Regina Capital Development Corporation

July 18, 2008 BIR RULING [DA-(C-010) 058-08] 24; 27; 57 (B); 106; 108; 237; 019-2005 Regina Capital Development Corporation Unit 806, Tower 1 PSE Plaza, Ayala Avenue Makati City Attention: Ms. Marita A. Limlingan President & CEO Gentlemen : This refers to your letter dated January 23, 2008 requesting for a ruling relative to the tax aspects of Regina Capital Development Corporation's (RCDC) electronic marketplace for issuing and trading commercial receivables evidenced by invoices and other documents evidencing trade related transactions which is titled Trade and Services Related Dealing and Quotation (TRESDAQ) and more particularly for confirmation of your opinion on the following: 1. The discount upon auction of the Receivable/Invoice will be a deductible loss from the gross income of the Commercial Trading Partner (CTP); 2. The 1%/2% withholding tax that the Corporate Acceptor will withhold on the face amount of the invoice is creditable against the income tax payable of the CTP; 3. For purposes of the VAT on the sale of goods and services, the CTP will be deemed to have received payment upon sale of the Receivable at the auction. No VAT is due on the sale of the Receivable/Invoice by the CTP or by the subsequent owners thereof; 4. No DST is due on the sale of the Receivable/Invoice by the CTP or by the subsequent owners thereof; 5. No Tax is due on the transfer of the Receivable/Invoice by the CTP in trust to RCDC (or to any other Broker/Dealer acting as trustee for the CTP; ASaTHc 6. The income realized upon secondary transfer of the Receivables/Invoices is subject to regular income tax; however, it is not subject to creditable or final withholding tax or to capital gains tax; 7. In case it is a financial intermediary that realizes income on the sale of the Receivable/Invoice, the income is subject to Gross Receipts Tax; 8. The Corporate Acceptor shall be able to avail of the input VAT paid on the Receivable/Invoice even if the CTP has not issued any official VAT receipt or VAT invoice, and that the following shall be acceptable: 1. For sale of goods the invoice issued by the CTP; 2. For sale of services (a) the invoice issued by the CTP, and (b) the Settlement Receipt issued by the Trustee. 9. Electronic data or information stored in connection with TRESDAQ ( i.e., invoice, invoice receipt, assignment documents of the invoice that may not have paper or hard copy counterparts, but remain in electronic form stored in the Document Hub) shall be sufficient compliance with Section 235 of the Tax Code to preserve and maintain accounting records. It is represented that: 1. The practice of merchants selling their trade receivables arising from their sale of goods or services on credit has long been established as being merely an alternative means of collection; that historically, merchants have sold their receivables to financial institutions on a private, direct, bilateral basis. 2. The Securities Regulation Code now allows for the classification of these receivables evidenced by invoices ("Receivables") as securities which can be registered and sold to investors. In this request letter, the terms "receivable" and "invoice" are used interchangeably. Whenever the term "invoice" is used, this shall specifically mean trade and services related receivables evidenced by invoices. AHEDaI 3. The principle of the sale of receivables/invoices as an alternative collection method remains the same. The innovation is that the merchant is now able to potentially access more funders. 4. Section 37, Registration of Innovative and Other Trading Markets, of the Securities Regulation Code (SRC) authorizes the Securities and Exchange Commission ("SEC") to promulgate rules for the registration and licensing of innovative and other trading markets or exchanges. In this regard, RCDC submitted TRESDAQ for licensing with the SEC last April 2007. 5. It is worth emphasizing that the underlying commercial transaction as well as the resulting creation of the trade receivable has already been assessed with the corresponding taxes such as VAT and creditable withholding taxes. Traditional sales of receivables/invoices do not create new tax obligations on the part of the parties to the underlying commercial transaction because of the view that this is a mere collection alternative. This treatment is expected to hold true as well if the receivables/invoices are sold through TRESDAQ. 6. You have successfully completed all documentary and operational requirements of the SEC. On the 28th of December 2008, the SEC, with the Commissioners approving application en banc, conferred RCDC with an Alternative Trading System ("ATS") license for TRESDAQ. 