November 2022 Articles - Suits the C-Suite | SGV & Co. | EY

28 November 2022

Jules E. Riego

A question of trust: Revocable or irrevocable?

The pandemic introduced a tectonic shift of perspective about wealth planning, changing from “it’s never too late to plan” to “it’s never too early to plan.” As people become more cognizant of their own mortality, they have also become more pragmatic because, as Dr. Susan David, award-winning Harvard Medical School psychologist and named one of the world’s most influential management thinkers, aptly said, “Life’s beauty is inseparable from its fragility.” Given this change in mindset, one favored tool for wealth planning is a Trust — a malleable tool even with the backdrop of the particularly challenging and sometimes complex compulsory heirship rules in the Philippines.A Trust is primarily a fiduciary relationship between a person called a Trustor or Settlor and a Trustee. The Trustor sets up a Trust, i.e., putting assets in a Trust or under the name of a Trustee. The Trustee is a person or entity appointed by the Trustor to take care of the assets placed in the Trust on behalf of or for the benefit of the Beneficiaries named in the Trust. As the Trustor is trusting the Trustee to take care of assets in favor of designated beneficiaries, the Trustee has a fiduciary obligation to the Trustor. Fiduciary obligation here means that the Trustee’s responsibility is not just within the level of a “good father of the family;” the Trustee should handle the Trustor’s and beneficiaries’ interests with the highest meticulous care. They hold a duty to preserve good faith and the trust reposed upon them.A TRUST AS A WEALTH OR ESTATE PLANNING TOOLEmploying a Trust is similar to writing a Last Will and Testament but without the burden of a costly, cumbersome and possibly protracted probate proceeding. Under Philippine rules, a Last Will and Testament has to be probated or have its legal validity recognized before a court. Because a probate proceeding is a judicial process in our jurisdiction, it will require lawyer’s fees and may result in considerable delays in the distribution of the benefit to the heirs.It is in the Trust Deed or Trust Agreement that the Trustor should put all their instructions as regards who should be benefited, when they should be benefited, what they will get (if hard assets), how much (if cash), and what conditions the beneficiaries must fulfill to be entitled to the income and/or principal of the Trust. In all of these, the Trustor must bear in mind the concept of “legitime” or the minimum entitlement under the law of compulsory heirs, which cannot be burdened with any condition.Once the Trustor passes away, the Trustee simply implements the distribution to the heirs/beneficiaries in accordance with the instructions of the Trustor. In most Trust arrangements, the Trustor is free to appoint a Protector or Overseer (usually a close and trusted family friend) who is tasked to see to it that the Trustee will perform all of its fiduciary obligations to the letter.REVOCABLE OR IRREVOCABLE?When deciding whether the Trust should be revocable or irrevocable, the following points should be considered:Generally, the substantial terms and conditions of an Irrevocable Trust (e.g., addition or subtraction of named beneficiaries) can no longer be changed. In a Revocable Trust, the Trustor can change the terms and conditions of the Trust for whatever reason. There is more flexibility for the Trustor in a Revocable Trust in terms of control over the assets in the Trust and in adding or removing beneficiaries.Transfers of assets to an Irrevocable Trust is essentially a donation, attracting a donor’s tax of 6%. This means that assets transferred to an Irrevocable Trust are no longer part of the estate of the Trustor and will no longer be subject to the 6% estate tax upon the passing of the Trustor. Therefore, the decision to set up an Irrevocable Trust is also a choice between paying a 6% donor’s tax at today’s value or paying the 6% estate tax based on the prevailing value later. This