Suits the C-Suite

09 October 2020

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

On the REIT track

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

05 October 2020

Aris C. Malantic

Managing the crisis: Three corporate insights from COVID-19

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

28 September 2020

Zorayda H. Panumpang and June Catherine G. Tañedo

Computerizing accounting systems: COVID-19 spurs move to digitize

The Philippines remains under various levels of community quarantine due to the COVID-19 pandemic. Government and private offices are temporarily closed or maintain limited operations with alternative work schemes such work-from-home. These measures have naturally affected business operations and processes. There has also been a noted increase in the use of online selling platforms as companies and entrepreneurs try to continue or augment operations during the quarantine. The transition to digital platforms has not been without compliance challenges. Businesses have experienced difficulties in issuing duly authorized invoices or receipts because of the expiration of the Authority to Print, the inaccessibility of invoices and receipts, or the near impossibility of mailing or sending them during the enhanced community quarantine (ECQ) from March 16 to May 31. This greatly limited sales and collection since these documents are vital for claiming deductions and input VAT. To address this, the Bureau of Internal Revenue (BIR) allowed businesses to adopt work-around procedures such as electronically sending invoices and receipts during the ECQ, subject to certain guidelines and procedures in Revenue Memorandum Circular (RMC) No. 47-2020. These circumstances and experiences highlight the importance of digitizing business operations and processes. It is certainly high time for businesses to adopt a computerized accounting system (CAS). For those with an existing CAS, this may be the opportunity to modify or enhance it to update bookkeeping, invoicing and accounting processes. One challenge though is that the BIR requires prior authorization or permit to use a CAS, computerized books of account (CBA) and/or its components. Revenue Memorandum Order (RMO) No. 21-2000, issued on July 17, as amended by RMO No. 29-2002, issued on Sept. 16, required all taxpayers with a CAS or their components, to apply for a Permit to Use (PTU). The RMO also required taxpayers to apply for a new PTU for any system enhancement that will result in changes to the system’s release and/or version number. PROCEDURE UNDER RMO NO. 21-2000, AS AMENDED Under the RMO, all applications for CAS are to be generally filed by a company’s head office at the Large Taxpayers Office (LTO) or Revenue District Office (RDO) having jurisdiction over the head office. The application will only be processed if the RMO requirements are complete. These include documentation on the functions and features of the application, system flow, process flow, back-up procedure, disaster and recovery plan, proof of ownership, reports, correspondences, receipts and invoices that can be generated from the system with a sample layout. The application will then be evaluated and approved by a Computerized System Evaluation Team (CSET) at the BIR national or regional office. The evaluation will include a system demonstration showing actual use of the CAS. Under the RMO, as amended, the PTU should be issued within 10 to 40 days, depending on certain conditions. In the experience of some taxpayers, however, the evaluation takes longer. The delay is usually due to the difficulty in scheduling the system demonstration and addressing issues identified by the CSET during the demonstration. CENTRALIZATION OF CAS APPLICATIONS In 2015, the BIR issued RMC No. 68-2015, creating the National Accreditation Board (NAB) composed of BIR officers from various divisions in the BIR National Office. The RMC directed that accreditation of cash register machines (CRM), point-of-sale systems (POS), and other sales machines/receipting software were to be processed at the BIR National Office level only through the NAB. While RMC No. 68-2015 specifically covered the accreditation of CRM, POS, etc., the NAB also took on the responsibility of evaluating CAS applications of taxpayers registered under the RDOs. Some would say that, as a result of the centralization, the scheduling of system demonstrations and evaluation of the applications took much longer because the national body was alone in handling all CAS applications of taxpayers under the RDOs. Others believe that this has contributed to a backlog of pending applications. SUSPENSION OF REQUIREMENT FOR A PTU Early this year, the BIR issued RMC No. 10-2020, suspending the requirements for a PTU. This was carried out to promote ease of doing business and more efficient government service delivery. The RMC also reverted the processing of CAS applications to the RDOs as well as simplified documentary requirements. Specifically, all taxpayers with pending PTU applications (including those that had undergone system demonstrations) will be allowed to use a CAS, CBA, and/or their components, without the PTU, provided the relevant requirements are submitted to the Technical Working Group (TWG) Secretariat of the RDO or Large Taxpayer Office (LTO) where they are registered. These requirements include a duly accomplished and notarized Sworn Statement and various attachments (i.e., Summary of System Description, Commercial invoice/receipts/document description, and special power of attorney, among others); sample printouts of system-generated principal and supplementary receipts or invoices; and sample printouts of system-generated Books of Account. Instead of the PTU, an Acknowledgment Certificate (AC) with a Control Number will be issued by the TWG Secretariat — within three working days from receiving the requirements. The Control Number should then be indicated on the system-generated principal and/or supplementary receipts/invoices. Taxpayers should be aware that a post-approval evaluation may be conducted to check compliance with revenue issuances. This can take place during a BIR audit or investigation. For any system enhancement, modification and/or upgrade that results in a change of version number and/or systems release, the taxpayer is now only required to inform the TWG Secretariat where it is registered. This is done in writing accompanied by a matrix showing the comparative changes in the current and upgraded system. The RMC specifically referred to taxpayers with pending PTU applications with the BIR. It is not clear if this simplified procedure is the same for new applications filed after its effectivity. Moreover, the RMC provides that the BIR release separate revenue issuances on the detailed procedures implementing the RMC and the post-approval evaluation check. Pending more succinct implementation guidelines, the RDOs and LTOs may interpret the RMC differently. The issuance of RMC No. 10-2020 is one of the many steps taken by the BIR to achieve its plans for a more digitized tax environment, encouraging compliance from taxpayers by allowing them, in the meantime, to use their existing CAS without a PTU. This also gives them the opportunity to start preparing for the upcoming implementation of the mandatory e-invoicing and electronic sales-reporting requirement under the TRAIN Act in 2023. RMC No. 10-2020 is certainly a welcome development for taxpayers particularly at this time when businesses may need to digitize to adapt and thrive during the pandemic. In the meantime, taxpayers eagerly await the immediate issuance of the implementing procedures to allow for greater clarity and a more uniform and effective application of the RMC. This would, once and for all, streamline the procedures for using CAS. 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. Zorayda H. Panumpang and June Catherine G. Tañedo are Senior Directors from the Tax Division of SGV & Co.

