November 14, 2006

BIR RULING [DA-667-06]

42 (B); Sec. 160 of RR 2 #197-82; 045-95

SGV & Co.

6760 Ayala Avenue
Makati City
Attention: Emmanuel C. Alcantara
Co-Head, Tax Services

Gentlemen :

This refers to your letter dated July 19, 2006 requesting on behalf of your client,
Koppers Wood Products Pty. Ltd.-Philippine Branch (KWPPL-Philippine Branch), for
con rmation of your opinion that KWPPL-Philippine Branch's ratable share from the
overhead expenses incurred by KWPPL-Philippine Branch's parent company, Koppers
Wood Products Pty. Ltd.-Australia (KWPPL-Australia), can be claimed by KWPPL-
Philippine Branch as its deductible expense for income tax purposes and that the
remittance of the same is not subject to Philippine taxes.
Background
KWPPL-Philippine Branch (formerly Koppers Timber Preservation Pty. Ltd.) is a
corporation duly registered with the Securities and Exchange Commission (SEC) as
Philippine branch of KWPPL-Australia, a foreign corporation duly organized and existing
under the laws of Republic of New South Wales. Its is primarily engaged in the business
of selling treated timber and in particular treated poles to electricity and
telecommunication companies on a whole basis.
KWPPL-Australia, as a parent-company, incurs certain overhead expenses in
connection with the nance, administration, research and development, all of which
directly bene t its branches all over the world, including the Philippines, which cannot
be de nitely allocated or identi ed with the operations of a single branch. Due to this,
KWPPL-Australia charges a ratable portion of the said overhead expenses to its
branches, including the Philippines. The share allocated to KWPPL-Philippine Branch is
computed based on ratio which KWPPL-Philippine Branch Sales bears to Head Of ce
Sales and evidenced by an external auditor's certi cate containing the necessary
information under Revenue Regulations No. 16-86. EaTCSA

Based on the foregoing, you now request for confirmation of your opinion that:
1. A branch of ce's ratable share in the overhead expenses incurred by its parent
company is a valid business expense under pertinent Philippine tax laws, rules and
regulations; and
2. The remittance made by a branch of ce to its parent company, representing
its ratable share in the overhead expenses incurred by the said parent company, being a
mere reimbursement, is likewise not subject to any Philippine tax.
In reply thereto, please be informed, as follows:
1. Expenditures made by a foreign corporation in conducting its business are deductible in
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 computing its taxable income from sources within the Philippines only when allocable to
the production of income from sources within the Philippines or where a ratable part of the
general expenditures is apportioned to income from sources within the Philippines. The
net income of a resident foreign corporation, is therefore determined by deducting from
the items of gross income specified in Section 42 (E) [formerly Section 37(a)] of the
National Internal Revenue Code, as amended, treated as income from sources within the
Philippines, the expenses, losses, and other deductions properly apportioned or allocated
thereto and a ratable part of any other expenses, losses, or deductions which cannot
definitely be allocated to some item or class of gross income. The remainder, if any, is
included in full as net income from sources within the Philippines. The ratable part is based
upon the ratio of gross income from sources within the Philippines to the total gross
income.
Consequently, in the Supreme Court (SC) case of Commissioner of Internal Revenue vs.
Court of Tax Appeals and Smith Kline & French Overseas Co. Phil. Branch (G.R. No.
54108, January 17, 1984), the SC applied the foregoing rule stated above, to wit:
" . . . it is manifest that where an expense is clearly related to the production of
Philippine-derived income or to Philippine operations (e.g. salaries of Philippine
personnel, rental of office building in the Philippines), that expense can be
deducted from the gross income acquired in the Philippines without resorting to
apportionment.
The overhead expenses incurred by the parent company in connection with
finance, administration, and research and development, all of which directly
benefit its branches all over the world, including the Philippines, fall under a
different category however. These are items which cannot be definitely
allocated or identified with the operations of the Philippine Branch. For 1971,
the parent company of Smith Kline spent $1,077,739. Under section 37(b) of the
Revenue Code and section 160 of the regulations, Smith Kline can claim as its
deductible share a ratable part of such expenses based upon the ratio of the
local branch's gross income to the total gross income, worldwide, of the
multinational corporation."

