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By: Euney Marie J. Mata-Perez on August 1, 2019

There is a specific rationale behind the imposition of value-added tax (VAT). VAT was not intended to be imposed on every transaction or transfer. Its imposition must bear some relevance to the taxpayer’s role or link in the production chain. While ultimately it is a tax on consumption (since the final consumers bear the entire VAT), VAT is actually assessed on various levels of the production chain and imposed based on the “value-added” or contribution by the taxpayer in the production chain. The absence or presence of profit is immaterial.

Our Tax Code (Republic Act No. 8424, as amended) makes it clear that VAT is imposed on any person who, in the course of trade or business, sells, barters or exchanges goods, renders services, or engages in similar transactions and any person who imports goods. The overriding principle is that it is imposed “in the course of trade or business”. Ergo, if the transfer is not in the course of trade or business, no VAT should be due.

The phrase “in the course of trade or business” is defined to mean the regular conduct or pursuit of a commercial or an economic activity, including transactions incidental thereto, by any person, regardless of whether or not the person engaged therein is a nonstock, nonprofit organization (irrespective of the disposition of its net income and whether or not it sells exclusively to members or their guests), or government entity. It requires regularity–the regular conduct or pursuit of a commercial or an economic activity regardless of whether or not the entity is profit-oriented.

In the recent case of Power Sector Assets and Liabilities Management Corporation [PSALM] v. Commissioner of Internal Revenue (G.R. No. 226556, July 3, 2019), the Supreme Court reiterated its ruling in an earlier case involving the same parties that no VAT should be due on the transfer by PSALM of its assets pursuant to its mandate under the EPIRA Law (Republic Act No. 9136, or the Electric Power Industry Reform Act of 2001) to privatize assets of the National Power Corporation (NPC). The Supreme Court held that the sale of the power plant was not in pursuit of a commercial or economic activity but a governmental function mandated by law to privatize NPC generation assets.

The ruling in the PSALM case is not new. The same rationale was used by the Supreme Court in the 2006 case of Commissioner of Internal Revenue vs Magsaysay Lines, Inc. (G.R. No. 146984, July 28, 2006). In this case, the Supreme Court held that the National Development Corporation’s sale of its vessels (also pursuant to a privatization mandate) was an “isolated transaction,” not done in the ordinary course of NDC’s business, and thus not subject to VAT. The Supreme Court also held that the sale of the vessels could not be considered as a “deemed sale” transaction subject to VAT since the transaction did not fall under the enumeration of transactions deemed sale in the Tax Code.

The same principle was laid out in the recent case of the Secretary of Finance v. Century Peak Property Development, Inc. (CTA Case EB No. 1776, July 5, 2019) (the “Century Peak case”), where the Court of Tax Appeals En Banc held that a transfer of property by a real estate company pursuant to a pre-incorporation subscription, in exchange for shares in the company being established, is not deemed a sale or transfer in the ordinary course of trade or business. Thus, such transfer is not subject to VAT, even if the assets transferred are ordinary real assets of the transferor, a company engaged in the real estate business.

Also, one cannot claim that simply because the transaction is not enumerated among the VAT-exempt transactions under Section 109 of the Tax Code, that there is no basis for a VAT exemption. To properly interpret the law on VAT, one has to go back to the essence or spirit behind the VAT imposition.

Thus, transfers for control, or transfers of assets in exchange for shares in a company, or the so-called tax-free transfers under Section 40(C)(2) of the Tax Code, could not be subject to VAT, even prior to the passage of TRAIN 1 (Republic Act No. 10963). TRAIN 1 just made it clearer by including such transfers as among the VAT-exempt transactions under Section 109 of the Tax Code. However, even without such inclusion, on the basis of the principles and decisions discussed above that VAT is imposed only on transfers in the course of trade or business, transfers for control or in exchange for shares, just like pre-incorporation transfers in the Century Peak case, should not be subject to VAT at all. Such transfers cannot be deemed to be made in the ordinary course of trade or business.

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Euney Marie J. Mata-Perez

Mark Anthony P. Tamayo

Gerardo Maximo V. Francisco