November 4, 2022

Reinforcing the Line that Separates a Representative Office, Regional Area Headquarters, and Regional Operating Headquarters​

The Supreme Court clarified the distinction between a (1) Representative Office, (2) Regional Area Headquarters (“RHQ”), and (3) Regional Operating Headquarters (“ROHQ”) in its recent decision in the case of Commissioner of Internal Revenue vs. Shinko Electric Industries Co., Ltd. (G.R. No. 226287, July 6, 2021).
Shinko Electric Industries Co., Ltd. (“Shinko”) is a Philippine-registered Representative Office of its Japanese parent company. It derives no income in the Philippines. The Commissioner of Internal Revenue (CIR) assessed Shinko of alleged deficiency income tax and value-added tax on the ground that Shinko should be properly considered as an ROHQ since it is engaged in the “promotion of the parent company’s product”. Further, Shinko earned interest income from its bank deposits and had investments in shares of stocks of a local utility company.
The Supreme Court held that Shinko is a Representative Office by clarifying the distinctions between the Representative Office, Regional Area Headquarters, and Regional Operating Headquarters as follows:
  1. A Representative Office and an RHQ are not allowed to engage in any income- generating activities in the Philippines. An ROHQ, on the other hand, provides qualifying services that generate income in the Philippines.
  2. A Representative Office deals directly with the parent company’s clients and not with the affiliates, branches, or subsidiaries while an RHQ and an ROHQ perform services only with the head office’s affiliates, branches, or subsidiaries but are prohibited by law to deal directly with other clients.
  3. A Representative Office and RHQs are exempt from both income tax and VAT while ROHQs shall be subject to a tax rate of ten percent (10%) of their taxable income from its qualifying services and twelve percent (12%) VAT.
While a Representative Office is not defined in the NIRC, as amended, it is akin to an RHQ and not an ROHQ. A Representative Office is only allowed to undertake activities such as but not limited to information dissemination, promotion of parent company’s products as well as quality control of products. These activities, while directed to the parent company’s clients, are not income generating, similar to the activities of an RHQ and in stark contrast with the qualifying services performed by ROHQs. Since a Representative Office is primarily engaged in non-income generating activities like an RHQ, by analogy, it should be considered exempt from income tax and VAT.
Applying the foregoing discussion, the Supreme Court found that Shinko is fully subsidized by its head office in Japan. These remittances cannot be considered as income because they are not payments for the services rendered by Shinko but only regarded as capital which is intended for the continued operation of a Representative Office in the Philippines, and from which no income tax may be collected or imposed.
In the same way, Shinko is not liable for VAT. The subsidy given to Shinko was not derived in relation to any sale, barter, or exchange of goods or services. As such, the subsidy received by Shinko from its parent company cannot be subject to VAT.
Lastly, the interest and dividend allegedly earned by Shinko are considered as passive income. The Court explained that passive income, such as dividends or interest, is not generated in the active pursuit and performance of the corporation’s primary purpose. It does not automatically render Shinko as an ROHQ liable to pay income tax and VAT since passive income is subjected to final taxes and is not covered by regular income tax.

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By: Atty. Cavin Jhon Cabarlo, CPA, REA, REB