Tax Reform for Acceleration and Inclusion (TRAIN)

The Tax Reform for Acceleration and Inclusion (TRAIN) is the first package of the comprehensive tax reform program (CTRP) envisioned by President Duterte’s administration, which seeks to to correct a number of deficiencies in the tax system to make it simpler, fairer, and more efficient.

Click here for the Department of Finance’s TRAIN webpage for more information.


‘Prior’ treaty relief application: A harsh rule?

By Olivier D. Aznar (Reported from Business World’s Let’s Talk Tax, September 5, 2011)

The Bureau of Internal Revenue (BIR) is currently intensifying its tax assessment efforts to raise revenues for the government, and a commonly disputed tax finding is the deficiency on final withholding tax as a result of a taxpayer’s failure to apply for a tax treaty relief ruling with the bureau before using a preferential tax treaty rate.

To illustrate, take for example a domestic corporation that pays royalties to a foreign corporation. Under the Philippine Tax Code, in the absence of a tax treaty, what will be applied to such transaction is a 30% (rate effective beginning Jan. 1, 2009) final tax to be withheld by the domestic corporation-payor. Thus, if there is a tax treaty between the Philippines and the country of that foreign corporation, and the tax treaty provides for an exemption or for a lower tax rate (preferential tax rate), then such preferential tax rate could be used.

Unfortunately, though, BIR imposed a strict condition before the above-mentioned preferential tax rate could be used. The condition is that there must be “prior” application for a tax treaty relief ruling with the BIR [see Revenue Memorandum Order (RMO) No. 01-00 and No. 72-10]; otherwise, the taxpayer will be disqualified to avail of the preferential tax rate. Consequently, the domestic corporation-payor — being the tax withholding agent in the Philippines — will be assessed for tax deficiency if it used the preferential tax rate without said prior application. Furthermore, disqualification of the taxpayer from using the preferential tax rate will bar it from any future claim for refund if, later on, it could be found out that the transaction of the taxpayer is covered by the preferential tax rate, and the only flaw was non-submission of prior application of tax treaty relief ruling.

To recall, as stated in RMO No. 01-00 issued by the BIR in 2000, the bureau conceived that the requirement of prior application will avert any erroneous interpretation and/or application of treaty provisions. Then, in 2010, RMO 72-10 was issued providing for more detailed/updated rules while retaining the condition on prior application for tax treaty relief ruling. But, could the BIR validly impose such condition even if the Philippines, itself and the foreign country counterpart did not actually specify any condition precedent on the use of the preferential tax treaty rate? Is there really a categorical Philippine Tax Code provision which will support the said authority of the BIR?

In a Court of Tax Appeals (CTA) case decided in 2010, the CTA, in upholding RMO No. 01-00, referred to Section 6 of the Tax Code, without pointing to the specific subsection thereof. It was said then, that Section 6 of the National Internal Revenue Code of 1997 duly grants the Commissioner the power to make assessments and prescribe additional requirements for tax administration and enforcement.

A cautious reading of Section 6 of the Tax Code will show that the nearest subsection was Section 6(H) — Authority of the Commissioner to Prescribe Additional Procedural or Documentary Requirements, which provides the following:

“The Commissioner may prescribe the manner of compliance with any documentary or procedural requirement in connection with the submission or preparation of financial statements accompanying the tax returns.” [emphasis supplied]

Now, based on the above section, is the condition of “prior application for tax treaty relief” embraced in the above provision? Is the provision broad enough to dictate what condition to be complied with before a proviso of an international agreement (i.e., tax treaty) could take effect?

BIR might say that there was already a resolution issued by the Supreme Court in 2008 (Mirant case) which favors implementation of the rule on prior application for tax treaty relief. In this case, however, careful analysis will show that such resolution was just a minute resolution issued by the Clerk of Court and not a Supreme Court (SC) decision certified by the SC Chief Justice.

