Suits the C-Suite

28 November 2022

Jules E. Riego

A question of trust: Revocable or irrevocable?

The pandemic introduced a tectonic shift of perspective about wealth planning, changing from “it’s never too late to plan” to “it’s never too early to plan.” As people become more cognizant of their own mortality, they have also become more pragmatic because, as Dr. Susan David, award-winning Harvard Medical School psychologist and named one of the world’s most influential management thinkers, aptly said, “Life’s beauty is inseparable from its fragility.” Given this change in mindset, one favored tool for wealth planning is a Trust — a malleable tool even with the backdrop of the particularly challenging and sometimes complex compulsory heirship rules in the Philippines.A Trust is primarily a fiduciary relationship between a person called a Trustor or Settlor and a Trustee. The Trustor sets up a Trust, i.e., putting assets in a Trust or under the name of a Trustee. The Trustee is a person or entity appointed by the Trustor to take care of the assets placed in the Trust on behalf of or for the benefit of the Beneficiaries named in the Trust. As the Trustor is trusting the Trustee to take care of assets in favor of designated beneficiaries, the Trustee has a fiduciary obligation to the Trustor. Fiduciary obligation here means that the Trustee’s responsibility is not just within the level of a “good father of the family;” the Trustee should handle the Trustor’s and beneficiaries’ interests with the highest meticulous care. They hold a duty to preserve good faith and the trust reposed upon them.A TRUST AS A WEALTH OR ESTATE PLANNING TOOLEmploying a Trust is similar to writing a Last Will and Testament but without the burden of a costly, cumbersome and possibly protracted probate proceeding. Under Philippine rules, a Last Will and Testament has to be probated or have its legal validity recognized before a court. Because a probate proceeding is a judicial process in our jurisdiction, it will require lawyer’s fees and may result in considerable delays in the distribution of the benefit to the heirs.It is in the Trust Deed or Trust Agreement that the Trustor should put all their instructions as regards who should be benefited, when they should be benefited, what they will get (if hard assets), how much (if cash), and what conditions the beneficiaries must fulfill to be entitled to the income and/or principal of the Trust. In all of these, the Trustor must bear in mind the concept of “legitime” or the minimum entitlement under the law of compulsory heirs, which cannot be burdened with any condition.Once the Trustor passes away, the Trustee simply implements the distribution to the heirs/beneficiaries in accordance with the instructions of the Trustor. In most Trust arrangements, the Trustor is free to appoint a Protector or Overseer (usually a close and trusted family friend) who is tasked to see to it that the Trustee will perform all of its fiduciary obligations to the letter.REVOCABLE OR IRREVOCABLE?When deciding whether the Trust should be revocable or irrevocable, the following points should be considered:Generally, the substantial terms and conditions of an Irrevocable Trust (e.g., addition or subtraction of named beneficiaries) can no longer be changed. In a Revocable Trust, the Trustor can change the terms and conditions of the Trust for whatever reason. There is more flexibility for the Trustor in a Revocable Trust in terms of control over the assets in the Trust and in adding or removing beneficiaries.Transfers of assets to an Irrevocable Trust is essentially a donation, attracting a donor’s tax of 6%. This means that assets transferred to an Irrevocable Trust are no longer part of the estate of the Trustor and will no longer be subject to the 6% estate tax upon the passing of the Trustor. Therefore, the decision to set up an Irrevocable Trust is also a choice between paying a 6% donor’s tax at today’s value or paying the 6% estate tax based on the prevailing value later. This is particularly crucial for real property assets to be passed on to the next generation since the appreciation in value of real estate, especially those in prime locations, is unbelievably exponential.On the other hand, assets transferred to a Revocable Trust are still considered assets of the Trustor, such that upon the Trustor’s demise, the assets in a Revocable Trust will still be subject to 6% estate tax as donor’s tax was not paid during the transfer of assets to the Revocable Trust.Assets transferred to an Irrevocable Trust are also protected from creditors of both Trustor and beneficiaries, subject to certain rare exceptions. This also means that assets in an Irrevocable Trust are protected from future in-laws. This is the complete opposite in the case of assets transferred to a Revocable Trust, as future in-laws can potentially acquire assets from the Trustor’s family line due to Philippine compulsory heirship rules or other contingencies like annulment. This is also the reason why an Irrevocable Trust is very useful in wealth planning if the Trustor intends for specific assets not to cross family lines. For example, an Irrevocable Trust can shield shares of stock in a family-owned corporation if it is the family’s policy not to allow in-laws from owning shares in the family corporation to prevent potential complexity to the family dynamics.In an Irrevocable Trust, as long as the title to the assets is in the name of the appointed Trustee, estate tax will not apply even if any of the beneficiaries passes away since none of the latter own any assets in the Trust. This means that several generations of estate tax can be saved for as long as the corpus of the assets remain in the Irrevocable Trust. This benefit is not present in a Revocable Trust arrangement as assets from a Revocable Trust are distributed to beneficiaries upon the death of the Trustor.An Irrevocable Trust can also be used for wealth replenishment or “reforestation” if used in combination with life insurance. The fund of an Irrevocable Trust can be used to insure the life of the beneficiaries, and name the Trustee of the Irrevocable Trust as custodian of the proceeds of the life insurance policy for the benefit of or on behalf of the next generation. As long as the designation of the intended beneficiaries is irrevocable, the beneficiaries of the policy will get the proceeds tax-free. This cycle can be repeated in every generation to replenish the fund in the Trust.This arrangement is also useful when the intended beneficiaries of the life insurance policy are minors, suffering from any physical or mental disabilities and require life-long care, or when the parents believe that the beneficiaries would not be able to handle their own finances. Appointing a Trustee to manage, grow and control the periodic distribution of the funds would be ideal. However, when the named beneficiary of a life insurance policy is the Revocable Trust, the proceeds of the life insurance policy will be subject to estate tax, since a Revocable Trust has no personality distinct and separate from the Trustor.In a blog article, “Are trusts on your radar for succession planning?” Michael Parets, EY EMEIA Private Tax Desk Leader, offered other insights about Trust as wealth planning tool, such as choice of jurisdiction and the presence of laws recognizing Trusts; the domicile and citizenship of intended beneficiaries; the competence and reputation of the Trustee; and of course, the expertise of the tax advisor.FUTURE-PROOFING WITH TRUSTA Trust is not just a planning tool for the wealthy, but a viable wealth management tool for everyone who wishes to future-proof their assets for their heirs. In addition, we should remember that while there is certainly a cost in planning, there is a potentially higher cost in doing nothing – not just in tax, but more importantly, in maintaining peace and harmony within the family.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.Jules E. Riego is the Business Tax Services (BTS) Leader of SGV & Co. and the EY Asean BTS Leader.

