Suits the C-Suite

22 December 2020

Rosalie T. Lapuz and Leomar G. Velez

Fiscal relief and accounting considerations on the road to recovery Part 2

(Second of two parts) In the first part of this article, we discussed the regulatory relief that the government provided to ease the impact of the pandemic on businesses. These include the 60-day grace period for all existing, current, and outstanding loans with principal and/or interest. We also discussed concessions for banks and non-bank institutions, and the impact of these relief efforts on financial reporting. In this second part, we will cover how to apply the COVID-19-related Rent Concessions Amendment to IFRS 16 on accounting for lease modifications. For lease arrangements, IFRS 16 Leases provides guidance on accounting for changes in lease payments for both lessees and lessors. However, IFRS 16 may be difficult to apply in accounting for changes to lease payments. In particular, assessing whether rent concessions are lease modifications and applying the relevant accounting guidance could prove difficult if there are many lease contracts affected by the pandemic. Multiple changes to each or some of the lease arrangements can also compound the issue. EFFECT OF COVID-19-RELATED RENT CONCESSIONS In May, the International Accounting Standards Board (IASB) issued the COVID-19-related Rent Concessions Amendment to IFRS 16. It provides optional relief to lessees from applying IFRS 16’s guidance in accounting for lease modifications arising from rent concessions given as a direct consequence of the pandemic. The Financial Reporting Standards Council (FRSC) adopted the international amendment and issued the COVID-19-related Rent Concessions Amendment to PFRS 16. This aims to provide lessees that have been granted COVID-19-related rent concessions by lessors with practical relief while still providing useful information about leases to users of the financial statements. Prior to the amendment, when a rent concession is granted by a lessor, a lessee assessed whether such a rent concession qualifies as a lease modification. A lease modification is defined in PFRS 16 as a change in the scope of a lease, or the consideration for a lease, that was not part of the original terms and conditions of the lease. Such guidance under PFRS 16 in accounting for pandemic-related lease concessions can be difficult, especially if there are many contracts to deal with and the rent concessions qualify as lease modifications. Our previous article Consensus in lease concessions due to COVID-19 by Jerome B. Ching, published on June 8 and 15, covers further details regarding assessing and accounting for lease modifications. ACCOUNTING FOR LEASE MODIFICATION PRIOR TO THE AMENDMENT A lease modification that increases the scope of the lease and increases the consideration by an amount commensurate with the stand-alone price is accounted for as a separate lease. For a lease modification not accounted for as a separate lease, a lessee applies modification accounting at the effective date of the lease modification (i.e., the date when both parties agreed to the lease modification). In such a case, a lessee allocates the consideration in the modified contract to the lease and non-lease components (where applicable), determines the lease term of the modified lease, and remeasures the lease liability by discounting the revised lease payments using a revised discount rate determined on that date. If the modification decreases the scope of the lease (e.g., reduces total leased space or the lease term), the lessee remeasures the lease liability and reduces the right-of-use asset to reflect the partial or full termination of the lease. Any difference between those two adjustments is recognized in profit or loss at the effective date of the modification. For all other modifications, the lessee recognizes the amount of the remeasurement of the lease liability as an adjustment to the right-of-use asset, without affecting profit or loss. Questions have been asked as to whether the lease concessions mandated by Bayanihan I and II constitute a lease modification. Some stakeholders believe that in these cases, changes to the lease were not part of the original terms and conditions and thus require modification accounting. However, other stakeholders take the view that when the lessee and lessor agreed to a lease contract, subject to the law of a jurisdiction, the parties also agreed to be bound by any future changes in applicable laws. Any changes therefore made to comply with a change in law are contemplated in the contract and should not be considered as a lease modification. Given that PFRS 16 does not specifically address this circumstance, there are likely differences in practice. Both approaches are acceptable. It is important to note, however, that irrespective of the view taken, a lease concession will not qualify as a lease modification only to the extent of what the law provides. For example, if the law requires a waiver only during the period of the pandemic, any concession provided beyond such period is a form of lease modification. Similarly, if the law requires a full waiver during a specified period, but if the lessor granted only 50% waiver which was also accepted by the lessee, the other 50% of the lease payments that would have been waived but were not constitute a lease modification. Moreover, some agreements include provisions that allow changes if unexpected events occur, such as a force majeure clause. However, these clauses do not automatically make the changes part of the original terms and conditions of contracts, as these are usually written in general terms and do not provide specific contractual rights and obligations that arise from the occurrence of a force majeure event. Therefore, the lessor and lessee may need to revisit the lease contract and agree on the coverage of a force majeure clause, including the involvement of legal experts. PRACTICAL EXPEDIENT TO ACCOUNTING FOR LEASE PAYMENT CHANGES With the amendment, a lessee may elect not to assess if a COVID-19-related lease concession from a lessor is a lease modification and simply account for such as it normally would under PFRS 16, assuming the change was not a lease modification. The amendment does not provide any practical expedient to lessors. It should be noted that the practical expedient under the amendment applies only to rent concessions occurring as a direct consequence of the pandemic, and only if all the necessary conditions are met. First, the change in lease payments must result in a revised consideration for the lease that is substantially the same as, or less than, the consideration for the lease immediately preceding the change. Second, any reduction in lease payments must also affect only payments originally due on or before 30 June 2021. For example, a rent concession meets this condition if it results in reduced lease payments before June 30, 2021, but reductions are recovered through equivalent increase in lease payments after June 30, 2021. This satisfies the condition because the intent is only to defer the payments without increasing the total lease consideration. Third, there must be no substantive change to other terms and conditions of the lease. ACCOUNTING FOR RENT CONCESSIONS BASED ON THE AMENDMENT The amendment does not provide explicit guidance on how a lessee accounts for a rent concession when applying the practical expedient. There are a number of potential approaches in accounting for a rent concession that is not accounted for as a lease modification. One approach is to account for a concession in the form of forgiveness or deferral of lease payments as a negative variable lease payment. In this case, the lessee remeasures the lease liability based on revised remaining lease payments without updating the discount rate (if the contract contains multiple components, reallocating the remaining payments proportionately between the lease and non-lease component using the same allocation from the original contract). This approach is similar to that used by the lessor to recognize variable lease income, is also easier to apply and immediately effects the concession to profit or loss. Another approach is to account for the abovementioned concession as a resolution of a contingency that fixes previously variable lease payments. The lessee remeasures the lease liability similar to the first approach, with a corresponding adjustment to the right-of-use asset. This approach is also easy to apply, but will not immediately affect profit or loss. The third approach is to account for the lease liability and right-of-use asset using the rights and obligations of the existing lease and recognizing a separate lease payable (that generally does not accrue interest) in the period that the allocated lease cash payment is due. In this case, the lessee continues to recognize the unpaid lease payment (i.e., as a lease payable) without accruing interest until it makes the lease payment at the revised payment date. In this approach, the lessee need not revisit the accretion of its lease liability based on the revised timing of payments. In many cases, this allows a lessee to use its existing systems to account for the lease liability using the existing payment schedule and discount rate. ECONOMIC RECOVERY AND COMPLIANCE With the pandemic’s continuing impact on the economy, government support will play a large part in preserving business confidence as we move towards a post-pandemic world. On the part of companies, a clear understanding of how COVID-related reliefs and amendments to accounting standards are crucial to ensuring not only compliance, but also a better state of preparedness as we all embark on the road to economic recovery. 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. Rosalie T. Lapuz is a Tax Senior Manager and Leomar G. Velez is an Assurance Senior Manager from SGV & Co.

