February 24, 2005

ITAD RULING NO. 016-05

Articles 5 (Permanent Establishment) and 8

(Business Profits) Philippines-United States
of America tax treaty
BIR Ruling No. 191-87
BIR Ruling UN-030-1-16-95
BIR Ruling No. DA-ITAD 14-03

Laya Mananghaya & Co.

Certified Public Accountants and Management Consultants
22nd Floor, Philamlife Tower
8767 Paseo de Roxas Street
Makati City

Attention: Atty. Raymund S. Gallardo

Partner
Atty. Melea Solis-Cruz
Manager
Tax and Corporate Services

Gentlemen :

This refers to your letter dated December 10, 2004 requesting for the
tax treatment of service fees to be paid by the United States Agency for
International Development (USAID) to Development Alternatives, Inc.
(Development Alternatives) under the pertinent provisions of the Philippines-
United States of America (United States or U.S.A.) tax treaty.
It is represented that Development Alternatives (formerly, The
Development Corporation) is a foreign company organized and existing
under the laws of the United States with principal office at 7250 Woodmont
Avenue, Suite 200, Bethesda, Maryland 20814, U.S.A., as confirmed by the
relevant Certificate issued by Development Alternatives' Corporate Secretary
on March 3, 2004, certified as a public document by a notary public in the
County of Montgomery, State of Maryland on March 3, 2004 and by the
Secretary of the State of Maryland on March 25, 2004; that Development
Alternatives is engaged in (1) assisting individuals, corporations and
government instrumentalities who are involved or considering involvement
in developing nations (a) to understand the political, economic, and cultural
environment of such nations, and (b) to devise and implement programs
relating to their involvement in the context of social and political changes in
those nations, and (2) assisting individuals, corporations and government
instrumentalities involved or considering involvement in social and economic
problems of the United States; that Development Alternatives is licensed to
establish a representative office in the Philippines (Representative Office), as
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 confirmed by the License issued to Development Alternatives by the
Securities and Exchange Commission on September 17, 1992 numbered
AFO92-000057; that the Representative Office's functions are to liaise with
potential customers in the Philippines and to undertake activities (like
information dissemination and sales promotion), for Development
Alternatives; that the Representative Office's address is at Unit 2007, 20th
Floor, Jollibee Plaza Condominium, Emerald Avenue, Ortigas Center, Pasig
City, Philippines; that on September 27, 2004, the USAID contracted
Development Alternatives to provide technical assistance in the
implementation of the Environmental Governance 2 Project (Project); that
the Project is pursuant to (1) the Memorandum of Understanding between
the United States of America (through the USAID) and the Republic of the
Philippines (through the National Economic and Development Authority) for
the Protection of Productive and Life-Sustaining Natural Resources dated
May 30, 2002, (2) the Strategic Objective Grant Agreement between the
Republic of the Philippines and the United States of America for Protection of
Productive and Life-Sustaining Natural Resources through Improved
Environmental Management and Enforcement dated August 22, 2001, and
(3) the Economic and Technical Cooperation Agreement between the
Government of the United States of America and the Government of the
Philippines signed on April 27, 1951 and entered into force on May 21, 1951,
whereby the United States government agreed to provide to and for the
Philippine government technical assistance, among others; that the
objectives of the Project are to strengthen the capacities of the Department
of Environment and Natural Resources (DENR), local government units
(LGUs), and local institutions to improve the management of forests, coastal
marine and water resources, and promote integrated solid waste
management by LGUs through effective environmental governance; that the
Project calls for a seven-year completion and that for the first five years,
Development Alternatives is expected to have achieved the following
targets:
(1) 80 institutions (e.g., DENR, Department of the Interior and Local
Government (DILG, LGUs) meeting environmental good
governance index benchmarks;
(2) 150,000 hectares of forest cover placed under improved
management;
(3) 800 hectares of coastal areas placed under improved management,
20 marine protected areas established covering 300 hectares and
the management of 60 existing marine protected areas (covering
about 750 hectares);
(4) 25% of waste diverted to recycling and composting in 90 LGUs; and
(5) 20 LGUs investing in sanitation facilities;
t h a t Development Alternatives has the following responsibilities for the
Project:
(1) Functional co-management arrangements established between, and
among, local and national government agencies, communities
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 and other stakeholders in the project sites to enable them to
implement forest, coastal and marine resource management
plans, to carryout waste reduction schemes, and to establish
sanitation and solid waste management facilities;
(2) Technical, financial, policy support and other governance tools put
in place to sustain the efforts of local and national government
agencies, communities and other stakeholders in the project sites
to improve environmental management;
(3) An index for Good Environmental Governance developed and
advocated to be adopted by participating national and local
