Taxation of AI and Cross-Border Services in the Philippines

On 10 January 2024, the BIR issued Revenue Memorandum Circular (RMC) No 5-2024 to clarify the taxation of cross-border services in the Philippines. The RMC expanded the coverage of the Philippine Supreme Court’s en banc decision in the case Aces Philippines Cellular Satellite Corp. v Commissioner of Internal Revenue, dated 30 August 2022. The Aces case involved a Bermuda company that owned and operated a satellite in outer space. This company provides satellite communications time to a Philippine company, which in turn provides telephone and mobile phone services to its subscribers or customers in the Philippines. 

When the Philippine company paid satellite airtime fees to the Bermuda company, it did not withhold any taxes from such payment, given that the Bermuda company was a non-resident foreign corporation whose services were all performed offshore. 

The Supreme Court ruled that the situs of satellite airtime fees was in the Philippines because (i) the income-generating activity is directly associated with the gateways located within the Philippine territory, and (ii) engaging in the business of providing satellite communication services in the Philippines is a government-regulated industry that necessarily invokes Philippine sovereignty and government intervention or protection. According to the Supreme Court, the fact that the Bermuda company’s income generation is dependent on the operations of facilities within the Philippines contributes to the income’s Philippine situs.  

RMC No 5-2024 provides that the source of income is the location where the underlying business activities that produced the income actually took place. In cases where business transactions occur in multiple stages across different taxing jurisdictions, the RMC goes on to say that it becomes imperative to ascertain whether the particular stages occurring in the Philippines are so integral to the overall transaction that the business activity would not have been accomplished without them. If the income-generating activities in the Philippines are deemed essential, the income derived from these activities would be considered as sourced from the Philippines for tax purposes.  

The RMC further enumerates a number of services akin to the Aces case:  

AI will most likely fall under IT outsourcing services. Under the RMC, IT outsourcing services provided by a technology company – such as software development, system maintenance, network management, or customer support – if performed in one country to businesses located in different countries, may be taxed in the Philippines to the extent any income from these services is allocated to the Philippines.

AI and other services performed outside of the Philippines for customers located in the Philippines may be subject to income tax and value-added tax in the Philippines because of the RMC. Even if consulting firms perform their services abroad, but the results or outputs are used locally, the payment to the foreign consulting firm is considered an inflow of economic benefits.

RMC 5-2024 introduced a paradigm shift in the concept of the situs of taxation for cross-border services. Foreign and Philippine companies will have to wait to see if there will be further pronouncements from the BIR to clarify the RMC. They should review their cross-border agreements and consult with advisers to determine if a portion of the service payments will now be subject to income tax and VAT under the provisions of the RMC.