VAT on digital services: Unraveling recharges and allocated costs

Digital services have become essential in today’s fast-paced world. For businesses, companies increasingly rely on cloud-based tools or enterprise software to enhance efficiency and aid in data-driven decision making, despite the significant investment these technologies often require. Multinational companies (MNCs) often contract with digital service providers (DSPs) at a global level, through their parent entities or regional headquarters and allocate or recharge the corresponding costs to their subsidiaries or affiliates based on consumption, including those in the Philippines. This leverages purchasing power to secure better deals, reduce costs, and maintain consistent service quality across all members of the group, even those located in other countries.

With the signing of Republic Act No. 12023, or the VAT on Digital Services Act, digital services provided by non-resident digital service providers (NDSPs) for Philippine consumers are now subject to 12% VAT. “Digital service” is defined as any service that is supplied over the internet or other electronic network with the use of information technology and where the supply of the service is essentially automated.

While there are still ongoing discussions around what exactly qualifies as “supplied over the internet” and “essentially automated,” the intention of the law is clear — to subject digital services consumed in the Philippines to 12% VAT, regardless of the residence of the service provider. However, questions may arise when these services are charged through cost allocations or recharges from a non-resident parent or affiliate. Should VAT still apply when the Philippine entity is not the direct contracting party of the NDSP, but simply bears its share of costs initially paid by its non-resident parent or affiliate? More importantly, which foreign entity would be reported as the actual NDSP and would bear the obligation of registering for and reporting the VAT?

The answer to the first question is quite straightforward since the VAT is imposed on consumption by a Philippine customer. In Q&A No. 30 of Revenue Memorandum Circular (RMC) No. 47-2025, the Bureau of Internal Revenue (BIR) confirmed that if the contracting party of the NDSP is outside the Philippines, for instance a non-resident parent or affiliate, and the costs are shared with different markets including Philippine subsidiaries, the allocated costs or recharges are to be subject to 12% VAT if these pertain to digital services consumed in the Philippines. The RMC reiterated that the VAT on Digital Services is based on consumption, not on the physical presence of the service provider in the Philippines. Accordingly, in these Business-to-Business (B2B) transactions, the Philippine subsidiary is responsible for withholding and remitting the VAT on the allocated costs attributable to the digital services it utilizes locally.

However, the RMC did not clearly discuss how this would be implemented. In particular, will a shared cost arrangement require the non-resident parent or affiliate to register as the NDSP in the Philippines, even if it merely passes on the cost and does not perform any digital services? Based on the language and objective of the law, I believe the registration requirement should remain with the third-party service provider, as this is the entity actually supplying the digital services consumed in the Philippines. It is likely that these NDSPs are also providing services to other Philippine customers and so are likely already registered for VAT. In contrast, the non-resident parent or affiliate merely acts as a pass-through entity for cost efficiency and to facilitate the income payments attributable to the digital services consumed by the Philippine subsidiary. To require the mere intermediary entity to register would unduly add an administrative burden that would negate the leverage that was gained by MNCs from such arrangements, and would not really benefit the government anyway. If at all, it would just add another layer of information that the government would have to sift through and eventually eliminate when collating information on digital services that consumed in the Philippines. Nonetheless, it would be helpful for the BIR to issue further guidance to clearly establish which entity must comply with the registration requirements and the corresponding documentation (for example, the relevant withholding tax reporting) in this type of scenario.

From a commercial perspective, the practice of imposing VAT on recharges or allocated costs may pose significant financial considerations within the global group of entities, especially if the amount of digital services is high and the Philippine customer is not able to claim the input VAT credit. The parties will need to agree on the VAT payment arrangement, whether this will be shouldered by the non-resident or by the Philippine payor. The non-resident parent or affiliate may reasonably push back against having 12% VAT withheld on the recharged amount, especially if it has already paid the full cost to the third-party service provider and it has no means to recover the VAT withheld by the Philippine subsidiary.

While the VAT withheld can be recovered by the Philippine customer/withholding agent by using it as credit against its output VAT, the withholding of tax will still require an upfront cash outlay. Certain taxpayers or industries may also not be able to immediately utilize the VAT withheld as credit (e.g., those who are engaged in VAT zero-rated transactions), or may be forced to absorb the cost (e.g., those who are engaged in VAT-exempt sales, who can only claim the input VAT as expense for income tax purposes).

In either case, regardless of the arrangement adopted by the non-resident parent or affiliate, it would be advisable for the parties to ensure that the agreement clearly states the VAT arrangement on recharges/cost allocations, and where VAT applies, the party who will shoulder the VAT due.

I hope that these matters will be clarified by the BIR soon to help support continued compliance from taxpayers. In the meantime, as digital services become deeply embedded in business operations, Philippine entities of MNCs may help manage the implications of the recharges and allocated costs by:

• Reviewing the intercompany service agreements to check whether the underlying services fall within the scope of “digital services” as defined by law;

• Coordinating with non-resident parents or affiliates and agree which entity will shoulder the cost of and account for the 12% VAT if the recharges and allocated costs are attributable to digital services consumed in the Philippines; and

• Revisiting and amending contracts to clearly describe how the services are delivered, where such services are rendered, and what type of outputs are provided. These details will help manage the risk of non-digital services being mistakenly classified as digital services subject to 12% VAT.

In navigating the complexities of the VAT on Digital Services, taxpayers can turn potential challenges into strategic advantages by aligning intercompany agreements and defining service parameters. By negotiating VAT responsibilities and staying adaptable, they can ensure compliance, and optimize operations, all while leveraging the group’s centralized procurement and digital tools for improved performance and growth.

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.

Ron Jacob Abaday is a senior associate at the Tax Services department of Isla Lipana & Co., the Philippine member firm of the PwC network.

+63 (2) 8845-2728

ron.jacob.abaday@pwc.com