Do VAT-exempt medicines need the BIR’s prescription?

The Constitution itself mandates every Filipino’s right to health: it declares that “the State shall protect and promote the health of the people and instill health consciousness among them” (Article II, Section 15).

Tax laws also carry out this mandate. Notable tax policies encourage everyone to be healthy. For instance, aside from their significant contribution to collections, “sin” and “sweet” taxes aim to regulate or discourage too much consumption of cigarette, alcohol, and sweetened beverages. The main objective of these tax measures is to promote a healthier society. Another health-related drive introduced in the Tax Reform for Acceleration and Inclusion law, or TRAIN, is the VAT exemption on medicines prescribed for diabetes, high cholesterol, and hypertension (DCH meds) with effect from 1 January. This VAT exemption will lessen the financial burden on patients with these conditions.

In early 2019, the Bureau of Internal Revenue (BIR) issued Revenue Regulations (RR) No. 25-2018, prescribing the rules on VAT exemptions for DCH meds. RR 25-2018 specifically declared that only those drugs on the “List of VAT-exempt diabetes, high-cholesterol and hypertension Drugs” identified by the Food and Drug Administration (FDA) are VAT-exempt. The BIR and the other government offices recently released more rules or prescriptions supplementing RR 25-2018, which are all very helpful.

One may need a doctor’s prescription to buy DCH meds from a drugstore. So, is a doctor’s prescription a prerequisite to VAT-exemption?

Nonetheless, the BIR may need to issue guidelines to explain the transitional impact of this VAT exemption, particularly its effect on the supply chain, e.g. wholesalers, distributors and retailers. Remember that the sales of DCH meds were subject to VAT until Dec. 31. This means that the DCH medicines bought by the drug traders prior to 1 January include input taxes, which they can validly claim as credit against their output taxes. Some of these previously bought stocks for resale were still on hand at the close of 31 December. The traders will eventually sell these DCH meds in 2019 as VAT-exempt. In the current VAT system, if a taxpayer’s sale is VAT-exempt, any input tax attributable to such sale forms part of the cost of the goods sold, and may not be claimed as input tax credit.

So, what will happen to the input taxes previously claimed by drug traders on the DCH meds they purchased prior to 1 January that are sold in 2019? Here are three possible approaches to address this transitional impact.

The first one is for the affected wholesalers, distributors and retailers to amend their previously filed VAT returns and take out the input taxes they claimed on the DCH meds. Upon selling these DCH meds in 2019, they can claim these input taxes as part of the purchase cost of the meds they sold instead of as input tax credits. Technically, this seems to be the right approach because it follows the VAT law to the letter. However, it could create more complications rather than solutions. For instance, if the drug traders were able to use the input taxes as credit against their output VAT liabilities in their previous VAT returns, such amendment would result in deficient VAT payments. Affected taxpayers would end up paying deficiency VAT plus penalties. This penalizes taxpayers for their previously valid actions which were nullified by a subsequent law. If this is applied, the TRAIN law will be an ex post facto law in this respect, which is unconstitutional. Obviously this was never the intention of the lawmakers.

The second approach requires drug traders to compute for input taxes corresponding to VAT-exempt sales of DCH meds in 2019. Drug traders will consider such amount as part of the cost of the goods sold. This will deducted from the input taxes in 2019. Thus, there is no need to amend the previous VAT returns. This approach may be more reasonable than the first, but otherwise tricky: it requires the taxpayer to treat theoretical input taxes as a cost. The law is clear that the input taxes forming part of the cost should be those that are actual and directly attributable to the VAT- exempt sale. This approach is therefore inconsistent with the rules.

The third approach is to allow the drug traders to apply the TRAIN law prospectively, plain and simple. No need to account for the input taxes on purchases prior to Jan. 1. Whether they were able to use such input taxes as credit against their output VAT in the previous years, drug traders would treat their old DCH meds stocks as if they were VAT-exempt purchases, which would be the scenario from 2019 and onwards (except for importers). This will give the drug traders some relief. Besides, they are just doing their part in promoting a heathier country as envisioned by the TRAIN law.

Considering the above issues, the BIR may need to issue further instructions about the transitional impact of VAT exemption on DCH meds. A prescription that should not cause headaches: it needs to be as effective as properly prescribed medical drugs. Who knows, with appropriate prescriptions from the BIR on gray areas, the Philippines could become a tax-healthier country.