Chapter 1 — Introduction to Consumption Taxes CHAPTER 1 INTRODUCTION TO CONSUMPTION TAXES a a lana Chapter Overview and Objectives: Business tax is a form of consumption tax. This chapter provides an overview of consumption and the types of consumption tax including business tax. After this chapter, readers are expected to comprehen ‘The concept of a consumption tax ‘Types of consumption and consumption taxes ‘The destination principle ‘The nature of the VAT on importation The nature and types of business tax The characteristics of the VAT on sales The characteristics of percentage tax Mouewne CONSUMPTION TAX Consumption occurs when one acquires goods or services by purchase, exchange or other means, A consumption tax is a tax upon the utilization of goods or services by pees buyers. It is a tax on the purchase or consumption. of the buyer and not}on the sale of the seller, Rationale of Consumption Tax 1. It promotes savings formation. 2. Ithelps in wealth redistribution to society. 3. It supports the Benefit Received Theory. Consumption tax promotes savings formation Income is inherently destined toward consumption, The residual income that remains after consumption is savings. Savings promotes capital formation and investment which are considered crucial to economic development. A tax on consumption is therefore important to limit consumption to shift penta the income to savings formation. Consumption tax helps redistributes wealth to society Itis a basic state policy to redistribute wealth to society so everyone in the State could enjoy the same.Chapter 1 ~ Introduction to Consumption Taxes -e they can afford expensive ‘em pay more tax. Therefore, ff wealth from the rich to the Rich people buy more and spend more sinc lifestyles. A tax on consumption will make th consumption tax supports the redistribution o} less privileged members of the society. Received Theory ive benefit from the ceiving benefits from Consumption tax supports the Benefit Under the Benefit received theory, those who rec government shall pay taxes. Everyone in the state is.r the government; hence, everybody should be tax. nd services. A tax on consumption butes to the support of the ical application of the Benefit Unarguably, everybody consumes goods at will effectively make everyone contril government. Consumption tax provides a practi Received Theory. ‘There is one important caveat to consumption tax however. It should not be education healthand shelter or levied upon basic necessities such as food, € althvan housing, Our current tax law observes this but with qualifications. Exempt consumptions of basic necessities will be extensively discussed in Chapter 2 and Chapter 4. Income tax and consumption tax, distinguished Tacome tax Consumption tax | Nature Tax upon receipt of Tax upon usage.of income income or capital Scope ‘tax to the capable ‘Atax to all ‘Supporting tax theory | Ability to pay theory | Benefit received theo Income taxation is consistent with the Ability to pay theory because it taxes only those who are capable to pay tax. Consum ption tax effectively taxes everyone. Note to readers: Your keen appreciation of the following section is highly critical in your understanding of rules of consumption taxes in future chapters. ‘Types of consumption 1. Domestic consumption - refers to consumption or purchases of Philippine residents 2. Foreign consumption ~ refers to consumption or purchases of non- residents Because taxation is inherently territorial, only domestic consumption can be subjected to Philippine taxation, Foreign consumption cannot be taxed. 2Chapter 1 - Introduction to Consumption Taxes In observing this territorial limitation, the Philippines follows the “destination principle”. Under the destination principle, goods and services destined for use or consumption in the Philippines are subject to consumption tax whereas those destined for use or consumption abroad are not imposed with consumption tax. Hence, goods that cross the border which are destined toward foreign territories should not be charged with consumption taxes. This is the cross- border doctrine of consumption tax. Summary of tax rules on consumption Domestic consumption | Foreign consumption The sellers is (Buyer is resident) | (Buyer is non-resident) Non-resident Taxable No tax Resident Taxable Effectively no tax Types of taxable domestic consumption 1. Purchase of residents of goods or services from no} dents abroad. This is most commonly known as “importation’. 