22 September 2020

Jonald Vergara and Betheena Dizon

Simplifying share valuation

The COVID-19 pandemic may have unwittingly triggered acquisition activity as private equity investors demonstrate an increased appetite for Philippine companies. Despite the expected economic slowdown, investors continue to look for opportunities, with many entities needing sufficient capital to sustain their businesses. Whether it be due to corporate restructuring or a simple divestment, the sale or transfer of shares of stock in a domestic corporation remains a routine commercial transaction. Under the Tax Code, the sale, barter, exchange or transfer of shares in a domestic corporation, not traded on the stock exchange, is subject to capital gains tax and documentary stamp tax. Donor’s tax may also be imposed if the consideration for the transfer of the shares is below fair market value, though amendments to the Tax Code by the TRAIN Law emphasizes that the sale, transfer, or exchange of property made in the ordinary course of business will be considered as made for an adequate and full consideration. As such, the Department of Finance (DoF), on the recommendation of the Bureau of Internal Revenue (BIR), recently issued Revenue Regulations (RR) No. 20-2020 effective Sept. 3, which simplified the process of determining the fair market value (FMV) of shares of stock for sale, exchange, or transfer. RR No. 20-2020 Under RR No. 20-2020, the FMV of common shares is prima facie equivalent to the book value based on the latest audited financial statement (AFS) prior to the sale, but not earlier than the immediately preceding taxable year. For preferred shares, the FMV is set at the liquidation value equivalent to the redemption price as of the balance sheet nearest the transaction date, including any cumulative and preferred dividends in arrears. If the investee corporation has both common and preferred shares, the book value of the common shares will be derived by deducting the liquidation value of the preferred shares from the equity and dividing the result by the number of the issued and outstanding common shares. Thus, RR No. 20-2020 underscores the difference in the valuation for common and preferred shares, given the nature and rights of each class of shares. This clarity on the valuation of preferred shares is a welcome development since, for the longest time, previous rules did not provide details in determining the FMV of preferred shares. NET BOOK VALUE ADJUSTMENT Prior to the effectivity of RR No. 20-2020, FMV was determined following the provisions of RR No. 6-2013. The 2013 regulations prescribed that to determine the FMV of shares of stock, the book value of the shares, based on the investee corporation’s (corporation selling shares) latest AFS, must be adjusted to take into account the actual FMV of the real properties owned, if any, by the investee corporation. This net book value (NBV) adjustment requires, among others, the actual valuation of the real property by an accredited appraiser and the tax declaration of the real property as issued by the City or Provincial Assessor. The highest FMV of the real property (among the appraisal report, the tax declaration, or the BIR’s zonal value) will be used to adjust the book value of the shares for FMV purposes. Consequently, the independent appraisal report and the tax declaration must be submitted to the BIR during the processing of the Certificate Authorizing Registration (CAR) covering the transfer of the shares of stock. Without the CAR, the transfer of the shares from the buyer to the seller cannot be recorded in the investee corporation’s books. Such requirements have complicated the processes of transferring shares, depriving the government of revenue from the taxes on such transactions. The preparation of an appraisal report may take some time, depending on the properties of the investee corporations to be assessed, and entails additional costs since the appraisal report must be prepared by an independent appraiser. STREAMLINING TAX PROCEDURES FOR COMPLIANCE RR No. 20-2020 also appears to be consistent with the government’s objectives to streamline tax procedures. It can be recalled that RR No. 12-2018 (or the consolidated regulations to Donor’s and Estate Taxes incorporating the TRAIN Law amendments), expressly exempted the valuation of shares of stock of a decedent for Estate Tax purposes from the provisions of RR No. 6-2013 in requiring the valuation report. Both RRs give credence to the government’s intent to streamline procedures. We can expect the simplified requirements under RR No. 20-2020 to lead to an increase in tax compliance. Without the need for a costly and complicated appraisal report, more parties may be encouraged to transfer shares. Establishing the FMV will also be easier and will minimize disputes among parties since the latest AFS should be able to provide the FMV that will serve as the base consideration. RR No. 20-2020 can also be expected to expedite the process of securing the CAR since the independent appraisal report and the tax declaration are no longer necessary, taxpayers will need to submit fewer documents to process and secure the CAR. Implicit in RR No. 20-2020 is the need for the investee corporation to maintain its AFS, which must also be submitted to the BIR and the Securities and Exchange Commission. Since the RR now requires that book value be based on the latest AFS not earlier than the immediately preceding taxable year, it is now imperative for corporations to always have the AFS of the immediately preceding taxable year prepared. POTENTIAL IMPACT ON OTHER REGULATIONS However, RR No. 20-2020 may also have an impact on other regulations that refer to RR No. 6-2013. For instance, Revenue Memorandum Order (RMO) No. 17-2016 requires that shares to be transferred from an absorbed corporation to the surviving corporation in a merger should also be valued following the guidelines under RR No. 6-2013. Now that RR No. 6-2013 has been superseded by RR No. 20-2020, it remains to be seen how the BIR will interpret the requirement in RMO No. 17-2016 on the adjustment of the FMV of shares to be transferred in a merger, as well as whether it will also adopt RR No. 20-2020 for such valuation purposes. RR No. 20-2020 is a welcome respite for taxpayers. With greater facility of transactions comes a potential increase in compliance. In turn, improved compliance can lead to an increase in the Government’s tax revenues, which could go a long way to support Government efforts in these challenging times. 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 authors and do not necessarily reflect the views of SGV, the global EY organization or its member firms. Partner Jonald Vergara and Senior Manager Betheena Dizon are from the Tax Service Line of SGV & Co.

