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Clarifying the taxability of cross-border services

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Lately, Revenue Memorandum Circular (RMC) No. 5-2024 has become a hot topic of discussion. Just last quarter, two articles were released discussing the implications of this circular and how it will impact transactions moving forward. You might be tired of hearing about this, but here is another one.

After negative reactions from various stakeholders, it’s no surprise that the Bureau of Internal Revenue (BIR) will release clarifications aiming to shed light on what has become one of the most controversial BIR issuances to date. The subject of the RMC is the Supreme Court decision involving cross-border service transactions in the case of G.R. No. 226680 dated Aug. 30, 2022. A new circular, RMC 38-2024, seeks to address issues arising from the earlier circular by clarifying critical points on cross-border services, as follows:

APPLICATION OF THE RULING IN G.R. NO. 226680 TO CROSS-BORDER SERVICESAccording to RMC 38-2024, the SC case does not automatically apply to international service provision or cross-border service agreements in Question 2 of the RMC 5-2024, since it did not expressly provide for such an application. Rather, a determination must be made on whether the source of income is within the Philippines by examining all the components of the cross-border service agreements between two taxing jurisdictions (i.e., that of the Philippines and the Non-Resident Foreign Corporations). Further, the services are to be viewed in their entirety and not as a single or compartmentalized particular activity as the income producing activity, in consonance with the Civil Code provisions on the performance of the thing or service which is the basis of the obligation. The same goes with the allocable or reimbursable expenses.

RMC NO. 5-2024 AND THE SOURCE OF INCOME RULES OF THE NIRCQuestion 3 of RMC 5-2024 does not run counter to the rules on situs of income outlined in Section 42 of the National Internal Revenue Code (NIRC or the Tax Code), since it merely spelled out the main guideline in the determination of the source of income for cross-border services as provided in the second question of RMC 38-2024. Ultimately, the latest circular explains that following the ruling in the SC case, the situs of the source of income for labor or personal services is the location of the service that produces the income or where the inflow of wealth originates.

RMC NO. 5-2024 AND TAX TREATIESQuestion 5 of RMC 38-2024 provides that if the income is clearly identified to be within the Philippines, the taxpayer is not precluded from invoking the particular tax treaty to either exempt the income (subject to the rules on the absence of permanent establishment) or reduce the tax to that of the preferential rate under the applicable tax treaty.

What is fascinating is the final provision of the latest circular which clarifies that the 25% final withholding tax and 12% final withholding VAT on the cross-border service transactions are actually not new impositions, suggesting a retroactive application of the two circulars and the SC decision.  It reiterated that the Tax Code and the relevant revenue regulations already impose these taxes on the income of NRFCs from all sources within the Philippines. Is this really the case though? In the first place, was the issuance of the earlier circular in accord with the situs rules on income taxation? 

In the January 2024 article on RMC 5-2024, the author thoroughly discussed how this RMC deviated from the Tax Code’s rules on situs of taxation — how the circular adopted the “benefits-received” theory to determine the source of the income, and consequently, its taxability in the Philippines. This appears to be an attempt to impose tax on transactions even though they may have been physically rendered outside the Philippines, following the standards enunciated in the SC case. We may be settled on the fact that both circulars, in a way, have been maintaining their position on the taxability of cross-border transactions. Equally settled however is the fact that most of us will not agree to such a treatment, applying strictly and technically the provisions of our Tax Code.

The situs rule under the Tax Code is clear that for service fees of NRFCs to be considered income from Philippine sources subject to Philippine taxes (both income tax and VAT), the underlying service activity must be performed within the Philippines. If the circulars merely adopt this principle, it may be correct in saying that the tax impositions are not new. However, the two circulars and SC decision introduced a concept called “benefits-received,” which is not in the NIRC.

The Tax Code does not categorically provide for a “benefits-received” approach in determining the taxability of certain transactions. Rather, the place where the services are performed set the parameters in determining taxability in the Philippines.  Assuming, for the sake of argument, that the administrative agency may introduce principles not provided under our laws, such as the “benefits-received” theory in this case, this does not merit a retroactive application as it runs against the principle of prospectivity of laws, as a general rule.  Notably, even an SC decision that introduces a new principle is applied prospectively. Tax laws impose burdens and are viewed like criminal laws, which should not be given retroactive effect unless beneficial to the taxpayers.  After all, tax laws are strictly construed against the taxing authorities and in favor of the taxpayers.

The latest circular could have been an avenue to reconcile the gap between the differences in the appreciation of the ruling in the SC case vis-a-vis its proposed application based on the earlier circular. It was a response to the adverse reaction of stakeholders and could have ended the confusion in the minds of the public, but it somehow failed to do. At the end of the day, it is important for us to look at the basic principles in tax law — the supremacy of laws over administrative issuance, prospectivity and strict construction of a tax law. At this juncture, I believe that the issuance of the latest circular is still not enough to address the confusion brought about by the earlier circular. If at all, RMC 38-2024 shows the tax authorities’ firm stand on the taxability of cross-border service transactions. In any case, I earnestly hope that the tax authorities will consider revisiting these circulars, taking into account the situs rules under the NIRC; otherwise, we will be running around in circles, stuck at an impasse.

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.

Mary Rose Lara is a manager at the Tax group of Isla Lipana & Co., the Philippine member firm of the PricewaterhouseCoopers global network.


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