For over a decade, the Philippines has encouraged foreign participation in economic development through productive investments in the country. This is demonstrated by the enactment of various laws, among which is the Foreign Investments Act (FIA). Under the FIA and its Implementing Rules and Regulations (IRR), our lawmakers, among others, defined and prescribed the procedures in the registration of foreign corporations to enable them to do business in the Philippines.
With the emergence of laws such as the FIA, foreign companies are a given variety of options in establishing their business presence in the Philippines. These options may be further classified as to whether the foreign company prefers to create a domestic entity (e.g. wholly-owned subsidiary or joint venture companies) or a Philippine entity (e.g. branch office, ROHQ, RAHQ or representative office). Among the Philippine offices, the simplest is the representative office.
Section 1(c), Rule I of the IRR of FIA defines the representative or liaison office as one “which deals directly with the clients of the parent company but does not derive any income from the host country and is fully subsidized by its head office. It undertakes activities such as, but not limited to information dissemination and promotion of the company’s products as well as quality control of products.”
Under our current tax rules, a representative office is not liable to pay income tax since it derives no income from the Philippines. The Court of Tax Appeals (CTA) in the case of Shinko Electric Industries Co., Ltd. vs. Commissioner of Internal Revenue dated Feb. 10, 2014 pronounced that a representative office, as defined, is fully subsidized by its head office in the form of foreign inward remittances which is utilized to cover the expense in doing business.
The CTA further ruled that the foreign inward remittances could not be considered “income” or flow of wealth but rather, a subsidy, which represents capital or fund, distinct from income. The CTA also concluded that, inasmuch as the representative office is not allowed to derive income from sources within the Philippines, and is fully subsidized by its head office, it is not subject to Philippine income tax.
In line with the CTA’s decision, the Bureau of Internal Revenue (BIR) has consistently held that a representative office, not being engaged in any income generating business in the Philippines, is not subject to income tax and hence, exempt from filing of the corporate income tax return.
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Recently, the Securities and Exchange Commission (SEC) released SEC Opinion No. 15-06, dated July 21, 2015, addressing the issue of whether a representative office of a foreign corporation may invest in stocks in a domestic corporation and earn dividends, a passive form of income. It was the opinion of the foreign corporation which requested for SEC’s confirmation, that its representative office is allowed to derive passive income without violating FIA since it may be implied from the law that the income that should not be derived by a representative office pertains only to income from carrying out the business activities of the head office.
In deciding in the negative, the SEC said that FIA together with its IRR is very clear that a representative office cannot derive any income from the host country. Further, the second sentence in the definition of a representative office should be interpreted to mean that any permissible act of a representative office should be akin to or resemble the same kind or class as those of information dissemination and promotion of the company’s products, or quality control for the parent company, or any other passive act that does not involve the earning of any income. To hold otherwise would run counter to the very nature of a representative or liaison office.
The SEC likewise opined the functions of a representative office are limited to what is stated in its license, specifically, a representative office cannot generate income within the Philippines. The SEC concluded that a perusal of the foreign corporation’s corporate records reveals it was duly licensed merely as a representative office to act as communication office for the parent company, and to promote and disseminate information about the company with marine insurance companies, insurance brokers and shipping companies in the Philippines. Nowhere in the corporate records was it indicated the said license includes investment in shares of stock.
From the foregoing discussions it is notable that SEC’s decision is in concurrence with the opinion held by the BIR that a representative office should not derive income or participate in income-generating activities. This position taken by both administrative offices is clearly consistent with the language used in the FIA and its IRR. After all, it is widely-accepted by the courts that interpretations of administrative agencies responsible for enforcement of laws are entitled to great weight and consideration.
Hana Kamille A. Escueta is a supervisor from the tax group of R.G. Manabat and Co. (RGMandCo.), the Philippine member firm of KPMG International.
This article is for general information purposes only and should not be considered as professional advice to a specific issue or entity.
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