21 November 2022

Henry M. Tan

Undaunted and unstoppable in the face of uncertainty

Throughout history, we have seen how times of great uncertainty and disruption have triggered sudden leaps and progress despite the problems and challenges they bring. The COVID-19 pandemic is no exception, it being the greatest global disruption the world has seen in many decades. Yet while the pandemic practically brought the world to a halt, it is also heartening to see how this period brought with it immense opportunities amidst many challenges. While is it true that many businesses suffered because of it, with many forced to close down, we have also seen numerous businesses accelerate their transformation and evolved to survive and then thrive as the world moved closer to post-pandemic recovery, pivoting their own business models and creating new ones.When the pandemic disrupted business strategies and challenged continuity, companies were forced to place a renewed focus on people, purpose and technology. Crisis, after all, inspires innovation, and this holds especially true for entrepreneurs.ENTREPRENEURSHIP AND INNOVATION DURING THE PANDEMICThough the pandemic caused many to lose their jobs, it also served as a catalyst for many others to enter the business landscape as entrepreneurs. According to a survey by Sales Force, the pandemic created a unique batch of startups that saw new opportunities to create new markets and attract new customers during a period of heightened uncertainty. As much as 56% of the survey respondents share that starting a business now was easier than before the pandemic. Most of the new startup founders embraced technology from the beginning, using digital tools and searching for more technology-based solutions to fuel business growth.NBC News reveals that entrepreneurs opened their own businesses at more than twice the rate seen in pre-pandemic times, aided by improved remote technology previously unavailable during other economic downturns like the Great Recession. Data from the US Census Bureau also shows that business applications nearly doubled during the first few months of the pandemic, remaining elevated and well above pre-pandemic levels. Economist Leila Bengali from the UCLA Anderson Forecast identifies lower fixed costs as one of the reasons for this, with the availability of the internet and a deeper familiarity with technology making it all the easier for innovative individuals to get their business online.In an interview, Christy Wyskiel, Senior Advisor to the President of Johns Hopkins University for Innovation and Entrepreneurship, said that the essence of entrepreneurship is identifying an unmet need and moving as fast as possible to get a meaningful product to market — which is exactly what society needs during a crisis. The pandemic dramatically accelerated productive collaboration in the service of society, and the paradigm has now changed, particularly in this period of post-pandemic recovery. Entrepreneurs should not be paralyzed by uncertainty, but instead should seek long-term value and success by continuing to serve their existing customers while being ready to pivot when needed to address potential opportunities.The pandemic also created a massive push towards digital transformation. In the Philippines, we now find almost every product or service available on online shopping platforms. Almost every brand in the country rapidly transitioned to existing online selling platforms or invested in developing their own online sales mechanisms. In the micro-sized enterprise space, people have gotten more used to the idea of starting their own businesses using digital tools and leveraging social media to take advantage of existing conditions — for example, during the lockdowns, the number of home-based online food sellers mushroomed like never before. Many found surprising success and were able to cultivate regular customers due to people being unable to go out and dine. The pandemic also gave rise to new business opportunities in logistics, entertainment, personal care and many other areas.CELEBRATING THE SPIRIT OF ENTREPRENEURSHIPAnalysts predict that the rate of growth of entrepreneurship will remain high in the post-COVID-19 economy, as shared by Forbes. Because of the massive increase in startups caused by the pandemic, developments on an individual entrepreneurship level will likely aid numerous economies.As Gaston Taratuta, EY World Entrepreneur Of The Year 2022, said in his acceptance speech in Monaco, “Being an entrepreneur is more than just building a successful business. It’s about creating and seizing opportunities where ones don’t readily exist or aren’t easily attainable.” This has never been truer than in the stories of 18 indomitable Filipino entrepreneurs that we are celebrating in the Entrepreneur Of The Year 2022 Philippines program. The program recently concluded its search for the country’s most successful and inspiring entrepreneurs with the theme of Undaunted. Unstoppable. And will be holding its awards gala tonight.Guided by their purpose, motivated by their aspirations and fueled by their relentless determination, these Filipino entrepreneurs helped empower communities and uplift the nation. Their stories have been published in BusinessWorld over the past few weeks with the hope that in sharing them, present and future entrepreneurs can be further inspired by their struggles and successes.Entrepreneurs showed us that a single idea can spark positive change and disrupt the status quo. According to a 2023 study, “Entrepreneurship during a pandemic,” entrepreneurs have been known to act as focal points during a time of crisis, playing a critical role in the context of post-disaster recovery by providing leadership and signaling that their communities are likely to survive. This same spirit burns strong within Filipino entrepreneurs who lead as Undaunted visionaries, equipped with Unstoppable resilience and the ability to adapt. 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.Henry M. Tan is a Partner and the Entrepreneur Of The Year Philippines Program Director of SGV & Co.

