In 2022, the Supreme Court decided the case of Aces Philippines v. Commissioner of Internal Revenue (G.R. No. 226680, 30 August 2022) where it held that a foreign corporation can be subject to Philippine income tax even though said foreign corporation has no physical presence in the Philippines.
By reason thereof, the Bureau of Internal Revenue saw the need to further clarify the proper tax treatment of cross-border services. As such it issued Revenue Memorandum Circulars 5-2024 which aimed to provide a framework for assessing the final withholding tax and final withholding Value-Added Tax (VAT) of the activities of Non-Resident Foreign Corporations (NRFC) within Philippine jurisdiction.
In RMC5-2024, the BIR clarified that in International Service Provision (or cross-border services), the income earned is allocated to the countries where the services are performed, taking into account factors such as the time spent, resources utilized, or value created in each jurisdiction. The source of income is determined by the location of the business activity rather than the disbursement or receipt of funds. It likewise cited examples of cross-border services such as: 1. Consulting services; 2. IT Outsourcing; 3. Financial Services including asset management; 3. Telecommunications; 4. Engineering and Construction; 5. Education and Training; 6. Tourism and Hospitality; and 7. Other Similar Services.
The BIR stressed that 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. As such, what is important to determine is 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.
Thereafter, the BIR further clarified RMC 5-2024 through RMC 38-2024 stating that the ruling in Aces v. CIR does not automatically apply to the sample cross-border services listed in RMC5-2024 or that the local entity must always be required to withhold tax on behalf of the foreign service provider and remit the same to the BIR. The BIR reiterated that they are mere examples and that each contract must still be analyzed in totality.
The BIR also clarified the guidelines in determining whether the sources of income of an NRFC is 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. The flow of wealth proceeded from, and occurred within the Philippine territory, enjoying the protection accorded by the Philippine government.
The BIR reminded that determination of the source of income involves an examination of all the components of the cross-border service agreement involving two tax jurisdictions (i.e., residence of the NRFC and the Philippines); taking into account the services to be performed in its entirety and not singled out or compartmentalized one particular activity as the income producing activity. Crucial factors to such determination are whether the – cross-border services are dependent on the successful use, consumption or utilization by the Philippine purchaser of the service for income to be accrued; or performance of the service depends on the facilities located in the Philippines; or particular stages occurring in the Philippines are so integral to the over-all transaction that the business activity would not have been accomplished without it; among others.
Given the complexities of the tax treatments 0f cross-border activities, it is best to seek the advice of legal and financial experts on the matter.