14 September 2020

Joanne Macainag-Cobacha

Aiding recovery: VAT exemptions on imported medicine

Health is wealth, particularly during the COVID-19 pandemic. It would seem that the government concurs when it passed Republic Act (RA) No. 9502, otherwise known as the “Universally Accessible Cheaper and Quality Medicines Act of 2008.” The RA empowers the Department of Health (DoH) to keep medicine affordable and accessible to promote the health and well-being of Filipinos. In light of this, the House and Senate included in RA No. 10963 (the TRAIN Law) a value-added tax (VAT) exemption on the sale of drugs prescribed for diabetes, high cholesterol and hypertension beginning Jan. 1, 2019. Revenue Memorandum Circular (RMC) No. 2-2018 clarified that the sale by manufacturers, distributors, wholesalers and retailers of drugs prescribed for the treatment of diabetes, high cholesterol and hypertension in its final form shall be exempt from VAT while the importation are subject to VAT. Evidently, the TRAIN Law and RMC No. 2-2018 were issued to address the objectives of RA No. 9502. However, apparently not taken into consideration when the law was passed was the effect on the pharmaceutical industry (manufacturers, importers, distributors, wholesalers and retailers) of imports not covered by the VAT exemption. VAT-EXEMPT SALES Prior to the passage of TRAIN Law, sales of drugs and medicines prescribed for diabetes, high cholesterol and hypertension were subject to 12% VAT. In turn, input VAT passed on to pharmaceutical companies from imports and local purchases of goods and services could be claimed against the output VAT. Due to the TRAIN Law and under Revenue Regulations (RR) No. 16-05, as amended, the input tax attributable to VAT-exempt sales was not allowed to be credited against output tax but should be treated as an expense. This finds support in Bureau of Internal Revenue (BIR) Ruling [DA-646-06] and BIR Ruling [DA-234-04] where the BIR held that the input taxes directly attributable or allocable to exempt transactions become part of the cost of capital goods purchased or of operating expenses. In other words, the input tax attributable to VAT-exempt sales shall not be allowed as credit against the output tax but should be treated as part of cost or expense. Input VAT from the following purchases which are directly attributable to VAT-exempt sales should be treated as follows: Purchases of goods for sale — should form part of the cost of the inventory Purchases of capital goods — should form part of the capitalized cost subject to depreciation Purchases of services/consumable goods — should form part of the operating expenses Since the VAT paid on imports is being paid and passed on to the pharmaceutical companies and forms part of the cost or expense, these companies are unable to significantly reduce the selling price to the public, which was not the intention of the legislators when the TRAIN Law was passed. INPUT TAX ON IMPORTED GOODS Pursuant to Section 110 (A) (2) of the 1997 Tax Code, as amended, input tax on imported goods or property by a VAT-registered person is creditable to the importer upon payment of the VAT prior to the release from the custody of the Bureau of Customs (BoC). To address this issue, the BIR issued RMC No. 34-2019 which provides that considering that input tax attributable to VAT-exempt sale cannot be passed on to the buyer, the inventory list as of Dec. 31, 2018 of drugs and medicine which became VAT-exempt beginning Jan. 1, 2019 is required from all manufacturers, wholesalers, distributors and retailers regardless of whether or not there is an existing excess input tax. As the sale of VAT-exempt drugs and medicines are made, the input tax corresponding to the sale shall be closed to cost or expense. It appears that the BIR, in issuing RMC No. 34-2019, has given credence to the Tax Code provision that input taxes attributable to VAT-exempt sales cannot be claimed as input tax credits but should be expensed out. Under the RMC, if the input VAT was already claimed in the 2018 VAT returns when VAT was paid on imports prior to release from the BoC’s custody, the RMC resolved to reverse the input taxes previously claimed at the time the related inventories were sold. This had a negative impact on the industry since the pharmaceutical companies were not able to recover fully the VAT paid on the importation of these VAT-exempt medicines. NEW HOPE FOR RECOVERY RA No. 11467 was signed and approved on Jan. 22, 2020. This law amended the VAT-exempt provision to now cover imports of these medicines beginning Jan. 1 2020 and to include the sale or importation of prescription drugs for cancer, mental illness, tuberculosis, and kidney diseases beginning Jan. 1, 2023. Another positive development for the industry is the issuance of RR No. 18-2020. In its transitory provisions, the RR specified that the VAT on imports of DoH-approved prescription drugs for diabetes, high cholesterol and hypertension from the effectivity of RA No. 11467 on Jan. 27, 2020 until the effectivity of RR No. 18-2020, shall be refunded in accordance with the existing procedures for refund of VAT on imports, provided that the input tax on the imported items has not been reported and claimed as input tax credit in the monthly and/or quarterly VAT declarations/returns. This is certainly good news for pharmaceutical companies, as including the imports as VAT-exempt transactions and allowing companies to claim refunds will surely help ease the strain on them during these trying 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. Joanne Macainag-Cobacha is a Tax Senior Director from the Global Compliance Reporting Service Line of SGV & Co.

