2019 Articles - Suits the C-Suite - Page 2 | SGV & Co. | EY

30 September 2019

Reynante M. Marcelo

Transfer pricing audit issues requiring attention Part 2

(Second of two parts) In the previous article, we discussed the salient points of RAMO No. 1-2019, the Transfer Pricing (TP) Audit Guidelines and the urgent need to have a TP documentation to prepare for the TP audits. These guidelines also provide the audit procedures to be applied to specific TP issues that are quite common to groups of companies today. These issues relate to intra-group services, intangible assets and interest payment transactions. Under the RAMO, intra-group services are activities undertaken within a group that provide benefits for one or more other members in the group. Intra-group services may take the form of management, administration, technical, support, purchasing, marketing, distribution and other commercial services provided in connection with the group’s business. Of the above forms of intra-group services, the most common are the management services for which a parent company or another company within the group charges a management fee, and the “shared services,” which include non-core or other support services that are centralized into and provided by a shared service center within the group. Under the guidelines, it is not enough that an arm’s-length fee is charged for these services. It is equally important to prove that the other party receiving the service has derived economic benefit from the service. Such benefit is derived by considering whether an independent party in similar circumstances would be willing to pay another independent party for the service or would just perform the services itself. There are also certain kinds of services that cannot be considered intra-group services because there is no economic benefit to the service recipient. These services include shareholder activities, duplicative services, those that provide incidental benefit, and on-call services. In such a case, such services do not justify a charge to the service recipient. Thus, the possible risk is a total disallowance or the downward adjustment of the service charge to the service recipient, insofar as it pertains to the excluded services, resulting in deficiency income tax from the additional income arising from a disallowed or lowered service fee. Given all these considerations, it is, therefore, important to revisit management and shared services agreements and the TP documentation itself. These agreements must be closely examined to ensure that the services described in the agreements fall within the category of intra-group services and not under the exclusions. The RAMO also provides procedures for identifying intangible assets in the conduct of functions, asset and risk (FAR) analysis of the parties to the related party transaction (RPT). Intangible assets are those that are neither physical nor financial assets. A higher profitability level than the average for the industry is a factor that may establish the existence of an intangible asset. It is not necessary that such intangibles be recorded as an asset in the balance sheet or registered with the Intellectual Property Office. Even costs or expenses incurred in connection with research and development and the marketing of a product may indicate the existence of an intangible asset. In transfer pricing, the existence of an intangible asset is an indication that the owner is engaged in high-value functions in its transaction with affiliates. In such a case, the owner of such an intangible asset should be compensated with more than a mere routine return for its functions. The owner must be remunerated at a higher return that will allow it to recover the costs incurred for the development of such an intangible asset. In addition, a company that owns an intangible asset cannot, in most cases, be selected as a comparable for a company that performs routine manufacturing or distribution functions. Thus, as part of the TP documentation, an analysis has to be made on whether a company, by the nature of its functions, owns such intangible assets. Finally, the RAMO also prescribes audit procedures on intra-group loan transactions. The two areas of focus are the arm’s-length nature of the debt-to-equity ratio and the reasonableness of the interest rate and other expenses for the intra-group loan transaction. In testing the interest payments, an analysis must be made of the need for the debt and the market conditions at the time the loan is extended. In determining the need for the debt, the level of debt held by the borrower of the affiliate should be considered. The debt-to-equity ratio of the borrower is also benchmarked against the debt and equity of similar companies, although the purpose for determining such ratio is unclear in the regulations. In other countries or jurisdictions, the debt-to-equity ratio is a factor that is taken into account in determining if a company is thinly capitalized, that is, whether the higher level of related-party debt than equity is intended to take advantage of the interest deductions that comes with financing with debt rather than with equity. Where a company is thinly capitalized, its interest deduction attributable to the higher debt-to-equity ratio may be disallowed. In the TP documentation covering the interest payments on intra-group loans, it is, therefore, important to establish what is an acceptable debt-to-equity ratio within the industry and to ensure that related-party debt is within the benchmarked ratio. Given the complexity of TP audits and the preparations being undertaken by the Bureau of Internal Revenue, it is now more vital than ever that companies consider the factors we presented when establishing a pricing policy for intra-group services, intangible assets and interest payment transactions. Companies with foresight will make advance work, prepare TP documentation or revisit an existing one, to be better positioned in managing risks brought on by a TP audit. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co. Reynante M. Marcelo is a Partner for International Tax and Transaction Services of SGV & Co.