14 December 2020

Rosalie T. Lapuz and Leomar G. Velez

Fiscal relief and accounting considerations on the road to recovery Part 1

(First of two parts) According to the Organisation for Economic Co-operation and Development (OECD) Economic Outlook Interim Report issued in September, global economic output collapsed in the first half of 2020, but recovered swiftly following the easing of measures to contain the COVID-19 pandemic and the initial re-opening of businesses. The report also noted that what prevented greater economic decline were economies that introduced prompt and effective policy support to cushion the blow to incomes and jobs. Moving forward, continued fiscal, monetary and structural policy support will be crucial to preserving business confidence and limiting uncertainty. In the Philippines, the government likewise acted swiftly and provided regulatory relief in aid of national healing and recovery. In the first part of this article, we will discuss the regulatory relief efforts the government provided to ease the impact of the pandemic on businesses, as well as concessions for banks and non-bank institutions and the resulting impact these have on financial reporting. REGULATORY RELIEF EFFORTS The Bayanihan to Heal as One Act (Bayanihan I) made effective on March 25 provided a minimum 30-day grace period on loan payments, without interest, penalties, or other fees charged on these payments. Six months later, the Bayanihan to Recover as One Act (Bayanihan II), which took effect on Sept. 15, doubled the grace period and increased its coverage. Separately, the Bangko Sentral ng Pilipinas (BSP) issued Memorandum No. M-2020-074 on Sept. 28, which required all BSP-supervised financial institutions to provide a one-time 60-day grace period for all existing, current and outstanding loans with principal and/or interest, with amortization falling due between Sept. 15 and Dec. 31 without incurring additional interest, penalties, fees, or other charges. The principal and accrued interest for the 60-day grace period may be paid in installments until Dec. 31 or as may be agreed upon by the involved parties. Other government support included the lowering of effective lending interest rates and reserve requirements, a three-year repayment term, and no collateral for loans below P3 million; conditional loan interest rate subsidies for affected learning institutions; and an increase in maximum loan amounts per borrower, reduced interest rates, and extended loan terms for micro, small and medium enterprises (MSMEs), cooperatives, hospitals, tourism companies and overseas workers affected by the pandemic. The government also initiated a low interest and/or “flexible term” loan program for operating expenses for businesses affected by the pandemic and provided guarantees for non-essential businesses. Moreover, it liberalized the grant of incentives for the manufacture or import of critical or needed equipment or supplies or essential goods, and provided a loan interest rate subsidy to critically-impacted businesses. CONCESSIONS FOR BANKS AND NON-BANK FINANCIAL INSTITUTIONS The general loan loss provision, which is part of a bank’s Tier 2 capital, is limited to 1% of a banks’ credit risk-weighted assets such that any excess amount will be considered in computing risk-based capital ratios. Non-bank financial institutions (NBFI) are also required to set up an allowance for credit losses and to report non-performing loans. Bayanihan II and BSP Memorandum No. M-2020-074 provides certain reliefs to banks and NBFIs in regard to the mandatory grace period to borrowers. These include the staggered booking of allowances for credit losses, with banks and NBFIs given the option to insulate net earnings and capital from the effects of higher credit risk, cushioning the banks and NBFI’s net earnings and capital; exemption of borrowers availing of the mandatory grace period from the limits on real estate loans when applicable, and from related party transaction restrictions, which gives the banks and NBFIs more opportunity to extend financial assistance to those affected by the pandemic; and non-inclusion in the bank’s or NBFI’s reporting on non-performing loans, reducing the regulatory burden on lenders as they extend more loans and restructure facilities of financially-burdened borrowers. These concessions are necessary to avoid putting pressure on any one sector of society, especially on sources of finance. They also ensure that policies to achieve recovery are sustainable in the long run. GRACE PERIOD IMPACT ON FINANCIAL REPORTING As financial institutions and corporations implemented the provisions of Bayanihan I and II, scheduled repayments under the loan and lease agreements were changed to reflect the grace period. Furthermore, borrowers and lessees may potentially negotiate further with lenders and lessors on concessions and forbearance that may significantly change the original terms of their arrangements. In such cases, companies will need to refer to the guidance provided under Philippine Financial Reporting Standard (PFRS) 9, Financial Instruments and PFRS 16, Leases to consider the potential accounting implication of such changes in contractual provisions. For loan agreements, the key consideration is to assess whether the changes represent a substantial modification or a potential contract extinguishment. For borrowers, PFRS 9 provides guidance on determining if a modification of a financial liability is substantial. This includes a comparison of the cash flows before and after the modification, discounted at the original effective interest rate (EIR) commonly referred to as the “10% test.” If the difference between these discounted cash flows is more than 10%, it is considered a substantial modification, and the existing financial liability is derecognized. However, other qualitative factors could lead to derecognition irrespective of the 10% test (e.g., if a debt is restructured to include an embedded equity instrument). If the change results in extinguishment of cash flows, the financial liability should also be derecognized. This is the case when the obligation specified in the contract is discharged, canceled or expires. The effect of derecognition of existing financial liability will result in extinguishment gain or loss recognized in profit or loss. For substantial modifications, a new financial liability is to be recognized based on the revised cash flows using the current EIR. Thus, interest expense will be based on the new EIR moving forward. While most of the renegotiations may result in an extinguishment gain to borrowers, future net earnings will be affected by the change in the interest expense based on the new EIR. From the perspective of lenders, there is no explicit guidance in PFRS 9 for when a modification should result in derecognition. Hence, entities apply their own accounting policies, which are often based on qualitative considerations and, in some cases, include the 10% test. It should be noted though that the International Financial Reporting Standard (IFRS) Interpretations Committee has indicated that applying the 10% test in isolation would not always be appropriate because of potential inconsistencies with the impairment requirements in IFRS 9 (the international standard equivalent of PFRS 9). ASSESSMENT OF RECEIVABLE MODIFICATIONS Some preparers of financial statements may apply different accounting policies depending on whether a modification is granted due to the financial difficulty of the borrower, with some concluding that such a circumstance would rarely result in the derecognition of the financial asset. If a measure provides temporary relief to debtors and the net economic value of the receivable is not significantly affected, the modification is not likely to be considered substantial. For example, if the payment terms of a receivable are extended from 90 days to 180 days, this change on its own would likely not be considered a substantial modification of the receivable. If, following the guidance above, a modified financial asset or liability is not considered a substantial modification, such does not result in derecognition. The original EIR is retained and there is a catch-up adjustment to profit or loss for the changes in expected cash flows discounted at the original EIR. The impact of such is much less compared to when the modification of financial asset or liability is considered substantial. For floating rate instruments, a change in the market rate of interest is prospectively accounted for. However, any other contractual change (e.g., the spread applied above the interest rate) would also result in a catch-up adjustment at the date of modification. It is expected that the changes in contractual cash flows that are solely based on the provisions of Bayanihan I and II will result in a non-substantial modification. However, companies should assess if there are further renegotiations and forbearances that should be considered. In the second part of this article, we will discuss how to assess lease modifications in relation to the COVID-19-related Rent Concessions Amendment to PFRS 16, and our insights on accounting for rent concessions. 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. Rosalie T. Lapuz is a Tax Senior Manager and Leomar G. Velez is an Assurance Senior Manager from SGV & Co.

