Tax treatment of cross-border services

The Bureau of Internal Revenue (BIR) made a significant move with the issuance of RMC No. 5-2024, clarifying the tax treatment of cross-border services. This decision was prompted by the Supreme Court’s (SC) ruling in the Aces Philippines Cellular Satellite Corp. v. Commissioner of Internal Revenue (Aces case), which raised questions about the taxability of satellite airtime fee payments between domestic and non-resident foreign corporations (NRFCs).

In the Aces case, the SC introduced a two-tiered test to determine tax liability:

1. Identifying the source of income; and

2. Identifying the situs of that source.

The SC ruled that the receipt of calls by gateways located in the Philippines constituted the source of income. Additionally, engaging in satellite communication services within the Philippines, a government-regulated industry, was deemed to attribute income to the Philippine situs.

RMC 5-2024 builds upon the Aces case, emphasizing the need to assess whether activities occurring in the Philippines are integral to transactions spanning different jurisdictions. This approach, grounded in the “benefits-received” theory, determines the Philippine source of income by considering the location of utilization or consumption of services.

Consequently, the RMC treats utilization or consumption as the economic activity generating income, granting the Philippines taxing authority over the entirety of the income without distinct allocation for each country involved.

Various sectors, including the BIR-Partnership with Multi-Sectoral Group — Private Sector Committee, raised concerns about RMC 5-2024’s applicability to cross-border services. Criticisms centered around the perceived broad application of the Aces case to all cross-border services, potentially disregarding tax situs rules and exemptions provided by tax treaties. In response, the BIR issued RMC 38-2024, clarifying that the ruling in the Aces case does not automatically apply to all cross-border services agreements.

In RMC 38-2024, the source of income for listed cross-border services is determined by the long-standing rule that income is sourced in the Philippines if the property, activity, or service generating it is in the country. This determination involves examining all components of cross-border service agreements between two tax jurisdictions, considering the services as a whole rather than isolating individual activities. Key factors in this determination include dependency on Philippine purchasers for successful utilization, consumption, or utilization of services; reliance on facilities in the Philippines for service performance; and the integral nature of the stages occurring in the Philippines to the overall transaction.

Despite the issuance of RMC 38-24, ambiguity persists regarding its applicability to cross-border services, as it does not clearly delineate which services/scenarios warrant its application. Both RMCs equate the utilization or consumption of NRFC’s services as benefits to local companies or income-payers, which needs to be taxed in the Philippines.

If this is so, then all services rendered by NRFCs to domestic companies may be deemed to give rise to Philippine-sourced income. Without benefits derived, local entities under RMC 5-2024 risk being accused of profit-shifting or tax evasion by shifting profits to foreign entities.

Furthermore, the RMC fails to address the tax implications if the scenario were reversed — how would it apply to export services by Philippine entities?

While it may not significantly affect domestic corporations taxed on worldwide income, it poses challenges for resident foreign corporations taxed only on Philippine-sourced income. Applying the benefits-received principle could imply that services rendered in the Philippines for foreign customers are not subject to Philippine tax. Similarly, concerning value-added tax, merely consuming the output/product outside the Philippines raises questions about exemption eligibility.