In a CTA case decided in 2010, the CTA explained that a minute resolution may amount to final action on the case but it is not a precedent, and cannot bind non-parties to the action. Therefore, the said minute resolution does not bind all others (not being parties to the Mirant case) who may come to question the validity of the rule on prior application.

Is there really an underpinning support from the Tax Code on the validity of the rule on prior application for tax treaty relief?

Leaving the question hanging and assuming, without admitting, that the rule on prior application is in accord with the Tax Code, the consequence of totally disqualifying a taxpayer from using the preferential tax rate just because of noncompliance with a procedural imposition of the BIR could be perceived to be onerous.

Remember that RMO No. 01-00 has the basic objective of averting any erroneous interpretation and/or application of treaty provisions. Thus, if there was really no erroneous interpretation and/or application of treaty provisions in using the preferential tax treaty rate, and that the only fault of the taxpayer was non-submission of prior application for tax treaty relief, then the evil sought to be avoided by the RMO is still not present.

After all, we know that the BIR has its means, during tax assessments, of determining whether a transaction is indeed qualified to be covered by a preferential tax treaty rate. BIR could easily make this determination even after the transaction has taken place.

Could the BIR somehow tone down the consequence of not strictly complying with the “prior application” rule? Instead of totally disqualifying a taxpayer from using the preferential tax treaty rate, could the penalty be just an administrative one if it would be found out that the transaction of the taxpayer indeed falls within the tax treaty provisions? Certainly, a review of the “prior application” rule could raise quite a number of questions, and it is just unfortunate that this present rule adds to the burden of domestic tax withholding agents who are the ones dealing with BIR examiners.

The author is a senior manager with Punongbayan & Araullo’s Tax Advisory & Compliance Division.

Imposing VAT on corporate reorganization

By Veronica A. Santos (Reposted from Business World’s Suits the C-Suite, September 4, 2011)

The Bureau of Internal Revenue (BIR) has, of late, been vigorously issuing regulations to interpret or clarify previous interpretations of tax laws.
Revenue Regulations (RR) 10-2011, issued on July 7, may have the most far-reaching consequences.

RR 10-2011 states that the exchange of goods or properties, including real estate properties used in business or held for sale or for lease by the transferor, for shares of stock of the transferee, whether resulting in corporate control or not, is subject to value-added tax (VAT).

RR 10-2011 amends the provisions of prior revenue regulations which deal with the VAT implications of asset transfers pursuant to Section 40(C)(2) of the Tax Code.
Section 40(C)(2) describes three types of asset transfers which are not gain recognition events (and therefore not subject to income tax, capital gains tax, or withholding tax).

Also known as “tax-free” transfers, these are: (1) a transfer to a controlled corporation, (2) a statutory merger/consolidation, and (3) a de facto merger.
Section 199 (m) of the Tax Code also exempts Section 40(C)(2) transfers from documentary stamp tax.

In a tax-free transfer to a controlled corporation, not more than five transferors transfer property in exchange for at least 51% of the voting shares of a transferee corporation.
In a statutory merger, the transferor(s) are the “absorbed corporations” while the transferee, an existing corporation, is the “surviving corporation.”

In a statutory consolidation, the transferors consolidate into a new corporation, which is the “surviving corporation.” The transferor(s) transfer property solely in exchange for shares of stock of the transferee and such shares are distributed to the shareholders of the transferor(s).
A statutory merger/consolidation requires the approval of the Securities and Exchange Commission (SEC), at which time the merger or consolidation shall be effective and the separate existence of the transferor(s) shall cease.

The surviving corporation shall come to possess all the rights, privileges, immunities, franchises, interests and property of the transferors which shall be deemed to be transferred to and vested in the surviving corporation without further act or deed.

The surviving corporation shall also be responsible for all the liabilities and obligations of the transferors as if it had itself incurred such liabilities and obligations.

A de facto merger, unlike a statutory merger, does not require the approval of the SEC and the transferor corporation is not absorbed into a transferee corporation.
Instead, at least 80% of the assets of the transferor is transferred solely in exchange for shares of stock of the transferee.

