In October 2024, the Philippines joined the growing list of countries like Indonesia, Malaysia, Thailand, Singapore, and Japan, imposing a consumption tax on digital services with the enactment of Republic Act (RA) No. 12023. According to the Department of Finance, the new law ensures equitable tax treatment on all digital businesses providing services in the Philippines, leveling the playing field between local and foreign digital service providers. At the same time, it aims to boost much-needed tax collections to aid national development.
RA No. 12023 explicitly includes digital services consumed in the Philippines within the scope of Philippine taxation. Under its provisions, the supply of digital services, whether rendered by a resident or non-resident digital service provider (DSP), is considered among the transactions specifically subject to 12% value-added tax (VAT).
Let’s take a closer look at the provisions of RA No. 12023 and possible areas of concern in its implementation.
DEFINITION OF DIGITAL SERVICES
RA No. 12023 classified supply of digital services as a sale or exchange of service subject to 12% VAT. The term “digital service” is 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. As provided under the law, digital services shall include: (1) online search engine; (2) online marketplace or e-marketplace; (3) cloud service; (4) online media and advertising; (5) online platform; or (6) digital goods.
Based on the above definition, a service can be classified as a “digital service” if it meets two conditions: first, it must be supplied over the internet using information technology (IT), and second, it must be essentially automated. If either of these conditions is not met, the service cannot be considered a “digital service” and will instead fall under the traditional definition of services for VAT purposes.
Digital services may include cloud and IT infrastructure like data storage and web hosting, e-commerce platforms and payment processing, targeted digital marketing and analytics, e-learning platforms and professional networking, artificial intelligence, and interactive media, among others. On the other hand, examples of digital goods classified under digital services are digital content purchases (downloads of e-books, music, videos, games, etc.), subscription-based contents (e.g., news, music, streaming media, online gaming), digital art, and virtual assets, among others, as provided under the proposed revenue regulation of the BIR.
On the other hand, I am of the view that services performed outside the Philippines that are not essentially automated and require human interventions, although delivered through the internet and accessed in the Philippines, such as rendition of management consultancy services and technical services like advisory, provisions of designs and studies, and after-sales services like systems maintenance, etc., should not be classified as a digital service.
It is important to note that RA No. 12023 did not amend the general coverage of 12% VAT on the sale or exchange of services, which is still defined as the performance of all kinds of services in the Philippines for others for a fee, remuneration, or consideration. When the law expanded this coverage to include supply of digital services, a different section provided that digital services delivered by non-resident DSPs shall be considered performed or rendered in the Philippines if consumed in the Philippines. Another section of the law also provided that the DSP, whether resident or non-resident, are responsible for assessing, collecting, and remitting the VAT on the digital services consumed in the Philippines, subject to the provisions on withholding of VAT.
Therefore, digital services will be subject to 12% VAT if consumed in the Philippines. In contrast, services, other than digital services, will only be subject to 12% VAT if they are performed in the Philippines.
Going back to our examples of management consultancy and technical services, performed principally with human interventions but delivered through the internet, the same may not be subject to 12% VAT if the services are performed outside the Philippines, as it is still covered by the previous rules on VAT prior to RA No. 12023. However, it is important to consider the provisions of the controversial twin circulars on cross-border services issued by the Bureau of Internal Revenue (BIR) earlier this year (Revenue Memorandum Circulars No. 05-2024 and 38-2024).
REGISTRATION REQUIREMENTS FOR DSPs AND APPLICABLE TAXES
A resident DSP shall register with the BIR following the usual policies and procedures under relevant tax laws and regulations applicable to Philippine taxpayers.
On the other hand, a non-resident DSP or those with no physical presence in the Philippines are required to register with the BIR to remit the 12% VAT on the supply of digital services. RA No. 12023 reiterated the existing rules on VAT registration wherein a non-resident DSP will be required to register for VAT if the gross sales for the past twelve (12) months have exceeded P3M or if there are reasonable grounds to believe that the gross sales for the next twelve (12) months will exceed P3M.
In relation to the above-required registration of non-resident DSP, the BIR shall establish a simplified automated registration system for said taxpayers.
In view of the foregoing, questions regarding the registration requirements for non-resident DSPs may include whether a non-resident DSP who will not meet the VAT threshold will be required to register with the BIR and whether they will be subject to percentage tax under Section 116 of the Tax Code on persons exempt from VAT. Sec. 116 of the Tax Code imposes 3% percentage tax on persons whose sales do not exceed the VAT threshold and who are not VAT-registered. If the above non-resident DSPs will be subject to percentage tax, how will the percentage tax be remitted to the BIR?
