October 2020 Articles - Suits the C-Suite | SGV & Co. | EY

26 October 2020

Jan Kriezl M. Catipay

Digital transactions on the rise: Are they taxable? Part 2

(Second of two parts) In last week’s article, we discussed the rise of digital transactions, House Bill No. 7425, and how it proposes to add another section in the Tax Code, which requires non-resident Digital Service Providers (DSPs) to collect and remit the VAT in transactions that go through its platform. We also defined DSPs as a provider of a digital service or goods to a buyer through operating an online platform for the purpose of buying and selling of goods or services, or by making transactions for the provision of digital services on behalf of any person. In the second part of this article, we will discuss how a VAT-registered non-resident DSP may issue an electronic invoice or receipt to substantiate transactions; the proposed amended VAT exemption on the sale, import, printing or publication of books; and the state of our digital tax laws compared with neighboring ASEAN countries. ELECTRONIC INVOICING A VAT-registered non-resident DSP may issue an electronic invoice or receipt to substantiate a transaction. Note that the TRAIN Law requires taxpayers engaged in e-commerce, among others, to issue electronic receipts or sales invoices in lieu of manual receipts or invoices within five years from the effectivity of the TRAIN law (on or before Jan. 1, 2023, subject to the establishment of a reliable system capable of storing and processing the required data). The e-invoicing will effectively create a mechanism for the BIR to properly monitor transactions conducted over the internet and increase the efficiency of tax administration. The BIR is also required to establish a simplified automated registration system for nonresident DSPs. However, a transitory period of 180 days from the effectivity of the Act is provided to enable the BIR to establish implementation systems before VAT is imposed on the DSPs. There may be challenges to ensure the proper monitoring and compliance of non-resident DSPs with the required BIR registration and payment of the appropriate tax. A similar challenge also applies to resident suppliers of electronic or online sale of services. The BIR was given only 180 days to create a simple yet efficient automated registration system for non-resident DSPs. Is this enough time for the BIR? Without efficient monitoring, it may be very difficult to implement and properly collect taxes. We also note that although most of the amendments are seemingly focused on VAT, it is not the DSPs that are being taxed but the consumers with the DSPs acting as a medium to collect VAT from their buyers. BOOKS SOLD ELECTRONICALLY OR ONLINE Another provision that the House Bill seeks to amend is on VAT exempt transactions. Currently, the Tax Code provides VAT exemption on the sale, import, printing or publication of books, newspapers, magazines, reviews or bulletins. RMC No. 75-2012 clarified that to be exempt, these should be materials in hard copy. The VAT exemption does not cover those in digital or electronic format or computerized versions. However, under the proposed House Bill No. 7425, it amended Section 109 (Exempt Transactions) to include books, newspapers, magazines, journals, reviews and bulletins that are sold electronically or online as VAT exempt. With schools now conducting online classes as the new normal, both educators and learners will need more convenient access to e-books or other educational materials in digital format. The proposed amendment will greatly support the academe in providing affordable quality education. ORGANISATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT (OECD) It is also worth mentioning that over the years, there have been global developments in digital tax. In 2015, the OECD published the Base Erosion and Profits Shifting (BEPS) Action 1 Report which recognized the broader tax challenges of the digital economy, in relation to nexus, data and characterization. In 2019, the members of the OECD or G20 released a Program of Work to Develop a Consensus Solution to the Tax Challenges Arising from the Digitalization of the Economy which focused on a Two-Pillar Approach. Pillar One covers the allocation of taxing rights and seeks to undertake a coherent and concurrent review of the profit allocation and nexus rules, while Pillar Two focuses on the remaining BEPS issues. A final report which will set out the technical details of the consensus-based solution is targeted to be released by the end of 2020. The Philippines may very well follow suit in the near future. CATCHING UP WITH ASEAN MEMBER COUNTRIES The additional tax compliance requirements will certainly have an impact on businesses involved in digital services, especially non-residents. These requirements may be daunting and may pose additional burdens to doing business in the Philippines. On the other hand, the proposed bill may be seen as setting the country out on the right track. Our digital tax laws need to catch up with those of our ASEAN neighbors, which have started imposing either VAT or GST on digital transactions. Indonesia introduced Reg 48/2020 in May which imposes a 10% VAT, effective July 1, 2020, on cross-border digital transactions. Singapore implemented a new Overseas Vendor Registration (OVR) system which requires foreign digital service providers to register and be charged 7% GST starting Jan. 1, 2020. Malaysia imposed a 6% Digital Service Tax effective Jan. 1, 2020, on its foreign digital service providers. Laos has been implementing a 10% VAT on supplies of goods and services by electronic means since December 2018, upon effectivity of its amended VAT law. In Thailand, a draft amendment to the Revenue Code has been approved by the cabinet which would require foreign electronic service providers to pay 7% VAT on digital services. The draft has yet to be approved by parliament. In this evolving digital era where technology constantly transforms and businesses continue to innovate, the tax ecosystem may falter if its laws fail to adapt to the changing times. Modernization and digitization challenge antiquated tax laws. Progress dictates that such laws be revisited for the benefit of national development. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the author and do not necessarily represent the views of SGV & Co. Jan Kriezl M. Catipay is a Tax Senior Director from the Global Compliance Reporting Service Line of SGV & Co.

