Even with the upcoming change in leadership, the Bureau of Internal Revenue (BIR) has not scaled back on efforts to meet its steep collection target of more than two trillion pesos. To this end, it is no coincidence that the BIR has come up with more detailed guidelines and strict control measures to plug possible loopholes in our tax system. In recent issuances, the BIR has provided guidelines covering the conduct of investigation on the capacity of parties to acquire properties and clarifying the tax treatment of gross receipts tax passed on to borrowers.
Meanwhile, in Revenue Memorandum Circular No. (RMC) 61-2016 dated 13 June 2016, the BIR focuses on “offsetting” or “netting” arrangements and practices. Under the RMC, the practice of offsetting the amounts recognized as accrued/trade receivables against amounts recognized as accrued/trade payables is strictly prohibited for taxation purposes. As a consequence, accrued receivables or payables arising from the sale or lease of goods or properties or the performance of services shall be recognized at gross amounts for income and value-added tax (VAT) or percentage tax purposes.
To appreciate the concept of “offsetting arrangements”, the RMC provides three illustrations of these transactions and the prescribed entries in the accounting books, detailed as follows:
THE SUPERMARKET AND THE MANUFACTURER
Illustration No. 1 is a typical commercial arrangement between a VAT-registered manufacturer selling food products to a VAT-registered supermarket. For displaying the food products in the store, the supermarket charges a service fee on the manufacturer. While the manufacturer issues a sales invoice for the sale of the food products reflecting the total value of the goods, the supermarket would be paying for the amount of its purchases, net of the service fee. In this example, both manufacturer and supermarket are assumed to be top 20,000 private corporations for withholding tax purposes.
To ensure that taxes are properly imposed, the receivable and the payable transactions, together with the corresponding sale and service fee expenses respectively, shall be recorded in the books of the manufacturer separately at gross amounts, subject to the applicable taxes (in this case, the creditable income tax and the output VAT on the sale, and the withholding tax and the input VAT on the expense). Likewise, the supermarket shall record separately the receivable and the payable at gross amounts, which correspond to its service fee revenue and purchases respectively, plus applicable taxes. The amount payable to the manufacturer for the purchase of food products cannot be recorded in the books of the supermarket as net of service fee since the transaction may appear in form to be a discount, but in substance is a sale of service. This misclassification must be avoided since the tax consequences of a discount and a service are different. To avoid simulated transactions, the principle of “substance over form” will apply to reflect the true intentions of the parties and ensure that they are taxed accordingly.
THE INTERCONNECTED TELECOMMUNICATION NETWORKS
Illustration No. 2 is an industry-specific transaction between two local telecommunications companies that are both top 20,000 private corporations for withholding tax purposes. A subscriber of the originating telecoms company calls a user from the receiving telecoms network. The caller’s network earns revenue from its subscriber who made the call but concurrently incurs an access charge expense payable to the network of the user who received the call.
The RMC provides that the telecoms company of the subscriber who made the call shall record separately at gross amounts the receivable and the payable relative to the revenue earned from the subscriber and the expense incurred from the interconnection access fee charged by the other telecoms network respectively. The applicable taxes -- creditable income tax and output VAT on the subscriber’s revenue/receipt as well as withholding tax and input VAT on the access charge expense -- shall likewise be separately recorded.
On the other hand, the telecoms network of the user who received the call shall record revenue from the interconnection fee charged to the caller’s network at gross amount, subject to the applicable taxes (creditable income tax on the amount withheld and VAT, if the telecoms network is VAT-registered).
THE LENDER AND THE DEPOSITOR
Illustration No. 3 covers interest income earned by a bank on a loan extended to a company. Since the company is likewise a depositor, the bank also incurs interest expense on the deposit. In this case, the bank must separately record at gross amounts the interest income from the loan and the interest expense from the deposit. The applicable taxes (e.g., gross receipts tax, final withholding tax on deposits and deposit substitutes) must likewise be separately computed and recorded accordingly.
The implications of the RMC are pervasive enough to affect taxpayers engaged in any kind of business activity or industry. Essentially, the RMC requires taxpayers to look into the substance of their commercial arrangements and treat each identifiable transaction separately for both recording (accounting) and tax purposes, regardless if the eventual settlement between the parties will be at a “net” amount. On this note, it may concern taxpayers whether the authority of the BIR under the Tax Code even includes prescribing journal entries to be recorded for accounting purposes.
Consequently, taxpayers will need to properly determine whether a reduction in the settlement amount qualifies as a discount or as a separate expense since in the case of the latter, taxpayers must ensure that such expense is properly supported by documents (e.g., invoice, official receipt) and subjected to the appropriate withholding tax to comply with the requisites for deductibility of costs and expenses for income tax purposes and the invoicing requirements under VAT rules.
To conclude, the prohibition on the practice of offsetting effectively requires: (1) recognition of revenues at gross, resulting in the correct taxable base; and (2) sufficient and appropriate documentation of purchases that are sought to be claimed as taxable base reductions, whether as cost/expense deductions for income tax purposes or as input tax credits from purchases for VAT purposes. The latter point is particularly crucial since the impact of disallowed costs/expenses and input VAT credits could be significant. Furthermore, the requirement to withhold on certain income payments should also be emphasized, as failure to appropriately withhold taxes would open the door to the possibility of significant tax consequences in the form income tax (at 30%) and withholding tax (at the appropriate rate, ranging from 1% to 30%), not to mention the considerable impact of interests and penalties on the deficiency taxes assessed.
Since the RMC touches upon both accounting and tax treatment of transactions, taxpayers and auditors alike should read the guidelines under critical lenses in light of the substantial tax impact that can be anticipated from its strict implementation.
The views or opinions expressed 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 the article.
Marion D. Castañeda is a senior consultant at the Tax Services Department of Isla Lipana & Co., the Philippine member firm of the PwC network.
(02) 845-2728
marion.d.castaneda@ph.pwc.com
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