Hon. Victor A. Domingo

December 23, 2009 VAT RULING NO. 017-09 Sec. 108 (A); 000-00 Hon. Victor A. Domingo Office of the Secretary Department of Public Works and Highways (DPWH) Manila Dear Sir : This refers to your letter dated February 12, 2008 relative to the VAT refund/adjustment claims of civil works contractors from the Department of Public Works and Highways (DPWH) due to insufficient VAT component in their contract which was caused by their compliance to the DPWH instruction during the bidding for the project to compute VAT as 10% of labor and equipment costs. Such instruction was, according to you, later found to be erroneous as the VAT component derived using such computation will only be approximately between 2% to 4% of the contract cost and therefore deficient to settle the VAT obligation to the Bureau of Internal Revenue. You represented that, "as a standard practice, the DPWH implements VAT inclusive contracts on civil works projects wherein the VAT is being passed on by the contractor and is assumed by that Department as a cost included in the bid submitted by contractors during the conduct of bidding for DPWH projects. The DPWH thus, processed the claims of these contractors and payments were effected to those whose claims were found to be meritorious. The computation of the VAT refund adjustment was based from the difference between the deficient in placed amount of VAT component in their contract and the corresponding withholding VAT of 8.5% that was deducted from their billings." With the effectivity of the new VAT law (R.A. No. 9337), the withholding VAT was reduced from 8.5% to %. * Correspondingly, you changed the basis of computing claims for VAT refund/adjustment from 8.5% to 5% VAT for those accomplishments to be paid after November 1, 2005. However, there are requests for reconsideration from contractors/claimants as to the manner of the DPWH usage of withholding VAT as basis in the computation of their VAT refund/adjustment. They disagree with the DPWH manner of computation considering that such withholding VAT is only an initial amount collected and remitted to the BIR as taxes and that these contractors are still to settle the balance of the total VAT obligations when they file the quarterly VAT returns to the BIR. DEcSaI Based on the foregoing representations, you want to seek our advice as to the merit of the contractors' request for reconsideration. Our advice will be anchored on a discussion and resolution of three (3) issues which are relevant in determining the merit of the contractor's request. 1. What is the proper base for computing the VAT? Is it only on labor and equipment component of the contract price or the total contract price consisting of materials, labor, equipment, OCM (overhead, contingencies and miscellaneous) and profit? 2. What is the rate of VAT to be billed or charged by the contractor? Is it the rate of VAT withholding that DPWH is mandated to withhold/deduct from its payment to the contractor or the actual rate of the VAT? 3. If the rate to be billed is the actual rate of the VAT, can the contractor bill the additional 2% increase in VAT rate beginning February 1, 2006 for a contract that was entered into at a time when the VAT rate, as stipulated in the contract, is 10%? On the first issue, please be informed that contractors of DPWH projects fall under the category of 'sellers of services' for VAT purposes and the tax base for the VAT is the gross receipts. "The term "gross receipts" means 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 advanced payments actually or constructively received during the taxable quarter for the service performed or to be performed for another person, excluding the value-added tax. (Section 108 (A), NIRC) . It is clear in the law that the tax base is the total contract price which necessarily includes materials, labor, equipment, OCM and profit. In fine, the total cost of the contract that was awarded to the contractors would be the base for the VAT and not only the labor and equipment components thereof. On the second issue, we take the position that the VAT to be charged by the contractor is not based on the rate of withholding tax but based on the rate of VAT prescribed under Section 106 to 108 of the Tax Code. This is clear under Section 105 of the same Code which provides in pertinent part "The value-added tax is an indirect tax and the amount of tax may be shifted or passed-on to the buyer, transferee or lessee of the goods, properties or services." The withholding tax whether imposed as a creditable withholding tax, as in the case of the 8.5% prior to R.A. 9337, or as a final withholding of the VAT, as is now implemented, is not a VAT but only a procedure of collecting the VAT. When the DPWH enters into a VAT inclusive bidding with its contractors, this means that part of the contract price is the actual rate of VAT. HEDSCc On the third issue, please be advised that beginning January 1, 1998 up to January 31, 2006, the rate of VAT to be shifted must be 10% and beginning February 1, 2006, the rate to be shifted is 12%. 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: "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: cTECHI 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." 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 them 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 contractor and is assumed by that Department as a cost included in the bid submitted by 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. aSTAcH 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. 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% beginning February 1, 2006, correspondingly the output tax that can be shifted by government contractors also 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 discussed 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. DSEIcT 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.) JOEL L. TAN-TORRES Commissioner of Internal Revenue