How do we tax services performed in outer space? Let’s float around the rules laid down in Revenue Memorandum Circular (RMC) No. 5-2024 and RMC No. 38-2024 which clarifies the proper tax treatment of cross-border services in light of the Supreme Court (SC) En Banc Decision in Aces Philippines Cellular Satellite Corp. v. Commissioner of Internal Revenue (Aces vs CIR) GR No. 22668.
As a brief background of the case, Aces Philippines, a subsidiary of PLDT, paid Aces Bermuda, a non-resident foreign corporation (NRFC), satellite airtime fees. Aces Philippines did not withhold any tax. The CIR argued that the satellite airtime fees are income payments to an NRFC which are subject to 35% Final Withholding Tax (FWT).
Aces Philippines argued that the act of transmission, which takes place in outer space, is the activity that produces income. The situs of the income is thus outside the Philippines. Aces Bermuda-operated earth stations that perform the required services outside the Philippines hence, it should not be liable to 35% FWT.
In ruling for the CIR, the SC used a two-tiered approach, (1) identify the source of the income and (2) identify the situs of that source.
For identifying the source of the income, the SC ruled that it is important to look into the property, activity, or service that produced the income or where the flow of wealth originated. An increase in economic benefits must be proven to constitute income. It was further ruled that the income-generating activity takes place only upon the gateway’s receipt of the call as routed by the satellite and is utilized by the Philippine subscriber for a voice or data call. The SC pointed out that “there is a continuous and very real connection” within the components of the Aces System.
To illustrate the “continuous and very real connection” while using the Aces system, (1) you make a call in the middle of the sea, (2) your call will be routed to the Satellite (3) which will then be beamed to the call the Network Control Center in Indonesia which Aces Bermuda owns. (4) The time the Network Control Center receives the call, there is still no complete delivery of “air time” or there is no economic benefit derived yet. The Network Control Center in Indonesia will then communicate the call back to the Satellite and eventually, (5) the Satellite will route the call to the Philippine Gateways which ultimately processes and transmits the call back to you. It is settled that it is only when the call is routed to the Philippine Gateway that the airtime fees accrue since the “continuous and very real connection” has ended. The only next step is for the Philippine Gateway to transmit the call back to you hence, the accrual of the fees signifies the inflow of economic benefits.
For the situs of the source of income, the SC ruled that the income-producing activity is within the Philippines since the operations and facilities for the gateways are situated in the Philippines.
RMC No. 05-2024 Expands the Decision in Aces vs CIR?
In response to the Aces vs. CIR case, the BIR issued what many say is controversial, RMC No. 5-2024. RMC No. 5-2024 states that the way to establish the situs of taxation for cross-border services is to check if the revenue-generating activity occurs within the Philippines. The source of the 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 actually took place. This analysis is more crucial for business transactions that have multiple stages (i.e. the airtime service fees in Aces vs. CIR). The focal point is to ascertain whether the particular stages of the business transactions occurring in the Philippines are so integral to the overall transaction that the business activity would not have been accomplished without them. The BIR argues that this principle aligns with the Benefits-received theory in taxation which submits that any inflow of wealth and/or economic benefit proceeds from, and occurs within the Philippine territory, it enjoys the protection of the Philippine government hence, the flow of wealth shall be taxed.
The BIR pounced on the opportunity to enumerate existing cross-border services “akin” to that of Aces vs. CIR, namely: (a) Consulting Services, (b) IT Outsourcing, (c) Financial Services, (d) Telecommunications, (e) Engineering and Construction, (f) Education and Training, (g) Tourism and Hospitality, (h) Other Similar Services. None of the enumerated services were mentioned in the Supreme Court’s Ruling in Aces vs. CIR.
Some tax experts argue that RMC No. 05-2024 is an overreach from the decision of the Supreme Court in Aces vs. CIR. It has been well-established that administrative issuances must only provide guidelines and implementations of the law. It cannot substantially increase or decrease the law or, as the saying goes, the spring cannot rise higher than its source.
Section 28 (b) of the National Internal Revenue Code (NIRC) provides that NRFCs shall only be taxed from all income sourced within the Philippines, and Section 42 of the NIRC defines “income from sources within the Philippines”. Section 42 of the NIRC establishes that the situs of taxation of income from services is the location where the service is performed.
