Hon. Hermogenes E. Ebdane, Jr.

November 5, 2009 VAT RULING NO. 014-09 Sec. 108 (A) Hon. Hermogenes E. Ebdane, Jr. Office of the Secretary Department of Public Works and Highways (DPWH) Manila Dear Sir : This refers to your letter dated January 10, 2008 relative to the VAT adjustment claims of civil works contractors from your Agency due to the increase in VAT from 10% to 12%. Such claims emanated from their contract with the DPWH the cost of which was based from the previous 10% VAT. With the imposition, however of the 12% expanded VAT effective February 1, 2006, the claimants are now requesting that their respective contract price be adjusted or that they be paid an additional 2% representing the increase in VAT rate. In support to your request, you have attached pertinent documents relative to your Agency's contract with China State Construction Engineering Corporation/Ciriaco Corporation (JV) for a DPWH project entitled: Metro Manila Urban Transport Integration Project (MMURTRIP), Phase I, Package 3: Marikina Bridge and Access Road. The bidding for the said project was held on August 21, 2003 or before the effectivity of the increase in VAT rate last February 1, 2006. In the attached detailed unit price analysis which became the basis of the contract executed with the Department and which likewise became the corresponding basis of payment to their accomplishment, the same shows that the 10% VAT was applied to the direct and indirect costs of the specific pay items. Since the project is now 100% completed, the Joint Venture is now requesting for the reimbursement of the additional 2% VAT for all work items which were accomplished starting February 1, 2006 up to the project completion. In this regard, you now seek advice from this Bureau as to the merit of the subject claim. In reply, please be informed that the 2% increase of the VAT rate from 10% to 12% under Revenue Memorandum Circular (RMC) No. 7-2006 which was made effective starting February 1, 2006 is in accordance with the conditions laid down under Section 108 (A) of the Tax Code of 1997, as amended by RA 9337, to wit: ITDHSE "SEC. 108. Value-added Tax on Sale of Services and Use or Lease of Properties. (A) Rate and Base of Tax. There shall be levied, assessed and collected, a value-added tax equivalent to ten percent (10%) of gross receipts derived from the sale or exchange of services, including the use or lease of properties: Provided, that the President, upon the recommendation of the Secretary of Finance, shall, effective January 1, 2006, raise the rate of value-added tax to twelve percent (12%), after any of the following conditions has been satisfied. (i) Value-added tax collection as a percentage of Gross Domestic Product (GDP) of the previous year exceeds two and four-fifth percent (2 4/5%); or (ii) National government deficit as a percentage of GDP of the previous year exceeds one and one-half-percent (1 1/2%)." Corollarily, Revenue Regulations No. 16-2005 specifically Section 4.105-2, has provided the specific manner of treatment of VAT with respect to existing contracts, as follows: "Sec. 4.105-2. Nature and Characteristics of VAT. VAT is a tax on consumption levied on the sale, barter, exchange or lease of goods or properties and services in the Philippines and on importation of goods into the Philippines. The seller is the one statutorily liable for the payment of the tax but the amount of the tax may be shifted or passed on to the buyer, transferee or lessee of the goods, properties or services. This rule shall likewise apply to existing contracts of sale or lease of goods, properties or services at the time of the effectivity of RA No. 9337. . . . ." Based on the above general provision, it appears that any increase in the VAT rate can be legally passed on or shifted to the buyer or transferee or consumer. This can be demanded by the supplier of goods or services without further need to amend the contract the supplier of goods/services executed with the buyer prior to the effectivity of RA 9337, which under the terms thereof originally fixed the VAT rate at 10%. In the case of Tolentino vs. Secretary of Finance, et al. (G.R. No. 115455, Aug. 25, 1994), the Supreme Court held that: xxx xxx xxx "It is enough to say that the parties to a contract cannot, through the exercise of prophetic discernment, fetter the exercise of the taxing power of the State. For not only are existing laws read into contracts in order to fix obligations as between parties, but the reservation of essential attributes of sovereign power is also read into contracts as a basic postulate of the legal order. The policy of protecting contracts against impairment presupposes the maintenance of a government which retains adequate authority to secure the peace and good order of society." AICHaS xxx xxx xxx From the foregoing, it can readily be seen that