INPUT VAT AS INCOME TAX DEDUCTIONS
By: Euney Marie J. Mata-Perez on July 18, 2019
Editor’s note: An earlier version of this article cited the wrong case number for Commissioner of Internal Revenue vs. Maersk Global Service Centres (Philippines), Ltd. The correct case number should be CTA EB Case No. 1786 and not 1789 as previously stated. See the link below for more information.
Should input value-added tax (VAT) or VAT passed on by a taxpayer’s supplier of goods or services be allowed as a deduction from income tax, if the claim for refund or tax credit was denied or disallowed?
To answer that question, one has to understand the difference between income taxation and the imposition of VAT.
Income tax is imposed on net taxable income (gross income less allowable deductions). In principle, it is imposed when there is “inflow of wealth”. It is governed by Title II of the National Internal Revenue Code (Tax Code).
VAT, on the other hand, is a transaction tax imposed on the sale or exchange of goods, and provision of services in the ordinary course of trade or business. It is governed by a separate title in the Tax Code.
The deductions for income tax purposes are allowed generally based on the principle that amounts are paid or incurred by a taxpayer in the development, management, operation and conduct of business to generate taxable income. On the other hand, input VAT as a deduction from output VAT is allowed based on the principle that VAT is imposed in what is “value-added” or the increase in the value of a product or service at each stage of production or distribution.
In seeking a refund of excess or unutilized input VAT (input VAT which is not applied against output VAT), a taxpayer has to present several documents, particularly the VAT invoices. The evaluation of such documents is strict, under the principle that claims for refund are akin to tax exemptions, and thus, should be strictly construed against the taxpayer. Thus, any failure to comply with the VAT invoicing requirements, such as the failure to indicate tax identification number (TIN) of the purchaser, will be fatal and will result in the denial of the claim.
The rules on substantiating income tax deductions, on the other hand, are based on a different standard. Income tax deductions are allowed generally if they are substantiated with “sufficient evidence” such as official receipts and “other adequate records”.
In several rulings and issuances, the BIR held that a denied claim for input VAT refund or credit may be treated as a deductible expense for income tax purposes if the denial is based on failure to comply with invoicing requirements. Revenue Memorandum Circular (RMC) No. 42-2003, states that the right to claim for refund or tax credit certificate is “without prejudice to the right of the taxpayer to charge the input taxes to the appropriate expense account or asset account subject to depreciation, whichever is applicable.” BIR Ruling No. DA591-2004, on the other hand, acknowledges that a denied claim for refund or credit would mean the termination of the usefulness and benefits of the input taxes, and a claimant suffers an actual loss as a result of such denial. Thus, the BIR held that such a loss should be deductible for income tax purposes.
However, RMC No. 57-2013, issued by then BIR Commissioner Kim Henares, repealed all the foregoing issuances and disallowed the income tax deduction of input VAT denied of refund or tax credit. RMC 57-2013 states “that unutilized creditable input taxes attributable to zero-rated sales can only be recovered through the application for refund or tax credit. Nowhere in the Tax Code can we find a specific provision expressly providing for another mode of recovering unapplied input taxes, particularly the proposition that unapplied input taxes may be treated outright as a deductible expense for income tax purposes.”
The foregoing should be settled in the recent case of Commissioner of Internal Revenue vs. Maersk Global Service Centres (Philippines), Ltd. (CTA EB Case No. 1786, June 13, 2019) (the “Maersk case”). The Court of Tax Appeals (CTA) En Banc held that the denial of the claim for refund of excess or unutilized input VAT led to the undesirable outcome of a risk and disappearance or diminution of value, and thus, should be considered a deductible loss for income tax purposes. The CTA considered the denied claim to have met the requirements of what is a deductible loss for income tax purposes. This ruling of the CTA apparently adopted the argument of the earlier cited BIR Ruling No. DA591-2004.
In the Maersk case, the CTA also pointed out that there is no law which prohibits a taxpayer from resorting to other modes of discovery of excess or unutilized input VAT. It held that Section 112 of the Tax Code, the provision which authorizes a taxpayer to claim input VAT refund or tax credit, uses the word “may”. This shows that the recovery of input VAT by way of tax credit or refund is an option of the taxpayer. This should not preclude the taxpayer from recovering the excess input VAT through other modes.
Thus, the CTA held that while the taxpayer may opt to claim full deduction of input VAT against its output VAT, the taxpayer may also resort to other modes of deduction or recovery, such as treating the excess input VAT as part of the cost of purchases or cost of sales, expense or loss, based on sound accounting principles or standards.
The decision of the CTA in the Maersk case is in direct contrast to the rule set out in RMC No. 57-2013. We expect the BIR to appeal the decision of the Maersk case though.