20 September 2019

Janice Joy M. Agati and Redgienald G. Radam

Preparing for the IBOR Transition part 1

(First of two parts) Financial markets globally are preparing the shift from referring to Interbank offered rates (IBORs) as a benchmark for financial products and services to alternative reference rates (ARRs). For decades now, IBORs have been the reference rates for variable-rate financial instruments with the London Inter-bank Offered Rate (Libor), the most widely used IBOR, underpinning trillions of dollars’ worth of financial contracts. Libor is referred to worldwide for many financial products — bonds, loans, derivatives, mortgage-backed securities, and others. It represents the average rate at which internationally active banks obtain funding from wholesale and unsecured markets. Libor is also used to gauge market expectations on central bank interest rates, liquidity premiums in the money markets, and even on the state of a banking system during periods of stress. In 2012, however, a group of banks was accused of manipulating their IBOR submissions during the financial crisis and a series of scandals ensued. In 2017, UK and US regulators simultaneously declared the uncertainty of the use of IBOR as a benchmark rate after 2021. Initiatives to reform the benchmark were made but actual transactions supporting Libor rates continued to dwindle and markets further questioned the integrity of the rates as a benchmark. Regulators proposed the solution to develop and adopt instead ARRs. These ARRs are believed to be more appropriate as reference rates as they are “near-risk free” and are based on actual transaction volumes. Regulators worldwide began laying down concrete policy steps for the transition. Relevant ARRs have been selected for major currencies with strategic transition plans to minimize market disruptions. The US Alternative Reference Rates Committee (ARRC), for example, has issued a 4-year timeline starting in 2018 for the transition from the US Libor to the Secured Overnight Financing Rate (SOFR). ARRs for other major currencies include the Reformed Sterling Overnight Index Average (SONIA) for GBP Libor, the Swiss Average Rate Overnight (SARON) for CHF Libor, and the Tokyo Overnight Average Rate (TONAR) for JPY Libor and JPY Tibor. As ARRs are selected and regulators provide for a transition procedure, financial institutions must assess early on the potential impact of the change of benchmark in order to re-assess their business strategies and make the uncertain, certain. As discussed in a recent EY publication titled End of an IBOR era, the top 10 challenges that banking, capital markets organizations, and other financial market participants will face in transition to the ARRs include: 1. Client outreach, repapering and negotiating contracts. Institutions should consider the necessity to re-negotiate existing contracts that will mature past 2021 based on the new reference rates. 2. High litigation, reputation and conduct risk. Spreads should be re-assessed based on the differences between the IBOR and the ARRs. 3. Market adoption and liquidity in ARR derivatives. The market must account for a transition in the adoption of ARR derivatives, thus affecting the liquidity in the market. 4. Absence of ARR term rates. As most ARRs will initially be an overnight rate, defining term rates for ARRs needs to be accelerated to facilitate the timely and smooth transition of cash products. 5. Differences in ARR and transition timelines across G5 currencies. There is also the need to harmonize the timing of the transition and publication of daily ARRs across the G5 currencies (dollar, euro, pound, Swiss Franc and yen) to address the impact on the FX swap markets. 6. Regulatory uncertainty. There is a need for regulatory guidance to be issued early on if only to allow markets to plan and work on their transition plans. 7. Operations and technology changes. As IBOR has already been embedded deeply in operational procedures and technological infrastructures, changes to systems may have to be planned early. 8. Valuation, model and risk management. A wide range of financial and risk models will have to be developed, recalibrated, and tested in order to incorporate the new reference rates. This poses a challenge given the lack of available historical time series data. 9. Accounting considerations. Financial institutions will need to review changes against accounting standards. 10. Libor may yet survive. The Financial Conduct Authority recently hinted at the potential use of synthetic Libor for existing contracts that may go beyond 2021. Additionally, the ICE Benchmark Administration also indicated the possibility that Libor may still be used for selected currencies and tenors. The lack of clarity and firm decision pose a challenge for institutions given the huge amount of “To Dos” needed to prepare the onset of year 2021. The Philippines should keep up with, if not be ahead of, these changes and prepare early as well. The domestic financial industry can see this as an opportunity to accelerate the Philippine Capital Market Agenda by establishing local reference rates. Regulatory guidance will play a crucial role at this point. Institutions also need to understand the structural differences between the IBOR and the ARRs and re-assess the impact to ensure their business models are abreast with the industry developments. In the next article, we will continue the discussion on expected IBOR transition, looking at some of the other business areas that institutions should start re-assessing, such as operations, risk management and regulatory frameworks, accounting and procedures that companies can adopt to ensure an efficient and effective transition. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the authors and do not necessarily represent the views of SGV & Co. Janice Joy M. Agati and Redgienald G. Radam are Senior Directors from SGV & Co.’s Financial Service Organization service line.

18 September 2019

Janice Joy M. Agati and Redgienald G. Radam

Preparing for the IBOR Part 2

(Second of two parts) In the first part of this article, we highlighted the current state of Interbank Offered Rates (IBORs), the factors behind the shift from IBORs to Alternate Reference Rates (ARRs), and the top 10 challenges to be faced in transitioning to the ARRs. In this second part, we will delve into the key operational, financial and accounting considerations that come along with the imminent discontinuation of IBORs. It is expected that the broad impact of transitioning to ARRs will be felt not just by banking and capital market organizations, but also by corporates with significant exposures to IBOR-linked instruments. This impact will cut across various functions within an organization, including treasury, legal, finance and risk. Given this, it is imperative for market participants to quickly assess the cross-functional implications of the transition to their businesses and clients. Having an awareness of these implications early on will help an organization plan for an efficient transition. Here are some of the key considerations for organizations before the IBOR reform is implemented: Determining your exposure to IBOR — Developing a detailed inventory of IBOR-linked products and contracts will be cumbersome for many organizations with existing financial contracts that are not digitized. The organization will have to ensure that relevant contract terms, including any fallback provision, are captured so that all legal and financial risks are determined. Contract renegotiations — IBOR-linked products and contracts may need to be modified and renegotiated. While the International Swaps and Derivates Association provides protocols to facilitate amendments to contracts between counterparties, having a huge number of derivative contracts to be amended can be a tedious task. For cash products, the renegotiation may be more burdensome due to the non-standard nature of most of the contracts. Multilateral negotiations will also be required for bonds, syndicated loans and other securitized products. It will also be necessary to establish governance processes and controls to avoid any financial, legal and operational risks. Impact on IT systems and infrastructure — The shift to ARRs will require changes to various platforms (e.g., valuation, trading and risk management systems) within the organization’s IT systems. Recalibration or redevelopment of models — Organizations need to build an inventory of all its pricing, valuation and risk models that use IBORs as an input and assess the need for recalibration or redevelopment. Any change in the models will also impact the front (in terms of pricing strategy and new product offerings) and back-office processes of the treasury function and will warrant an update of the organization’s risk management strategy. Accounting and hedging — The transition to IBOR will have a significant impact on various aspects of accounting, more notably on the application of hedge accounting and derecognition assessment for any contract modification due to changes in reference rates. Although amendments to IAS 39 Financial Instruments: Recognition and Measurement and IFRS 9 Financial Instruments are underway to address some problematic hedge accounting issues pre-IBOR transition, financial reporting issues post-IBOR transition are still to be dealt with by the International Accounting Standards Board (IASB). The pre-IBOR transition issues covered by the proposed amendments to IAS 39 and IFRS 9 relate to the assessment of the probability of the hedged forecasted IBOR cash flows occurring, assessment of effectiveness of hedging relationships and the immediate release of any amount lodged in equity to profit or loss if hedged IBOR cash flows will no longer occur. WHAT ORGANIZATIONS SHOULD START DOING NOW Given the various considerations discussed above and the impending completion of the IBOR reform by local jurisdictions, there is a need for organizations to plan and prepare for a smooth transition to ARRs. As discussed in a recent EY publication titled How will you respond to IBOR transition (https://www.ey.com/Publication/vwLUAssets/EY-end-of-an-ibor-era/$FILE/EY-end-of-an-ibor-era.pdf), organizations must establish an IBOR transition program as a necessary foundation upon which they can plan their transition strategy and implementation programs. Here are recommended steps in establishing an IBOR transition program according to the EY report: Assemble a broad-based IBOR transition team — Mobilize a formal IBOR transition program team with a strong governance framework and senior leadership appointed to oversee and report progress to relevant executive committees and the board. This program team should be cross-functional in nature, with business leaders represented from inception. Conduct a comprehensive impact assessment — The impact assessment should cover all areas of the business that are exposed to IBOR. This would include: (1) product assessment — categorize and quantify financial IBOR exposure by various parameters, including maturity, optionality, counterparty, client segment, business and jurisdiction; (2) legal contract assessment — extract and analyze the contractual language of the impacted products with a priority on positions that are due to mature beyond 2021; (3) risk assessment — analyze the potential impacts of transitioning to ARRs on the risk profile and financial resources of your organization; (4) operational assessment — identify impacted areas, including systems, models and processes that are linked to current IBORs; and (5) inventory management — establish and maintain an inventory of products and contracts linked to IBORs across jurisdictions. Develop a transition roadmap — A comprehensive implementation roadmap is needed for prioritized initiatives, including key workstreams, projects, milestones and ownership. A strategy for educating and communicating with both internal and external stakeholders should also be addressed, including clients, technology vendors, regulators and industry bodies. Launch the formal IBOR transition program — Publish a multi-year enterprise-wide transition program, including a program charter, a stakeholder map and resourcing requirements. As the pace of IBOR transition picks up, complacency will be detrimental to organizations with significant exposure to IBORs. Considering the complexity and wide-ranging scope of the transition, these organizations should initiate steps to prepare and make the most out of this exercise. A “wait and see” approach to implementation will not work with the overwhelming challenges that are expected to emerge when the IBOR is discontinued. At this point, an organization that can get ahead of the curve will have the advantage of identifying early market opportunities with the new ARRs. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the authors and do not necessarily represent the views of SGV & Co. Janice Joy M. Agati and Redgienald G. Radam are Senior Directors from SGV & Co.’s Financial Service Organization service line.

