Training expenses: To claim or not to claim in full?

SUITS THE C-SUITE By Celine M. Bedonia

Business World (04/27/2015 – p.S1/4)

The work force is vital to any company’s success. This is one reason why most companies, especially those in the service industry, make significant investments in the training and development of their people.

In the case of a business process outsourcing (BPO) company, well-trained employees allow it to deliver excellent service to its clients worldwide. However, for BPO companies in the Philippines that are registered with the Philippine Economic Zone Authority (PEZA) and avail the 5% gross income tax (GIT) incentive, the deductibility of the training expenses as part of direct cost from the 5% GIT has not been clearly addressed by the Bureau of Internal Revenue (BIR).

Section 42 of Republic Act (RA) No. 7916 or the PEZA Law provides that an additional deduction equivalent to half the value of training expenses incurred in developing skilled or unskilled labor or for managerial or other management development programs incurred by enterprises in the economic zone (ecozone) can be deducted from the National Government’s 3% share as provided in Section 24 of the law.

Moreover, under Section 1 (b), Rule XIV of the law’s Implementing Rules and Regulations (IRR), half of the value of the abovementioned training expenses by an ecozone export enterprise may be deducted from the 5% final tax due from such enterprise, but not to exceed the National Government’s 3% share, under such guidelines as may be prescribed by PEZA in coordination with the Department of Labor and Employment and the Department of Finance.

Based on the foregoing provisions, it may be interpreted that a PEZA-registered enterprise can deduct half of its training expenses from the 3% share, a position supported by BIR Ruling [DA-(C-164) 499-08] dated December 4, 2008 wherein the BIR ruled that half of the training costs should be allowed as a tax credit, and not deductible as a business expense, which can be deducted from the National Government’s share.

However, in interpreting Section 42 of RA 7916, the additional deduction of half of the training expenses from the National Government’s 3% share will not be in harmony with the phrase “additional deduction.” A deduction, for tax purposes, refers to such amount deducted to arrive at the taxable income. Moreover, there are no other allowable deductions from the 3% National Government share to give credence to the word “additional” deduction.

Some BIR examiners argue that the language of the PEZA Law does not expressly convey the legislative intent; hence, it should not be taken strictly from its context but rather from its spirit. One can argue that Congress intended to grant an additional allowable expense deductible only from gross income and not from the final tax due.

As a general rule in statutory construction, the legislative intent or spirit of the law is the law itself and said to be the controlling factor in the interpretation and application of a statute.

Taken together, it appears that an additional deduction equivalent to the half of the value of training expenses is to be deducted from gross income subject to the 5% GIT. This application is consistent with the use of the phrase “additional deduction,” as this will be in addition to the allowable deductions as provided under the IRR of the PEZA Law.

In the past, the BIR has occasionally ruled that training costs incurred, which are directly connected with and necessary in the performance of the registered activities, are treated as part of the direct costs, thus, deductible from the gross income subject to the 5% GIT. (BIR Ruling DA No. 339-08 dated June 4, 2008; BIR Ruling No. DA-(C-134) 385-09 dated July 20, 2009)

These rulings are inconsistent with those issued by the BIR in 2012 and 2013 wherein it held that only the allowable deductions enumerated under the PEZA Law can be claimed as deduction for 5% GIT purposes.

Recently, the Court of Tax Appeals (CTA) has taken a more favorable position for PEZA-registered entities. In the case of East Asia Utilities Corp. vs. Commissioner of Internal Revenue (CTA Case No. 8179 dated May 21, 2014), the Court ruled that the enumeration of direct costs under Revenue Regulations 11-2005 is not an exclusive list of expenses that may be deducted by PEZA-registered enterprises in computing the 5% GIT. Instead, the list is intended as a guide in determining the items that may be considered as direct costs or cost of sales. PEZA entities may be allowed to deduct expenses which are in nature of direct costs even though the same are not included in the list.

While the CTA allowed as deduction technical-related training expenses (as these focus on the development of special skills or practical knowledge especially in mechanical, industrial arts, scientific field or practical science of a particular position or job function), it disallowed non-technical training and development, i.e., management skills, behavioral skills and personality development, as direct costs.

Using the East Asia decision, there may be basis to argue that training expenses which are directly related to the registered activities may be considered as direct costs deductible in the computation of the 5% GIT, unlike non-technical training expenses will are not similarly deductible.

Finally, the position of some PEZA entities is that the phrase “additional deduction” under the PEZA Law may be interpreted as an additional deduction on top of the training expenses which can be considered as direct cost, effectively deducting 150% of the training expenses from the gross income subject to 5% GIT.

With the conflicting issuances on training expenses, PEZA-registered enterprises have no choice but to take a position on the issue. It would be beneficial to all concerned if the BIR could once and for all issue clear guidelines on the deductibility of training expenses, taking into consideration the recent CTA decision.

Celine M. Bedonia is a Tax Senior Director of SGV & Co.