07 December 2020

Czarina R. Miranda

Business mobility in the new normal

The new normal has created multi-layered and complex conditions for businesses. At the onset of the pandemic, organizations were forced to implement remote working procedures; and now, businesses are considering appropriate strategies to enable their people to safely return to work. There have also been challenges around business travel and mobility, with domestic and international travel limitations severely affecting many companies. Based on the EY article, Transforming the Mobility Function in the Wake of COVID-19, 98% of companies have suspended or outright cancelled international business travel, and travel industry forecasts indicate a two- to three-year timeline before recovery and a return to pre-COVID-19 level operations. However, the bigger picture is far more complicated. The swiftly evolving situation has exposed weaknesses in the mobility programs of many businesses, especially when it came to real-time data and information-sharing. Simply put, many organizations were caught unprepared. According to a report conducted by EY and the RES Forum, Now, Next and Beyond: Global Mobility’s Response to COVID-19, only 49% of the respondents had a major incident response policy in place when the pandemic hit. Being able to reach and manage a mobile or remote workforce posed a major hurdle. People also found themselves unable to cross borders, becoming stranded in countries beyond their permitted time, or working outside their country of tax residence. These situations created a slew of immigration and compliance issues. Fortunately, the situation surrounding stranded and overstaying workers was alleviated in part because governments implemented protective measures on work permits and immigration status. Nonetheless, any leniency is bound to be removed eventually. In the Philippines, the Bureau of Immigration acted to suspend entry into and departure from the Philippines of both Filipino and foreign nationals at the onset of the pandemic. Lately, however, these rules have been relaxed with policies instituted to safeguard the interests of the public. Outbound and inbound travel now require the usual exercise of precautionary measures, COVID testing, and immediate quarantine in an accredited facility after arrival, among others. The Bureau of Internal Revenue has also issued some guidelines to address concerns and provide some tax relief to non-resident workers who become saddled with unexpected tax burdens from being stranded or quarantined in the Philippines. From a wider perspective and for businesses to move forward in the near term, there are four key areas that must be considered for a more optimal and comprehensive transformation of the mobility function. BORDER CONTROL As restrictions begin to ease, the risks to the workforce increases commensurately. This makes the border situation central to any mobility program. Companies need to monitor these carefully, particularly the quarantine periods enforced in countries where borders are already open. In some cases, quarantine only applies to arrivals from “blacklisted” countries, which can be implemented at very short notice. An example was when the UK suddenly added Spain to its quarantine list in July. Being granted entry to another country presents new challenges that organizations have to consider. One place to start is to establish a business’s risk tolerance and a comprehensive understanding of actual risks. Under what circumstances are they willing to allow travel for their employees? What policies will have to be implemented should employees refuse to travel for health and safety reasons? Policies will need to be communicated to the right corporate decision-makers who may not be aware of the risks that are familiar to the head of mobility or immigration. Ensuring that proper processes and policies are established will be absolutely critical as global businesses execute strategies and objectives while navigating this period of economic disruption. VISAS AND PERMITS For the most part, countries have been understanding of situations regarding permits and visas, particularly for applications and renewals. In fact, 57 countries acted swiftly by granting automatic extensions for migrant workers and stranded business travelers to protect them from overstaying. However, organizations have to note that any leniency will be, by necessity, limited in duration as the pandemic runs its course. New procedures may be implemented, and it could be easy to overlook changes. This makes the continuous monitoring of visa and permit policies critical to ensure that any necessary paperwork is kept up-to-date and compliant in order to avoid any penalties or travel restrictions. TAX OBLIGATIONS Whether due to business or personal travel, many employees were stranded in foreign countries during the pandemic, some beyond the expiry of their visa or contracts. Naturally, many of these people continued to work for their respective companies, which in turn, triggered potential tax penalties. Providentially, many countries were understanding of the situation. With insights from the Organisation for Economic Co-operation and Development (OECD), several countries issued guidance to address concerns like social security, income tax, and permanent establishment. However, this was merely guidance and not clear recommendations, which led governments to rely on bilateral agreements and updates from local tax administrations. One key tax risk is the question of permanent establishment. A stranded executive may trigger permanent establishment by simply continuing to work remotely from a temporary location. It then becomes a challenge for any company to determine whether there actually is a permanent establishment; and consequently, to determine if such a situation triggers a corporate tax filing obligation. There could be significant penalties for failure to file or for mistakes in filing, and a sizable taxable presence may very quickly be created. The environment will become more challenging as borders open and regulations are reinstated, but companies may still want their workforce to stay home and may not push seconded national experts (SNEs) to return to their “home” locations. This may need policy changes on behalf of the businesses, the implementation of virtual assignment policies, and a real-time view of any tax agreements between countries. LOCAL SAFETY CONSIDERATIONS When borders reopen to allow business travel and mobility, companies will have to prioritize issues of employee health and safety. They will need to know and require employees to follow local rules on social distancing, sanitation, occupation limits for locations and public transport, among others. These rules may change regularly and will require constant tracking and communication for people to be adequately informed and safeguarded. Companies should consider leveraging technology to address this risk. For example, EY LLP entered an alliance with WorldAware, to enable the delivery of alerts and regulations for the safety of business travelers, crucial trip data, and a better understanding of travel-related compliance during and after the pandemic. TRANSFORMING THE GLOBAL MOBILITY PROGRAM Business travel and mobility will never be the same post-pandemic, according to the findings of the Now, Next and Beyond: Global Mobility’s Response to COVID-19 report which projects how significantly the landscape is expected to shift. Around 72% of surveyed organizations believe business travel will be reduced, 52% believe that short-term assignments will decrease, and 58% surmise that long-term assignments will become less frequent. More than 82% of respondents see increased use of virtual work, where assignees can complete the objectives of a foreign assignment without physical relocation. The mobility function and the HR team will need to be more closely aligned with the business, and any cross-border activity will have to be intrinsically linked to the business objectives of the organization. “Business critical” will need to be revisited in the context of defining the specific purpose of a business trip and its Return on Investment. The opportunity to transform does not signal the end of mobility — it will spur the creation of a leaner, more considerate mobility program that focuses on increased value creation for the organization while keeping the wellbeing of its people in check at all times. 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. Czarina R. Miranda is a Tax Partner and the People Advisory Services Leader of SGV & Co.

