8/10/2019 444. Incidental Transactions Subject to VAT - EMW 7.31.14

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BDB Laws Tax Law for Businessappears in the opinion section ofBusiness Mirrorevery Thursday.

Incidental transactions subject to VAT

THE late United States Chief Justice John Marshall once said that the power to tax involves thepower to destroy, and involves, as it does, one of the most illimitable powers of thegovernment. The courts, in viewing that power as destructive, have espoused the principle thattax statutes are to be strictly construed against the taxing authority and, thus, may neither beextended by implication beyond the clear import of their language nor may they be enlarged byoperation so as to embrace matters not specifically provided (Commissioner of InternalRevenue [CIR] v Philippine Airlines, GR 180066, July 7, 2009). Therefore, before a certain typeof tax may be imposed, it is first necessary to determine who or what are to be taxed.

Value-added tax (VAT) is an indirect tax imposed on any person who, in the course of trade orbusiness, sells, barters, exchanges, leases goods or properties, renders services, and anyperson who imports goods (Section 105 of the National Internal Revenue Code). To be subjectto VAT, one must sell, barter, exchange, lease goods or properties, or render service in thecourse of trade or business. The term in the course of trade or business is defined under

Section 105 of the Tax Code as the regular conduct or pursuit of a commercial or an economicactivity, including transactions incidental thereto. But what, exactly, are the transactionsincidental to the pursuit of ones commercial or economic activity? The Court of Tax Appeals(CTA) has provided insights into what are the incidental transactions that would be subject toVAT.

8/10/2019 444. Incidental Transactions Subject to VAT - EMW 7.31.14

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In CIR v Thomas C. Ongtenco (CTA EB Case 995 [CTA Case 8190], June 30, 2014), the CTAdefined incidental as [d]epending upon or appertaining to something else as primary;something necessary, appertaining to or depending upon another, which is termed the principal;something incidental to the main purpose. It, thus, held that, for a transaction to be consideredincidental under Section 105 of the Tax Code, the transaction must be dependent upon orappertaining to a primary transaction or activity. It then ruled that the loans granted by

Ongtenco to a company, of which he is a director, were not incidental transactions to his mainbusiness of selling motorcycles. The loans granted were not dependent upon or appertainingto such primary business purpose and, thus, could not have been the subject of VAT.

This case was not the first time the tax court tried to define what incidental transactions are. InLapanday Foods Corp. v CIR (CTA EB Case 367 [CTA Case 7097], January 29, 2009), the CTAruled that the loans granted by Lapanday Foods to its affiliates were transactions incidental toits business, which involves assisting corporations. Thus, the loans granted to affiliates wereincidental to its main business activity, for which it may be held liable for VAT. In WaterfrontPhilippines Inc. v CIR (CTA Case 8024, November 13, 2012), the tax court ruled thatWaterfronts moves to grant cash advances to its affiliates were not incidental transactions, forwhich it could be held liable for VAT. Why? Because the companys main business activity was

to be an investment holding company, which had nothing to do with granting cash advances toaffiliates. In Kepco Philippines Corp. v CIR (CTA Case 8319, November 7, 2013), power-generation firm Kepco extended loans to its affiliates, which the court ruled were transactionsincidental to the companys main business of rehabilitating, operating, maintaining andmanaging other power-generating plants and related facilities for the conversion of fuel intoelectricity.

To determine whether a transaction is incidental or not, two things must be considered. First,the main or primary business activity of the taxpayer must be determined; and second, thereasonable connection of the transaction to a taxpayers main business or activity should beascertained. In case such a connection exists to such an extent that the transaction isdependent upon or appertaining to the primary transaction or activity, then it is an incidental

transaction that should be subject to VAT.

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The author is a junior associate of Du-Baladad and Associates Law Offices, a member-firm ofthe World Tax Services Alliance.

The article is for general information only, and neither intended nor should be construed as asubstitute for tax, legal or financial advice on any specific matter. Applicability of this article toany actual or particular tax or legal issue should, therefore, be supported by a professionalstudy or advice. If you have comments or questions about the article, e-mail the author atesther.weigand@bdblaw.com.ph or call 403-2001, local 340.