This was similarly decided in BIR Ruling No. 045-95 dated February 24, 1995 wherein it
was declared:
" . . . In reply, please be informed that under Section 36(b) [then Section 37(b) of
the Tax Code as implemented by Section 160 of Revenue Regulations No. 2, as
amended by Revenue Regulations No. 16-86, a resident foreign corporation is
allowed to deduct from its gross income derived from sources within the
Philippines, the expenses directly and clearly related to the production of
Philippine-derived income or to Philippine operations (e.g. salaries of Philippine
personnel, rental of office building in the Philippines), without resorting to
apportionment. However, the overhead expenses incurred by the parent
company in connection with the finance administration, and research and
development, all of which directly benefit its branches all over the world,
including the Philippines, fall under a different category. These are items which
cannot be definitely allocated or identified with the operations of the Philippine
Branch. Under said Section 36(b) [then Sec. 37(b)] of the Tax Code as
implemented by Section 160 of Revenue Regulations No. 2, as amended, the
local branch can claim as its deductible share a ratable part of such expenses
based upon the ratio of the local branch's gross income to the total gross
income, worldwide, of the multinational corporation or patent corporation."
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 In view thereof, this Of ce hereby con rms your opinion that a branch of ce's
ratable share in the overhead expenses incurred by its parent company is a valid
business expense under pertinent Philippine tax laws, rules and regulations.
Furthermore, Revenue Regulation No. 16-86 also provides the necessary guidelines in
arriving at the proper ratio, to wit:
"Sec. 160. (a) Apportionment of deductions. From the items specified
in Section 37(a) as being derived specifically from sources within the
Philippines, there shall be deducted the expenses, losses, and other deductions
properly allocated thereto and a ratable part of any other expenses, losses, and
other deductions effectively connected with the business or trade conducted
exclusively within the Philippines which cannot be definitely allocated to some
items or class of gross income. The remainder shall be included in full as net
income from sources within the Philippines.
The ratable part shall be based upon any of the following ratios
consistently allowed from year to year:
1. Gross income from sources within the Philippines to the total gross
income.
2. Net sales in the Philippines to total net sales.
3. If any other method of allocation is adopted, a written permission from
the Commissioner of Internal Revenue shall first be secured. HTaSEA

(b) External Auditor's certificate. The income tax return to be filed

should be accompanied by a certification from an independent and reputable
Certified Public Accountant containing the following information:
1. The home office deductions for the year involved have been examined
in accordance with generally accepted auditing standards and
accordingly included such tests of accounting records and such
other auditing procedures as were considered necessary in the
circumstances;
2. The deductions pro-rated to the Philippine branch do not include:
(a) net losses of any operating unit or branch;
(b) income tax payment;
(c) capital expenditures; and
(d) expenses directly changeable to any branch.
3. The amount of allocable overhead expenses used in the pro-rata
allocation to the Philippine branch is the same amount used in the
pro-ration to all branches worldwide and the amount disallowed in
other countries because of governmental requirement is not added
back to the allocable amount;
4. Should there be an exception or qualification on the above requested
certification, an explanation with supporting documents should be
submitted."
Accordingly, prior to the claim of a branch's share from worldwide overhead
expenses as a deduction from its gross income, it must provide the necessary
documents as required under the aforesaid regulations.
2. The remittance made by the KWPPL-Philippine Branch represents the payment
of its ratable share in the expenses of the head of ce. Such payment is a mere
reimbursement of expenses incurred by its Head Of ce (HO) or parent company
through the cost sharing arrangement. The said payment is made in order to satisfy an
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 existing obligation, that is, KWPPL-Philippine Branch's share in head of ce expenses,
and not to distribute some of its earnings. This remittance is not meant to transfer
pro ts, income or revenues of KWPPL-Philippine Branch to KWPPL-Australia. ( BIR
Ruling No. 197-82 dated June 17, 1982)
Such being the case, since the remittance discussed above only represents the
cost sharing arrangement and not transfer of pro ts, income or revenues by a KWPPL-
Philippine Branch to KWPPL-Australia, the same is not subject to income tax or
withholding tax. AHcCDI

Moreover, for the expenses to be deductible on the part of KWPPL-Philippine

Branch, it is understood that KWPPL-Australia and KWPPL-Philippine Branch have
exerted reasonable efforts to ensure that the method of allocation and charges is
consistent with the arm's length principle as may be determined through adequate
documentation. Finally, in the event that transfer pricing regulations implementing
Section 50 of the Tax Code of 1997, as amended, are issued by the BIR, the parties shall
comply with the requirements thereof.
This ruling is being issued on the basis of the foregoing facts as represented.
However, if upon investigation, it shall be ascertained that the facts are different, then
this ruling shall be without force and effect insofar as the herein parties are concerned.

Very truly yours,

Commissioner of Internal Revenue

By:
(SGD.) JAMES H. ROLDAN
Assistant Commissioner
Legal Service

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