Tax Articles

Riddle me this: What are Digital Services?

By: Atty. Jomel N. Manaig

Atty. Jomel N. Manaig Partner   +632 8403-2001 loc. 140 This email address is being protected from spambots. You need JavaScript enabled to view it. View Profile

The imposition of VAT on digital services is not considered as a new tax. Nonetheless, the law provided for a variety of new concepts for taxpayers: the expansion of what is considered as being performed in the Philippines, the reverse-charge mechanism, and the automated registration for nonresident service providers, to name a few.

There is a slew of complicated topics that may be prodded. But for today, let me invite you to take a step back and focus on a more fundamental and rudimentary aspect of this new law. Before we even think about imposing VAT on digital services, let’s first ask ourselves: what are digital services?

The law provided a definition for digital services but let me break it down into two simple elements. The first element requires that digital services must be “supplied over the internet or other network with the use of information technology.” On the other hand, the second element insists that digital services must be “essentially automated.”

This definition was copied verbatim in the draft Revenue Regulations (RR) seeking to implement the new law. However, the RR included a range of services it deems as digital services but lacked one or both of the elements. This may lead to confusion and the erroneous characterization of what digital services really cover.

These two elements must be clarified further in the RR to avoid confusion and erroneous implementation of the law.

First element: Supplied over the internet or other network with the use of information technology

There is much confusion here due to the simple reason that the Internet is ubiquitous in modern business transactions. But should anything and everything done with the use of the internet be labeled as digital services? I proffer that it should not.

A clear distinction must be made between using the internet as mode of “supplying the service” and its use as a mere mode of communication. In other words, if the service may be supplied without the use of the internet (or other network), then the service should not be considered as digital service for purposes of imposing VAT.

The mere fact that the internet was used should not be the ultimate determinant of what is a digital service. For example, the services of a nonresident service provider transmitted via the internet (e.g. e-mail) should not automatically be considered as a digital service if the same could have been transmitted through other means such as through couriers or other physical delivery services.

The supply over the internet should be of such importance that the digital service could not have been performed without it. Otherwise, its use as a mode of communication is merely incidental and has nothing to do with the performance of the service itself.

Second element: Essentially automated

Considering the nature of digital services, I believe it should mean that the service should require minimal or even no human intervention. So much so that the service provider does not have to interfere, carry, or perform any activity but the consumer will still be able to acquire or download the digital service.

In other words, if a human had any substantial active input in the actual performance of the service, then such service cannot be considered as essentially automated. Consequently, it should likewise not be considered as a digital service.

I do realize that with the advancement of technology, more and more services are requiring less and less human intervention. What was once the sole domain of human activity may now be performed by chatbots and other artificial intelligence (AI) platforms – thus, transforming services traditionally performed by humans into digital services. Which is why it is extremely important to delineate what is considered as “essentially automated.”

For example, if a customer sought the opinion of a nonresident service provider, the rendering of the opinion may be considered as a digital service or not depending on who/what performed the actual service. If the opinion was made and prepared by a human, then the service should not be considered as a digital service due to the person’s active intervention. On the other hand, if the opinion was made by the customer prompting his question through a chatbot or an AI assistant, then it is rightly considered as a digital service since the supply of the service was essentially automated (lacking any human interference from the nonresident service provider).

It is interesting to note that we share the same basic definition of digital services (including the two elements) as some of our neighbors, namely Indonesia, Malaysia, Thailand, and Vietnam. The only difference is that they clarified, either in the law itself or in the implementing rules and regulations, the scope and limitations of those two elements. This has led to our neighbors having consistent and reliable implementation of their respective digital service taxes.

We hope the Bureau takes note of these clarifications and includes the recommendations in the final version of the RR. This would promote a standard and fair implementation of the new law at par with our regional counterparts.