Tax Articles

Can RMC 5-2024 Overturn a Tax Treaty?

By: Atty. Irwin C. Nidea, Jr.

Irwin C. Nidea Jr. Senior Partner   +632 8403-2001 loc.330 This email address is being protected from spambots. You need JavaScript enabled to view it. View Profile

In November 2023, the Philippines joined the OECD/G20 Inclusive Framework on BEPS, an international collaboration with over 140 member countries and jurisdictions. The Philippines has promised to help redefine tax treatments of the digital economy by participating in the Two Pillar Solution.

Pillar Two refers to the global minimum tax of 15%. It is designed to ensure that multinational companies will not be able to avoid paying tax by dumping all its income to a low-tax jurisdiction. The OECD has agreed that Pillar Two will be adapted. As a result, many countries have already passed the necessary legislation to enforce Pillar Two. Unfortunately, the Philippines has not even reached the first base in formulating the law.

Pillar One on the other hand, is centered on the world’s digital revolution where the current international income tax rules are being challenged - are the current tax rules that envisioned a “brick and mortar” economy still applicable to the digital economy?

The fundamental rules as we know it, that are enshrined in decades old tax treaties and jurisprudence, which defined where taxes should be paid ("nexus" rules based on physical presence) are on shaky grounds.

New business models are created where physical presence in a country is not necessary for a non-resident entity to earn income. This results in friction between countries on how to distribute taxing rights on income generated from cross-border activities. These new business models have also facilitated tax avoidance through the shifting of profits by multinational enterprises (MNEs) to low or no tax jurisdictions.

Pillar One is still a work in progress. It must be emphasized that member countries have not agreed to change the rules on nexus. The definition of permanent establishment in tax treaties, as we know it, remains.

But there is growing discontent among countries because they find that unfair allocation of taxing rights in the digital economy continues. This leads to dangerous unilateral actions by some countries, which would be harmful to their economy and to their international standing as a treaty partner.

Although not squarely related to digital transactions, a perfect example of a unilateral action that is harmful to a country’s economy is RMC 5-2024. The circular seems to forget that the Philippines has signed treaties with other countries which clearly state that profits of an enterprise of another country shall be taxable only in that country unless the enterprise carries on business in the Philippines through a permanent establishment. Permanent establishment is defined as a fixed place of business through which the business of an enterprise is wholly or partly carried on. Thus, in general, for a foreign enterprise to be taxed in the Philippines, it must have a physical presence in the Philippines where it generates income.

Unfortunately, RMC 5-2024 has singlehandedly changed the fundamental principles of international tax. Almost all services to a Philippine entity that are performed by a foreign entity in their country is now taxable here in the Philippines. The Philippine entity is now required to withhold the 25% income tax and the 12% VAT that the foreign entity must pay to the Philippine government. In other words, if I have a lawyer in England and our contract states that his professional fee is P100,000, I must only remit P75,000 to him and I must withhold the remaining P25,000 in favor of the government. Do you think my lawyer will agree that he will only be paid P75,000? In reality, what will happen is that I will be forced to shoulder the P25,000 tax to ensure that my consultant still receive P100,000. In effect, I will be paying P125,000 instead of just paying P100,000. I will shoulder the tax since my lawyer will insist that our countries have signed a tax treaty and for him it is clear that the services he performed outside the Philippines are exempt from tax.

In the end, I and every other Philippine entity will suffer. This additional expense will trickle down to the ultimate Filipino consumer and to the economy as a whole. Since the cost of doing business is more expensive, inflation will be triggered and prices of goods and services will increase.

If Philippine companies will enforce RMC 5-2024 and tax non-resident foreign corporations that have no permanent establishment in the Philippines, we must also be ready when these foreign companies leave and offer their services elsewhere, where tax treaties are respected.

Generating more income for the government through administrative or judicial legislation may backfire. We cannot be too excited to change the situs or nexus rules on our own.

As regards digital transactions, our country still respects tax treaties and has agreed to adapt what the OECD will conclude as the binding rule that every member country must follow. Whether the current nexus rule on digital transactions will change, is still up in the air. As of now, there is no consensus. But as a country, we have agreed to participate in the formulation of these new rules while we acknowledge that the prevailing nexus rule should still be followed, in the meantime.

If we are waiting for Pillar One to introduce change in the nexus rule before we abandon the current rule on digital transactions, why is there an attempt to overstretch a Supreme Court decision on a case involving satellite services and apply the peculiar facts of the said case in redefining the nexus rule of cross-border services?

Every policy that imposes tax on non-resident foreign corporations cannot be taken lightly. If we are careful not to be tagged as a lone wolf in imposing income tax on digital transactions by joining the OECD/G20 Inclusive Framework on BEPS, we must be equally cautious not to tax income of services that are performed outside the Philippines. We are a third-world country and we cannot afford to act as if we are indispensable.