Managing DST on intercompany advances

(First of two parts)

Who would forget the question that faced the impeachment court recently – a loan or cash advance? Others may have chuckled thinking the question unwise, but in the realm of taxation, this question finds substance, especially with the recent doctrine of the Supreme Court on documentary stamp tax (DST) imposed on intercompany advances.

Akin to the commonly used doctrine in taxation that “taxes are the lifeblood of the Government;” in the field of commerce “organizations need cash for business survival.” The lifeblood doctrine in taxation is commonly used to justify the speedy collection of taxes. In business, cash is indispensable for an entity to level up and survive in a competitive market.

Challenges in the financial world can ambush business activities in an instant where problems on sourcing funding requirements become more real. Some businesses think of ways to internally generate cash through business expansion, introduction of new products and implementation of new business ideas and strategies. Businesses streamline processes, cut costs and even lay off workers. At the end of the day, companies try to source cash practically from whatever source imaginable. 

Others resort to equity funding. However, from a global perspective, more structured companies resort to debt funding. Presumably, this is because of probable tax benefits such as deductibility of interest expense. Affiliated groups also favor lending to affiliates where its return of “investment” does not rely on unrestricted retained earnings.      

However, companies are faced with problems on where to get debt financing. It is likely that third party loans are not preferred because these may not be as speedy as an expected solution to the problem on liquidity. The cumbersome process, various requirements, and voluminous paperwork in securing approval of loans from third parties make this option unattractive. Other companies, especially the newly set up entities, inhibit from securing third party loans because their credit standing may not be stable. Securing a loan from third parties most often needs security or collateral, which may be lacking. Guarantors and insurance are likewise being mandated by third party lenders, not to mention finance charges and other fees that may add burden to the company’s liquidity problem.

As a recourse, financially-capable companies back-up their affiliates through intercompany loans, which prove to be a more speedy, more convenient way of raising funds. Intercompany loans are often implemented through advances evidenced by simple documents such as cash vouchers, inter-office memoranda, instructional letters, journals and similar documents evidencing credit as opposed to the formalities required when a loan is obtained from third parties. With the trust reposed on affiliated entities, formalities and contractual legalese are most often disregarded. In a group, multinational companies normally channel their resources to their affiliates through credit facilities or through setting up of financial centers. Intercompany advances can be used not only to minimize trading costs but also to salvage business failures of affiliated companies caused by liquidity problems. The general idea is that intercompany advances can readily answer emergency company funding requirements. Ultimately, it is a way of generating money in an instant to help the company implement business plans and to stay afloat in a difficult economy.           

Nonetheless, the practicality of obtaining cash through intercompany loans does not necessarily follow that its tax implication is also more convenient than when loan is covered by a loan agreement or promissory note – the traditional or formal ways of obtaining a loan.

There might be basis to believe that taxpayers think that DST is imposed only on loan agreements, promissory notes or similar written contracts with direct semblance of a loan agreement. Who is to fault them when even the Bureau of Internal Revenue (BIR) had varying positions with respect to the imposition of DST on intercompany advances? It is interesting to note that the BIR previously had the idea that DST is not imposable on cash vouchers, inter-office memoranda and other instruments evidencing cash advances that are not in the same nature as loan agreement or promissory note. In fact, the BIR had a prior pronouncement that inter-office memo evidencing advances, which is neither a form of promissory note nor a certificate of indebtedness issued by the corporation-affiliate is not subject to DST. Rather it was prepared for accounting purposes only in order to avoid co-mingling of funds of the corporate affiliates. After sometime, the BIR modified its position when it issued a ruling imposing DST on inter-office memo covering the advances granted by a corporation affiliate company. Subsequently in another ruling, the BIR declared that intercompany advances covered by board resolutions of the lenders and cash vouchers issued by the lenders are not subject to DST.  

The different positions of the BIR on the tax implication of intercompany advances are tested with the advent of the Supreme Court decision in the recent case of Commissioner of Internal Revenue vs. Filinvest Development Corp. (Filinvest). The Court in the said case resolves that instructional letters, journal and cash vouchers evidencing the advances Filinvest extended to its affiliates in 1996 and 1997 qualified as loan agreements upon which DST may be imposed. Consequently this was the basis for the issuance of Revenue Memorandum Circular No. 48-2011 by the Commissioner of Internal Revenue, which practically enjoined the BIR to assess deficiency DST on all intercompany cash advances evidenced by cash vouchers, inter-office memoranda, instructional letters and similar instruments.

The decision in the Filinvest case may have effectively revived the position of the BIR in imposing DST on inter-office memo covering the advances granted by an affiliate company. It gives notice to the taxpayers that intercompany advances extended to affiliates evidenced by debt instruments other than loan agreement or promissory note are now subject to DST.

Vida Cortez is a supervisor of tax of Manabat Sanagustin & Co., CPAs, a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity.

The views and opinions expressed herein are those of the author and do not necessarily represent the views and opinions of KPMG in the Philippines. For comments or inquiries, please email [email protected] or [email protected]

Note: The article entitled “The New Landscape of Income Tax Returns for Individuals and What It Asks From You” that was published last Feb. 21, 2012 was written by Cecille Fernando, supervisor of tax of Manabat Sanagustin & Co., CPAS. The views and opinions expressed in the said article are those of the author and do not necessarily represent the views and opinions of KPMG in the Philippines.