Tax Articles

Understanding the Proposed Tax on Digital Services

By Atty. Fulvio D. Dawilan

Fulvio D. Dawilan Managing Partner   +632 8403 2001 loc.310 This email address is being protected from spambots. You need JavaScript enabled to view it. View Profile

I just arrived from a trip abroad where I and colleagues from the region conducted a seminar on the developments in taxation within our respective countries. Included in that discussion is an overview of the implementation of the digital services tax in the region. Apparently, some of our neighbors are ahead of us in crafting their laws on the taxation of digital services and are already implementing the same.

In the Philippines, the proposed law on digital services tax is about to become law. As they say, better late than never. Similar to most of the other countries, our version of the tax is limited to the business tax – the value-added tax. Earlier drafts included income tax but that was dropped as the legislation process progressed.

Here are some of the important features.

Amendment of the VAT Law to Include in its Coverage Digital Services Consumed in the Philippines. Our VAT law has always limited its coverage only to the sale or exchanges of services in the Philippines. Services rendered outside the Philippines are not included in the coverage of our VAT system. In other words, the place of performance of the service matters in determining the taxability of the transaction. The place of consumption is insignificant. This rule applies for both resident and non-resident service providers. And the rule had been observed since the VAT system was introduced in the country.

The law is introducing an amendment to the effect “that digital services delivered by nonresident digital service providers are considered performed or rendered in the Philippines if the digital services are consumed in the Philippines.” Is this changing the rule on the place of performance as a factor in the imposition of VAT? Definitely, Not. With the new law coming in, the rule remains unchanged – that is, performance of service in the Philippines still dictates the imposition of VAT. What is modified is that delivery of digital services and consumption in the Philippines is equated to performance of service in the country. Digital services are now in the same category as intellectual property or intellectual property rights where the use in the Philippines is considered as performance of service in the Philippines.

To me, this is the most important provision of the law, as it gives the Philippines the right to impose VAT on non-resident digital service providers (“NRDSP”). While the law also repeatedly mentions resident digital service providers, these are supposed to be covered by the existing VAT system, with or without the new law. Also, the other amendments are mere implementation mechanisms.

Who Are Digital Service Providers? A Digital Service Provider is defined as “a resident or nonresident supplier of digital services to a consumer who uses digital services subject to value-added tax in the Philippines.” This definition includes both resident and non-resident service providers. But as already mentioned above, resident digital service providers are already covered by the existing VAT system. Hence, only NRDSPs (those providers with no physical presence in the Philippines) will effectively be captured by the proposed law.

Reverse charge mechanism in digital services purchased from non-residents by VAT-registered taxpayers. For non-residents, what are the mechanisms for the compliance with the VAT due on digital services? Who is responsible in remitting the VAT liability?

In other jurisdictions, the responsibility for the remittance of VAT due on digital services rendered by non-residents depends on whether the transaction is “business to business” or “business to consumer”. That is not so under our proposed law. The duty to remit the VAT depends on whether the buyer is VAT or non-VAT registered. NRDSPs should therefore assess whether they are dealing with VAT or non-VAT-registered purchasers.

Purchases by VAT-registered taxpayers. The law is introducing a new term – the reverse charge mechanism. But this is not a new concept – it is the same as the withholding VAT system. In essence, the Philippine customer is responsible in withholding and remitting the VAT due on its purchases of digital services from NRDSPs. But this responsibility on the part of the buyer applies only when said buyer is VAT-registered.

This process conflicts with our existing rules on withholding VAT. In general, the application of our withholding VAT system does not depend on whether the buyer is VAT-registered or not. The duty to withhold is required on Philippine customers on their payments of service fees to non-residents for the latter’s services rendered in the Philippines. Such duty is imposed whether the buyer is VAT registered or not and whether corporation or individual.

Note that the business tax system in the Philippines is not limited to the VAT regime. There are industries which are subject to some other types of business taxes, other than the VAT and therefore not registered for VAT purposes. Yet for purposes of withholding VAT on services in general, they are not exempted. With the reverse charge mechanism for digital services being required only for VAT-registered taxpayers, non-VAT-registered businesses would be exempted even if they are big users of digital services. For these industries, they will have dual personalities – exempted from withholding for digital services and acting as withholding agent for all other types of services. This could create confusion in the implementation.

Purchases by non-VAT registered taxpayers. Except in cases where the reverse charge mechanism applies, it shall be the duty of the NRDSP to collect the VAT. That may either be the NRDSP itself or the digital platform through which the digital transactions are made. To be able to comply with their VAT obligations, these NRDSP should register with the tax bureau as VAT taxpayers. For this purpose, there will be a simplified system for registration. Again, NRDSP are mandated to comply with these obligations if they are dealing with non-VAT registered taxpayers.

To summarize, resident digital service providers are already covered by the existing VAT system. Likewise, NRDSPs selling their services only to VAT-registered taxpayers will be covered by the reverse charge mechanism. These digital service providers will not significantly be affected by the new law. However, heavy burden lies on the NRDSPs dealing with non-VAT registered Philippine customers.

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