Coming soon: VAT in the digital age

For some people, a typical weekend is spent curling up on the couch with a bowl of popcorn, immersed in their TV shows from their favorite streaming service. This, along with many other online consumption habits, is expected to become a bit more expensive as subscription fees and other digital services are likely to increase when 12% VAT starts applying to digital services supplied by non-resident digital service providers (DSPs) whose products are consumed in the Philippines.

On Nov. 12, the Bureau of Internal Revenue (BIR) conducted a public consultation to solicit inputs on the proposed implementing rules and regulations (IRR) to Republic Act No. 12023 covering VAT on Digital Services. The BIR is expected to release the final IRR by January, and non-resident DSPs will start being liable for VAT 120 days after. Let’s discuss some salient provisions of the law and draft IRR, as well as some key takeaways.

Digital Services are defined as any service that is supplied over the internet or other electronic network with the use of information technology and where the supply of the service is essentially automated.

This broad definition potentially extends to almost all, if not all, services which are performed virtually or over the internet. For instance, in the draft IRR, online consulting services (e.g., through virtual calls or e-mails) provided by foreign nationals, even if conducted remotely, may be at risk of being subject to VAT.

As consumers, we may notice increased costs for these services; for businesses, this may entail additional tax compliance obligations.

A critical factor in determining if the digital services provided by non-resident DSPs are subject to VAT is the place of consumption. The draft IRR clarifies that digital services are considered consumed in the Philippines if the consumer/user is located in the country. Also, place of consumption can be determined via several factors such as payment or credit card information, the user’s home/billing address, and access information, among others.

This point needs further contemplation. During the public consultation, questions arose on the tax treatment of scenarios where the actual user and the paying party are located in different countries. For example, would a Philippine company that subscribes to a cloud-based software accessible worldwide be subject to VAT, even if the end-users are located outside the Philippines?

While pegging the VAT to the location of the payor would simplify tax administration, doing so raises concerns regarding the consistency with the law’s intent. Following the language of the law, consumption outside the Philippines would not trigger VAT. On the other hand, in scenarios where a portion of the service fee is attributable to services consumed abroad, bifurcating revenues to ensure proper VAT application might impose additional compliance challenges on taxpayers and hinder effective implementation of the law by the BIR.

The law requires all non-resident DSPs whose gross annual sales are expected to exceed P3 million to register for VAT. However, in the draft IRR, it appears that all non-resident DSPs selling to Philippine customers are required to register for VAT, regardless of whether or not the P3 million threshold is breached. The BIR will need to clarify this matter in the final IRR to be issued to avoid any confusion.

Non-resident DSPs may also appoint a third-party service provider to help them register with the BIR, to receive notices, maintain records, file returns, among others. The appointment of a third party shall not result in the non-resident DSP being classified as a non-resident foreign corporation doing business in the Philippines for VAT purposes. In my view, this clarification indicates that these onshore services provided by the third-party service providers to a non-resident DSP would be considered zero-rated for VAT purposes if paid for in acceptable foreign currency. It would be good for the IRR to clarify that all services purchased by non-resident DSPs from VAT-registered Philippine suppliers (i.e., not limited to those provided for recordkeeping and compliance reporting) can qualify for VAT zero-rating. This is critical as non-resident DSPs are not allowed to claim any input VAT credits. Without the VAT zero-rating, digital consumers in the Philippines may also end up paying for this tax leakage if the non-resident DSPs decide to pass on the additional cost as a price hike

For simplicity and considering the existing reverse charge mechanism under Section 114 of the Tax Code even prior to the new VAT legislation, non-resident DSPs are only liable to remit the VAT on their supply of digital services in business-to-consumer (B2C) transactions, and in case they are classified as an e-marketplace (with respect to sales of non-resident sellers that go through their platform). On the other hand, business-to-business (B2B) transactions, similar to the collection method under the old VAT rules, should be accounted for and remitted by the Philippine resident business consumer.

During the public consultation, concerns were raised, however, regarding the VAT withholding by business consumers. While the law requires the VAT withholding by VAT-registered consumers, the draft IRR imposes this obligation on all business consumers, without any qualification as to the VAT registration status.

In my humble opinion, the imposition on non-VAT registered business consumers still finds basis under the general provisions of Section 114 of the Tax Code, which covers all services performed in the Philippines by non-residents. A B2B supply of digital services to a non-VAT Philippine business consumer is clearly subject to VAT, and for sure, the VAT will be passed on to and shouldered by the Philippine consumer. The only question is who is liable for the remittance. Putting the remittance obligation on the Philippine party seems to me like a simplified method for effective tax administration which is reasonable. It not only helps the BIR, but also the non-resident DSP. At least, the non-resident DSP will only need to confirm whether the Philippine customer is engaged in business, and eliminates the need to determine whether or not the Philippine business customer is a VAT taxpayer.

Further, the BIR may consider further easing the compliance burden on non-resident DSPs whose transactions are limited to B2B transactions by exempting them from VAT registration.

In determining a contracting party’s business status (i.e., engaged in business or not), both the DSPs and consumers may rely on the documents submitted by their contracting parties.

The draft regulations did not specify the required documentation to verify such status, although it was suggested during the public consultation that this may include the tax registration certificate (BIR Form No. 2303) of the consumers. This could be burdensome, especially for non-resident DSPs with numerous transactions.

In its revised IRR, the BIR may consider providing guidance on the specific documents required, including alternative options when the primary documents are unavailable; and requiring business consumers to provide the necessary documents to the non-resident DSPs.

The digital age has brought us convenience, from streaming to shopping online. Now, our tax laws are catching up with these conveniences. While I may not be totally thrilled about this personally, it’s clear that the intent is to bridge the tax gaps created by the evolving digital landscape. Let’s hope that once finalized, the IRR addresses the concerns and provide much-needed clarity on any inconsistencies to allow the effective collection of tax, without losing the convenience we’ve grown accustomed to. Else, we’ll be spending more time on compliance burdens than binge-watching our favorite shows.