In this time of uncertainty, COVID-19 continues to impact the public and private sectors and the way they operate. Businesses looking to cope with the challenges raised by these unusual times look for ways to innovate the way they do business.
Rethinking how business should be done, embracing the digital economy and safeguarding business continuity: these factors may lead businesses to rely on consultants or contractors for advice on improving their operations and to implement changes in their business.
Considering consultants and contractors offer different kinds of services, businesses should know the difference between consultants and contractors.
Under Revenue Regulations (RR) No. 11-2018, consultants are categorized as professionals whose income is subject to 5% / 10% creditable withholding tax (CWT), depending on the gross income of the payee, while income payments to certain contractors are subject to 2% CWT.
The RR enumerates contractors as those engaged in the business of:
- General engineering construction;
- General building construction;
- Specialty contractors involved in specialized building trades or crafts; and
- Other contractors enumerated under the RR.
Consultants, on the other hand, refer to management and technical consultants. Professional fees of consultants who are individuals are subject to 5% CWT if the current year gross income does not exceed P3,000,000.00 (3M), otherwise 10% CWT if exceeding. If the consultant is a juridical entity, their professional fees are subject to 10% CWT if the current year gross income does not exceed P720,000, otherwise, 15% CWT if exceeding.
Moreover, unlike contractors who are categorically enumerated under the RR, existing and prior regulations do not provide a clear definition on who can qualify as management and technical consultants.
The issue commonly arises when it comes time for companies to withhold taxes on payments to their vendors – whether to classify independent contractors performing management services as management and technical consultants. Without specific guidance from the tax authorities, however, withholding agents may mistakenly classify a management and technical consultant as an independent contractor or vice versa.
While the regulations do not explicitly define the term “management and technical consultant” withholding agents may find guidance from previous rulings of the tax authorities to determine the correct classification of payees.
In 2001, the Bureau of Internal Revenue (BIR) held in BIR Ruling No. 040-01 that management and technical consultants are entities engaged to supervise, direct and control the management and operation of other companies, and, normally render services to various unrelated parties. In the BIR Ruling, the tax authority held that generally management fees paid by a managed company to a managing company are income payments made to a management and technical consultant, hence subject to CWT. The tax authority qualified in BIR Ruling No. 040-01, however, that when the service is rendered by a Regional Operating Headquarters (ROHQ) limited to qualifying services to affiliates, branches and subsidiaries the payment is not subject to CWT. This was reiterated in BIR Ruling Nos. DA-265-04 and DA-733-06.
Notwithstanding these Rulings, confusion is still present in actual practice. Let’s take into consideration a scenario where the payee is a registered contractor but likewise renders management services, will it still be considered a contractor, or a management and technical consultant, for EWT purposes?
Likewise, note that the afore-cited BIR Rulings say that for the payee to be considered a management and technical consultant, it must render services to various unrelated parties. So, if the payor or the recipient of the service is a related party, does it mean that the payee should not be considered a management and technical consultant?
Given that the requirement to withhold taxes not only requires withholding but withholding using the correct tax rate, the burden is on every withholding agent to ensure that they apply the correct withholding tax rate. The determination of the correct withholding tax rate becomes crucial during tax audits or assessments, as the withholding agent can be assessed deficiency EWT and applicable penalties for failure to withhold or erroneous withholding.
While it holds true that the withholding tax system intend to ease the collection of tax, when tax rules and regulations are vague it becomes difficult for withholding agents to comply with tax regulations. It would be helpful if tax authorities consider providing clearer guidelines on management and technical consultants to achieve the aim of the withholding tax system - to simplify tax compliance and tax collection for both the taxpayers and the BIR.
Nicoleigh A. Balagtas is an Associate from the Tax Group of KPMG R.G. Manabat & Co. (KPMG RGM&Co.), the Philippine member firm of KPMG International.
This article is for general information purposes only and should not be considered as professional advice to a specific issue or entity.
The views and opinions expressed herein are those of the author and do not necessarily represent the views and opinions of KPMG International or KPMG RGM&Co. For comments or inquiries, please email ph-kpmgmla@kpmg.com.