VAT on isolated transactions

THE VAT TREATMENT of sale of motor vehicle by persons who are not in the regular business of selling cars has often been raised as an issue in tax examinations. The provision usually cited is Section 105 of the Tax Code which provides that VAT shall be imposed on any person who, in the course of trade or business sells, barters, exchanges, leases goods or properties, and renders services. The phase "in course of trade or business" is defined in the same section as "the regular conduct or pursuit of a commercial or an economic activity, including transactions incidental thereto."

The critical issue in this provision is the meaning of "incidental", i.e., when is a transaction considered incidental to the regular business of a taxpayer? The term "incidental" is defined in Black’s Law Dictionary as "depending upon or appertaining to something else as primary; something necessary, appertaining to, or depending upon another which is termed the principal; something incidental to the main purpose." This definition apparently suggests that an incidental transaction is one which is necessary or essential to the regular business, although not done on a regular basis.

In 2006, the Bureau of Internal Revenue (BIR) issued a ruling which considered the sale of motor vehicle not done in the regular business of the taxpayer as not subject to VAT (BIR Ruling DA-563-2006). This ruling clearly relates the word "incidental" to something which is regularly done and not just simply isolated. However, the Court of Tax Appeals, in a succeeding case, considered the sale of a motor vehicle by a garment manufacturing company to its general manager an incidental transaction on the grounds that the motor vehicle was purchased and used in the furtherance of the company’s business. (CTA E.B. Case No. 287) As a consequence, the BIR issued Revenue Memorandum Circular No. 015-11 in March 2011 which revoked the 2006 ruling and adopted this CTA decision. Notwithstanding these pronouncements, the basis in determining what constitutes an "incidental" vatable transaction, as applied to isolated or one-off transactions, has remained to be a contentious issue.

On March 11, 2013, the Supreme Court (SC) rendered a decision which finally settles the issue on whether an isolated transaction, such as the sale of a motor vehicle by a person not regularly engaged in this business, partakes the nature of an incidental transaction and as such, shall be subject to VAT. (G.R. Nos. 193301 and 194637)

In this particular case, the taxpayer is engaged in the business of power generation which is subject to zero-rated VAT. The taxpayer sold a fully depreciated motor vehicle used in its business and did not pay VAT on said transaction, considering it as an isolated transaction. Subsequently, the taxpayer was assessed deficiency 12% VAT. The taxpayer protested the assessment and countered that the sale is a one-time transaction and is not incidental to its operations, and therefore should not be subject to 12% VAT.

The SC ruled that the sale of the motor vehicle by the taxpayer is an incidental transaction in furtherance of the taxpayer’s business and as such, is subject to 12% VAT.

The decision of the SC in effect clarified that the word "incidental" in Section 105 of the Tax Code does not necessarily exclude isolated transactions. The fact that a transaction is "isolated" in nature, i.e., one-off or unrepeated, does not result to the conclusion that the same cannot be an incidental transaction for purposes of VAT liability.

While the taxpayer’s business of power generation does not obviously include the sale of motor vehicle, the SC nonetheless considered the latter activity as incidental to its main business activity. The decision seems to highlight the fact that taxpayer purchased the vehicle because the vehicle was necessary in the operation of its business, and was in fact actually used in said business and recorded in the books as part of the taxpayer’s property, plant, and equipment. For these reasons, although the subsequent sale of the motor vehicle after it has been fully depreciated is not a regular activity of the taxpayer, such transaction was deemed incidental to its regular activity since the acquisition and subsequent sale of the motor vehicle occurred in the regular course of the taxpayer’s business. Simply stated, if it were not for the regular conduct of the taxpayer’s business, purchase of the motor vehicle would not have been required. Clearly, it appears that the basis of the VAT on incidental transactions is not whether the transaction is isolated or one-off, but whether the transaction has some form of connection or relation to the regular activity of the taxpayer, however, minor.

Now that the issue on what constitutes "incidental" transaction that is subject to VAT has been settled by jurisprudence, it would be advisable that taxpayers take a conservative approach and seriously consider the VAT implications of the sale or disposition of assets used in their business even though isolated.


The author is a senior manager at the Tax Services Department of Isla Lipana & Co., the Philippine member firm of the PricewaterhouseCoopers global network. Readers may call 845-2728 or e-mail the author at john.edgar.maghinay@ph.pwc.com for questions or feedback.Views or opinions presented in this article are solely those of the author and do not necessarily represent those of Isla Lipana & Co. The firm will not accept any liability arising from such article; the author will be personally liable for any consequent damages or other liabilities.

source:  Businessworld