2. Purchase of residents of goods, properties or services from resident _ sellers. This transaction is a “sale” on the seller’s perspective. In short, domestic consumption encompasses import and sale. CONSUMPTION TAX ON IMPORTATION~ Every importer of goods shall pay consumption tax on his importation. This consumption tax is called “Value Added Tax (VAT) on importation”. The VAT on importation is 12% of the fotal import costiof the goods prior to the withdrawal of the goods from the warehouse of the Bureau of Customs. Every purchaser of service from non-residents (i.e. import of service) shall likewise pay VAT on importation of the service. This VAT on importation is called the “Withholding VAT”. The withholding VAT is computed as 12% of the Contract prige of the service These consumption taxes on importations are payable without regard of whether the foreign seller or the resident buyer is engaged or not engaged in business or whether the importation is for business or personal consumption, Mlustration 1 Mr. Lawag, a Philippine resident, imported several goods from a foreign seller. He incurred the following costs before withdrawal of the goods from the warehouse of the Bureau of Customs: 3Chapter 1 ~ Introduction to Consumption Taxes Total costs of importation for personal use P 1,000,000 Total costs of importation for business use 2,000,000 ‘The VAT on importation shall be computed as 12% of the total import costs as follows: ‘Total costs of importation for personal use P 1,000,000 Total costs of importation for business use —2.000,000 Total costs of importation P 3,000,000 Multiply by: ——12% VAT on importation Pp 360,000 Mr. Lawag shall pay the P360,000 to the Bureau of Customs prior to the release of his goods from the Custom’s warehouse. Mlustration 2 Mr. Enchong hired the services of a foreign power solutions company to install a solar power in his home in the Philippines for P500,000. ‘Mr. Enchong shail pay P60,000 (12% x P500,000) withholding VAT to the Bureau of Internal Revenue. This applies regardless of the purpose of the foreign purchase of service whether for business or for personal purposes. Ilustration 3 A Philippine firm contracted the services of a foreign web-developer for P2M. 80% of the service was rendered abroad while 20% was rendered in the Philippines, The Philippine firm shall pay withholding VAT on the entire P2M contract price. The purchase is a domestic consumption, which must be subject to VAT even if the service is totally rendered abroad. CONSUMPTION TAX ON DOMESTIC CONSUMPTION FROM RESIDENT SELLERS ‘The consumption tax on the purchases of Philippine residents from resident sellers is collected from the seller. Our tax law imposed the consumption tax upon the sales of sellers of goods or receipts of sellers of services. Mlustration Tugue Company, a resident business, purchases P100,000 worth of goods from Isabela Company, another resident business. Tugue records the transaction as a purchase while Isabela records the same as sales. Both Tugue and Isabela are subject to 3% business tax - a consumption tax. Tugue, the buyer, shall pay the P100,000 to Isabela. It is not mandated to pay the consumption tax to the government. Isabela, the seller, is legally required to remit the P3,000 (P100,000 x 3%) consumption tax on its sale (Le. Tugue’s purchase) to the government.Chapter 1 - Introduction to Consumption Taxes This should not be confused, however, that the seller is the one being taxed: Itis the buyer who is actually taxed, Note that the sales or gross receipts of resident sellers upon which the tax is imposed are, by themselves, the purchases or consumptions of resident buyers. The sellers are the ones named by law to pay the tax. The sellers are the statutory taxpayers. However, the buyers are the ones who actually shoulder the tax burden. The buyers are the real taxpayers or economic taxpayers. This indirect imposition of tax is necessitated by administrative feasibility. For the government, it is easier to collect the tax from fewer regulated sellers than from numerous buyers. ‘Thus, the law collects the consumption tax from sellers, Sellers, in turn, pass the consumption tax by including it in their sales prices of goods or services. Most often, the buyers do not notice the tax. This is a simple and convenient way to collect tax without undue disturbance to the consumers. Another illustration | Mr. Aramay is a trader who is subject to a 3% business tax. During a month, he sold the following: Sales to Philippine resident buyers P 100,000 Sales to foreign buyers (export) 150,000 Total sales P__250,000 The business tax (consumption tax) which Mr. Aramay shall remit to the government shall be P3,000, computed as 3% of the P100,000 domestic sales (te. domestic consumption) only. Note that export sales are foreign consumptions not subject to Philippine consumption tax. Consumption tax on resident buyers applies to businesses only It must be emphasized, however, that the consumption tax levied on the sales or receipts of a resident seller is applicable only when the seller is regularly engaged in business. The tax does not apply where the seller is not in business, That is why this consumption tax is called a “business tax’. Mlustration 1 Mr. Sabiano is regularly engaged in the buy-and-sell of used cars. During the month, he sold a used Ford Expedition for P1,200,000 which he previously purchased froma friend, The P1,200,000 sale of the Ford Expedition is subject to business tax,Chapter 1 — Introduction to Consumption Taxes Mlustration 2 Mr. Colyong is regularly engaged in the practice of his profession as a medical doctor. During the month, he sold his residential dwelling for P2,000,000, The P2,000,000 sale of residential dwelling is not subject to business tax since Mr, Colyong is not engaged in the business of selling residential dwellings. Mlustration 3 Ms. Cheong is an employee at a private university. During the month, she received a P 40,000 compensation income. Employment is not engagement in business. The P40,000 compensation income is not subject to business tax. ‘The term "Business Tax" is a misnomer It must be emphasized again that businesses are merely acting as agents of the government for the collection of consumption taxes from the buyers. Businesses are not the real taxpayers. In law, sellers are made directly liable for the payment of the consumption tax. Businesses would suffer penalties for non-compliance. Business tax is made to appear as tax on the privilege to do business. As a result, business tax is often viewed as a “privilege taxes’. This, however, do not change the very essence of business tax as a consumption tax. The rule is merely intended to enforce compliance. ‘Table of Comparison VATon Importation Business Tax Basis of tax ‘Acquisition cost Sales or receipts ‘Scope of tax Allconsumption | Consumption from businesses only Nature of consumption tax Pure form Relative form Statutory taxpayer Buyer Seller ‘The economic taxpayer Buyer Buyer Nature of imposition Direct Indirect, Table summary: Consumption tax rules on domestic consumption Resident Seller Buyer Applicable consumption tax Domestic sellers = Business Business Business tax - Business Non-business Business tax — Non-business_| Business None = CNon-business_| Non-business NoneChapter 1 ~ Introduction to Consumption Taxes Resident Seller Buyer Applicable consumption tax Foreign sellers Business Business VAT on importation i Business Non-business VAT on importation Non-business Business VAT on importation* ‘Non-business | Non-business VAT on importation™ *The VAT on importation consistently applies regardless of whether or not the seller or the buyer is engaged in business. BASIS OF BUSINESS TAXES 4, Sales - for businesses which sells goods or properties 2. Receipts - for businesses that sells services “Sales” pertain to the total amount agreed as consideration for the sale of goods whether collected or uncollected. "Receipts" pertain to collections from the sale of service. ‘TYPES OF BUSINESS TAXES 1, Value Added Tax (VAT) on sales ~ 2. Percentage Tax- 3. Excise Tax _ ‘TYPES OF BUSINESS TAXPAYERS 1. VAT taxpayers - those required to pay VAT 2. Non-VAT taxpayers - those who pay the percentage tax Excise tax is an addition to either VAT)or/percentage tax, if the taxpayer produces certain excisable goods such as alcohol or cigarettes. THE VALUE ADDED TAX (VAT) ON SALES ‘The VAT on sales is a consumption tax imposed upon the sale of goods, properties or services or lease of properties. Characteristics of the VAT on sales 1. Taxon value added VAT is a tax on the value added by the seller (mark-up) on its purchases in making sales. It is an imposition based upon the price increases made by producers and distributors at each level of production or distribution.Chapter 1 — Introduction to Consumption Taxes 2. Top-up on sales - The VAT on sales is required by the law to be included in the price of the goods as a top-up thereto. The amount which will be billed to the customer shall include both the selling price and the VAT. This amount is called the “invoice price’. If the VAT is not separately indicated in the sales document, the amount appearing therein is presumed inclusive of var, 3. Tax credit method . The VAT on sales shall be reduced by the amount of VAT paid by the business on its purchases. The resulting excess VAT on sales is the amount due to be remitted to the government. An excess VAT payment on purchases is carried-over as deduction against the VAT on sales in future periods. Note however that if no VAT is paid on purchases, the VAT on sales effectively becomes the VAT due of the business. 