14 November 2022

Cheryl Edeline C. Ong and Karen Mae L. Calam-Ibañez

What’s new with Philippine investment incentives

2022 has ushered in several changes to the Philippines: a new administration, the winding down of the COVID-19 pandemic, and updates to the country’s investment incentive strategy.Investment incentives are government concessions meant to attract inbound capital. Taking advantage of these incentives is integral to strategic business optimization. From the relaxing of foreign equity restrictions, to the 2022 Strategic Investment Priority Plan, to environmental laws and more, entrepreneurs should be aware of every opportunity to decrease the cost of doing business in the Philippines.ENCOURAGING FOREIGN EQUITYForeigners have been gradually given more freedom to invest. They may enter industries previously exclusive to Filipino citizens, subject to reciprocal treatment. Instead of dreading competition, organizations should use this opportunity to seek more funding for their operations.Amendments to the Public Service Act limited the activities that are considered public utilities, namely the distribution of electricity, transmission of electricity, petroleum and petroleum products pipeline transmission systems, water pipeline distribution systems and wastewater pipeline systems, including sewerage pipeline systems, seaports, and public utility vehicles. This effectively removes from the “public utility” classification the domestic shipping, railways and subways, airlines, expressways, tollways, and transport network vehicles services, among others. These can now be fully owned by foreigners.Telecommunications and other vital services are subject to safeguards for critical structure and the reciprocity rule. On the other hand, the amended Retail Liberalization Act grants foreign enterprises the right to invest in retail trade businesses with a minimum paid-up capital of P25 million. If it owns more than one physical store, the investment per store should be at least P10 million.If successful, these equity market liberalizations could lead to increased foreign direct investment (FDI). A higher FDI means an improved exchange rate for the peso. Furthermore, investment incentives can also be used to boost job creation as well as job quality. The latter is crucial amid rising underemployment rates.For example, the amended Foreign Investments Act of 1991 lets foreigners invest in micro and small Domestic Market Enterprises (DMEs) with a minimum paid-up capital of $100,000.00. The DMEs should either involve advanced technology; or be endorsed as startup enablers; or directly employ at least 15 Filipinos, with a majority of its employees being Filipino citizens. This has been amended from the previous requirement of at least 50 direct Filipino employees.AN OVERVIEW OF THE 2022 SIPPTo effectively implement the Corporate Recovery and Tax Incentives for Enterprises (CREATE) Law, Memorandum Order No. 61 was issued to approve the 2022 Strategic Investment Priority Plan (SIPP). It grants investment incentives to entities registered as Registered Business Enterprises (RBEs). RBEs are categorized as either Export Enterprises (EEs) if 70% of their output is directly or indirectly exported, or as DMEs if the situation is otherwise.The regulatory power of investment incentives can be observed in the following aspects of the SIPP and the CREATE Law:Export Enterprise vs. Domestic Market Enterprise. To address the trade deficit, EEs get additional benefits over DMEs. EEs get VAT incentives and have the option to avail of either a 5% tax on their gross income earned, in lieu of all national and local taxes, or Enhanced Deductions (ED) for 10 years following the end of the income tax holiday (ITH) period. Meanwhile, DMEs have no VAT incentives, and can only avail of the ED for five years after the lapse of the ITH period.Provincial benefits. The period to enjoy the benefits of the 2022 SIPP depends on both the kind of RBE (whether DME or EE), as well as the location of the registered project or activity. Following the push towards rural development as embodied in the Balik Probinsya program, the CREATE Law gives longer ITH periods to RBEs operating outside of the National Capital Region and other metropolitan areas.Priority activities in the tier system. The administration aims to create a self-sufficient Philippines. Thus, longer benefits are granted to industries such as agriculture to promote food security, healthcare to better withstand future pandemics, power to reduce reliance on imported fuel, and higher tier activities. PUSHING FOR A GREEN ECONOMYThe right of Filipinos to a balanced and healthful ecology goes hand-in-hand with the need for economic development. Hence, the current administration’s socioeconomic agenda includes the pursuit of a green economy. It is willing to compensate sustainable, eco-friendly businesses through investment incentives under the Renewable Energy (RE) Law, as implemented by Revenue Regulations (RR) No. 07-2022.Under the RE Law, RE developers may avail of a seven-year ITH. Afterward, the developer is to pay 10% corporate tax on taxable income, provided that the resulting savings are passed on to end-users in the form of lower power rates. They may also avail of the incentives under the CREATE Law, e.g., four to seven years of ITH, depending on location and industry tier, followed by five years of Enhanced Deductions. The main consideration in determining which incentive to apply for is the time-bound incentives under CREATE Law which is not applicable under the RE Law.In addition, the Philippine Green Jobs Act of 2016 promotes the creation of “green jobs,” or employment which contributes to environmental preservation. Under RR No. 05-2019, businesses offering green jobs will be granted an additional deduction equal to 50% of the total expenses for skills training and research development. The law also provides that capital equipment that are actually, directly and exclusively used in the promotion of green jobs, may be imported free of taxes, though the government has not yet issued any implementing rules for this provision.BALANCING INCENTIVES WITH SUSTAINABLE GROWTHInvestment incentives have been introduced by the government in a conscious effort to remain globally competitive. Granting incentives must nonetheless be balanced with sustainable growth.Every concession comes with an equivalent benefit to ordinary Filipinos, either through employment opportunities or through eco-friendly communities. Companies have just as much to gain from investment incentives as their foreign counterparts and taking advantage of tax and regulatory benefits is integral to any business strategy. 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.Cheryl Edeline C. Ong is a tax partner and Karen Mae L. Calam-Ibañez is a tax senior manager of SGV & Co.

07 November 2022

Ana Katrina C. De Jesus and Natasha Kim R. Tec

Transfer Pricing is here to stay

Whether before or during the pandemic, related party transactions continued to proliferate both on a domestic and global scale. Business organizations should be mindful of the complexities of the rules surrounding their transactions with related parties. Philippine taxpayers have been anticipating transfer pricing audits by the Bureau of Internal Revenue (BIR) as it intensifies its risk assessment and audit activities.The regulatory framework for transfer pricing is envisaged to alter the overall tax architecture under which related party businesses operate. A thorough understanding of transfer pricing would allow businesses to effectively plan and future-proof their operations. We take a step back as we look into the evolution of rules in the Philippines and what the future holds for transfer pricing.TRANSFER PRICING THROUGH THE YEARSTransfer pricing is rooted in Section 50 of the National Internal Revenue Code which empowers the Commissioner of Internal Revenue to make an allocation of income and expenses between or among controlled group of companies if he determines that a related taxpayer has not reported their true taxable income. Prior to the issuance of local regulations, the BIR sought guidance from the Organization for Economic Cooperation and Development (OECD) transfer pricing guidelines.In 2013, the BIR issued the Transfer Pricing regulations to provide a set of rules in the determination of the appropriate revenue and taxable income of parties in a controlled transaction. The regulations require the maintenance of contemporaneous transfer pricing documentation, which must exist when the associated enterprises develop or implement any arrangement, or at the latest, when preparing the annual income tax return.In 2019, the implementation of transfer pricing was given more teeth when the BIR issued the Transfer Pricing Audit regulations. These provided a set of guidelines for revenue officers to propose adjustments by imputing an arm’s length price on related party transactions that are not in accordance with the arm’s length principle.The next set of relevant BIR issuances on transfer pricing were released in rapid succession during the height of the pandemic, progressing to the next phase of transfer pricing from compliance to enforcement.In 2020 and 2021, to generate new sources of funding for the government’s pandemic response, the BIR prescribed rules on the disclosure of related party transactions and submission of a transfer pricing form for taxpayers which are covered by the documentation requirement. Through these disclosures, the BIR has clearer visibility on taxpayers with related party transactions, which could be the target for transfer pricing audits.In 2022, new regulations on Mutual Agreement Procedures (MAP) provide Philippine taxpayers with an alternative mode to resolve disputes from differences in the interpretation or application of tax treaties. One of the typical scenarios requiring MAP assistance is when a taxpayer is subjected to additional tax in one country due to a transfer pricing adjustment from a transaction with its related party in the other country.THE NECESSARY PREPARATION OF TRANSFER PRICING DOCUMENTATIONWith the issuance of amendatory regulations limiting the scope of preparation of transfer pricing documentation to certain types of related party taxpayers and providing for materiality thresholds on the amount of their transactions, other taxpayers with related party transactions are still enjoined to prepare transfer pricing documentation. After all, the burden of proof rests upon the taxpayer on whether its related party transactions adhere to the arm’s length principle. The Transfer Pricing Audit regulations provide that taxpayers must ensure that the related party transaction they enter into is commercially realistic and makes economic sense. As such, taxpayers are expected to maintain contemporaneous documentation. In case of operating losses, the documentation must outline the non-transfer pricing factors that contributed to the losses. In light of the pandemic, affected taxpayers with related party transactions should carry out a Special Factor Analysis in their transfer pricing documentation where all legal and economic justifications are in place to establish a defensible position for business losses or reduced profits during the covered periods.With the issuance of a Revenue Memorandum Order in 2021 streamlining the procedures and documents for the availment of treaty benefits, taxpayers applying for a tax treaty relief application or request for confirmation in relation to interest income are now required to present proof that the interest rate used in the finance transaction is arm’s length. In addition, we have seen the BIR request for the submission of transfer pricing documentation even for tax treaty relief applications or requests for confirmation for other types of cross-border transactions such as business profits and royalties.There is also an interplay with the Bureau of Customs as it has the authority to question the determination of customs valuation relating to cross border transactions between related parties. A transfer pricing documentation could help support and justify the value of the imported goods purchased from foreign related parties.Further, the MAP regulations make it clear that the preparation of a transfer pricing documentation is a prerequisite in availing of MAP assistance.THE FUTURE OF TRANSFER PRICINGGovernment tax policymakers around the world are working together on proposals for significant changes to long-standing international tax rules in light of the OECD’s Base Erosion and Profit Shifting (BEPS) initiative on the globalization and digitalization of the economy. These developments would significantly alter the overall international tax architecture under which multinational businesses with related party transactions operate.In the Philippines, tax audits with transfer pricing issues have yet to be fully operationalized by the BIR since the inception of transfer pricing audit guidelines. However, taxpayers should not rest on their laurels because the BIR is continuously beefing up its capabilities through continued training of its revenue officers.With the recent issuance of the MAP regulations, it will only be a matter of time before the Advance Pricing Arrangement (APA) regulations will be released. An APA is an arrangement that determines in advance of controlled transactions, an appropriate set of criteria for the determination of the transfer pricing for transactions over a fixed period of time. The APA has always been a part of the BIR’s strategic plan for 2019-2023 because it is expected to address the country’s growing transfer pricing problems with the cooperation of taxpayers, particularly in relation to tax base reduction and profit apportionment schemes.While the OECD BEPS Action Plan 13 has not yet been adopted in the Philippines, multinational companies operating in the Philippines and Philippine conglomerates may still be required to comply with the Master File, Local File and Country-by-Country Reporting requirement.Now that the BIR has information on related party disclosures that are not otherwise disclosed in traditional tax returns, we may expect increased traction in the conduct of transfer pricing audits. In view of the upcoming e-Invoicing System implementation by the BIR, taxpayers with related party transactions must be aligned with their transfer pricing policies as they will be providing information to the BIR in real time. Taxpayers should be proactive in examining their transfer pricing risks by preparing contemporaneous transfer pricing documentation.This means a comprehensive approach to systematically address transfer pricing issues and the preparation of robust transfer pricing documentation will be critical to ensure compliance with the arm’s length principle. 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.Atty. Ana Katrina C. De Jesus is a tax principal and Atty. Natasha Kim R. Tec is a tax associate director of SGV & Co.