02 September 2019

Cecille S. Visto

Redefining corporate rules Part 2

Second of two parts In the first part of this article, we covered Republic Act 112321 or the Revised Corporation Code of the Philippines (RCC), which redefined the corporate rules to promote ease and flexibility in doing business, as well as take full advantage of technological innovation. We also discussed the first two key provisions in the RCC, which make it relevant for the changing global business landscape. These were: (1) the relaxation of the minimum number of incorporators, and the residency requirement for incorporators and directors; and (2) the introduction of the One-Person Corporation (OPC). We will now continue with the other provisions in the RCC which are considered by many as significant changes highly beneficial to the Philippine business community. ALLOWING PERPETUAL EXISTENCE AND REVIVAL OF CORPORATIONS Under the old rules, the maximum corporate term is 50 years, unless extended for a maximum of 50 years (or sooner dissolved). The RCC, however, now allows companies to exist in perpetuity, unless majority of the stockholders elect to retain its specific term pursuant to the Articles of Incorporation (AoI). Corporations with expired terms may also be revived under the RCC. The revival applies to their corporate existence, all their rights and privileges under the certificate of incorporation, and their existing duties and liabilities prior to the revival. Certain types of companies, such as banks, pre-need and insurance, pawnshops and other financial intermediaries need favorable recommendation from the appropriate government agency for the revival. While the RCC does not provide any exception to the revival of a corporation whose corporate life has expired, it appears that the SEC proposes to exclude the benefit of revival to corporations whose registration were revoked for reasons or causes other than the non-filing of reports. Based on the draft rules on revival of corporations that the SEC has circulated, the regulatory body clarified that the revival applies only to corporations with expired terms, not to those whose registrations have been revoked due to fraud or continuous inoperation. We hope that the final regulations will specifically address issues on corporate revival to erase any doubt on the ability of corporations whose registrations have been revoked to avail of the benefit of revival under the RCC. INTRODUCING MEANS FOR DISPUTE RESOLUTION AND EMERGENCY ACTION Intra-corporate disputes are inevitable but the RCC provides stop-gap measures to minimize, if not totally prevent, long-drawn intra-corporate disputes in court. Companies now have the option to include an arbitration clause in the AoI. Arbitration is an option to resolve issues between the corporation and its stockholders arising from the implementation of AoI or By-Laws or from intra-corporate relations. With this new provision, all controversies can be referred to arbitration. However, the SEC still needs to formulate the governing rules, including the organization of an arbitral board. The board of directors has also been given the prerogative to constitute an emergency board to undertake any emergency action sought to prevent grave damage to the corporation. Vacancy in the board may be filled temporarily when the vacancy prevents the remaining directors from constituting a quorum and the remaining directors voted unanimously. The action of the temporary director shall be limited to the emergency action necessary and his or her term shall cease within a reasonable time from the termination of the emergency or upon the election of the replacement director. The SEC is expected to clarify in a separate issuance what may constitute grave, substantial, and irreparable loss or damage to the corporation that will necessitate the appointment of an emergency board. TAKING ADVANTAGE OF TECHNOLOGY From filings to notices to attendance in board meetings and voting, the law takes full cognizance of advances in technology. AoIs and their amendments may now be filed electronically, fortifying the already established Company Registration System of the SEC. The RCC allows written notices to be sent to regular stockholders through e-mail or such other means that the SEC will allow under its guidelines. A corporation may also specify in its By-Laws the manner of communication through notices of meetings are sent, including the extension or shortening of corporate term, increase or decrease of capital stock, and sale or other disposition of assets. Notably, shareholders may vote through any forms of remote communication such as videoconferencing or teleconferencing using available systems and computer applications or even in absentia. Voting in absentia may be done using any electronic voting platform that may be established. Similarly, directors can remotely participate in meetings, provided they are given reasonable opportunities to participate. In corporations vested with public interest, stockholders entitled to elect directors may do so either in absentia or remotely, even without specific provisions in the By-Laws authorizing such voting. THE FUTURE OF THE BUSINESS LANDSCAPE Aside from the ease of doing business, the RCC seeks to address various reform clusters, such as prioritizing corporate and stockholder protection, instilling corporate and civic responsibility, and strengthening the country’s policy and regulatory corporate framework. As the law is new and regulations have yet to be fully formulated, the role of the SEC will be crucial in its proper implementation. The SEC has already informed registered companies that it will come up with piecemeal rules implementing the provisions of the RCC in lieu of consolidated guidelines. The passage of the law brings much optimism and rightfully so. However, only time can tell how the RCC will be able to transform the business landscape in the short term and the whole economy in the years to come. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co. Cecille S. Visto is a Tax Senior Director of SGV & Co.