07 September 2020

Clairma T. Mangangey

Environmental, social and governance factors take center stage

We are increasingly seeing the need for accelerated change in businesses to pave the way for recovery from the COVID-19 pandemic. Digital transformation has become necessary for many to continue operations, and the rules for capital markets are being rewritten as the pandemic’s economic and social impact plays out worldwide. This poses the question of how investors will direct capital to support economic recovery. Based on the findings of the 2020 EY Climate Change and Sustainability Services (CCaSS) Institutional Investor survey, institutional investors are raising the stakes in assessing company performance through environmental, social and governance (ESG) factors as they look to build insight into long-term value. Companies unable to meet investor expectations in terms of ESG factors risk losing access to capital markets. ESG information is more important than ever. The survey showed that investors were increasingly dissatisfied with the information received on ESG risks compared to 2018. At 98%, the majority of the investors surveyed signaled a move to a more rigorous approach to evaluating non-financial performance, while 91% also identified how non-financial performance played a pivotal role in investment decision-making. To meet the expectations of investors, companies must prioritize building a more robust approach to analyzing the risks and opportunities from climate change, build strong connections between financial and non-financial performance, and instill discipline into non-financial reporting processes and controls in order to build confidence and trust. A ROBUST APPROACH TO TCFD RISK DISCLOSURES Capital markets are heavily considering the potent impact of environmental disruption, with the failure to consider social and environmental risks leaving many to wonder how well-prepared capital markets are to withstand such shocks. Investors from the survey are building their understanding of the ESG reporting universe, factoring in disclosures made as part of the Task Force on Climate-related Financial Disclosures (TCFD) framework in their investment decision-making. While regulators look to companies to play a leading role in rebuilding global economies, investors are more concerned about whether risks such as climate change will be sufficiently addressed. The survey notes that 72% of investors conduct a methodical evaluation of non-financial disclosures, which is a significant jump from the 32% who said that they used a structured approach in 2018. Though the research shifts toward a structured approach, the quality of the approach remains critical. The research also shows significant investor appetite for a formal framework that allows companies to communicate intangible value, allowing investors to evaluate long-term value-creation strategies. Companies should ensure a connection between nonfinancial and financial reporting to provide investors a comprehensive view of their plans to create, communicate and measure long-term value. CONNECTING FINANCIAL AND NONFINANCIAL INFORMATION Expectation gaps between investors and companies could come at a significant price, where companies may find it harder to access capital, and investors may respond to a lack of risk insight by raising a company’s risk profile. Investors may come to their own conclusions should companies choose not to engage in ESG or weigh performance solely towards positive aspects. A growing area of disconnect is how companies disclose ESG risks in their current business models, and research shows dissatisfaction with risk disclosures rose across all areas since 2018. Environmental risk in particular is a key issue for investors, and when asked, the TCFD framework emerged as the most valuable way companies can report on this ESG information. The research also points to concerns about the provided information, with risk management highlighted as the area where investors received the least developed information. Some companies disclose that they have processes to manage climate risks in their organizational risk management system but described in general terms without the necessary connection between climate-related risks and overall risk management. BUILDING TRUST AND CREDIBILITY IN NON-FINANCIAL REPORTIN With ESG performance seen as a core element in investment decisions, it is likely that the trend of using non-financial information to determine the value of a business is likely to continue in the post-pandemic world. Investors look not only at the resiliency of a business, but also on its focus on long-term value creation. Climate change plays a key role in investor considerations because investors seek to understand what it means to companies, as well as gauge how business leaders adapt to climate risk due to its potential to disrupt supply chains and damage infrastructure. Because ESG risks will play a key role in how investors understand a company’s resilience maturity, credible ESG disclosures will be essential. Investors will only find environmental and climate change disclosures useful if they have confidence in what is reported. The investor community will therefore play an active part in driving companies toward non-financial assurance, and companies that will want to communicate their story to investors to access capital must respond to this demand. REINFORCING A SUSTAINABLE FUTURE With investors increasingly using non-financial factors when it comes to assessing a company’s performance, they also seek a formal framework to measure and communicate intangible value, as well as establish closer connections between ESG and mainstream financial reporting. Rather than distracting us from the necessity of driving a sustainable future, the COVID-19 pandemic actually reinforces it. Transitioning to a decarbonized future is a critical component to long-term company resilience as well as that of the economy, while strong ESG frameworks and strategies will be critical to recovery. Recovery itself will be closely observed by investors, and companies and national economies with an agenda for climate-resilient growth and the ability to withstand systemic shocks will have the highest potential of being seen as an attractive prospect. 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. Clairma T. Mangangey is the Climate Change and Sustainability Services Leader of SGV & Co.

