By: Atty. Sarah T. Ganto on April 5,2024

With the issuance of Revenue Memorandum Circular (“RMC”) No. 5-2024, as clarified by RMC No. 38-2024, on the taxation of cross-border services, another topic tackled by the said RMCs equally merits discussion: the taxation of reimbursements among multinational enterprises.

RMC No. 5-2024 provides that reimbursable or allocable expenses charged by a foreign corporation to Philippine counterparts are considered “income because it represents a financial gain or savings” to the foreign corporation being reimbursed. The RMC states that the reimbursement will result in the foreign corporation’s receipt of additional funds which can be used for other purposes or retained as profit, and, thus, should be viewed as a form of income to the foreign corporation.

First and foremost, it is worth noting that the Supreme Court case of Aces Philippines Cellular Satellite Corp. v. Commissioner of Internal Revenue (G.R. No. 226680, August 30, 2022), which served as the foundation of RMC No. 5-2024, did not deal with the tax treatment of reimbursable expenses among multinational enterprises. RMC No. 38-2024 did acknowledge though that cross-border services usually involve related party transactions which would give rise to issues on reimbursements, and thus, it is necessary to also lay down the basic rules on reimbursable or allocable expenses for services between or among related parties.

It should be emphasized that the tax treatment on reimbursements had already been clarified by the courts, as well as by the Bureau of Internal Revenue (“BIR”) in previous issuances. 

It has been previously settled that reimbursements-at-cost (reimbursements without mark-up) are not income, and thus, are not  subject to income tax and value-added tax (“VAT”).  Reimbursements-at-cost are in the nature of expenses paid or advanced by one party for on behalf of another.  By their very nature, reimbursements are a mere return of capital, i.e., a return of amounts advanced.  Accordingly, being a mere return of capital, they cannot be income per se on the party receiving the reimbursement. 

In Commissioner of Internal Revenue v. Sony Philippines, Inc. (G.R. No. 178697. November 17, 2010), the Supreme Court affirmed the decision of the CTA En Banc which held that a subsidy for the advertising expenses made by a foreign company to its Philippine affiliate because of the adverse economic situation being experienced by the latter is not subject to VAT. The CTA En Banc held that there was no sale, barter or exchange of goods or properties nor an exchange of service by the payee. 

It is likewise worth noting that the BIR has previously recognized cost-sharing agreements among related parties, wherein parties agree to share the costs in proportion to their respective share of anticipated benefit. In Revenue Audit Memorandum Order No. 1-98 (July 7, 1998), the BIR said that such agreements should be reviewed considering various factors, such as  benefits-received, size of the company and participation in the venture.

Also, in BIR Ruling [DA-058-08] (February 1, 2008), the BIR held that no VAT and income taxes are due in a cost-sharing agreement made among affiliates on a “no-mark-up, reimbursement” basis. In this ruling, San Miguel Corporation (“SMC”) received reimbursements from its affiliates/subsidiaries (“SMC-Affiliates”) for advances SMC made on payments for utilities and services. The BIR ruled that these reimbursements did not result to any income from SMC since the payment actually represents reimbursements of expenses without any mark-up or profit on the part of SMC. Accordingly, no income tax liability should result. The BIR also held that the reimbursements received by SMC are not subject to VAT since SMC is neither engaged in the sale of services of SMC-Affiliates nor does it receive the payments from SMC-Affiliates as fee/remuneration for services rendered by SMC.

A similar ruling was held in BIR Ruling [DA-289-07] (May 9, 2007) concerning withholding taxes. The BIR ruled that income, in the broad sense, means all wealth which flows into the taxpayer other than as a mere return of capital. Reimbursement of cost is merely a return of capital and does not constitute income, because no “wealth” was received by the taxpayer. Consequently, any amount reimbursed is not subject to income tax and is not the proper subject of withholding taxes.

On a final note, while the power of taxation is an inherent prerogative of the State, its exercise is subject to limitations, one of which is income tax cannot be imposed on capital.  In Chamber of Real Estate and Builders’ Associations, Inc. v. Executive Secretary (G.R. No. 160756, March 9, 2010), the Supreme Court held that the due process clause may properly be invoked to invalidate a revenue measure when it amounts to a confiscation of property. The Supreme Court held that an income tax is arbitrary and confiscatory if it taxes capital because capital is not income.

As discussed above, there is basis in jurisprudence and taxation principles that reimbursements-at-cost are not income but merely a return of capital. Accordingly, the statements on taxation of reimbursements between or among related parties under RMC No. 5-2024 should be reviewed and applied with caution.  Such sweeping statements could have the effect of discouraging multinational conglomerates from establishing or maintaining business presence in the Philippines due to the increased taxes of doing business.

Sarah Rose T. Ganto is an associate of Mata-Perez, Tamayo & Francisco (MTF Counsel). This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. If you have any questions or comments regarding this article, you may email the author at info@mtfcounsel.com or visit MTF website at www.mtfcounsel.com.