Before entering Philippine borders, foreign companies always evaluate the complexities of doing business here. Foreign companies send hundreds of their employees each year to the Philippines due to the country’s fast growing economy. Over the years, we have witnessed the Bureau of Internal Revenue (BIR) become more and more aggressive when it comes to collecting taxes through stricter interpretations of the law. This should be a clear warning for taxpayers including nonresident foreign corporations, to carefully study the tax implications of their investment plans in the Philippines.
A recent ruling issued by the BIR held that a foreign corporation has a permanent establishment (PE) in the Philippines for rendering services through employees which is more than an aggregate of six months within any 12 month period. The BIR ruled the said foreign corporation should be treated as a resident and their service fees are subject to Philippine income tax.
When is a foreign company deemed to have a PE in the Philippines?
A PE is a bilateral tax treaty concept. The existence of a PE is a basic precondition before any taxation on business profits may occur under a tax treaty. Between two countries with a tax treaty in force, a PE essentially determines the right of one country to tax the profits of an enterprise of the other country. The PE framework of the Organization of Economic Cooperation and Development Model Tax Convention (OECD Model) is used by the Philippines when negotiating tax treaties. Article 7 of the OECD Model says a country may not tax business profits of an enterprise unless that enterprise has a PE in that country. Article 5, on the other hand, lists the several types of PE to include: a place of management; a branch; an office; a factory; a workshop; a mine, an oil or gas well, a quarry or any other place of extraction of natural resources; a building site or construction, or installation project constitutes a permanent establishment only if it lasts more than 12 months and an agent habitually exercising the authority to conclude contracts.
In a number of treaties entered into by the Philippines, a PE could also include the furnishing of services, including consultancy services, by a resident of one of the Contracting States through employees or other personnel, provided activities of that nature continue (for the same or a connected project) within the other contracting state for a period or periods aggregating more than 183 days or six months within any 12 month period in some tax treaties.
Based on this definition, a PE can be broadly classified into two: (1) PE through a fixed place of business, either through management of assets of the non-resident entity located in a one country and (2) PE by agency, through the acts in one country of individual employees or agents of the non-resident entity of the other country. The latter, which is commonly in the form of employee presence, can be more complex for tax authorities to track and determine.
How does the BIR count the days in determining PE?
Recently, the BIR harmonized the counting of days for establishing PE with the OECD Model’s method of counting the minimum days stay in a country to tax-exempt income from independent and dependent personal services.
According to the commentaries of the OECD Model, the “days of physical presence” method is used to determine if the individual’s physical presence in the Philippines has exceeded the threshold provided in the tax treaty and conclude whether his employment income can be exempt from tax. Further, it states that under this method, the counting of days is straightforward as the individual is either present in a country or he is not.
Physical presence includes day of arrival, day of departure, and all other days spent inside the state of activity such as saturday and sundays, national holidays before, during and after the activity, short breaks (training, strikes, lock-out, delay in supplies), days of sickness, and death or sickness in the family. A day during any part of which, however brief, the taxpayer is present in a country counts as a day of presence in that country.
However, days spent in the country of activity in transit in the course of a trip between two points outside the country of activity should be excluded from the computation. It follows from these principles that any entire day spent outside the country of activity, whether for holidays, business trips, or any other reasons, should not be taken into account.
The BIR applied the days of physical presence method in counting the aggregate number of days stay of the Japanese corporation’s employees in concluding the corporation has a deemed PE. Also, the BIR only made one count for the days when there are two or more personnel present in the country.
Will the same approach be used to count days in determining individual residency status?
Under the tax code, a citizen of the Philippines who works and derives income from abroad and whose employment thereat requires him to be physically present abroad most of the time during the taxable year (i.e. he stays there for at least 183 days) is considered a non-resident citizen. On the other hand, a non-resident alien individual who shall come to the Philippines and stay therein for an aggregate period of more than 180 days during any calendar year shall be deemed as a non-resident alien doing business in the Philippines.
The BIR currently has no clear guidance on how to count the physical presence of an individual in determining residency status based on the above rules. However, since the BIR adopted the method provided in the OECD Model to determine PE, it is plausible they will also make use of the same method in counting days for determining residency status. This is particularly important for individuals as we are taxed depending on residency status. Residency determines what income will be subject to tax and what tax rates will be used. In general, a resident citizen is taxable on worldwide-sourced income at the graduated rates of 5-32 percent, while a non-resident citizen is taxable only on income within the Philippines at the same tax rates applied to a resident citizen. On the other hand, resident aliens and non-resident aliens engaged in trade or business are generally taxed in the same manner as a nonresident citizen. A non-resident alien not engaged in trade or business is taxable on income within the Philippines at a flat rate of 25% based on gross income. Considering these different tax treatments, a difference of one day in physical presence can affect how an individual gets taxed.
The BIR’s continuous efforts to provide clear guidance on tax law application will make it easier for companies to assess their would-be tax circumstances in doing business in the Philippines and develop informed business decisions.
Jan Kent Q. Viray is a supervisor from the tax group of KPMG R.G. Manabat & Co. (KPMG RGM&Co.), the Philippine member firm of KPMG International. KPMG RGM&Co. has been recognized as a Tier 1 tax practice, Tier 1 transfer pricing practice and Tier 1 leading tax transactional firm in the Philippines by the International Tax Review.
This article is for general information purposes only and should not be considered as professional advice to a specific issue or entity.
The views and opinions expressed herein are those of the author and do not necessarily represent the views and opinions of KPMG International or KPMG RGM&Co. For comments or inquiries, please email ph-inquiry@kpmg.com or rgmanabat@kpmg.com.
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