Revisiting the rules on offsetting

arrangements
October 28, 2018 | 10:41 pm

Suits The C-Suite

Offsetting (or netting) may arise in business transactions where there is a
debtor-creditor relationship. Considering that two parties can be both debtor
and creditor of each other, offsetting can be resorted to in order to reduce, or
even extinguish the liability, if the legal conditions are present and if the
criteria under Philippine Financial Reporting Standards (PFRS) are met.

While offsetting is not defined under Philippine law, the concept is introduced
as “compensation” under the Civil Code.

Compensation takes place when two persons, in their own right, are creditors
and debtors of each other. In one Supreme Court case, compensation has
been defined as “a mode of extinguishing to the concurrent amount, the
obligations of those persons who in their own right are reciprocally debtors
and creditors of each other,” and “the offsetting of two obligations which are
reciprocally extinguished if they are of equal value, or extinguished to the
concurrent amount if of different values.”

Although it is clear under the Civil Code that offsetting may take place
between parties who are both debtor and creditor of each other, and in some
instances even without their consent, it is a different scenario altogether when
it comes to taxation.

Under existing tax regulations, the Bureau of Internal Revenue (BIR) has
categorically prohibited the practice of offsetting the due to/due from and/or
payable/receivable transactions of taxpayers.
In June 2016, the BIR issued Revenue Memorandum Circular No. 61-2016
prescribing the policies and guidelines for accounting and recording
transactions involving “netting” or “offsetting.” Although the effectivity of RMC
61-2016 was suspended by virtue of RMC 69-2016, the BIR lifted the
suspension in the last quarter of 2016 upon its issuance of Revenue
Memorandum Circular 127-2016.

Under RMC 61-2016, the BIR mandates that taxpayers shall, at all times,
recognize at gross the accrued receivables or payables arising from the sale
or lease of goods or properties or the performance of services for income and
value-added tax or percentage tax purposes.

The same Circular further provides that income payments subject to creditable
and withholding taxes shall be recorded at gross, and any amount offset
against the income payments by the payor not subjected to tax shall not be
allowed as deductible expense of the payor. This is pursuant to RR 12-2013,
which disallows an expense to be deductible if no withholding tax is remitted.

To provide a full understanding on transactions with an offsetting

arrangement, the Circular provides for three illustrations:

1. A manufacturer sells its food products to a supermarket that, on the other

hand, charges a service fee to the manufacturer for the display of its product
in the store of the latter. The manufacturer issued a sales invoice for the full
amount of the products sold. However, the supermarket records its purchases
net of service fees, which it records as a discount. For VAT purposes, the
service fees disguised as a discount in this scenario are not within the
discount contemplated under the provisions of RR 16-2005, as amended.
Hence, the service fee disguised as discount shall be considered revenue
regardless of the “netting arrangement” between the payor and payee. The
parties shall record the sale of goods and service fees at gross amount
instead of netting the transaction and making it appear that there is a
discount.
2. In the telecommunications industry, companies interconnect their
telecommunication service networks with one another. As part of their
revenue sharing or fixed-rate charge arrangement, parties bill each other for
interconnection fees, or access charges on voice and data transmissions
passing through their respective network. The interconnection, sharing, or
access charges, shall form part of the gross revenue of the company receiving
the same, and a corresponding interconnection fee expense and set up of
liability shall be recorded by the company paying the share or charge. In this
scenario, the outright set-off of payments due to the other telecommunication
company against the gross revenue of the collecting telecommunication
company is prohibited.

3. A bank extends a loan to its depositor who happens to maintain a deposit

account with the bank. The bank earns interest income from the loan
extended to the depositor while at the same time, incurring interest expense
on the deposit account. In this case, the bank shall declare in its percentage
tax return the full amount of the interest earned from the loan extended
without offsetting the interest expense due to the depositor.

It may be inevitable for some businesses to enter into a “netting” arrangement

in order to settle an obligation. It is, however, necessary for taxpayers to be
mindful of their procedures when recording transactions for settlement
arrangements. For both accounting and tax purposes, the “substance over
form” of business settlement agreements must be considered, and each
particular transaction must be recorded separately.

Taxpayers may have potential tax exposures on income tax, value-added tax
(VAT) and other tax obligations as a result of noncompliance with the
prescribed guidelines for accounting and recording of transactions involving
offsetting. Taxpayers are strongly encouraged to evaluate their compliance
with RMC 61-2016, so that risks on possible tax deficiencies can be
minimized, especially in case of future BIR tax audit investigations. A prudent
and careful study of changes to tax policies and obligations should be a
priority for every business, professional, and entrepreneur.

This article is for general information only and is not a substitute for
professional advice where the facts and circumstances warrant. The views
and opinion expressed above are those of the author and do not necessarily
represent the views of SGV & Co.