Having guidelines in navigating the complex web of taxation is pivotal to a well-informed and prosperous society. There is a challenge for the Government and tax authorities to align rules and regulations with the evolving economic and societal needs while clearing out gray areas along the way.
The determination of the prescriptive period and the assessment of tax liabilities during tax audits require careful consideration due to some of its complexities. In a recent case decided by the Supreme Court concerning a domestic corporation (Petitioner), the significance of the prescription period in assessing value-added tax (“VAT”) deficiency and the issue of VAT imposed on interest on loan transactions were brought to the forefront. The decision, in this case, hinged on the impact of the taxpayer’s amendment of return to the prescriptive period to assess and on when loan transactions are considered incidental business transactions subject to VAT.
On the issue of prescription, Section 203 of the National Internal Revenue Code of 1997, as amended, (“Tax Code”) provides that internal revenue taxes shall be assessed within three (3) years after the last day prescribed by law for the filing of the return or from the day the return was filed, whichever is later. Considering that the Petitioner’s VAT declaration was originally filed on 25 April 2000 and the Formal Assessment Notice was issued on 21 January 2004, it was protested that the assessment of its VAT liability has been prescribed. The Petitioner argued that the three-year prescriptive period for assessment shall be counted from the filing of the original return unless a subsequent return filed at a later date contains substantial amendments. It is to be noted that the subsequent return filed by the Petitioner on 04 September 2001 did not change the VAT payable as it merely corrected its mistake of filing BIR Form No. 2550M instead of BIR Form No. 2550Q. However, the petition was initially dismissed by the CTA First Division and CTA En Banc, ruling that the first return (BIR Form No. 2550M) is distinct and different from its second filed return (BIR Form No. 2550Q). The Supreme Court, however, ruled that a substantial amendment is an increase or reduction of either taxable sales/receipts or input VAT for any of the months of the taxable quarter, which would lead to a corresponding change in the amount of VAT payable for the quarter. However, there was no such alteration in this case.
Given the foregoing, it was ruled that the prescriptive period should commence from the filing of the original VAT return (i.e., 25 April 2000), which the government only had until 25 April 2003 within which to assess the Petitioner on its VAT return for the first quarter of 2000. Due to the passage of time, the Bureau’s pursuit of the case was legally prevented due to the statute of limitations.
On the issue of VATability of interest on loans granted, generally, only transactions that are made “in the course of trade or business” are subject to VAT pursuant to Section 105 of the Tax Code. The phrase "in the course of trade or business" means the regular conduct or pursuit of commercial or economic activity, including transactions incidental thereto.
The Commission of Internal Revenue (“CIR”) contended that the Petitioner’s loan assistance to its affiliates is incidental to the latter’s business and the interest on such should be subject to VAT. The Petitioner opposed this and considered the loan transactions to be outside the scope of VAT, as they were not income derived from its regular trade or business. The Petitioner further supported its assertion by adding that such activity or transaction is merely occasional and for accommodation since it granted only five loans and only on three occasions during the entire year 2000. However, the Supreme Court’s rationale in considering whether a loan transaction is incidental was not based on the regularity or habituality, but on whether it is something else primary or incidental to the main line of business. Looking at the instant case, there is an apparent lack of basis showing the connection between the granting of financial assistance and the Petitioner’s primary purpose of providing management services to clients. Hence, the Supreme Court ruled in favor of the Petitioner taxpayer that VAT should not be applied to the interest income on the loans.
The Supreme Court's decision on this case provides much-needed legal certainty for taxpayers filing returns without substantial amendments and for taxpayers engaging in loan activities that fall outside their ordinary trade or business. This provides some clarity on the reckoning period of the three years of assessment and the consistency of our tax laws governing the nature of incidental transactions. The court drawing finer lines of distinction allows taxpayers to have a clearer understanding of their rights and obligations, ensuring consistency and reducing potential confusion.
Striking a balance between the rights of taxpayers and the government's need for revenue collection fosters transparency and fairness within the tax system. This ultimately allows taxpayers to plan their financial affairs with confidence while ensuring that revenue authorities can fulfill their collection duties effectively.
Diego Jerico Dakiwag
KPMG in the Philippines