Tax Aspects of DBP Marketplace for SMEs/Suppliers Receivables Purchases Project

September 21, 2005 BIR RULING NO. 019-05 000-00 Development Bank of the Philippines Sen. Gil J. Puyat Ave. cor. Makati Ave. Makati City Attention: Mr. Reynaldo G. David President & Chief Executive Officer Gentlemen : This refers to your letters dated February 18, 2004, June 9, 2004, August 5, 2004, November 17, 2004, January 6, 2005 and June 22, 2005 requesting for a confirmatory ruling on various tax aspects of Development Bank of the Philippines' (DBP) Marketplace for SMEs/Suppliers Receivables Purchases Project. You stated in your letters that the Office of the President has endorsed the Marketplace for SMEs/Suppliers Receivables Purchases Project (M4SME-RP) as it will cater to the financing requirements of Small- and Medium-Scale Enterprises (SMEs). A Memorandum from Malacaang dated June 17, 2004 instructs DBP, in coordination with the Department of Trade and Industry (DTI) and the Department of Finance (DOF), to spearhead the implementation of the web-based marketing of SME receivables of M4SME-RP. The invoices to be traded in M4SME-RP are evidence of indebtedness of the Big Brothers (large corporations with good credit standing which purchase goods from SMEs) initially to the SMEs, and eventually to whoever may acquire the invoices. The said invoices are securities, and M4SME-RP itself will be a licensed alternative trading system (ATS) which is a marketplace like an exchange. On June 22, 2004, DBP was the first to file an application with the Securities and Exchange Commission (SEC) to qualify M4SME-RP as an ATS. Its application has been approved by the SEC in January, 2005. Under the ATS Rules of the SEC, an ATS is "any organization, association, person, or group of persons, or system: 1. 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 of innovative registered securities of any kind of SEC-registered enterprise and the buyers of those securities; iii. Secondary market sellers and buyers of 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; . . ." The statutory basis for the ATS Rules is Section 37, Registration of Innovative and Other Trading Markets of the Securities Regulation Code (SRC) which authorizes the SEC to promulgate rules for the registration and licensing of innovative and other trading markets or exchanges covering, among others, securities of SMEs, pursuant to Section 33 of the SRC. In turn, Section 33 is the provision on Registration of Exchanges. M4SME-RP aims to assist SMEs/Suppliers by providing a ready market for the discounting of their trade receivables so that they will no longer have to wait to collect on the purchase price of goods and services delivered to and accepted by large credit-worthy corporations. At the same time, large corporations can lessen their cost of borrowing and be able to generate the equivalent of working capital through an alternative means of credit accommodation. DBP expects that the M4SME-RP will assist in the government's tax collection efforts. By providing financing facilities to the SMEs/Suppliers, it hopes to spur growth in this sector. aCASEH DBP will also require that the counter-parties be large corporations with at least 80% of their operations captured by automated general ledger, and that they turn over their accounts to the BIR on a consistent and regular basis. M4SME-RP will effectively elevate the SMEs/Suppliers which will participate in M4SME-RP from the informal to the formal sector of our economy. M4SME-RP involves the application of new technologies through the establishment of an electronic hub where the authentication and storage of accepted invoices shall be undertaken without the use of traditional paper documentation. DBP envisions that the transactions under M4SME-RP shall be carried out electronically. Through M4SME-RP, DBP 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. Due to the novelty of the issues posed by M4SME-RP, its conceptualization has required close coordination with the SEC and the Bangko Sentral Ng Pilipinas ("BSP"). The SME/Supplier will deliver goods or render service to the Big Brother for which the SME/Supplier shall issue all invoice. Initially, an electronic invoice will run parallel with a paper invoice. It is envisioned, that eventually, only an electronic invoice will be issued. The Big Brother will accept the invoice by which it will acknowledge the outstanding amount due to the SME/Supplier and commit to pay such amount on a specified maturity or settlement date to the SME/Supplier and/or its assigns. In the case of one Big Brother with which DBP is in discussions, upon its acceptance of the invoice, that Big Brother will electronically record an invoice receipt (paper document). The invoice receipt contains the details of the accepted invoice, such as the face amount of the invoice, and the applicable creditable withholding tax rate and amount due thereon. The invoice accepted by the Big Brother which shall be traded under the M4SME-RP shall be net of the applicable creditable withholding tax (on income of SME/Supplier arising from the sale of goods or services) and which creditable withholding tax (CWT) will be paid by the Big Brother to the BIR for the account of the SME/Supplier. The authenticated invoice shall then be stored with the Document Hub's Storage Facility. The SME/Supplier transfers the accepted invoice in trust to a