuneration paid by Yung Sung to its local engineers who would be present at the BSP
Security Plant Complex in Quezon City, during regular working hours from 8:00 AM to 5:00
PM, and all regular working days from July 4, 2010 to July 3, 2011. Giesecke's taxable profits
from this undertaking would be the service fees paid by BSP equivalent to 21,300.00 euros
every month (255,600.00 euros every year) minus commission paid by Giesecke to Yung
Sung.
Giesecke's taxable profits shall be subject to income tax at the rate of 30 percent under
Section 28 (A) (1) of the National Internal Revenue Code of 1997 ("Tax Code"), as amended,
to wit:
"SEC. 28. Rates of Income Tax on Foreign Corporations.
(A) Tax on Resident Foreign Corporation.
(1) In General. Except as otherwise provided in this Code, a foreign corporation
organized, authorized, or existing under the laws of any foreign country, engaged in trade or
business within the Philippines, shall be subject to an income tax equivalent to thirty-five
percent (35%) of the taxable income derived in the preceding taxable year from all sources
within the Philippines: Provided, That effective January 1, 2009, the rate of income tax shall be
thirty percent (30%)".
As permanent establishment of Giesecke, Yung Sung shall cause the filing of
Giesecke's Quarterly Income Tax Return (BIR Form No. 1702Q) and Annual Income Tax
Return (BIR Form No. 1702) at RDO 39, as required under Section 52 of the Tax Code:
"SEC. 53. Corporation Returns.
(A) Requirements. Every corporation subject to the tax herein imposed, except
foreign corporations not engaged in trade or business in the Philippines, shall render, in
duplicate, a true and accurate quarterly income tax return and final or adjustment return in
accordance with the provisions of Chapter XII of this Title. The return shall be filed by the
president, vice-president or other principal officer, and shall be sworn to by such officer and by
the treasurer or assistant treasurer."
RDO 39 shall obtain information and documents from BSP about the amount of service
fees it paid to Giesecke pursuant to the Full Service and Maintenance Contract, and from Yung
Sung about the commission it received from Giesecke for actually rendering the services to
BSP. As ruled, the difference between the service fees and the commission shall constitute
Giesecke's taxable profits in this transaction and shall be the basis for the 30 percent income
tax. Meanwhile, the said commission shall form part of Yung Sung's taxable income as a
domestic corporation and subject to income tax accordingly.
Finally, under Section 108 (A) in relation to Section 105 of the Tax Code, the service
fees paid by BSP to Giesecke shall be subject to value-added tax ("VAT"), to wit:
"SEC. 108. Value-added Tax on Sale of Services and Use or Lease of Properties.
(A) Rate and Base of Tax. There shall be levied, assessed and collected, a valueadded tax equivalent to ten percent (10%) of gross receipts derived from the sale or exchange
of services, including the use or lease of properties: Provided, that the President, upon the
recommendation of the Secretary of Finance, shall, effective January 1, 2006, 2 raise the rate
of value-added tax to twelve percent (12%) . . ."
"SEC. 105. Persons Liable. Any person who, in the course of trade or business,
sells, barters, exchanges, leases goods or properties, renders services, and any person who

imports goods shall be subject to the value-added tax (VAT) imposed in Sections 106 to 108 of
this Code.
The value-added tax is an indirect tax and the amount of tax may be shifted or passed
on to the buyer, transferee or lessee of the goods, properties or services. This rule shall
likewise apply to existing contracts of sale or lease of goods, properties or services at the time
of the effectivity of Republic Act No. 7716.
The phrase 'in the course of trade or business' means the regular conduct or pursuit of
a commercial or an economic activity, including transactions incidental thereto, by any person
regardless of whether or not the person engaged therein is a non-stock, non-profit private
organization (irrespective of the disposition of its net income and whether or not it sells
exclusively to members or their guests), or government entity.
The rule of regularity, to the contrary notwithstanding, services as defined in this Code
rendered in the Philippines by nonresident foreign persons shall be considered as being
rendered in the course of trade or business."
Relative thereto, BSP shall withhold VAT on the service fees at the rate of 12 percent
before remitting them to Giesecke. BSP shall use BIR Form No. 1600 (Monthly Remittance
Return of Value-Added Tax and Other Percentage Taxes Withheld). The duly filed BIR Form
No. 1600 and its accompanying proof of payment shall serve as documentary substantiation
for BSP's claim of input VAT on the fees; otherwise, if it is not a VAT-registered taxpayer, BSP
shall treat the passed-on VAT as an asset or expense, whichever is applicable. VAT withheld
shall be remitted within ten days following the end of the month the withholding was made.
This ruling is issued on the basis of the facts as represented. However, if upon
investigation it shall be disclosed that the actual facts are different, then this ruling shall be
without force and effect insofar as the herein parties are concerned.
Very truly yours,
(SGD.) KIM S. JACINTO-HENARES
Commissioner of Internal Revenue
Footnotes
1. Refer to http://www.bsp.gov.ph.
2. The VAT rate was increased to 12 percent beginning February 1, 2006, in
accordance with the Memorandum of the Executive Secretary to the Secretary of Finance
dated January 31, 2006, as circularized by Revenue Memorandum Circular No. 7-2006
(Publishing the Full Text of the Memorandum from Executive Secretary Eduardo R. Ermita
dated January 31, 2006 Approving the Recommendation of the Secretary of Finance to
Increase the Value Added Tax Rate from Ten Percent to Twelve Percent) dated January 31,
2006.
3. Pursuant to Section 4.112-2 of Revenue Regulations No. 16-2005 (Consolidated
Value-Added Tax Regulations of 2005), as amended by Revenue Regulations No. 4-2007
(Amending Certain Provisions of Revenue Regulations No. 16-2005, As Amended, Otherwise
Known as the Consolidated Value-Added Tax Regulations of 2005), which provides:
"SEC. 4.114-2. Withholding of VAT on Government Money Payments and
Payments to Non-Residents.
xxx
xxx
xxx
(b) The government or any of its political subdivisions, instrumentalities or
agencies including GOCCs, as well as private corporation, individuals, estates and trust,

