Tax Articles

Foreign Digital Service Providers: Income Taxation

By Atty. Fulvio D. Dawilan

Fulvio D. Dawilan Managing Partner   +632 8403 2001 loc.310 This email address is being protected from spambots. You need JavaScript enabled to view it. View Profile

Until such time as existing tax treaties and tax laws are revised and revisited to account for the digital economy, the Courts must apply the laws as they currently are (Saint Wealth LTD. vs. Bureau of Internal Revenue, G.R. No. 252965, December 7, 2021). The Supreme Court made this pronouncement when it declared that there was no basis to impose tax on offshore-based gaming operators.

The reason for that decision - no income is derived by these offshore gaming licensees from sources within the Philippines, based on the laws existing at that time. Our laws had changed where we now have specific provisions dealing with the imposition on offshore gaming licensees of gaming taxes on their gaming revenues and income taxes on non-gaming revenues derived from within the Philippines.

While the Court made that decision, it also observed that “with the proliferation of digital and online commerce, it had become more complicated and less straightforward to determine where the activity which produces the income occurs, as when the transaction is conducted over the internet.” Indeed there are challenges in taxing the digital economy, many of which were already identified by international organizations like the OECD.

Why am I mentioning this? Because these observations will remain as we are not expecting any change soon. At least for VAT, there is a move to modify the law to include digital transactions in the coverage of our VAT system. The final version of the law is not yet clear, but definitely it would include non-resident providers transacting with consumers in the Philippines. But for income tax, there is none. And that is because there are complications related to the modification of the income tax system.

What does that mean? Our current income tax rules will continue to govern, including the income taxation of digital transactions. As in the Saint Wealth LTD case, we may never have the right to impose tax, even if we Filipinos are among the consumers of digital services provided by foreign suppliers. Compared to domestic corporations which are taxed on their worldwide income, foreign corporations are liable to income tax in the country only on their income derived from sources within the Philippines. Hence, there is a need to determine the source of their income.

Our current domestic law is clear that for services, the related income is considered derived from sources within the Philippines if the service is performed in the Philippines. On the other hand, income for services performed without the Philippines is considered income derived from sources without the Philippines. Thus, we simply refer to the place where the service is rendered in determining the source of the income. Jurisprudence had further explained the “source of income” as relating to the property, activity or service that produced the income.

Compared to traditional services, there may indeed be a challenge in determining the source of income for digital transactions and other business activities transacted online or electronically. But again, applying the Saint Wealth LTD case, as long as the property, activity or service is not located or done in the Philippines, then the country has no right to impose tax. Our tax authority had in fact made pronouncements that if the servers, websites and other related facilities are located outside the country, the income generated from the activity should be treated as sourced from outside the Philippines and therefore not taxable in the Philippines.

There are some views that the recent case of Aces Philippines Cellular Satellite Corporation vs. CIR, G.R. No. 226680 could be basis for imposing income tax on digital transactions consummated outside the Philippines but provided with Philippine subscribers/consumers. That is misplaced. In that case, there are two segments in providing the services – the transmission of communication time by the satellite located in outer space and the delivery of the communication time to the gateway located in the Philippines. The gateway’s receipt of the call in the Philippines signifies the completion of the service by the non-resident service provider. In this case, the Court determined that the source of the income is associated with the gateway that is located in the Philippines. In other words, the property, activity and service that produces the income is located in the Philippines. That makes the income subject to Philippine income tax.

That cannot be said to apply to all types of digital transactions. Transactions conducted over the internet have varying business models. But most of the facilities used to provide the services are located outside the Philippines. The delivery and completion of services transpire outside the Philippines. As in the Saint Wealth LTD case, income generated from these services by foreign providers are not subject to Philippine income taxes. If we want to impose tax, we have to change the laws.

Indeed, until such time as existing tax treaties and tax laws are revised and revisited to account for the digital economy, we will continue to lose our rightful share in the digital economy.