Section 40(C)(2) transfers are tax-free reorganizations because the transferors or, in the case of a merger or consolidation, the shareholders of the transferors maintain a continuity of interest in the assets transferred (since shares of the transferee constitute the consideration for the transfer).

This provision is drawn largely from the various US revenue acts of the 1920s (which have been carried forward to the present US Internal Revenue Code).

Congressional records show that the rationale for tax-free reorganization was to avoid interference with business readjustments and to allow holders to undertake such readjustments without having to liquidate their investments.

The emphasis was on encouraging new and continued investments, and on avoiding taxing an investor who has not cashed out on his investments.

VAT, on the other hand, is not an income tax but a tax on the transaction and is not dependent on gain recognition. Section 105 of the Tax Code, however, is clear that the VAT is imposed only on a person who, in the course of trade or business, sells, barters, exchanges, leases goods or properties, renders services, and any person who imports goods.

Section 105 defines the phrase “in the course of trade or business” as “the regular conduct or pursuit of a commercial or economic activity, including transactions incidental thereto.”

Republic Act (RA) No. 7716 (which, in 1994, first imposed VAT on the sale of real property held primarily for sale to customers or for lease in the course of trade or business) introduced the said definition, and this has been reenacted substantially unchanged by subsequent amendments to the VAT Law, specifically, by RA 8424 in 1997 and RA 9337 in 2005. With such reenactment, Congress adopted prior executive issuances, specifically RR 7-95, Revenue Memorandum Circular 3-96, Revenue Memorandum Ruling 01-01, and Revenue Memorandum Ruling 01-02, all of which provide that Section 40(C)(2) transfers are not subject to VAT.

Certain issues immediately become apparent.

First, will the BIR impose VAT on Section 40(C)(2) transfers which became effective prior to the issuance of RR 10-2011? Does it matter that, at the time of issuance of RR 10-2011, the transferor had not yet filed a request for ruling with the BIR to confirm the tax implications of such transfer or, if a request has been filed, that the same had not yet been acted upon?

Second, will the BIR distinguish between transfers to a controlled corporation on one hand, and mergers/consolidations on the other hand, such that only the former is subject to VAT? RR 10-2011 amends Section 4.106-8 (b)(1) of RR 16-2005, while the output tax implications of mergers/consolidations are in another subsection, i.e., Section 4.106-8(b)(3). Moreover, transfers by way of a statutory merger/consolidation take effect by operation of law and certainly cannot be construed as being in the course of trade or business of the transferor, or even incidental to such trade or business.

It may be said that the VAT is not an additional cost for either the transferor (who may have input VAT credits to offset output VAT liability on the transfer) or the transferee (to whom the transferor can pass on the amount of the VAT which can be used as credit against output VAT on the transferee’s own sales).

Nonetheless, a newly incorporated transferee may not have cash in the amount of the VAT passed on it by the transferor, so that restructuring business operations or structuring the entry of new investors using Section 40(C)(2) becomes an expensive exercise.

Hopefully, this concern will be factored into the revenue issuances implementing RR 10-2011 or in new revenue memorandum rulings which may be issued for tax-free reorganization.

Veronica A. Santos is a Tax Principal of SGV & Co. This article is for general information only and is not a substitute for professional advice where facts and circumstances warrant. Views and opinion expressed are those of the author and do not necessarily represent views of SGV & Co.

Paid-up capital for IAET purposes

By Eleanor Lucas Roque (Reposted from Business World’s Let’s Talk Tax,August 29, 2011)

The Bureau of Internal Revenue (BIR) recently issued Revenue Memorandum Circular (RMC) No. 35-2011.
The new RMC clarified certain issues concerning the imposition of improperly accumulated earnings tax (IAET) under Section 29 the Tax Code, as amended.

The RMC stated that the amount that may be retained, taking into consideration the accumulated earnings “within the reasonable needs of the business,” shall be 100% of the paid-up capital.