Trustee which is a financial institution designated by the Big Brother in order to keep the identity of the SME/Supplier confidential as its list of suppliers is among the Big Brother's trading secrets. If and when instructed by the SME/Supplier, the Trustee auctions the invoice in M4SME-RP and assigns the same to the winning bidder. The Trustee then receives payment on behalf of the SME/Supplier. The Trustee shall issue its own official receipt in the name of the winning bidder acknowledging receipt of payment for the assignment of the invoice (trustee receipt). The amount received by the Trustee, net of applicable transaction costs and fees, shall then be credited to the account maintained by the SME/Supplier with the Trustee. As the invoice is not discharged at this point but remains outstanding, no official receipt is issued to the Big Brother. Even if the SME/Supplier does not wish to sell the invoice but rather holds it until maturity, the SME/Supplier will still have to transfer the same in trust to the Trustee. This is because the Big Brother's invoice-tagging system will identify those SMEs/Suppliers that are enrolled in M4SME-RP. On maturity of invoices in the name of an SME/Supplier enrolled in M4SME-RP, the Big Brother will course payment only to the Trustee. Thus, once, an SME is enrolled in M4SME-RP, all its invoices whether to be auctioned or not, will be authenticated and transferred to the Trustee which, on maturity date, will receive payment from the Big Brother. After the invoice is transferred in trust to the Trustee, the Trustee, upon counter-signature of DBP, then electronically lodges the invoice with the Settlement Bank-Registrar. Thus, the first registered owner of an invoice will always be a Trustee. Investors who have previously established a client relationship with participating banks, non-bank financial intermediaries performing quasi-banking functions, and other non-bank financial intermediaries (the Investor Participants, or "IPs"), which purchase, sell or otherwise trade or deal in the invoices or securities generated under the M4SME-RP, and the IPs themselves, participate in M4SME-RP through the trading of the invoice. It is contemplated that at the level of the investors, the invoice may be dispersed, i.e., broken down into different values. Delivery of invoices and payments will be coursed through the Settlement Bank-Registrar. On maturity date of the invoice, the Big Brother delivers payment to the Trustee which then issues a receipt (the Settlement Receipt) evidencing discharge of the obligation of the Big Brother. For proper recording of the statement of the invoice, the Settlement Receipt shall indicate the Tax Identification Number (TIN) of the SME/Supplier whose invoice was paid. The Trustee then remits the amount to the Settlement Bank-Registrar. Based on its record of the final holder/s of the invoice, the Settlement Bank-Registrar shall then credit the accounts of the IPs/investors. After maturity date, the Big Brother shall remit to the BIR the creditable tax withheld from the payment due to the SME/Supplier on the sale of goods or services. The basis for computing the (CWT) shall be the invoice receipt appearing in the invoice for the account of the SME/Supplier whose TIN is identified in the Settlement Receipt. While it is contemplated that M4SME-RP will be carried out, and all documents stored, electronically, the Settlement Receipt, as well as the Trustee Receipt, shall still be in paper form. However, the accepted invoice and the documents of transfer shall all be in electronic form. Based on the foregoing, you are requesting for a confirmatory ruling on the following: 1. The discount upon auction of the Invoice will be deductible loss from the gross income of the SME/Supplier. 2. The tax that the Big Brother will withhold on the face amount of the Invoice is creditable against the income tax payable of the SME/Supplier. The creditable withholding tax rates vary depending on the nature of the business of the SME/Supplier. 3. No VAT is due on the sale of the Invoice by the SME/Supplier or by the subsequent owners thereof. 4. No DST is due on the sale of the Invoice by the SME/Supplier or by the subsequent owners thereof. 5. No tax is due on the transfer of the Invoice by the SME/Supplier in trust to DBP (or to any other IP acting as trustee for the SME/Supplier). 6. 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 capital gains tax. 7. In case it is a financial intermediary that realizes income on the sale of the Invoices, the income is subject to Gross Receipts Tax. 8. The Big Brother shall be able to avail of the input VAT paid on the Invoice even if the SME/Supplier has not issued any official VAT receipt or VAT invoice, and that the following shall be acceptable: (i) For sale of goods the invoice issued by the SME/Supplier; (ii) For sale of services (a) the invoice issued by the SME/Supplier, and (b) the Settlement Receipt issued by the Trustee. cACEHI 9. Electronic data or information stored in connection with M4SME-RP shall be sufficient compliance with Section 235 of the Tax Code to preserve and maintain accounting records. In reply thereto, we hereby rule 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 a discount, the sale is accorded ordinary loss treatment. (Mertens, Law of Federal Income Taxation, 22.25) Accordingly, the discount upon auction of the invoice will be a