19 October 2020

Jan Kriezl M. Catipay

Digital transactions on the rise: Are they taxable? Part 1

(First of two parts) For many of us, digital transactions have become well-integrated into our daily lives — from online banking, shopping, ordering food to booking flights. This has been especially true during the pandemic, where the convenience of access to basic services and even complex ones like telemedicine within the confines of one’s home, has pretty much become the norm. With the increase in revenue generated through digital services comes the need to plug in and capture tax leakages arising from these transactions to promote equity and fairness. For instance, the purchase of goods and services, regardless of whether these are from a physical store or online, should be subjected to VAT. However, since there are no existing mechanisms which allow the tax authorities to monitor them nor are there tax rules that detail how online transactions (coursed through various web/mobile-based applications) are subject to VAT, most, if not all, of these digital transactions escape taxation. This gives undue advantage to online sellers and platforms even when the products sold are basically the same. DIGITAL TRANSACTIONS With the increasing usage of digital transactions in the past decade, the Bureau of Internal Revenue (BIR) tried to keep pace by issuing Revenue Memorandum Circular (RMC) No. 55-2013. The RMC emphasizes that taxpayers engaged in online business transactions (e.g., online selling/retail, intermediary service, advertisement/classified ads, auctions) should be treated akin to traditional or physical business establishments. It reiterated that existing tax laws and regulations on the tax treatment of sales/purchases of goods/services are to be applied equally without distinction on whether the marketing channel is online or through traditional physical locations. Additionally, with the subsequent increase of on-demand ride-hailing and sharing apps, the BIR then issued RMC No. 70-2015 to reiterate the tax treatment of persons engaged in the business of land transportation, particularly Transport Network Companies (TNC) and their partners and suppliers. The RMC states that if the TNC is a holder of a valid and current Certificate of Public Convenience, it will be treated as a common carrier and subject to 3% Common Carrier’s Tax. Otherwise, it will be classified as a land transportation service contractor and subject to 12% VAT. The current global pandemic has further spurred the growth of online sellers. In response, the BIR issued RMC No. 60-2020 to remind persons doing business and engaging in digital transactions to ensure the registration of their businesses and pay their correct taxes. This Circular not only covers sellers but also payment gateways, delivery channels, internet service providers, and other facilitators. HOUSE BILL NO. 7425 — AN ACT IMPOSING VALUE-ADDED TAX ON DIGITAL TRANSACTIONS With the country’s struggle to continuously finance its efforts to combat COVID-19, the government sought to increase its revenue collection and at the same time, set a statutory clarification on the “VATability” of services rendered electronically. House Bill No. 7425 was filed on Aug. 18 as a substitute bill for House Bills No. 4531, 6765, 6944, and House Resolution No. 685. This bill also seeks to clarify the imposition of 12% VAT on the supply by a resident or non-resident seller of electronic devices, the online sale of services that includes online advertisement services and provision for digital advertising space, digital services in exchange for a regular subscription fee, and the supply of other electronic and online services that can be delivered through the internet. The substitute bill aims to level the playing field between traditional and digital businesses by clarifying the imposition of VAT on digital service providers. NON-RESIDENT DIGITAL SERVICE PROVIDERS (DSPS) The bill proposes to add another section in the Tax Code which requires non-resident Digital Service Providers (DSPs) to collect and remit the VAT in transactions that go through its platform. However, these non-resident DSPs are precluded from claiming any creditable input tax. The new section defines a DSP as a provider of a digital service (defined as any service that is delivered or subscribed over the internet or other electronic network, which cannot be obtained without the use of information technology and where the delivery of the service may be automated) or goods to a buyer through operating an online platform for the purpose of buying and selling of goods or services or by making transactions for the provision of digital services on behalf of any person. DSPs may include a third party that acts as a conduit for goods or services offered by a supplier to a buyer and receives commission; a platform provider for the promotion that uses the internet to deliver marketing messages to attract buyers; a host of online auctions conducted through the internet, where the seller sells the product or service to the person who bids the highest price; a supplier of digital services to a buyer in exchange for a regular subscription fee; and a supplier of electronic and online services that can be delivered through the internet. It also requires non-resident DSPs that engage in the sale or exchange of digital services to register for VAT if the gross sales/receipts for the past year exceeded P3 million or if there are grounds to believe that the gross sales/receipts for the next year will exceed P3 million. In the second part of this article, we will discuss the following topics: how a VAT-registered non-resident DSP may issue an electronic invoice or receipt to substantiate transactions; the proposed amended VAT exemption on the sale, importation, printing or publication of books, and the state of our digital tax laws compared with neighboring ASEAN countries. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the author and do not necessarily represent the views of SGV & Co. Jan Kriezl M. Catipay is a Tax Senior Director from the Global Compliance Reporting Service Line of SGV & Co.