27 August 2019

Cecille S. Visto

Redefining corporate rules Part 1

First of two parts For nearly 40 years, Batas Pambansa 68 or the old Corporation Code governed the way corporations operate in the Philippines. While the Code has been interpreted by jurisprudence and has been complemented by the Securities Regulations Code (SRC), the Revised Code of Corporate Governance, and the Foreign Investments Act, among others, it has taken nearly four decades to overhaul its provisions. In a recent study by the World Bank on the ease of doing business across 190 countries, the Philippines ranked 124th, lagging way behind its Southeast Asian neighbors like Malaysia (15th), Thailand (27th), and Vietnam (69th). In the 2019 World Competitiveness Report of the Swiss-based International Institute for Management Development (IMD), the Philippines ranked 46th out of 63 economies. While it improved its standing from 50th in 2018, the Philippines still ranked 13th out of 14 countries in the Asia Pacific Region alone, beating only Mongolia. Republic Act (RA) 112321 or the Revised Corporation Code of the Philippines (RCC), signed into law by President Rodrigo R. Duterte on Feb. 20, has redefined the corporate rules to promote ease of doing business, foster flexibility, and take full advantage of technological innovation. This article will discuss the key provisions, which are either new or are amendments to the old Corporation Code, making RA 112321 relevant, timely and more in step with the changing global business landscape. RELAXING THE MINIMUM NUMBER OF INCORPORATORS, RESIDENCY RULES In the past, one of the main concerns of foreign investors in establishing a local subsidiary was the difficulty in complying with incorporator-related requirements under the old Corporation Code. Prior to the RCC, the minimum requirements for incorporation included the participation of at least five incorporators, all of whom are natural persons. These requirements appeared simple, but often proved difficult for a foreign investor who did not have the ready support of another incorporator, let alone four others. Another concern was the need for majority of these incorporators, along with the directors, to be residents of the Philippines. In SEC-OGC Opinion No. 04-18 dated March 19, 2018, the Securities and Exchange Commission (SEC) said the residency requirement, particularly for directors, is mainly for the protection of stockholders “against inactivity of the board where no quorum can be mustered due to repeated absence of a director who resides abroad.” Legislators, however, recognized that with advances in technology, foreign investors and multinational companies can continue to conduct their business in the Philippines even if they are not physically present all the time. Aside from natural persons, a partnership, association, corporation, trust or estate are now allowed in the RCC to act an as incorporator, subject to the compliance with certain requirements, including the approval of their respective boards or members to invest in the corporation. INTRODUCTION OF THE ONE-PERSON CORPORATION (OPC) With the relaxed minimum number of incorporators, it follows that the RCC allows the formation of an OPC, which is a corporation with a sole stockholder having a legal personality separate and distinct from that of such sole stockholder. The SEC issued the guidelines for incorporation of OPCs and began accepting applications on May 6. It approved the first OPC application a day after. OPCs are only required to submit Articles of Incorporation (AOI) but can forego the standard submission of the By-Laws. The OPC is a welcome development, particularly for entrepreneurs without business partners but who would like to set up an entity. Even a foreign natural person may put up an OPC, subject to the applicable capital requirements, as well as the constitutional and statutory restrictions on foreign participation in certain investment areas or activities. As to liability, the sole stockholder in an OPC can claim limited liability, provided he is able to prove that the corporation is adequately financed. Otherwise, the stockholder becomes jointly and severally liable with the OPC for the latter’s debts and other liabilities. Moreover, if the sole stockholder serves as the corporation’s concurrent treasurer, he is required to post a bond of at least P1 million. The rule on the “piercing of the corporate veil,” which holds a corporation’s shareholders personally liable for the corporation’s actions or debt in lieu of limited liability, is applied with equal force to an OPC as with other corporations. An ordinary stock corporation may apply for conversion to OPC when a single stockholder acquires all the stock of such a corporation, with the OPC succeeding the ordinary stock corporation in the outstanding liabilities as of the date of conversion. Conversely, the OPC may also be converted into a stock corporation after compliance with the requirements provided by law. In next week’s article, we will continue the discussion on the changes brought by the RCC, looking closely at three other important provisions, namely the corporate term, the use of arbitration and guidelines on appointing an emergency board, and the more effective use of technology to comply with regulatory requirements. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co. Cecille S. Visto is a Senior Tax Director of SGV & Co.