01 September 2020

Fatma Aleah A. Datukon

Transforming tax and finance functions

As we continue to navigate the disruption brought about by the COVID-19 pandemic, companies are reshaping their operations in the new normal to focus on business continuity and to prepare for recovery once the economy bounces back. Part of this transformation strategy is to revisit and reimagine the tax and finance function. The 2020 Tax and Finance Operate (TFO) survey sponsored by EY and conducted by Euromoney Thought Leadership Consulting with over 1,000 executives representing 42 jurisdictions (including the Philippines), 17 industries and 178 publicly listed organizations, demonstrated that the tax and finance function in organizations is generally struggling to cope with digital advances and rapidly evolving global and local conditions. While the survey was conducted before the pandemic, nearly all respondents (99%) indicated that they are taking steps to transform their tax and finance operating models due to deficiencies in their current target operating model. Meanwhile, 73% are looking to co-source critical activities in the next two years as a solution to relieve growing pressures. This also aims to aid in successfully adapting to the constantly evolving tax environment and rapidly transforming digital landscape, which have been amplified by the unforeseen business and human impact of COVID-19. DEFICITS IN DATA AND TECHNOLOGY TRANSFORMATION Based on the survey, 65% of respondents cited the lack of a sustainable plan for data and technology as their biggest barrier to delivering the tax function’s long-term purpose and vision. In fact, 73% of the respondents said that their organizations do not have a formal tax technology strategy in place. The unprecedented operational disruption due to the pandemic — where organizations struggle to manage business continuity amidst the abrupt need to shift to telecommuting and develop digital workspaces — only highlighted the deficit in the technological capabilities of most organizations. This has brought the urgent need for digital readiness in organizations to the forefront. Contributing to the urgency are the growing demands for tax and finance functions to quickly and effectively respond to the dynamic tax landscape, due in part to the Philippine government’s tax reform programs and the implementation of the digital transformation roadmap, which is a priority program of the Philippine Bureau of Internal Revenue (BIR). Organizations that are not pushing to operate in new ways or investing in data and technology adoption (e.g., automation, cloud storage and data governance, data analytics and reporting) may eventually find themselves at a competitive disadvantage. This is in comparison to others that have fast-tracked their digital transformation and have integrated digital technologies into their tax and finance functions to manage tax risks and provide greater focus on value generation. EVOLVING TALENT NEEDS Under their current tax operating models, 62% of the survey respondents spend majority of their tax function time on routine compliance activities. Examples of these include data collection and processing, workpaper preparation, tax returns and reconciliations — as opposed to higher value/higher risk activities — with nearly half (45%) of the organizations struggling to provide new responsibilities and career advancement opportunities for their tax and finance personnel. With the move towards digitally transforming the tax and finance function, a corresponding reimagination of the tax and finance workforce would necessarily follow. This will, however, pose a challenge for organizations to search for and retain the appropriate talent in today’s evolving tax and finance function. In fact, 83% of the survey respondents believe that the core technical competencies of their tax and finance personnel will shift from traditional technical skills to data, process and technology skills over the next three years. However, 61% admit that they are unable to attract and retain talent with the skills required for the tax and finance function of the future. As talent demands continue to evolve, organizations will have to revisit, reskill and/or upskill their tax and finance workforce. This can be achieved by either providing their current employees with the necessary learning and skills development (e.g., digital fluency, data analytics proficiency) to cope with the evolving tax and finance function, or by considering an entirely different strategy to bridge the talent and skills gap (e.g., establishing new tax operating models, co-sourcing) to improve the financial operational effectiveness and efficiency of their tax departments in the new and next normal operations. TAX AND FINANCE OPERATE (TFO) SOLUTIONS Organizations need to use the right mix of people, process and technology to maximize the value of their tax and finance functions and meet the evolving organizational goals now and in the future. One way to do this in the shorter term is by engaging an experienced external TFO solutions provider who can deliver a customized and flexible technology-driven tax service delivery model that can help business leaders reimagine their tax and finance functions. With the right TFO provider, organizations can achieve a sustainable corporate tax function that can support their strategic efforts and bring new innovation and transformation to their tax function. ACCELERATED TRANSFORMATION In today’s highly dynamic tax and regulatory environment, which has been further complicated by the COVID-19 pandemic, sustaining a strong and stable tax and finance function with the right technological and talent capabilities may be one of the most difficult challenges of an organization. In order to more effectively navigate through these changes, organizations should consider accelerating the transformation of their tax and finance functions into agile and cost-effective tax operating models. This will allow businesses to prioritize long-term value creation and risk management as well as redirect valuable internal tax and finance resources to more strategic activities and efforts. A focused effort will manage and boost business continuity and resilience, achieving operational optimization for the now, next and beyond. 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. Fatma Aleah A. Datukon is a Senior Director of SGV & Co.

