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Offsetting (or netting) may arise in business transactions where there is a debtor-creditor relationship. Considering that two parties can be both debtor and creditor of each other, offsetting can be resorted to in order to reduce, or even extinguish the liability, if the legal conditions are present and if the criteria under Philippine Financial Reporting Standards (PFRS) are met.
While offsetting is not defined under Philippine law, the concept is introduced as “compensation” under the Civil Code.
Compensation takes place when two persons, in their own right, are creditors and debtors of each other. In one Supreme Court case, compensation has been defined as “a mode of extinguishing to the concurrent amount, the obligations of those persons who in their own right are reciprocally debtors and creditors of each other,” and “the offsetting of two obligations which are reciprocally extinguished if they are of equal value, or extinguished to the concurrent amount if of different values.”
Although it is clear under the Civil Code that offsetting may take place between parties who are both debtor and creditor of each other, and in some instances even without their consent, it is a different scenario altogether when it comes to taxation.
Under existing tax regulations, the Bureau of Internal Revenue (BIR) has categorically prohibited the practice of offsetting the due to/due from and/or payable/receivable transactions of taxpayers.
In June 2016, the BIR issued Revenue Memorandum Circular No. 61-2016 prescribing the policies and guidelines for accounting and recording transactions involving “netting” or “offsetting.” Although the effectivity of RMC 61-2016 was suspended by virtue of RMC 69-2016, the BIR lifted the suspension in the last quarter of 2016 upon its issuance of Revenue Memorandum Circular 127-2016.
Under RMC 61-2016, the BIR mandates that taxpayers shall, at all times, recognize at gross the accrued receivables or payables arising from the sale or lease of goods or properties or the performance of services for income and value-added tax or percentage tax purposes.
The same Circular further provides that income payments subject to creditable and withholding taxes shall be recorded at gross, and any amount offset against the income payments by the payor not subjected to tax shall not be allowed as deductible expense of the payor. This is pursuant to RR 12-2013, which disallows an expense to be deductible if no withholding tax is remitted.
To provide a full understanding on transactions with an offsetting arrangement, the Circular provides for three illustrations:
1. A manufacturer sells its food products to a supermarket that, on the other hand, charges a service fee to the manufacturer for the display of its product in the store of the latter. The manufacturer issued a sales invoice for the full amount of the products sold. However, the supermarket records its purchases net of service fees, which it records as a discount. For VAT purposes, the service fees disguised as a discount in this scenario are not within the discount contemplated under the provisions of RR 16-2005, as amended. Hence, the service fee disguised as discount shall be considered revenue regardless of the “netting arrangement” between the payor and payee. The parties shall record the sale of goods and service fees at gross amount instead of netting the transaction and making it appear that there is a discount.
2. In the telecommunications industry, companies interconnect their telecommunication service networks with one another. As part of their revenue sharing or fixed-rate charge arrangement, parties bill each other for interconnection fees, or access charges on voice and data transmissions passing through their respective network. The interconnection, sharing, or access charges, shall form part of the gross revenue of the company receiving the same, and a corresponding interconnection fee expense and set up of liability shall be recorded by the company paying the share or charge. In this scenario, the outright set-off of payments due to the other telecommunication company against the gross revenue of the collecting telecommunication company is prohibited.
3. A bank extends a loan to its depositor who happens to maintain a deposit account with the bank. The bank earns interest income from the loan extended to the depositor while at the same time, incurring interest expense on the deposit account. In this case, the bank shall declare in its percentage tax return the full amount of the interest earned from the loan extended without offsetting the interest expense due to the depositor.
It may be inevitable for some businesses to enter into a “netting” arrangement in order to settle an obligation. It is, however, necessary for taxpayers to be mindful of their procedures when recording transactions for settlement arrangements. For both accounting and tax purposes, the “substance over form” of business settlement agreements must be considered, and each particular transaction must be recorded separately.
Taxpayers may have potential tax exposures on income tax, value-added tax (VAT) and other tax obligations as a result of noncompliance with the prescribed guidelines for accounting and recording of transactions involving offsetting. Taxpayers are strongly encouraged to evaluate their compliance with RMC 61-2016, so that risks on possible tax deficiencies can be minimized, especially in case of future BIR tax audit investigations. A prudent and careful study of changes to tax policies and obligations should be a priority for every business, professional, and entrepreneur.
This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co.
Kristine Joyce A. Dalangin is a Senior Associate at SGV — Financial Services Tax.