15 August 2019

Evert De Bock

Project management in the transformative age

New platforms and drivers of productivity are creating new possibilities at unprecedented speeds, with steady advances in robotics, cognitive technologies and intelligent automation. To remain relevant and competitive, businesses are looking to implement digital strategies to keep up with the speed of change. However, while disruption has become the new buzzword to reflect the new trends challenging traditional business paradigms, the truth is that the fundamental changes in business models across industries convey a deeper shift that can be better described as “transformative” instead of disruptive. One of the defining traits of the transformative age besides the speed of change is the increasing dependence on connectivity. As Norman Lonergan, EY Global Vice Chair of Advisory puts it, “the transformative age goes beyond mere disruption, and is instead about being connected, whether to interfaces, data, experiences, or people.” Local businesses are already being recognized for using digital technologies that have transformed the market and for leadership in their digital transformation efforts, such as through the International Data Corp. (IDC) Digital Transformation Awards. Efforts are being taken to address the technological needs of many organizations and future-proof various businesses ranging from real estate, hospitality, restaurants, and infrastructure. A Microsoft/IDC Asia Pacific white paper, ‘Unlocking the Economic Impact of Digital Transformation in Asia Pacific,’ predicts that by 2021, digital transformation will add an estimated $8 billion to the Philippines’ GDP and increase its annual growth rate by 0.4%. CHALLENGES OF DIGITAL TRANSFORMATION To successfully lead their organizations through digital transformation, leaders will need to be well-versed in all aspects of the business environment, have the foresight to anticipate change, and integrate the disparate parts of a company. It’s certainly no easy feat. While 80% of organizations are undergoing digital transformations, only 25% of digital transformation projects result in real benefits. This is according to the Project Management Institute (PMI), a leading non-profit professional association. Since ownership of digital efforts should cut across the C-Suite and the different groups within a company, company leaders, IT, and project managers must all partner for optimum results while maintaining a broad view of the organization. Digital transformation projects can be especially challenging for global organizations or financial services companies. These often have legacy technology, third-party partners that contribute to the company’s complexity, and ingrained ways of conducting business. While smaller, digital-oriented startups merely have to execute their digital strategy, larger companies will need to take extensive current operations through digital transformation. Some of the challenges that arise due to the nature of transformation projects are resource allocation and priority in staff selection when weighed against ongoing operations. Another one is the impact of the transformation on the organization’s people, of whom many will be participants in the transformation effort. Transformation projects may result in changes to an organization’s structure, business processes, workplace location, or workforce, which, in turn, may trigger a natural human tendency to resist change. Addressing this human side of change is a key factor in ensuring that the results of any transformation project will endure. Further challenge comes from the scale of transformation projects, with diverse stakeholders both internal and external that will have varied, and sometimes, competing interests. STRATEGIES FOR SUCCESSFUL TRANSFORMATION These challenges can be addressed through the principles used to manage a transformation journey. By choosing the approach that best addresses the needs of the project, organizations will help minimize risks, control costs, and increase value. Murat Bicak, PMI senior vice president of strategy, shares the following strategies for successful digital transformation. Set clear goals and ROI metrics. There are several organizations that may still be confused about what it means to transform into digital. The effort encompasses more than the IT organization, and involves more than just digitization, according to Bicak. It is more about the business-wide use of emerging digital technologies to transform business processes and bring more value to both stakeholders and customers. Ensure that C-Suite sponsors are actively involved in projects. Inadequate sponsor support is one of the leading causes of project failure, according to the PMI. Conversely, the most common reason that transformative strategies succeed is strong support and buy-in from leadership. Executives can be more effective by staying connected with the program, helping navigate challenges, communicating its role, and advocating the program. Elevate the role of the project manager. The project manager role is evolving from that of an operational role to a strategy delivery role. Project managers are expected to bring forward expertise on innovation, strategy, and communication. Bicak adds that technical skills are only part of what project managers will need to lead digital transformation efforts, along with strategic business management and leadership. The essence of project management is the application of knowledge, skills, tools, and techniques to project activities in order to meet project requirements. It can be said that the rigor, discipline, standardized methodologies, and common language for complex change initiatives from project management can help increase the odds of success when applied to digital transformation. Investing in project management professionals by providing them with the tools, training, and skills they need to make their organizations as effective as possible will be key to driving the value delivery mindset needed for a successful project. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the authors and do not necessarily represent the views of SGV & Co. Evert De Bock is an Advisory Principal from SGV & Co.

