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INTERNAL REVENUE

REPUBLIC OF THE PHILIPPINES

DEPARTMENT OF FINANCE
BUREAU OF INTERNAL REVENUE
Quezon City

Date
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REVENUE MEMORANDUM CIRCULAR NO. S - 2 Q 2 A

SUBJECT : Further Clarifying the Proper Tax Treatment of Cross-Border Services

in Light of the Supreme Court En Banc Decision in Aces Philippines
Cellular Satellite Corp. v. Commissioner of Internal Revenue, G.R. No.
226680, dated August 30, 2022

TO : All Internal Revenue Officers and Others Concerned

This Circular is being issued to further clarify the proper tax treatment of cross-border
services in light of the Supreme Court’s En Banc Decision in Aces Philippines Cellular
Satellite Corp. v. Commissioner of Internal Revenue, G.R. No. 226680, dated August 30, 2022.
The Circular offers a framework for assessing the final withholding tax and final withholding
Value-Added Tax (VAT) of the activities of non-resident foreign corporation (NRFC) within
the Philippine jurisdiction, allowing the Bureau to make informed determinations based on
established legal interpretations. As such, the Court’s Decision serves as a valuable reference
point for the Bureau in evaluating and addressing tax considerations related to the services
rendered by NRFCs, contributing to a clearer understanding of the tax obligations associated
with such transactions.

QI: What are the salient features of the Supreme Court’s En Banc Decision in Aces
Philippines?

A l : The following are the relevant salient features of the Decision of the Supreme Court
concerning final withholding tax on income payments abroad. The satellite airtime fee
payments in this case were income payments made by Aces Philippines
(payor/withholding agent) to Aces Bermuda (payee/income earner), a NRFC, for the
satellite airtime services it provided to Aces Philippines:

“xxx xxx xxx

Resolving the issue of -whether the satellite air time fee payments to Aces
Bermuda is subject to FWT requires a two-tiered approach, where we identify,
first, the source of the income and, second, the situs of that source.

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A.
Identifying the source

XXX XXX XXX

"Income" refers to the flow of -wealth. In ascertaining the income source,

We must inquire into the property, activity, or service that produced the income,
or -where the inflow of wealth originated. It is insufficient to identify just any
property, activity, or service. The subject may only be regarded as an income
source if the particular property, activity, or service causes an increase in
economic benefits, which may be in the form of an inflow or enhancement of assets
or a decrease in liabilities with a corresponding increase in equity other than that
attributable to a capital contribution, (emphasis and underscoring supplied)

XXX XXX XXX

The Court agrees with the CTA 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. The Court identifies the gateway's receipt of the call
as the income source as it coincides with (1 ) the completion or delivery of the
service, and (2) the inflow of economic benefits in favor of Aces Bermuda.
(underscoring supplied)

(l)The [Philippine] gateway's receipt

of the routed call marks the
completion or delivery of the
service.

In rejecting Aces Philippines’ attempt to single out the act of transmission

as the income-producing activity, the Court echoes the CTA En Banc's keen
observation that "there is a continuous and very real connection" within the
components of the Aces System (emphasis and underscoring supplied); and

XXX XXX XXX

In other words, the satellite air time fees accrue only when the satellite air
time is delivered to Aces Philippines (i.e., upon the gateway's receipt of the routed
call) and is utilized by the Philippine subscriber for a voice or data call. The
accrual of fees payable to Aces Bermuda signifies the inflow of economic benefits.
(underscoring supplied)

B.
Identifying the situs

XXX XXX XXX

After having identified the source of income, We now inquire into its situs. It
is settled that where the inflow of wealth and/or economic benefits proceeds from,
and occurs within Philippine territory, it enjoys protection of the Philippine
government. In consideration of such protection, the flow of wealth should share
the burden of supporting the government, and thus, is subject to tax.
The following establishes the Philippine situs of Aces Bermuda's income
from satellite air time fee payments: (1) the income-generating activity is directly