More importantly, the term “paid-up capital” has been defined as the amount contributed to the corporation representing the par value of the shares of stock.

Under this definition, any excess capital over and above the par shall be excluded.

Consequently, any premium or additional paid in capital (APIC) shall not be considered in determining the paid-up capital of the corporation in determining the amount that may be reasonably accumulated by the corporation.

Under IAET rules, a corporation that permits the accumulation of earnings and profits beyond the reasonable needs of the business, instead of dividing or distributing the said profits, is subject to the 10% improperly accumulated earnings tax on the improperly accumulated taxable income.

Also known as a “tax on success,” the IAET is essentially a penalty tax designed to compel corporations to distribute earnings so that the said earnings received by the shareholders will, in turn, be subject to dividends tax, as applicable.

But why are corporations and stockholders alike reluctant to declare dividends?

One would ordinarily think that declaration of dividends is much anticipated by stockholders.

However, considering that IAET is generally imposed on closely held corporations, stockholders feel that declaring dividends is really just transferring funds from one pocket to the other and paying dividends tax for such transfer.

Since a closely held corporation cannot raise capital from the public, its source of capital will be contributions from its stockholders.

Thus, these same stockholders who had previously been subjected to dividends tax, may later on need to re- invest the same dividends previously received as capital into the corporation at such future time when the corporation has need of such funds again.

Under the Revenue Regulations 2-2001 which implemented Section 29 of the Tax Code on IAET, allowance for the increase in the accumulation of earnings up to 100% of the paid-up capital of the corporation as of balance sheet date is one of the instances which is considered “within reasonable need of the business.”

Thus, any amount of unrestricted retained earnings in excess of the 100% of the paid-up capital is a prima facie instance of accumulation of profits beyond reasonable business needs and will be subject to the IAET unless the corporation can show proof that such retention is required for reasons such as corporate expansions, capital expenditures, acquisitions, compliance with loan covenants and the like.

With the exclusion of premium and APIC in the definition, the amount of paid-up capital for some corporations may have substantially decreased.

As a result, if the paid-up capital is small, the corporation is under pressure to declare dividends as soon as its unrestricted retained earnings reach more that 100% of its paid-up capital.

However, the Tax Code is not the only law that prohibits the retention of profits.

Section 43 of the Corporation Code also prohibits corporations from retaining surplus profits in excess of 100% of their paid-in capital stock unless justified under certain circumstances.

The Securities and Exchange Commission (SEC), in implementing said provision of the Corporation Code, issued SEC Memorandum Circular No.11-2008.

In this circular, the term “paid-in capital” was defined as the amount of outstanding capital stock and the additional paid-in capital or premium paid over the par value of the shares.

Thus, corporations now have to be mindful that, in retaining profits, they must contend with the different requirements of the Tax Code and the Corporation Code, specifically on the threshold amount.

Taxpayers wonder why premium or additional paid-in capital is not considered part of the paid-up capital of a corporation for purposes of IAET.

Taxpayers are also baffled why the implementing rules under the Corporation Code and the Tax Code are so different from one another in determining threshold amounts for retention of profits.

Of course, the two laws don’t have to be the same in implementation.

However, considering that both rules talk of a threshold amount for profit retention, it may have been more business-friendly if the rules are the same. That way, taxpayers don’t have to separately track their compliance with the two laws.

Both par value of the shares and the APIC represents capital contributions of shareholders in a corporation.

They both comprise capital of the corporation that cannot be distributed to shareholders as profits or dividends, considering that the SEC specifically prohibits the declaration of additional paid-in capital as dividend (SEC Memorandum Circular No. 11-08 dated Dec. 5, 2008).

They can be returned to stockholders generally, only upon corporate liquidation and after satisfaction of all legitimate creditors.

They are both considered part of the cost of investment of stockholders for purposes of capital gains tax.