09 October 2020

Marie Stephanie C. Tan-Hamed and Veronica A. Santos

On the REIT track

After the first Real Estate Investment Trust or REIT listing recently, several real estate developers and potential REIT Sponsors are considering converting their portfolio of assets into REITs, and many domestic and foreign investors are eager to participate in future REIT listings. With such significant interest from across the industry, the focus is on larger listings and more successful REIT conversions. Our REIT law provides an advantageous tax regime to a REIT Company (REITCo) as long as the REITCo complies with the necessary requirements. However, this undertaking is not merely an exercise in applying for and maintaining one tax regime in lieu of another. The REIT journey begins with an assessment of the opportunity with guiding principles grounded on maximizing shareholder value, articulating the value story, preparing the organization for the operational changes as well as the myriad external communications and reporting requirements to the capital markets, all in addition to the tax considerations. STARTING THE REIT JOURNEY Considering the complexity of parts, how can an organization embark on such a journey? With the above guiding principles, the organization can start with an evaluation of capital structure and regulatory requirements that will maximize deal value and liquidity. Tax and capital markets considerations will still drive the overall transaction structure, while the analysis of capital structure will involve an assessment of debt capacity. A Sponsor can transfer to a REIT real property that is subject to a mortgage by way of a taxable transfer (i.e., an outright sale to a REIT together with the mortgage) or by way of a tax-free transfer under Section 40(C)(2) of the Tax Code. In the case of the latter, however, if the amount of the liabilities assumed by the REITCo plus the amount of the liabilities to which the property is subject exceed the total of the adjusted basis in the property transferred, then the excess shall be recognized as a gain on the part of the transferor, which shall be taxed accordingly. Apart from such incidental transfers of liabilities to a REITCo, the REITCo itself can issue publicly traded debt, or incur bank debt to finance acquisitions of REITable assets. The total borrowings and deferred payments of a REITCo that has a publicly disclosed investment credit grade rating by a duly accredited or internationally recognized rating agency may exceed 35% (which is the default ceiling) but may not exceed 70% of its deposited property. CONSIDERATIONS TO MAKE Leverage is one means to maximize returns to shareholders and introducing debt into the REIT structure should be considered early on, since it may bring with it issues on seniority of debt claims, approval of creditors, and costs of refinancing. Another area to consider would be the regulatory framework. This includes an assessment of the ease in the actual transfer of title, actual sale or transfer of the assets, alternatives to lease renewal, any restrictions that may limit the assets to be transferred, and most importantly, an assessment of the timeliness of securing rulings from the Bureau of Internal Revenue (BIR) confirming tax-free transfers to a REITCo. Strategic analysis of the asset portfolio and its potential for sustained growth beyond the initial listing are of equal importance in evaluating the benefits of a REIT conversion. Within the pool of assets in a