government agencies. In relation, baseline information shall be
established and procedures in place for annual monitoring;
(4) Appropriate financing options identified, developed and made
accessible to project partners to support community-based
natural resource management and water pollution control
projects. Public-private alliances shall be encouraged to mobilize
investments for implementing improved environmental
management practices;
(5) Training provided to government and non-government law
enforcement agencies in the project sites, (e.g., Bantay Dagat
(Protect the Ocean)/Bantay Gubat (Protect the Forest)/ Bantay
Basura (Solid Waste Management) volunteers, PEDOs, Judges,
Office of the Environmental Ombudsman and prosecutors) on
environmental laws and alternative dispute resolution techniques.
A national environmental law enforcement protocol developed
and best efforts exerted to facilitate its adoption by concerned
government and non-government agencies;
(6) Local service providers such as local academic institutions and
other non-profit groups identified and strengthened to provide
technical assistance to LGUs, other government agencies and
communities;
(7) A small-grants program established to support community-based
natural resource management and water pollution abatement
actions. This includes a monitoring system done in partnership
with local and national government agency partners; and
(8) LGU leagues, sectoral, and professional associations strengthened
to promote environmental good governance and implement
public awareness campaign on environmental issues;
and that the estimated cost of the Project, exclusive of service fees, is
$17,873,909 for the base period (years 1 to 5) and $4,282,714 for the
extension period (years 6 to 7), and that the service fees of Development
Alternatives are $1,126,034 for the base period and $262,973 for the
extension period.
In reply, please be informed that the service fees to be paid by the
USAID to Development Alternatives are business profits taxable under the
provisions of paragraph 1, Article 8 (Business Profits) of the Philippines-
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 United States tax treaty below:
"Article 8
"BUSINESS PROFITS
"1. Business profits of a resident of one of the Contracting
States shall be taxable only in that State unless the resident has a
permanent establishment in the other Contracting State. If the
resident has a Permanent establishment in that other Contracting
State, tax may be imposed by that other Contracting State on the
business profits of the resident but only on so much of them as are
attributable to the permanent establishment.
"xxx xxx xxx"
According to paragraph 1, the service fees are subject to Philippine income
t a x o n l y if they are attributable to a permanent establishment which
Development Alternatives has in the Philippines.
A permanent establishment, as defined in paragraphs 1 and 2, Article 5
(Permanent Establishment) of the same tax treaty, means "a fixed place of
business through which a resident of one of the Contracting States engages
in trade or business," and includes, for example, "a seat of management, a
branch, an office, a store or other sales outlet, a factory, and a workshop." It
also includes "the furnishing of services, including consultancy services,
which continues for a period or periods aggregating more than 183 days."
In the first instance, where it is required that there be a fixed place of
business and with respect to the representation that Development
Alternatives has an office in the Philippines (Representative Office), the same
can constitute a permanent establishment if the activities carried out therein
are not preparatory and auxiliary in character a n d if the Representative
Office has a certain degree of permanency.
As regards examples of activities that have a preparatory and auxiliary
character, paragraph 3, Article 5 of the tax treaty mentions:
"3. Notwithstanding paragraphs 1, 2, and 4, a permanent
establishment shall be deemed not to include any one or more of the
following:
a) The use of facilities solely for the purpose of
storage, display, or occasional delivery of goods or
merchandise belonging to the resident;
b) The maintenance of a stock of goods or
merchandise belonging to the resident solely for the
propose of storage, display, or occasional delivery;
c) The maintenance of a stock of goods or
merchandise belonging to the resident solely for the
purpose of processing by another person;
d) The maintenance of a fixed place of business
solely for the purpose of purchasing goods or
merchandise, or for collecting information, for the
resident;
e) The maintenance of a fixed place of business
solely for the purpose of advertising, for the supply of
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 information, for scientific research, or for similar activities
which have a preparatory or auxiliary character, for the
resident; or
f) The furnishing of services, including the provision
of equipment, in one of the Contracting States by a
resident of the other Contracting State, including
consultancy firms, in accordance with, or in the
implementation of an agreement between the
Contracting States regarding technical cooperation."
Where it is represented that the Representative Office's functions are
to liaise with potential customers in the Philippines and to undertake
activities (like information dissemination and sales promotion) for
Development Alternatives, said activities (without more) can be regarded as
preparatory and auxiliary, in accordance with subparagraphs (a) and (d)
above. However, if the liaising with potential customers and sales promotion