It seems that the only difference lies in the fact that the BIR has included the par value as paid-up capital and excluded APIC.

With this new RMC, corporations that required APIC from their shareholders — in order to increase capitalization without going through the administrative process of increasing authorized capital stock and saving on payment of documentary stamp tax on original issuance of shares — now have to reexamine this mode of increasing capital, or else they will be exposed to IAET come dividend declaration time.

Considering that the RMC is a new interpretation of an old law, the issue again is whether it will be given retroactive effect by the BIR.

With all the changing interpretations of the BIR of old laws, taxpayers are now at a quandary on how to properly do their tax planning

It seems that old interpretations are no longer reliable and taxpayers can only wait to see what old law will next be given new interpretations by the BIR.

While efforts of the BIR to identify new sources of collections, without any new tax law being legislated, is laudable, investor confidence — based partly on the ability to rely on existing interpretations of current laws — is also equally important in maintaining a sound and robust economy.

Otherwise, the promise of the President of “no new taxes” will seem a meaningless platitude to taxpayers.

(The author is a principal and head of the Tax Advisory and Compliance Division of Punongbayan & Araullo.)

Common best tax practices

By Wendell D. Ganhinhin (Reposted from Business World’s Let’s Talk Tax, June 27, 2011)

One of the strategies that unscrupulous taxpayers employ in a bid to become successful in business is not paying the right taxes.

These taxpayers justify such claim by saying that their businesses will not survive if they pay taxes diligently, since their competitors do not pay proper taxes either.

Applying such strategy, these taxpayers maintain at least two books of accounts — one for the Bureau of Internal Revenue (BIR) and one for management’s use.

The latter supposedly reflects the true income and value of the company.

Indeed, some of these taxpayers have become successful in the past and some of them are still successful today.

In general, companies employing the said strategy did not experience any significant tax problems during the reign of first and second generation of owners since most of them are united and committed to observing the same practice.

At that stage, confidentiality of information is properly kept.

However, problems will arise in the next generation of owners.

The new generation of owners might be active in the business, but some could be passive stockholders who are not directly involved in operations.

These stockholders, particularly the passive owners, will normally demand more transparency regarding the affairs of the business.

They will ask: Is the amount of dividends declared enough? How much is the true value of my shareholdings if it will be sold? Can the internal financial statements be relied upon?

If those questions cannot be answered satisfactorily, internal conflict will likely arise. Several cases could be filed against the management of the company.

Information about noncompliance might be fed to the BIR.

If not handled properly, such dissent might cause the collapse of the company.

Another scenario is when a company wants to tap the stock market to avail of cheap funds for business expansion.

However, some of these companies cannot do so because of the bad condition of their accounting records and huge possible tax exposure.

When a company wants to be listed in the stock exchange, it should expect high demand for transparency and good corporate governance, including a high level of tax compliance.

If existing business owners want to keep their legacy and share it with their progeny, they might consider adopting a number of common best tax practices to ensure transparency and continuity of their business.

Always maintain only one set of accounting records

Accountants say that it is difficult enough to maintain one set of books of accounts.

Hence, it is doubly difficult for a company to maintain two sets of accounting records.

Likewise, it is costly to keep more than one set of books of accounts in terms of needed accounting software and manpower.

Moreover, keeping two sets of books would be prone to a lot of errors.

Also, owners and officers have the burden of keeping these data confidential and avoid any leak of information which can lead to criminal prosecution.

Having more than one set of accounting records is like keeping a time bomb inside the house. For your peace of mind, maintain one set of reliable and accurate accounting records.

Comply with tax laws

Some businessmen say that if you will not cheat on your tax obligations, you will not succeed.

But our country is replete with success stories of companies that complied with tax laws from the very start of their business and have continuously succeeded. In fact, if you survey the top businesses in the country, these are mostly businesses who are top taxpayers and who have paid their taxes honestly.

Noncompliance will result only in unnecessary costs like the 25% penalty for late filing, 20% interest per year and compromise penalties, as well as possible imprisonment.

