Ondoy, Pepeng, Calamities and Your Income Tax Return

Typhoons Ondoy and Pepeng which hit the country just several months ago (i.e., September 26 and October 2, 2009, respectively), are two of the most devastating catastrophes that will forever be remembered in our country’s history. Although business have already normalized, it will take a while for businesses to be able to recover the overwhelming losses in property and investments that Ondoy and Pepeng have caused on them.

From the point of view of taxation, the Bureau of Internal Revenue (BIR) in anticipation of the significant number of taxpayers that will be claiming deductions for casualty losses suffered as a result of the destruction wrought by Ondoy and Pepeng, issued Revenue Memorandum Order (RMO) No. 31-2009 which provided for the policies and guidelines for the reporting of said casualty losses. Under the RMO, taxpayers engaged in trade or business may be entitled to claim as business deductions, casualty losses incurred for the properties actually used in the business enterprise but not the loss of assets not used in the business and/or are personal in nature. Said assets must have been properly reported as assets in the taxpayer’s books and financial statements in the year immediately preceding the occurrence of the loss, i.e., prior to September and October 2009, with the cost of acquisition clearly established and recorded.

Procedurally, the claim for loss shall require the preparation and filing of a Sworn Declaration of Loss stating the following relevant information: (1) nature of the event that gave rise to such losses and the time of its occurrence; (2) description and location of the damaged property; (3) items needed to compute the losses, i.e., cost or other basis of the properties; depreciation allowed, if any; value of the properties before and after the event; the cost of repair and the amount of insurance or other compensation received or receivable. The Sworn Declaration of Loss shall further be supported by various documents, e.g., Financial Statement for the year immediately preceding the event, copies of the insurance policy(ies), if any, for the concerned properties; and proof of the elements of the loss(es) claimed.

The Sworn Declaration of Loss and supporting documents must be filed within forty five (45) days from the date of event, with the concerned revenue district offices where the taxpayer is registered. This means that the deadline for the filing of the application for loss shall be on 10 November 2010, in the case of casualty losses resulting from Ondoy, and 16 November 2010, in the case of casualty losses resulting from Pepeng. Since RMO 31-2009 was issued and disseminated to the public only on 16 October 2009, affected taxpayers had barely less than 45 days to comply with the claim for loss requirements, i.e., 25 days for Ondoy and 31 days for Pepeng.

Given the extent and magnitude of the property damaged and the emotional trauma caused on the victims of Ondoy and Pepeng, 45 days from the occurrence of the event does not seem enough to expect businesses (whose owners and employees are victims as well) to be able to readily prepare their claim for loss and comply with the documentary requirements. Recovering from the shocking effect of the typhoons in the personal lives of our people and gathering together all the required documents which may have probably been lost or damaged by the floods that destroyed countless of business establishment and offices, warehouses, factories and plants, would take time and cannot be strictly imposed on people. With more reason that compliance has become impractical, if not impossible, since the remaining days to comply were effectively shortened to 25 days for Ondoy and 31 days for Pepeng, because RMO 31-2009 which provided for the 45 days deadline was issued only several days after Ondoy and Pepeng.

The critical issue now is, whether it is just and fair that taxpayers who were unable to comply with the requirements of RMO 31-2009 within the 45 days deadline be outrightly deprived of their right to claim legitimate losses sustained as a result of the damages caused by Ondoy and Pepeng? How about those who discovered their loss only days, weeks or months after the typhoons, which is not remotely impossible, since taking an inventory of damaged stocks, files records and properties can take a long period depending on the extent of the loss and damage.

In my view, taxpayers who failed to meet the deadline set under RMO 31-2009 should not be prejudiced by a mere regulation. The validity of claims for casualty losses must be considered in accordance with Section 34 (D) of the Tax Code which provides, as follows:
"(D) Losses. —
"(1) In General. — Losses actually sustained during the taxable year and not compensated for by insurance or other forms of indemnity shall be allowed as deductions: xxx
"(b) Of property connected with the trade, business or profession, if the loss arises from fires, storms, shipwreck, or other casualties, or from robbery, theft or embezzlement.
"The Secretary of Finance, upon recommendation of the Commissioner, is hereby authorized to promulgate rules and regulations prescribing, among other things, the time and manner by which the taxpayer shall submit a declaration of loss sustained from casualty or from robbery, theft or embezzlement during the taxable year: Provided, however, That the time limit to be so prescribed in the rules and regulations shall not be less than thirty (30) days nor more than ninety (90) days from the date of discovery of the casualty or robbery, theft or embezzlement giving rise to the loss.

