Revisiting DST on advances between affiliates
Assets = Liabilities + Equity.
It is the basic accounting equation that should be familiar to those in the world of business and even business students. These three are presented in the statement of financial position (or balance sheet’ as it is usually called). The balance sheet gives various stakeholders such an important view of the business, it is normally the first part to be presented in a complete set of financial statements (FS). For instance, potential investors may conclude that a company encumbered with a substantial amount of liabilities will consequently incur a significant amount of interest expense, which could negatively affect the bottom line.
Another stakeholder with an interest in a company’s liabilities would be the Bureau of Internal Revenue (BIR). Under the Tax Code, documentary stamp tax (DST) is imposed on every original issuance of debt instruments, including loan agreements, promissory notes, and other instruments representing borrowing and lending transactions, at the rate of P1 on each P200, or fractional part (effectively 0.5%), of the issue price of any such debt instruments.
In a landmark Supreme Court (SC) case decided en banc, the high court held that instructional letters, as well as the journal and cash vouchers evidencing advances extended by a company to its affiliates, qualify as loan agreements subject to 0.5% DST. Since the promulgation of the SC decision in 2011, there have been a number of tax cases that touch upon this particular issue as discussed below.
DST ON ADVANCES TO/FROM A PHILIPPINE BRANCH
In a 2014 Court of Tax Appeals (CTA) case involving a Philippine branch, the BIR assessed deficiency DST on the branch’s cash advances booked under its “due to/from accounts” in 2007, including advances to/from its head office, parent company, and affiliates. In its decision, the CTA agreed with the BIR’s assessment of deficiency DST. The tax court held that the general rule that a foreign corporation is the same juridical entity as its branch office in the Philippines cannot apply to the taxpayer’s case on the basis that when a foreign corporation transacts business in the Philippines independently of its branch, the principal-agent relationship is set aside.
On appeal, the CTA sitting en banc decided in 2015 to affirm the tax court’s earlier decision, adding that the SC decision applies retrospectively (i.e., from the effectivity of the related DST provisions), not just from its promulgation in 2011.
DST ON ADVANCES FROM STOCKHOLDERS
In 2015, the CTA sustained the assessment of deficiency DST on advances from stockholders for the tax year 2008. Citing the definition of “affiliates” from the Philippine Accounting Standards, the CTA held that a stockholder is within the scope of a related party and therefore, the 2011 SC decision involving affiliates would apply. Hence, advances to or from shareholders shall be subject to DST.
DST ON ADVANCES FROM AFFILIATES AS DISCLOSED IN THE NOTES TO THE FS
Last year, a CTA decision upheld the deficiency DST assessment for the tax year 2009 on advances from affiliates on the basis of disclosures presented in the Notes to the FS. According to the CTA, since the transaction is clearly shown and declared in the Notes, its existence cannot be denied. Furthermore, the tax court noted that it would be relatively easy for any taxpayer to circumvent the law on DST by simply hiding the corresponding and/or supporting documents if these are required to be presented to prove the existence of the taxable transaction.
DST NOT APPLICABLE TO FUNDS RECEIVED FROM HOME OFFICE’
Interestingly, a more recent CTA case decided just last month held that “funds received from home office” by a Philippine branch are not subject to the 0.5% DST on debt instruments. While the CTA took note of its previous decision in the 2014 case mentioned earlier, the tax court found the said case inapplicable considering that no cash and journal vouchers evidencing intercompany advances and no intercompany trade payables and receivables that can be considered debt instruments were mentioned in this case. Additionally, the assessed deficiency DST in the 2014 case was based on accounts such as “due from head office and parent company” and “due to parent company and affiliates,” which meant that not only was the head office involved in the said case but also the parent company and affiliates, which have separate legal personalities.
By contrast, only the “due to home office” account is involved in this 2017 CTA case. As such, the tax court concluded that neither the home office nor the Philippine branch in this particular case transacted business with another entity. The CTA also noted that the “due to home office” account of this Philippine branch appears in the “Equity” section of the balance sheet and not as part of “Liabilities.” The foregoing considered, the CTA deemed the transactions recorded under “due to home office” as simple internal dealings within the same legal entity and therefore not subject to the 0.5% DST.
In view of the cases cited above, the following are factors that may be considered in determining whether the 0.5% DST would apply on advances between affiliates:
• The existence of the advances must be established (e.g., evidenced by inter-office memos, cash and journal vouchers, or disclosures in the Notes to the FS).
• Advances qualify as loan agreements or debt instruments if they represent borrowing and lending transactions, and accordingly recorded as intercompany payables or receivables, not as equity accounts.
• The parties involved fall within the definition of related parties’ or affiliates.’
• The affiliates involved are treated as separate and distinct taxpayers. In the case of a Philippine branch of a foreign corporation, the DST would apply when a foreign corporation transacts business in the Philippines independently of its branch. On the contrary, internal dealings within the same legal entity would not trigger DST.
Intercompany and intracompany advances are common transactions among both multinational and local companies. That said, we can expect the BIR to continue scrutinizing such transactions in part due to its pursuit of assessing deficiency DST on these advances. While the DST imposed is a relatively small percentage of the transaction amount, there are instances when these advances amount to millions (or even billions) of pesos which could translate to a substantial DST impact.
Considering that a seemingly straightforward transaction could have significant tax consequences, it is as important as ever to stay up-to-date with recent tax-related developments.
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 firm will not accept any liability arising from the article.
Marion D. Castañeda is an assistant manager belonging to the tax services department of Isla Lipana & Co..