The community of tax experts opine that the application of the Benefits Theory approach runs contrary to Section 28 (b) and Section 42 of the NIRC since the services performed abroad, with the benefit being enjoyed and used in the Philippines, shall still be classified as income sourced within the Philippines. Hence, the Filipino Resident shall be liable for FWT. The focal point of analysis of the BIR shifted from the performance of the service to the place of payment as the determination of income. This analysis runs contrary to Section 42 of the NIRC.
For example, a Filipino Resident hires a financial consultant from Singapore. They discuss over the Internet via Zoom and the Singaporean never flies over to the Philippines hence, the services are rendered purely in Singapore. Under the present tax code and long line of jurisprudence, the Filipino Resident is not taxable in the Philippines. However, under RMC No. 5-2024, it can be argued that since the benefits were received by Filipinos in the Philippines, then there is not only FWT but also VAT implications.
Surprisingly, the BIR took it upon itself to discuss Value-added Tax (VAT), despite it not being discussed in Aces vs CIR, for revenues generated from service fees paid to foreign companies or individuals. The BIR concluded that foreign companies are located outside the Philippines. However, if the service is utilized, applied, executed, or consumed for a recipient within the Philippines then Final Withholding VAT is applicable.
Lastly, the BIR warns Philippine companies that if the Philippine company derives no benefits from cross-border transactions, it may be seen as an attempt to evade taxes or manipulate profits by funneling them to a foreign entity.
The BIR Clarifies RMC No. 5-2024
In response to the clamor of the tax experts community, the BIR issued RMC No. 38-2024 to clarify RMC No. 5-2024. The BIR stated that the ruling of the Aces vs. CIR case does not automatically apply to the international service provision or cross-border services listed in RMC No. 5-2024 as there is no express mention thereof. The BIR reckoned back to the long-standing rule that the source of income is in the Philippines if the property, activity, or service that produces the income is in the Philippines. The flow of wealth proceeded from, and occurred within the Philippine territory, enjoying the protection accorded by the Philippine government. The BIR enumerated crucial factors to determine the sources of income, such as: (1) whether the cross-border services are dependent on the successful use, consumption, or utilization by the Philippine purchaser of the service for income to be accrued; or (2) whether the performance of the service depends on the facilities located in the Philippines; or (3) whether the particular stages occurring in the Philippines are so integral to the overall transaction that the business activity would not have been accomplished without it; among others.
RMC No. 5-2024 further added that the reimbursable or allocable expenses charged by a foreign corporation in the Philippines should contribute to the value or benefit received by a local company. The reduction of expenses for a foreign corporation can be considered as income because the company is spending less on its operations, resulting in additional funds that can be used for other purposes or retained as profit. The BIR justified itself in talking about reimbursable or allocable expenses for cross-border services under RMC No. 38-2024. It stated that cross-border services usually involve related parties, a common of which are intra-group services. As such, intra-group services, issues arise on whether the pricing of such services is at arm’s length. Hence, the BIR deemed it necessary to lay down the basic rules on reimbursable or allocable expenses for services between or among related parties.
The BIR stood firm with its pronouncement as it further stated in RMC No. 38-2024 that if the source of income of cross-border services is within the Philippines, the NRFCs are subject to VAT.
Lastly, RMC No. 38-2024 enunciated that RMC No. 5-2024 is not inconsistent with the provisions of tax treaties because the latter only sets forth guidelines to establish the source of taxation or cross-border services that are akin to Aces vs. CIR. After the source of income is established, the taxpayer can apply any particular tax treaty to try and get an exemption from income tax.
Considering the foregoing, Philippine Residents and Non-Resident Foreign Corporations have a legal framework for assessing their FWT and Final Withholding VAT respectively for cross-border services. RMC No. 38-2024 provided some clarity on the determination of the source of income, however, more questions can be brought up and further clarifications are needed. Nonetheless, we must still respect & uphold RMC No. 5-2024 & RMC No. 38-2024 until another clarificatory issuance is published or stricken down by the Court, to infinity and beyond.