Tax Articles

VAT on Interest Income

By: Atty. Mabel L. Buted

Is interest income subject to VAT?

To recall, sales that are subject to VAT are those which are made in the course of trade or business. These cover sales of all tangible and intangible objects and the performance of all kinds of services. This means that the sale or transaction to be taxable must be regularly conducted in the pursuit of a commercial or an economic activity.

The law also treats transactions undertaken that are incidental to the pursuit of such activity as entered in the course of trade or business. So, these incidental transactions are also subject to VAT. On what may be considered as “incidental,” it has been settled to include those that depend upon or belong to something else considered as primary or principal, or those which are incidental to the main purpose of the activity.

Interest income may be subjected to VAT if the grant of the loans or advances giving rise to the income is made “in the course of trade or business” or is considered as incidental to the trade or business. Unless the company is engaged in lending activity, this is usually difficult to determine. As a matter of fact, VAT on interest income has been the subject of many debates.

Recently, the Supreme Court (SC) promulgated a decision further clarifying the VAT treatment of interest income (G.R. No. 186155, January 17, 2023). The subject of the case is the interest income earned by the company from the loans extended to its parent company and subsidiaries. The company is engaged in management services – managing, promoting, administering, or assisting in any business or activity of other corporations. The loans were extended only on few times during the taxable year. The purpose of the loan is to accommodate the related parties which did not have existing credit lines with banks.

The Court held that the income is not subject to VAT. The interest is not subject to VAT not because of the fact that the loans were granted on an isolated or occasional basis only. This is so, because an isolated transaction may still be considered an incidental transaction that is subject to VAT. Instead, in ruling upon the case, the Supreme Court considered the presence or absence of intimate connection between the granting of financial assistance and the company’s primary purpose of providing management services.

In other words, to determine if an interest income is subject to VAT, there should be a resolution as to whether the loans are related or connected with the conduct of the main business activity of the company. And if there is, it is at this instance where the interest income arising from the loans would be subjected to VAT. Otherwise, in the absence of any relation or connection of the grant of loans with the primary business of the entity, the interest will not be subjected to VAT. To illustrate – in a sale of an asset, the asset must have been actually used in the business before the said sale may be subjected to VAT.

In the same case, the SC concluded that the loans extended by the company had no connection with its main business. The SC did not agree with the decision of the tax court stating that the granting of the loan to the related parties as a form of financial assistance was covered in purpose of the company of ”assisting” other entities. This cannot be embraced in its activity of managing, controlling, or directing the affairs of, or advertising or publicizing, the business operations of another. Because there is no connection or relation established between the activity that gave rise to the income and the main business of the company, it cannot be said that the loans were made in the course of trade or business nor considered an incidental transaction. Therefore, the interest arising from the loans is not subject to VAT.

I hope the SC has clarified the VATability of interest income. But if you have doubt on the vatablity of your interest income, seek the help of your counsel.