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associated with the gateways located within the Philippine territory; and (2)
engaging in the business of providing satellite communication services in the
Philippines is a government regulated industry, (underscoring supplied)

xxx xxx xxx

To stress, the income-generating activity (i.e., accrual of satellite airtime fee

payments and completion of the principal undertaking) coincides with the receipt
of the routed call by gateways located within Philippine territory. That income
generation is dependent on the operations of facilities situated in the Philippines
contributes to the income's Philippine situs. Verily, the gateways are legally owned
by Aces Philippines. Nonetheless, Aces Bermuda has sufficient
economic/beneficial interest in these Philippine properties, inasmuch as its
Philippine operations are dependent on these local facilities, (underscoring
supplied)

xxx xxx xxx

All told, that the main asset is situated in outer space cannot be
determinative of the income source and the situs thereof. At this point, it is clear
that: (a) Aces Bermuda's income attaches to property operated and maintained in
the Philippines, and (b) making Aces Services available to Philippine subscribers,
albeit through its local service provider, is an endeavor that requires the
intervention of the Philippine government. In the Court's view, it is only fair that
this income be subjected to Philippine taxation; to hold Aces Bermuda accountable
for its share in compensating the government for the protection it accords to Aces
Bermuda's arrangements, operations, and related transactions in the Philippines,
(underscoring supplied)

xxx xxx xxx

Aces Philippines failed to establish

that the satellite air time fee payments
are foreign-sourced.

The rule is that the taxpayer bears the burden of proving that the "income
was from sources outside the Philippines and exempt from the application of our
income tax law.

xxx xxx xxx

The statements merely narrated that the satellite is situated in outer space but did
not contradict the finding that Aces Bermuda's service is completed and performed
in the Philippines, (underscoring supplied)

xxx xxx xxx"

Q2: What are the existing cross-border services akin to that of Aces vs. CIR1

A2: International Service Provision (or cross-border services) - A service-based company

operates in various countries, providing services to clients. The income earned is
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allocated to the countries where the services are performed, taking into accounts factors
such as the time spent, resources utilized, or value created in each jurisdiction. The
source of income is determined by the location of the business activity rather than the
disbursement or receipt of funds.

International service provision includes the following or similar transactions:

1. Consulting Services - A consulting firm based in one country provides

advisory or consulting services to clients located in different countries. The firm
may offer expertise in various areas such as management, finance, technology,
or marketing. The consulting is carried abroad, but the results or outputs are
used locally. The payment to the foreign consulting firm is considered an inflow
of economic benefits to the foreign company. The income is sourced within the
Philippines.

2. IT Outsourcing- A technology company in one country offers IT outsourcing

services to businesses located in different countries. This can involve services
like software development, system maintenance, network management, or
customer support.

3. Financial Services - Banks, investment firms, or insurance companies

operating internationally provide financial services to clients across borders.
This can include services like asset management, wealth advisory, international
banking, or insurance coverage.

4. Telecommunications - Telecommunication companies offer services such as

international calling, data connectivity, or internet services to customers located
in different countries. These services enable global communication and
connectivity.

5. Engineering and Construction - Engineering and construction firms

undertake projects in different countries, providing services like architectural
design, project management, infrastructure development, or construction
services.

6. Education and Training - Educational institutions or training providers offer

international programs, courses, or professional training to students or
professionals from various countries. This can involve language courses,
academic programs, vocational training, or skill development courses.

7. Tourism and Hospitality - Travel agencies, hotels, online booking

application, or tour operators cater to tourists, providing services like, planning,
accommodation, transportation, tour packages, or entertainment activities.

8. Other Similar Services - refers to services that are not specifically mentioned
above but still follow the same concept of being provided, processed, or
performed overseas and then utilized, applied, executed, or consumed within
the Philippines.
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Q3: Based on the above-discussion by the Court in Aces Philippines, how would you
establish the situs of taxation for the aforesaid cross-border services?

A3: The revenue-generating activity occurs within the Philippines.

It is settled 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 source of 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
principle is crucial in cases where business transactions occur in multiple stages across
different taxing jurisdictions. In such instances, it becomes imperative to ascertain
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 them. If the income-generating activities in the Philippines are deemed
essential, the income derived from these activities would be considered as sourced from
the Philippines for tax purposes, irrespective of where the payment is ultimately
received. This principle aligns with the benefits-received theory in taxation, which
submits that the jurisdiction providing the essential services or factors for income
generation should be entitled to tax that income.