17 August 2020

Akhil Hemrajani

Digital transformation: A growth necessity

The coronavirus pandemic has irreversibly altered society and the global economy. This forced companies in every sector to reflect on how they have been dealing with market forces in the past and, moving forward, how can they address the rapid shifts in consumer behavior. Some of the biggest shifts are going to be witnessed in the financial, telecommunications and retail sectors, with significantly accelerated steps taken towards digitalization. Even before the pandemic, disruptive technology startups (created in the digital age with purely online marketplaces or platforms) that organically intensify disruption in various sectors forced industry leaders to undergo digital transformation to compete and, for some, to survive. For many entities, it has become critical to develop a digital customer experience that creates a personalized, seamless process across every touchpoint a consumer has with a brand. For banks, COVID-19 has accelerated shifts in consumer behavior patterns, while elevating the risk of financial distress for businesses and customers. Telecommunications providers find themselves in a unique situation where they provide the very platform that so many disruptive technology startups depend upon — powering the phones that make their mobile apps possible. And yet telcos find that they too, must still digitally transform to remain relevant. Traditional retail companies find themselves in the precarious position of seeing a dramatic drop in foot traffic as consumers shift almost exclusively to online purchases. UNDERTAKING THE DUAL TRANSFORMATION JOURNEY Although digital transformation is multi-faceted, this segment will cover just two aspects of it. • Increasing current customer value — This segment of the dual transformation initiative relies on companies offering better experiences and more services to its existing customers. This enhances the likelihood of “stickiness” for their customers, meaning it is more likely that those customers will continue to transact with the company, but it also increases the customer lifetime value through availing of new subscriptions and upselling/cross-selling various other products. The perfect example of this are the telcos that not only offer consumers an online platform to pay their bills but also additional services such as savings, investment products, and small ticket loans. One particular telco offers its consumers an opportunity to borrow load amounts via its digital payments app. Another telco is utilizing alternative credit scoring data to offer gadget loans to its customer base, albeit offline. Financial institutions are similarly undertaking this journey to enable customers to not only transact digitally but be able to avail of various products for their needs. • New customer acquisition — This segment of the dual transformation journey pertains to how organizations can transform digitally, thus enabling them to broaden their customer base in cost-effective ways. For financial institutions, this is critical: 66.4% of the population in the Philippines remain unbanked or underbanked (BusinessWorld article dated May 22: “Unbanked Filipinos to decline by 2025”). Traditional financial institutions are increasingly adopting an omni channel model to enable branchless banking. Initiatives such as agency banking, virtual onboarding, and relying on alternative credit scoring models to lend to more retail customers enable banks to significantly reduce friction in reaching untapped segments. For telcos, the race to develop the next super app is imperative for them to reach new customers in a market where Internet penetration is at 67% (Datareportal Digital 2020 Report). Since new demand for traditional telco products has stagnated, they must shift to offering more innovative products through cost effective digital channels. To execute a dual transformation strategy, it is critical for organizations to establish a viable channel strategy that can accelerate their objectives and can provide an effective route-to-market. CHANNEL STRATEGY To accelerate their digital transformation, traditional organizations are increasingly moving towards an omni-channel approach. This approach enables companies to cater to their customers in a more efficient and effective way by reducing overhead and expenses and marketing a new service or product to a certain geographical demographic. Organizations such as banks, telcos and retailers can analyze data to better understand the prospective adoption rates of digital services so that they can better expand to those markets digitally rather than physically. For example, a bank can analyze which consumers in which areas are more likely to undertake simple transactions (check deposits, money transfer, cash withdrawals) to better understand which customer bases can be reached through a digital platform that offers the same service. Areas where a majority of the transactions are complex (high-value loans, wealth management services, etc.) can still be catered to via the bricks and mortar route. Similarly, telcos can use their own data to ascertain which customers are more interested in transacting online, thereby giving the telcos more initiative to reduce overhead through shorter branch hours and fewer personnel, among others. The shift from offline to online can also be accelerated through the gamification of tasks that can tie into rewards programs, especially those catering to a more digital-savvy generation of customers. One online retailer, for example, offers additional coins or rewards points on their app in exchange for completing tasks such as watching livestreams or reviewing products. Some banks or telcos are also adopting this approach by offering reward points in exchange for additional information about their customers on their apps. THE ULTIMATE SHIFT As we move through challenging times because of the pandemic, it will be important to see how organizations and even countries maneuver to address the ultimate shift to the digital sphere, the timeline of which has been accelerated. Organizations need to disrupt internally to meet the future demands of changing consumer preference, behavior and real-time priorities. At the same time, governments need to promote regulations that not only encourage improvements in existing technological infrastructure, but also create an environment that strongly supports and encourages innovation. We live in troubling times, and the only way to see our way to the future is by taking the necessary steps to evolve and adapt digitally, rapidly and efficiently. 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. Akhil Hemrajani is a Consulting Senior Director of SGV & Co.

