VAT Ruling No. 056-03

December 15, 2003 VAT RULING NO. 056-03 Sec. 108 (A) 181-92, 422-93, and 046-2000 Atty. Vic C. Mamalateo V. C. Mamalateo & Associates Unit 6C, 20 Lansbergh Place 170 T. Morato Ave. cor. Castor St. Quezon City S i r : This refers to your letter dated April 15, 2002, seeking clarification, on behalf of your client, the Philippine Constructors Association, Inc. (PCA), whether or not the eight and one-half percent (8.5%) withholding Value-Added Tax (VAT) being deducted and withheld by the Department of Public Works and Highways (DPWH) from the "advance payment" made to the contractor has legal basis. It is your contention that: (a) the "advance payment" made by the DPWH to its contractor, in connection with a construction contract, is not subject to the ten percent (10%) VAT because it is a loan transaction and does not constitute as a taxable activity of the contractor; (b) the fact that the fifteen percent (15%) "advance payment" is computed on the basis of the total contract price does not make the former part of the total contract price, which is the one subject to the VAT; (c) the total contract price is merely used as the basis in computing the loan (advance payment), which DPWH extends to the contractor; (d) it has been the traditional practice of the Bureau of Internal Revenue (BIR) of not imposing VAT at the time of receipt of the "advance payment" by the contractor; and, (e) your position finds strong support from certain provisions in the Implementing Rules and Regulations (IRR) of Presidential Decree No. 1594, which provides thus: "CI 4 ADVANCE PAYMENT "1. The Government shall, upon a written request of the contractor . . . make an advance payment to the contractor in an amount equal to fifteen percent (15%) of the total contract price . . . . "2. The advance payment shall be made only upon the submission . . . of an irrevocable standby letter of credit of equivalent value . . . . "3. The advance payment shall be repaid by the contractor by deducting 20% from his periodic progress payment, with the first repayment to be made when the contract value of the work executed and materials delivered shall equal or have exceeded twenty percent (20%) of the contract price and further refunds shall be done thereafter at monthly intervals. The first work accomplishment equivalent to 20% of the contract price shall not be subjected to the 20% deduction. (All emphasis supplied.) You, likewise, cited certain provisions in the "Conditions of Contract for Construction", which is adopted as the standard contract by the International Federation of Consulting Engineers (FIDIC) for building and engineering works designed by the Employer, and which states, thus: "14.2. Advance Payment "The Employer shall make an advance payment, as an interest-free for mobilization, when the Contractor submits a guarantee . . . . "xxx xxx xxx "The Engineer shall issue an Interim Payment Certificate for the first installment after receiving a Statement under Sub-Clause 14.3 . . . and after the Employer receives (i) the Performance Security . . . and (ii) a guarantee in a form and issued by an entity approved by the Employer. This guarantee shall be in amounts and currencies equal to the advance payment. "The guarantee shall be valid until the advance payment has been repaid, but its amount shall be progressively reduced by the amount repaid by the Contractor as indicated in the Payment Certificates. If the terms of the guarantee specify the date on which the entity's obligations expire (the "expiry date"), and the advance payment has not been repaid by the date 28 days prior to the expiry date, the Contractor shall extend the guarantee accordingly, until the advance payment has been repaid. "The advance payment shall be repaid through percentage deductions in Payment Certificates. Unless other percentages are stated in the Appendix to Tender: "(a) deductions shall commence in the Payment Certificate in which the total of all certified interim payments (excluding the advance payment and deductions and repayments of retention) exceeds ten percent (10%) of the Accepted Contract Amount less Provisional Sums; and "(b) deductions shall be made at the amortization rate of one quarter (25%) of the amount of each Payment Certificate (excluding the advance payment and deductions and repayments of retention) in the currencies and proportions of the advance payment, until such time as the advance payment has been repaid. " (All emphasis supplied.) In reply, please be informed that under Section 114(C) of the National Internal Revenue Code of 1997, as implemented by Revenue Regulations No. 2-98 (as amended), the Government or any of its political subdivisions, instrumentalities or agencies, including government-owned or controlled-corporations, shall, before making payment on account of each services rendered by government public works contractors which are subject to VAT, deduct and withhold the VAT due at the rate of eight and one-half percent (8.5%). And, in the case of government public works contractors, pursuant to Sec. 108(A) of the same Code, the VAT shall be levied, assessed and collected on their "gross receipts", which is defined as "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". Moreover, the BIR has already 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 Rev. Regs. No. 2-98" (see BIR VAT Review Committee Ruling No. 046-2000) . 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. ScaHDT Going by trend of your argument, however, the real issue being raised is factual: whether, for VAT purposes, the "advance payment" made by the DPWH to government public works contractors is to be interpreted literally as payment made in anticipation of a contingent or fixed future liability or obligation (Black's Law Dictionary), or metaphorically as a loan. P.D. 1594 (which is one of the basis of your contention) merely prescribes the policies, guidelines, rules and regulations covering government contracts for infrastructure and other construction projects; it does not authorize the Government to enter into a contract of loan. As a matter of fact, it does not even speak of "advance payment", and the "performance bond" mentioned therein is to guarantee the faithful performance of the contractor. As to the afore-cited IRR, notwithstanding the use of the word "repaid" in relation to "advance payment", there are no indications therein showing unequivocally that the Government is authorized to enter into a contract of loan for the benefit of government public works contractors. Finally, granting arguendo that all government public works contracts contain the provisions copied from the afore-cited "Conditions of Contract for Construction" adopted by the FIDIC, still it does not prove clearly that the Government is indeed entering into a contract of loan for the benefit of the said contractor. Verily, therefore, in the absence of any evidence proving otherwise, for VAT purposes "advance payments" to government public works contractors shall and must be construed in its literal meaning payments made by the Government in anticipation of its fixed future obligation arising out of a public works construction contract hence, they are subject to the eight and one-half percent (8.5%) withholding VAT. Very truly yours, Commissioner of Internal Revenue By: (SGD.) JOSE MARIO C. BUAG Deputy Commissioner Legal and Inspection Group