As the world continues to face the effects of the COVID-19 pandemic, the government has acknowledged its immediate fiscal impact, including the adverse consequences on tax collections in recent months. Having missed collection targets by a significant margin starting in March, the Bureau of Internal Revenue (BIR) expects future collections to also fall below target as an effect of the economic slowdown.
With the urgency of generating more funds to continue fighting the pandemic, the government has now put the spotlight on digital services. House Bill (HB) No. 6765, or the “Digital Economy Taxation Act,” was filed on May 19 to capture into the tax system the value created by the digital economy. The bill seeks to impose a 12% value-added tax (VAT) on digital advertising services (such as those on search engines and social media platforms), subscription-based services (including music and video streaming subscriptions), services rendered electronically, and transactions made on electronic commerce (e-commerce) platforms. Moreover, the bill would require suppliers of digital services, network orchestrators, and e-commerce platforms to establish a resident agent or representative office to act as a withholding agent in the Philippines. According to the bill’s explanatory note, it is projected that the proposal would yield about P29.1 billion in new revenue for the government.
The concept of a “digital services tax” is not new from an international standpoint. As early as 2017, Australia imposed a tax on electronic/digital services. Several territories across Europe have introduced their digital services taxes as of 2020. In Southeast Asia, Singapore and Malaysia have imposed similar taxes starting Jan. 1, while Indonesia will be imposing its tax beginning July 1.
As tax is jurisdictional, each territory has its own set of rules in implementing a “digital services tax.” Nevertheless, there are common characteristics, such as:
Subject matter: While “digital service” or similar term is defined differently per territory, essentially, a digital services tax encompasses cross-border or importation of services primarily available digitally or electronically (e.g., via Internet).
Coverage: Notwithstanding the territories’ different registration requirements, the tax generally covers all companies (including foreign ones) whose digital services are supplied to consumers located within their territories.
Tax base: The tax is generally computed based on revenue generated from consumers within their territories, albeit at a different rate per territory.
CURRENT PHILIPPINE PERSPECTIVE
Although the proposed Digital Economy Taxation Act is still subject to further deliberation, the bill should be contextualized against the current tax rules to understand the rationale for the proposal. In general, Philippine income taxation is based on either: (a) nationality, i.e., resident citizens and domestic corporations are taxed on worldwide income, or (b) territoriality, i.e., individuals other than resident citizens and foreign corporations are taxed on Philippine-based income. Meanwhile, value-added taxation generally covers sales and imports of goods in the Philippines, as well as the performance of services domestically.
While the current Tax Code has gone through numerous amendments, its main provisions emanate from Republic Act No. 8424, a law that was passed over two decades ago. At that time, “traditional” transactions were the norm, and “digital” transactions were practically non-existent. While the BIR has introduced amendments governing innovations (e.g., taxation of software payments and transportation network vehicle services), broadly speaking, the treatment of “digital” transactions remains unclear.
Many of these online transactions are conducted with foreign service providers that do not have Philippine subsidiaries or are not licensed to do business in the Philippines. Thus, for tax purposes, they are non-resident foreign corporations (NRFCs), subject to corporate income tax (CIT) on Philippine-based income and VAT on services performed in the Philippines.
However, the crux of the matter lies on the territoriality of digital transactions. While the dealings are conducted in the virtual realm, without physical stores or facilities within the Philippines, nonetheless, it is arguable that the income or gross receipts from the transactions are generated from Philippine sources. Hence, such transactions must fall within the jurisdiction of Philippine taxation.
The provisions of the Digital Economy Taxation Act and its implementing regulations would determine how Philippine tax on digital services would be imposed. The bill is still at an early stage in the legislative process and is subject to deliberation and changes, thus there are opportunities to iron out possible contentious matters that could arise, including some considerations that I will mention below.
In terms of tax administration, since the companies intended to be covered by the bill are NRFCs that would ultimately be required to transition into resident foreign corporations (RFCs) by virtue of establishing a representative office or appointing a resident agent, would they be required to be registered with the BIR? How would bookkeeping, registration and related requirements apply to these RFCs?
In terms of tax compliance, what would be the RFCs’ tax compliance requirements? Which filing and payment requirements would they need to comply? Will the RFCs be required to issue invoices/receipts in accordance with current VAT invoicing requirements?
There are also other matters, such as reconciling the limited authority of a representative office or a resident agent based on relevant laws, including the restriction on generation of revenues, with the proposed tax administration and compliance measures to be imposed. While the bill supposedly covers VAT, would the RFCs be treated as permanent establishments in the Philippines from an international tax perspective and consequently expose these RFCs to Philippine CIT as well?
Taxing the digital economy has been on the government’s agenda even before the current health crisis. Driven by the need for additional revenue sources, however, our lawmakers are given an even more compelling reason to catch up with rapid growth of the digital economy and bring it into the tax fold.
For digital platforms and service providers, HB No. 6765 could be their new normal moving forward.
The views or opinions expressed in this article are solely those of the author and do not necessarily represent those of Isla Lipana & Co. The content is for general information purposes only, and should not be used as a substitute for specific advice.
Marion D. Castañeda is a Manager at the Tax Services Department of Isla Lipana & Co., the Philippine member firm of the PwC network.
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