BIR Ruling [DA-616-06]

October 13, 2006 BIR RULING [DA-616-06] DA 257-03 SGV & Co . 6760 Ayala Avenue Makati City Attention: Atty. Cirilo P. Noel Vice Chairman & Deputy Managing Partner and Atty. Luis Jose P. Ferrer Partner Gentlemen : This refers to your letter dated December 28, 2005 stating that your client, Tupperware Philippines, Inc. (TWP), is a corporation duly organized and existing under the laws of the Philippines, with principal office address at 19th Floor, Multinational Bancorporation Building, 6805 Ayala Avenue, Makati City; that it acts as the commissionaire agent of Tupperware Products, Inc. (TPI), a non-resident foreign corporation based in the United States (US); that as commissionaire agent of TPI, TWP primarily renders marketing services to the former for an arm's length fee and is responsible for the performance of the following services, namely: (a) cultivation and expansion of the sales network (Home Party Plan) for TPI, (b) production of product catalogs, (c) promotion of TPI products, (d) processing of orders, (e) recommending distributor margins, dealer commission and product prices, and (f) monitoring the shipments and distribution of products belonging to TPI; that in late 2003, TWP, as marketing agent of TPI, launched in the Philippines a new line of products belonging to TPI called BeautiControl Products (BC Products); that BC Products are comprised of high-end imported cosmetic, beauty and healthcare products targeted to capture the A&B market of the social spectrum; that however, while developing the market for BeautiControl Products in the ensuring years of 2004 and 2005, TWP incurred significant market development expenses; that hence, in order to insure its viability as a marketing entity for the continued expansion of BeautiControl Products in the Philippines, TWP has to generate revenue to sustain its operations; that for this purpose, TWP intends to assign the commission income stream (hereafter referred to as the "Income Stream") it expects to receive from TPI for the first six (6) months of 2006 to Tupperware International Capital Limited (TCIL), a non-resident foreign corporation duly organized and existing under the laws of Ireland, with principal office address at ABN Amro House, IFSC, Dublin 1, Ireland; that in return, TICL shall pay TWP a consideration for the assignment of its Income Stream to TICL, on a without recourse basis; that thereafter, TPI, pursuant to the assignment agreement between TWP and TICL, shall deliver directly to TICL in 2006, the subject commission income sold by TWP to TICL; that under present financial accounting standards, TWP will record the consideration as deferred credit; record commission income from January to June 2006; and apply the recorded amount of commission income against deferred credit; and that for tax purposes, TWP will report the consideration at the time of its receipt in 2005 as part of its gross income and pay the income tax thereon based on taxable income as well as include the same in its gross receipts subject to VAT. In connection therewith, you now request confirmation of your opinion that "1. The consideration received by TWP for the assignment of its Income Stream for 2006, without recourse, should be included as part of TWP's gross income in 2005 and subjected to income tax based on taxable income for said year; 2. The consideration received by TWP for the assignment of its Income Stream for 2006, without recourse, is subject to VAT in year 2005 or the year the said consideration was actually received by TWP; and 3. TWP is no longer required to report any commission income for the first semester of 2006 for income and VAT purposes, as the same has already been reported by TWP for tax purposes in 2005." In reply thereto, please be informed that your opinion is hereby confirmed as follows: 1. Section 38 of Revenue Regulations No. 2, otherwise known as the Income Tax Regulations provides "Section 38. Bases of Computation . Approved standard methods of accounting will be ordinarily regarded as clearly reflecting income. A method of accounting will not, however, be regarded as clearly reflecting income unless all items of gross income and all deductions are treated with reasonable consistency. All items of gross income shall be included in the gross income for the taxable year in which they are received by the taxpayer and deductions taken accordingly, unless in order clearly to reflect income such amounts are to be properly accounted for as of a different period. . . . ." EAHDac As can be gleaned from the above-cited provision, it is clear that the recognition of income from a sale transaction must be at the point of sale. This Office had already the occasion to rule on the matter when it said in BIR Ruling No. DA257-03 dated August 28, 2003 , that "Revenue is recognized when it is probable that future economic benefits will flow to the enterprise and these benefits