4, Anexplicit consumption tax . The amount of VAT is explicitly disclosed in the invoice or official receipt of the seller. Hence, the buyer knows the amount of VAT he is paying in his purchase. 5. Quarterly tax The VAT return is filed quarterly but is paid on a monthly basis. (Sec. 114 (A), NIRC as amended) Methods of computing VAT 1. Direct method 2, Tax credit method Direct method ‘The value added tax is computed by applying the VAT rate to the difference of the selling price and the purchase. Mlustration A business purchased goods for P200,000 and sold the same for P250,000. The business paid P24,000 VAT on the purchase of the goods. The business is subject to 12% VAT. . ‘The VAT would simply be computed as: VAT = 12% x (P250,000 -P200,000) = P 6,000. Though quiet simple, this method is not employed in the Philippines.Chapter 1 ~ Introduction to Consumption Taxes ‘The Tax Credit Method ‘The VAT rate is imposed upon the sales or reveipt (output) of the business. ‘This is called the “Output VAT". The output VAT is then reduced by the VAT. paid by the business on its purchases (input). This is called the “Input VAT". ‘The excess of the Output VAT over the Input VAT is the VAT due or payable. Mlustration ‘Assuming the same data in the previous illustration, the VAT due or payable shall be computed as: ‘Output VAT (12% x P250,000) P 30,000 Less: Input VAT 24,000 VAT due £ 6 ‘The tax credit method is the computation method used in the Philippines. Special features of the tax credit method 1, Invoice-based crediting Entitlement for input VAT is to be substantiated with invoices. Because of this, our VAT system is known as "invoice-based”. 2. Non-observance of the matching of costs or expenses and sales Output VAT is recorded when a sale is made. Input VAT is recorded whenever a purchase is made and not when the goods were sold. The output VAT and input VAT accounts are simply closed at the end of each month, Ilustration: The VAT on sales Pelizloy Corporation is a VAT-registered seller of goods. During the month, it purchased goods:for P1,120,000 inclusive of P120,000 VAT. Pelizloy also sold goods to a client for P1,500,000, exclusive of VAT. Pelizloy shall bill the goods to the client by passing an output VAT on the sale. Pelizloy shall bill the sale as follows: Selling price P 1,500,000 Plus: Output VAT (P1,500,000 x 12%) 80,000 Invoice price P.1,680,000 ‘The invoice price shall be the amount to be paid by the client. ‘The VAT due and payable of Pelizloy Corporation shall be determined as follows: Output VAT (VAT collected on sale) P 180,000 Less: Input VAT (ie. VAT paid on purchases) 120,000 VAT due and payable P__60,000Chapter 1 — Introduction to Consumption Taxes Note: If the client is a VAT-taxpayer, he shall also claim the P180,000 passed-on VAT by Pelizloy as his input VAT against is Output VAT om his sles. VAT Accounting Entries: Pelizloy shall record the transactions in its books as follows: Inventories/Purchases 1,000,000 Input VAT 120,000 Accounts payable/Cash 1,120,000 To record the purchase of goods Cash/Accounts receivables 1,680,000 Sales 1,500,000 Outpue VAT 180,000 To record the sales of goods Output VAT P 180,000 Input VAT P 120,000 VAT due and payable 60,000 To close the VAT account and setup the VAT payable VAT due and payable P 60,000 Cash P 60,000 To.record the payment ofthe VAT to the government Note: The Input VAT on purchases and Output VAT on sales are specifically monitored by VAT 4 taxpayers on separate accounts. i VAT Taxpayers ‘The following businesses pay VAT: 1. VAT-registered taxpayers 2. VAT-registrable taxpayers Businesses which exceeded P1,919,500 in sales or receipts in any 12-month period are mandatorily required to register as VAT taxpayers. Smaller businesses with smaller annual sales or receipts may opt to voluntarily register as VAT taxpayers. A VAT registered taxpayer is required to pay VAT even if their annual sales fall below the P1,919,500 VAT threshold. A registrable taxpayer is one who exceeded the P1,919,500 threshold in any 12-month period but did not register as VAT taxpayer. Even if not so registered, they are still subject to VAT. PERCENTAGE TAX Percentage tax is a sales tax of various rates, generally 3%, imposed upon the gross sales or gross receipts of non-VAT taxpayers. 