RAMO 1-86

April 25, 1986

REVENUE AUDIT MEMORANDUM ORDER NO. 01-86

1.

SUBJECT :

Procedure for Tax Audit of Philippine Branches of Foreign Corporations.

TO

All Internal Revenue Officers and Others Concerned.

:

Background 1.1

Some branches of foreign corporations engage in business in the Philippines by soliciting orders from local importers. These branches are called "liaison offices or branches." Sales made from such solicitations are not reported by these branches as their own sales purportedly because the branch office merely relays to its head office abroad purchase orders from local importers and it is purportedly its head office that actually consummates the sales. At the end of the taxable period, the branch office simply reports for income tax purposes its purported share of the income generated from sales but the allocation of this purported share is left entirely at the discretion of its head office. The revenue service is completely at the mercy of multi-national companies. cda

1.2

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Some branches engage in business in the Philippines by soliciting orders from local importers and relays this information to its head office abroad. The head office in turn solicits prospective exporters for a compensation. At the end of the taxable period, the head office allocates a certain portion of the compensation to its branch in the Philippines. The branch in turn reports its purported share for income tax purposes but does not pay the commercial broker's tax thereon purportedly because the compensation was received from its head office and purportedly because the branch cannot be legally considered a commercial broker in relation to its head office since the branch and its head office possess only a single legal personality (PHILIPP BROTHERS OCEANIC, INC. vs. COMMISSIONER OF INTERNAL REVENUE, CTA Case No.

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3140, March 8, 1984). Again, in this second situation, allocation of the compensation is left at the discretion of the head office — the revenue service also left at the mercy of these multi-national companies. 2.

Legal Consequences 2.1

The foregoing scope of activities of these branch offices is considered under R.A. 5455 as business acts. "'Doing business' shall include soliciting orders, purchases, service contracts opening offices, whether called 'liaison' offices or branches. . . . any other act or acts that imply a continuity of commercial dealings or arrangements, and contemplate to that extent the performance of acts or works, or the exercise of some of the functions normally incident to, and in progressive prosecution of, commercial gain or of the purpose and object of the business organization." (SEC. 1 (1), R.A. 5455).

2.2

These branch offices, like any other businesses, are required by law to account for their business operations in accordance with generally accepted accounting practices (SEC. 38, NIRC). Thus, a branch office although not possessing a separate and distinct juridical personality is, however, considered under generally accepted accounting practices as a distinct character, a separate business unit and should be "supplied by the home office with cash and merchandise and such other assets as may be needed" (Advance Accounting by Simons and Karrenbrock, 4th ed., p. 202). Generally accepted accounting practices also dictate that income and expenses of the branch shall be segregated from those of the home office in order to clearly reflect their respective operating results (ibid). cdasia

2.3

The doctrine on corporate fiction is not absolute — the veil of corporate fiction may be legally pierced should it be used to subvert just application of laws. ". . . Where the corporate form or organization is adopted or a corporate entity is asserted in an endeavor to evade a statute or to modify its intent, courts will disregard the corporation or its entity. This has been applied to violations of . . . tax laws, . . ." (FLETCHER, 170-171, Commentaries and Jurisprudence on the Commercial Laws of the Philippines by Agbayani, Vol. 3, 1970 ed., p.

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21). ". . . Where a corporation is a dummy, is unreal or a sham and serves no business purposes and is intended only as a blind, the corporate form may be ignored for the law cannot countenance a form that is bald and a mischievous fiction." (LIDDEL & CO. v. COLLECTOR OF INTERNAL REVENUE, L-9687, June 30, 1961, citing Gregory v. Helvering, 293 US 465, L. ed. 596-599; Higgins v. Smith, 1940, 308 US 406 L. ed., cited in p. 20, Commentaries and Jurisprudence on the Commercial Laws of the Philippines by Agbayani, Vol. 3, 1970 ed.). ". . . To allow a taxpayer to deny tax liability on the ground that the sales were made through another and distinct corporation when it is proved that the latter is virtually owned by the former or that they are practically one and the same is to sanction a circumvention of our tax laws." (ibid).

Corporate fiction may be inquired upon where there is "inadequacy of capital . . ., confusion of affairs . . . and direct intervention in management causing inequitable results (Ballantine, 314; Rorhlick, 417-422). 3.