30 November 2020

Evert De Bock

How CFOs can transform Finance in the Age of Disruption

Even before COVID-19, finance leaders across a range of sectors were already in the process of evaluating their operating models in response to a broad and well-documented set of drivers and challenges. These include delivering value, managing costs, making efficient use of technology and automation, and complying with new regulations. The arrival of the pandemic, however, has accelerated the need to transform the finance function to meet current and upcoming disruptions. With most employees working from home, businesses were forced to run operations remotely, and had to swiftly deal with unexpected challenges. Pressing issues such as client payment delays became especially problematic due to cash flow drying up and supply chains coming under pressure. It is not anymore a question of whether organizations should adopt new and emerging technologies, but a matter of how and when. With the exponential acceleration of digital adoption, finance organizations are no longer simply seeking an increase in efficiency and productivity. They are now looking for ways to adapt to shifting marketplace pressures as well as to expand and compete in new markets. The question on the minds of executives now is how quickly these technologies can be adopted so that their organizations do not lose their competitive advantage. THE ROLE OF CFOS IN TRANSFORMATION With the pandemic dictating the new normal and pushing organizations to reconsider their business continuity, chief financial officers (CFOs) play a significant role in supporting business during these uncertain times. Finance leaders must aid the business while keeping finance operations running, supporting the workforce, planning for possible scenarios, and managing cash and liquidity while focusing on stability and revival. The finance function is gaining further importance while changing and expanding in scope. Historic reporting activity will continue to be vital but take less time, thanks to improved efficiency brought about by end-to-end reporting systems, consistent data and automation. Capacity will be available for more future-focused insights and analysis to support business units and decisions that drive increased stakeholder value. On the other hand, the need to satisfy regulatory information demands will continue and regulators may ask for more and possibly even real-time data, requiring finance teams to shape up their finance and business processes and leverage more advanced technology as an enabler. The reality of unrelenting disruptive change brought about by the pandemic has placed CFOs at the forefront, balancing competing demands and driving future growth. CFOs who will build long-term value will have to cultivate a transformational mindset — one that starts from the future and defines where an organization wants to be, working its way back to where the organization is today. This is indicative of how transformation is designed and brought to life, guided by three key transformation drivers — technology at speed, humans at center, and innovating at scale. TECHNOLOGY AT SPEED According to an EY and Forbes Insights survey covering 564 executives in large global enterprises, 57% of CFOs believe that it will be critical for the finance function to deliver data and advanced analytics for business intelligence and management. Despite this, many organizations still struggle to apply the promise of data analytics into improved performance. Moreover, most admit they still do not have an effective strategy in place to compete in a digital world and struggle with getting business users to adopt analytics insights. Two-thirds of adoption leaders, comprising the top 10% of all enterprises, rate this change management as a vital component of their data and analytics objectives; yet only one-third of the broader cross-section of respondents see it this way. As a role that spans across organizational silos, the CFO can extend the use of analytics from the traditional finance functions of budgeting and forecasting to the operational needs of the wider business. CFOs need to be the champions and drivers for the use of analytics in all current core financial processes under their responsibility, as financial data is one of the key inputs to many business decisions — whether in supply chain, procurement, operations or risk management. By viewing data from the perspective of a data and money-conscious CFO, organizations will be able to act on the opportunities and insights that analytics can reveal as they occur before it’s too late. Without necessarily owning the area of analytics application, CFOs can act as a catalyst to help encourage and drive the use of analytics in business processes outside core finance. HUMANS AT CENTER Harnessing new and emerging technologies allows companies to more readily respond to or even anticipate changing customer behaviors and expectations. According to a recent EY study, Digital Deal Economy, 90% of companies are prioritizing an increase in capital allocation toward digital transformation, with a majority of global finance leaders saying artificial intelligence will be vital to the finance function of the future, while other finance leaders see blockchain as the most important technology in the function. However, the pandemic has revealed that people aren’t merely anonymous elements of the many layers in an organization — they embody the organization and are its most critical asset. While it is undoubtedly a massive global crisis, the pandemic also serves as a live demonstration of how human resourcefulness, ingenuity, and diversity of experience can combine with the technology of today to create solutions and business models for the future, changing industries overnight and solving issues at scale. The skills and expertise required from teams will change in a remodeled finance function. CFOs will need to build a finance function consisting of the right people with the right skills to complement and get the most of new technologies, playing an important role in the overall people strategy of the organization. Qualified accountants will still be needed within the central core to implement and understand the implications of evolving accounting standards and other legal and regulatory requirements, but alongside them will be a new breed of data scientists and business analysts. These individuals will understand how to use data, the IT systems that generate it and the questions that business units will want help in answering. It will be a complex blend of skills gained partly through education, training and certainly, through frontline experience across the organization. Success will depend on combining the intelligence of smart technologies with the emotional intelligence and interpersonal skills of talented people. Companies that leverage technology and enable innovation at scale while placing humans at the center will be capable of accelerating long-term value. INNOVATION AT SCALE Though the world continues to evolve at an increasingly fast pace, many organizational structures and operating models remain unchanged. Digital initiatives are too often conducted within outdated frameworks — and superimposing 21st century technologies over 20th century structures and processes will likely result in suboptimal results, or even failure. In addition, the resulting economic fallout from the impact of COVID-19 will likely worsen before it can improve, with possible recovery only seen well into 2022. CFOs will be expected to save costs wherever possible and as soon as possible, with significant economic disruption in the interim, all while balancing financial resilience and business continuity. The finance function will need to become more agile in order to drive innovation with as little resistance as possible and be in a better position to create long-term value. It, like the rest of the organization, needs to become flatter, leaner, more fluid and globally integrated to become truly transformative. REFRAMING FINANCE FOR THE FUTURE The CFO will be one of the C-Suite’s most critical roles in reframing the future of the organization beyond the pandemic, according to the 2020 EY DNA of the CFO survey, with more than 800 senior finance executives and global CFOs as respondents. How organizations create value in this increasingly hyperconnected world will shift from within company walls to out into network space. The finance function needs to become more open and work as part of an extended ecosystem, collaborating deeper within as well as beyond the organization. This poses the opportunity for CFOs not just to adapt to the new normal, but to reframe finance for this new reality. 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. Evert De Bock is a Consulting Principal from SGV & Co.