31 October 2022

Lucil Q. Vicerra and Yzrael Edwin V. Pineda

Navigating Customs audit and prior disclosure

After more than three years from the time the Bureau of Customs (BoC) resumed the conduct of customs audits, many importers stepped forward and voluntarily paid deficiency duties and taxes by availing of the Prior Disclosure Program (PDP).Based on international best customs practices, the PDP authorizes the BoC Commissioner to accept, as a potential mitigating factor, the prior disclosure by importers of errors and omissions in goods declaration that resulted in the deficiency in duties and taxes on past imports. It is both a compliance and revenue measure aimed to generate additional revenue with the least administrative cost both to government and importers. The PDP also helps importers avoid a full customs audit and the steep penalty in case of deficiency duty and tax findings in the course of an audit.In availing of the PDP, the bigger question is — is it worth the potential risk of being exposed to closer scrutiny? We break down our observations to assist importers in navigating their customs audits and in deciding whether to avail of the PDP or not.WHAT IS THE STATUS OF THE BOC POST CLEARANCE AUDIT?Since January 2019, the BoC has issued almost a thousand Audit Notification Letters (ANLs) to conduct audits on importers, covering companies from various industries and groups such as oil and gas, automotive, pharmaceutical, consumer, and those in the Super Green Lane category, etc. Based on information from the BoC website as of June 2022, the BoC Post Clearance Audit Group (PCAG) has collected about P600 million from audit findings and P5 billion from PDP applications filed by importers, whether under audit or not. Based on these figures alone, around 90% of the PCAG’s collection came from PDP applications.It appears that there were several companies under audit who availed of the PDP. Moreover, there were also companies who, even without an ongoing audit, availed of the PDP. This goes to show that importers who are not under audit may come forward at any time and volunteer to pay their deficiency duties and/or taxes to show good faith and commitment to comply with the customs laws and its rules and regulations. WHO MAY FILE AND WHEN TO FILE A PDP?Importers who are not undergoing an audit may file a PDP at any time. Those undergoing audit should file the PDP within 90 days from the receipt of the ANL as provided under Customs Administrative Order (CAO) 1-2019. In this case, the PDP application may be amended within 30 days from the filing of the initial PDP.Some of the common issues covered by the PDP applications filed include dutiable royalties, upward transfer pricing adjustments, error in value declared, excise tax on sweetened beverages, industry specific issues, among others.Moreover, importers may avail of the PDP for the following reasons without penalty and interest: dutiable royalty payments; other proceeds of any subsequent resale, disposal, or use of the imported goods that accrue directly or indirectly to the seller; or any subsequent adjustment to the price paid or payable. For these, the PDP application should be filed within 30 calendar days from the date of payment or accrual of subsequent proceeds to the seller or from the date of the adjustment to the price paid or payable is made.PENALTIES TO BE PAID FOR AVAILING OF PDP AND HOW TO AVOID OR MINIMIZE THEMWhile the PDP provides for a facility to pay deficiency duties and taxes, the same is subject to penalty and/or interest depending on whether the importer is under audit or not. If the importer is under audit, the availment of the PDP with the 90-day period is subject to a 10% penalty and 20% interest per year.On the other hand, an importer who is not under audit will only be subject to 20% interest per year. Since the penalty and/or interest may be significant, importers availing of the PDP normally request for its waiver pursuant to the power of the BoC Commissioner to compromise any administrative case arising under the Customs Modernization and Tariff Act (CMTA) involving the imposition of fines and surcharges, including those arising from the conduct of a post clearance audit. The BoC Commissioner’s power to compromise, however, is subject to the approval of the Secretary of Finance.Since there is no specific guidance on the parameters or requirements for the approval of PDP applications with request for waiver of penalty and/or interest, the PCAG has to consider on a case-to-case basis the PDP applications that they will endorse to the Commissioner and ultimately to the Secretary of Finance for approval. We understand that for PDP applications of importers without an audit and which are found to be complete and accurate, the same are being approved by PCAG and endorsed to the Commissioner for approval.Meanwhile, PDP applications of importers with an audit which are also found to be complete and accurate will be subject to evaluation by PCAG. These applications may or may not be endorsed for approval depending on the issues applied for PDP and the relevant facts and circumstances.To ensure the approval of PDP applications, the same should be filed on time and should include a full disclosure of the relevant issues. Moreover, the same should comply with the documentary requirements provided under CAO 1-2019. If importers fail to comply with these, the PDP application may be denied.THE BEST TIME TO AVAIL OF THE PDPGiven the greater certainty in the approval of the PDP filed by importers not undergoing an audit, it seems more prudent to avail of the PDP while the company is not yet under audit. Though some importers think that availing of the PDP when they are not yet under audit may expose them to additional risks and potential liabilities, it seems this is not the case based on previously filed applications.We are not aware of an importer who is not under audit and availed of PDP who was subsequently subjected to a full-blown customs audit. It appears that the BoC recognizes the good faith of the voluntary payment made given that there is no on-going audit that may possibly result in deficiency findings.PROACTIVITY IS THE KEYIt is prudent for importers to review their customs practices and procedures without waiting for an ANL. Upon determination of the actual exposure, importers may consider availing of the PDP considering that the benefits far outweigh the risks, if any. The filing of PDP without awaiting an ANL may potentially save importers from the customs audit for a certain period. This may also help importers avoid the hassle of going through a three-year audit, saving time, effort, steep penalties and interest.This will also enable importers to contribute to the collection efforts of government while complying with customs laws and regulations. Moreover, importers who are aware of their exposure and risk areas can better implement corrective measures to strengthen compliance with existing customs rules and regulations.To encourage more importers to avail of the PDP, the BoC and the DoF should continue to exert their best efforts in expediting the processing of filed PDP applications. In the end, success in any initiative will undoubtedly be achieved when all stakeholders work together. 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.Lucil Q. Vicerra is a Tax Principal for Indirect Tax Services – Global Trade & Customs and Yzrael Edwin V. Pineda is a Tax Senior Director, respectively, of SGV & Co.

