Whenever the word “zero” comes to mind, it is usually perceived negatively, often because having zero means you literally have nothing. However, this is not the case when it comes to value-added tax (VAT). VAT zero-rating basically entails that the sale of goods and services is subject to zero VAT. It is designed to promote business growth by reducing the tax burden on eligible transactions, thereby increasing the competitiveness of local businesses. However, the entitlement to VAT zero-rating for services rendered to a non-resident customer is subject to certain conditions.
To qualify for VAT zero-rating, the following requisites under Section 108(B)(2) of the National Internal Revenue Code, as amended by RA 9337, must be met: First, the services rendered should be other than ‘processing, manufacturing or repacking of goods’; second, the services are performed in the Philippines; third, the service-recipient is (a) a person engaged in business conducted outside the Philippines; or (b) a non-resident person not engaged in a business outside the Philippines when the services are performed; and fourth, the services are paid for in acceptable foreign currency inwardly remitted and accounted for in conformity with the Bangko Sentral ng Pilipinas’ rules and regulations.
In a recent case, the Supreme Court had a comprehensive analysis of the abovementioned requisites. The respondent in this case is a VAT-registered corporation engaged in the general business of shipping, including manning and crewing of vessels, as well as the carriage of passengers, freight, mail, livestock and other lawful merchandise.
The respondent filed an administrative claim for refund or issuance of tax clearance certificate for its unutilized input VAT for taxable year 2014 with the Bureau of Internal Revenue (BIR). The respondent alleged that it rendered manning services to shipping companies located and doing business outside the Philippines, for which it was paid manning fees in foreign currency that were subject to zero VAT.
The petitioner, however, contended that while the respondent had established the existence of the requisites to qualify for VAT zero-rating services, an examination of the Manning Agreements or Purchasing and Infrastructure Support Agreements would reveal that the recipients are engaging in activities that suggest a continuity of business dealings or arrangements within the Philippines.
While the manning services are not directly related to the main business of the foreign shipping companies, they are incidental to and in pursuit of commercial gain or for the purpose and object of the foreign shipping companies, such that it would not be able to operate without said services. Thus, the petitioner opined that the respondent is not entitled to VAT zero-rating since the manning services imply that the foreign companies are doing business in the Philippines.
The concept of doing business in the Philippines is associated with activities that are primarily profit-oriented.
The Supreme Court has provided clarity on this matter in several cases. In one decision, the Court held that an appointment of a local agent signifies a continuity of conduct and intention to establish a continuous business. Similarly, in another case, the Court ruled that to constitute “doing business,” the activity to be undertaken in the Philippines must be largely for profit-making purposes.
Further, under the implementing rules and regulations of Republic Act 7042, otherwise known as the Foreign Investments Act of 1991, the term “doing business” includes “participating in the management, supervision or control of any domestic business, firm, entity or corporation in the Philippines, and any other act or acts that imply a continuity of commercial dealings or arrangements, and contemplate to that extent, the performance of acts or works, or the exercise of some of the functions normally incidental to and in progressive prosecution of commercial gain or of the purpose and object of the business organization.”
Applying the abovementioned rulings and law, the Court rejected the petitioner’s contention that the shipping companies are doing business in the Philippines. The Court found that the respondent, as representative or agent of the shipping companies, the principal, does not operate under the full control of the latter.
The shipping companies have no command over the respondent on the operation of the latter’s business, even in the conduct of its recruitment process. The recruitment instructions and the approval of the dismissal or transfer of crew members are merely necessary consequences of outsourcing manpower recruitment.
Also, the hiring of the crew members in the Manning Agreements or Purchasing and Infrastructure Support Agreements with the shipping companies is not considered a continuity of their commercial dealings, nor is this in pursuit of commercial gain.
Although the hiring of crew members or engineers and the purchase of provisions are essential for the operation of these vessels, these procurements do not necessarily bring in profit to the shipping companies, which primarily earn profit by providing transport services.
In ruling in favor of granting the refund claim, the Court emphasized that the term “doing business” includes regularity, continuity and intention behind the activities.
This decision can serve as a useful reference for taxpayers when it comes to services performed for their nonresident foreign customers. If a foreign entity performs actions that are consistent, sustained and aimed at garnering profit, it may be considered as doing business in the Philippines. As such, the taxpayer will not be allowed to claim for zero VAT on these services.
Shirley Marie Cada 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 Tax Supervisor Shirley Marie Cada or to Tax Partner Kathleen Saga through [email protected], social media or visit www.home.kpmg/ph.
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