26 November 2020

Warren R. Bituin

Cybersecurity during the pandemic Part 2

(Second of two parts) In last week’s article, we highlighted the challenges of cybersecurity in terms of remote working, identity and access management risk, physical security and data privacy. In this second part, we will focus on cybersecurity management and discuss additional challenges that require recalibrating traditional security for the remote workspace; potential analyst disruption; the pandemic’s impact on cybersecurity budgets; and reassessing the cybersecurity function as we adjust to the new normal of business. Global and larger Philippine companies, in general, have been able to ride out the storm more comfortably than smaller companies. While recent news of a vaccine is a welcome development, many organizations still expect the current working protocols to continue at least until the end of 2021. For the chief technology officers (CTOs) and chief information security officers (CISOs), this means that budgets will be affected as the full risk impact is assessed. Companies will continue to engage in projects designed for effective remote working and are expected to invest more on network upgrades, mobile devices, cloud applications and infrastructure. Budgets around these areas can therefore be reasonably expected to increase. How the pandemic affected cybersecurity management varies according to organizations’ size, geography, and industry. Small- and medium-sized companies noticed the impact the most, with higher network and staff disruptions, as well as a disproportionally higher number of cyber threats such as phishing, malware, ransomware and zero-day exploits. Large companies have faced remote-working challenges but, perhaps unsurprisingly, have been more resilient to cyber threats. RECALIBRATING TRADITIONAL SECURITY The cybersecurity team needs to adapt quickly to the dynamically changing threat landscape. It needs to be more proactive in identifying new threats and detecting attackers. The traditional security solutions, such as firewalls, threat monitoring software, vulnerability management tools and identity solutions may need to be recalibrated to address the new working setup in the enterprise. An EY research study conducted during the pandemic confirms that the COVID-19 crisis has caused significant disruption in day-to-day security operations, particularly with enabling remote working. It is a mixed picture, but the research shows that what most leaders seem to agree on is that day-to-day security operations have been disrupted, almost a third (29%) saying significantly so. Remote-working support was the biggest challenge (71%), followed by budget restrictions (41%), network overload (40%) and reduced staffing levels (37%). Indeed, during the total lockdown when physical movements of employees (including cybersecurity professionals) were very limited, providing 24/7 operational support from remote locations remains a formidable challenge for many CISOs. For example, additional privileged workstations were configured and deployed for a more secure remote connection by system and security administrators. Physical security of the work areas of these privileged users were also required and at times supported by companies. ANALYST DISRUPTION Many CISOs also learned to be prepared for any disruptions in the security operations caused by the unavailability of a security analyst becoming unavailable either due to home network or health issues. It becomes a real concern for CISOs when one or two analysts contract the virus and become indisposed for a long period. A viable plan to address reduced staffing levels should be ready and implemented immediately as required. Considering that incidents of phishing and other threats like malware and ransomware are on the rise, CISOs should increase focus on the people side of cybersecurity. A well-designed security awareness campaign that includes webinars, periodic advisories, as well as directed phishing tests should be continuously implemented to address this risk. CYBERSECURITY BUDGET IMPACT Disruption is definitely happening, and with respect to budgets, change is expected to happen fast. In the same EY research study, 79% of respondents expect cybersecurity budgets to be impacted within the next six months if not sooner (21% believe “immediately”), though not all think budgets will be cut. As many as a third (32%) think that investment will increase or at the worst, stay the same (24%). Identity and access management and data protection and privacy are considered priority areas for an increase in spending. Additionally, outsourcing is being considered, notably for data protection, privacy, risk, compliance and resilience. A majority of businesses surveyed in the EY research study are considering (or would consider) outsourcing security operations as part of their cybersecurity strategy. The findings tend to be consistent across geographies, sectors and roles, although there is a bias within smaller companies to prioritize security operations as well as architecture and engineering. Interestingly, there is a marked difference between CISOs and CTOs in their attitude toward outsourcing security operations: 44% versus 81%. REASSESSING THE CYBERSECURITY FUNCTION Following the COVID-19 pandemic, should we expect any more longer-lasting or even permanent changes in cybersecurity strategy and approach? Certainly, some security leaders expect their function to become even more important and visible at the board/executive level. Some Philippine companies are starting to step back and reassess their cybersecurity posture as they become accustomed to the new normal of business operations. With the introduction of surveillance mechanisms (such as mobile apps) to track and manage the virus vis-à-vis the ongoing DoLE and DoH requirements to collect health details of employees and customers, data privacy will further increase in value and importance. In a related survey by PSB Research of 1,000 US consumers (April 2020), the findings suggest that consumers are especially reluctant to surrender their personal privacy, regardless of the challenges posed by the pandemic, and similarly are not convinced that any such engagement will be for their own good. While the survey was done in the US, similar public sentiments may emerge here judging from recent advisories and activities by the National Privacy Commission on the use COVID-19-related personal data. As we emerge slowly into a post-crisis world and a new normal, it will be interesting to see if the cybersecurity teams’ predictions of an elevated status will come true and are to be embedded beyond the short term. While this is yet to be seen, it is evident that there has never been a better time for CTOs and CISOs to demonstrate their mettle and validate their deserved place in the C-Suite. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views reflected in this article are the views of the author and do not necessarily reflect the views of SGV, the global EY organization or its member firms. Warren R. Bituin is the Technology Consulting Leader of SGV & Co.