It will result not only in monetary penalties, but may also damage the reputation of the company.

This, in turn, can sometimes cause its ultimate demise.

Avail of tax exemptions

Study your business operation and determine if it will qualify for registration with incentive giving bodies such as the Philippine Economic Zone Authority or Board of Investments to avail of tax incentives like income tax exemption and lower corporate income tax rates.

Small enterprises can also consider availing tax incentives under the Barangay Micro Business Enterprise Act of 2002.

Tax evasion is a crime, but tax avoidance is legal.

Hence, a taxpayer can always adopt a legal tax avoidance scheme to minimize its taxes.

Know when to consult a tax specialist

If you do not know which tax rules and regulations are applicable to your business, hire a good and reputable tax specialist to either perform tax consulting job or tax compliance review, or both.

The tax function of your accounting department can also be outsourced if you want to avail the expertise and stability of service from an accounting firm.

If you want to know the tax implications of any significant agreements, you can engage a tax specialist so you will not overlook any tax exposures and avoid penalties.

In the old days, we believe that “honesty is the best policy.”

In addition to this, advocates of good corporate governance also believe that “transparency is the best policy.”

To have a successful and sustainable company, businessmen should learn to incorporate honesty and transparency in their corporate values.

An honest and transparent company is not just every businessman’s responsibility to the tax agency; it should be his legacy to his progeny.

The author is a Director at the Cebu branch of Punongbayan & Araullo.

Foreign currency deposits’ exemption from documentary stamp tax

By Catherine Dela Cruz-Quilantang (Reposted from Business World’s Let’s Talk Tax, June 13, 2011)

It was reported in the news last April that the net income of foreign currency deposit units (FCDUs) of banks in 2010 grew by 31% from the 2009 level.

An FCDU is a unit of a local bank or a local branch of a foreign bank authorized by the Bangko Sentral ng Pilipinas (BSP) to engage in foreign currency-denominated transactions, including accepting deposits and lending in currencies other than the Philippine peso.

The growth in FCDUs was due to the increased demand for the products and services of FCDUs, including dollar-denominated loans.

A news report quoted the BSP as saying that income from the extension of loans denominated in dollars and other foreign currencies was brisk last year, as demand for such types of credit grew with the increase in the importation of various goods.

Another report said that loans granted by FCDUs increased by 18.1% in 2010 and that the borrowers were mostly residents and corporate entities engaged in external trade, as well as utility firms that needed to import oil.

Likewise, the FCDUs’ deposit liabilities, which were largely held by residents, increased in the last quarter of 2010.

With this growth in FCDU loans and deposits in 2010, the tax collections of the Bureau of Internal Revenue (BIR) from this sector should have increased.

One of the major sources of tax revenues from FCDUs is the documentary stamp tax (DST).

However, are foreign currency-denominated loans and deposits subject to or exempt from DST? Is the DST exemption on the transactions or on FCDUs?

These are the issues that took a while to resolve with the enactment of Republic Act No. (RA) 9294 in 2004 which restored the tax exemption of FCDUs.

Prior to the 1997 Tax Code, the taxation of FCDUs was covered by the Presidential Decree No. (PD) 1035.

Under this special law, the net income from foreign currency transactions by FCDUs with nonresidents, offshore banking units (OBUs) in the Philippines and other FCDUs was subject to a 5% tax, which was in lieu of all taxes on said transactions.

The exemption privilege is waived only on certain net income from transactions, as may be specified by the Secretary of Finance, upon recommendation of the Monetary Board, to be subject to the usual income tax payable by banks.

On the other hand, income from foreign currency loans granted by such FCDUs to residents was subject to 10% final withholding tax, except those from loans to other OBUs in the Philippines or depository banks under the expanded system.

Revenue Regulations No. (RR) 10-76, the implementing regulations of PD 1035 enumerates the taxes that are covered by the in-lieu-of nature of the 5% income tax. These include — but are not limited to — the privilege tax, gross receipts tax, documentary and science stamp tax and profit remittance tax.

