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Commissioner Rene Banez and his team, presently in earnest chase of revenues to meet the Bureau of Internal Revenue’s collection target for 2001 would do well to precipitate a review of a ruling issued by the former Commissioner a little more than a year ago on 06 December 2001. The ruling, among the very few that then BIR Commissioner signed during his short career, deals with the general subject of "permanent establishment", a concept uniformly found in our tax treaties with other countries. Typically, having a permanent establishment in the Philippines results in the business profits of a foreign corporation being subject to tax in the Philippines.

Paragraphs 4 and 5 of Article 5 of the RP-Singapore Tax Treaty in essence provide that a person in the Philippines, other than an independent agent, who habitually enters into contracts (other than simply purchasing goods or merchandise) in the Philippines or habitually maintains in the country a stock of goods which he regularly delivers on behalf of a Singapore person, is in fact a "permanent establishment" of that person. Independence is not lost simply because the person in the Philippines acts as a broker or general commission agent for the Singaporean principal.

The ruling was requested by a multinational company which for as long as anyone can remember did its manufacturing in the Philippines. However, its mother office decided to "implement changes to its organization structure, work process, culture and reward structure" as well as achieve a lot of goals often mouthed by students in business grad school, and, accordingly changed the legal vehicles of its presence in the Philippines.

The first major change was to convert the manufacturing entity in the Philippines simply as a "toll manufacturer", i.e. one that does not manufacture its own goods but simply provides the service of manufacturing of goods owned by others. It thus organized Corporation X to manufacture the goods for the Singaporean mother office. Corporation X, naturally, is a wholly owned subsidiary of the Singapore enterprise.

This was coupled with the organization of another subsidiary, Corporation Y, that had the function, in the concept an independent agent, of selling in the Philippines the goods manufactured by Corporation X for its Singaporean mother.

Both Corporation X and Corporation Y receive payment for their services from the Singaporean company. Corporation Y, the distributor, in addition, imports the goods in its own name and sells the goods to Philippine customers also in its own name. However, all these arrangements are in name only because the Singaporean mother company remains the legal owner of the raw materials imported by Corporation Y as well as the finished goods sold by it. That is why, although payment is made by Philippine customers to Corporation Y, the latter is obliged to account for the proceeds to Singapore.

The result of this re-engineering and re-inventing is, according to then Commissioner Fonacier, that the business profits of the Singaporean firm are not taxable in the Philippines. Reason? Neither Corporation X nor Corporation Y are "permanent establishments" in the Philippines because they are "independent entities that merely provide services…in return for arm’s length consideration acting in the ordinary course of their trade or business…"

"Independent services", my foot! That is the sort of legal alchemy that puts tax experts in disrepute. True, on paper, everything looks above board. Corporation X and Corporation Y have all the trimmings of independent operations, such as their own respective business plans, denial of authority to act for the Singapore company, retention by Singapore company of ownership over raw materials and finished goods, "sole discretion" to make their own decisions, and so-called "arms length" fees.

But since when, in the real world of tax examiners and taxpayers, has a subsidiary been accorded "the freedom and autonomy to carry out its business operations without any immediate interference or control from" its mother company? How can the fees paid to the subsidiaries be called "arms length" when the only credible buyer in town is the mother company?

It has been one year since the ruling was issued and time is now to put into effect the ever present caveat found in rulings from the BIR: "This ruling is issued on the basis of facts as represented. However, if upon investigation, it will be disclosed that the facts are different, then this ruling will be considered null and void".

Send your examiners, Rene, to the company and march them off singing the battle cry "Substance over Form!". Rip apart those cardboard packing of independence and show us all how you can safeguard the tax system from the body germs of soapy sophistry.

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