It will be noted that under the above provision, the deadline for the filing of the Sworn Declaration Loss for casualty losses is within 30 to 90 days counted from the date of discovery of the event (casualty, robbery, theft or embezzlement) giving rise to the loss and not from the occurrence of said event as was provided under RMO 31-2009. Common sense dictates that Ondoy and Pepeng were events that were actually experienced and witnessed and therefore, there was no need for them to be discovered. However, common sense also dictates that the actual damage caused by said typhoons may not necessarily be known or discovered immediately at the time of their occurrence.

An inventory and accounting of the loss must first be done before the actual loss can be properly accounted for. And if we are talking of huge properties, stocks, assets, files and records, from a practical perspective, it may be difficult if not impossible, to finish the process within a period of 45 days or even 90 days from the event or catastrophe. This precisely, is the rationale why Section 34(D) of the Tax Code reckoned the counting of the period within which to submit the Sworn Declaration of Loss from the time of discovery of the loss and not from the occurrence of event that caused the loss.

By requiring the filing of the Sworn Declaration of Loss to 45 days from occurrence of the event, many taxpayers would be unfairly precluded from claiming legitimate casualty loss deductions in violation of Section 34(D) of the Tax Code.

Indeed, while the 45 days deadline from occurrence of the event was based on an earlier revenue issuance (i.e., RMO 12-77), application of the same deadline to casualty losses borne by Ondoy and Pepeng may not be appropriate since these two typhoons were extraordinary events with insurmountable effects and not just regular natural calamities which are contemplated under RMO 12-77. Hence, instead of imposing the same deadline provided in RMO 12-77, RMO 31-2009 should have provided for more reasonable terms and conditions taking into account the magnitude of the devastation caused by Ondoy and Pepeng and the provisions of Section 34(D).

It is well settled that the rules and regulations which are the product of a delegated power to create new or additional legal provisions that have the effect of law, should be within the scope of the statutory authority granted by the legislature to the administrative agency.
"In case of discrepancy between the basic law and a rule or regulation issued to implement said law, the basic law prevails because said rule or regulations cannot go beyond the terms and provisions of the basic law (People v. Lim, 108 Phil. 1091)."

In the recent case of Fort Bonifacio Development Corporation vs. CIR, G.R. No. 158885, decided on October 2, 2009, the Supreme Court struck down Section 4.105-1 of RR 7-95 for being in conflict with the law. It held that the BIR had no power to limit the meaning and coverage of the term “goods” in Section 105 of the Old National Internal Revenue Code (Tax Code) without statutory authority or basis and justification to make such limitation.

Given the situation faced by taxpayers who were victims of Ondoy and Pepeng, the pronouncements of the Courts could offer a ray of hope for those who are qualified and entitled to claim the deduction for casualty losses under the provisions of the law, but unable to file their claim within the 45 days deadline. On the part of the BIR, it may be advisable to revisit RMO 31-2009 and amend it in consonance with the law it seeks to implement. For humanitarian reasons, the BIR should also be able to provide relief to taxpayers who were victims of these calamities and not to further aggravate their loss by disallowing losses they sustained simply for their failure to comply with a procedural requirement provided by regulation.

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Declogging CTA Docket and Exhaustion of Administrative Remedies

One of the major concerns facing the taxpayer is the difficulty as well as delays involved in seeking a refund of taxes already paid. Due to the amounts involved, the subject of refund frequently injects an element of material uncertainty in the financials of the concerned taxpayers.

The Bureau of Internal Revenue (BIR) has earlier issued Revenue Memorandum Circular (RMC) No. 29-2009 seeking to allay the taxpayers’ collective concerns about the delay in the administrative processing of claims for tax credit certificate (TCC). Under the said RMC, the BIR seeks to implement more effectively Section 112(C) of the National Internal Revenue Code as amended (Tax Code) which mandates the BIR to act on claims for refund or TCC of unused input VAT related to VAT zero-rated transactions within 120 days from the date of submission of complete documentation. This RMC is laudable and if implemented seriously, would be favorable to the taxpayer since a claim which is approved at the administrative level at the earliest possible time would no longer require the taxpayer to resort to judicial remedy, i.e., to elevate the claim to the Court of Tax Appeals (CTA), which is costly. Hence, in principle, RMC 29-2009 should work effectively.