10Chapter 1 — Introduction to Consumption Taxes Characteristics of the percentage tax: 4. Taxon sales or gross receipts The total amount due from the buyer(invoice price) is considered sales or gross receipt. The percentage tax is computed directly from this amount. = . An expensed tax In income taxation, the percentage tax is presented as an expense deductible against the sales or gross receipt. This treatment gives percentage tax the impression of being a direct tax or privilege tax of the sellers. 3. An implicit consumption tax ‘The percentage tax is inherently factored by sellers in the pricing of their goods or services. The percentage tax passes to the buyer by inclusion to the selling price but the same is not separately presented in the invoice; hence, not specifically disclosed to the buyer— ‘The percentage tax is actually a consumption tax in the form of a _privilege tax. It is an indirect tax in the form of a direct tax. 4, Monthly or quarterly tax The percentage tax is payable monthly»for most percentage taxpayers and quarterly for certain percentage taxpayers. Mlustration During the month, Mr. Alno purchased P80,000 worth of goods. P56,000 of this was purchased from a VAT supplier inclusive of P6,000 VAT while P24,000 were purchased from non-VAT taxpayers. Mr. Alno, a percentage taxpayer, sold and invoiced the goods for P100,000. ‘The transactions shall be recorded as follows: Purchases P. 80,000 Cash P 80,000 To record the purchase of goods Cash P 100,000 Sales P 100,000 Torecord the sales Percentage tax expense P 3,000 Cash (P 100,000 x 3%) P 3,000 To record the remiteance of the percentage tax to the government oeChapter 1 ~ Introduction to Consumption Taxes Note: 1. The concept of invoice price and selling price to a percentage taxpayer is the same, The invoice price is recorded as sales. 2. The percentage tax and the input VAT paid on purchases are not separately recognized, 3. The percentage tax is computed directly on the sales and is reported as an expense, The percentage taxes expense is presented as part of “taxes and licenses" and is presented as a deduction against gross income under income taxation. ‘Who pays percentage tax? 1. Non-VAT taxpayers 2. Taxpayers who sells services specifically subject to percentage tax Non-VAT taxpayers are those with sales or receipts not exceeding the P1,919,500 VAT registration threshold and who did not opt to register as VAT-taxpayers. Certain services are specified by the law to be subjected to percentage taxes at various rates. Businesses which have receipts from these services will pay the corresponding percentage tax on such services even if they are VAT- registered. These services will be discussed in detail under Business Taxation in Chapter 5. Important points to consider: 1. The concept of sales between VAT taxpayers and percentage taxpayers differs. For percentage taxpayers, sales or gross receipt is equivalent to the invoice price. For VAT taxpayers, sales or gross receipts plus the 12% VAT composes the invoice price. 2. VAT and percentage tax are mutually exclusive. Normally, businesses pay either VAT or percentage tax. Businesses which pay VAT do not pay the percentage tax. Similarly, businesses which pay percentage tax do not pay VAT. However, a VAT-registered taxpayer may pay both VAT and percentage tax when it engages in activities which are specifically designated by the law as subject to percentage tax. Moreover, business taxpayers will pay VAT if they erroneously or intentionally use a VAT invoice or official receipt to bill its VAT-exempt sales. 12Chapter 1 - Introduction to Consumption Taxes EXCISE TAX Excise tax is imposed, in addition to VAT or percentage tax, on certain goods manufactured, produced or imported in the Philippines for domestic sale or consumption. Excise tax is levied on the production or importati 1. sin products, such as tobacco products and alcohol products 2. petroleum products 3. automobiles 4. non-essential commodities like jewelry, perfumes, toilet waters, yachts and sports cars, 5. metallic or non-metallic minerals, mineral products, and quarry resources such as coal, coke, gold, chromite and silver Mlustration Fortunate Corporation, a business subject to VAT, manufactures machine- packed cigarette which sells for.P20 per pack, excluding VAT. During the month, it produced 