One of the hot topics in tax circles is Revenue Memorandum Circular (RMC) No. 5-2024, which was issued by the Bureau of Internal Revenue (BIR) to clarify the tax treatment of cross-border services, applying the Supreme Court (SC) decision in Aces Philippines Cellular Satellite Corp. v. Commissioner of Internal Revenue. The RMC imposes Philippine withholding tax on payments for services rendered by non-resident foreign corporations (NRFCs), even if rendered entirely outside the Philippines, as long as the utilization or consumption happens within the Philippines. Because of the widespread impact and apparent shift in the tax treatment, the new issuance has raised uncertainty on the proper taxation of service fees paid to NRFCs by service recipients in the Philippines.
It should be noted that the parties involved in the SC case are associated enterprises located in various jurisdictions. Since associated enterprises or related parties are bound by international and local transfer pricing rules, I wonder whether the Court took into account the transfer pricing considerations present in the case.
Transfer pricing comes into play in determining whether the profits earned by related parties are appropriate considering the proper allocation of the income earned across various jurisdictions and among enterprises based on their functions, assets, and risks (FAR). Given the facts of the case, with various phases of the service being performed by different entities in multiple jurisdictions, personally, I find it reasonable (and even necessary) to consider the application of transfer pricing principles.
In the SC case, the court acknowledges the fact that the NRFC’s provision of satellite communication services relies on its entire system, consisting of a communications satellite located in outer space that is interconnected with a network control center in Indonesia, and terminals and gateways located in Indonesia, Thailand, and the Philippines. The case also emphasized that some activities and assets such as: (i) the communication satellite which receives, switches, amplifies, and/or transmits signals to and from the terminals and gateways; (ii) the satellite control facility that monitors and controls the satellite; and (iii) the network control center which consists of the hardware, software, and facilities required in the management and control of the telecommunications system, are performed, located, owned and maintained by NRFCs outside the Philippines. Specific terminals and gateways located in various jurisdictions receive, route, and process the call to a local subscriber until termination. Accordingly, if the network control center beams the signal to the Philippine gateway, any subsequent activities to be performed by the local entity will take place in the Philippines.
Consistent and aligned with economic theory, transfer pricing principles dictate that the more functions being performed, the more assets used, and the more risks assumed, the higher would be the expected profitability or returns. Having said this, it is appropriate to determine each party’s proportionate share of the overall revenues based on their FAR profiles specific to the transaction, and subject to tax only the allocated share of the entity. Aligning with the SC’s decision in Commissioner of Internal Revenue v. British Overseas Airways Corp., it is the property, activity or service that produces the income. Accordingly, only the NRFC’s income, which is attributable to any functions it performs, any of its own assets that is used, and any risks it assumes in the Philippines, should be considered Philippine-sourced income. The remaining portion of the income derived by the NRFC from FAR outside the Philippines should be subject to tax in the jurisdictions where the foreign parties are residing for tax purposes, and hence should be beyond Philippine taxation.
As far as the allocated portion which ties in with the FAR that the NRFC has/employs in the Philippines, any Philippine income taxation should also consider any relief available under an existing tax treaty. Based on Philippine tax treaties, an NRFC’s income can only be taxed if the company has a taxable presence in the Philippines, whether through a fixed place, employees or personnel present and providing services in the Philippines, or through definite actions of a dependent agent. While the SC ruled that the OECD Commentaries on Article 5 of the Model Tax Convention on Income and on Capital is irrelevant to the Aces case simply because the NRFC is a Bermudan resident, which is a non-treaty country, the RMC did not expressly disregard the OECD nor the availability of applicable treaty benefits. Given this, I think it is safe to assume that NRFCs residing in treaty countries would still be able to avail of the treaty relief if requirements under the treaty are met.
Contrary to the circumstances present in the SC case where service providers are in multiple jurisdictions, some of the specific cross-border services enumerated in the RMC can likely be performed completely offshore by a single NRFC. In other words, the income from satellite airtime fees, which require the completion of segmented processes before the communication services can be delivered, is not comparable with the income that may be derived from other cross-border services listed in the RMC. However, assuming a similar case where a cross-border service involves multiple related parties from various jurisdictions, I believe a FAR and an economic analysis should be conducted to properly allocate the income, and consequently, determine the tax base.
We are all pondering how far the RMC will take us, especially now that taxpayers, through a number of business and professional organizations, have submitted their unanimous stand on the RMC. Now, the ball is in the BIR’s court. Perhaps the BIR can likewise consider transfer pricing when it revisits the RMC and address the taxpayers’ uncertainty.
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.
Crystabelle Cruz-Lucas is a senior manager at the Tax Services department of Isla Lipana & Co., the Philippine member firm of the PwC network.