However, an important aspect in a refund case that taxpayers should be concerned about is the two (2) years prescription period to refund as prescribed under Section 229 of the Tax Code, which has likewise been applied to claims for refund of input taxes under Section 112. The CTA has consistently held that the 2-year prescriptive period to refund applies to both the administrative and judicial aspects of the refund. As explained by the CTA in one case, “a taxpayer is given only two (2) years from the payment of a tax or liability, regardless of any supervening event, to file its claim for refund. The claim should first be filed before the Commissioner who shall decide the same within sixty (60) days. If the Commissioner denies the claim, the taxpayer has thirty (30) days from receipt of denial to appeal before the CTA. If the Commissioner does not act on the claim within the sixty-day period, the taxpayer may go directly to the CTA provided it is still within the two years mandated by Section 229 (See CTA Case No. 7657)

In other words, a taxpayer must file his claim for refund with the BIR within the 2-year prescriptive period and if his claim is not acted upon or is denied, he must timely elevate his claim to the CTA before the expiration of the 2-year prescription period, otherwise, he would be forever barred from further pursuing his judicial remedy to refund.

More often than not, taxpayers elevate their refund claims to the CTA if there is no assurance as to the outcome of the BIR’s action on their claim for refund, and this becomes mandatory when the two-year prescriptive period is about to lapse, with or without any action on the part of the BIR. This apparently resulted to the filing of numerous Petitions for Review with the CTA even before the resolution of their administrative claims.

Petitions of Review filed before the end of the 120 days has been consistently objected to by the BIR on the grounds of failure to exhaust administrative remedies and that the filing is premature since they are allowed under the law to act on the refund claim. So far, however, the CTA has consistently held that the taxpayers need not wait for the lapse of the subject 120-day period before lodging their judicial claim. As a consequence, however, a growing number of refunds are being effectively processed at the CTA or at the court level. Hence, instead of being an appeal body, the CTA has in many instances taken over the task of processing claims for refund, which was a material factor in the clogging of the dockets of the CTA.

This resulting practice is not, in reality, the proper procedure to do since the CTA is an appellate Court body, at the same level and of equal footing as the Court of Appeals (CA) on tax matters by virtue of Republic Act No. 9282, and not a tax processing agency or body. The task of processing claims is thus best left to the BIR.

Given the foregoing, taxpayers are well-advised to file their claims for refund well ahead of the two-year prescriptive period, with complete documentary support, to allow the BIR sufficient time to process the claim. Allowing the BIR sufficient time to process and dispose of the refund at this level should contribute much in declogging the court dockets, which should also benefit taxpayers in the form of faster disposition of cases. At any rate, the taxpayer has thirty (30) days from receipt of the decision of the BIR denying the request, or upon the expiration of the 120-day period, to elevate the matter to the CTA.

Another alternative to declog CTA dockets of appeals taken in contemplation of the lapse of the two-year prescriptive period is to relax the said requirement insofar as refunds of input VAT under Section 112 are concerned. Section 112, as noted in the dissenting opinion in CTA E.B. No. 426, only provides for the filing of the application within two years, but it is not apparent from the language thereof that there same period is required for taking the judicial remedy.

Allowing the BIR the full use of the 120-day period to resolve the claim as long as the claim is filed within two (2) years should result in less appeals to the CTA taken in contemplation of the expiration of the two-year period. After all, the taxpayer should prefer to recover at the BIR level rather than on the appeal due to the costs involved in litigating a claim. Further, if the BIR is able to dispose of the refund due to longer processing time, then this would also go a long way in achieving the objective of clearing and declogging CTA dockets.

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BIR revocation of VAT exemptions to HMOs

Reminiscent of the earlier SARS and EBOLA outbreaks, the specter of a modern-day pandemic is again raised to public awareness by the recent outbreak of Swine Flu in various parts of the United States, Canada and Mexico, and with it, the means to secure effective but reasonable and inexpensive means to ensure medical help when the necessity arises.

