Communist Party of the Philippines (CPP) founding chairman Jose Ma. Sison and presidential peace adviser Jesus Dureza. Berit Roald / NTB scanpix via AP, File

Application by analogy: The (un)favorable effect
TOP OF MIND - Ruth V. Ricardo (The Philippine Star) - July 24, 2017 - 4:00pm

For obvious reasons, taxation plays a big role in a corporation’s choice of business model and structure in any jurisdiction. Despite having business transactions in the Philippines, many foreign corporations choose not to establish their business presence (e.g. branch, subsidiary or representative office) here to avail of the incentives afforded by local laws and tax treaties. One of which is the exemption from income tax of nonresident foreign corporations (NRFC) if it does not have a permanent establishment (PE) in the Philippines to which business profits may be attributed to. Generally, a PE is defined as a fixed place of business through which the NRFC carries on business in another state. What constitutes a PE may vary from treaty to treaty.

Under most tax treaties to which our country is a signatory, one of the modes in which an NRFC is deemed to have a PE is when it furnishes services, including consultancy services, through an employee or other personnel for the same or a connected project for a period aggregating more than six months within any 12-month period. Countless NRFCs have benefited from this treaty provision. For instance, an NRFC that subcontracts its work to a Philippine entity is not deemed to have a PE here since it is the local entity and not the NRFC that renders the service in Philippines.

However, the aforementioned rule is not applicable to the subcontracting of any work in connection with a building site or construction, or assembly project. Understandably so because 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 is deemed a PE under tax treaties.

More importantly, the commentaries of the Organisation for Economic Co-operation and Development Model Tax Convention on Income and on Capital (OECD commentaries) specifically states that if a general contractor which has undertaken the performance of a comprehensive project subcontracts parts of such a project to other 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 above mentioned provision in the OECD commentaries was applied by analogy to ITAD BIR Ruling No. 007-16 issued on March 4, 2016. Such ruling held that Giesecke and Devrient GmbH (Giesecke Germany) is deemed to have a PE in the Philippines by virtue of its full service and maintenance contract with the Bangko Sentral ng Pilipinas (BSP). Under said contract, Giesecke Germany is to provide BSP with regular service and maintenance activities for the operations of two units of banknote processing system installed at the cash department of the BSP through subcontracting the work to Yung Sung Industrial Philippines, Inc. (Yung Sung).

As the sole distributor of all banknote processing systems in the Philippines, Yung Sung is responsible for supplying spare parts, accessories and related items as well as after sales service for such systems. Consequently, it will provide local engineers to BSP for the servicing of the banknote processing systems.

However, despite the fact that the work was subcontracted to Yung Sung by providing the required engineers on-site daily (Monday to Friday) for a duration of one year, such engineers are considered Giesecke Germany’s other personnel in the Philippines in accordance with the Philippines-Germany Tax Treaty. Accordingly, Giesecke Germany is deemed to have a PE and is considered a resident foreign corporation which is subject to 30 percent regular corporate income tax (RCIT) based on Section 28 (A) (1) of the National Internal Revenue Code (NIRC), as amended. In addition, according to Section 105 and 108 of the NIRC, it is also liable for value-added tax (VAT) which BSP shall withhold before remitting any payment to Giesecke Germany.

As a consequence of the application by analogy in ITAD BIR Ruling No. 007-16, NRFCs with business transactions in the Philippines not related to a building site or construction or assembly project that intend to subcontract the work to a local entity can no longer avail of the tax treaty exemption. Certainly, there were other factors that led the NRFCs to subcontract the work such as the Filipinos’ technical skill and proficiency in providing the service. Nevertheless, even though NRFCs are aware that local entities are more than capable of performing the services as a subcontractor, it is undeniably a letdown for them that they will be subject to RCIT and VAT. While the effect on the government is favorable such that it can collect more taxes, NRFCs will surely think twice whether to push through with their business ventures in the Philippines. Perhaps arguably, this will lead to less investments coming into the country. And we all know how these investments have a favorable effect on our economy.

Ruth V. Ricardo is a supervisor from the tax group of KPMG R.G. Manabat & Co. (KPMG RGM&Co.), the Philippine member firm of KPMG International. KPMG RGM&Co. has been recognized as a Tier 1 tax practice, Tier 1 transfer pricing practice, Tier 1 leading tax transactional firm and the 2016 National Transfer Pricing Firm of the Year in the Philippines by the International Tax Review.

This article is for general information purposes only and should not be considered as professional advice to a specific issue or entity.

The views and opinions expressed herein are those of the author and do not necessarily represent the views and opinions of KPMG International or KPMG RGM&Co. For comments or inquiries, please email or

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