can be measured reliably. Thus, two conditions must be present for the recognition of revenue, namely: (a) it is probable that future economic benefits will flow to the enterprise; and (b) the economic benefits can be measured reliably. "Undoubtedly, both conditions are present at the point of sale. Accordingly, the point of sale is the point of revenue recognition. The reason is that it is at the point of sale that the enterprise has transferred to the buyer the significant risks and rewards of ownership of the goods. Revenue Memorandum Circular (RMC) No. 22-2004 provides that "in case of difference between the provisions of the Tax Code and the rules and regulations implementing the Tax Code, on one hand, and the generally accepted accounting principles (GAAP) and the generally accepted auditing standards (GAAS), on the other, the provisions of the Tax Code and the rules and regulations issued implementing the said Tax Code shall prevail." Considering that in the instant case, the sale in 2005 of the income stream of TWP for 2006 was without recourse, the risks and rewards as to the income stream have already been transferred to TICL in 2005. In other words, the title to the income stream has passed to TICL at the point of sale, and the corresponding revenue must already be recognized by TWP upon receipt of the consideration thereof. Accordingly, TWP is no longer required to report as part of its gross income in 2006 the income stream remitted by TPI to TICL pursuant to the Assignment Agreement. This is so because, the said future income has already been reported and subjected to tax as income by TWP in 2005 or in the year it actually received the consideration for the sale of the income stream for 2006. 2. Section 105 of the Tax Code of 1997, as amended by Republic Act (R.A.) No. 9337, provides that any person who, in the course of trade or business, sells, barters, exchanges or leases goods or properties, or renders services, and any person who imports goods, shall be subject to VAT on gross receipts. 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. Gross receipt refers to the "total amount of money or its equivalent representing the contract price, compensation, service fee, rental or royalty, including the amount charged for materials supplied with the services and deposits and advance payments actually or constructively received during the taxable quarter for the services performed or to be performed for another person, excluding VAT." (Sec. 4.108-4, Revenue Regulations No. 16-2005) Since the commission income to be earned by TWP in the first six months of 2006 was effectively received already by TWP in 2005 with its receipt of the consideration thereof from TICL, TWP is liable for the 10% VAT upon receipt of the consideration for the income stream. However, TWP is no longer required to report any commission income for the first semester of 2006 for VAT purposes, since TWP will no longer receive any commission income from TPI for the first six months of 2006 as ownership to the same has been legally sold and transferred to TICL. This is in consonance with the VAT Ruling No. 056-03 dated December 15, 2003 , where this Office ruled that ". . . "advance payments" and deposits for work not yet started or accomplished are already includible as part of the gross receipts subject to VAT, without waiting for liquidation through actual accomplishments (see BIR Ruling No. 181-92). Said ruling was affirmed in another case involving a contractor of the Philippine Ports Authority (PPA) where, in accordance with their contract, PPA made advance payments, which in turn the contractor reported as part of its gross receipts subject to VAT at the time of its actual receipt thereof, and which were then periodically deducted by the contractor from its subsequent billings (see BIR Ruling No. 422-93). It was further affirmed in another ruling, which states that "gross payments include the money paid out of the mobilization fund pursuant to Sec. 4.114(A) of Revenue Regulations No. 2-98". (see BIR VAT Review Committee Ruling No. 046-2000) EDSHcT "Clearly, therefore, "advance payments" for services to be performed are subject to withholding VAT at the time of its payment, whether actual or constructive; and that the eight and one-half percent (8.5%) withholding VAT being deducted and withheld by the Government, including the DPWH, from the "advance payment" made to government public works contractors has sufficient legal basis. "xxx xxx xxx" 3. Finally, TWP is no longer required to report any commission income for the first semester of 2006 for income and VAT purposes, as the same have already been reported by TWP for tax purposes in 2005. This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it will be disclosed that the facts are different, then this ruling shall be considered null and void. Very truly yours, (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service