With the passage of Republic Act No. 7875, or the “National Health Insurance Act”, the Philippines aims to make essential goods, health and other social services available to all the people at affordable cost. Among the essential providers of health care under the program are health management organizations or “HMOs”, defined under the act as an entity that provides, offers, or arranges for coverage of designated health services needed by plan members for a fixed prepaid premium. This law has been made more effective as HMOs were classified as VAT exempt entities as confirmed by various rulings earlier issued by the BIR (BIR Rullings DA (VAT-054) 529-2008, DA (VAT-019) 121-2008, DA (C-032) 122-2008 dated August 8, 2008 and DA (VAT-026) 375-2008 dated October 31, 2008.

Earlier this year, however, the BIR issued two controversial Revenue Memorandum Circulars (RMC) which may seem to have adversely affected the development of the health care industy in the Philippines. RMCs Nos. 2-2009 and 6-2009 circularized the revocation of the VAT exempt status of HMOs as earlier confirmed in the above-mentioned VAT Rulings. Pursuant to said RMCs, HMOs are now subject to VAT based on the membership fees they receive from members undiminished by any amount paid or payable to owners/operators of hospitals, clinics and medical and dental practitioners. This means that under this rule, even funds received by HMOs from members which are earmarked for payment to unrelated third party service providers and placed under Third Party Administered arrangements or reimbursements for advances made on behalf of another, shall now form part of their gross receipts in computing their VAT liability.

The imposition of the VAT is not so much the issue but rather the tax base of the HMOs’ VAT liability. It will be noted that the crux of the HMOs’ continuing objections to the imposition of the VAT on their gross receipts arise from the VAT exemption of payments for medical, dental, hospital and veterinary services, which, under the above RMCs are now effectively subjected to VAT.

This issue has a long and storied past, dating back to the time the VAT was first imposed under Executive Order (E.O.) No. 273 by President Corazon C. Aquino. Before the effectivity of E.O. No. 273, the HMOs were able to secure a VAT Ruling (VAT Ruling No. 231-88) exempting them from the payment of the VAT on the basis of Section 103(1), [now 109(1)] of the Tax Code, which exempts medical, dental, hospital and veterinary service except those rendered by professionals from VAT.

Subsequently, however, the BIR reversed its position and issued VAT Ruling No. 18-98 stating that the basis in computing the VAT in the case of HMOs shall be the membership fees received from the members undiminished by any amount paid or payable to owners/operators of hospitals, clinics and medical and dental practitioners.

The Supreme Court (SC) later in one case, affirmed the validity of the imposition of the VAT on HMO as enunciated in VAT Ruling No. 18-98, on the ground that HMOs are not actually providing medical and/or hospital services but merely arrange for the provision of said services, which under the law, is not a VAT exempt activity. However, the decision of the SC was silent on the tax base, i.e. whether the HMOs’ gross receipts for purposes of computing their VAT liability should include the amount earmarked for payment to owners/operators of hospitals and clinics. (CIR vs. Philippine Health Care Providers, Inc., G.R. No. 168129 dated April 24, 2007)

The impact of RMC Nos. 2-220 and 6-2009 to the public cannot be dismissed. Since the issue on what constitutes gross receipts is unclear, HMOs may have no choice but to increase the amount of membership contributions to cover the additional VAT cost, thus, making health care very expensive for the ordinary people who, unfortunately, are the major recipients of HMO services.

Perhaps it is ironic that despite the avowed intentions of the BIR to encourage the taxpayers to properly comply with their tax obligations through proper tax information and education, the deepening impact of the financial crisis, however, forces it to reconsider any measure that may potentially undermine its collection targets. Like Odysseus caught between Charybdis and Scylla, while the BIR needs our understanding and support during these tough and difficult times, this should not be at the cost of the public interest which the BIR is also mandated to serve and protect.

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The Global Credit Meltdown

While not exactly a prophet of doom, the world’s wealthiest man (or second wealthiest, depending on the year), Warren Buffet, astutely predicted the present financial crisis back in 2002:

"Large amounts of risk, particularly credit risk, have become concentrated in the hands of relatively few derivatives dealers ... The troubles of one could quickly infect the others ... In our view, however, derivatives are financial weapons of mass destruction ..."
-- Warren Buffett, 2002 Berkshire Hathaway shareholder letter

The US financial crisis is the result of various risky financial transactions which spawned from the aggressive financial engineering done by the US federal reserve (US fed) in spurring the US economy largely through consumer spending. The gradual cutting down of interest rates to record 40-year lows for a prolonged period after the 2000 Stock Market Crash fueled a massive housing bubble through speculative buying and mortgaging of real estate properties by debtors financially unable to pay for them except through refinancing at steadily higher prices. This eventually resulted to what we call ”toxic mortgages”.