Branch Operation and Consequences 3.1

The Philippine branch solicits purchase orders from local buyers, relays the information to its home office abroad, and the home office purportedly directly makes the sale. In this type of operation: (i) Sales purportedly consummated abroad by the home office shall be treated as sales constructively consummated in the Philippines and made by the branch office, hence, income therefrom shall be considered income from sources within the Philippines; (ii) the branch shall record and report the gross selling price of commodities sold thru its home office; and (iii) report for income tax purposes its net income therefrom. (iv) Since under this situation, the import taxes, duties and charges have already been paid by the local buyers, the same shall not anymore be chargeable against the branch. Under this paragraph, these transactions are treated sales constructively consummated by the branch office in accordance with generally accepted accounting practices required under Section 38 of the Tax Code since the branch solicitations are

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actually trading acts. Accordingly, the home office is obligated to supply its branch with merchandise in pursuing its trading business in the Philippines. Hence, sales purportedly made directly by its home office shall be considered no more than merely a constructive supplying of the merchandise to its branch which eventually constructively sells the same to Philippine buyers. cdasia

3.2

The branch solicits purchase orders from local buyers, relays the information to its home office, the home office solicits prospective sellers abroad and eventually receives compensation for services rendered. In this second type of operation: (i) the branch shall be considered "a commercial broker" or indentor; (ii) its share from compensation as allocated by its home office shall be subject to commercial broker gross receipts tax; (iii) the branch shall provide itself with the corresponding fixed tax as a commercial broker; and (iv) pay income tax on its share of the compensation. Under this paragraph, the branch office shall be considered a commercial broker since its activities is well within the ambit of the term "broker". Brokers are ". . . those who are engaged for others in the negotiation of contracts relative to property with the custody of which they have no concern. They act as negotiators in bringing other persons together to bargain; generally, they ought not to sell in their own names, have no implied authority to receive payment, are not entrusted with the physical possession of the principal's goods when engaged to buy or sell, and have no special property therein or lien thereon." (8 Am. Jur. 889-890, cited in Philipp Brothers Oceanic, Inc. v. The Commissioner of Internal Revenue, CTA Case No. 3140, March 8, 1984).

4.

Audit Procedure 4.1

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For constructive trading by branch office (a)

Determine gross sales generated from branch's constructive trading (from solicitations made by the branch);

(b)

Require

the

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submit

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authenticated (i) income statement; and (ii) statement of cost of sales re worldwide operation of the entire corporation during the taxable year; (c)

Extract the gross income generated from such constructive sales by applying against the gross constructive sales the gross profit rate shown in the cost of sale statement referred to in paragraph (b) (ii) above. Illustration: Assume that the gross profit ratio, based on worldwide statement of cost of sales, is 20% and the gross constructive sales amounts to P1,000,000. Gross income therefrom shall be computed as follows: Gross sales

P1,000,000

Gross income therefrom (20% G/P rate)

(d)

P200,000

Check from the records of the Bureau of Customs all shipments coming from the branch's home office during the taxable year in determining the branch's constructive sales in the Philippines. cdasia

(e) 4.2

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Require the branch to reconcile computations of its constructive sales in the Philippines.

For broker activity by branch office (a)

Verify veracity of the amount of compensation allocated to the branch by its home office;

(b)

Require submission of sworn declaration from home office on the correctness of the allocated share of the branch office and cross check this declaration in connection with the branch records re extent of solicitations undertaken in the Philippines during the tax year;

(c)

Require the branch to pay the corresponding fixed tax as a commercial broker;

(d)

Require the branch to pay the corresponding commercial broker's gross receipts tax, based on its total share from compensation derived for services rendered in the Philippines; and

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(e)

5.

Determine also the branch income tax obligation for the said income which is being considered income from sources within the Philippines.

Implementation Strict enforcement of this Revenue Audit Memorandum Order is enjoined.

6.

Effectivity This Order shall take effect immediately.

7.

cdt

Publication The Bureau shall give this Order as wide a publicity as possible for proper guidance of multi-national companies doing business in the Philippines under a branch-head office relationship; and for strict enforcement by revenue personnel.

(SGD.) BIENVENIDO A. TAN, JR. Commissioner

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