RA No. 12023 mentioned the withholding of percentage taxes imposed, which may be required by the Secretary of Finance upon recommendation by the Commissioner of Internal Revenue; however, there are no express provisions for the imposition of a 3% percentage tax on the supply of digital services by non-resident DSPs who will not meet the VAT threshold.
Another possible concern is whether only the gross sales for digital services consumed in the Philippines should be considered in determining the P3M VAT threshold. The rules provide that sales specifically considered VAT exempt under Section 109 of the Tax Code should not be considered in determining the VAT threshold. However, supply of digital services by the non-resident DSPs consumed in other countries does not squarely fall under the enumerated VAT exempt transactions. Considering this, does it mean that the sales by the non-resident DSPs for digital services consumed outside the Philippines should also be considered in determining the gross sales on which the VAT threshold will be applied, or should they be excluded considering that digital services consumed outside the Philippines are not covered by our VAT laws?
REMITTANCE OF 12% VAT ON DIGITAL SERVICES
A resident VAT-registered DSP supplying digital services to consumers, regardless of whether the latter are engaged or not engaged in business, is liable for remitting the 12% VAT by following the usual policies and procedures in filing VAT returns.
On the other hand, for digital services supplied by a non-resident DSP, the 12% VAT can either be remitted directly by the non-resident DSP or withheld and remitted by the Philippine buyer-consumer in what the law described as a reverse charge mechanism. As such, the non-resident DSP must determine whether its customer is engaged in business by obtaining supporting documents and other evidence from its customers.
If the consumer is not engaged in business, the non-resident DSP is directly liable for filing a VAT return and remitting the 12% VAT on the digital services consumed in the Philippines. For this purpose, including receiving notices and record-keeping, the non-resident DSP may appoint a third-party service provider, such as a law firm or an accounting firm.
If the customer is engaged in business, including the government or any of its political subdivisions, instrumentalities, agencies, and GOCCs, said customers shall withhold and remit the 12% VAT due on their purchase of digital services consumed in the Philippines by filing a monthly withholding VAT return.
Issues arise in cases where the customer is engaged in business but is non-VAT registered. Will they be required to withhold the VAT on the digital services? Considering that the 12% VAT is tax imposed on the non-resident DSP but passed on only to the customer, non-VAT registered suppliers may still be required to withhold and remit the 12% VAT.
Furthermore, if a VAT-registered non-resident DSP is classified as an e-marketplace, it shall remit the VAT on transactions of non-resident sellers or merchants that go through its platform, provided it controls key aspects of the supply and sets any of the terms and conditions in supplying the goods or involved in the ordering or delivery of goods.
INVOICING REQUIREMENTS FOR NON-RESIDENT DSPs
A resident VAT-registered DSP shall comply with existing rules on the issuance of invoices.
For a non-resident DSP, there will be a new compliance requirement of issuance of digital sales or commercial invoice for every sale, barter, or exchange of digital services made, with the following information: (1) date of the transaction, (2) transaction reference number, (3) identification of the consumer (including Tax Identification Number); (4) brief description of the transaction; and (5) the total amount with the indication that such amount includes VAT.
The above requirement applies whether the customer of the non-resident DSP is engaged in business or not. Take note that based on the above provisions, the total amount of sales, including VAT, should be indicated in the invoice even though the customer of the non-resident DSP is engaged in business and liability for remittance of VAT is actually shifted on to said customers, as previously discussed.
Also, note that VAT paid by the above customers can be claimed as input VAT credit or as part of cost/expense, as the case may be, depending on whether the customer is VAT-registered or not. For those claiming input VAT, what will then be the primary support for claiming input VAT credit? Will this be the digital invoice issued by the non-resident DSP; hence, failure by the non-resident DSP to issue a digital invoice or issuance of a digital invoice with incomplete information will result in disallowance of the claimed input VAT credit? I wish to highlight that the existing VAT regulations provide that the withholding tax remittance return filed by the resident payor on behalf of the non-resident evidencing remittance of VAT due will be sufficient proof of claiming input VAT credit for VAT withheld on services rendered by non-residents.
RA No. 12023 became effective on October 18, 2024. Nonetheless, the transitory provision of the law provides that non-resident DSPs shall immediately be subject to VAT after 120 days from the effectivity of the implementing rules and regulations. Accordingly, the BIR has until 90 days from the effectivity of the law (or until January 16, 2024) to issue the implementing revenue regulations.
We can't stop the wave of digitalization because it brings so many economic benefits, making it an essential part of our modern world. As such, new legislation is important in order for our tax laws to catch up with the ever-evolving transactions they regulate. The enactment of RA No. 12023 marks a new upgrade in our tax laws, and we hope that it is an update that we need for a more equitable and efficient tax system.
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.
As published in BusinessWorld, dated 19 November 2024