11,000 packs out of which it sold 10,000 packs. It also paid P16,000 VAT on various purchases. Under the NIRC, the sale of cigarettes at a price above P10.00 per pack shall be subject to an excise tax of P12.00 per pack. Fortunate Corporation shall pay the following taxes: Excise tax due at the point of production: Excise tax (11,000 packs x P12 excise tax per pack) P_132,000 Value Added Tax on sale: Gross selling price (10,000 packs x P20) x 12% P 24,000 Less: Input VAT™ 16.000 VAT due and payable B__8.000 Note: 1. Under Sec. 106 of the NIRC, excise tax on excisable articles is part of the basis of the Output VAT. In practice, the selling price fixed is inclusive of all costs such as production costs and_excise tax plus the mark-up of the seller. Hence, output VAT is normally ‘computed directly from the selling price, If Fortunate is subject to 39% percentage tax, it shall pay the same P120,000 excise tax plus 3% percentage tax on its sales. ‘The excise tax is an addition to VAT or percentage tax. As such businesses manufacturing excisable articles are either subject to VAT and excise tax or percentage tax and excise tax. 13Chapter 1 ~ Introduction to Consumption Taxes Percentage Tax, VAT and Excise Tax apply only to domestic consumption The export sale of non-VAT registered taxpayers is exempt from percentage tax. The export sale of a VAT-registered taxpayer is imposed by the law with 4.0% VAT. In both cases, there is effectively no consumption tax. When excisable articles are exported without returning to the Philippines whether exported in their original state or as ingredients or parts of any manufactured goods or products, any excise tax paid thereon shall be credited or refunded upon submission of the proof of actual exportation, (See Sec. 130(D), NIRC) Imposable Tax per Types of Consumption Buyer/Consumer Sellers of goods Resident Non-resident Domestic business ert) - VAT-registered 12% VAT on gross sales | 0% VAT on gross selling business price = Non-VAT-registered | 3% Percentage tax Exempt business On gross sales Foreigners 12% VAT on landed cost Exempt of importation j Buyer/Consumer Sellers of services Resident Non-resident Domestic business - VAT-registered 12% VAT on gross 0% VAT on gross business receipts receipts* + Non-VAT-registered ‘3% Percentage tax Exempt business on gross receipts Foreigners 12% final withholding Exempt vars * Under the law, the services must be rendered in the Philippines to be subject to O-rated VAT. It is exempt ifthe service is rendered abroad. ‘This apply regardless of the place where the service is rendered Comparison of the Business Taxes VAT % Tax Excise Tax Various ad valorem Tax rate 12% Generally 3% tax rates and specific taxes Basis Markcupor | Sales or receipts | Sales value or per value added unit of excisable goods or articles 14Chapter 1 — Introduction to Consumption Taxes Timing of Upon sales or | Upon sales or ] Upon production or imposition collection collection importation Generally paid by Bigger Smaller Both big or small businesses businesses businesses Export sales Subject to 0% Exempt Exempt VAT (axis reimbursable) Note: ‘The various excise tax rates are enumerated in Section 141 to Section 151 of the National Internal Revenue Code (NIRC). 2, Excisable articles produced for foreign markets are also exempt from excise tax. Points to Remember: 1. There are two types of consumption: a. Domestic consumption, and b. Foreign consumption Note: 1. Only domestic consumption is subject to tax. 2. If goods enter the Philippines, it will be taxed to consumption tax at the point of entry. 3. If goods are exported, itis effectively not subjected to consumption tax. It is subject to 0% VAT for VAT taxpayers and is exempt from percentage tax for non-VAT taxpayers. Its also exempt from excise tax. There are two types of consumption tax on domestic consumption: a. VAT on importation, and b. Business tax Note: 1. The VAT on importation applies uniformly to all taxpayers. 2. The business tax applies only if the seller is engaged in business, There are three types of business tax: a. VATonsales b. Percentage taxes ©. Excise tax Note: 1, Taxpayers either pay VAT on sales or percentage tax with the excise tax as an additional tax ifit produces excisable articles. 2. The VAT on sales and percentage tax accrues at the point of sales or collection while excise tax accrues at the point of production, 3. VAT is based on the value added. It is 12% of sales or receipt less VAT paid on purchase. Percentage tax Is directly computed on the sales or receipts. 15