Controversial new source rules for cross-border services

IN its Revenue Memorandum Circular (RMC) 5-2024, the Bureau of Internal Revenue (BIR) is espousing new rules regarding the situs or source of income.

RMC 5-2024 sprung from the Supreme Court decision in Aces Philippines Cellular Satellite Corp. v Commissioner of Internal Revenue, GR 226680, Aug. 20, 2022 (Aces case), involving payment of satellite airtime fees. The Supreme Court held in the Aces case that the airtime fees paid by a domestic company to a foreign company are Philippine-sourced income because the income-generating activity takes place not during the act of transmission but only upon the receipt of calls routed by the satellite through gateways in the Philippines.

Based on the Aces case, the BIR enumerated “cross-border” services such as consulting services, IT outsourcing, financial services, telecommunications, engineering and construction, education and training, tourism and hospitality, and other similar services, and stated that these services are “akin” to that of the services rendered by the foreign satellite-company in the Aces case.

In RMC 5-2024, the BIR stated: – Income earned is allocated to the countries where the services are performed, taking into account factors such as time spent, resources utilized or value created in each jurisdiction.

– The source of income is determined by the “source of business activity” rather than disbursement or receipt of funds.

– That income is Philippinesourced if the “property, activity or services” that produces the income is in the Philippines.

– Citing the “benefits-received theory,” the BIR states that it is imperative to ascertain if the particular stages occurring in the Philippines are so integral to the overall transaction that the business activity would not have been accomplished without them.

The BIR proceeded to state that the “payment or income generated from service fees paid to the foreign company, including those made through internet or other electronic means with the use of IT, is considered an “inflow of economic activity in favor of the foreign company.” It also stated that “the utilization of these services indicates that they offer benefits to the local company and are considered necessary to its business operations.”

Citing the source-based taxation principle, the BIR said that the jurisdiction where the economic activity occurs should have the right to tax the income derived from that activity, regardless of where the payment is made or received. This ensures that countries can maintain their tax base and collect taxes on income generated within their jurisdiction, promoting fairness in taxation by avoiding situations where income is artificially shifted or allocated to jurisdictions with more favorable tax regimes.

That the jurisdiction where the economic activity or service is performed has the right to tax the income arising therefrom, or the source-based taxation is a sound taxation principle. However, in determining source of income, the “economic activity” referred to should be the activity of the income recipient or the service provider, because what is in question is the income of such service provider; thus, it should not be the benefit to or economic activity of the payor of the income that should be the key factor.

This economic activity should be distinguished from the payment or source of money. Thus, it is not the place of payment which gives rise to the income activity; rather, it is the place of performance of the service by, or the economic activity of the service provider which gives rise to or entitles the service provider to the payment of such income.

Of course, the payor of the income, the domestic company which engaged the services of the foreign company and thus, is obliged to make service payments, necessarily needs and thus benefits from the services of the foreign company for its business needs; otherwise, it would not engage the services of such foreign company. But the business needs of and benefits to the local company should be distinguished from the business of or economic activity or service rendered by the service provider.

If these two concepts are confused, and for the purpose of income taxation, the value of the business or economic activity of the foreign corporation is determined by the benefits received or business activity of the Philippine company, then all services rendered foreign corporations to domestic companies will be deemed Philippine-sourced income.

Also, this interpretation would also be contrary to Section 42 of our National Internal Revenue Code (Tax Code), which clearly sets out the source rules for income from services is Philippinesourced income while those for services performed outside the Philippines is not Philippinesourced income. Thus, the key factor is the “place of performance” of the services.

In the Aces case, the Supreme Court considered the domestic gateways’ receipt of calls or signals from the satellite as the completion of the delivery of the service, which gives rise to the inflow of economic benefits in favor of the foreign satellite-owning company. Such interpretation considered the place of activity of the services rendered by the foreign service provider and the peculiar nature of such services. Also, the Supreme Court acknowledged that “no Philippine tax law” characterizes international satellite communications as foreign-sourced income only.

Thus, the Supreme Court ruling in the Aces case cannot just

be applied wholesale to other types of cross-border services because

there are specific rules under our Tax Code on determining the sources of various types of income. As acknowledged by the Supreme Court itself in Aces case, “it is fundamental that the power to determine the nature, object, extent, coverage and situs of

taxation rests with Congress.”

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.