Tax Articles

Tax Obligations of Permanent Establishments

By Atty. Fulvio D. Dawilan

The Philippines generally follows the “source of income” rule in identifying the income that are taxable to corporations in the Philippines. For a foreign corporation, whether engaged in business or not in the Philippines, it is taxable only on income derived from sources within the country. The concept of source taxation is premised on the relationship of the income and the taxing state. A state’s claim to tax a particular income is based on the state’s specific relationship with that income.

In this light, the source of income is necessary in determining if an item of income should be taxed in the Philippines or not, especially for foreign corporations. If the income is sourced from the Philippines, our tax authority has the jurisdiction to call for the payment of tax. While this is the rule, the same would yield to the provisions of a tax treaty (double taxation agreement) that the Philippines has with the country of which the recipient of the income is a resident. In so far as business profits are concerned, they may be taxed in the Philippines if the income recipient has a permanent establishment (PE) in the Philippines.

For income taxation purposes, a foreign corporation is classified into two types of taxpayers: (a) resident foreign corporation(RFC) or a foreign corporation that is engaged in trade or business within the Philippines, or (b) nonresident foreign corporation (NRFC), which refers to a foreign corporation not engaged in trade or business within the Philippines. Doing business in the Philippines makes the foreign corporation a resident foreign corporation.

The income taxation of an RFC and NRFC in the Philippines are essentially the same. Both are subject to Philippine income taxes only with respect to income derived from sources within. The difference lies in the tax base. An NRFC is taxed based on the gross income while an RFC is, in general, taxed based on net taxable income, which means that related expenses are allowed as deductions. The taxes due on income of NRFCs are paid through the final withholding tax system. It follows that an NRFC does not have reportorial requirements. The payment of taxes of an NRFC, if any, is the responsibility of the payor/customer as withholding agent. Thus, except for the one-time TIN, it is not required to register as a regular taxpayer. On other hand, an RFC has to comply with the reportorial requirements, including the filing of its own tax returns and the payment of taxes due. It is thus required to register as a regular taxpayer. Apparently, registration as a regular taxpayer requires the submission of the SEC registration documents. Thus, to be able to register as a regular taxpayer, a foreign corporation has to register with the SEC, usually as a branch (in any of its forms). An RFC, therefore, is usually referred to as a Philippine branch of a foreign corporation.

In line with this, a usual question raised is with respect to a PE—how should a PE be classified and/or how should it comply with its tax obligations, especially PEs created by reason of short-term projects where no branch is registered? There are decisions of the Tax Court holding that PEs are still treated as NRFCs for income taxation purposes, in the absence of registration. As such, income taxes due on their income derived from sources within the Philippines shall still be subject to the final withholding taxes. Accordingly, the customer/payor of the income shall be required to withhold final tax on the gross amount of income.

Impliedly, it is not enough that a foreign corporation is doing business in the Philippines to be treated as an RFC for income taxation purposes. Also, the fact that a foreign corporation has a PE in the Philippines does not necessarily make the foreign corporation an RFC. It is still treated as an NRFC if it has no license to transact business in the Philippines and not registered with the tax authority.

Even the tax authority has a conflicting view on this matter. It has earlier issued a number of rulings confirming that the payments to a foreign corporation with a PE in the Philippines are subject to the final withholding tax, thereby treating them as NRFCs. But there are also issuances holding that a foreign corporation that has created a PE in the Philippines is treated as a foreign corporation engaged in trade or business in the Philippines or an RFC. In one ruling, for example, a German company, by reason of its service and maintenance contract with a Philippine entity, was found to have a PE. The tax bureau ruled that the enterprise shall be taxed in the same manner as an RFC, which should also be entitled to claim deductions for expenses incurred for purposes of the PE. But there was no guidance on how the filing of tax returns and payment of taxes should be made.

The apparent incompleteness or differences in issuances/rulings is due to the fact that there is really no specific rule governing the registration and compliance by a PE, which is not registered as a branch. I believe that there is basis to state that a foreign entity with a PE is to be treated as an RFC, considering that it is doing business in the Philippines. Thus, it should be allowed to register as a regular taxpayer.

It is time for the tax authorities to craft guidelines on how PEs should be registered for tax compliance purposes so that they can comply with their tax obligations, even without commercial registration, especially for shorter-term projects where maintaining an entity is not viable. Also, with the reform in the international tax system on its way, including taxation of the digital economy, the concept of permanent establishment will potentially be expanded to cover activities not covered by the traditional definition. This will provide jurisdictions outside an enterprise’s physical residence the right to tax a portion of the income. Nonetheless, if there is no mechanism for these entities without physical presence to register for tax purposes, these will still provide a convenient excuse for these enterprises to escape from their tax obligations, and the income supposedly allocable to the country will remain untaxed.