Tax Treatment of Cross-Border Transactions

On 10 January 2024, the Bureau of Internal Revenue (“BIR”) issued Revenue Memorandum Circular (“RMC”) No. 5-2024 clarifying the proper tax treatment of cross-border services in light of the Supreme Court En Banc Decision in Aces Philippines Cellular Satellite Corp. v. Commissioner of Internal Revenue, G.R. No. 226680 dated 30 August 2022.

In line with Aces Philippines Cellular Satellite Corp. v. Commissioner of Internal Revenue, the BIR laid down a mechanism for evaluating tax obligations related to the services rendered by non-resident foreign corporations and the payments to be made to them by Filipino individuals or entities for the services they performed.

Background of Aces Philippines v. CIR

The Supreme Court (“SC”) faced an issue of whether Aces Philippines’ satellite airtime fee payments to Aces Bermuda were subject to Final Withholding Tax (“FWT”). The SC employed a two-tiered approach, evaluating the source of income (the activity causing economic benefits) and the situs of income (where the inflow occurs, like the Philippine territory). Despite Aces Philippines claiming the income source was the transmission in outer space, the SC determined that the gateway’s receipt of the call in the Philippines marked the completion of the service and accrual of the fees payable to Aces Bermuda. This accrual of fees payable to Aces Bermuda was considered the inflow of economic benefits. The SC found that the following established the Philippine situs of Aces Bermuda’s income: (i) the income-generating activity is directly associated with the gateway located within the Philippine territory, and (ii) engaging in the business of providing satellite communication services in the Philippines is a government regulated industry. Consequently, the income source was deemed to be in the Philippines, leading to Aces Philippines’ liability for deficiency FWT.

Situs of Taxation of Cross-Border Transaction

It is settled that the source of income is in the Philippines if the property, activity, or service that produces the income is in the Philippines. However, 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 took place.

Thus, even if the services are conducted or paid abroad, if there are activities to be performed in the Philippines that are integral to the entire service transaction that cannot be accomplished without them, then, the benefit-received theory applies. This means that the revenue-generating activity occurs within the Philippines. The income generated by the foreign company providing the services, which are considered sources within the Philippines, shall be subject to income tax and, consequently to FWT.

Effect of No Benefits Derived from the Cross-Border Transactions

If a Philippine company derives no benefits, payment may be deemed unnecessary for regular commercial activity and instead viewed as a profit-shifting tactic to a foreign company. The crucial aspect is that the income source should align with the location of the business activity generating it, not where the payout is received. This principle supports taxing income in the jurisdiction where economic activity occurs and benefits are received.

Applicability of VAT on Revenue Generated from Service Fees Paid to Foreign Companies or Individuals, which are considered Sources within the Philippines

Section 108(A), in relation to Section 114 of the National Internal Revenue Code of 1997, as amended, plays a significant role in determining the applicability of value-added tax (“VAT”) on payments related to the sale or exchange of services. This provision generally states that a 12% VAT is levied only if the services in question are performed within the Philippines.

The phrase “sale or exchange of services” encompasses a broad range of activities involving the provision of services in the Philippines to others in exchange for a fee, remuneration, or consideration. Such phrase would include any service performed within the country for the benefit of another party, including income generated from service fees paid to foreign companies or individuals which is subject to VAT if the source of that income is within the Philippines. 

Following this, even if the service provider is located outside the country, if the service is utilized, applied, executed, or consumed for a recipient within the Philippines, the income payment for such service is considered sourced within the country and, thus, the VAT is applicable. Consequently, payment for such service shall be subject to final withholding VAT.