In September, I wrote about a Supreme Court (SC) case covering the sale of satellite communications services by a non-resident corporation, which may potentially have an impact on the taxation of digital services, or what seems (or seemed to be) a gray area in the Philippine taxation. In that case, the SC ruled that the service fees arising from the transmission of satellite signals from a satellite in outer space and Indonesian control center were considered as Philippine-sourced income and thus, subject to withholding taxes in the Philippines. The SC applied a two-tier approach in making its decision: (1) it determined the source of income, and thereafter, (2) the situs of the source. Considering that the income was only earned upon successful delivery of the satellite signals to the Philippine gateways, and that the equipment making up the gateways was situated in the Philippines, the situs for taxation purposes was deemed to be in the Philippines.
The decision was interesting, to say the least, primarily because it appeared to go against the Philippine tax laws on the situs of services – that income from services are only treated as sourced within the Philippines if these are performed locally. Just this month, the Bureau of Internal Revenue (BIR) released Revenue Memorandum Circular (RMC) No. 5-2024 on the basis of the above decision and laid out new cards on the table. Surprisingly and unfortunately, the RMC has not limited the application of the SC decision to transactions similar to satellite services, but has instead used it as reference to determine the taxability of cross-border services — including those that can be physically performed entirely outside the Philippines.
RMC No. 5-2024 provides a list of existing cross-border services which it deems to be “akin” to the transaction covered by the SC case. The list includes consulting services, IT outsourcing, financial services, telecommunications, engineering and construction, education and training, tourism and hospitality, and other similar services where the services are carried out abroad but the results are used, applied, consumed, or executed in the Philippines. Thus, such services are deemed subject to Philippine income tax/withholding tax and 12% VAT. I should mention that VAT was not even touched upon by the SC in the case.
The concept seems to have been anchored on the SC’s decision where it held that for transactions conducted in different jurisdictions, “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.” On this basis, the RMC focuses on the “benefits-received” theory in determining whether the income is Philippine-sourced, where the place of utilization/consumption of the output or result now appears to be crucial in determining the taxability of a transaction. For this purpose, the RMC seems to consider the utilization or consumption as the economic activity that generates the income, thus giving rise to Philippine taxing rights on the entire amount of income without any clear separation or attribution of revenue for each country.
However, our tax law is not ambiguous on the taxation of services, especially those which arise from physical labor. Under Sections 42 and 108 of the Tax Code, it is very clear that service fees are only considered as sourced within the Philippines and subject to income tax and VAT if the services are performed within the country. Philippine tax literature is likewise replete with court decisions and even BIR rulings upholding that income arising from services rendered outside the Philippines are not subject to Philippine tax. The SC itself has repeatedly held that administrative rules must not go beyond the law that it seeks to implement. I am, thus, very curious on how the RMC has arrived at what seems to be a categorical imposition of Philippine tax on offshore services rendered to Philippine residents.
Interestingly, the RMC does not mention how it will be applied in instances where the counterparty is a resident of a tax treaty country, unlike the SC decision which takes cognizance of tax treaties (but were not applied since the case involved a non-resident entity from Bermuda, a country with no existing tax treaty with the Philippines). Tax treaties are bilateral tax agreements between countries. Generally, if certain conditions under the treaty are met, income derived by the foreign income earner from Philippine sources would be exempt from Philippine tax. Since tax treaties are international agreements which have the force and effect of law, I believe that even though the RMC is silent, residents of treaty countries may be protected from the RMC’s ramifications if there is applicable treaty relief. Applying the RMC, however, affected foreign taxpayers will be subject to similar administrative requirements as other taxpayers seeking tax treaty relief.
The RMC likewise does not cover the tax implications if the situation were reversed — how do we apply it to export services by Philippine entities? For income tax purposes, it may not have a significant impact on domestic corporations which are taxed based on worldwide income. However, how would it affect resident foreign corporations which are only taxed on Philippine-sourced income? By applying the benefits-received principle in the RMC, does it mean that if a branch of a foreign corporation were to render services in the Philippines for a foreign customer, the situs of the services would likewise be in the foreign country where the customer is and therefore the revenue is not subject to Philippine tax? Similarly for VAT, can we consider the mere consumption of the output/product outside the Philippines as a basis for exemption?
Previously, the SC decision’s potential impact was anticipated to possibly affect the taxation of foreign digital services consumed in the Philippines. Before the issuance of the RMC, digital services were considered a gap in our system, which pushed legislators to draft laws to address such shortcomings. With the RMC, it seems the enactment of a formal law taxing digital services, which Congress has been working on for the past few years, has become moot. Considering, however, that the RMC did not stem from a new law, there is an increasing concern among taxpayers that the rules provided would be applied retrospectively by the BIR, particularly in ongoing tax audits.
The issuance of this RMC has not only touched upon the digital realm, but has also trod outside Philippine waters. Non-residents who are currently providing or those planning to provide services to Philippine customers must take note of this, even if they have no physical presence in the Philippines. While we await (and hope for) further clarification, local income payors, as the agents who are primarily liable to withhold taxes on their payments to non-residents, must also now carefully review their transactions to ensure that they comply with the new requirements. The RMC is clear in its intention — it wants to change the rules of the game.
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.
Olivia Erika Susa is a senior manager at the Tax Services department of Isla Lipana & Co., the Philippine member firm of PricewaterhouseCoopers global network.