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Suits The C-Suite

Will it be endgame now for 5% GIT?

Once again we wait to see if the Corporate Income Tax and Incentives Rationalization Act or the CITIRA bill (either House Bill No. 4157 or Senate Bill No. 1357) will pass into law this month. The bill is being repackaged for the third time after its predecessor bills were no legislated (TRAIN 2 and TRABAHO). If passed, CITIRA is expected to have a strong impact on Philippine Economic Zone Authority (PEZA)-registered firms. For PEZA-registered firms availing of the 5% Gross Income Tax (GIT) incentive, the withdrawal of the privilege would eventually mean a reassessment of their direct costs and expenses that would qualify as deductions in light of Revenue Regulations (RR) No. 11-05 — Definition of Gross Income Earned. This makes it an ideal time for companies to prepare for the eventual implementation of CITIRA by conducting simulations and evaluations using their most recent balances. DEDUCTIBLE EXPENSES FOR 5% GIT UNDER THE EXISTING PEZA LAW Favorably for PEZA-registered firms under 5% GIT, the Court of Tax Appeals (CTA) in recent years has been consistent with its interpretation that the list of direct costs in RR No. 11-05 is not exclusive but merely enumerates the expenses that are in the nature of direct costs. Thus, PEZA-registered entities may be allowed to deduct expenses which are in the nature of direct costs even if they are not specifically included in the list provided in RR No. 11-05. However, these items must be directly attributable to the entity’s PEZA-registered services/activities. The same position — that the list of expenses provided by RR No. 11-05 is not exclusive but merely instructive — was carried on in the recent CTA En Banc (EB) Case No. 1809-10 dated Nov. 14, 2019 (Moog Controls Corporation-Philippine Branch vs CIR). Moreover, Moog was able to prove that expenses (i.e., repairs and maintenance, data processing expense, building insurance expense and outside services) claimed under 5% GIT were directly related to its registered activities, and hence allowed as deductions under 5% GIT. However, it is worth pointing out that while a number of recent court decisions held by the CTA adopted the non-exclusivity of the list of expenses under the mentioned RR, the CTA has also disallowed the inclusion of certain expenses such as accident/life insurance, equipment and uniforms for on-the-job trainees, employee activities (e.g. holy mass for Sto. Nino Feast, Ping-Pong tournament expenses, treadmills for physical fitness clubs), non-technical training and development, the Department of Energy (DoE) electrification fund, general office expenses, business expenses, taxes and licenses for being unrelated to the rendition of PEZA-registered services. (CTA EB Case No. 1207 dated Feb. 3, 2016, East Asia Utilities Corp. vs. CIR) Needless to say, it is crucial that adequate documents (e.g., journal vouchers, accounts payable voucher, invoices/receipts) are maintained to support that the expenses can be attributed to the rendition of the PEZA-registered activity. (CTA Case No. 8508 dated Sept. 1, 2014, Medtex Corporation vs. CIR) 5% GIT UNDER CITIRA HOUSE AND SENATE BILLS While both CITIRA versions of the House and Senate seek to lower the regular corporate income tax rate and rationalize the tax incentives currently enjoyed by entities with special registration (e.g., PEZA–registered firms), each bill has its own proposed provision on the continuation of incentives granted before it takes effect as a law. HOUSE BILL NO. 4157 In the House version, registered activities granted an Income Tax Holiday (ITH) shall be allowed to continue and the incentive may be availed of for the remaining period of the ITH or for only five more years (whichever comes first). This is allowed provided that the 5% GIT shall commence only after the ITH period has lapsed; and further, that the 5% tax on gross income earned shall be allowed to continue for periods based on a schedule that varies depending on how many years the current tax incentive is being enjoyed (up to a maximum of five more years). After the lapse of the 5% GIT period, the regular corporate income tax rate shall take effect. At the same time, this version grants ITH, a reduced corporate income tax of 18% or enhanced deductions for commercial operations dependent on location. For example, companies in the NCR can enjoy up to three years ITH and up to two years reduced corporate income tax rate. Areas adjacent to Metro Manila get slightly longer periods, while all other areas can get up to six years ITH and four years reduced corporate income tax. The bill also states that the regular corporate income tax rate will be reduced by 1% every two years from 2022 until 2030. SENATE BILL NO. 1357 In the Senate version, registered activities only granted an ITH can continue to enjoy the incentive for the remaining period of the ITH. On the other hand, the 5% tax on the gross income of registered activities granted prior ITH (where the ITH will expire within five years once CITIRA takes effect) shall commence only after the lapse of ITH and shall continue for the remaining period (but not to exceed five years). Further, the 5% tax on gross income earned shall, similar to the House version, be allowed to continue for periods based on a schedule that varies depending on how many years the current tax incentive is being enjoyed, up to a maximum of five more years. Interestingly, the Senate version added a provision extending the sunset period for availing of 5% tax on gross income up to seven years for firms that export 100% of output, employ 10,000 Filipino workers in the incentivized activity, or are engaged in “footloose” manufacturing, which are operations outside of Manila that export manufactured goods and have a designated labor to asset ratios for a period of time before CITIRA. Similar to the House version, the Senate version grants an ITH followed by a special corporate income tax rate (SCIT) or enhanced deduction whose durations are based on the registered enterprise’s location and industry tier, with the caveat that the total period with incentives not last more than 12 years. The Senate version, however, sets the SCIT at 8% of the gross income earned in lieu of all national and local taxes, rising 1% per year until it reaches 10% in 2022 and onwards. Nevertheless, the determination of what constitutes direct costs will remain relevant during the sunset years of existing registered activities under the 5% GIT prior to CITIRA, and likewise under the new SCIT rates proposed by the Senate in this version. We should also note that PEZA-registered activities that qualify for registration under the strategic investments priority plan (SIPP) may opt to be governed by the provisions under both House and Senate versions of CITIRA. In such a case, such enterprises will have to surrender their Certificate of Registration, signifying their intent to waive the incentives they previously enjoyed. WHAT CAN BE DONE IN THE MEANTIME? At this point, knowing that the 5% GIT regime may slowly fade out of the picture once CITIRA takes effect, it would be prudent for PEZA-registered firms to evaluate the law’s impact on their current and future operations by way of a simulation using the most recent account balances. PEZA-registered firms should consider the following scenarios: • The companies continue to avail of their current incentives as PEZA-registered entities. • The companies opt to waive their privilege to avail of the incentives as PEZA-registered entities: 1. Where the registered activities of the companies qualify for registration under the SIPP. 2. Where the registered activities of the companies does not qualify for registration under the SIPP. By carefully conducting this gap analysis, PEZA-registered firms will be better able to evaluate if it is better for them to maintain their current incentives or to deregister from PEZA and instead fall under the new provisions of CITIRA. As with many projection matters, advance knowledge and the results of the simulation are often invaluable in helping companies decide on their way forward. By using real data from the company’s most recent balances, the simulations then become even more accurate and relevant to the company’s actual operations. 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. Erickson Errol R. Sabile is a Tax Senior Director from the Global Compliance Reporting Service Line of SGV & Co.
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Suits The C-Suite

How to make digital taxation click

Digital technology has undoubtedly revolutionized the world economy. With the growing popularity of online shopping in particular, businesses can reach consumers without needing a physical location. The increasing digitization of the world economy has not only made the sale of goods and services instantaneous and efficient — it has also provided a convenient way for consumers to purchase goods without having to waste time being stuck in heavy traffic. According to research pioneered by Google, the internet economy in Southeast Asia hit the $100 billion mark in 2019. By 2025, the internet economy is projected to grow to $300 billion. These numbers indicate a significant opportunity for tax authorities to not only regulate appropriately, but to also tap this source for additional government revenue. CROSS-BORDER ONLINE TRANSACTIONS In 2013, the BIR issued Revenue Memorandum Circular (RMC) No. 55-2013 to set the tone for companies operating in the digital market. By reiterating the obligations of parties in online transactions, the Circular sought to enforce our tax laws in the digital economy. However, the Circular has yet to address cross-border online transactions, or how taxes will be imposed on non-residents for online sales to local consumers. One apparent reason for this may be the inadequacy of our present tax laws as basis for taxing this type of transactions. Like most jurisdictions, the Philippines relies on physical presence or locus of activity within the country as a condition for the imposition of taxes. Tax treaties are likewise framed this way. However, cross-border online sales do away with physical presence since most online servers are located outside the country. Sales activities conducted through these portals are deemed to occur outside Philippine territory, as it can be argued that since an online transaction’s server is located outside the Philippines, the business itself isn’t considered to be held within the country. Such transactions can therefore be said to be outside the country’s taxing jurisdiction. Regardless, it is difficult to determine where the locus of the sales activity truly lies, only making it more difficult to enforce tax rules. THE NEED TO INNOVATE PRESENT TAX LAWS Tax authorities will need to come up with innovations to our present tax laws to address tax profits earned by non-residents from consumers here, as well as the enforcement or collection of taxes, the visibility over tax reporting data, and the addressing of the controversy surrounding the issue of capturing lost profits for our country. However, doing so without disrupting how bricks-and-mortar businesses are taxed can be daunting. In this light, perhaps our tax authorities can revisit the recent proposals of the Organization for Economic Cooperation and Development (OECD). Last year, the OECD released the Programme of Work to Develop a