24 October 2022

Marivic M. Rebulanan

Transformative-tax-compliance-requirements

In the last two years, the world has witnessed how an unforeseen event can bring about a major shift in the business environment, forcing governments and business leaders to make drastic changes. Accountants and tax practitioners became economic frontliners for a struggling economy during the pandemic. Fast-forward to 2022. Businesses are slowly reopening and their operations are recovering. Offices are transitioning to either 100% face-to-face or hybrid set-ups. Simultaneously, the Bureau of Internal Revenue (BIR) is also keen to implement transformative changes to adapt to these developments to ease the process of paying taxes and comply with administrative requirements. By streamlining these processes, the government is effectively helping taxpayers meet the social responsibility of paying their tax obligations. These can pave the way for changes in policy that are sustainable and, at the same time, environment-friendly, resilient against unforeseen events, with the potential for reducing the financial burden on taxpayers.In this regard, the BIR issued Revenue Regulations (RR) No. 6-2022 to remove the five-year validity of receipts and invoices. This RR covers manual receipts and invoices with Authority to Print, those that are generated by Computerized Accounting Systems (CAS) and related components, and those issued from Cash Register Machines (CRM) and Point of Sale (POS) Machines with Permit to Use. This removal took effect on July 16, 2022. The implementation of this RR will reduce the burden on taxpayers to comply with the BIR’s administrative requirements when the receipts and invoices expire. This may also reduce the cost of doing business, allowing taxpayers to improve their financial performance.This initiative is also in line with the BIR’s adoption of the Electronic Invoicing/Receipting System (EIS). This requires certain taxpayers to electronically report their sales data to the BIR, which should be implemented within five years from the effectivity of the TRAIN Law, and upon establishment of a system capable of storing and processing the required data used by electronic point of sale systems. This will be mandatory for taxpayers engaged in the export of goods and services, those engaged in e-commerce, and taxpayers under the jurisdiction of the Large Taxpayers Service. The EIS is capable of storing and processing the data that taxpayers must transmit using the taxpayers’ Sales Data Transmission System (SDTS).Now, taxpayers are required to issue electronic receipts and invoices, and the related sales data should be transmitted to the BIR within three calendar days from the date of transaction, which is almost real time. With this, taxpayers are no longer required to issue hard copies of receipts and invoices with ATP, or print those that are generated from the CAS, CRM, and POS machines. The soft copies of these documents are considered valid for tax purposes. Relative to sales data transmission, taxpayers are required to develop a BIR-certified SDTS. Moreover, taxpayers are required to submit an application for the issuance of the Permit to Transmit to allow transmission of sales data to the EIS. The SDTS will effectively link the taxpayers’ accounting system with the BIR’s EIS.The implementation of the EIS may result in long-term cost savings in doing away with the cost of paper and supplies, mailing, handling, archiving, storage, and labor, among others. While refining the administrative aspect of the business processes, this may also result in improved financial performance for taxpayers. To add, this change is environment-friendly and more sustainable in the long run. However, taxpayers will have to incur costs at the start, particularly the cost of developing the SDTS. Nonetheless, this is a forward-looking investment and the benefits from implementation may eventually outweigh the related costs.Another important change implemented by the BIR is the removal of the 25% surcharge in amending tax returns. This is to ensure consistency with the rules applicable when paying deficiency taxes and penalties during a BIR audit. To provide context, in 2018, the BIR set the rule that a 25% surcharge will be imposed on additional tax payments arising from the amendment of tax returns. However, no 25% surcharge is imposed if the additional tax payments are made in the course of a tax assessment. In effect, taxpayers are being unduly penalized for voluntarily amending their tax returns to pay their taxes correctly. Under this recent RMC, the 25% surcharge for amending tax returns will be removed, provided that the original tax returns were filed on time. With this new rule, taxpayers may be encouraged to voluntary amend their tax returns to address any errors or corrections in their original filings.Given the economic agenda of the new administration, investors and business owners would do well to closely monitor the government’s efforts to rationalize tax policies to ensure not only compliance, but to also take advantage of any beneficial changes to the tax filing and payment process. Prudent business entities would be wise to consult experienced tax professionals as early as possible to better transform their tax compliance efforts, and by doing so, more effectively support the resurgence of our country’s economy. 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.Marivic M. Rebulanan is a tax senior director of SGV & Co.

