Impact of taxation of satellite services on cross-border services

IN taxation of foreign corporations in the Philippines, the determination of source of income is key, and this determination has taken a significant turn lately.

Taxation is an inherent power of sovereignty of a state. For a state to exercise such power, there must be a nexus between the subject (person, property, income or business) and the state that exercises that power.

Under our National Internal Revenue Code (Tax Code), the nexus is determined by one’s residence and source of income. While resident citizen individuals and domestic corporations are taxed on their worldwide income, foreign corporations, whether they be resident or not (or doing business in the Philippines or not), are taxed only on their Philippine-sourced income.

Since income is an inflow of wealth, one has to inquire on the property, activity or service that produced the income. Under our Tax Code, service fees are considered Philippine-sourced if the service is performed in the Philippines. Therefore, in determining whether or not fees payable to a nonresident foreign corporation are Philippine-sourced income, it is crucial to determine where the services are performed.

In the case of Aces Philippine Cellular Satellite Corporation v. the Commissioner of Internal Revenue, GR 226680, the Supreme Court ruled that the satellite air time fee payments were made by Aces Philippines Cellular Satellite Corp. (Aces Philippines) to Aces International Ltd., a company incorporated in Bermuda (Aces Bermuda), is Philippine-sourced income and, thus, should be subject to withholding tax. The satellite, Garuda 1, is, of course, in outer space, and, thus, outside the Philippine territorial jurisdiction. It is also being monitored, operated, controlled and managed by a network control center located in Indonesia.

Aces Philippines argued that the income payment to Aces Bermuda is not Philippine-sourced, and thus, should not be subject to withholding tax. According to Aces Philippines, the services (the transmission of calls using the satellite in outer space) were performed outside the Philippines, without using any Philippine equipment owned by Aces Bermuda. It cited laws and jurisprudence outside the Philippines, which do not regard satellite airtime fee payments as subject to withholding tax. It also cited the earlier Bureau of Internal Revenue (BIR) Ruling ITAD-214-02 wherein the commissioner of Internal Revenue opined that when no equipment is installed in the Philippines, the services of a nonresident foreign corporation coursed through satellites are not Philippine-sourced income.

To understand the nature of the service, one has to understand the operation of a satellite. Aces Philippines pointed out that the satellite’s systems operations can be broken into two separate segments: first, the satellite receives the call (from a subscriber) and beams the signal to the network control center in Indonesia which, in turn, would determine the exact Philippine gateway the call shall be routed to. Second, the Philippine gateway receives the call, routes its switch and processes it for termination. The gateways are located in the Philippines and owned by Aces Philippines, not by Aces Bermuda. According to Aces Philippines, Aces Bermuda’s service is terminated or finished by the time the Indonesia network control center provides information to the Garuda 1 satellite.

The Supreme Court, however, agreed with the Court of Tax Appeals and held that the income-generating activity takes place not during the act of transmission, but only upon the gateway’s receipt of the call as routed by the satellite. It then concluded that it is the gateway’s receipt of the call which completes the delivery of the service and determines the inflow of economic benefits in favor of Aces Bermuda. It noted that the income generation of Aces Bermuda is dependent on the operation of facilities situated in the Philippines. While the gateway facilities are legally owned by Aces Philippines, the Supreme Court held that Aces Bermuda has sufficient economic or beneficial interest in these properties, “inasmuch as its Philippine operations are dependent on these local facilities.”

In summary, the Supreme Court held that the main asset situated in outer space cannot be determinative of the income source and the situs thereof. It is clear then that the higher court gave much weight on the receipt of the service by gateway facilities in the Philippines vis-a-vis the services rendered through the satellite in outer space.

The Supreme Court also rejected the US cases and commentaries of the Organization for Economic Cooperation and Development cited by Aces Philippines, holding that all these are only persuasive. It did acknowledge that no Philippine law characterizes international satellite communications income as foreign-sourced income and took the view that this only reveals that our legislature also did not intend to remove income from foreign satellite companies from the reach of Philippine taxation.

The Supreme Court’s decision does not only significantly impact the interpretation of situs of income of satellite companies, but it may also now affect the view or taxation of other cross-border services. In the recently passed Revenue Memorandum Circular 5-2024, the BIR cited the benefits-test theory and said that it is now imperative to determine whether the particular stages of a transaction occurring in the Philippines are so integral to the overall transaction that the business activity would not have been accomplished without them.

Moreover, the payment or income generated from service fees paid to the foreign company, including those made through the internet or other electronic means with use of information technology, is considered an inflow of economic benefits in favor of the foreign company. This view, which can always be skewed in favor of the Philippine leg of any transaction, can definitely be very controversial, especially when not applied properly, fairly and equitably.

Euney Marie J. Mata-Perez is a CPAlawyer and the managing partner of Mata-Perez, Tamayo & Francisco (MTF Counsel). She is a corporate, M&A and tax lawyer and has been ranked as one of the top 100 lawyers of the Philippines by Asia Business Law Journal and is the incoming chairman of the Tax Committee of the Management Association of the Philippines. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. If you have any question or comment regarding this article, you may email the author at info@mtfcounsel.com or visit MTF website at www.mtfcounsel.com.