2024 will go down as the year of numerous clarifications and amendments in Philippine tax rules. Both the Bureau of Internal Revenue (BIR) and National Government are active in improving the tax laws and streamlining processes to ease the taxpayer’s burden. The BIR and the government recognize the impact of digitalization and the growing connectedness of economies, driven by cross-border trade in goods and services, technological advancements, and flows of investment, people, and information.
From the Philippine standpoint, the growth of global digital trade has resulted in more transactions with non-residents. The trade flows are seen by the government as an opportunity to boost its revenue. Accordingly, one of the highlights in 2024 is the change in the way non-resident foreign corporations (NRFCs) are taxed.
THE FORMER NRFC TAX REGIME
Generally, NRFCs are taxable only on income received from sources within the Philippines. The income tax rate is 25% based on gross income. In determining whether the income is sourced from the Philippines, Section 42 of the 1997 National Internal Revenue Code (Tax Code), as amended, provides for the qualification. For example, income payments for services rendered by NRFCs are considered income sourced from the Philippines if the labor or personal services are performed in the Philippines. On the other hand, the income is sourced outside the Philippines if the labor or personal services are performed outside of the Philippines.
As regards the value-added tax (VAT), Section 108(A) provides that the sale or exchange of services, including the use or lease of properties, are subject to 12% VAT if such services are performed in the Philippines. Accordingly, for income from services, the NRFCs are liable only for VAT if the service is performed in the Philippines.
NRFCs also enjoy the benefit of relief from payment of tax as provided in the tax treaties. Under the Business Profit article of Philippine tax treaties, the profits of an enterprise of a Contracting State are taxable in the Philippines only if such enterprise carries on business through a permanent establishment (PE) in the Philippines, but only so much of the profits as is attributable to that PE.
RMCS AND JURISPRUDENCE AFFECTING NRFC TAXATION
Earlier this year, the BIR issued Revenue Memorandum Circulars (RMC) No. 5 and 38-2024, which clarify the tax treatment of cross-border services in light of the Supreme Court En Banc decision in Aces Philippines Cellular Corp. v. Commissioner of Internal Revenue. The RMC laid down the guidelines and crucial factors in determining the source of income of cross-border services.
According to the RMCs, the source of income is in the Philippines if the property, activity, or service that produces the income is in the Philippines. It also provides that the situs of the source of income for labor or personal services is not just the location but, more importantly, the location of the service that produces the income or where the inflow of wealth or economic benefits originates.
The RMC reasoned that since the economic benefits proceed from and occurred within the Philippines, the NRFCs enjoy protection from the Philippine government. In consideration of such protection, the flow of wealth should share the burden of supporting the government and thus be subject to tax.
VAT ON DIGITAL SERVICES
In addition to the amendments in the Tax Code, the VAT on Digital Services Law, or Republic Act No. 12023, was signed on Oct. 2, 2024. It imposes 12% VAT on digital service providers. A digital service provider is defined as a resident or nonresident supplier of digital services to a consumer who uses digital services subject to VAT in the Philippines.
Digital services refer to any services that are supplied over the internet or other electronic network using the use of information technology. It includes online search engines, online marketplaces or e-marketplaces, cloud services, online media and advertising, online platforms, or digital goods.
The new law amended the Tax Code by adding that digital services delivered by nonresident digital service providers are considered performed or rendered in the Philippines if the digital services are consumed in the Philippines.
Hence, NRFCs who are digital service providers are now required to register as VAT taxpayers, issue invoices for their transactions, and pay the VAT due on their transactions consumed in the Philippines if the consumers are non-VAT registered. If their consumers in the Philippines are VAT-registered, the reverse charge mechanism will apply, and the VAT taxpayer will take care of withholding the VAT and remitting the same to the BIR.
NRFC TRANSACTIONS NOT SUBJECT TO TAX
Based on the above discussions, apparently, there is now a thin line that separates the taxability and non-taxability of services performed by NRFCs outside the Philippines. Before, NRFCs enjoyed the benefits of tax exemption if they could establish that the labor or personal services were performed outside the Philippines. However, it can be gleaned from the latest issuances and new law that the BIR is now imposing tax on NRFCs for some types of services consumed in the Philippines.
The BIR is now of the view that under certain conditions, if there is an inflow of the benefits and consumption of service in the Philippines, the NRFC may be subject to tax notwithstanding that the services are performed outside the Philippines.
These new concepts on taxation of cross-border services are now causing some confusion and anxiety among taxpayers. With the foregoing changes, there are questions that need to be resolved to properly apply the provisions of the law and RMCs without prejudice to the rights of the taxpayers.
Although parameters were put in place to guide the determination of the source of income, it would be best if the BIR provided for specific transactions and their correct taxation. Moreover, it would be in the best interest of both taxpayers and regulators if the conflicting provisions of the law are harmonized and clarified using sample transactions and circumstances.
Clearly, it is expected that cross-border transactions will continue to grow in the succeeding years. This is a great opportunity for the Philippines to leverage its resources as well as to increase its revenue. In doing so, it will boost the production of goods and services. However, to effectively capitalize on this opportunity, the conflicting rules in taxation laws must be harmonized to correctly and properly allow taxpayers to pay the correct tax due to the government.
Let’s Talk Tax is a weekly newspaper column of P&A Grant Thornton that aims to keep the public informed of various developments in taxation. This article is not intended to be a substitute for competent professional advice.
Lorenzo Miguel A. Soriano is a manager from the Tax Advisory & Compliance division of P&A Grant Thornton, the Philippine member firm of Grant Thornton International Ltd.