7. Under the ATS Rules of the SEC, an ATS is any organization, association, person, or group of persons, or system: That constitutes, operates, maintains, or provides an electronic market place or facility for bringing together: i. Primary market issuers of securities of SEC-registered small, medium, growth, venture enterprises and technology-based ventures, and the investors who wish to purchase those securities; ii. Primary market issuers or innovative registered securities of any kind of SEC-registered enterprise and the buyers of those securities; IEAacS iii. Secondary market sellers and buyers or securities of SEC-registered small, medium, growth, venture enterprises, and technology-based ventures; iv. Secondary market sellers and buyers of innovative registered securities of any kind of SEC-registered enterprise: v. Primary issuers and buyers and secondary sellers and buyers of other securities as may be approved by the Commission; or for otherwise performing with respect to securities, the functions commonly performed by a recognized exchange or clearing house: . . ." 8. The receivables/invoices to be traded in TRESDAQ are evidence of indebtedness of the large corporations with good credit standing which purchase goods from the merchants, initially to the merchants, and eventually to whoever may acquire the receivables/invoices. The said receivables/invoices are fixed income securities, and TRESDAQ itself will be a licensed alternative trading system (ATS) which is a marketplace like an exchange. 9. By way of milestones over the last three years, you refer to the prior work established by the Development Bank of the Philippines ("DBP") for their Marketplace for SMES/Suppliers Receivables Purchases (M4SME-RP) which they applied for and secured an ATS license from the SEC in 2005. DBP applied for a tax ruling for M4SME-RP and was favored by the BIR with Revenue Ruling 019-2005 issued on September 21, 2005. caDTSE 10. RCDC, in its ATS license application with the SEC, represented that similar to the DBP application, it will likewise list and trade commercial receivables evidencing the indebtedness obligations of large corporations with good credit standing which purchase goods or services from suppliers and to whomever will subsequently acquire said receivables/invoices. As allowed by Sec. 37 of the SRC, these receivables/invoices are classified as innovative securities and so registered with the SEC. 11. The essential difference between the TRESDAQ and DBP's M4SME-RP is the economic classification of the originator of said receivables. M4SME-RP was purposely limited only to Small and Medium Enterprises (SMEs). On the other hand, RCDC has validated the desire and need of large corporations to go past the self-imposed limitation of the innovative security to only SMEs and to embrace suppliers of any size. All other operational and documentation aspects will be identical between TRESDAQ and M4SME-RP in keeping with the preferences so stipulated by the SEC. 12. TRESDAQ aims to assist commercial enterprises by providing a ready electronic market for the discounting of their trade receivables/invoices. They will no longer have to wait to collect on the purchase price of goods and services delivered to and accepted by large creditworthy corporations, a vast improvement over the time-tested paper-based method of discounting paper receivables/invoices. At the same time, large corporations reduce their cost of borrowing and generate the equivalent of working capital through an alternative means of credit accommodation. 13. RCDC has the following expectations for TRESDAQ. a. Firstly, RCDC expects that TRESDAQ will assist in the government's tax collection efforts. By providing financing facilities to commercial enterprises, RCDC hopes to encourage visibility of commercial transactions in this sector. RCDC will also require that the counter-parties be large corporations with their operations captured by automated general ledger, and that they turn over their accounts to the BIR on a consistent and regular basis. Thereby, TRESDAQ will effectively elevate those commercial enterprises which will participate in the TRESDAQ from the informal to the formal sector of our economy. DAETHc b. RCDC likewise expects that TRESDAQ can improve the collection cycles of the National Government. In the case of receivables/invoices arising from the delivery of services, if rediscounting occurs, the possibility arises that the timing of the recognition of VAT liability will differ or diverge between the vendor and the vendee ( i.e. the large credit worthy corporation). RCDC proposes that the vendor of services has already constructively received his income on the day he receives the funds from rediscounting his receivable/invoice while the vendee records his input VAT on the actual date of payment of the receivable/invoice. c. RCDC also expects that the TRESDAQ, will initially start on a small scale as the commercial and financial institution participants gain experience with the innovative paradigm. However, RCDC believes that as familiarity increases, broad market acceptance and increasing participation and trading volumes in TRESDAQ will follow. d. RCDC also believes that there are significant gains to be earned as far as attainment of National Government objectives on economic development if it were to work hand in hand with the BIR on TRESDAQ. Enabling Commercial Trading Partners (CTPs) to sell their receivables in TRESDAQ provides clear, substantial, and immediately realizable gains for the CTPs to make their commercial transactions visible to the BIR. This is because participation in TRESDAQ allows the CTPs to fund themselves at attractive interest