Written by Rhea M. Regala, 12 June 2008
Lately, the incumbent Commissioner of Internal Revenue has been quite successful in implementing her initiatives to improve revenue collections, and this presumably is a trend that the government will want to continue.
What remains to be seen is how many of such recent revenue initiatives have been based on legal interpretations that would prove the reliability and stability of the tax system.
The Bureau of Internal Revenue (BIR) recently released DA Ruling 084-2008 which interpreted some provisions of Revenue Regulations (RR) 6-2006 (RR) implementing the functional currency (FC) reporting, particularly on the income tax computation of taxpayers using functional currency financial statements other than Philippine Pesos.
In this ruling, a consortium of two industry leaders purchased the shares of a foreign entity in its Philippine subsidiary that is engaged in the energy business. The consideration for the shares acquisition was paid in US dollars.
Even before the acquisition, the acquired company’s (investee) functional currency based on the recent accounting standards is the US$, which means that foreign exchange (forex) losses/gains are only recognized for non-US$ denominated transactions.
Furthermore, even prior to this acquisition, the investee company already computes its income tax liability using its peso books or the "historical rate method."
Thus, as a result of the different accounting and income tax treatments of recording these transactions, it has recognized a deferred tax asset or liability.
In view of these conflicting positions, the taxpayer sought clarification from the BIR on the interpretation of the RR, particularly on whether it requires the use of "historical rate method" (peso books) or "current rate method" (US$ books) for computing its income tax liability. In addition, it sought to verify whether or not it is allowed to use the "current rate method" after the said acquisition, which started on June 23, 2007.
Reading through the ruling, the BIR made an interpretation that the RR prescribes the "historical rate method" or the use of the actual conversion rate prevailing on the transaction date for purposes of computing the income tax liability.
Thus, at the end of the year, a taxpayer will be required to make a reconciliation of the converted amounts with the figures in the peso subsidiary ledgers which the taxpayer has to maintain for purposes of its other tax liabilities. Such reconciling item shall be reflected in the annual income tax return (ITR).
The regulations actually prescribe that only transactions "subject to the other taxes" (taxes other than income tax) shall be recorded in foreign currency using the exchange rate prevailing at the transaction date. It was also mentioned that it is only at yearend that the difference between income and expense in the annual ITR, based on monthly average rates, shall be compared with income and expense subject to other taxes, and the difference of which shall be treated as a reconciling item in the ITR.
In actual practice, though, this procedure is proving to be very difficult to implement, considering the volume of transactions that need to be reconciled at yearend by the concerned taxpayers.
Another issue raised in this BIR ruling is the disallowance of the use of the functional currency books (US$ books) for income tax computation purposes.
This author believes that it is reasonable to opine that taxpayers using functional foreign currency in their financial statements and books of accounts should be allowed to compute their income tax liability using said functional currency books (using monthly average conversion rates), since this clearly represents the taxpayer’s results of operations and supports the realization principle for tax purposes.
Using such method, the forex losses/gains shall be derived from transactions on foreign currencies other than the functional currency used (US$), eliminating the artificial gains and losses recorded in the computation of income tax due.
In conclusion, the BIR allowed in this ruling the use of the "current rate method" (US$ books) where it stated that the conversion rate to be used in determining the taxpayer’s income tax liability shall be the rate issued by Philippine Dealing System (PDS) at balance sheet date, that is, as of the end of the related taxable year.
Such method shall be applicable from June 23, 2007 onwards, which was the date of shares acquisition. Prior to such date, the BIR ruled that the companies must adhere to the historical rate method, as previously prescribed by the BIR.
Again, this is a contentious and debatable conclusion. Although the use of "current rate method" is appropriate, the ruling appears to be inconsistent with the regulations that prescribe monthly average conversion using the PDS rate and not the end-of-year conversion rate. Furthermore, considering that the taxpayer is assumed to be using US$ as its functional currency even before the acquisition, a cut-off for the use of different methods in computing its income tax liability is not necessary. In addition, the regulations do not prescribe the use of a cut-off period for taxpayers using the functional currency system. Instead, applica-tion of functional currency reporting other than the peso should be made annually.
Obviously, no clear position has been actually issued on this transaction. In fact, the BIR contradicted itself in this ruling by recommending two "acceptable" yet conflicting methods in computing income tax, making it more confusing to the taxpayers.
Conventional wisdom relative to policy development dictates that if there are two conflicting positions, there must first be a final policy statement or guideline that should reconcile them before adopting the solutions.
In the Philippines, however, particularly at the BIR level, the policy issues are not yet even defined. And yet in its eagerness and zeal to collect taxes, half-baked solutions are introduced, thereby, fusing both policy guidelines and technical solutions into a single rule without first addressing the underlying conflicting principles. History has demonstrated that this will most likely not work in the long run.
Therefore, the BIR should issue consistent guidelines based on principles relative to functional currency reporting to allow taxpayers proper compliance, penalty free.
