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Documenting offsetting arrangements in a tax credit or refund

We often hear the phrase: “Taxes are the lifeblood of the Government,” as the main reason why collecting them is essential. However, there are instances when this should give way to the taxpayer’s right to claim a tax refund or credit. One such instance is a claim for tax refund or tax credit on input Value-Added Tax (VAT) arising from VAT zero-rated export sales. A taxpayer claiming this type of tax credit or refund must present at least three types of documents, as follows:

a. Sales invoice as proof of sale of goods;

b. Export declaration and bill of lading or airway bill as proof of actual shipment of the goods from the Philippines to a foreign country; and,

c. Bank credit advice, certificate of bank remittance or any other document proving payment for the goods in acceptable foreign currency or its equivalent in goods and services.

However, in case of offsetting arrangements, a taxpayer may not be able to show proof of inward remittance of foreign currency if the offsetting results in a net payable. Offsetting arrangements are made between parties for the purpose of offsetting the liabilities in favor of one against the receivables of another.

To illustrate: X (domestic company) and its affiliate, Y (foreign company) entered into an agreement whereby Y may directly conclude sales transactions and X shall provide certain support services. Y shall pay X a certain percentage of the invoice amount of direct transactions as service fees. X books the service fees as commission income and invoices the same in US dollars and offsets the same against the trade liability of X with Y. The service income of X is subject to VAT at zero percent (0%).

How does this relate to tax refunds? In Bureau of Internal Revenue (BIR) Ruling No. [DA-(VAT-009) 075-08] dated July 24, 2008, the BIR ruled that an intercompany offsetting arrangement is considered acceptable foreign currency payment in accordance with Bangko Sentral ng Pilipinas Rules and Regulations, for VAT zero-rating purposes.

Now, going back to documentary requirements for offsetting arrangements, the BIR in Revenue Memorandum Circular No. 42-2003 enumerated the acceptable proofs of the existence of offsetting arrangements, in lieu of the bank credit advice or certificate of inward remittance as proof of export proceeds, as follows:

a. Import documents which created liability accounts in favor of the foreign parent or affiliated company;

b. Other contracts with the foreign or affiliated company that brought about the liabilities which were offset against receivables from export sales;

c. Evidence of proceeds of loans, in case the claimant has received loans or advances from the foreign company;

d. Documents or correspondence regarding offsetting arrangements;

e. Confirmation of the offsetting arrangements by the heads of the business organizations involved;

f. Documents to prove actual export of goods; and,

g. Documents to prove that the sales are zero-rated sales.

In Court of Tax Appeals Case No. 7223 (C.T.A. EB No. 799), the Court clarified that the phrase “import documents which created liability accounts in favor of the foreign parent or affiliated company” means that the liability should be in favor or to the benefit of the foreign parent company or its affiliates, and therefore, at the expense or liability of the local entity. The main purpose of the provision is to prove that the offsetting arrangement is actually in place, by proving that taxpayer has payables to the foreign parent or its affiliates against its receivables from the export of goods were offset. Hence, the sales invoices issued by the taxpayer to the foreign parent are not the proper documents to prove the existence of its payables to the foreign parent. Instead, it should be supported with billings or invoices from the foreign parent to establish the existence of the liability of the domestic company to the former.

In the same manner, the “other contracts” should pertain to contracts that will also bring about liabilities of the domestic company that can be offset against the receivables from export sales. Hence, a contract that allows the domestic company to earn a commission for services rendered to the foreign parent is not useful. It should be the other way around. The domestic company should present other contracts that would support the existence of its liabilities to the foreign parent.

Given that tax credit or refunds are in the nature of tax exemptions and are strictly construed against the claimant, the latter has the burden of proof of establishing the factual basis of his or her claim.

Thus, to avoid denial, taxpayers who want to avail of the tax credit or refund must ensure that their interpretation of the tax rules and regulations is correct and the documentary requirements are on point.

Ed Warren L. Balauag is a senior associate of the Tax Advisory and Compliance division of Punongbayan & Araullo.

As published in Business World dated 31 May 2016