Revisiting income source rules: Significant local activity drives tax liability

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Last year, a tax ruling clarified that payments made by a domestic entity to a foreign service provider are subject to Philippine income tax and value-added tax (VAT) because the services were considered rendered within the Philippines. 

This comes amid increasingly complex cross border transactions and the uncertainty brought about by Revenue Memorandum Circular 5-2024, clarified by RMC 38-2024 and the recently issued RMC 24-2026, which raised questions about the proper tax treatment of offshore service arrangements involving Philippine-based clients.

In BIR Ruling OT-168-2025, a Philippine-based online lending company sought confirmation from the BIR that its service fee payments to an Estonia-based non-resident foreign corporation (NRFC) providing advertising services, were not subject to income tax and VAT.

Background of the transaction

The online lending company entered into an Advertising Agreement on June 20, 2022 with the foreign advertising service provider to attract potential borrowers to the online lending company’s loan platform.

Based on the Advertising Agreement, the foreign advertising service provider’s role involved placing advertisements through websites, email and SMS targeting consumers. These clickable ads showcased the online lending company’s services in the Philippines and redirected users to its website, where they could submit loan applications. 

Under the payment terms of the Agreement, the online lending company shall pay the foreign advertising service provider $1.60 per application submitted through the foreign advertising service provider’s link. The foreign advertising service provider performed these advertising services abroad, specifically in Tallinn, Estonia.

It was the online lending company’s position that its service fee payments to the foreign advertising service provider should not be subject to income tax and VAT, considering that the advertising services were rendered entirely outside the Philippines.

The BIR’s findings 

The BIR rejected the online lending company’s position, emphasizing that the key issue was determining where the income was actually sourced. The ruling noted that, in general, income from services is sourced within the Philippines if the services are performed in the country. Similarly, VAT applies only when services are rendered within Philippine territory.

However, the BIR explained that determining the true source of income requires analyzing the income-generating activity as a whole, rather than focusing solely on where a portion of the service is performed.

In support of its position, the BIR cited a Supreme Court decision in a case involving a local telecommunications service provider and the Commissioner of Internal Revenue, where the Court emphasized that income-generating activities must be viewed in their entirety, particularly when services involve interconnected processes across jurisdictions.

The Court ruled that income is sourced where the service is completed and where economic benefit is realized, not merely where initial or partial activities take place. In the local telecommunications service provider’s case, the Court determined that the airtime fees paid by the local telecommunications service provider to the Bermuda-based NRFC accrued only when the satellite airtime was delivered—specifically, upon the gateway’s receipt of the routed call—and used by the Philippine subscriber. The accrual of fees marked the inflow of economic benefits.

Applying this principle, the BIR found that the foreign advertising service provider’s income was generated when consumers in the Philippines successfully applied for loans after clicking the advertisements. Thus, the BIR concluded that the services were effectively performed within Philippine territory. 

Impact on taxation

This ruling highlights the proper approach to taxing cross-border services, especially when the service involves multiple segments. It reinforces the principle that substance prevails over form, meaning that what matters is not only where activities are physically performed, but where the essential and value-creating parts of the service occur.

For a segmented service to be considered Philippine-sourced, it is not enough that some activity happens in the country. It must be shown that a portion of the service is performed in the Philippines and, more importantly, that this portion is integral or significant to the completion of the overall service rendered by the NRFC.

In other words, the local activity must play a real and meaningful role in delivering the service. It cannot be merely incidental or supportive; it must directly contribute to completing the service. If this is the case, then it is reasonable to treat the income as sourced in the Philippines and therefore subject to income tax and VAT.

Overall, the ruling promotes a more practical and fact-based approach by focusing on where the critical components of a service are carried out, rather than relying solely on how the transaction is structured on paper.

Dyana Katrina Roldan is a Tax Supervisor from the Tax Group of R.G. Manabat & Co. (KPMG in the Philippines), a Philippine partnership and a member firm of the KPMG global organization of independent member firms affiliated with KPMG International Limited, a private English company limited by guarantee. The firm has been recognized as a Tier 1 in Transfer Pricing Practice and in General Corporate Tax Practice by the International Tax Review. For more information, you may reach out to Dyana Katrina Roldan or Maria Myla Maralit through [email protected], social media or visit www.home.kpmg/ph.