whether large or non-large taxpayers, shall withhold twelve percent (12%) VAT, starting
February 1, 2006, with respect to the following payments:
(1) Lease or use of properties or property rights owned by non-residents;
and
(2) Services rendered to local insurance companies with respect to
reinsurance premiums payable to non-residents; and
(3) Other services rendered in the Philippines by non-residents.
In remitting VAT withheld, the withholding agent shall use BIR Form No. 1600
Remittance Return of VAT and Other Percentage Taxes Withheld.
VAT withheld and paid for the non-resident recipient (remitted using BIR Form
No. 1600), which VAT is passed on to the resident withholding agent by the non-resident
recipient of the income, may be claimed as input tax by said VAT-registered withholding agent
upon filing his own VAT Return, subject to the rule on allocation of input tax among taxable
sales, zero-rated sales and exempt sales. The duly filed BIR Form No. 1600 is the proof or
documentary substantiation for the claimed input tax or input VAT.
Nonetheless, if the resident withholding agent is a non-VAT taxpayer, said
passed-on VAT by the non-resident recipient of the income, evidenced by the duly filed BIR
Form No. 1600, shall form part of the cost of purchased services, which may be treated either
as an 'asset' or 'expense', whichever is applicable, of the resident withholding agent.
VAT withheld under this Section shall be remitted within ten (10) days following
the end of the month the withholding was made."
November 4, 2014
ITAD BIR RULING NO. 312-14
Articles 5 and 7, Philippines-Singapore Tax Treaty
Du-Baladad and Associates
20th Floor, Chatham House, Rufino corner Valero Streets
Salcedo Village, Makati City
Attention: Atty. Benedicta Du-Baladad
Gentlemen :
This refers to your tax treaty relief application filed on July 19, 2012, requesting
confirmation that the income payments by Bank of Philippine Islands ("BPI") to Softplus Pte.
Ltd. ("Softplus") are subject to the preferential rate pursuant to the Convention between the
Republic of the Philippines and the Republic of Singapore for the Avoidance of Double
Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income. ("PhilippinesSingapore tax treaty").
It is represented that Softplus is a resident of Singapore with principal address at 190
Middle Road #19-05, Singapore based on the Certificate of Residence issued by the Assistant
Commissioner of the Corporate Tax Division on July 20, 2012; that Softplus is not registered
either as a corporation or as a partnership in the Philippines, as shown in the Certification of
Non-Registration of Company dated May 30, 2012 issued by the Securities and Exchange
Commission; and that on the other hand, BPI is a domestic banking institution with principal
address at BPI Head Office Building, Ayala Avenue corner Paseo de Roxas, Makati City.