is particularly crucial for real property assets to be passed on to the next generation since the appreciation in value of real estate, especially those in prime locations, is unbelievably exponential.On the other hand, assets transferred to a Revocable Trust are still considered assets of the Trustor, such that upon the Trustor’s demise, the assets in a Revocable Trust will still be subject to 6% estate tax as donor’s tax was not paid during the transfer of assets to the Revocable Trust.Assets transferred to an Irrevocable Trust are also protected from creditors of both Trustor and beneficiaries, subject to certain rare exceptions. This also means that assets in an Irrevocable Trust are protected from future in-laws. This is the complete opposite in the case of assets transferred to a Revocable Trust, as future in-laws can potentially acquire assets from the Trustor’s family line due to Philippine compulsory heirship rules or other contingencies like annulment. This is also the reason why an Irrevocable Trust is very useful in wealth planning if the Trustor intends for specific assets not to cross family lines. For example, an Irrevocable Trust can shield shares of stock in a family-owned corporation if it is the family’s policy not to allow in-laws from owning shares in the family corporation to prevent potential complexity to the family dynamics.In an Irrevocable Trust, as long as the title to the assets is in the name of the appointed Trustee, estate tax will not apply even if any of the beneficiaries passes away since none of the latter own any assets in the Trust. This means that several generations of estate tax can be saved for as long as the corpus of the assets remain in the Irrevocable Trust. This benefit is not present in a Revocable Trust arrangement as assets from a Revocable Trust are distributed to beneficiaries upon the death of the Trustor.An Irrevocable Trust can also be used for wealth replenishment or “reforestation” if used in combination with life insurance. The fund of an Irrevocable Trust can be used to insure the life of the beneficiaries, and name the Trustee of the Irrevocable Trust as custodian of the proceeds of the life insurance policy for the benefit of or on behalf of the next generation. As long as the designation of the intended beneficiaries is irrevocable, the beneficiaries of the policy will get the proceeds tax-free. This cycle can be repeated in every generation to replenish the fund in the Trust.This arrangement is also useful when the intended beneficiaries of the life insurance policy are minors, suffering from any physical or mental disabilities and require life-long care, or when the parents believe that the beneficiaries would not be able to handle their own finances. Appointing a Trustee to manage, grow and control the periodic distribution of the funds would be ideal. However, when the named beneficiary of a life insurance policy is the Revocable Trust, the proceeds of the life insurance policy will be subject to estate tax, since a Revocable Trust has no personality distinct and separate from the Trustor.In a blog article, “Are trusts on your radar for succession planning?” Michael Parets, EY EMEIA Private Tax Desk Leader, offered other insights about Trust as wealth planning tool, such as choice of jurisdiction and the presence of laws recognizing Trusts; the domicile and citizenship of intended beneficiaries; the competence and reputation of the Trustee; and of course, the expertise of the tax advisor.FUTURE-PROOFING WITH TRUSTA Trust is not just a planning tool for the wealthy, but a viable wealth management tool for everyone who wishes to future-proof their assets for their heirs. In addition, we should remember that while there is certainly a cost in planning, there is a potentially higher cost in doing nothing – not just in tax, but more importantly, in maintaining peace and harmony within the family.This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co.Jules E. Riego is the Business Tax Services (BTS) Leader of SGV & Co. and the EY Asean BTS Leader.