In addition, esoteric derivative instruments by aggressive investment bankers like Bear Stearns and Lehman Brothers, got traded over the counter unregulated. The unregulated credit default swaps market alone reached an astounding $50 trillion. When the US fed raised interest rates steeply in 2005, the housing bubble collapsed, and falling real estate prices resulted in widespread defaults of these toxic mortgages. It spread like cancer throughout the entire financial sector, from the government-sponsored enterprises holding the mortgages to the investment bankers who could no longer finance their highly-leveraged purchases, and eventually to the sound insurance giants, e.g., AIG, which guaranteed the instruments but somehow failed to meet their obligations.

Moreover, the widely criticized bail outs by the US Government of Freddie Mac and Fannie Mae and even AIG, effectively nationalized the US financial sector and arguably ending laissez-faire capitalism, while leaving others to their fate. The bill for US taxpayers alone could amount to at least US$700 billion, excluding interest, against which Warren Buffet’s US$10 billion offer for support seem ridiculously trifling. For scale, this amounts to over twenty times the entire national budget of the Philippines. And while the Central Banks of the other highly developed, sophisticated and capitalized countries followed suit in scrambling to provide funds and liquidity to their banks and financial institutions reeling from this unprecedented financial implosion, the Philippines and the average Juan stand on an arguably enviable position of being virtually oblivious to the global credit meltdown, principally because our financial and capital markets are neither highly developed, nor heavily capitalized, and consequently much less financially sophisticated to suffer the full effects thereof.

But even so, news of the global financial meltdown still reached the eyes and ears of the average Juan, thanks to modern media. A probable immediate effect of said meltdown has likewise been felt locally with the recent fall in stock market prices, which caused heavy losses to investors. What may be largely overlooked, however, is that the stock market crash may already herald a global depression or deep recession much like the Stock Market crash of 1929 which preceded the Great Depression of the 1930’s in the US. The public, wearied of the spate of high prices a few months back and now expectantly looking forward to lower prices due to falling crude oil prices in the world market, may not realize that the lowering of oil prices is a mere side effect in anticipation of lower world demand for oil, and that the depression itself would have more serious consequences and deeper and longer lasting effects on the life of the average Juan than the preceding rise in prices.

The financial meltdown is expected to result to freeze in hiring, or worse, bankruptcy and loss of jobs, particularly in the US, Japan and other developed markets. Most affected therefore, will be our OFW’s. A reduction in their foreign currency remittances will affect our balance of payments, and when their dependents have much less to spend, our own domestic markets. While pundits in the BPO industry are optimistic about the prospect of foreign firms further availing of the outsourcing option during hard times, the overall loss in demand for our other export goods, leading to cutbacks, closures and loss of jobs might far outweigh any such benefits gained by the BPO sector alone. This is not far fetched if we look at the effects of the Great Depression in the 1920s where more than a third of the working force in the US alone lost their jobs and were left wth no source of income and countless households all over the world also suffered from lack of employment and famine, not to mention the resulting strife in these countries.

Worse, the prospect of stagflation is also staring us in the eye. This invariably happens when recession occurs with inflation wherein production and employment falls but prices of commodities increase, as what had happened during post-war Germany and the oil shock years, among others, and most recently, in Kenya. Needless to say, this can even have more serious consequences than depression and is to be avoided at all cost.

What is now the challenge for the Philippines in the face of this crisis? Our government has assured our citizenry that our country is ready for any challenge, citing strong OFW base as shield against recession. However, as pointed out, such reliance is like building a house on shifting sands. Given this uncertainty, Government must be able to present more concerted and well-thought strategies and measures to meet the prospect of a worldwide depression and/or stagflation. As citizens of this country, we must do our share to keep our financial institutions afloat and stable. Panic buying and massive withdrawal of our investments or savings or deposits would not do us any good and would even worsen our situation. Thus, the less we panic and be overwhelmed with the possible adverse effects to our economy, the better for all us.