17 October 2022

Jocelyn M. Magaway

Tax issues arising from cross-border WFH arrangements

Before COVID came, flexible work arrangements, such as work-from-home (WFH), were for the large part unheard of, at least in the Philippines. However, when lockdowns were implemented, there was no other choice but to embrace WFH to continue business operations.Lockdowns have now been lifted, but the COVID threat remains, resulting in WFH arrangements becoming accepted as the new normal. In fact, in the EY 2022 Work Reimagined Survey, 40% of respondents from the Philippines indicated that they would like to work remotely more than five days a week (essentially the entire work week), 20% prefer four days a week, 24% three days a week, 12% two days a week, 2% once a week and only 2% want to return full-time to the office. We can also see an increasing number of companies supporting their employees with WFH allowances and subsidies (e.g., internet allowances and equipment subsidies) so that they can set up their workstations and be able to carry out their tasks efficiently and effectively at home.The WFH arrangement has also expanded to the cross-border workforce. Some foreign companies are now engaging Filipino or foreign nationals in the Philippines without physically moving such talent to foreign/host locations. There are also cases where foreign nationals are hired/assigned to Philippine entities but continue to work outside the country or from their foreign residences. While cross-border WFH may satisfy an employee’s remote working preferences, it may pose some tax issues to both the employer and the employee.The Philippine Tax Code, with its various amendment in recent years, still considers the situs of taxation for income on services as the place where the personal services are rendered. Thus, compensation for labor or personal services performed within the Philippines regardless of the residence of the payor, or of the place in which the contract of services was made, or the place from which payment was made, is considered Philippine-sourced income. The determination of the tax residency also remains unchanged and so is the scope of taxation, based on the tax residency status of the taxpayer/filer.To illustrate what these issues are, let us take as an example a Filipino citizen, Juan, who was hired by a Japanese entity, receiving payroll from Japan but living in the Philippines due to a WFH arrangement with the employer. For tax purposes, Juan will remain a resident Filipino citizen and is subject to tax on his worldwide income. His Japan-paid salary is Philippine-sourced income. Thus, even if his salary is paid by his Japanese employer and taxed in Japan, he will not be able to claim Japan-paid taxes as foreign tax credits for his Philippine income tax return because the salary, on which Japan imposes taxes, is not foreign-sourced but Philippine-sourced income. Consequently, there may be double taxation on the same income. Also, as Juan is an employee of the Japanese entity, there is a risk that his presence in the Philippines is creating a permanent establishment (PE) in the Philippines for his employer. If a PE status is created, the Japanese entity may be exposed to corporate taxes (i.e., income tax, VAT or withholding tax) and will be required to fulfill administrative tax compliance here in the Philippines.Consider another example, this time a foreign national, John, who is on assignment to a Philippine entity, receives his payroll from the Philippine company but stays in his home country while on foreign assignment. Technically, John should not be subject to tax in the Philippines. As a foreign national, he is subject to tax only on his Philippine-sourced income. As he is rendering his services in his home country, the remuneration that he receives for such services is foreign-sourced income, not Philippine-sourced compensation. However, a corporate tax issue arises if the Philippine entity claims John’s salary as an expense in its books. There is a risk that the tax authorities may disallow the tax deduction of such salaries if these were not subjected to Philippine withholding taxes. Furthermore, as an employee of a Philippine entity working in a foreign jurisdiction, there is again a PE risk being created in that foreign jurisdiction. If PE is created, the Philippine entity may be subject to tax and administrative compliance in such foreign jurisdiction.There are other variations to WFH arrangements (e.g., split payroll, working in third country, among others) that would likely result in the same double taxation, PE creation and tax deduction disallowance risks). Given that cross-border tax on WFH scenarios can be significantly more complex than what most people believe, it is advisable for both companies and their cross-border employees to proactively consult tax professionals who are well-versed in these issues before entering into such arrangements, if possible. For companies that have pre-existing cross-border employees, they should consider conducting a review well ahead of the actual filing of tax returns to ensure that they are not only compliant in both home and host jurisdictions, but that they also understand what options they have to address possible challenges that may arise. 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.Jocelyn M. Magaway is a tax senior director of SGV & Co.

10 October 2022

Maria Margarita D. Mallari-Acaban and Michelle C. Arias

BEPS 2.0: A Philippine perspective

More than a year since the OECD/G20 Inclusive Framework proposed the two-pillar approach, we have heard much about BEPS 2.0 from a global standpoint. In this article, we now look at the Philippine perspective, what MNEs in the Philippines should start considering and what’s at stake once it is implemented.LOOKING BACK ON BEPS 1.0BEPS 1.0 started back in 2015 when the Organization for Economic Cooperation and Development (OECD) and the G20 countries led the first ever global initiative to address base erosion and profit shifting (BEPS) practices. Essentially, these referred to aggressive tax planning strategies that tend to exploit gaps and mismatches in the tax rules of various countries. Some Multinational Entities (MNEs) would often choose to locate in lower tax jurisdictions and treat their profits as sourced from that country instead of the jurisdiction where the activity creating those profits takes place (profit-shifting) or reduce tax bases through certain deductions (base erosion). While not illegal per se, BEPS practices were viewed as unfair since they allowed international companies to reduce their effective tax rate and gain competitive advantage over local competitors.The rise of the digital economy in recent years created another gap in prevailing tax rules as MNEs took advantage of online platforms to enter foreign markets without having to establish a physical presence. Some of the early responders began imposing a “Digital Services Tax” on the revenue of MNEs engaged in online economic activity. However, this approach was viewed as ineffective not only because the additional tax cost will likely be passed on to the consumers, but also because it could lead to double taxation and other trade-related issues due to inconsistent tax treatment.ENTER BEPS 2.0To effectively address the increasing tax challenges and complexities arising from the digitalization of the economy, the OECD introduced BEPS 2.0.A two-pillar approach was proposed under this reform package to help ensure that MNEs pay their fair share of taxes wherever they operate in the world:(1) Pillar 1 on new nexus and profit allocation rules aims to reallocate a certain portion of taxable profits of MNEs with more than €20 billion in global revenue and profitability above 10% to market jurisdictions.(2) Pillar 2 has two components: the Global Anti-Base Erosion (‘GloBE’) Rules, which seek to ensure that MNEs pay a 15% minimum tax and the Subject To Tax Rule (STTR), which seeks to limit the treaty benefits on certain related-party payments.PILLAR 1: NEW NEXUS AND PROFIT ALLOCATION RULEPillar 1 proposes a new taxation system to capture and reallocate 25% of excess profits of MNEs to the various jurisdictions where the goods and services are actually sold and consumed. Ultimately, it will give a taxing right to these market jurisdictions to facilitate re-allocation.Realistically, however, Pillar 1 may take longer to implement given the complexity of the issues at the MNE Group level as well as the removal of the Digital Services Taxes (DST) from some jurisdictions. Hurdling these issues is necessary before Pillar 1 can take effect. Pillar 2, on the other hand, is more likely to take off earlier as some jurisdictions are already looking at legislation to implement the minimum tax. Given this, it is imperative to understand the concept of global minimum tax and how it stands to affect MNEs headquartered or operating in the Philippines.PILLAR 2: GLoBE RULESTo start off, Pillar 2 does not require any country to increase corporate income tax rates. Instead, it envisions imposing an additional tax (top-up tax) to bring the total Effective Tax Rate (ETR) for MNEs in that particular jurisdiction to 15%.The GloBE rules are intended to cover only MNE groups with consolidated annual revenue of more than €750 million. Moreover, government entities, international organizations, non-profit organizations, pension funds or investment funds that are ultimate parent entities of an MNE group or any holding vehicles used by such entities, organizations or funds are exempt.Now, the mechanism for the 15% minimum tax is quite tricky as Pillar 2 talks about three kinds of top-up taxes (Qualifying Domestic Minimum Top-up Tax, Income Inclusion Rule and Undertaxed Payments Rule) imposed either at Subsidiary or Parent level.In applying these top-up taxes, Pillar 2 contemplates a hierarchical approach where the taxing right is primarily exercised at the subsidiary level of an MNE, followed by parent level and then finally by another subsidiary within the group (in case any residual amount of the top-up tax remains unpaid).CONSIDERATIONS FOR MNEsAs MNEs continue to do business and invest in the Philippines and overseas, much thought should now be given on how they should approach the future with the GloBE rules in mind. Some initial considerations and action items for the MNEs are:• Review of the group structure to determine (1) whether one is likely to fall within the scope of the GloBE rules under the €750-million consolidated revenue test, (2) which are in-scope entities where the top-up taxes may be applied and (3) which are excluded entities.• Run initial simulations on GloBE Income and ETR of each in-Scope entity. For this purpose, the group should consider subsidiaries in the Philippines (and elsewhere) enjoying income tax holidays and special income tax rates in the ETR calculation.• Conduct a resource assessment across functions such as Tax, Treasury, Internal Audit and IT to determine if any capability is lacking and consequently tap the necessary internal or external resources to ensure the group’s overall preparedness.• Consider any potential accounting, legal, transactional issues and other complications resulting from potential application of different top-up taxes.It is also important to note that even in cases where the GloBE ETR of a group is more than 15%, it is not necessarily compliance-free. There could still be compliance and calculation requirements to be made especially if the jurisdictions involved have local GloBE legislation in place.REGULATORY AND POLICY CHALLENGESAdmittedly, developing countries like the Philippines stand to gain tax revenue if and when they implement local top-up tax rules. However, this must be weighed against possible foreign investment flight and other adverse effects on investment promotion efforts. In such a case, the government will have to revisit our investment packages to maintain our competitive advantage.The other practical consideration is the resources needed to manage the complexity of the implementation framework and address possible challenges at every stage. Without a tried and tested framework, the top-up tax may not translate to real tax collections and instead end up as disputed assessment cases in the tax courts. CONCLUSIONThe Philippines has yet to adopt its own legislation to implement Pillar 2. For now, it appears that it is not yet at the top of the government’s tax agenda. From an MNE perspective, however, the top-up tax could always find its way into the group — with or without a local top-up tax as yet. Accordingly, there is clear value in preparation and early Pillar 2 impact assessment. Without it, MNEs may not have sufficient time and resources for potential restructuring and other planning opportunities to address associated risks. 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.Maria Margarita D. Mallari-Acaban is a lawyer and tax principal and Michelle C. Arias is a tax senior director of SGV & Co.