It is further represented that on May 29, 2012; Softplus and an authorized distributor of
cfSOFTWARE (as licensor) and BPI (as user) entered into a Proprietary Software Perpetual
License Agreement ("Agreement"), whereby Softplus grants to BPI a non-transferable and
non-exclusive perpetual license to use the proprietary computer software, pcMainframe, on the
central processing unit located at the BPI Makati Office; that the products may only be used
for, by and on behalf of BPI, and only (i) on data owned by BPI, (ii) for BPI's internal purposes
and (iii) at the installation site and on the designated CPUs specified; that the simultaneous
use of the products at any other site or on any other CPU is prohibited, unless expressly
contracted for between Softplus and BPI; that Softplus agrees to maintain the products in an
operable condition according to the current published specifications for the products for the
initial period without additional charge to BPI; that Softplus will furnish the product in machinereadable object code form and provide documentation to BPI containing detailed specifications
for the installation and use of the product; that for and in consideration of the said license, BPI
shall pay Softplus maintenance fee of US$20,794.50 per year and license fee in the amount of
US$20,250; that all amounts payable under the Agreement, including any taxes or other
charges described below, are invoiced by Softplus and are to be paid in full by BPI within ten
days after receipt of the invoice therefor; that BPI shall pay a late payment charge of 1.5% per
month, or the maximum rate permitted by applicable law, whichever is less, on any unpaid
amount for each calendar month or fraction thereof that any payment to Softplus in arrears;
that the services to be performed by Softplus under the Agreement are not to be performed in
the Philippines pursuant to the Certification issued by the Vice President of BPI dated June 22,
2012; and that as of July 13, 2012, no payment has been made with respect to the
maintenance fee agreed upon in the Agreement based on the Certification issued by the Vice
President of BPI on even date.
It is finally represented that the payments subject of this ruling are not under
investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit
certificate, collection proceedings, or judicial appeal, based on the Sworn Statement issued by
the Vice President of BPI on May 14, 2012.
In reply, please be informed that Section 28 (B) (1) of the National Internal Revenue
Code (Tax Code) of 1997, as amended, applies, in general, to income derived in the
Philippines by a non-resident foreign corporation:
"Section 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
subparagraph 5(c) and (d): * Provided, That effective January 1, 2009, the rate of income tax
shall be thirty percent (30%). aTIEcA
xxx
xxx
xxx"
However, Section 32 (B) (5) of the Tax Code of 1997, as amended, provides:
"Section 32. Gross Income.
xxx
xxx
xxx

(B) Exclusions from Gross Income. The following items shall not be included in
gross income and shall be exempt from taxation under this Title:
xxx
xxx
xxx
(5) Income Exempt under Treaty. Income of any kind, to the extent required by
any treaty obligation binding upon the Government of the Philippines. DaEATc
xxx
xxx
xxx"
The Bureau of Internal Revenue has issued two Revenue Memorandum Circulars
(RMC) that govern the taxation of software payments. The first Circular (RMC 77-2003) covers
software payments made as of November 18, 2003 and until the effectivity of the second
Circular and generally treats software payments as royalties. It provides
"Definition of Royalties Includes Payments for the Use of Software:
The term 'royalties' as generally used means payment of any kind received as a
consideration for the use of, or the right to use, any copyright of literary, artistic or scientific
work including cinematograph films, or films or tapes used for radio or television broadcasting,
any patent, trade mark, design, or model, plan, secret formula or process, or for the use of, or
the right to use, industrial, commercial or scientific equipment, or for information concerning
industrial, commercial or scientific experience. The term 'use' as contained herein shall include
the reselling or distribution of software. THcEaS
Software is generally assimilated as a literary, artistic or scientific work protected by the
copyright laws of various countries including the Philippines; thus payments in consideration
for the use of, or the right to use, a copy or a copyrighted article relating to software are
generally royalties."
On the other hand, the second Circular (RMC 44-2005) covers payments made as of
September 8, 2005 and onwards and substantially amends the first Circular by treating
software payments either as business income, royalties, rental income, or capital gains,
depending on the nature of the transaction out of which such payments are made. It provides:
"Section 5. Characterization of Transactions. The character of payments received
in a transaction involving the transfer of computer software depends on the nature of the rights
that the transferee acquires under the particular arrangement regarding the use and
exploitation of the program.
a.
Transfer of copyright rights. (emphasis supplied) A transfer of software is
classified as a transfer of a copyright right if, as a result of the transaction, a person acquires
any one or more of the rights described below:
i.
The right to make copies of the software for purposes of distribution to the public
by sale or other transfer of ownership, or by rental lease or lending;
ii.
The right to prepare derivative computer programs based upon the copyrighted
software;
iii.
The right to make a public performance of the software;
iv.
The right to publicly display the computer program; or
v.
any other rights of the copyright owner, the exercise of which by another without
his authority shall constitute infringement of said copyright.
The determination of whether a transfer of a copyright right in a software is a sale or
exchange of property is made on the basis of whether, taking into account all facts and
circumstances, there has been a transfer of all substantial rights in the copyright. A transaction
that does not constitute a sale or exchange because not all substantial rights have been
transferred will be classified as a license generating royalty income.