21 November 2022

Henry M. Tan

Undaunted and unstoppable in the face of uncertainty

Throughout history, we have seen how times of great uncertainty and disruption have triggered sudden leaps and progress despite the problems and challenges they bring. The COVID-19 pandemic is no exception, it being the greatest global disruption the world has seen in many decades. Yet while the pandemic practically brought the world to a halt, it is also heartening to see how this period brought with it immense opportunities amidst many challenges. While is it true that many businesses suffered because of it, with many forced to close down, we have also seen numerous businesses accelerate their transformation and evolved to survive and then thrive as the world moved closer to post-pandemic recovery, pivoting their own business models and creating new ones.When the pandemic disrupted business strategies and challenged continuity, companies were forced to place a renewed focus on people, purpose and technology. Crisis, after all, inspires innovation, and this holds especially true for entrepreneurs.ENTREPRENEURSHIP AND INNOVATION DURING THE PANDEMICThough the pandemic caused many to lose their jobs, it also served as a catalyst for many others to enter the business landscape as entrepreneurs. According to a survey by Sales Force, the pandemic created a unique batch of startups that saw new opportunities to create new markets and attract new customers during a period of heightened uncertainty. As much as 56% of the survey respondents share that starting a business now was easier than before the pandemic. Most of the new startup founders embraced technology from the beginning, using digital tools and searching for more technology-based solutions to fuel business growth.NBC News reveals that entrepreneurs opened their own businesses at more than twice the rate seen in pre-pandemic times, aided by improved remote technology previously unavailable during other economic downturns like the Great Recession. Data from the US Census Bureau also shows that business applications nearly doubled during the first few months of the pandemic, remaining elevated and well above pre-pandemic levels. Economist Leila Bengali from the UCLA Anderson Forecast identifies lower fixed costs as one of the reasons for this, with the availability of the internet and a deeper familiarity with technology making it all the easier for innovative individuals to get their business online.In an interview, Christy Wyskiel, Senior Advisor to the President of Johns Hopkins University for Innovation and Entrepreneurship, said that the essence of entrepreneurship is identifying an unmet need and moving as fast as possible to get a meaningful product to market — which is exactly what society needs during a crisis. The pandemic dramatically accelerated productive collaboration in the service of society, and the paradigm has now changed, particularly in this period of post-pandemic recovery. Entrepreneurs should not be paralyzed by uncertainty, but instead should seek long-term value and success by continuing to serve their existing customers while being ready to pivot when needed to address potential opportunities.The pandemic also created a massive push towards digital transformation. In the Philippines, we now find almost every product or service available on online shopping platforms. Almost every brand in the country rapidly transitioned to existing online selling platforms or invested in developing their own online sales mechanisms. In the micro-sized enterprise space, people have gotten more used to the idea of starting their own businesses using digital tools and leveraging social media to take advantage of existing conditions — for example, during the lockdowns, the number of home-based online food sellers mushroomed like never before. Many found surprising success and were able to cultivate regular customers due to people being unable to go out and dine. The pandemic also gave rise to new business opportunities in logistics, entertainment, personal care and many other areas.CELEBRATING THE SPIRIT OF ENTREPRENEURSHIPAnalysts predict that the rate of growth of entrepreneurship will remain high in the post-COVID-19 economy, as shared by Forbes. Because of the massive increase in startups caused by the pandemic, developments on an individual entrepreneurship level will likely aid numerous economies.As Gaston Taratuta, EY World Entrepreneur Of The Year 2022, said in his acceptance speech in Monaco, “Being an entrepreneur is more than just building a successful business. It’s about creating and seizing opportunities where ones don’t readily exist or aren’t easily attainable.” This has never been truer than in the stories of 18 indomitable Filipino entrepreneurs that we are celebrating in the Entrepreneur Of The Year 2022 Philippines program. The program recently concluded its search for the country’s most successful and inspiring entrepreneurs with the theme of Undaunted. Unstoppable. And will be holding its awards gala tonight.Guided by their purpose, motivated by their aspirations and fueled by their relentless determination, these Filipino entrepreneurs helped empower communities and uplift the nation. Their stories have been published in BusinessWorld over the past few weeks with the hope that in sharing them, present and future entrepreneurs can be further inspired by their struggles and successes.Entrepreneurs showed us that a single idea can spark positive change and disrupt the status quo. According to a 2023 study, “Entrepreneurship during a pandemic,” entrepreneurs have been known to act as focal points during a time of crisis, playing a critical role in the context of post-disaster recovery by providing leadership and signaling that their communities are likely to survive. This same spirit burns strong within Filipino entrepreneurs who lead as Undaunted visionaries, equipped with Unstoppable resilience and the ability to adapt. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co.Henry M. Tan is a Partner and the Entrepreneur Of The Year Philippines Program Director of SGV & Co.