rates without the need to provide extensive collateral or documentation about themselves. e. TRESDAQ involves the application of information technologies through the establishment of an "electronic hub" where the authentication and storage of accepted receivables evidenced by invoices shall be undertaken without the use of traditional-paper documentation. It is envisaged that the transactions under TRESDAQ shall be carried out electronically. Thus, through the TRESDAQ, RCDC will be harnessing technologies that are in compliance with the intentions and requirements of the E-Commerce Act of 2000, most important of which is the endowment of legal effect to the documents that will be processed by the Document Hub. STIHaE In reply thereto, we hereby rule on the issues raised as follows: 1) Loss incurred in a sale of receivable at a discount is a deductible item from gross income. Thus, if a taxpayer acquires an account or note receivable in payment for inventory or services rendered, reports it as income, and sells it at a discount, the sale is accorded ordinary loss treatment. (Mertens, Law of Federal Income Taxation, Section 22.25) Accordingly, the discount upon auction of the invoice will be a deductible loss from the gross income of the CTP. However, the CTP must declare as gross receipt the whole amount of the trade receivables and not the discounted amount only. 2) Pursuant to Revenue Regulations (Rev. Regs.) No. 6-85 implementing Section 57 (B) of the Tax Code of 1977, as amended by Rev. Regs. No. 12-94, as further amended by Rev. Regs. No. 2-98, as further amended by Rev. Regs. No. 17-2003, in order that income payments to the CTP will be subject to the 1% or 2% creditable withholding tax (CWT), as the case may be, the Corporate Acceptor (CA) must be among the top ten thousand (10,000) private corporations, as determined by the Commissioner, and has transacted at least six (6) transactions with the CA, regardless of the amount per transaction, either in the previous year or current year (BIR Ruling No. 141-94 dated September 20, 1994). Thus, under Revenue Memorandum Circular No. 28-94, a taxpayer will be subject to the withholding provisions when he receives a notice that he is included in the list of the top 10,000 corporations (BIR Ruling No. 166-94 dated December 5, 1994). Accordingly, the large corporation shall be constituted as withholding agent of its suppliers, the CTPs. For as long as the above conditions are complied with, the 1% or 2% CWT, as the case may be, the CA will withhold on the face amount of the invoice shall be credited against the amount of income tax due of the CTP (Section 204, Revenue Regulations No. 2). In addition, other withholding tax rates may be applicable depending on the nature of the business of the CTP. The CWT shall be applied against the selling price of the goods/services appearing in the invoice receipt. Notwithstanding that the CTP has assigned the invoice and is no longer the payee of the invoice on maturity date, the CTP is still entitled to the CWT withheld by CA as the amount of invoice that will be assigned will be net of the withholding tax. 3) Pursuant to Sections 106 (A) and 108 (A) of the Tax Code of 1997, there shall be levied, assessed and collected, a value-added tax (VAT) equivalent to 12% of gross selling price derived from the sale or exchange of goods and/or 10% on the gross receipts derived from services performed or to be performed, excluding the VAT. ECTIHa Thus, in the case of sale or exchange of goods, the 12% VAT is automatically due upon exchange or sale of such goods or properties, irrespective of the time of payment of the same. On the other hand, in the case of sale of services, the 12% VAT does not become due until income is actually or constructively received by the taxpayer. In the case at hand, the CTP shall be considered to have constructively received income or deemed to have received payment only upon sale of the invoice at the auction for purposes of the imposition of the VAT on its sale of services. On the other hand, despite the classification of the invoice as securities, the sale by CTP of the same is not subject to VAT. In VAT Ruling No. 16-97 dated February 27, 1997, this Office held that the sale of account receivables to banks and/or financial institutions in the nature of financing arrangement is a mere collection alternative. Since such sale on credit was already subjected to VAT, the financing scheme intended to convert the account receivables of the seller to cash is no longer subject to another round of VAT under Section 100 of the Tax Code of 1997. However, the net trading gains derived from the subsequent trading of the invoice as securities is subject to the 12% VAT computed by multiplying by 12% the net gain realized from its trading, which gain is the spread between the yield or selling price from trading of such securities and the cost (carrying cost net of unearned discount) of obtaining the same. The net trading gain shall be considered as the gross receipt in the said transaction. Notwithstanding the foregoing, banks and non-bank financial intermediaries, however, are not subject to VAT but to gross receipt tax (GRT) in accordance with