REVENUE MEMORANDUM CIRCULAR NO. 5 – 2024
Clarifies the proper tax treatment of cross-border services in relation to Supreme Court En Banc decision in Aces Philippines Cellular Satellite Corp. v. Commissioner of Internal Revenue (GR No. 226680 dated August 30, 2022), to identify if income payments to anNon-Resident Foreign Corporation (NRFC) is subject to Final Withholding Tax (FWT)/Final Withholding VAT (FWVAT), the source of income and the situs of that source must be determined.
Resolving the issue of whether the satellite air time fee payments to Aces Bermuda is subject to FWT requires a two-tiered approach, where we identify, first, the source of the income and, second, the situs of that source.
a. Identifying the Source of Income
Q&A No. 1 of the Revenue Memorandum Circular (RMC) No.5-2024, defined the term “income “as follows:
““Income” refers to the flow of wealth. In ascertaining the income source, we must inquire into the property, activity, or service that produced the income, or where the inflow of wealth originated. It is insufficient to identify just any property, activity, or service. The subject may only be regarded as an income source if the particular property, activity, or service causes an increase in economic benefits, which may be in the form of an inflow or enhancement of assets or a decrease in liabilities with a corresponding increase in equity other than that attributable to a capital contribution.”(Underscoring oOurs)
The following are the relevant salient features of the Decision of the Supreme Court concerning Final Withholding Tax (FWT) on income payments abroad. The satellite airtime fee payments in this case were income payments made by Aces Philippines (payor/withholding agent) to Aces Bermuda (payee/income earner), a Non-Resident Foreign Corporation (NRFC), for the satellite airtime services it provided to Aces Philippines:
In the case of Aces Philippines Cellular Satellite Corp. (Aces Philippines) v. CIR (G.R. No. 226680) dated 30 August 2022, the SC ruled that satellite airtime fees paid by Aces Philippines to Aces Bermuda, a NRFC, are considered income sourced within the Philippines. The decision emphasized that the location of the income-generating property, activity, or service determines where the income shall be taxed. The Court agrees that the income-generating activity takes place not during the act of transmission but only upon the gateway’s receipt of the call as routed by the satellite. The Court identifies the gateway’s receipt of the call as the income source as it coincides with (1) the completion or delivery of the service, and (2) the inflow of economic benefits in favor of Aces Bermuda, the NFRC supplier.
b. Identifying the Situs of the Source
The following establishes the Philippine situs of Aces Bermuda’s income from satellite airtime fee payments:
- The income-generating activity is directly associated with the gateways located within the Philippine territory; and
- Engaging in the business of providing satellite communication services in the Philippines is a government regulated industry.
International Service Provision (or cross-border services) – A service-based company operates in various countries, providing services to clients. The income earned is allocated to the countries where the services are performed, taking into account factors such as the time spent, resources utilized, or value created in each jurisdiction. The source of income is determined by the location of the business activity rather than the disbursement or receipt of funds. International service provision includes the following or similar transactions:
- Consulting Services — A consulting firm based in one country provides advisory or consulting services to clients located in different countries. The firm may offer expertise in various areas such as management, finance, technology, or marketing. The consulting is carried abroad, but the results or outputs are used locally. The payment to the foreign consulting firm is considered an inflow of economic benefits to the foreign company. The income is sourced within the Philippines.
- IT Outsourcing — A technology company in one country offers IT outsourcing services to businesses located in different countries. This can involve services like software development, system maintenance, network management, or customer support.
- Financial Services — Banks, investment firms, or insurance companies operating internationally provide financial services to clients across borders. This can include services like asset management, wealth advisory, international banking, or insurance coverage.
- Telecommunications — Telecommunication companies offer services such as international calling, data connectivity, or internet services to customers located in different countries. These services enable global communication and connectivity.
- Engineering and Construction — Engineering and construction firms undertake projects in different countries, providing services like architectural design, project management, infrastructure development, or construction services.
- Education and Training — Educational institutions or training providers offer international programs, courses, or professional training to students or professionals from various countries. This can involve language courses, academic programs, vocational training, or skill development courses.
- Tourism and Hospitality — Travel agencies, hotels, online booking application, or tour operators cater to tourists, providing services like, planning, accommodation, transportation, tour packages, or entertainment activities.
- Other Similar Services — refers to services that are not specifically mentioned above but still follow the same concept of being provided, processed, or performed overseas and then utilized, applied, executed, or consumed within the Philippines.
It is settled that the source of income is in the Philippines if the property, activity or service that produces the income is in the Philippines. The flow of wealth proceeded from, and occurred within the Philippine territory, enjoying the protection accorded by the Philippine government.
Moreover, to establish the situs of taxation for other cross-border services, in Q&A No. 3 of the same RMC , it is provided provides as followsthat:
“Q3: Based on the above-discussion by the Court in Aces Philippines, how would you establish the situs of taxation for the aforesaid cross-border services?
A3: The revenue-generating activity occurs within the Philippines. It is settled that the source of income is in the Philippines if the property, activity or service that produces the income is in the Philippines. The flow of wealth proceeded from, and occurred within the Philippine territory, enjoying the protection accorded by the Philippine government.
The source of income is not necessarily determined by the location where the payment is disbursed or physically received, but rather by the location where the underlying business activities that produced the income actually took place. This principle is crucial in cases where business transactions occur in multiple stages across different taxing jurisdictions. In such instances, it becomes imperative to ascertain whether the stages occurring in the Philippines are so integral to the overall transaction that the business activity would not have been accomplished without them.If the income-generating activities in the Philippines are deemed essential, the income derived from these activities would be considered as sourced from the Philippines for tax purposes, irrespective of where the payment is ultimately received. This principle aligns with the benefits-received theory in taxation, which submits that the jurisdiction providing the essential services or factors for income generation should be entitled to tax that income.
The payment or income generated from service fees paid to the foreign company, including those made through the internet or other electronic means with the use of IT, is considered an inflow of economic benefits in favor of the foreign company.
On the other hand, the utilization of these services indicates that they offer benefits to the local company and are considered necessary to its business operations. The decision to avail these services is made with the intent of their relevance and importance to the local company’s operations, reflecting sound judgment at the initial stage before engaging in such services. The outcomes or results of these services are subsequently put into practical use, applied, or utilized within the local country.” (Underscoring ours)
Based on the foregoing, even if the service provider is located outside the country, if the service is utilized, applied, executed or consumed for a recipient within the Philippines, the income payment for such service is may be considered sourced within the country subject to FWT. Consequently, payment for such service shall be subject to Final Withholding VAT.