29 July 2019

Stephanie G. Vicente-Nava

Benchmarking Philippine VAT against global key trends

In 2017, EY launched a Worldwide Indirect Tax Developments Map. It is a tool designed to track changes occurring around the world in value added tax (VAT), goods and services tax (GST) and other sales taxes, global trade, excise and other indirect taxes. Initially, the team gathered 400 records for VAT/GST and sales taxes from across the globe and noted an average of 30 to 40 changes per month. Based on these developments, five key VAT trends for succeeding years were identified: Trend 1: The standard VAT/GST rates have peaked Trend 2: Reduced rates and exemptions are instruments of tax policy Trend 3: The worldwide spread of VAT/GST continues Trend 4: Digital tax measures continue to spread and Trend 5: Tax administrations are embracing technology Given this global backdrop, is the current Philippine VAT setting aligned with the key trends and developments? Let us now look at how the Philippines fares in terms of global VAT trends. The Philippine VAT rate is stable at 12% According to the EY article, VAT/GST rates increased in many jurisdictions after the global financial crisis in 2008. However, the upward trend eventually subsided as the global economy stabilized. Subsequently, only a few countries increased their VAT/GST rates. Some countries postponed their plans to increase rates, while countries such as Croatia, Ecuador and Switzerland reduced VAT/GST rates. In the Philippines, the VAT rate has remained constant at 12% since 2006. VAT is based on the gross selling price in the case of sale of taxable goods, or gross receipts from the sale of taxable services, except on transactions subject to zero rate (generally export and export-related activities). However, while the rate is stable, it is still regarded as high compared to the average VAT/GST rate in the region. There have been several moves proposing a reduction in the VAT rate, which includes Senate Bill No. 1671 filed early 2018 seeking to cut the rate to 10%. However, the Department of Finance (DoF) reported that the Philippine government needs significant funds until 2022 to build and construct necessary infrastructure nationwide and consequently, any move to reduce tax rates may face strong challenges from the executive department. TAX REFORM LAW BROADENS THE VAT BASE Another global trend observed, as economies continue to improve, is that a number of countries are starting to introduce exemptions for specific goods and services that were previously subject to VAT/GST as a matter of tax policy. The Tax Reform for Acceleration and Inclusion (TRAIN) Act or RA No. 10963, the initial package of the Comprehensive Tax Reform Program (CTRP), took effect in 2018. One of the law’s main objectives is to raise the revenue needed to fund the government’s infrastructure programs by restricting VAT exemptions. Accordingly, 54 out of 61 special laws with non-essential VAT exemptions have been repealed and the law identified certain transactions previously subject to 0% VAT and imposed the 12% VAT on them upon establishing and implementing an enhanced VAT refund system. Offhand, these local VAT provisions appear contradictory to the global trend. However, the same TRAIN Act retained and provided additional VAT exemptions on certain transactions as a matter of policy, which is consistent with global VAT trends. The VAT threshold increased from P1.9 million to P3 million. This effectively exempts from VAT the sale of goods and services of marginal establishments. According to the DoF, the exemption is provided to protect poor, low-income Filipinos and small and micro businesses, as well as to promote manageable administration. Additional exemptions under the TRAIN Act include: • The sale or lease of goods and services to senior citizens and persons with disabilities, as provided under RA Nos. 9994 (Expanded Senior Citizens Act of 2010) and 10754 (An Act Expanding the Benefits and Privileges of Persons with Disability), respectively. • Transfer of property pursuant to Section 40(C)(2) of the Tax Code, as amended, or tax-free exchange transactions. • Association dues, membership fees, and other assessments and charges collected on a purely reimbursement basis by homeowners’ associations and condominium corporations established under RA Nos. 9904 (Magna Carta for Homeowners and Homeowners’ Association) and 4726 (The Condominium Act), respectively. • Sale of gold to the Bangko Sentral ng Pilipinas (BSP). • Sale of drugs and medicines prescribed for diabetes, high cholesterol, and hypertension. This global key trend appears harmful and contradictory to the current policy of the government to simplify the VAT system in the Philippines. Perhaps the Philippines learned its lessons from the past that providing reduced VAT rates and exemptions for particular industries as a matter of tax policy leads to multiple VAT rates which complicates the system and increases the risk of errors in the application of VAT rates and disputes with taxpayers. INTRODUCTION OF E-INVOICING AND E-SALES Tax administrations are now embracing the digital revolution to administer indirect taxes more effectively. Most authorities now require the electronic submission of VAT/GST declarations, and many are mandating the use of electronic invoicing. The Philippines has been aligned with this global trend for several years now. Certain taxpayer groups have been mandated to use the electronic filing and payment system (EFPS), as well as the eBIRForms return preparation software and online filing facility. Covered taxpayers are also required to submit their Summary Lists of Sales, Purchases and Importations, as well as periodic alphabetical lists (or “alphalists”) of payees subjected to withholding taxes — periodic, summary-type data that is analyzed by the BIR through the Reconciliation of Listings for Enforcement (or RELIEF) Validation System. In addition, the TRAIN Act introduced e-Invoicing and e-Sales reporting requirements, which present significant advancements in terms of digitalizing tax administration. Under the law, large taxpayers and exporters are required, within the next five years, to electronically issue their invoices/receipts, as well as to report their sales data to the tax authorities at the point of sale. Upon implementation of this provision, tax authorities will be able to capture more valuable, transactional-level tax Big Data in real time. This will also allow them to perform complex analytics, improve the selection of taxpayers for audit, rationalize tax findings, and streamline tax examinations. Therefore taxpayers should prepare for this move toward the digitalization of invoicing and sales as this reporting requirement may change the way their business operates. Modifying longstanding business processes for new systems will not only involve significant capital investment but will also entail a change in the organizations culture to ensure that the new system or process is accepted and properly adopted. Taxpayers should also be able to match the pace of the tax authorities in responding to inquiries during a tax audit to ensure compliance with the law and avoid administrative penalties and interests. With the advent of the digital age, tax authorities increase the pace of development and implementation of tax measures by leveraging on the interconnected global tax environment. Taxpayers must be vigilant to learn about emerging tax trends and developments in order to be able to design policies and adopt processes to sufficiently address changes in indirect tax policies, ensuring compliance with the law and capitalizing on their benefits. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the authors and do not necessarily represent the views of SGV & Co. Stephanie G. Vicente-Nava is a Partner from SGV & Co.

