With the recent relaxation of travel restrictions in Metro Manila and most areas in the Philippines under the Inter-Agency Task Force’s COVID-19 Alert Level System, people can now start planning their travel getaways almost two years after being constrained by the pandemic quarantine — though there is a new variant that we now need to again consider.
When traveling as a group, one common practice is the “abono” or “paluwal,” in which someone advances the payment for another person or the entire group, subject to reimbursement. More often, instead of paying, the others take up the subsequent expenses during their travel to offset the group’s payables. This arrangement reduces the inefficiencies of collecting each person’s share right before every group activity and saves everyone the trouble of making payments back and forth. However, the group must maintain a list of expenses incurred and ideally keep all the receipts as a reference for when it’s time to compute each person’s net receivables or payables.
Offsetting is also common for companies with multiple transactions with the same counterparty. To cover this arrangement, in 2016, the Bureau of Internal Revenue (BIR) issued Revenue Memorandum Circular (RMC) No. 61-2016, which prescribed policies and guidelines for accounting and recording transactions involving “Netting” or “Offsetting.”
Under the RMC, the practice of offsetting payable or receivable transactions of taxpayers, and consequently the accounting and recording of the transaction in the books of the parties, is strictly prohibited for tax purposes. As such, accrued receivables or payables arising from the sale or lease of goods or properties or the performance of services must be recognized at gross amounts for income and value-added tax (VAT) or percentage tax purposes. Moreover, payments subject to withholding tax (i.e., creditable or final) must also be recorded at gross, regardless of whether the transactions are offset or provide for net settlement of cash flows.
A careful reading of the Circular would show that the prohibition on offsetting arrangements ensures that gross amounts are reported for tax purposes, not just the net amounts. If the transaction only involves settlement through offsetting or through a net settlement of cash flow, but sales and expenses are reported at gross for income tax and VAT/percentage tax purposes, then such transactions must be acceptable.
Prior to 2016, a number of court cases and BIR rulings recognized offsetting as a mode of payment, which satisfies the requirement for a zero-rated sale to be paid for in acceptable foreign currency and accounted for in accordance with the rules and regulations of the Bangko Sentral ng Pilipinas (BSP). For instance, in 2005, the Supreme Court ruled that a taxpayer need not present proof of foreign currency proceeds from its sales to qualify for zero-rating. Instead, the taxpayer must show that there was an actual offsetting of intercompany accounts (i.e., intercompany receivables and payables) to support the constructive inward receipt of foreign currency proceeds. Moreover, the BIR confirmed in a 2008 ruling that payments for the export sale of services, made through offsetting arrangements, satisfies the zero-rating requirement for the consideration to be paid for in accordance with BSP rules and regulations.
In Revenue Memorandum Order (RMO) No. 47-2020, which provides consolidated and updated guidelines and procedures on the processing of claims for VAT credit/refund, the BIR recognized that the “paid for in acceptable foreign currency” requirement of a zero-rated sale also includes constructive remittance. Under the RMO’s Annex D – Verification procedures for sales of services, in case of constructive remittances, such as offsetting arrangements, the assigned Revenue Offices need to obtain a copy of any of the following: board resolution authorizing the offsetting arrangement; intercompany debit/credit memorandum on the amount of constructive remittance under the offsetting arrangement; or loan documents or proofs of intercompany advances.
However, in a Court of Tax Appeals (CTA) case in July, which involves a taxpayer whose actual proceeds were lower than the reported VAT zero-rated sales due to certain adjustments, including offsetting arrangements, the CTA allowed only the peso equivalent of the net proceeds to be treated as valid zero-rated sales for two reasons. First, the taxpayer failed to connect the offsetting adjustments to the zero-rated sales with documentary support, and second, offsetting is prohibited under RMC No. 61-2016.
The rules and jurisprudence are clear that offsetting arrangements must be justified by supporting documents. However, with due respect, I beg to disagree with the CTA when it used the offsetting arrangement as grounds to disqualify a sale as a valid zero-rated transaction, by referring to the 2016 RMC as the legal basis. The facts of the case show that the taxpayer diligently reported gross sales as VAT zero-rated. The taxpayer did not under-declare its sales, at least for VAT purposes, through its offsetting arrangements. At any rate, CTA cases are not case law unless upheld by the Supreme Court. As such, the 2005 Supreme Court decision should still bear more weight as a legal precedent.
In sum, offsetting arrangements are allowed for tax purposes if it is for the settlement of receivables/payables. Considerably, it is practical and helpful for taxpayers in managing their cash flows and avoiding unnecessary charges when transferring cash from one bank account to another. It is only prohibited if the taxpayer is offsetting to reduce the amount of sales or even expenses reported for tax purposes. In any case, sufficient and appropriate documents must always be presented to support the taxpayer’s tax treatment for each transaction.
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.
Nestine P. Buisan is a manager at the Tax Services Department of Isla Lipana & Co., the Philippine member firm of the PwC network.