ON March 15, 2024, the Bureau of Internal Revenue (BIR) issued Revenue Memorandum Circular (RMC) 38-2024, clarifying its earlier pronouncements in RMC 5-2024 on the taxation of cross-border transactions.

To recall, in Aces Philippines Cellular Satellite Corp. v. Commissioner of Internal Revenue (GR 226680, Aug. 20, 2022), which involves payment of satellite airtime fees, the Supreme Court held that the airtime fees paid by a domestic company to a foreign company are Philippine-sourced income. This is because the income-generating activity takes place not during the act of transmission but only upon the receipt of gateways (which are located in the Philippines) of the call as routed by the satellite.

Based on the Aces case, the BIR issued RMC 5-2024, maintaining that existing cross-border services [such as consulting services, information technology (IT) outsourcing services, telecommunications services and financial services] are "akin" those provided by the foreign satellite company which was the subject of the Aces case. Consequently, payments to non-resident foreign corporations (NRFCs) rendering cross-border services should be subject to a 25-percent withholding tax and 12-percent value-added tax (VAT).

In RMC 38-2024, the BIR clarified as follows:

1. RMC 5-2024 did not expressly provide that the ruling in the Aces case, finding that the source of income of the service agreement to be within the Philippines, automatically extends to the listed international service provision or cross-border services.

2. The determination of whether the source of income for the listed cross-border services is within the Philippines is found in Question 3 of RMC 5-2024, following the established principle 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. (It acknowledges that while Section 42 of the Tax Code outlines the 'traditional rule' on recognizing income, in the Aces case, the Supreme Court held the aforesaid rule).

3. Determining the source of income entails examining all the components and aspects of the cross-border service agreement, taking into account the services to be performed as a whole rather than isolating or compartmentalizing one particular activity as the sole income-producing activity.

– It states that this approach is consistent with Article 1233 of the Civil Code, which states that there is performance when "the thing or service in which the obligation consists has been completely delivered or rendered."

– 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 Philippine-sourced for tax purposes, regardless 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.

4. Once the source or situs of income is established to be within the Philippines using the aforesaid guidelines, the affected taxpayer can invoke the application of a particular tax treaty to assert that the income derived or sourced within the Philippines (e.g., business profits, dividends, royalties or interests) is exempt from income tax for lack of permanent establishment or subject to preferential rate, as the case may be.

5. If it is established that the source of income for cross-border services is within the Philippines, applying the rule that the source of income is the location of the property, activity, or service that produces the income, the subject transaction will also be subject to VAT.

6. The source of income is not determined by where income is disbursed or physically received.

With RMC 38-2024, the BIR made clear that the Aces case doctrine does not automatically apply to all cross-border services, that income tax treaty benefits can be availed of, and that the physical source of payment is not determinative of the source of income. However, we believe that there are still lingering issues that would haunt taxpayers on the issuance of RMC 5-2024.

The BIR still espouses the view that completion of the delivery of the service of the Philippines dictates the determination of whether the income is Philippine-sourced. This will still put in peril various services engaged by Philippine corporations, especially those involving technology and the internet, like hosting cloud services and online IT support, among others.

There is also the risk that BIR examiners will take a sweeping view that payments to nonresident service providers are Philippine-sourced.

Lastly, VAT is still upheld to be due, even though there is a big difference in determining the source of income versus the source of VAT. VAT is a transaction tax, and it can also be imposed if the service is "rendered" in the Philippines.

With the recent Aces case and the aforesaid RMCs, it is apparent that the scope of the rule on determining situs or source of income (and necessarily, the place of performance) has been expanded and widened in favor of Philippine sourcing and taxation. Definitely, this will increase the tax costs on affected cross-border services.

(Note that RMC 38-2024 also clarified the rule on reimbursements, which we will tackle in our next article).

Euney Marie J. Mata-Perez is a CPA-Lawyer and the managing partner of Mata-Perez, Tamayo & Francisco (MTF Counsel). She is a corporate, M&A and tax lawyer and has been ranked as one of the top 100 lawyers in the Philippines by Asia Business Law Journal. She is the incoming chairman of the Tax Committee of the Management Association of the Philippines. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. If you have any questions or comments regarding this article, you may email the author at info@mtfcounsel.com or visit the MTF website at www.mtfcounsel.com.