Lastly, in our land where hope springs eternal, prayers that we will be able to weather the impact of this financial crisis would be a safe haven during this tumultuous and volatile period.

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The Food Tax Pyramid

Hardest hit by the recent spate of rising prices are the marginalized income earners, particularly those below the poverty line, who spend more than half their disposable income on such basic commodities as rice, pan de sal, canned goods, cooking oil and other daily necessities. It is even more lamentable if seen from the perspective that the marginalized bear a disproportionate tax burden on such basic necessities of life.

While the poorer segments of society are indeed spared from direct taxation, particularly the income tax, this does not mean they are exempt from indirect taxes, particularly the Value-Added Tax, excise taxes, and withholding taxes. In Contex vs. Commissioner, the Supreme Court had occasion to clarify that “unlike a direct tax, such as the income tax, which primarily taxes an individual's ability to pay based on his income or net wealth, an indirect tax, such as the VAT, is a tax on consumption of goods, services, or certain transactions involving the same. The VAT, thus, forms a substantial portion of consumer expenditures.”

Thus, indirect taxes, such as VAT, being a tax on consumption, is actually borne by the individual consumer, regardless of his station in life. Certain exemptions had been retained with respect to food products in their original state, i.e, those that had gone simple processes of preparation or preservation such as freezing, drying, salting, broiling, roasting, smoking, stripping, polishing or husking. However, most inputs to production of these food products even in their original state have been subjected to several taxes at various stages.

Thus, even the most basic staple, rice, is not spared from the cascading effect of taxes, which occurs when tax is imposed upon previously imposed taxes comprising the price of the commodity. Inputs to rice production, for instance, fuel, had first been subjected to the excise tax upon removal from the depot, and later on, again subjected to VAT upon sale by gas stations and other retailers. Rice farmers reliant on mechanized machinery to till, harvest, and eventually transport rice, as well as the rice traders and distributors, cannot recover input taxes on fuel and services subject to VAT, and charge the same as part of the costs of the palay/rice sold, hence further increasing the tax component of the price of rice.

Worse, other commodities such as canned goods, pan de sal/bakery products, cooking oil, and the like, that are not considered in the original state, fall squarely within the scope of the VAT, and thus subject to VAT upon sale by the grocery, supermarket or retailer as the case may be, and so are non-food essentials such as detergents, clothing, and the like.

Consequently, the marginalized, comprising perhaps 80% of our population, end up paying a huge chunk of the nation’s taxes by indirect taxation of their consumption. Many are not able to shoulder the burden of providing for their families’ needs and end up borrowing for food, or worse, forced to commit crime in desperation. Unrest due to rising costs of living has already become a worldwide phenomenon, with the latest food riots in Haiti offering a grim example of what we may have to contend with in the near future in our very own backyard.

It is all the more pitiful because the Philippines, once self-sufficient in rice, is now listed by the US Department of Agriculture as the world's top importer of milled rice for 2007, ahead of Nigeria, Indonesia and Bangladesh. The President had practically begged Thailand to allow continued importation, while Vietnam, China, India and other rice-exporting nations had already closed shop in a bid to safeguard their own populace, further exacerbating the shortage in the world market. Evidently, we can no longer rely on other nations to allay the food shortage that threatens the stability of our nation.

Although the government is now taking steps to ease the supply shortage by importing the shortfall and discouraging possible acts of hoarding, these have been criticized as being too late, or as overreaction bordering on threats and coercion, which may worsen the situation by damaging business confidence. Instead, concrete steps should be taken to reverse myopic policies, political neglect or even indiscriminate corruption that resulted in critical loss of production over the years. Over the past 20 years or so, the country lost nearly half of its irrigated land to rapid urban development. The agricultural sector has also lost much ground to imports due to high cost of production, as well as competition with other nations’ highly subsidized agricultural products while ours remain woefully undercapitalized and overtaxed.

The crisis may yet be averted if the government is able to adopt crucial policies to ameliorate the burden on the marginalized consumers and improving the plight of the producers – farmers – who after all are the real heroes in this struggle for self-sufficiency. Otherwise, the time is short, and the stakes are high, not only for the marginalized consumers and farmers, but for all of us stakeholders in this much-vaunted economic recovery, which can be lost all too soon, too early.