portfolio, the challenge is to identify which of those are REITable assets, including the current tax incentives the property is enjoying versus the tax incentives the REIT offers, as well as those assets that can provide steady streams of income and cash flow. In case a building is decided to be part of the REITable assets, the question of whether a Sponsor-owned land will be transferred as well or will be leased out to the REIT company is another important consideration given its impact on the future valuation, cash flow and calculated distributable income. These considerations will involve heavy modelling and optimization with various scenario analyses. Analysis of cost structures is just as important. This is because while a REIT Company can operate within a lean infrastructure, standalone costs should be identified and considered in the overall return analysis. Identifying which are centralized costs previously incurred by the Sponsor and which are standalone costs once a REIT is set-up is critical to a REIT operating model. It would be useful to compare pre-REIT and post-REIT scenarios to benchmark the costs and better analyze the value creation potential of a REIT conversion. Lease analyses are also cornerstones in the benefit analysis of a REIT conversion. A true analysis of the leases is required to ensure that lease agreements are reflected in the financial statements in accordance with the current reporting standards. A review of the lease terms, rates, renewal provisions and remaining economic life of the REIT assets will be critical to ensure that these satisfy not just the tax and accounting requirements but also the commercial implications. Appropriate valuation of the assets and leases is also necessary to validate the REIT status and transaction structuring. THE REIT STRATEGY It also goes without saying that, with all the above considerations, the resulting accounting impact must be carefully evaluated to ensure that the correctness of application of the accounting standards and the anticipated outcome in the financial statements is as it should be. The appropriate accounting method for recognition and measurement of the asset transfers, leases, fair value measurement, and revenues for both the Sponsor and the REITCo must be properly applied. This may be a daunting task for some organizations contemplating a REIT listing. Setting up a framework in the form of a “gating” mechanism to guide the organization will be useful to aid in the analysis of whether to continue with the listing journey or defer to the future when a more opportune time is best for the organization. A simple framework can start with the evaluation of alternatives and selection of a REIT strategy where the organization can conduct a feasibility and readiness assessment, prior to deciding whether to go ahead or not. After which, it can develop a plan to implement the selected REIT strategy and then execute the REIT conversion. Embarking on and getting your REIT conversion journey on the right track can be challenging, but ultimately, rewarding. However, as with all things, timing will be different for each organization and it will greatly depend on the readiness of the organization, and ideally, the right market conditions. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the authors and do not necessarily represent the views of SGV & Co. Marie Stephanie C. Tan-Hamed And Veronica A. Santos are a Strategy and Transactions Partner and a Tax Principal, respectively, of SGV & Co.

