The concept of a permanent establishment (PE) relates to a tax treaty entered by the Philippines with other countries. PE determines the right of the Philippines to tax a foreign enterprise doing business in the Philippines. If a foreign enterprise is deemed to have a PE, the said enterprise may be taxed in the Philippines.
Permanent establishment is generally defined in tax treaties as a fixed place of business, through which the business of an enterprise is wholly or partly carried on. This definition connotes the presence of facilities and premises such as an office, branch, factory, equipment or place of management. However, there are other factors that may trigger the existence of a PE other than physical facilities and premises. Among these is the presence of persons acting on behalf of the foreign enterprise.
As a rule, agents with independent status acting in the ordinary course of his business do not give rise to a permanent establishment. Dependent agents on the other hand are persons whose activities may create a PE for the principal enterprise. Dependent agents may or may not be employees of the enterprise. They may either be individuals or even companies in the country in which they operate.
In the recent ITAD BIR Ruling No. 13-13, dated January 2013, the commissioner of Internal Revenue (CIR), applying the provisions of the Philippine-Switzerland tax treaty, ruled on the existence of a PE. In the said case, a Singapore branch of a Swiss company entered into a Manufacturing and Related Services Agreement (MRSA) with a local manufacturing company. Under the agreement, the local manufacturing company will manufacture the products of the Singaporean company and provide other related services for at least five years. The Singapore branch will deliver a firm order to the local manufacturing company specifying the actual quantities of products to be supplied every month. The Singapore branch likewise entered into a distribution agreement with a local distributing company. Under the agreement, the local distributing company will be the exclusive distributor of the Swiss company’s products in the Philippines. As exclusive local distributor, the distributing company may conclude contracts with wholesalers, retailers or any commercial establishments or persons for the sale of the products.
The CIR held that both local manufacturing company and local distributing company are deemed as PE of the Swiss company because said local companies habitually maintain products of the Swiss company in their premises and regularly delivers these products to third parties.
Citing the decision of the Court of Tax Appeals (CTA) in the case of Philippine Fund Inc. vs. Commissioner of Internal Revenue, dated 13 May 1994, the CIR held that an independent agent is a person whose business activities are the same or similar to those rendered by a broker or a commission agent to the general public. According to the CIR, to be considered an independent agent, the person acting on behalf of the enterprise must have the authority to bind the enterprise and another person by contract. Thus, the local manufacturing company may not be considered as an independent agent as it merely manufactures and delivers products for the Swiss company without the authority to negotiate and conclude contracts with third parties on its behalf.
The CIR also emphasized that the independent status of an agent depends on the number of principals/enterprises that are represented by the agent. The independent status of an agent is negated by the fact that its activities are performed wholly or almost wholly on behalf of only one principal. Thus the local distributing company may not be considered as an independent agent as it does not have any other clients other than the Swiss company.
The ruling of the CIR effectively made the Swiss company liable to Philippine income tax for the manufacture and sale of its products in the Philippines, in addition to the two local companies.
The ruling clearly demonstrates the thrust of the present BIR to strictly construe and implement the tax rules. This makes it even more imperative for corporate planners to carefully consider the risk of PE in structuring its business in the Philippines.
Benedict Vincent L. Ines is an assistant manager from the tax group of Manabat Sanagutin & Co. (MS&Co.), the Philippine member firm of KPMG International.
This article is for general information purposes only and should not be considered as professional advice to a specific issue or entity.
The view and opinions expressed herein are those of the author and do not necessarily represent the views and opinions of KPMG International or MS&Co. For comments or inquiries, please email manila@kpmg.com or rgmanabat@kpmg.com