16 November 2020

Maria Vivian C. Ruiz

How boards can set the course for a stronger future

As society continues to evolve towards a post-pandemic world and the economy adjusts to the new normal, organizations are presented with the opportunity to set the tone for how they adapt their operations and positively impact society. The current situation allows boards an expanded role in steering their organizations along this journey. EY’s Global Board Risk Survey reveals that only 43% of board members in the Asia-Pacific considered their organization as “more than somewhat effective” in managing emerging risks, compared to 58% for traditional risks. Based on the survey, there are three pressing issues that boards should prioritize, reflecting the unique blend of challenges and opportunities in these uncertain times. These involve building trust in the face of digital disruption; managing capital allocation through business transformation scenarios; and addressing enterprise risk resulting from climate change. BALANCING DIGITAL TRANSFORMATION, RISK AND TRUST Organizations have been forced to rely almost completely on digital infrastructure to communicate, function, and be competitive. Looking ahead after the crisis passes, companies will need to consider becoming fully and truly digital. As digital adoption deepens, more businesses are investigating new ways to embed emerging technologies across their ecosystem while navigating increasing vulnerability to cyber-attacks. Boards will need to regularly discuss data and digital issues such as data privacy, ethical and disinformation risk, and cybersecurity in board meetings. There is a need to ensure that they have the expertise to oversee these risks by way of a standalone sub-committee or subject matter experts. The stakes are especially high because should systems fail, customers, regulators and shareholders will hold executives and boards accountable for the resulting reputational and financial costs. Furthermore, boards are expected to support their executives in building digital trust across emerging technologies such as intelligent automation, blockchain and artificial intelligence. Boards must understand what these emerging technologies mean for their organizations, what risks they bring, and the role of their Audit Committees in managing those risks. PLANNING FOR MORE VARIED BUSINESS TRANSFORMATION SCENARIOS When the EY Global Capital Confidence Barometer (CCB) was published in March, 55% of organizations in the Asia-Pacific were expecting a U-shaped recovery extending well into 2021. This resulted in organizations exercising more caution by renegotiating contracts, revisiting financial plans, and monitoring how direct cost increases affect their margins. However, many also planned to take advantage of a rise in distressed assets coming to market and lower valuations to either build resilience or support their digital transformation agenda. In addition, the CCB found that 52% of respondents from the Asia-Pacific expressed the intention to pursue mergers and acquisitions (M&A) within the next 12 months. These reactions establish the necessity within organizations to balance the need to be cautious against seizing opportunities for sustainable growth through targeted acquisitions. Boards can reinforce this by influencing management to protect the organization’s assets while also taking calculated risks that offer the best chances of seizing a competitive advantage. Divestments are another attractive option to fund much-needed investment in technology, as presented in a recent EY divestment study, in which 56% of Asia-Pacific companies responded that they are more likely to divest for this purpose compared to the 31% that articulated the same intention before the pandemic. Boards need to discuss strategy on an ongoing basis as well as utilize scenario planning for a much wider range of possibilities. Employing this tool ensures that the models created remain relevant and updated, consequently placing the organization in a better position to quickly predict and adapt to a post-crisis future. Boards must also plan for different economic outcomes and scenarios within a range of time frames. It is also vital to determine if they have a framework in place to assess their performance and progress. They need to question how frequently they oversee and challenge how their organizations allocate resources and capital, making sure they protect their assets, optimize operations and consider long-term growth strategies. DRIVING TO COMBAT CLIMATE CHANGE In the 2019 EY CEO Imperative survey, 40% of CEOs in the Asia-Pacific cited climate change as a top global challenge, while investors globally ranked climate change as the joint priority issue along with national or corporate security. However, what is more significant than the ranking itself is the investors’ expectation that CEOs respond to this appropriately. According to the 2020 EY Global Institutional Investor survey, investors are more rigorously evaluating environmental, social and governance (ESG) disclosures while factoring in disclosures made as part of the Task Force on Climate-related Financial Disclosures (TCFD) framework. The COVID-19 crisis spurred this on by exposing unsustainable business practices. The pandemic revealed that climate action is vital to becoming a responsible, resilient organization that prioritizes long-term impact over short-term gain. Many of our ASEAN neighbors and Japan and South Korea have announced plans to stimulate low-carbon industries in their respective nations through their economic recovery. Board members are in a prime position to advocate for their organizations to reduce their carbon footprint. This can be achieved by encouraging management to analyze the risks and opportunities resulting from climate change and transition to a decarbonized future. Boards can help management identify effective, non-financial KPIs that quantify progress when setting and acting upon climate targets. It will be imperative to understand the role the organization plays in transitioning to a green recovery, as well as to more comprehensively communicate these through TCFD reporting. In addition, boards need to assess if they themselves have the skills, structures and processes to guide management teams in addressing climate change. The sooner management understands climate risks and opportunities, the better the organization can take actionable steps to transform the business to suit a low-carbon economy and create a competitive advantage. CHARTING A COURSE FOR THE FUTURE Decisions that leaders make are crucial as they set the course for the future. Such decisions give organizations the ability to adapt to that envisioned future through a well-crafted plan. Focusing on these priorities allows business leaders to navigate around uncertainty and to harness business transformation opportunities that will lead their organizations to a path of stronger resilience and greater competitive advantage. At this time of great uncertainty, the moment is for boards to seize. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views reflected in this article are the views of the author and do not necessarily reflect the views of SGV, the global EY organization or its member firms. Maria Vivian C. Ruiz is the Vice Chair and Deputy Managing Partner of SGV & Co.