Consensus Solution to the Tax Challenges Arising from the Digitization of the Economy. While the Philippines is not a member of the OECD, the issues tackled by the organization are felt worldwide, and our tax treaties are patterned after the publication. The tax authority has also cited OECD commentaries in several rulings, giving the commentaries a more persuasive effect. The Philippines can benefit from the suggestions raised by the organizations in addressing base erosion issues for tax purposes. The proposals contained in the publication were grouped into two pillars: Pillar One, which focuses on the allocation of taxing rights and seeks to undertake a coherent and concurrent review of the profit allocation and nexus rules; and Pillar Two, which seeks to develop rules that provide jurisdictions with a right to tax back where other jurisdictions have not exercised their primary taxing right, or where the payment is otherwise subject to low levels of effective taxation. It calls for the development of a coordinated set of rules such as the income inclusion rule, switch-over rule, undertaxed payment rule, and the subject to tax rule. Their development addresses the ongoing risks from structures that allow multinational companies to shift profit to jurisdictions with very low or no taxation. There are three proposals under Pillar One that tackle how taxing income generated from cross-border activities in the digital age could be allocated among countries. These are composed of the “user participation” proposal, the “marketing intangibles” proposal and the “significant economic presence” proposal. All are supposed to allocate more taxing rights to the jurisdiction of the customer and/or user. Of special interest is the “user participation” proposal, which focuses on digitized business models such as search engines, social media platforms and online marketplaces. This proposal suggests that profits should be allocated to market jurisdictions based on the value-creating activities of the active user base. THE DIGITAL ECONOMY AS AN ADDED SOURCE OF REVENUE As a burgeoning digital economy, we may wish to explore how value-creating activities can be a source of taxing rights over income from digital cross-border sales. Granted, tax authorities will need to carefully weigh the nature of digital taxing rights vis-à-vis the importance of negotiations. One only needs to ask about the fate of the digital tax passed by France last year, which had to be postponed amid US retaliatory tariffs. However, once the statutory foundation for a set of tax rules that apply to the digital economy is drafted, bilateral as well as region-wide discussions in matters of implementation will surely follow. The key here is to find the right balance between creating a consistent and globally accepted set of digital tax rules that can benefit tax authorities in all jurisdictions while also being fair and supportive of digital enterprises that face new and rapidly evolving challenges to remain competitive in an increasingly crowded online market. 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. Ma. Theresa M. Abarientos-Amor is a Senior Manager from the Tax Advisory Services Group of SGV & Co.
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Suits The C-Suite

Foreign nationals and the taxman

Foreign nationals working in the Philippines are governed by at least three sets of rules — those of taxation, immigration and labor. Only by fully complying with each set of rules can foreign nationals ensure a fruitful and worry-free stay in the Philippines. This article focuses on taxation. For regular Filipino employees, taxes due on salaries are withheld by their employers and remitted to the tax authorities during the year. Foreign nationals, however, may be covered by Philippine tax rules but are unaware that they have tax reporting obligations. Certain tax obligations pertain to foreign nationals on home payment arrangements, whether partially or in full, and to those who come to the Philippines as short-term business travelers. There are foreign nationals who work in the Philippines under a split-payroll arrangement, i.e., their salaries are paid both from their home countries and from their Philippine employers. Some foreigners come to the Philippines for a specific business purpose within a short time period with wages usually paid from their home payrolls. Under both circumstances, there are fewer issues to consider if the home country payments are recharged to a Philippine entity as these will eventually be subject to withholding tax. However, in instances when the payroll costs remain with the home country, it is more difficult for the Philippine government to tax the foreign national. This is because no local entity or agency is privy to the amount that they receive from abroad. This is further complicated by existing tax rules governing foreign nationals that relate more to their presence and privilege to work in the country, but not to their tax obligations. The question arises: Are these foreign nationals really subject to Philippine income tax on offshore wage payments? The answer may seem to be a straightforward “no” since the income or part of it is not paid by a Philippine company. However, the reality is not that simple. We will need to take into account the basic principles on situs (or place) of taxation. FOREIGN-SOURCED INCOME As a general rule, the basis for taxation of foreign nationals is on Philippine-sourced income only. The issue may lie in what constitutes foreign-sourced income. Employment income is considered Philippine-sourced if it pertains to services performed in the country. This is regardless of where the income was paid, where the contract was perfected, or where the