This previous law and its implementing regulations clearly stated that the exemption was on the transaction and such exemption included DST.

In 1977, all tax laws were codified under PD 1158, otherwise known as the National Internal Revenue Code (NIRC) of 1977.

Under this law, the wordings of PD 1035 were changed and rephrased as: “Income derived by a depository bank under the expanded foreign currency deposit system from foreign currency transactions with nonresidents, OBUs in the Philippines, local commercial banks including branches of foreign banks that may be authorized by the Central Bank to transact business with foreign currency deposit system units and other depository bank under the expanded foreign currency deposit system shall be exempt from all taxes, except taxable income from such transactions as may be specified by the Secretary of Finance, upon recommendation of the Monetary Board to be subject to the usual income tax payable by banks: Provided, that interest income from foreign currency loans granted by such depository banks under said expanded system to residents (other than OBUs in the Philippines or other depository banks under the expanded system) shall be subject to a 10% tax.”

Note that the exemption provision is embodied in the Income Tax chapter of the NIRC of 1977.

It would appear that the exemption from taxes, based on the above provisions, refers only to income derived by the FCDUs.

Since the DST cannot be imposed on income, but is a levy on the document or on the transaction, it may not be included in the exemption.

In fact, in a 1982 ruling issued on the basis of the provisions of NIRC of 1977, the BIR took the position that the bank drafts, telegraphic transfers or travelers’ checks to be issued by the bank in case of withdrawals from its FCDU account are subject to DST since the exemption from all taxes refers only to the income derived by FCDUs from its foreign currency deposit transactions.

Notwithstanding this, the BIR has recognized that the current provisions of the law under the 1997 Tax Code, as amended by RA 9294 which restored the tax exemption of FCDUs, is substantially the same as the NIRC of 1977.

It has been clarified in BIR Ruling No. 051-2010 that with the restoration of the tax exemption of FCDUs in 2004, under the principle of legislative approval of administrative interpretation by reenactment, the provisions of RR 10-76 exempting FCDUs from gross receipts tax, among other taxes, is re-enforced.

Hence, RR 10-76 will still be the implementing regulations for the FCDU provision of the 1997 Tax Code, as amended, although DST was not an issue in this ruling.

Consequently, FCDUs should continue to be exempt from DST.

This BIR ruling is consistent with the recently decided case of the Court of Tax Appeals (CTA) in CTA No. 7874 (March 29, 2011). One of the issues raised in this case is whether or not the bank is liable to the alleged deficiency DST on its FCDU for taxable year 2004 in light of the categorical provisions of RR 10-76 and PD 1035.

The CTA held that from the date of effectivity of RA 9294, the FCDU transactions, except net income from such transactions, as may be specified by the Secretary of Finance, are now exempt from all taxes, including the assessment for deficiency DST. Section 1 of RA 9294 provides for an all-inclusive exemption from all other taxes.

Both the BIR and the CTA apparently agree that FCDU is indeed exempt from DST under the current law. However, under existing regulations, if one of the parties to the taxable transaction is exempt from the DST, the other party who is not exempt shall be the one directly liable for the DST.

However, even if the bank is exempt from the DST, it shall be regarded as an agent of the Commissioner for the collection of the tax under the regulations that the BIR has issued.

As a collecting agent, it becomes responsible for collecting the DST from borrowers and depositors, and remitting the same to the BIR. Hence, the FCDU is liable to charge the DST to the borrower.

Notwithstanding that the DST is not its direct liability, there will be corresponding penalties — if assessed by the BIR — if it fails to perform obligation to collect and remit the tax.

With the reported growth of the FCDU loans and deposits in 2010, the BIR would most likely look for growth in the tax remittances of FCDUs, including DST.

The author is a senior manager with the Tax Advisory & Compliance Division of Punongbayan & Araullo, a member firm within Grant Thornton International Ltd.