22 July 2019

Leslie Anne G. Huang

Alternative credit scoring through mobile phone data

Traditionally, credit is extended to customers based on a credit score. Lenders such as banks, credit card companies and other financial institutions assess creditworthiness using information from credit bureaus and their own databases. The traditional credit-scoring process usually verifies customers’ identity and assesses their ability and willingness to pay. The ability to pay is based on current income and outstanding debt, and willingness to pay is based on past credit performance. In emerging economies such as the Philippines, the traditional credit-scoring process can be a barrier to accessing credit, especially for the lower-income segment. Their ability to pay is a challenge to establish because many of them do not have regular fixed wages. Instead, they are often self-employed or engaged in different income-earning activities that do not have consistent cash inflows. They are usually paid in cash, with little to no formal savings accounts or registered assets that can be used as collateral. Similarly, their willingness to pay is also difficult to assess because they do not have records of past credit performance and borrowing behavior. Their segment is the so-called unbanked — people who are not served by a bank or a similar financial institution. The traditional credit-scoring process creates a cycle that can be limiting to the lower-income segment. They lack financial records to establish creditworthiness caused by little to no opportunity to secure credit or access to other financial tools necessary to secure a loan or save money. Ironically, for them, access to credit is especially critical. It can provide them with the instrumental opportunity to get an education, start a livelihood, or purchase a house. Without loan grants, they end up relying on informal and costlier alternatives. According to the Bangko Sentral ng Pilipinas third quarter 2018 Financial Inclusion Survey, only 3% of adults with outstanding loans actually borrowed from a bank, while 39% borrowed from informal sources. From the lenders’ point of view, expanding the coverage of possible borrowers can be a growth area. To reach the unbanked and underbanked, financial technology (Fintech) companies are now developing approaches to credit-scoring by looking beyond the traditional credit bureau databases and using other available sources of information. One of the more promising data sources is mobile phones. Mobile phones are available, accessible and replete with valuable information that can be used for credit-scoring. This is particularly true in the Philippines as in 2017, the International Telecommunications Union identified the country as having 110.4 mobile-cellular telephone subscriptions for every 100 people. In fact, the National Telecommunications Commission (NTC) identified a total of 120 million users and 96% of them are prepaid subscribers. Mobile phone usage is presumed to be a good indicator of the user’s lifestyle and economic activity. Simple inputs such as the way users organize their contacts (e.g., first name and last name) and structure their text messages (i.e., grammar and punctuation) can be used as data points in the credit-scoring model. More complex data points include analyses of location movements and call detail records, among others. Mobile phone data also shows location movements, which can be used to infer the users’ frequent locations, such as their home and their workplace. Location movements also provide insight on employment, modes of transportation and frequency of travel. Call detail records connecting individuals who contact each other result in social networks that can be indicative of age, gender, economic status and geography. These records can additionally be used to infer a user’s socioeconomic class due to homophily, or the individual’s strong tendency to associate with others whom they perceive as like themselves in some way. This is actually the same concept that one of Facebook’s patents anchors upon. The United States Patent and Trademark Office granted Facebook a patent on technology that determines users’ creditworthiness based on their social network connections — where after taking the average credit rating of the user’s social network into consideration, a lender can either proceed with or reject a loan application. While the long-term predictive power of using mobile phone data for credit-scoring remains to be seen, it promises to be an alternative or complement to an existing process that is worth exploring. A person’s digital footprint is difficult to manipulate, although not impossible, and provides a more holistic view of the customer’s socioeconomic activity compared to traditional credit reports. It makes the credit-scoring and risk-profiling processes simpler and faster through the input of the customer’s mobile phone number, where results can be generated in a matter of seconds. For lenders, embracing credit-scoring alternatives can boost profits. Reaching more customers can increase revenue and new technologies can reduce costs in the long run. Valuable insights from these alternative data sources can also enable cross and up-selling of products. However, crucial to alternative credit-scoring are data privacy and banking regulations which influence how Fintech companies and creditors obtain, analyze and use information. Prior to implementation, the process must be configured to applicable laws and regulations to ensure compliance. Part of the considerations would be ensuring that customers provide consent and authorization to creditors and Fintech companies in obtaining data on mobile usage from telecommunications companies. Mobile phones are both convenient and accessible. Customers may not have credit history, but they have mobile phone records. Converting data from digital footprints to financial track records and creating meaningful credit insights out of them can be a powerful tool. It provides opportunities to lenders to offer the right products according to the customer’s needs, enable them to make good financial decisions, provide access to credit to a larger segment of the population, and move toward an inclusive financial system that meets the needs of all income levels. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the authors and do not necessarily represent the views of SGV & Co. Leslie Anne G. Huang is a Senior Manager from the Financial Services Organization of SGV & Co.

15 July 2019

Elena D. Manuel

Final call for applications: SSS condonation program

The new Charter of the Social Security System (SSS) took effect on March 5 with the passage into law of Republic Act (RA) No. 11199 or the “Social Security Act of 2018.” The law aims to strengthen the state pension fund through the introduction of a new monthly contribution rate of 12% (with gradual increases up to 15% by 2025), the setting of minimum and maximum monthly salary credits, and the expansion and mandatory coverage of the fund for certain individuals, i.e., self-employed persons and OFWs, among others. More importantly, the law introduces a condonation program, which allows employers with delinquent SSS contributions to settle their delinquencies without the imposition of penalties. Following the passage of the SSS Charter, the Social Security Commission (SSC) issued Circular No. 2019-004, which implements the Transitory Clause of RA No. 11199, granting a six-month period for qualified employers or covered persons to settle their delinquencies and apply for a condonation of penalties. In general, the penalties offered to be waived under the program are the 3% penalty (2% beginning April 2019) per month, possible initiation of litigation, and damages, among others. Notably, the offer period for the condonation is set to end on Sept. 6 (after its commencement on March 5). Given that the window closes in less than two months, it now becomes worthwhile for employers to check on possible delinquencies that would call for an application for condonation. To an employer, questions like “am I or my employees covered by the requirement to contribute?,” “are there any missed contributions for covered employees?” would need some answers before a decision can be made. Here are some points to consider. Basically, all employers, acting on behalf of covered employees, are required to withhold and remit monthly employer-employee contributions to a Social Security authorized agent or bank — and any employer or covered person who has not remitted all contributions due and payable to the SSS may avail of the Program. Under the law, the types of employees covered include contractual or permanent employees not more than 60 years old, regardless of citizenship or nationality, the nature and duration of employment, and the manner of payment of compensation. Even foreign nationals or expatriates under a local employment contract are considered covered “employees” in the absence of an explicit exemption under bilateral agreements. While the Philippines has Bilateral Social Security Agreements with 13 countries possibly providing exemptions from the mandatory coverage, the exemption is, however, not automatic. To be exempt, there needs to be a submission of a Certificate of Continuing Liability from the employees’ home country Social Security Office and approval of the Philippine SSS. Other than the said general coverage, the following employers or covered persons are specifically included in the list of those who may apply for condonation: – Those not yet registered with the SSS, including household employers; – Those with pending or approved proposals under the existing Installment Payment Scheme Program of the SSS; – Those with pending or approved applications under the SSS Program for the Acceptance of Properties Offered Through Dacion En Pago; – Those with pending cases involving the collection of contributions and/or penalties or non-reporting of employees before the SSC, the regular Courts or the Department of Justice or Office of the Prosecutor; – Those against whom judgment had been rendered either by the SSC or the regular Courts but have not complied with the judgment; – Those who settled all contributions before the effectivity of RA No. 11199 but with unpaid or partially paid penalties for late or non-remittance; and – Those against whom a Warrant of Distraint/Levy/Garnishment (WDLG) or Encumbrance had been issued. The program also extends the entitlement to a condonation to those who have already paid contributions, partially or in full, before the effectivity of RA No. 11199, but are still faced with accrued penalties. Now that the condonation program is about to close on Sept. 6, the SSS is making a final call on all employers to revisit their compliance and settle all past due SSS contributions, if any, without the pain of penalties. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the authors and do not necessarily represent the views of SGV & Co. Elena D. Manuel is a Tax Senior Director of SGV & Co.

