VAT on intercompany loans

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Monday, August 11, 2014


It has been a practice among a group of related companies to grant advances and loans between and among subsidiaries and affiliates for working capital requirements and capital expenditures. The Bureau of Internal Revenue (BIR) has recognized this practice and has tried to generate revenues from these transactions.

As early as 2009, the CTA en banc had occasion to pass upon the issue of VAT on interest on loans extended to affiliates. The CTA en banc decision involved a domestic company (as lender) “engaged in managing, promoting, administering or assisting in any business or activity of corporations, partnerships, association s, individual or firms.” The CTA en banc explained that even though the lender-company was not a lending investor or financing company and does not habitually extend loans to its affiliates, when it did so, “it provided assistance to corporations, and thus, performed services incidental to its business.”

Furthermore, the loan assistance provided by the lender-company to its affiliates, being incidental to its business, is deemed a transaction “in the course of trade and business.” The phrase “in the course of trade and business” means regular conduct or pursuit of a commercial or an economic activity, including transactions incidental thereto. If the income from the main business activity is subject to VAT, incidental income shall also be subject to VAT. In this case, considering that the lending company’s income from its management services is subject to VAT, it necessarily follows that the interest from loans granted to its affiliates, which is an incidental income, is also subject to VAT.

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In Waterfront Philippines, Inc. v. Commissioner of Internal Revenue (CIR) (Court of Tax Appeals [CTA] Case No. 8024, April 24, 2013) and Kepco Philippines Corp. v. CIR (CTA Case No. 8319, Nov. 7, 2013), the CTA ruled that the act of extending loans to affiliates is a transaction incidental to the taxpayer’s main business activity; hence, is deemed a transaction in the course of trade and business subject to Value-Added Tax (VAT).

The CTA explained that “in the ordinary course of its operations, the parent company extends and obtains cash advances and loans to/from related parties for working capital purposes as well as to finance the construction and operation of projects, which is in the furtherance of its primary purpose as stated in its Articles of Incorporation. Hence, interest income is revenue realized from the services rendered by the parent company to its related parties as part of its normal course of trade or business.”

In view thereof, interest income earned from financing working capital and other funding requirements among related companies by way of intercompany borrowing will give rise to VAT and consequently to income tax and documentary stamp tax. Taxpayers would be well-advised to examine carefully and thoroughly the options available to them to raise funds for their working capital and capital expenditure requirements.

(Source: Punongbayan & Araullo)

Published in the Sun.Star Cebu newspaper on August 12, 2014.

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