all pertinent laws with respect to an agreement between parties are automatically incorporated as part of any contract between them. It is not necessary to amend the terms of contracts to reflect the provisions of such laws in order to give their effect. This is particularly true in cases where taxation is the issue at hand. No less than the Supreme Court has declared that the Constitutional policy on the non-impairment of contracts may not be invoked against the sovereign power of the State to maintain itself through the exercise of the power of taxation. In this regard, the provisions of Section 105 of the Tax Code of 1997, RA 9337, RR 16-2005, and RMC 7-2006 covering the increase in the applicable VAT rate are all deemed as read into contracts executed by the supplier with its clients or buyers, thus, have full force and effect even if they are not expressly stated or provided for in such contracts. It must be noted in this connection that as represented, DPWH implements VAT inclusive contracts on civil works projects wherein the VAT is being passed on by the contractors during the conduct of bidding for DPWH projects. Accordingly, for contracts consummated prior to February 1, 2006 but collections thereon were made on or after February 1, 2006, the billing on the contract must be inclusive of the increased rate of VAT. But since the contract price originally included a 10% VAT, the 10% must first be removed before adding the rate of VAT prevailing (12%) at the time the collection is made by the contractor. Thus, the billing must be divided by 1.10 to remove the tax previously tucked as part of the contract price and the quotient is multiplied by 1.12 to determine the amount payable to the contractor. In so far as government contracts are concerned, the VAT of the supplier is collected as a final withholding tax, the rate of which did not change despite the increase in VAT rate. This means that the increase in VAT rate effectively increased both the rate of input tax and the rate of output tax of every VAT taxpayer effective February 1, 2006. Section 4.114-2 of Revenue Regulations No. 16-2005 as amended by Revenue Regulations No. 02-2007, implementing the provisions of RA 9337 as amended by RA 9361, provides for the withholding of final VAT on government money payments as follows: "SECTION 4.114-2. Withholding of VAT on Government Money Payments and Payments to Non-Residents. (a) The government or any of its political subdivisions, instrumentalities or agencies, including government-owned or controlled corporations (GOCCs) shall, before making payment on account of each purchase of goods and/or of services taxed at 10% VAT [now 12%] pursuant to Secs. 106 and 108 of the Tax Code, deduct and withhold a final VAT due at the rate of five percent (5%) of the gross payment thereof. AEIcTD The five percent (5%) final VAT withholding rate shall represent the net VAT payable of the seller. The remaining five percent (5%) [now 7%] effectively accounts for the standard input VAT for sales of goods or services to government or any of its political subdivisions, instrumentalities or agencies including GOCCs, in lieu of the actual input VAT directly attributable or ratably apportioned to such sales. Should actual input VAT exceed five percent (5%) [now 7%] of gross payments, the excess may form part of the sellers' expense or cost. On the other hand, if actual input VAT is less than 5% [now 7%] of gross payment, the difference must be closed to expense or cost (bold fonts and underscoring supplied; new rate inserted) (b) . . . Since the rate of VAT increased to 12%, this means that the output tax that can be shifted by government contractors increased by two percentage points. This is not affected by the fact that the final VAT to be withheld by the Government remains at 5%. The withholding tax is only a procedure for the collection of the 12% VAT thereby giving the contractor a standard input tax of 7% (formerly 5%) under the increased rate of VAT. The 5% final VAT withholding approximates the 12% VAT on the contractor's value-added. In view thereof, it is the opinion of this office that there is no legal obstacle to adjust the VAT rate from 10% to 12% on the subject government contracts existing at the time of the increase of the VAT rate under R.A. 9337, and because as intimated earlier, any increase in the rate of a tax which can be passed on to the purchaser effectively increases the contract price following the doctrine laid down by the Supreme Court in the Tolentino case cited above and as provided for under Sec. 105 of the Tax Code of 1997, as amended by RA 9337. This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it shall be disclosed that the facts are different, then this ruling shall be considered null and void. Very truly yours, (SGD.) SIXTO S. ESQUIVIAS IV Commissioner of Internal Revenue