08 July 2019

Ramil C. Cantoneros

The essence of digital trends

We continue to see how technology disrupts traditional business models, resulting in new trends, products, and services, as well as how it dramatically transforms customer behaviors. Technology and innovation are considered great enablers, with the potential to rapidly remake the way we live, work and play. Yet, nearly all of today’s greatest disruptions have one common element — at their very core, these innovations are again empowering people. Centuries ago, business transactions happened between individuals. Consumers and vendors had control and flexibility to transact within their limited geographically-based market, as in a village. Contrast this with the industrial revolution. Power shifted to the hands of companies with the technology, machines and infrastructure to operate mass production facilities. Fast forward to the present — the digital revolution returns the power to ordinary consumers and vendors through an unprecedented level of control and flexibility, direct peer-to-peer transactions, and a wealth of information and content to empower their own lives at a personal level within a vast global arena. SOME COMMON ATTRIBUTES OF DIGITAL TECHNOLOGY Most people grew up in a culture with pre-defined norms, e.g. one works eight hours, earns a wage, and spends these wages at a physical store operated by a business or company. However, this was one of the first paradigms to go out the window with the rise of technological platforms that now provide an incredible level of control and flexibility to people over the use of their time, assets, resources, and the work and services they provide. Take the sharing economy, where digital platforms facilitate the exchange of goods and services among peers, allowing those in a network to transact directly with each other at the time and engagement level of their own choosing. Online platforms have made it much easier for those who wish to monetize their assets, time or skills at their own convenience. This has also led to the rise of the gig economy, where freelancers can work and earn on their own terms on a project basis. Consumers can cater to each other in this peer-to-peer setup, developing reputations that can be defined by reviews provided by fellow consumers to reward high performers. Blockchain, the technology behind cryptocurrencies, is commonly described as a tamper-proof digital record that can securely exchange and track assets on an end-to-end process. Blockchain is another example of peer-to-peer setups among users. Due to their ability to facilitate transactions on a secure platform, blockchains have the potential to displace intermediaries, allowing consumers and vendors to independently transact with each other online without a third-party to facilitate payment. Online shopping also allows consumers the privilege of purchasing goods any time by almost completely automating the sales process. Research by Gartner in their Customer Experience Summit 2018 predicts that by 2020, 25% of customer service operations will integrate chatbot technology or virtual customer assistants (VCA) into their channels, automating self-service while still providing the ability to escalate complex situations to a human agent. Information dissemination, or how easily an individual can share information, is best seen in the context of social media. This technology empowers an individual with the ability to create, publish, and share information on public platforms any time a connection is provided. Dissemination is no longer confined to small groups with access to broadcast media. The connectivity of these platforms is further enabled by mobile devices, allowing anyone to create and share content, amplifying their voices to anybody who would want to listen. Some creators take this ability a step further and make a name for themselves in social spaces, giving rise to viral popularity. While many talents have been brought to light from obscurity thanks to these platforms, their brands’ resulting products and services are more easily provided at a flexible pace they can dictate for themselves. Another aspect worth considering is how technology and disruption elevate the capability and potential of today’s workforce. With automation and artificial intelligence set to replace repetitive jobs (such as data entry, assembly line manufacturing and cashier sales), technology is giving room for the individual to develop new skills and competencies. Carl Frey and Michael Osborne in the 2017 study The Future of Employment: How Susceptible are Jobs to Computerization predict that 47% of existing jobs in the US will be at high risk of automation in the future. This gives the employees previously holding these jobs the incentive to pursue their passions or engage in creative, imaginative and strategic work. Though automation rendered and will continue to render certain jobs obsolete, history shows us that it also introduces new forms of employment. THE INFORMED, EMPOWERED CONSUMER Modern consumers are better equipped to consume greater amounts of data to make informed decisions. These decisions are often disseminated through social media, which in turn, can potentially influence fellow consumers. This level of awareness raises the standards consumers apply to their customer experience, resulting in a demand for personalization in a company’s marketing efforts. According to Anjali Lai, lead author of 2016 report Forrester’s Empower Customer Segmentation in Asia Pacific, “The power has shifted from the business to the customer. Consumers have rising demands and a new understanding of speed, the brand relationship and personalization, and these new levels of expectation and standards of customer experience have upended traditional business models.” This poses the question of how companies can adapt to meet the demands and expectations of modern consumers. INDUSTRY OPPORTUNITIES In the digital age where change is constant and innovation is key, companies who respond fastest gain the most traction. To remain competitive and relevant in the market, companies need to reinvent themselves by maximizing the opportunities that emerging technologies bring. To begin transforming a traditional business model and adapting to technological disruptions, companies can start by asking themselves four important questions: Who is their customer? What experiences are important to their customers? How can their business model support these experiences? What digital tools can enable their business model? While today’s consumers are empowered by technology, companies will find that adopting and properly utilizing digital tools will help them improve the overall customer experience. Digital technology also allows them to relate data to customers on a micro level, providing more resources than ever to aid in their anticipation of the customer’s needs. According to the EY Megatrends report, delivering rich customer experiences has the potential to generate more income and improve profit margins. Companies will have more to gain from listening to customers and tailoring their services to their needs. By leveraging digital platforms, adding value, providing a more personal and engaging customer experience, and creating a seamless balance of automated and personal touch points, companies have the opportunity to turn consumers into loyal stakeholders, and potentially, even into voluntary endorsers on social media and other platforms. As we said at the beginning of this article, digital technology and platforms are once again empowering customers and individuals. Companies need to understand that while innovation will clearly be a key driver of future competitiveness, the ability to more closely engage today’s empowered customers by providing fresh, dynamic and bespoke experiences may prove to be the greater challenge. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the authors and do not necessarily represent the views of SGV & Co. Ramil C. Cantoneros is a Senior Manager in the Advisory Services of SGV & Co.

2019