Republic Act (R.A.) No. 9238, as implemented by Rev. Regs. No. 9-2004. Thus, even if they act as brokers or dealers of the invoices that will be traded in the TRESDAQ, their earnings will not be subject to VAT but to GRT. 4) In view of the amendment made by R.A. No. 9243 (which took effect on March 20, 2004) to Title VII of the Tax Code of 1997, fixed income and other securities traded in the secondary market or through an exchange are exempt from DST. [Now paragraph (g) of Section 199 of the Tax Code, as amended]. Accordingly, and since the receivables of a CTP from the CA (evidenced by invoices) are going to be traded at the TRESDAQ as securities, the said invoices/receivables traded therefore are exempt from DST. 5) An implied trust was created between the CTP and RCDC [or any other trustee] upon the transfer by the former to the latter of the invoice pursuant to Articles 1448 and 1453 of the New Civil Code. Such being the case, no capital gains tax (CGT) is due on the transfer of the invoice by the CTP in trust to RCDC (or to any other trustee for the CTP). cEAaIS Sections 24 (C), 24 (D) (1), 27 (D) (2) and 27 (D) (5) of the Tax Code of 1997 impose (CGT on the sale of shares of stock and real property only, thereby, sale of any other property, other than those mentioned therein, shall not be subject to the capital gains tax. Accordingly, the sale of invoice by the CTP to the winning bidder will not be subject to capital gains tax since the invoice does not constitute capital assets of the CTP. 6 & 7) Your opinion is confirmed that the sale of invoice by the Broker/Dealer among themselves and to individual investors shall be subject to the GRT on financial institutions pursuant to R.A. No. 9238, as implemented by Rev. Regs. No. 9-2004, which excludes "services of banks, non-bank financial intermediaries performing quasibanking functions, and other non-bank financial intermediaries" from the coverage of VAT beginning January 1, 2004, thereby reverting to the GRT system. The GRT shall be applied to the net gain realized from the trading of the invoice, which gain is the spread between the yields or selling price from trading of such invoice and the cost (carrying cost net of unearned discount) of obtaining the same. In the light of what tax regulations consider as gross receipts of financial institutions from financial intermediation, the sale of the invoice by the Broker/Dealer will not be subject to CGT. Moreover, considering the short-term character of investments in the invoice even by non-banks, such invoice cannot be considered capital assets under Section 39 of the Tax Code, and hence, any gain from sale thereof does not constitute capital gain but ordinary income. The spread earned by an owner/part-owner of the invoice subsequent to the CTP ( i.e., from the winning bidder to the final owner/s at maturity) on the sale of the invoice to other Broker/Dealers or to individual investors results in a trading gain which becomes part of his ordinary income subject to the regular individual or corporate income tax. The income derived from the sale and purchase of receivables, being yield or monetary benefit derived by the Broker/Dealers on their traditional lendings, is not subject to final or creditable withholding tax. As explained under RMC No. 39-85, traditional finance company activities such as the extending of credit facilities to consumers and to industrial, commercial or agricultural enterprises by buying and selling of accounts receivables and other evidence of indebtedness, are not subject to withholding tax. TEAICc Neither is the income realized by non-bank investors subject to withholding tax, as it is not among the types of income covered by the withholding tax regulations. Accordingly, the income realized upon secondary transfer of the invoices is subject to regular income tax; however, it is not subject to creditable or final withholding tax or to CGT. Further, since the transfer of the invoice by the Broker/Dealer to investors is on a without recourse basis, it will not, therefore, constitute as an investment in deposit substitutes as defined under Section 22 (Y) of the Tax Code and, thus, not subject to the 20% final withholding tax imposed under Rev. Regs. No. 2-98, as amended. Instead, any gain, profit or income that may be realized by an investor will constitute part of his/its ordinary income which shall be taxed in the following manner: Individual Citizen 5%-32% (schedular rates) Resident alien individual 5%-32% (schedular rates) Non-resident alien individual 5%-32% (schedular rates) doing business in the Philippines Non-resident alien not individual 25% doing business in the Philippines Domestic corporation 32% Foreign Corporation doing 32% business in the Philippines Foreign Corporation not doing 32% business in the Philippines In case it is a financial intermediary that realizes income on the sale of the invoices, the income is subject to GRT. SCHATc 8) In case the invoice is auctioned, upon receipt by the Trustee of payment for the sale of the invoice, the CTP shall be liable for payment of the output VAT on the underlying transaction (applicable to sale of services only). Although in sale of services VAT does not