CHAPTER 1

INTRODUCTION TO CONSUMPTION TAXES

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.

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 consumers or 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. It helps 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 part of the income to
savings formation.

Consumption tax helps redistribute wealth to society.

It is a basic state policy to redistribute wealth to society so everyone in the state could enjoy the same.
Rich people buy more and spend more since they can afford expensive lifestyle. A tax on consumption will
make them pay more tax. Therefore, consumption tax supports the redistribution of wealth from the rich to
the less privileged members of the society.

Consumption tax supports the Benefit Received Theory.

Under the Benefit received theory, those who receive benefit from the government shall pay taxes. Everyone
in the state receives benefits from the government; hence, everybody should be taxed.
Unarguably, everybody consumes goods and services. A tax on consumption will effectively make everyone
contribute to the support of the government. Consumption tax provides a practical application of the Benefit
Received Theory.
There is one important caveat to consumption tax however. It should not be levied upon basic necessities such
as food, education, health, and shelter or housing. Our current tax law observes this but with qualifications.
Exempt consumption of basic necessities will be extensively discussed in Chapter 2 and Chapter 4.
Income tax distinguished from consumption tax
Income Tax Consumption tax
Nature Tax upon receipt of income Tax upon usage of income
or capital
Scope A tax to the capable A tax to all
Supporting tax theory Ability to pay theory Benefit received theory

Income taxation is consistent with the ability to pay theory because it taxes only those who are capable to tax.
Consumption tax effectively taxes everyone.

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.

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 subject to 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 seller is (Buyer is a resident) (Buyer is a 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 non-residents abroad this is most commonly known as
“importation.”
2. Purchase of residents of goods, properties or services from resident seller- this transaction is a “sale” on the
seller’s perspective.

CONSUMPTION TAX ON IMPORTATION

Importers of good shall pay consumption tax on their importation. This consumption tax is called “Value
Added Tax (VAT) on importation.” The VAT on importation is 12% of the total import cost of the goods paid
prior to the withdrawal of the goods from the warehouse of the Bureau of Customs.

Every Purchaser or service from non-residents (I.e., import of service) shall likewise pay VAT on importation of
the service. This VAT on importation is called “Withholding VAT.” The withholding VAT is computed as 12% of
the contract price of the service.

These consumption taxes on importations are payable without regards as to 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.

CONSUMPTION TAX ON DOMESTIC CONSUMPTION FROM RESIDENT SELLERS

The consumption tax on the purchase of Philippine residents from resident seller 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.

Consumption tax for 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 “business tax.”

The term “Business Tax” is a misnomer

It must be emphasized again that businesses are, in effect, agents of the government for the collection of
consumption taxes from the buyers. Businesses are not the real taxpayers.

In law, businesses are made directly liable for the payment of the consumption tax. They 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 tax.” This, however, does not change the very essence of business
tax as a consumption tax. The rule is merely intended to enforce compliance

Table of Comparison
VAT on Importation Business Tax
Basis of tax Acquisition cost Sales or Receipts
Scope of tax All consumption 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 of summary: Consumption tax rules on domestic consumption

Seller Resident Buyer Applicable consumption tax
Domestic sellers
- Business Business Business tax
- Business Non-business Business tax
- Non-business Business None
- Non-business Non-business None
 Seller Resident Buyer Applicable consumption tax
Foreign sellers
- Business Business VAT on importation
- 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

1. 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, services of lease of
properties.

Characteristics of the VAT on sales

1. Tax on 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.
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 VAT.
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. An explicit consumption tax
The amount of VAT is explicitly disclosed in the invoice or official receipt of the seller. Hence, buyers know
the amount of VAT they are paying on their purchases.
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 TAX
1. Direct Method
The value added tax is computed by applying the VAT rate to the difference of the selling price and the
purchase.

2. The Tax Credit Method

The VAT rate is imposed upon the sales or receipt (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.

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
“invoiced-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 are sold. The output VAT and input VAT accounts are simply closed at the end of each
month.

VAT Taxpayers
The following businesses pay VAT:
1. VAT-registered taxpayers
Businesses which exceed 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. VAT registered taxpayers are required to pay VAT even if their annual sales fall
below the P1,919,500 VAT threshold.
2. VAT-registrable taxpayers
Registrable taxpayers are those who exceed the P1,919,500 threshold in any 12-mont period but did not
register as VAT taxpayers. 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.

Characteristics of the percentage tax

1. Tax on 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.

2. 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 in by sellers in the pricing of their goods or services. The
percentage tax is passed on to the buyer by inclusion in the selling price, but the same is not separately
presented in the invoice; hence, it is 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 masked as
a direct tax.

4. Monthly or quarterly tax

The percentage tax is payable monthly for most percentage taxpayers and quarterly for certain percentage
taxpayers.

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 comprises 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 their VAT-exempt
sales.

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 importation of:

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

Percentage Tax, VAT and Excise Tax apply only to domestic consumption.
The export sale of a non-VAT registered taxpayer is exempt from percentage tax. The export sale of a VAT-
registered taxpayer is imposed by the law with a 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
- VAT-registered business 12% VAT on gross sales 0% VAT on gross
selling price
- Non-VAT registered business 3% Percentage tax on Exempt
gross sales
- Foreigners 12% VAT on landed cost Exempt
of importation

Buyer/Consumer
Sellers of services Resident Non-resident
Domestic Business
- VAT-registered business 12% VAT on gross receipts 0% VAT on gross
receipts*
- Non-VAT registered business 3% Percentage tax on Exempt
gross receipts
- Foreigners 12% final withholding Exempt
VAT**
*Under the law, the services must be rendered in the Philippines to be subject to 0-rated VAT. It is exempt if the
service is rendered abroad.
*This applies regardless of the place (Philippines or abroad) where the service is rendered.

Comparison of Business Taxes

VAT % Tax Excise Tax
Tax Rate 12% Generally 3% Various ad valorem
tax rates and specific
taxes
Basis Mark-up or value Sales or receipts Sales value or per
added unit of excisable
goods or articles
Timing of Imposition Upon sales or Upon sales or Upon production or
collection collection importation
Generally paid by Bigger Businesses Smaller Both big and small
businesses businesses
Export sales Subject to 0% Exempt Exempt
VAT (Tax is reimbursable)

Note:
1. 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, they will be subject to consumption tax at the point of entry.
3. If goods are exported, they are effectively not subjected to consumption tax. They are subjected to 0%
VAT for VAT taxpayers and exempt from percentage tax for non-VAT taxpayers. They are also exempt from
excise tax.

2. 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.

3. There are three types of business tax:

a. VAT on sales
b. Percentage taxes
C. Excise tax
Note:
1. Taxpayers pay either VAT on sales or percentage tax with the excise tax as an additional tax if they
produce 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. The VAT is based on the value added. It is 12% of sales or receipt less VAT paid on purchase. The
percentage tax is directly computed on the sales or receipts.