03 October 2022

Thyrza F. Marbas

What to expect when BIR tax audits resume

At the start of the third quarter, the Bureau of Internal Revenue (BIR) declared a moratorium on the conduct of BIR audits via Revenue Memorandum Circular (RMC) No. 77-2022. The RMC suspended all field audits and other field operations covered by Letters of Authority/Mission Orders relative to examinations and verification of taxpayers’ books of account, records, and other transactions, including suspending any field audits or any form of business visitation. No new orders to audit or investigate taxpayers were issued or served.The suspension was not without exceptions though. The exception included, among others, the investigation of cases prescribing on or before Oct. 31, which generally covers taxable years 2019 and prior.Consequently, RMC No. 121-2022 was issued setting the guidelines for the lifting of the suspension on field audits and operations pursuant to RMC No. 77-2022. Accordingly, the lifting will be on a per investigating office basis upon the approval of the Commissioner of Internal Revenue (CIR). Once approved, the investigating office is to immediately resume its field audit and operations on all outstanding LoAs/Audit Notices and Letter Notices. However, no new LoAs are generally be issued/served until further instructions from the CIR.Thus, in recent weeks we have seen numerous Notices of Discrepancies (NoDs) in connection with prescribing cases being served as the respective Investigating Offices comply with RMC No. 121-2022.Some taxpayers who have multiple existing LoAs covering prescribing cases have, in fact, received NoDs one after the other. Tax professionals are also frantic after having to deal with multiple, sometimes simultaneous, deadlines for the respective replies to the NoDs due to the numerous cases being handled.This has raised the eyebrows of some taxpayers who feel that the periods given to respond to audit notices, especially when a NoD is already served, have been abbreviated considering that the nature of the issues usually raised by the BIR require tedious reconciliation procedures, collation of voluminous supporting documents, and the drafting of protest letters.In one of the breakout sessions in the recently concluded 1st SGV Tax Symposium held on Aug. 19, the author facilitated a discussion on BIR audits in which participants were refreshed on the assessment process. It also focused on taxpayer remedies and periods to file replies or protest letters, as well as a discussion on the latest court decisions relevant to BIR audits.Receiving a NoD, or any kind of assessment notice for that matter, can be overwhelming. Imagine addressing multiple assessment notices at the same time. In such situations, having a deep understanding of the tax assessment rules, procedures, and remedies, as well as periods and deadlines, will significantly help ease the stress and pressure of managing simultaneous BIR audits.Consider, for example, how a taxpayer who is not familiar with the deadlines under the rules might react with panic once he or she receives a NoD, particularly upon reading the standard statement in the NoD that the presentation of a response, in a Discussion of Discrepancy (DoD), is needed within five days from receipt. A five-day period to respond is admittedly too short to prepare the necessary reconciliations and supporting documents, which may involve massive piles of paper receipts and invoices.However, those who understand the rules will know that taxpayers are afforded a 30-day period for the DoD. And while taxpayers can maximize this full 30-day period, they should also coordinate closely with the handling examiner on the proposed schedule of discussions. Generally, it is better to settle as many issues as possible at the NoD level or at the earliest stage of the audit.Taxpayers may also consider pursuing discussions with the handling examiner and submitting documents, reconciliations, and position papers with factual and legal bases in tranches as they become available. In this way the handling examiner will have a better chance of appreciating the taxpayer’s submissions.Taxpayers who are subject to audit should understand just how fast-paced the response time for all types of assessment notices can be. Given such a short window of time to prepare response letters and supporting documents, it would greatly benefit taxpayers to proactively prepare for tax audits. They can do this by carrying out advance reconciliation work. Another thing taxpayers can also do is to keep accurate, detailed and easily accessible records of transactions and documents so they can quickly and easily address any questions from the BIR. These and many other areas are where a robust and experienced tax team or the support of trusted tax professionals can make a significant difference in reducing time, costs, and anxiety overall.Given the BIR’s intent to transform the way it conducts audits with digital transformation, such as with the use of electronic invoicing and receipting systems (EIS), taxpayers will also need to quickly evolve their strategy and approach to handling BIR audits. These are possibilities we generally see in the future of tax audits. For now, taxpayers who have already received NoDs will be under pressure to act quickly to timely respond to the BIR. At the same time, taxpayers who have not received a NoD should not be complacent. As we approach the close of the calendar year and the lifting of audit suspensions, we can expect the BIR to go full throttle very soon. 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.Thyrza F. Marbas is lawyer and a tax partner of SGV & Co.