When only copyright rights are transferred, payments made in consideration therefor
are royalties. On the other hand, when copyright ownership is transferred, payments made in
consideration therefor are business income.
b.
Transfer of copyrighted articles. (emphasis supplied) A copyrighted article
incorporating a software includes a copy of the software from which the work can be
perceived, reproduced, or otherwise communicated, either directly or with the aid of a machine
or device. The copy of the software may be fixed in the magnetic medium of a floppy disk or a
CD-ROM, or in the main memory or hard drive of a computer, or in any other medium.
If a person acquires a copy of a software but does not acquire any of the rights
described above (or only acquires a de minimis grant of such rights), and the transaction does
not involve the provision of services or of know-how, the transfer of the copy of the software is
classified solely as a transfer of a copyrighted article and payments for which constitute
business income.
c.
After-sales services. Contracts for the use of software are often accompanied
with the provision of services (e.g., installation, maintenance, and customization of the
software) by personnel of the relevant foreign licensor/owner of the relevant local subsidiary,
reseller, and distributor. Payments as consideration for after-sales service in a mixed contract
are not royalties alone, but will include income from services. The appropriate course to take
with such a contract is, in principle, to break down, on the basis of the information contained in
the contract or by means of a reasonable apportionment, the whole amount of the stipulated
payments according to the various parts of what is being provided under the contract, and then
to apply to each part of it so determined the taxation treatment proper thereto. Thus, the part of
the payments representing the use of the software will be treated as royalties and taxable as
such and the other part of the payments representing the provision of services will be treated
as income from services and taxable as such.
If, however, one part of what is being provided constitutes by far the principal purpose
of the contract and the other parts stipulated therein are only of an ancillary and largely
unimportant character, then the treatment applicable to the principal part should generally be
applied to the whole amount of the consideration.
xxx
xxx
xxx"
The substantial difference between the two Circulars lies in the characterization of
payment from the purchase of a copyrighted article incorporating a software. Under the first
Circular, payment for the purchase of any software is treated as royalties and taxable as such,
while under the second Circular, the payment for software may be treated as business income
(or business profits) and taxable as such, depending on circumstances as described above.
Since what is being transferred to BPI is only a copy of a software for its use, and since
there will be no transfer of ownership thereto including pertinent rights protected under relevant
intellectual property laws, Revenue Memorandum Circular (RMC) 44-2005, particularly the
Section 5b thereof which states that "If a person acquires a copy of a software but does not
acquire any of the rights described above (or only acquires a de minimis grant of such rights),
and the transaction does not involve the provision of services or of know-how, the transfer of
the copy of the software is classified solely as a transfer of a copyrighted article and payments
for which constitute business income" will apply to the instant case.
As you have invoked the provisions of the Philippines-Singapore tax treaty, we apply
Article 7 and, in relation thereto, Article 5 of the same tax treaty on the subject fees, which
provide:

"Article 7
Business Profits
1.
The profits of an enterprise of a Contracting State shall be taxable only in that
State unless the enterprise carries on business in the other Contracting State through a
permanent establishment situated therein. If the enterprise carries on or has carried on
business as aforesaid, the profits of the enterprise may be taxed in the other State but only so
much of them as is attributable to that permanent establishment.
xxx
xxx
xxx"
"Article 5
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:
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, in relation to a person providing storage facilities for others;
h)
A mine, quarry, or other place of extraction of natural resources;
i)
A building site or construction or assembly project or installation project or
supervisory activities in connection therewith, provided such site, project or activity continues
for a period more than 183 days; and
j)
The furnishing of services, including consultancy services, by 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.
xxx
xxx
xxx." (Underscoring supplied)
Based on the aforequoted, the profits of a Singapore enterprise shall be taxable only in
Singapore unless such enterprise carries on business in the Philippines through a permanent
establishment situated therein. If the Singapore enterprise carries on business as aforesaid,
the profits of such enterprise may be taxed in the Philippines but only so much of them as is
attributable to that permanent establishment.
Applying this to the instant case, the fees received by Softplus from BPI for the
services pursuant to the Agreement, shall be taxable in the Philippines only if it has a
permanent establishment in the Philippines in connection with the activities giving rise to such
income. Inasmuch as it is represented that the services shall not be performed in the
Philippines based on the Certification of the Vice President of BPI, then Softplus is deemed not
to have a permanent establishment in the Philippines to which payment of the service fees
may be attributed and is therefore exempt from Philippine income tax.
This ruling is issued on the basis of the facts as represented. However, if upon
investigation it shall be disclosed that the actual facts are different, then this ruling shall be
without force and effect insofar as the herein parties are concerned.
Very truly yours,
(SGD.) KIM S. JACINTO-HENARES

Commissioner
Bureau of Internal Revenue