14 November 2022

Cheryl Edeline C. Ong and Karen Mae L. Calam-Ibañez

What’s new with Philippine investment incentives

2022 has ushered in several changes to the Philippines: a new administration, the winding down of the COVID-19 pandemic, and updates to the country’s investment incentive strategy.Investment incentives are government concessions meant to attract inbound capital. Taking advantage of these incentives is integral to strategic business optimization. From the relaxing of foreign equity restrictions, to the 2022 Strategic Investment Priority Plan, to environmental laws and more, entrepreneurs should be aware of every opportunity to decrease the cost of doing business in the Philippines.ENCOURAGING FOREIGN EQUITYForeigners have been gradually given more freedom to invest. They may enter industries previously exclusive to Filipino citizens, subject to reciprocal treatment. Instead of dreading competition, organizations should use this opportunity to seek more funding for their operations.Amendments to the Public Service Act limited the activities that are considered public utilities, namely the distribution of electricity, transmission of electricity, petroleum and petroleum products pipeline transmission systems, water pipeline distribution systems and wastewater pipeline systems, including sewerage pipeline systems, seaports, and public utility vehicles. This effectively removes from the “public utility” classification the domestic shipping, railways and subways, airlines, expressways, tollways, and transport network vehicles services, among others. These can now be fully owned by foreigners.Telecommunications and other vital services are subject to safeguards for critical structure and the reciprocity rule. On the other hand, the amended Retail Liberalization Act grants foreign enterprises the right to invest in retail trade businesses with a minimum paid-up capital of P25 million. If it owns more than one physical store, the investment per store should be at least P10 million.If successful, these equity market liberalizations could lead to increased foreign direct investment (FDI). A higher FDI means an improved exchange rate for the peso. Furthermore, investment incentives can also be used to boost job creation as well as job quality. The latter is crucial amid rising underemployment rates.For example, the amended Foreign Investments Act of 1991 lets foreigners invest in micro and small Domestic Market Enterprises (DMEs) with a minimum paid-up capital of $100,000.00. The DMEs should either involve advanced technology; or be endorsed as startup enablers; or directly employ at least 15 Filipinos, with a majority of its employees being Filipino citizens. This has been amended from the previous requirement of at least 50 direct Filipino employees.AN OVERVIEW OF THE 2022 SIPPTo effectively implement the Corporate Recovery and Tax Incentives for Enterprises (CREATE) Law, Memorandum Order No. 61 was issued to approve the 2022 Strategic Investment Priority Plan (SIPP). It grants investment incentives to entities registered as Registered Business Enterprises (RBEs). RBEs are categorized as either Export Enterprises (EEs) if 70% of their output is directly or indirectly exported, or as DMEs if the situation is otherwise.The regulatory power of investment incentives can be observed in the following aspects of the SIPP and the CREATE Law:Export Enterprise vs. Domestic Market Enterprise. To address the trade deficit, EEs get additional benefits over DMEs. EEs get VAT incentives and have the option to avail of either a 5% tax on their gross income earned, in lieu of all national and local taxes, or Enhanced Deductions (ED) for 10 years following the end of the income tax holiday (ITH) period. Meanwhile, DMEs have no VAT incentives, and can only avail of the ED for five years after the lapse of the ITH period.Provincial benefits. The period to enjoy the benefits of the 2022 SIPP depends on both the kind of RBE (whether DME or EE), as well as the location of the registered project or activity. Following the push towards rural development as embodied in the Balik Probinsya program, the CREATE Law gives longer ITH periods to RBEs operating outside of the National Capital Region and other metropolitan areas.Priority activities in the tier system. The administration aims to create a self-sufficient Philippines. Thus, longer benefits are granted to industries such as agriculture to promote food security, healthcare to better withstand future pandemics, power to reduce reliance on imported fuel, and higher tier activities. PUSHING FOR A GREEN ECONOMYThe right of Filipinos to a balanced and healthful ecology goes hand-in-hand with the need for economic development. Hence, the current administration’s socioeconomic agenda includes the pursuit of a green economy. It is willing to compensate sustainable, eco-friendly businesses through investment incentives under the Renewable Energy (RE) Law, as implemented by Revenue Regulations (RR) No. 07-2022.Under the RE Law, RE developers may avail of a seven-year ITH. Afterward, the developer is to pay 10% corporate tax on taxable income, provided that the resulting savings are passed on to end-users in the form of lower power rates. They may also avail of the incentives under the CREATE Law, e.g., four to seven years of ITH, depending on location and industry tier, followed by five years of Enhanced Deductions. The main consideration in determining which incentive to apply for is the time-bound incentives under CREATE Law which is not applicable under the RE Law.In addition, the Philippine Green Jobs Act of 2016 promotes the creation of “green jobs,” or employment which contributes to environmental preservation. Under RR No. 05-2019, businesses offering green jobs will be granted an additional deduction equal to 50% of the total expenses for skills training and research development. The law also provides that capital equipment that are actually, directly and exclusively used in the promotion of green jobs, may be imported free of taxes, though the government has not yet issued any implementing rules for this provision.BALANCING INCENTIVES WITH SUSTAINABLE GROWTHInvestment incentives have been introduced by the government in a conscious effort to remain globally competitive. Granting incentives must nonetheless be balanced with sustainable growth.Every concession comes with an equivalent benefit to ordinary Filipinos, either through employment opportunities or through eco-friendly communities. Companies have just as much to gain from investment incentives as their foreign counterparts and taking advantage of tax and regulatory benefits is integral to any business strategy. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the authors and do not necessarily represent the views of SGV & Co.Cheryl Edeline C. Ong is a tax partner and Karen Mae L. Calam-Ibañez is a tax senior manager of SGV & Co.