VAT on incidental transactions

By Ivin Ronald D.M. Alonza (Reposted from Business World’s Let’s Talk Tax, April 11, 2011)

Despite the Bureau of Internal Revenue’s (BIR) failure to meet its collection targets that resulted in higher budget deficit of P21.5 billion in February, the Aquino administration has reaffirmed its “no new taxes, no increase in taxes” policy by rejecting any proposal to impose new taxes or increase existing tax rates, specifically the value-added tax (VAT) rate from 12% to 15%.

To address the ballooning budget deficit, the BIR reinforced its thrust of improving its tax collection efficiency by going after tax evaders, filing cases against tax officials who fail lifestyle checks, and employing stricter interpretation and implementation of tax laws.

In connection to this, the BIR recently issued Revenue Memorandum Circular No. (RMC) 15-2011, revoking a 2006 BIR Ruling (BIR Ruling No. DA-563-06) which previously held that the sale of a company car is not subject to VAT if made by one whose regular line of business is manufacturing and export of custom-made dental products.

In the revoked BIR ruling, it was ruled that since the company’s regular line of business is the manufacturing and export of custom-made dental products, it follows that the company may only be subjected to 12% VAT on sales related to this kind of business activity. The said ruling further observed that there is nothing to indicate that the sale of the company cars is made on a regular basis or even incidental to the manufacturing and/or export of dental products. Thus, the BIR found no basis to subject the sale of the company cars to VAT.

In stark contrast to said ruling, however, is a 2008 Court of Tax Appeals (CTA) decision which served as basis by the BIR in revoking BIR Ruling No DA-563-06 under RMC 15-2011. In the said decision, the CTA held that although the primary business of a company is the manufacturing of garments for sale abroad, the sale of motor vehicle to its general manager is a transaction incidental to such business, and thus, subject to VAT.

In the said CTA case, the petitioner argued that before a particular transaction may be subject to VAT, it is important to determine the taxpayer’s role or link in the production chain of that particular product or service. Where the sale, barter or exchange of that particular product or service is not made in the course of trade or business, such transaction may not be made subject to VAT.

It may be recalled that under Section 105 of the National Internal Revenue Code of 1997, as amended, VAT is imposed on a sale or transaction entered into by a person in the course of trade or business. A transaction will be characterized as having been entered into by a person in the course of any trade or business if it is: (a) regularly conducted; and (b) undertaken in pursuit of a commercial or economic activity.

Likewise, transactions that are made incidental to the pursuit of a commercial or economic activity are considered as entered into in the course of trade or business. “Incidental” means something else as primary, something necessary, appertaining to, or depending upon another, which is termed the principal.

In interpreting this provision, the CTA ruled that the sale of motor vehicle is incidental transaction because the said vehicle was purchased and used in furtherance of the company’s business.

The CTA noted that the petitioner’s primary business is the manufacturing of garments for sale abroad. In carrying out its business, petitioner acquired and eventually sold the company car to its general manager. Prior to its sale, the motor vehicle formed part of petitioner’s capital assets, specifically under the account “Property, Plant and Equipment.”

In construing the sale of a motor vehicle as an incidental transaction, the CTA likewise relied on the rules of International Accounting Standards which defines property, plant and equipment as “tangible assets that (a) are held by an enterprise for use in the production or supply of goods or services, for rental to others, or for administrative purposes; and (b) are expected to be used during more than one period.” Thus, where a company car is being used for administrative purposes, its subsequent sale is an incidental transaction that is subject to VAT.

Consequently, an isolated transaction is not necessarily disqualified from being made incidentally in the course of trade or business. Considering this recent revenue memorandum circular, it is not remote that sale of other assets that are not held for sale or lease but used in business will be subject to VAT. Hence, taxpayers should be careful and should seriously consider the VAT implications of any plan to sell their properties that are used in business.

The author is a tax associate with Punongbayan & Araullo’s Tax Advisory & Compliance Division.