10 August 2020

Joyce A. Francisco

More than just a form

The sensitivities of the new RPT Information Return With the drive for more transparency on related party arrangements, tax authorities worldwide have been increasing their focus on transfer pricing (TP). In the Philippines, the Bureau of Internal Revenue (BIR) has also been taking strides to strengthen its rules regarding Related-Party Transactions (RPT). To improve the TP risk assessment and audit of taxpayers, the BIR has issued Revenue Regulations (RR) No. 19-2020, requiring the submission of a three-page Information Return on Related Party Transactions or RPT Form (BIR Form No. 1709), to be attached, together with supporting documents, to the Annual Income Tax Return (AITR). This form will help the BIR monitor taxpayer compliance with the TP documentation requirement prescribed by the TP Regulations, which the BIR issued in 2013. More importantly, the BIR will use the data gathered from the forms to select which taxpayers to prioritize for TP audits given its limited resources. RPT FORM FILING The RPT Form requires a granular disclosure by Philippine taxpayers, corporations and individuals alike, of all RPTs, whether international or domestic. While the filing of the RPT form is also intended to implement Philippine Accounting Standards (PAS) 24 on Related-Party Disclosures, more details, especially on the taxation aspect of income paid or received from related parties, need to be supplied in the form and its attachments as compared to the disclosure for financial reporting purposes. Thus, taxpayers must prepare the form judiciously, and merely reproducing the related-party disclosures in their financial statements may not be sufficient to comply with the requirements under RR No. 19-2020. There is no threshold, either in terms of amount or volume, on the RPTs that should be disclosed. As the term “related parties” under PAS 24 is a broad concept, taxpayers must also take extra care to determine their relationships with other entities to ensure that all transactions with those considered as “related parties” are properly reported, and that disclosures are consistent among the entities involved in the transactions. In ascertaining whether a person or entity is a related party, the substance of relationships between entities shall be considered and not merely the legal form. INFORMATION DISCLOSURE Bearing in mind that one of the objectives of the RPT Form is to ensure that taxpayers are reporting their true taxable income, questions are thus raised on the level of information that may be disclosed on related-party transactions. Of particular note is the disclosure on transfer under financial arrangements, such as equity contributions. As clarified by the BIR in its Revenue Memorandum Circular (RMC) No. 76-2020, dividends and redemption of shares between and among related parties, though not usually covered by a TP documentation, should likewise be disclosed in the RPT Form. However, investments in another entity do not affect the income or expense of either the investee or investor. Hence, there is no possibility of erosion of the tax base which the BIR intends to guard against by the submission of this RPT Form. Companies are also required to disclose in detail transactions with each member of their key management personnel even if these pertain only to salaries received during the covered year. These officers are correspondingly required to submit the RPT Form in their individual capacities. An issue to take note of is the disclosure of sensitive information, such as the names and addresses of these officers. However, the BIR emphasized that the power of the Commissioner of Internal Revenue to obtain the necessary information to ascertain the correctness of any return, or in determining the liability of any person for any internal revenue tax, or in evaluating tax compliance serves as an exception to the Data Privacy Act (DPA). In addition to the RPT Form, taxpayers also need to submit a certified true copy of the relevant contracts or proof of transactions, withholding tax returns and the corresponding proof of payment of taxes withheld and remitted to the BIR, proof of payment of foreign taxes, certified true copy of advance pricing agreement (if any), and any transfer pricing documentation. CONTRACTS AND OTHER DOCUMENTS Contracts are deemed the primary proof of the transactions with related parties. Other documents such as receipts and invoices are considered corroborating evidence only. Hence, all contracts executed by the parties to substantiate the RPTs in the covered taxable year have to be attached to the RPT Form. In case of voluminous contracts and documents, electronic copies may be submitted under certain conditions. It is important to note that the RMC specifically mentions certain RPTs that should be covered by a formal written contract. Agreements on cost-sharing arrangements among members of a group of companies need to be submitted to prove that they are for legitimate expenses. This is in addition to documents (e.g. receipts, proof of payment) needed to substantiate the expenses. Moreover, contracts for the importation of goods or any equivalent genuine document must be submitted aside from other proof of transactions. The TP documentation to be attached to the RPT Form should be the same documentation that the taxpayers relied upon to determine the transfer pricing prior to or at the time of undertaking the RPTs and must have been prepared contemporaneously — that is, not later than the filing due date of the tax return for the taxable year in which the transactions took place. The date of its preparation should also be indicated on the report so that the BIR can evaluate if the TP documentation was prepared contemporaneously. According to the BIR, requiring the submission of contemporaneous documentation ensures the integrity of the taxpayer’s position. TRANSACTION DISCLOSURE Again, since there is no threshold on the amount and volume of RPTs for purposes of the preparation of a TP documentation, a question is raised on whether all the transactions disclosed in the RPT Form should be covered by the TP documentation. As recognized in the RMC, there are RPTs that are not usually covered by a TP documentation such as dividends and redemption of shares. Transactions which do not have an impact on the revenue and taxable income of taxpayers, e.g. equity contributions, are usually not covered by TP documentation. It must be emphasized that the purpose of TP documentation is to demonstrate that the TP policies of a taxpayer are compliant with the arm’s-length principle, thereby ensuring that it is reporting its true taxable income. Reference to the OECD TP Guidelines, which was largely adopted in the TP Regulations, may be made to determine the amount of transactions that must be included in the TP documentation. The OECD TP Guidelines suggests that a balance between the tax authority’s needs and taxpayers’ costs should be maintained in determining the scope and the extent of the information to be included in a TP documentation. Taxpayers should, thus, not be expected to go through such lengths that compliance costs for the preparation of documentation are disproportionate to the amount of tax revenue at risk or to the complexity of the transactions. COMPLIANCE AND CONSISTENCY AMID COVID With the COVID-19 pandemic, many companies will find it challenging to comply with this new RPT Form, faced as they are with the imposition of travel bans and lockdowns as well as the added pressures for workforce safety and well-being. Nonetheless, it would be imprudent to disregard this regulatory requirement. With the large amount of information that needs to be supplied, taxpayers must work closely with their related parties to ensure that transactions are disclosed in a consistent manner among the entities involved. Companies should also consider accelerating the digitization of their systems to more efficiently manage any information requested by the BIR. 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. Joyce A. Francisco is a Tax Senior Director of SGV & Co.

