March 21, 1995

REVENUE AUDIT MEMORANDUM ORDER NO. 1-95

SUBJECT : Audit Guidelines and Procedures on the Proper Determination of the Income Tax Liability of Philippine Branches and Liaison Offices of Multi-National Enterprises (MNEs) Engaged in Soliciting Orders, Purchaser, Service Contracts, Trading, Construction and Other Activities in the Philippines All Internal Revenue Officers, Employees and Others Concerned

TO

I.

RATIONALE

Whereas Revenue Audit Memorandum Order (RAMO) No. 1-86 dated April 25, 1986 imposes income tax on the gross income generated from constructive trading and commission income derived from brokering activities of Philippines branches of MNEs engaged in trading activities. Whereas RAMO No. 1-86 makes no recognition of such factors as the nature of item traded, the risk involved and participation of the local branch; Whereas the implementation of RAMO No. 1-86 makes use of much approximations and estimates; Therefore, this Order is issued to revise RAMO No. 1-86 and to cover taxation of Philippine branches and liaison offices of MNEs engaged in soliciting orders, purchases, services contracts, trading, construction and other activities. With this Order, taxation of Philippine branches and liaison offices of MNEs engaged in soliciting orders, purchases, service contracts, trading, constructions and other activities becomes more practical, easy and equitable. At the same time, this Order addresses taxation of construction and other activities by the same Philippine branches and liaison offices of MNEs as separate undertakings. II. OBJECTIVES

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This Order is issued to: a) Amend and supersede RAMO No. 1-86 dated April 25, 1986 which provides for the procedures for tax audit of Philippine branches or foreign corporation. Address the issue on the proper determination of the income tax liability of Philippine branches and liaison offices of MNEs pursuant to Section 43 of the National Internal Revenue Code (NIRC) wherein the Commissioner of Internal Revenue (CIR) is authorized to distribute, apportion or allocate gross income or deduction among organizations in order to clearly reflect the income of any such organization. Provide guidelines on implementation of policies on the proper determination of the income tax liability of Philippine branches and liaison offices of MNEs. Prescribed the minimum procedure required in the audit of the income tax liability of Philippine branches and liaison offices of MNEs.

b)

c)

d)

III. COVERAGE a) This Order shall pay only to Philippine branches and liaison of Japanese trading firms which are members of the Sogo Shoshas and registered with the Japanese Chamber of Commerce and Industry (JCCI), and also all other foreign trading companies similarly situated as determined by the Commissioner of Internal Revenue. Furthermore, the content of this Order will apply only to income tax liabilities of Philippine branches and liaison offices of MNEs and will not affect the withholding, including branch profit remittance, and business tax obligations of the same Philippine branches and liaison offices of MNEs which shall be subject to the provisions of the National Internal Revenue Code (NIRC).

b)

IV. GUIDELINES 1. The Philippine income tax due from soliciting orders, purchaser, service contracts, trading, construction and other activities of the Philippine branches and liaison offices of
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MNEs will be ascertained using the following formula. For solicitation and trading activities
{(Worldwide Operating Sales to the Philippines attribution tax)} {( Income X Worldwide Sales X rate X rate )}

For construction and other activities plus {(Net Income from construction and other activities X tax rate )} 2. In implementing the above formula, the following terms shall be construed to mean as follows: (a) Worldwide (W/W) shall include head office accounts and those of branches located in difference countries but shall exclude subsidiary accounts. W/W Operating Income shall include the Gross Income minus Selling General & Administrative expenses. Operating Income does not include non-operating and extraordinary items like interest expense, exchange profit/loss capital gains/losses or other income/loss not related not related to operation. Sales to the Philippines shall be defined as the aggregated amount of exports and offshore transactions to the Philippines by the Head Office, all branches and liaison offices and shall include the amount of indent transactions from which commissions are generated. These shall also include imported materials and equipment of construction projects undertaken in the Philippines, but shall exclude local service income from construction projects or onshore income from local construction. W/W Sales shall consist of domestic, export, import and offshore transactions which include nor only principal transactions but also indent transactions from which commissions are generated. Attribution rate shall mean a rate of 75% to be applied against formula. The tax rate to be applied shall be in accordance with
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(b)

(c)

(d)

(e) (f)
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Section 25(a) of the NIRC which is 35%. (g) Net income on construction shall consist of local service income from construction projects income from construction projects less the costs associated with local construction projects including the cost of locally purchased materials equipment, if any. Net income on all other activities shall consist of income such as branches and liaison offices of MNEs are engaged in, net of costs and expenses associated with such income.

(h)

3.

In the application of the formula, no offsetting of losses from one line of business to the detriment of the other line of business shall be allowed. This would mean that the tax due from each line of business shall be computed independently from the other line of business.

V.

PROCEDURES 1. Request documents containing information on the nature of business transactions of the taxpayer as follows: a) the structure of the Philippine branch or liaison office, the Home Office, other branches or more than 50% owned or controlled subsidiaries located outside the Philippines dealing with the local branch; the ownership, relationship, extent of control, directors and officers of the Philippine branch or liaison office and the Home Office; the business activity of the MNE and how it relates to the activity of the local branch or liaison office and other branches or more than 50% owned or controlled subsidiaries dealing with the local company

b)

c)

2.

Ascertain the mathematical accuracy and completeness of the income tax return, financial statements and supporting schedules filed by the taxpayer. Require the submission of financial statements exclusive for transactions dealing with construction and all other activities
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3.

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and have a certified public accountant render an opinion as to its fairness and conformity with accepted accounting standards. For solicitation/trading activities 4. Obtain a copy of the Worldwide Financial Statement duly certified by an independent public accountant of the country which issues the financial statements and authenticated by the Philippine Embassy or Consulate situated within the country where the Home Office of the MNE is located. Verify correctness of Worldwide Operating Income and the Worldwide Sales figures against the financial statements obtained in 4 above. Request for a summary of Sales to the Philippines duly certified by an independent public accountant and authenticated by the Philippine Embassy or Consulate situated within the country where the Home Office of the MNE is located. The Sales to the Philippine shall include the offshore portion of the local construction projects which includes the supply of machinery and equipment. Request for presentation of copies of pertinent sales invoices, bills of lading, freight and insurance coverages and other documents to verify Sales to the Philippines, on a test sampling basis.

5.

6.

7.

For construction activities 8. Review all Contracts and analyze the nature of the Contracts, the parties involved, the terms and conditions, the total contract price, the payment and other pertinent information. Determine method of accounting, whether completed contract or the percentage of completion, and check the correctness of take up in the books of accounts. Segregate the income from exempt transactions from that of taxable transactions, if applicable. Determine the total contract price and composition of the project. The total contract price includes:
a.
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9.

10. 11.

Supply of Machinery and Equipment

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b.

(Sometimes referred to as the "offshore portion") Supply of Labor/Civil Works (Sometimes referred to as the "onshore portion") Total Contract Price

xx

xx xx ====

12.

Verify that only the supply of local/civil works (onshore portion) is included in computation of profit/loss on local construction project. Determine if costs and expenses corresponded only to the service portion of the project referred to in 11 above. Be aware of charging of income and expenses by mere book entries using the branch/home office account.

13. 14.

For all other activities 15. 16. Verify that all income from other activities are included as part of the gross income Ensure that only expenses related to the activities above are included in the determination of the net income.

VI. EFFECTIVITY This Order shall take effect immediately.

LIWAYWAY VINZONS-CHATO Commissioner of Internal Revenue

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