26 September 2022

Victor C. De Dios and Josephine Grace R. Sandoval

Risk vs reward: Are VAT refunds worth it?

Most taxpayers generally have a negative impression of the process for seeking VAT refunds, whether from personal experience or from word of mouth. Some dread the many requirements that need to be prepared, as well as the challenges of having to file the claim, monitor its slow movement, and hurdle the strict scrutiny of BIR examiners. Others believe that the chances of winning approval are slim, and may just attract further scrutiny from the Bureau of Internal Revenue (BIR). For many taxpayers, the burdensome experience has discouraged them from pursuing repeat claims.Our lawmakers enacted the TRAIN law to address various tax issues, including institutionalizing an efficient VAT refund mechanism. The BIR then followed suit by issuing rules and regulations that streamlined the review process for refunds, which in part trimmed down the documentary requirements to support a claim. With these changes, many taxpayers were hopeful that the refund process would be eased.However, with denial of claims still a recurring topic of conversation, taxpayers ask themselves: is it really worth pursuing?THE COMPLEXITY OF VAT REFUNDS: WHAT HAPPENS IN THE BACKGROUNDTax refunds are complicated. Specifically for VAT refunds, claimants are faced with the pressure of being able to prepare the application package before a prescribed deadline. The package should be complete and accurate as they will undergo rigorous review by the BIR. True to its billing as a “mandatory audit,” the review is conducted every single time to cover all submissions. If the package is found to be lacking or non-compliant, the claim likely ends up in a denial, or worse, may trigger in the issuance of a letter of authority to formalize an assessment.The preparation alone can be daunting. Companies will usually designate a point person or team, typically within the finance or tax function, to retrieve records, sort them out, and prepare corresponding schedules in a timebound manner. The investment in time and effort will be significant, particularly if the same person or team also needs to handle equally important day-to-day functions while preparing the application.Filing the claim is an experience in itself. For reasons attributable to delayed preparation, companies almost always find themselves filing claims at or near the deadline. Often, the stress of rushing to the BIR for a routine “checklisting” prior to being stamped “received” can be a struggle, especially when the claim is refused acceptance for being incomplete. Time management and planning are crucial, although often, this just adds to the pressure of preparation.The difficult part is not even in the filing, but in the monitoring. After filing, the company, through its point person or team, needs to monitor the BIR’s review process, and this is possible only by way of effective coordination with the assigned BIR examiners and reviewers. From experience, the BIR can pose questions around the claim, which the company needs to quickly address or risk summary denial of the application. Questions can vary from legal basis to additional documentary support. By law, refunds are strictly construed against the taxpayer, and with this, the importance of addressing questions that cast doubt on the claim’s validity cannot be over emphasized.The VAT refund process is time-consuming and requires significant expense and effort — with no guarantee of return. Because of this, decision makers often have to make a tough choice between pursuing or forgoing their claims.In this situation, determining the best option for the company is never easy. Some would attempt to identify and quantify the possible risks, and then proceed to assess whether the possible grant of claim is adequate to compensate. Striking a balance between risk and reward, therefore, becomes vital particularly when the risks are outweighed by the rewards. However, the real issue lies in defining what “reward” really means. Is it simply the refundable amount, or can it be some other potential that can be unlocked in the process?In one of the breakout sessions in the recently concluded 1st SGV Tax Symposium held on Aug. 19, one of our authors delivered a presentation, “Balancing Risks and Rewards in VAT Refund Claims.” The main goal of the session was to get the message across that companies need to consider the balance of risk and reward, where risks are lowered by means of active preparation, and rewards are increased as a necessary consequence of the exercise. The rewards take the form of a grant or a seal of overall tax compliance.LOWERING THE RISKSActive preparation is very critical to the success of any VAT refund claim. In an ideal world, companies should strive to be proactively VAT refund-ready at all times. This can be done by developing and maintaining a well-organized record-retention system where relevant documents can be quickly and easily retrieved for package preparation. They can also conduct internal reviews to examine current levels of compliance and try to improve them by way of process improvement and suggested remediation. This exercise, incidentally, helps companies identify issues, giving them a preview of the actual refund process, and an opportunity to simulate and strategize for better ways to address issues raised in the process.To ease the burdens and demands required by the refund process on the persons tasked with preparation, companies can also explore outsourcing the task to tax experts who specialize in handling claims. The outsourced tasks are usually designed to be end-to-end to cover internal review, preparation of the refund package, filing, and monitoring. Having the guidance of tax experts also helps keep internal teams abreast of relevant laws, rules and regulations, and the current position of the BIR on certain issues. The interaction with tax experts inevitably leads to an overall improvement in internal teams, an investment in resources that lowers the companies’ risks over time.INCREASING THE REWARDSIt must be stressed that choosing to lower the risks by active preparation already tilts the balance in favor of successful refunds. By being VAT refund-ready, companies are likely able to resolve potential issues even before they ripen into real ones during the BIR’s review. Companies also get a better shot at presenting a complete set of documents and attending to inquiries that may be raised during the review. While companies envision the refund as the instant reward, they should also recognize that improved overall tax compliance will redound to more value for the company in the long term.THE FUTURE OF VAT REFUNDSThe BIR is already actively promoting the implementation of its digital transformation program through its new Electronic Invoicing System (EIS). With digitalization, stakeholders can look forward to a simplified VAT refund process, hopefully doing away with the need to submit voluminous hard copies of invoices and official receipts. The potential for a simplified process should make refunds more attractive to taxpayers. Digitalization is a change in process enabled by technology. It can be a complementary solution to easing the usual refund concerns relating to proper substantiation and adequate presentation.The recent granting by the BIR of VAT refund claims is certainly encouraging news and tax experts hope that it is a precursor of more refunds to come. Yet, while encouraging, this does not change the fact that the BIR will continue to adhere to the strict review guidelines required by law. More than ever, companies that intend to file refund claims should ensure that they are VAT-refund ready at all times, both to improve their chances as well as enhance their level of tax compliance. After all, as Benjamin Franklin once said, “failing to prepare is preparing to fail.” 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.Atty. Victor C. De Dios is a tax principal and Josephine Grace R. Sandoval is a tax senior director, respectively, of SGV & Co.