03 August 2020

Meynard A. Bonoen

Impairment considerations during COVID-19 Part 2

(Second of two parts) In last week’s article, we discussed how to determine the timing of assessment for any impairment for non-financial assets, as well as the indicators of impairment. This article will cover how to measure and estimate the recoverable amount of an asset, how to determine the recognition and reversal of impairment, and provide detailed disclosure on assumptions used to fully understand an impairment assessment especially in these uncertain times. MEASUREMENT An asset is impaired when an entity is not able to recover its carrying value (i.e., the amount shown on the entity’s balance sheet) either by using it or selling it. The recoverable amount is the higher of the asset’s (or group of assets’) fair value less costs of disposal (FVLCD) and value in use (VIU). VIU involves estimating the future cash inflows and outflows that will be derived from the use of the asset and from its ultimate disposal and discounting the cash flows at an appropriate rate. The calculation of an asset’s VIU incorporates an estimate of expected future cash flows, and expectations about possible variations of such cash flows. The forecasted cash flows should reflect management’s best estimate at the end of the reporting period of the economic conditions that will exist over the remaining useful life of the asset. This means entities should consider both short-term effects and long-term effects on assets with longer useful life, such as capital assets and goodwill. Due to the evolving COVID-19 situation, there are significant challenges to preparing the forecast or budgets for future cash flows. In these circumstances, an expected cash-flows approach based on probability-weighted scenarios may be more appropriate than the traditional single best estimate when estimating VIU. In coming up with scenarios, entities should consider the length and severity of the pandemic, government measures, availability of proper intervention (i.e., vaccine), distribution and supply chains, revenue growth and collections, capital, changes in regulations, and changes in customer behaviors, among others. Cash flows are discounted at an appropriate rate, which is a pre-tax discount rate that reflects current market assessments of the time value of money and asset-specific risks for which future cash flow estimates have not been adjusted. The discount rate should likewise consider the price for bearing the uncertainty inherent in the asset, and other factors, such as illiquidity, that market participants would reflect in pricing the future cash flows the entity expects to derive from the asset. It is therefore highly important to exercise careful judgement when determining the discount rate to be applied. RECOGNITION AND REVERSAL OF IMPAIRMENT An impairment loss is recognized to the extent the carrying amount exceeds its recoverable amount. In subsequent periods, external and internal sources of information (such as significant favorable changes in the market conditions, the asset’s value, use and performance) may indicate that an impairment loss recognized for an asset, other than goodwill, may no longer exist or may have decreased. In this case, previous impairment losses may be reversed. Note, however, that an impairment reversal cannot be recognized merely from the passage of time or improvement in general market conditions. When an impairment reversal is recognized for assets other than goodwill, the adjusted carrying amount of the asset may not exceed the carrying amount of the asset that would have been determined had no impairment loss been previously recognized. PAS 36 specifically prohibits the reversal of impairment losses for goodwill. If impairment on goodwill was determined and recognized in the interim period, it cannot be reversed in the subsequent interim periods or at year-end. DISCLOSURE Disclosure is particularly crucial in these times. Due to sensitivity, it is critical for an entity to provide detailed disclosures on the assumptions used, the evidence these are based on, and the impact of a change in key assumptions. Disclosures include, among others, the valuation methodology used and the approach in determining the appropriate assumptions and key assumptions used in cash flow projections aside from long-term growth rate and discount rate; the values of the key assumptions and the probability weights of multiple scenarios when using an expected outcome approach; and inputs used in determining the discount rate and the source thereof. This makes it also important to go beyond minimum disclosure requirements to help users better understand the impairment assessment. KEY TAKEAWAY With the COVID-19 situation, impairment assessment will be a complex and difficult undertaking. Hence, it is imperative for management to be judicious, more prudent and to employ careful judgment in making assumptions, especially when forecasting cash flows and determining the discount rate to be used. It must be noted that cash flow forecasts may now be substantially — if not completely — different from pre-pandemic or existing budgets. Moreover, historical and comparative data may no longer be relevant and helpful in making such forecasts. Assumptions must be updated and should be drawn from and be reflective of the current pandemic circumstances. This naturally requires a more cautious outlook for the future. As previously mentioned, the impact of COVID-19 may no longer be reflected in a single set of cash flows due to the high degree of uncertainty involved; there may be a need to develop multiple scenarios and apply probabilities to each scenario to arrive at the expected cash flows. In evaluating these scenarios, those with a downward impact on cash flows and on the value of the asset should be given more weight to reflect the market view of risk and uncertainty. On the other hand, determining the discount rate is equally challenging given the current market volatility, and that most relevant parameters and inputs to determine discount rates have become unpredictable. Values and assumptions which were accepted, used and applied in the past and in previous impairment assessments and testing may no longer be reasonable or appropriate. For instance, beta and cost of equity may have increased significantly due to capital market volatility; risk-free rates are reaching lows; and debt liquidity issues are severely affecting the cost of debt for many companies. That said, the risk-adjusted discount rates to be used should be calculated with serious considerations for the current market and economic conditions, the value of comparable reporting entities or assets that is available and evident in the market, and the risks of the asset or cash-generating unit to be valued. The pandemic continues to evolve and until such time that a proper and permanent intervention is identified, there remains significant uncertainty about our future, our economy and business viability. Until then, the recoverability of most entities’ assets remains the focus and they will need to continuously reassess, recalibrate and be transparent about their assumptions and outlook for the future of their business. Disclosure is key — if not paramount — to understanding all these under the current situation. 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. Meynard A. Bonoen is an Assurance Partner of SGV & Co.