become due until income is actually or constructively received, the CTP will be deemed to have collected the receivable which comprises its gross receipt upon the sale or discounting of the invoice. Consequently, the CTP immediately becomes liable for the 12% VAT on its gross receipt upon the sale or discounting of the invoice, which ultimately represents payment for the sale of services (VAT Ruling No. 47-98 dated December 2, 1998). As stated beforehand and as a distinction from the above foregoing, the 12% VAT on sale of goods is automatically due upon sale or exchange of such goods. The Output VAT on both sale of goods and services shall be computed on the basis of the original face amount of the invoice stored in the records of the Document Hub, particularly the invoice receipt of the CA, which may be crossreferenced against the physical books of accounts of the CTP. The records shall be sufficient basis for the computation of the output VAT due on the sale of goods and services by the CTP to the CA, notwithstanding that no official VAT receipt may have been issued by the CTP. The month/quarter when input VAT may be claimed by the CA depends on whether the CTP sold goods or rendered services. Thus, in case of sale of goods, the CA may claim input VAT on the basis of the seller's invoice while in case of sale of services, the CA may claim input VAT only upon presentation of the corresponding official receipt. Although the invoice may have a maturity much later, say, 90 days, after it is issued, and the CTP opts to assign the invoice immediately, thereby becoming liable for the output VAT, the CA may avail of the input VAT paid on the invoice even if the CTP has not issued any official VAT receipt or VAT invoice. In lieu of the official VAT receipt or VAT invoice, the following shall be acceptable: a. For sale of goods the invoice issued by the CTP b. For sale of services b.1. The invoice issued by the CTP, and b.2. The Settlement Receipt issued by the Trustee The electronic invoice/settlement receipt issued should be in the name of the buyer-claimant. cDHCAE The foregoing shall be an exception to the rule that for purposes of claiming the input tax the official VAT receipt or VAT invoice shall be the primary document to substantiate the claim. The said exception to the rule is in consonance with the effectivity of E-Commerce Act of 2000. 9) Pursuant to the E-Commerce Act, information shall not be denied validity or enforceability solely on the ground that it is in the form of an electronic data message of electronic document, purporting to give rise to such legal effect. Electronic data messages or electronic documents shall have the legal effect, validity and enforceability as any other document or legal writing, particularly: a. A requirement under the law that information is in writing is satisfied if the information is in the form of an electronic data message or electronic document. b. A requirement under law for a person to provide information in writing to another person is satisfied by the provision of the information in an electronic data message or electronic document. c. A requirement under law for a person to provide information to another person in a specified non-electronic form is satisfied by the provision of the information in an electronic data message or electronic document if the information is provided in the same or substantially the same form. d. Nothing limits the operation of any requirement under law for information to be posted or displayed in specified manner, time or location; or for any information or document to be communicated by a specified method unless and until a functional equivalent shall have been developed, installed, and implemented. (Section 7, E-Commerce Act) The last paragraph of Section 237 of the Tax Code of 1997 provides that the Commissioner may, in meritorious cases, exempt any person subject to an internal revenue tax from compliance with the provisions thereof. IaEHSD Since as represented, the transactions will be carried out, and all documents stored electronically under the strict guidelines of the Electronic Commerce Act of 2000 (E-Commerce Act) applying new technologies to TRESDAQ in such a manner as to ensure the integrity and reliability of electronic information generated under the project, the electronic data or information ( i.e., invoice, invoice receipts assignment documents of the invoice that may not have paper or hard copy counterparts, but remain in electronic form stored in the Document Hub) stored in connection with TRESDAQ shall be sufficient compliance with Section 235 of the Tax Code to preserve and maintain accounting records. The foregoing, however, is not automatically allowed. The taxpayer concerned must process first their application under Revenue Memorandum Order (RMO) No. 21-2000 dated July 17, 2000, as amended by RMO No. 29-2002 dated September 16, 2002, re: Revised Procedures in the Processing and Approval of Taxpayer's application for Permit to Adopt Computerized Accounting System (CAS) or Components thereof. 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 as null and void. Very truly yours, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service