Not as simple as it seems

During tax audits, particularly for companies that provide services to non-resident foreign corporations (NRFCs), one of the usual findings of the Bureau of Internal Revenue (BIR) is whether such sales of services qualify for value-added tax (VAT) zero-rating.

Under Section 108(B)(2) of the Tax Code, the following conditions must be satisfied for services (other than processing, manufacturing or repacking of goods) to qualify for VAT zero-rating:

1. The services should be rendered in the Philippines;

2. The payment for such services must be in an acceptable foreign currency and accounted for in accordance with Bangko Sentral ng Pilipinas (BSP) rules and regulations; and

3. The recipient of such services must be doing business outside the Philippines.

Normally, the first two requisites can easily be supported by available documents, such as agreements/contracts, certificates of inward remittance, among others, and are no longer disputed by the BIR in most cases.

From my experience, it is the third requisite that generally gets contentious. While the condition as written in the law is for the foreign customer to be doing business outside the Philippines, in practice, the BIR and courts equally watch out for the converse action, i.e., that the foreign customer must not be doing business in the Philippines.

Under the Foreign Investment Act of 1991, the phrase “doing business” includes soliciting orders, service contracts, opening offices, whether called “liaison” offices or branches; appointing representatives or distributors domiciled in the Philippines or who in any calendar year stay in the country for a period or periods totaling 180 days or more; 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 incident to, and in progressive prosecution of, commercial gain or of the purpose and object of the business organization.

Based on a 2021 Supreme Court case, there are two general tests to determine whether a foreign corporation is “doing business” in the Philippines:

1. Substance test – whether the foreign corporation is continuing the body of the business or enterprise for which it was organized or whether it has substantially retired from it and turned it over to another.

2. Continuity test – continuity of commercial dealings and arrangements, and contemplates, to that extent, the performance of acts or works or the exercise of some of the functions normally incident to, and in the progressive prosecution of, the purpose and object of its organization.

Meanwhile, in terms of appropriate documentation to prove that the NRFC is doing business outside the Philippines, the Supreme Court and Court of Tax Appeals (CTA) sitting en banc in several cases have held that at the very least, both (1) a Securities and Exchange Commission (SEC) Certificate of Non-registration of Corporation/Partnership, and (2) a Certificate/Article of Foreign Incorporation/Association, should be provided. However, bear in mind that it is not as simple as it may seem. These are just the minimum requirements to prove that the NRFC is indeed a foreign corporation. During a tax audit, the BIR may still request additional documentation to prove that these NRFCs are not doing business in the Philippines, and therefore, qualified for VAT zero-rating. Following the substance and continuity tests laid down by the Supreme Court, there must be no indication that the NRFC is doing business in the Philippines.

In fact, just this year in CTA en banc No. 2685 dated Jan. 24, the CTA held that although the above documents were provided as support, even including a Tax Residency Certificate and Certificate of Business Registration issued by a foreign government authority, the transaction still did not qualify for VAT zero rating.

In that case, the main reason cited by the tax court for imposing VAT on the services was the appointment of the Philippine taxpayer/service provider as the NRFC’s authorized representative in the Philippines and the terms of their agency agreement. Based on their agreement, the Philippine taxpayer-service provider would promote, make available, facilitate access to the NRFC’s System and act as a neutral agent for all NRFC subscribers in the Philippines subject to the payment of a distribution fee.

However, the Court noted that the NRFC has the following rights which manifest its continuous participation in the dealings of the Philippine taxpayer in the Philippines:

1) The NRFC is permitted to directly contract with multinational subscribers based within or outside the Philippines;

2) The NRFC may contract with subscribers within the Philippines who wish to make use of the global distribution system services through the NRFC’s online and corporate products; and

3) The NRFC may, on its own, terminate the agreement entered between any Philippine subscriber in the event of misuse or abuse of the System.

Article 1868 of the Civil Code provides that a contract of agency requires the presence of the following essential elements: (1) there is consent, express or implied of the parties to establish the relationship; (2) the object is the execution of a juridical act in relation to a third person; (3) the agent acts as a representative and not for himself, and (4) the agent acts within the scope of his authority.

According to the CTA, it is clear that the agreement meets the elements of an agency contract, debunking any notion that the NRFC is not doing business in the Philippines. With this, the Court ruled that even though the parties were able to prove through the submission of the required minimum documents that the NRFC is indeed a foreign corporation, it is, however, doing business in the Philippines. Thus, the related distribution fees paid by the NRFC are not qualified for VAT zero rating.

This just goes to show once again what the Supreme Court has held on multiple occasions, that the determination of whether or not a NRFC is doing business in the Philippines should be done on a case-to-case basis. It is not as simple as presenting evidence that an NRFC is a foreign corporation; as that only satisfies one part of the equation. To fully satisfy the “doing business” condition for VAT zero-rating, there must also be no indication that such foreign corporation is performing acts or functions that are normally incident to the pursuit of its primary purpose or main business.

The views or opinions expressed in this article are solely those of the author and do not necessarily represent those of Isla Lipana & Co. The content is for general information purposes only, and should not be used as a substitute for specific advice.


Steven Lloyd Co is a manager at the Tax Services department of Isla Lipana & Co., the Philippine member firm of the PwC network.

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