Source and situs

With the advancements and increased access to technology, the interconnection between countries in terms of their people, culture and economies has become more seamless.

This, in turn, has strengthened markets and contributed to much more stable economies. This is due, in no small part, to the fact that the flow of wealth is no longer limited to local sources but has expanded through various international channels.

As income continues to flow, the corresponding obligation of the government is to protect the wealth and patrimony of its people. Corollary to that protection is the duty to contribute an amount of money sufficient to defray the expenses of the government in which taxation plays a vital part. However, tax laws, no matter how vast the coverage of this inherent power, are enforced only within its territorial jurisdiction. The power of taxation, as exercised by Congress, is limited to apply only to those transactions contemplated by the framers in the past.

The power of taxation is enforced upon its citizens for income wherever it may be derived. Foreign entities registered outside the Philippines, on the other hand, may only be taxed for income realized in the country. Philippine tax rules are easily applicable to those transactions that can be discerned physically taking place in our territory. The problem arises when the service takes place in the cyber world and the payment is made in the foreign country. Can the Philippine government enforce its taxation powers on a non-resident foreign corporation for transactions performed through the internet? Is the payment made abroad by Philippine subjects to non-resident entities considered income realized in the Philippines and thus may be taxed in this country?

Seamless as the wealth moves from one state to another, our tax laws should also progress to bridge and address the gap between the wisdom brought by traditional rules of taxation and these modern transactions currently existing between nations. These rules should be as comprehensive to cover those complex transactions presented by this ever-changing world.

One of the recent developments in our taxation rules is the promulgation of the Supreme Court decision resolving the issue of whether fee payments made by a resident corporation to non-resident foreign corporation are subject to Final Withholding Tax (FWT) and Final Withholding Value-Added Tax (FWVAT) by identifying, first, the source of the income and second, the situs of that source.

The Bureau of Internal Revenue issued Revenue Memorandum Circular (RMC) 5-2024 to clarify the tax treatment of cross-border services in light of said Supreme Court decision. Shortly thereafter, RMC 38-2024 was released to clarify the issues raised by stakeholders on the earlier mentioned circular.

Identifying the source of income

In the cited case, the Supreme Court discussed that “income” refers to the flow of wealth. In ascertaining the income source, we must inquire into the property, activity or service that produced the income, or where the inflow of wealth originated. It is insufficient to identify just any property, activity or service. The subject may only be regarded as an income source if the particular property, activity or service causes an increase in economic benefits, which may be in the form of an inflow or enhancement of assets or a decrease in liabilities with a corresponding increase in equity other than that attributable to a capital contribution.

Identifying the situs

After identifying the source of the income, inquiry may already be made as to its situs. It is settled that when the inflow of wealth and/or economic benefits proceeds from and occurs within Philippine territory, it enjoys protection of the Philippine government. In consideration of such protection, the flow of wealth should share the burden of supporting the government and thus is subject to tax. The Philippine situs of income taxation from fee payments may be established if: (1) the income-generating activity is directly associated with the facilities located within the Philippine territory; and (2) engaging in a particular business activity in the Philippines is a government-regulated industry.

International service provision (cross-border services)

RMC 5-2024 discussed that International Service Provision or cross-border services refers to a service-based company that operates in various countries, providing services to clients. 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. However, RMC 38-2024 clarified that in the Supreme Court decision cited, finding the source of income of service agreement to be within the Philippines and thus subject to final withholding tax, does not automatically apply to the list provided in RMC 5-2024 of international service provision or cross-border services. The mentioned list is only to highlight that such services are likewise performed, rendered, delivered or supplied by a non-resident foreign corporation to a domestic or resident entity in the Philippines.

Situs of taxation of cross-border services

In the RMCs, the BIR had the opportunity to reiterate that the source of income is in the Philippines if the property, activity or service that produces the income is in the Philippines, which consequently gives the Philippine government the jurisdiction to tax the same. It is further explained 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.

This principle is crucial in cases where business transactions occur in multiple stages across different taxing jurisdictions. In such instances, it becomes imperative to ascertain whether the particular stages occurring in the Philippines are so integral to the overall transactions that the business activity would not have been accomplished without them. If the income-generating activities in the Philippines are deemed essential, the income derived from these activities would be considered as sourced from the Philippines for tax purposes, irrespective of where the payment is ultimately received. This principle aligns with the benefits received theory in taxation, which submits that the jurisdiction providing the essential services or factors for income generation should be entitled to that income.

In summary, what needs to be noted in cross-border services rendered by a Non-resident Foreign Corporation to a resident entity to be liable of FWT and FWVAT is to determine the source and the situs of that income which may be further examined by breaking down the components of the service to be performed into stages. If an integral part of the service is going to take place in the Philippines, then the income derived therein shall be deemed sourced from this country and likewise will be taxed here.

Ram Dominique Billedo is a Supervisor from the Tax Group of KPMG in the Philippines (R.G. Manabat & Co.), a Philippine partnership and a member firm of the KPMG global organization of independent member firms affiliated with KPMG International Limited, a private English company limited by guarantee. The firm has been recognized as a Tier 1 in Transfer Pricing Practice and in General Corporate Tax Practice by the International Tax Review. For more information, you may reach out to Ram Dominique Billedo or Manuel Salvador III through [email protected], social media or visit www.home.kpmg/ph.

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 KPMG International or KPMG in the Philippines.