Tax Alert No. 3 [Revenue Memorandum Circular No. 5-2024 dated 10 January 2024]

Further clarification on the proper tax treatment of cross-border services in view of the Supreme Court Decision in the case of Aces Philippines Cellular Satellite Corporation versus Commissioner of Internal Revenue (G.R. No. 226680, 30 August 2022)

Please be informed that the BIR issued Revenue Memorandum Circular No. 5-2024 to clarify the tax treatment of cross-border services in light of the Supreme Court’s Decision in Aces Philippines Cellular Satellite Corporation versus Commissioner of Internal Revenue (G.R. No. 226680, 30 August 2022).

In the case, Aces Philippines Cellular Satellite Corporation (“Aces Philippines”) argued that it is not liable for deficiency Final Withholding Tax ("FWT") on satellite air time fees paid to Aces International Limited ("Aces Bermuda"), a non-resident foreign corporation (“NRFC”) incorporated in Bermuda, because the latter performed the services completely outside of the Philippines and does not own equipment in the Philippines. Specifically, Aces Philippines limits the income-generating activity to the receipt and beaming of satellite signals which all happens in the satellite and control center which are located outside of the Philippines. Aces Philippines opines that Aces Bermuda's service ends when its control center provides information to the satellite as to which Philippine gateway the call shall be routed to, after which it is Aces Philippines' gateway that will receive the call and route the same to a local subscriber.

However, as summarized in the RMC, the Supreme Court held that the income source is the Philippine gateway's receipt of the call as it coincides with the completion or delivery of the service, and the inflow of economic benefits in favor of Aces Bermuda. The Supreme Court found that the satellite air time fees paid by Aces Philippines to Aces Bermuda accrue only when the satellite air time is delivered to Aces Philippines (i.e. upon the Philippine gateway's receipt of the routed call) and utilized by the Philippine subscriber for voice or data call. It is the accrual of fees payable to Aces Bermuda that signifies the inflow of economic benefits.

Proceeding to the issue of the situs of taxation, the Supreme Court held that the Philippines is the situs of Aces Bermuda's income from satellite air time fee payments as 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. The Supreme Court further underscored that the income generation is dependent on the operations of facilities situated in the Philippines, which contributes to the income's Philippine situs.

Based on this Supreme Court Decision, the BIR laid down the following guidelines on the situs of taxation of international or cross-border services akin to the Aces case:

• Coverage - cross-border services rendered to clients in the Philippines by companies that operate in different countries. These include consulting services, IT Outsourcing, financial services, telecommunications, engineering & construction, education & training, tourism & hospitality, and other similar services that are provided, processed or performed overseas and then utilized, applied, executed or consumed within the Philippines.
• The source of income is in the Philippines if the property, activity or service that produces the income is in the Philippines. Under the source-based taxation principle, the source of income should be determined by the location of the business activity that generates the income, rather than the location of the payout or where it is physically received.
• 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.
• In cases where business transactions occur in multiple stages across different taxing jurisdictions, it should be ascertained whether the particular 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, regardless of where the payment is ultimately received.
• 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 information technology, is considered an inflow of economic benefits in favor of the foreign company.
• On reimbursable or allocable expenses charged by a foreign corporation in the Philippines, the reduction of expenses for a foreign corporation can be considered as income because it represents financial gain or savings for the company, which effectively increases the foreign corporation's net income or profit.
• If there are no benefits derived by the Philippine company from a cross-border transaction, i.e. income is not generated through business activities conducted in the Philippines or does not provide any benefits to the local company, it may be seen as an attempt to evade taxes or manipulate profits by funneling them to a foreign entity. The source of the income should be determined by the location of the business activity that generates the income, rather than the location of the payout or where it is physically received.
• The income generated by the foreign company which is considered sourced in the Philippines shall be subject to FWT and also to Final Withholding VAT.

You may access a copy of the RMC through the BIR website.

PwC Comment: The Supreme Court held in the Aces case that the income is Philippine-sourced as the income-generating activity is directly associated with the gateways located within Philippine territory. However, the RMC appears to have generalized the application of the case to all cross border services where the situs of taxation is considered to be in the Philippines if the services rendered by non-resident foreign corporations are utilized, applied, executed or consumed within the country.

For any inquiry or request for assistance, please feel free to contact anyone from our Tax Services group. You may also reach us through this link.