09 November 2020

Jose Rey R. Manuel

What is double nontaxation of income?

Tax law, as a rule, is constantly evolving and adapting, which is why tax authorities all over the world frequently issue new or enhanced rulings, policies and procedures to address new trends or situations that come up. It is, however, unusual to encounter new terms or definitions in new issuances. Take, for example, the seldom used phrase “double nontaxation of income,” which was found in Revenue Memorandum Order (RMO) No. 51-2019. The RMO was issued by the Bureau of Internal Revenue (BIR) when it laid down its guidelines and procedures for the processing and issuance of Tax Residency Certificates (TRCs) requested by those claiming to be “residents” of the Philippines. In theory, “nontaxation” occurs when income is left untaxed by a taxing jurisdiction. When this happens, say in the case of an individual receiving compensation from an international assignment — the impact would usually be, at the very least, on two taxing jurisdictions — the home and host countries. Put simply, these are contracting parties or states which are not able to impose tax on income earned by the individual, hence the term “double nontaxation.” While the chances of this happening are remote, considering the strict implementation of tax rules on cross-border transactions, such an occurrence could be the worst thing to happen in the eyes of a taxing authority. However, RMO 51-19 seems to address this as it endeavors to ensure that no income payment is left untaxed because of actions resorted to by taxpayers (individuals or corporations alike), who seek to obtain unintended tax treaty benefits by securing a TRC. WHAT IS A TAX RESIDENCE CERTIFICATE? This is a document secured by Philippine “residents” from the BIR to avail of preferential tax treatment, under the applicable and effective tax treaties of the Philippines, on income derived from sources within the jurisdiction of the Other Contracting State (i.e., non-Philippine state). For instance, in the past, foreign nationals would present the TRC issued by the BIR to their countries’ internal revenue authorities to claim non-resident status so that they can enjoy exemption from their home countries’ tax. In the Philippines, a TRC is a certificate issued by the International Tax Affairs office of the BIR to confirm the residency status in the Philippines of taxpayer applicants. These applicants claim to be “residents” of the Philippines and are subject to taxation in the Philippines for a given period of time. Documents are required for substantiation purposes before the application for TRC is processed and issued upon approval. WHAT IS THE MAIN PURPOSE OF TAX TREATIES? Tax treaties exist to avoid the effects and risks of double taxation with respect to taxes on income derived from sources outside of the Contracting State or the Philippines (in the case of taxpayers of the Philippines). In addition, they help ensure that exorbitant taxation in the source country is not a hindrance to cross-border investments, capital and trading activities. The taxing right is then allocated between the two states to make sure that income is taxed appropriately. At present, the Philippines is signatory to about 43 tax treaties worldwide. For a tax treaty exemption to be invoked, taxpayers must prove their residency in the Philippines. This is done through the application of a TRC by “residents.” Who are considered “residents?” WHO IS ENTITLED TO SECURE A TRC FROM THE BIR? In order to avoid double nontaxation of income, the tax bureau made it clear that only “residents” of a Contracting State who are subject to comprehensive liability to tax or full tax liability are entitled to TRCs. The BIR added that only those who are subject to tax on the basis of their worldwide income are entitled to claim treaty benefits. For individual taxation purposes, these taxpayers are categorized as “Resident Citizens.” It should be noted, however, that we do not have a definition of the term Resident Citizen in our Tax Code. What we have in Section 22E of the Code is an enumeration of those who are considered Non-Resident Citizens (NRCs) and who are taxed on their Philippine-source income only. These are Philippine citizens who: Establish to the satisfaction of the Commissioner the fact of his physical presence abroad with a definite intention to reside therein. Leave the Philippines during the taxable year to reside abroad, either as an immigrant or for employment on a permanent basis. Work and derive income from abroad and whose employment thereat requires him to be physically present abroad most of the time during the taxable year. A Philippine citizen who has been previously considered a non-resident citizen and who arrives in the Philippines at any time during the taxable year to reside permanently in the Philippines shall likewise be treated as a non-resident citizen for the taxable year in which he arrives in the Philippines, with respect to his income derived from sources abroad until the date of his arrival in the Philippines. Accordingly, those who do not fall under the definition of NRCs above may generally be considered Resident Citizens (RCs) who are subject to tax on their worldwide income. These RCs may apply for Tax Residency Certificates. For the purposes of this article, whether they are entitled to the treaty preferential tax rates or exemption later is a topic for another time. WHERE DOES THE CONFUSION LIE? For proper application of TRC, there is a need to distinguish individuals, particularly foreign nationals, who are residents for treaty purposes and residents for domestic tax purposes. This is because they may also be treated as “residents” for domestic tax rules or for income tax purposes but cannot apply for a TRC simply because they are not taxed on their worldwide income. Note that there are various categories of foreign national taxpayers in the Philippines. Foreign nationals (aka Aliens) are classified as either Resident or Non-Resident. We are guided by BIR Rulings 051-81 and 052-81 which mention that a foreign national assigned in the Philippines for a period of approximately two years is considered a non-resident alien engaged in trade or business (NRAETB) in the country. Since there is no specific tax rule that states who would be considered as a Resident Alien in the Philippines, residents are instead considered to be those whose length of assignment are, from the start, indefinite or exceed two years. However, although they are considered residents, they are taxed only on income from sources within the Philippines. In terms of who can properly secure a TRC, while it is true that foreign nationals are considered residents for income tax purposes or per domestic tax rules, they are not considered residents for treaty benefits purposes as they are taxed only on income from Philippine sources and therefore, cannot possess a tax residency certificate from the Philippine tax bureau. Doing so can possibly make them not taxable on income derived from their home country, which is not treated as subject to Philippine income tax either. If this is the case, this would mean double nontaxation of income. ENSURING COMPLIANCE DESPITE THE PANDEMIC Despite COVID-19, with foreign nationals in effect being stranded, residency in the country for the purpose of treaty exemption cannot be invoked by foreign nationals even though they have acquired resident alien status in the Philippines for domestic income tax purposes. Though foreign nationals may be forced to overstay due to the pandemic and have the assumption that the Tax Residency Certificate provides relief as regards taxation in their respective home countries, this will not work. There might not even be any residency status to begin with in this case as the tax bureau separately tackled this in its Revenue Memorandum Circular 83-2020, which provides guidance to individuals who are stranded in a country that is not their country of residence due to travel restrictions related to the pandemic. With foreign nationals unable to return home and a large number of OFWs returning home for good due to various COVID-related reasons, companies and taxpayers may wish to review these guidelines to ensure compliance and avoid potential tax issues. 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. Jose Rey R. Manuel is a Tax Senior Director from the People Advisory Services team of SGV & Co.