The payment or income generated from service fees paid to the foreign
company, including those made through the internet or other electronic means with the
use of IT, is considered an inflow of economic benefits in favor of the foreign company.

On the other hand, the utilization of these services indicates that they offer
benefits to the local company and are considered necessary to its business operations.
The decision to avail these services is made with the intent of their relevance and
importance to the local company's operations, reflecting sound judgment at the initial
stage before engaging in such services. The outcomes or results of these services are
subsequently put into practical use, applied, or utilized within the local country.

Q4: What is the treatment of reimbursable or allocable expenses, especially for cross-
border services between or among related parties?

A4: 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. It
includes charges to the local company, with the affiliates abroad facilitating the
payment to other affiliates or third parties for common incurred expenses.

The reduction of expenses for a foreign corporation can be considered as income

because it represents a financial gain or savings for the company, it effectively increases
the foreign corporation's net income or profit. This is because the company is spending

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less on its operations, resulting in additional funds that can be used for other purposes
or retained as profit. Therefore, the reduction in expenses is viewed as a form of income
for the foreign corporation.

Q5: What would be the effect if there are no benefits derived from the cross-border
transactions?

A5: If there are no benefits derived by the Philippine company, then the payment becomes
unnecessary for regular commercial activity and instead becomes a means of shifting
profits to a foreign company. In other words, if the income is not generated through
business activities conducted in the Philippines or does not provide any benefits to the
local company, then, it may be seen as an attempt to evade taxes or manipulate profits
by .funneling them to a foreign entity.

The main point here is that the source of income should be determined by the location
of the business activity that generates the income, rather than the location of the payout
or where it is physically received. This perspective aligns with the principle that income
should be taxed in the jurisdiction where the economic activity takes place and where
the benefits of that activity are received.

Q6: What do you mean by the phrase, “the source of income should be determined by
the location of the business activity that generates the income, rather than the
location of the payout or where it is physically received”’!

A6: This principle is known as the source-based taxation principle. 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 income
is taxed in the jurisdiction (Philippines) where the economic activity occurs and, thus,
prevent tax avoidance.

By attributing income to the source of the business activity, countries can maintain their
tax base and ensure that they can collect taxes on income generated within their
jurisdiction. This principle also promotes fairness in taxation by avoiding situations
where income is artificially shifted or allocated to jurisdictions with more favorable tax
regimes.
Q7: Are revenues generated from service fees paid to foreign companies or individuals,
which are considered sources within the Philippines, also subject to VAT?

A7: As propounded above, the source of income is not determined by where the payout is
disbursed or physically received, but rather by where the business activity that
generated the income took place. Even if the services are conducted or paid abroad, but
there are activities to be performed in the Philippines so essential that the entire service
transaction cannot be accomplished without them, then, the benefit-received theory
applies. This means that the revenue-generating activity actually occurs within the
Philippines. The income generated by the foreign company providing the services,
which are considered sources within the Philippines, shall be subject to income tax and,
consequently to final withholding tax.

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 In relation to VAT, it is important to note that Section 108(A), in relation to
Section 114 of the NIRC of 1997, as amended, plays a significant role in determining
the applicability of VAT on payments related to the sale or exchange of services and
the use or lease of properties. This provision generally states that a twelve percent
(12%) VAT is levied only if the services in question are performed within the
Philippines.

The phrase "sale or exchange of services" encompasses a broad range o f

activities involving the provision of services in the Philippines to others in exchange
for a fee, remuneration, or consideration. It includes any service performed within the
country for the benefit of another party, whether it involves professional services,
consulting, technical assistance, or any other form of service provision.

This includes income generated from service fees paid to foreign companies or
individuals which is subject to VAT if the source of that income is within the
Philippines. This means that even if the service provider is located outside the country,
if the service is utilized, applied, executed or consumed for a recipient within the
Philippines, the income payment for such service is considered sourced within the
country and, thus, the VAT is applicable. Consequently, payment for such service shall
be subject to final withholding VAT.

All internal revenue officers, employees and others concerned are hereby enjoined to
give this Circular the widest dissemination and publicity as possible and strictly implement the
provision thereof.

This Circular takes effect immediately.

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