deductible loss from the gross income of the SME/Supplier. However, the SME/Supplier 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 SME/Supplier will be subject to the 1% or 2% creditable withholding tax (CWT), as the case may be, Big Brother 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 SME/Supplier, 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 Big Brother shall be constituted as withholding agent of its suppliers, the SMEs/Suppliers. For as long as the above conditions are complied with, the 1% or 2% CWT, as the case may be, that the Big Brother will withhold on the face amount of the invoice shall be credited against the amount of income tax due of the SME/Supplier (Section 204, Revenue Regulations No. 2). In addition, other withholding tax rates may be applicable depending on the nature of the business of the SME/Supplier. The CWT shall be applied against the selling price of the goods/services appearing in the invoice receipt. Notwithstanding that the SME/Supplier has assigned the invoice and is no longer the payee of the invoice on maturity date, the SME/Supplier is still entitled to the CWT withheld by Big Brother 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 10% 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. Thus, in the case of sale or exchange of goods, the 10% 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 10% VAT does not become due until income is actually or constructively received by the taxpayer. In the case at hand, the SME/Supplier 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 SME/Supplier 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 10% VAT computed by multiplying by 10% 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 receipts tax (GRT) in accordance with Republic Act (RA) 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 M4SME-RP, 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 no exchange is exempt from DST. [Now paragraph (g) of Section 199 of the Tax Code, as amended]. Accordingly, and since the receivables of an SME/Supplier from the Big Brothers (evidenced by invoices) are going to be traded at the M4SME-RP as securities, the said invoices/receivables traded therefore are exempt from DST. 5) An implied trust was created between the SME/Supplier and DBP (or any other IP acting as 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 SME/Supplier in trust to DBP (or to any other IP acting as trustee for the SME/Supplier). 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 SME/Supplier to the winning bidder will not be subject to capital gains tax since the invoice do not constitute capital assets of the SME/Supplier. 6 & 7) Your opinion is confirmed that the sale of invoice by the IPs among themselves and to individual investors shall be subject to the GRT on financial institutions pursuant to RA. No. 9238, as implemented by Rev. Regs. No. 9-2004, which excludes "services of banks, non-bank financial intermediaries performing quasi-banking 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 yield 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 IP 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 SME/Supplier ( i.e. , from the winning bidder to the final owner/s at maturity) on the sale of the invoice to other IPs 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 IPs 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. DEICHc 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 IP 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. 8) In case the invoice is auctioned, upon receipt by the Trustee of payment for the sale of the invoice, the SME/Supplier 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 SME/Supplier will be deemed to have collected the receivable which comprises its gross receipt upon the sale or discounting of the invoice. Consequently, the SME/Supplier immediately becomes liable for the 10% 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 10% 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 Big Brother, which may be cross-referenced against the physical books of accounts of the SME/Supplier. The records shall be sufficient basis for the computation of the output VAT due on the sale of goods and services by the SME/Supplier to the Big Brother, notwithstanding that no official VAT receipt may have been issued by the SME/Supplier. The month/quarter when input VAT may be claimed by the Big Brother depends on whether the SME/Supplier sold goods or rendered services. Thus, in case of sale of goods, the Big Brother may claim input VAT on the basis of the seller's invoice while in case of sale of services, the Big Brother 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 SME/Supplier opts to assign the invoice immediately, thereby becoming liable for the output VAT, Big Brother may avail of the input VAT paid on the invoice even if the SME/Supplier 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 SME/Supplier b. For sale of services b.1. The invoice issued by the SME/Supplier, 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. 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. 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 M4SME-RP 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 M4SME-RP 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. IcESDA 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, (SGD.) JOSE MARIO C. BUAG OIC-Commissioner of Internal Revenue