As the world continues to grapple with the pandemic, cross-border transactions are not spared from the impact of restrictions on human mobility. For tax purposes, such travel restrictions could result in the inadvertent creation of a taxable presence for a foreign employer or principal, or what is called a permanent establishment (PE) in treaty parlance.
At the outset, it is crucial to properly determine whether a non-resident foreign corporation (NRFC) has a taxable presence in the Philippines since it provides the basis for a legitimate exercise of the government’s taxing authority. In applying the tax treaties entered into by the Philippines with other countries, an NRFC’s business profits from Philippine sources are generally not subject to Philippine income tax unless there is a PE to which such profits are attributable.
Under Philippine tax treaties, a PE is generally defined as a fixed place of business through which the business of an enterprise is wholly or partly carried out. A PE could also arise without a fixed place of business if there is a construction site, employees or agents performing services or concluding contracts in the other country.
Undoubtedly, the PE issues due to the COVID-19 crisis need to be resolved. In response, the Bureau of Internal Revenue (BIR) issued Revenue Memorandum Circular (RMC) No. 83-2020 providing guidelines on the unintended creation of a PE due to the travel restrictions and quarantine measures imposed by the Philippine government to address the crisis.
The issue of individuals exercising their employment outside of their home country was discussed in last week’s article. In this article, I will cover the Home Office PE, Construction PE and Dependent Agent PE issues under the RMC.
HOME OFFICE PE
A fixed place PE under Philippine tax treaties must be established with a certain degree of permanency. The fact that an enterprise has a certain amount of space at its disposal used for its business activities is sufficient to constitute a place of business for PE purposes.
The BIR recognizes that an NRFC’s employees in the Philippines due to travel restrictions may need to work at home to comply with the strict home quarantine measures imposed by the government and not as a requirement of the NFRC. With this, the BIR is of the view that working from home would not create a PE of the NRFC because the business activity lacks certain degree of permanency and the home office is not at the disposal of the NFRC.
As further explained in the RMC, it would be different if even after the crisis, the home office is continuously used to carry out the business of the NRFC and employees are required by the NRFC to work at home. In this case, the home office may be considered to be at the disposal of the NRFC and deemed a PE.
Generally, a building site, construction, assembly, installation project or related supervisory activities, existing for a given period (generally six months or 183 days) may constitute a PE.
With the pandemic, most construction activities except for essential ones have been put on hold. Under the RMC, the BIR considered no stoppage of work for this type of PE. As such, the period of work interruptions is included in computing the duration of the project to determine the existence of a PE. This is based on the OECD Commentary which states that a site should not be regarded as ceasing to exist when work is temporarily discontinued.
It should be noted though that the work disruptions brought about by the crisis are beyond anyone’s expectation or even imagination. Realistically, the work interruptions are unpredictable, and it may take years to attain normalcy since there is no established cure nor effective vaccine for COVID-19 yet. Given this uncertainty which represents “force majeure,” I think the BIR should reconsider its position and exclude the duration of work interruptions during the quarantine period for PE purposes.
DEPENDENT AGENT PE
The presence of a dependent agent of the NRFC in the Philippines may create a PE. Generally, a person acting on behalf of the NRFC (other than an independent agent) would constitute a PE if such person has and habitually exercises an authority to conclude contracts in the name of the NRFC.
The RMC clarified that if an NRFC’s employee, partner or agent continues to stay in the Philippines due to the travel restrictions, his presence will be disregarded for PE purposes. As such, his continued presence in the Philippines shall be excluded in counting the days of the NRFC’s presence.
The period in which the authority to conclude contracts is exercised is also a key factor in PE determination. To illustrate, the RMC discussed the case of an employee of a Japanese company (JPCo) who was in the Philippines for a two-week vacation. As part of his duties, he has authority to conclude contracts on behalf of the Japanese company. Unfortunately, he was unable to return to Japan due to the travel restrictions and was forced to habitually conclude contracts on behalf of JPCo while he was stranded in the Philippines. In this situation, the BIR held that JPCo has no PE in the Philippines. If not for the travel restrictions, the employee would have been regularly performing his duties in Japan. In contrast, a PE would exist if the employee had concluded contracts on behalf of JPCo in the Philippines before the COVID-19 crisis or if he continues to do so after the lifting of the travel restrictions and quarantine measures.
In a nutshell, the BIR clarified that the effects of COVID-19 do not result in the creation of a PE if the following requirements are met: (a) the NRFC had no PE in the Philippines before the travel restrictions due to COVID- 19; (b) there are no changes in the circumstances except the extended stay of the NRFC’s employee or agent in the Philippines due to travel restrictions; and (c) the employee or agent will leave the country as soon as circumstances permit.
The markets continue to be very volatile given the current bleak economy. Thus, taxpayers are seeking tax relief to keep them financially afloat. This RMC is a welcome step as it provides guidance on PE and relaxes certain rules. However, since the crisis is far from over, I hope that the BIR and Philippine Legislature continue to hear their grievances for relief to survive in this difficult time.
The views or opinions expressed in this article are solely those of the author and do not necessarily represent those of Isla Lipana & Co. The content is for general information purposes only, and should not be used as a substitute for specific advice.
Sylvia B. Salvador is a director at the Tax Services Department of Isla Lipana & Co., the Philippine member firm of the PwC network.
+63 (2) 8845-2728