payor resided. Thus, in determining the extent to which foreign nationals are subject to tax, the basic consideration is where the work for which the income is earned was performed. The paying entity need not be a Philippine company; there does not even have to be a performance agreement between the foreign national and the local office. As long as the work is rendered in the country, the income derived from such work is generally subject to Philippine income tax. We say “generally” as there may be income tax exemptions for foreign nationals who are tax residents of countries with which the Philippines has bilateral agreements on double taxation. TAX ISSUANCES FOCUSING ON FOREIGN NATIONALS Adding to the ambiguity is the absence of other government rules on how foreign nationals are to be taxed. However, in 2019, following the sudden and steady influx of foreign nationals working in the Philippines (not to mention the lost revenue from this working group) the government released four issuances directed towards subjecting foreign nationals to tax. At the forefront is the Joint Memorandum Circular (JMC) No. 001, series of 2019, Rules and Procedures Governing Foreign Nationals Intending to Work in the Philippines. Drafted by nine government agencies, the JMC aims to harmonize the regulations and policy guidelines on the issuance of work permits and work visas to foreign nationals as well as the authority to hire and employ foreign nationals. Such permits are usually issued by various government agencies, including the Department of Labor and Employment (DoLE), Professional Regulation Commission, Bureau of Immigration (BI), and others. The JMC requires foreign nationals and/or the employer/withholding agent to secure a Tax Identification Number (TIN) from the Bureau of Internal Revenue (BIR) as a precondition for permits and visas. A special task force (composed of the DoLE, the BI and the BIR) was also created to conduct joint inspection of establishments employing foreign nationals. Moreover, a database will be created to record all issued work permits and authority to employ and hire foreign nationals. Aside from the JMC, the BIR also issued Revenue Memorandum Order (RMO) 28-2019, which prescribed the registration requirements for foreign individuals not engaged and/or engaged in trade or business or gainful employment in the country. The BI then issued two Operations Orders, both dealing with the TIN as a requirement for work permits and non-immigrant visa applications. CONSIDERATIONS FOR TAX COMPLIANCE To allow strict monitoring of the presence of and tax compliance among foreign nationals, it would be helpful for the government to clarify the definition of “taxable work or services” for foreign nationals. To illustrate, there are short-term business travelers who stay in the Philippines for only a few days or months under a 9a visa and perform activities even without a Special Work Permit (SWP). Securing a 9a business visa does not require a TIN, and these individuals may assume that they do not have tax obligations (either to report any income and pay tax, or to file any applications for tax treaty relief), even if their activities in the country qualify as work or performance of a service. Furthermore, compliance with TIN registration of foreign nationals may be difficult, especially if additional documents are required. For example, foreign nationals married to Filipinos and who apply for a TIN used to be required to submit English-translated and authenticated/consularized marriage certificates with their application. REVISITING TAX OBLIGATIONS FOR FOREIGN NATIONALS Policies should be reviewed to consider the changes that come with the fast-evolving world of workforce mobility, such as with the Emigration Clearance Certificate (ECC). An ECC is required from foreign nationals departing from the Philippines (either temporarily or for good) to ensure they have no pending obligation with the government. Current BI rules on ECC issuance, however, do not mention any need for the foreign national to submit documentary clearance of unfulfilled responsibilities from other government agencies. There appears to be no solid coordination process among government institutions. There is also no database to provide the information necessary to support an ECC application. With the JMC mentioned previously, it may help all concerned agencies to look into the ECC process and develop a method to cover the tax compliance obligations of departing foreign nationals. It would also be worth looking into the best practices of tax jurisdictions like Singapore, the US and Canada on their exit permits and non-residency status upon departure of foreign nationals. While the government is undoubtedly concerned about regulating the activities and rightful tax obligations of foreign nationals, there is much that can be done in terms of efficient implementation. We can hope that, given the number of government agencies involved in legalizing the affairs of foreign nationals, forthcoming guidelines will facilitate compliance. Moreover, with a TIN now a pre-requisite for work permit application, it may be advisable for foreign nationals and their employers to revisit their actual tax obligations arising from locally-sourced income. This is an opportune time to do so, as the April 15 tax filing deadline quickly approaches. Surely, no one wants the additional burden of stiff penalties, a BIR examination, or reputational peril that may be brought about by failure to comply with tax obligations. 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. Marlynda I. Masangcay is a lawyer and Tax Senior Director from the People Advisory Service Line of SGV & Co.
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