03 November 2020

Redgienald G. Radam

PFRS 9 expected credit losses: How can banks apply pre-pandemic models?

The pandemic has created disruptions affecting industries at a global scale. As an offshoot, we have seen unprecedented levels of government relief measures to help curb the pandemic’s economic impact. The pandemic and the subsequent government actions to aid borrowers on their loan payments, have, in turn, affected how banks apply their Expected Credit Loss (ECL) models under PFRS 9 Financial Instruments, which had been developed prior to the pandemic. The economic disturbances have led to liquidity issues for many entities and individuals, putting into question the credit quality of the financial assets or receivables currently held by banks. Yet events continue to unfold, which means that we have not seen the full extent of COVID-19 impact. This makes the measurement of ECL more challenging as PFRS 9 requires that the calculated ECL capture expectations of future economic conditions that will affect borrowers’ ability to pay. Under PFRS 9, ECL is a probability-weighted amount determined by a range of possible outcomes (scenarios) and requires the incorporation of reasonable and supportable information about past events, current conditions and forecasts of future economic conditions (i.e., forward-looking information) that are available at the reporting date. Relating these to the current crisis, banks should be making assumptions in their ECL calculation about the extent of the pandemic’s impact on the collectability of financial assets. As such, it is clear that banks will need to update the ECL models or assumptions previously applied to their reporting as of Dec. 31, 2019 reporting because those would not have foreseen the economic impact of the pandemic. INSIGHTS IN RELATION TO ECL MODELS Based on the EY survey results on COVID-19 benchmarking undertaken in March 2020 across selected global banks, we share some insights on how the impact of the COVID-19 pandemic was considered in the surveyed banks’ ECL models. While there are variations in the approach to quantify the impact of COVID-19, a majority used portfolio level overlays. This involves incorporating the effect of the pandemic to the forward-looking adjustment to be applied to a group of borrowers with similar credit risk characteristics. A majority of the banks surveyed also defined specific COVID-19 scenarios for their ECL models. Many have revised the probability weightings applied to the economic scenarios used in the ECL measurement. Some banks have captured staging movements (i.e., assessment of significant increase in credit risk) through management overlays while others are taking a “top down” approach by migrating part or all of the most impacted portfolios from Stage 1 (requiring 12-month ECL) to Stage 2 (requiring Lifetime ECL). Banks are also evaluating enhancements to credit risk monitoring measures (e.g., forbearance, watchlist, etc.) in response to recent regulatory requests for these data. For the surveyed banks, these approaches may just be short-term solutions for their interim financial reporting. Locally, we note that some banks have also applied the same or similar approaches for their own interim financials. Cognizant that the massive and lingering effects of the pandemic will continue to impact the measurement of ECL moving forward, it is imperative that banks develop a comprehensive response to the additional complexities to proactively prepare for year-end reporting and beyond. The approach to this response must be agile considering the time left from now until the year-end. It is vital for banks to have risk modelling capabilities to address the limitations of the short-term solutions adopted in the interim while understanding the impact of the model changes under different assumptions in the long term. URGENT PRIORITIES WHEN UPDATING ECL MODELS As banks prepare for the year-end and beyond, they will need to consider some urgent priorities in the immediate term when updating their ECL models, including: Incorporating the impact of government relief measures into the ECL calculation The impact of the relief measures imposed by the government, such as payment holidays or moratoriums, must be assessed to determine how they affect the measurement of ECL. The assessment should consider whether these measures address short-term liquidity issues rather than signal a significant increase in the credit risk of borrowers. Determining reasonable and supportable macro-economic scenarios These should include the integration of possible pandemic or crisis scenarios (including government relief measures over time) not envisioned previously and how these could have altered the other economic scenarios and their related probability weightings in the ECL measurement. In coming up with the scenarios, banks should also consider the expected duration of the pandemic and the recovery period of the economy. Due care must be exercised so that there is no double counting of the impact of the assumptions on the scenarios and on the other inputs to the ECL measurement. Consideration of management overlays As there is no consensus on how to forecast future conditions, banks may have to rely on overlays and on their own expert judgment. They will also need to determine the reasonableness of these overlays. Maintaining strong governance over the ECL process The operational impact of the changes to the ECL models on data, systems and controls must be considered. Increased governance around the significant judgments (including overlays) and assumptions, modelling changes and other changes to the PFRS 9 processes and controls must be in place to ensure the reasonableness of the ECL measurement. Also, they will need to consider the disruptions in operational processes within the bank that may lead to other constraints in running the calculation of ECL. Disclosures Given the high level of uncertainty and the inherent sensitivity of estimates, it is critical for banks to be transparent in the disclosures of the key assumptions used and judgments made to update the ECL models. However, as banks work on addressing the urgent priorities above, they must also look at long-term considerations in order to have more robust PFRS 9 ECL models. In addition to being able to model and simulate possible pandemic or crisis-specific data (e.g., default and recovery data) once historical data regarding the pandemic becomes more available, they should also consider approaches to credit management. There must be stronger integration between credit risk management (risk appetite framework, credit approvals, limits, etc.) and the PFRS 9 ECL triggers given current challenges and learnings. The current credit risk assessment process should also be strengthened by incorporating robust sensitivity analysis and stress testing in light of the use of significant judgments and management overlays in the ECL measurement. OPPORTUNITY IN RESILIENCE While current conditions are indeed unprecedented, banks should see this not just as a challenge in measuring ECL, but as a unique opportunity to advance their credit risk modelling capabilities. Doing so may help them become more resilient and even gain a competitive advantage in these unpredictable and uncertain times. 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. Redgienald G. Radam is a Partner from the Financial Services Organization service line of SGV & Co.

26 October 2020

Jan Kriezl M. Catipay

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

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

19 October 2020

Jan Kriezl M. Catipay

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

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

Fiscal relief and accounting considerations on the road to recovery Part 2

Fiscal relief and accounting considerations on the road to recovery Part 1

Business mobility in the new normal

How CFOs can transform Finance in the Age of Disruption

Cybersecurity during the pandemic Part 2

How boards can set the course for a stronger future

What is double nontaxation of income?

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