05 October 2020

Aris C. Malantic

Managing the crisis: Three corporate insights from COVID-19

Corporates in the COVID-19 world continue to experience the effects of the pandemic. In managing these, CFOs have focused on key areas gathered from deliberations by crisis management teams and boardrooms as well as observed from other companies. Even as economic and business climates evolve, common challenges across sectors remain relevant. As we move to the last quarter of the calendar year, allow us to highlight lessons learned in three areas: financial reporting; cash and liquidity; and engagement with customers, suppliers and shareholders. FINANCIAL REPORTING The pandemic brought about key financial reporting issues that had to be addressed by financial statement preparers. For example, impairment indicators on assets, including goodwill, may be observed in certain manufacturing, retail, hospitality and real estate concerns which operations have been hampered by the current situation. While these indicators may not necessarily translate to impairment losses, these companies will need to perform more rigorous impairment tests to determine any impairment losses that they will need to recognize in their financial reports. The deterioration in credit quality of receivable portfolios as a result of the pandemic will have a significant impact on expected credit losses measurement. Given the uncertainties, incorporating the specific effects of the pandemic and government support measures on a reasonable and supportable basis pose challenges in the measurement. When it is not possible to reflect such information in models, post-model overlays or adjustments would need to be considered. As a result of the pandemic, some companies see significant costs in restructuring their businesses and in reconfiguring workplaces and adopting systems in order to continuously operate even within the constraints of social distancing and remote working. This may reveal potential financial reporting issues when it comes to the timing of recognition of employee expenses and provisions. New revenue models were developed or accelerated due to COVID-19, such as the use of online platforms. Certain contracts have also been revisited or modified. These will need to be correctly accounted for to ensure they give an accurate picture of a business’s financial health. These are examples of the financial reporting considerations and the applicability depends on the related facts and circumstances. CFOs are proactively engaging management, Audit Committees, Boards, auditors and advisors as they develop the comprehensive assessments and reflect the impact in financial reports. CASH AND LIQUIDITY The slowdown in economic and business activities vis-à-vis cash requirements placed cash and liquidity management at the forefront of the corporate agenda. Finance teams employ several techniques in managing liquidity, including but not limited to cash flows forecasting, more proactive budget review and cash flows management. Cash flow forecasting and budget reviews, in the near and medium term, incorporate various scenarios supported by economic modelling where possible. These scenarios show different types of recovery (V-shaped, U-Shaped, L-Shaped, etc.) as a single cash flow forecast will not be enough to sufficiently address the uncertainty that prevails in most organizations. Management customizes the responses based on these scenarios. An agile approach to forecasting is also utilized, such as performing forecasts that are typically between one and three months in length, taking into account the fluid nature of current events. This activity includes a comprehensive review of cash sources and uses such as those from trade debtors and creditors and credit lines. Cash-flow prioritization includes reducing certain expenditures such as those for advertising and marketing or deferring projects to the extent that these do not adversely affect revenue or cash generation. A specific area of liquidity risk lies in leases, especially in sectors where businesses commonly have significant long-term lease obligations such as retail. If businesses are unable to reduce these obligations, particularly during this period where their cash flow is diminished, they may be constrained to close certain branches or outlets or even the entire business. Locally, property owners have already offered rent concessions such as deferred payments or rental based on percentage of sales to retailers, among others. Government has also sought to ease the burden of these obligations on lessees and businesses by enjoining property owners to ease lease payments. ENGAGEMENT WITH SUPPLIERS, CUSTOMERS AND SHAREHOLDERS Finance and operational teams are working together to actively engage suppliers and customers in negotiating payment terms, accelerating collections and crafting new arrangements. Payment terms can be made a means of providing support, where they are extended for stricken customers or sped up for struggling suppliers. Companies are taking more than a near-term view with respect to relationships with suppliers and customers. This will help ensure a functioning ecosystem during the recovery period. Meanwhile, transparent financial reporting reinforces effective communication between businesses and shareholders, with periodic reporting presenting opportunities to build shareholder trust. This is particularly true around sensitive issues such as asset impairment, dividends, and going concern. It should be noted that the rise in virtual annual general meetings requires finance teams to carefully consider the potential need to provide further updates outside formal reporting timelines. STRATEGIZING FOR TOMORROW Managing the impact of the pandemic on financial reporting, liquidity and engagement with various stakeholders are pressing matters that will need to be addressed swiftly. However, companies will also need to take a long-term view by thinking about how the new normal will affect their business models and workplaces. They need to review the organization’s purpose as well as how they generate long-term value to stakeholders. As a strategic partner, CFOs must be nimble and flexible as they help the companies navigate in unchartered territories. This article has been adopted from the EY article, “Seven corporate reporting lessons from Asia’s experience of COVID-19” by Peter Wollmert, EY EMIA Assurance Leader. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the author and do not necessarily represent the views of SGV & Co. Aris C. Malantic is the Financial Accounting Advisory Services (FAAS) Leader of SGV & Co. and EY ASEAN FAAS and Market Group 7 Leader of SGV & Co.

October 2020

Digital transactions on the rise: Are they taxable? Part 2

Digital transactions on the rise: Are they taxable? Part 1

On the REIT track

Managing the crisis: Three corporate insights from COVID-19

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