Are all incidental transactions subject to VAT?
The deadline for filing the Annual Income Tax Return (AITR) in taxable year 2022 is fast approaching, and many taxpayers are striving to beat the April deadline. Once the ITR has been filed, taxpayers should start preparing for possible audit investigations that may be ordered by the Bureau of Internal Revenue (BIR). This is why it is important to determine the taxability of our transactions.
Deficiency Value-Added Tax (VAT) is going to be an area of focus by BIR auditors because this type of tax relates to the operations of the taxpayer’s business, specifically revenue. One of the common VAT deficiencies lies in transactions considered incidental transactions subject to VAT. In certain cases, the BIR assesses the taxpayer for VAT deficiency for any other transactions, either declared, isolated, or incidental, that are found to be actual or appearing to be made in connection with the course of trade or business of the taxpayer.
Hence, one of the questions of taxpayers is whether or not all incidental income is subject to VAT. Well, the answer to this is, it depends on whether such income is related to or connected with the conduct of the main business activity which is subject to VAT.
VAT is imposed upon any person who, in the course of trade or business, sells, barters, exchanges, leases goods or property, and renders services, and any person who imports goods as provided under Section 105 of the National Internal Revenue Code, as amended. Under the law, the phrase “in the course of trade or business” means the regular conduct or pursuit of a commercial or an economic activity, including transactions incidental thereto. Thus, the law also includes incidental transactions that are made during the course of a regular transaction or the main activity. Furthermore, the term “incidental” means depending upon or appertaining to something else primary; something necessary appertaining to, or depending upon another, which is termed the principal; or something incidental to the main purpose.
In the recent Supreme Court ruling in the case of Lapanday Corp. v. Commissioner of Internal Revenue (G.R. No. 186155, Jan. 17, 2023), the Court ruled that it must be clearly established that such alleged incidental income in question must be related or connected with the conduct of the main business activity which is subject to VAT. In the decision, the Court overturned the decision of the Court of Tax Appeals (CTA) sitting En Banc, because the taxpayer merely earned interest income through a loan accommodation it facilitated for its affiliates, which could not be considered as derived from a commercial or economic undertaking. Hence, the SC ruled that the interest income on loans to affiliates is not subject to VAT.
Do note that it does not follow that an isolated transaction cannot be an incidental transaction for purposes of the VAT liability. However, it must be clearly established that the transaction in question must be related or connected with the conduct of the main business activity which is subject to VAT. In fact, there are other decisions of the SC that ruled that the taxpayer’s incidental or isolated transactions may be either subject or not subject to VAT. In Mindanao II Geothermal vs. CIR (2006), the Supreme Court ruled that the sale of a Nissan Patrol vehicle by a company which was not primarily engaged in the business of selling motor vehicles may be subjected to VAT because the vehicles was part of the company’s Property, Plant and Equipment. Hence, the Court ruled that it is an incidental transaction made in the course of business, which is subject to VAT.
On the other hand, in CIR vs. Magsaysay Lines, Inc. (2006), the sale by the National Development Co. of its vessels to Magsaysay Lines, Inc. was an isolated transaction, but the Court ruled that it was not subject to VAT because it was made pursuant to the government’s privatization program, and that the transaction could no longer be repeated or carried on with regularity. In the case of Power Sector Asset and Liabilities Management Corp. (PSALM) v. CIR (2017), the Court considered the sale of power plants by PSALM as transactions not made in the course of trade or business because they show an exercise of a governmental function mandated by law for the primary purpose of privatizing NPC assets in accordance with the guidelines of RA 9163 or the Electric Power Industry Reform Act (EPIRA).
Accordingly, taxpayers should provide documentary information and determine the nature of the transaction whether it be regular, incidental, or isolated. Taxpayers should also evaluate the tax implications of their transactions, and if they should be categorized as isolated or incidental in the conduct of their regular business. As pointed out by the SC in the Lapanday case, such transactions are not transactions incidental to the taxpayer’s main business because not only are they merely isolated and not for commercial or economic purpose, but they also apparently lack any showing of a connection between the particular transaction and the primary purpose of the company.
Let’s Talk Tax is a weekly newspaper column of P&A Grant Thornton that aims to keep the public informed of various developments in taxation. This article is not intended to be a substitute for competent professional advice.
Mark Ebenezer A. Bernardo is a senior associate from the Tax Advisory & Compliance division of P&A Grant Thornton, the Philippine member firm of Grant Thornton International Ltd.