extend to negotiation and/or signing of sales contracts and/or to after-sales
services, the same are regarded as being beyond preparatory and auxiliary
and as such can deem the Representative Office a permanent
establishment.
As regards permanency, where it is represented that the
Representative Office has been in existence immediately after it was given
license by the Securities and Exchange Commission on September 17, 1992
and it continues to be so at present or for more than twelve years now, the
Representative Office is considered as already having acquired a certain
degree of permanency.
Hence, considering that the activities carried out in the Representative
Office are merely preparatory and auxiliary, although the Representative
Office, over time, has already acquired a certain degree of permanency, the
Representative Office does not yet constitute a permanent establishment of
Development Alternatives.
In the second instance, with respect to furnishing of services and where
it is represented, that Development Alternatives (through its personnel or
employees) will provide technical assistance for the Project in the Philippines
for five years and for not less than 183 days, said activity will generally be
considered as constituting a permanent establishment for Development
Alternatives. However, subparagraph (f) of the above-quoted paragraph 3,
excludes from the concept of a permanent establishment "the furnishing of
services, including the provision of equipment, in one of the Contracting
States by a resident of the other Contracting State, including consultancy
firms, in accordance with, or in the implementation of an agreement
between the Contracting States regarding technical cooperation." In other
words, even if the furnishing of services exceeds the allowed period of 183
days, the same cannot be regarded as giving rise to a permanent
establishment if said activity is carried out in pursuance of a technical
cooperation agreement between the Philippines and the United States.
Where it is represented that the provision of technical assistance by
Development Alternatives is pursuant to a technical cooperation agreement
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 between the Philippines and the United States (namely, (1) the Memorandum
of Understanding between the United States of America (through the USAID)
and the Republic of the Philippines (through the National Economic and
Development Authority) for the Protection of Productive and Life-Sustaining
Natural Resources dated May 30, 2002, (2) the Strategic Objective Grant
Agreement between the Republic of the Philippines and the United States of
America for Protection of Productive and Life-Sustaining Natural Resources
through Improved Environmental Management and Enforcement dated
August 22, 2001, and (3) the Economic and Technical Cooperation
Agreement between the Government of the United States of America and
the Government of the Philippines signed on April 27, 1951 and entered into
force on May 21, 1951), said activity is covered by the exclusion from the
concept of a permanent establishment in subparagraph (f). By mentioning
the phrase "including consultancy firms," subparagraph (f) extends the
exclusion to other entities (like Development Alternatives) whom the United
States may assign or delegate to fulfill its obligations to the Philippines under
the relevant technical cooperation agreement/s. This being so, the service
fees to be paid by the USAID to Development Alternatives for the provision of
technical assistance for the Project are exempt from Philippine income tax.
(BIR Ruling No. 191-87 dated July 2, 1987 and BIR Ruling UN-030-1-16-95
dated December 16, 1994)
Finally, the service fees to be paid by USAID to Development
Alternatives, being payments for the performance of services in the
Philippines, are generally subject to 10 percent value-added tax (VAT) under
Section 108(A) of the Tax Code below:
"Section 108. Value-added Tax on Sale of Services and Use or
Lease of Properties. —
(A) Rate and Base of Tax. — There shall be levied, assessed and
collected, a value-added tax equivalent to ten percent (10%) of gross
receipts derived from the sale or exchange of services, including the
use or lease of properties.
'The phrase `sale or exchange of services' means the
performance of all kinds of services in the Philippines for others for a
fee, remuneration or consideration . . . "
However, since VAT is an indirect tax and the amount of tax may be
shifted or passed on to the buyer, transferee or lessee (Section 105, Tax
Code), the USAID, in this case, and not Development Alternatives, will
ultimately shoulder the payment of VAT on the service fees. But in view of
the existing VAT Exemption Certificate No. 2004-109 dated December 16,
2003 issued to the Embassy of the United States of America (to which the
USAIDis a part and is working dependently) valid until December 31, 2004
and renewable every year, the USAID cannot be obliged to shoulder the VAT
on the subject service fees. Thus, the service fees to be paid by the USAID to
Development Alternatives are exempt from VAT. (BIR Ruling No. DA-ITAD 14-
03 dated January 27, 2003) EIAHcC

This ruling is issued on the basis of the facts as represented. However,

if upon investigation it shall be disclosed that the facts are different, then
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 this ruling shall be without force and effect insofar as the herein parties are
concerned.

Very truly yours,

Commissioner of Internal Revenue

By:

(SGD.) JOSE MARIO C. BUÑAG

Deputy Commissioner
Legal and Inspection Group

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