07 November 2022

Ana Katrina C. De Jesus and Natasha Kim R. Tec

Transfer Pricing is here to stay

Whether before or during the pandemic, related party transactions continued to proliferate both on a domestic and global scale. Business organizations should be mindful of the complexities of the rules surrounding their transactions with related parties. Philippine taxpayers have been anticipating transfer pricing audits by the Bureau of Internal Revenue (BIR) as it intensifies its risk assessment and audit activities.The regulatory framework for transfer pricing is envisaged to alter the overall tax architecture under which related party businesses operate. A thorough understanding of transfer pricing would allow businesses to effectively plan and future-proof their operations. We take a step back as we look into the evolution of rules in the Philippines and what the future holds for transfer pricing.TRANSFER PRICING THROUGH THE YEARSTransfer pricing is rooted in Section 50 of the National Internal Revenue Code which empowers the Commissioner of Internal Revenue to make an allocation of income and expenses between or among controlled group of companies if he determines that a related taxpayer has not reported their true taxable income. Prior to the issuance of local regulations, the BIR sought guidance from the Organization for Economic Cooperation and Development (OECD) transfer pricing guidelines.In 2013, the BIR issued the Transfer Pricing regulations to provide a set of rules in the determination of the appropriate revenue and taxable income of parties in a controlled transaction. The regulations require the maintenance of contemporaneous transfer pricing documentation, which must exist when the associated enterprises develop or implement any arrangement, or at the latest, when preparing the annual income tax return.In 2019, the implementation of transfer pricing was given more teeth when the BIR issued the Transfer Pricing Audit regulations. These provided a set of guidelines for revenue officers to propose adjustments by imputing an arm’s length price on related party transactions that are not in accordance with the arm’s length principle.The next set of relevant BIR issuances on transfer pricing were released in rapid succession during the height of the pandemic, progressing to the next phase of transfer pricing from compliance to enforcement.In 2020 and 2021, to generate new sources of funding for the government’s pandemic response, the BIR prescribed rules on the disclosure of related party transactions and submission of a transfer pricing form for taxpayers which are covered by the documentation requirement. Through these disclosures, the BIR has clearer visibility on taxpayers with related party transactions, which could be the target for transfer pricing audits.In 2022, new regulations on Mutual Agreement Procedures (MAP) provide Philippine taxpayers with an alternative mode to resolve disputes from differences in the interpretation or application of tax treaties. One of the typical scenarios requiring MAP assistance is when a taxpayer is subjected to additional tax in one country due to a transfer pricing adjustment from a transaction with its related party in the other country.THE NECESSARY PREPARATION OF TRANSFER PRICING DOCUMENTATIONWith the issuance of amendatory regulations limiting the scope of preparation of transfer pricing documentation to certain types of related party taxpayers and providing for materiality thresholds on the amount of their transactions, other taxpayers with related party transactions are still enjoined to prepare transfer pricing documentation. After all, the burden of proof rests upon the taxpayer on whether its related party transactions adhere to the arm’s length principle. The Transfer Pricing Audit regulations provide that taxpayers must ensure that the related party transaction they enter into is commercially realistic and makes economic sense. As such, taxpayers are expected to maintain contemporaneous documentation. In case of operating losses, the documentation must outline the non-transfer pricing factors that contributed to the losses. In light of the pandemic, affected taxpayers with related party transactions should carry out a Special Factor Analysis in their transfer pricing documentation where all legal and economic justifications are in place to establish a defensible position for business losses or reduced profits during the covered periods.With the issuance of a Revenue Memorandum Order in 2021 streamlining the procedures and documents for the availment of treaty benefits, taxpayers applying for a tax treaty relief application or request for confirmation in relation to interest income are now required to present proof that the interest rate used in the finance transaction is arm’s length. In addition, we have seen the BIR request for the submission of transfer pricing documentation even for tax treaty relief applications or requests for confirmation for other types of cross-border transactions such as business profits and royalties.There is also an interplay with the Bureau of Customs as it has the authority to question the determination of customs valuation relating to cross border transactions between related parties. A transfer pricing documentation could help support and justify the value of the imported goods purchased from foreign related parties.Further, the MAP regulations make it clear that the preparation of a transfer pricing documentation is a prerequisite in availing of MAP assistance.THE FUTURE OF TRANSFER PRICINGGovernment tax policymakers around the world are working together on proposals for significant changes to long-standing international tax rules in light of the OECD’s Base Erosion and Profit Shifting (BEPS) initiative on the globalization and digitalization of the economy. These developments would significantly alter the overall international tax architecture under which multinational businesses with related party transactions operate.In the Philippines, tax audits with transfer pricing issues have yet to be fully operationalized by the BIR since the inception of transfer pricing audit guidelines. However, taxpayers should not rest on their laurels because the BIR is continuously beefing up its capabilities through continued training of its revenue officers.With the recent issuance of the MAP regulations, it will only be a matter of time before the Advance Pricing Arrangement (APA) regulations will be released. An APA is an arrangement that determines in advance of controlled transactions, an appropriate set of criteria for the determination of the transfer pricing for transactions over a fixed period of time. The APA has always been a part of the BIR’s strategic plan for 2019-2023 because it is expected to address the country’s growing transfer pricing problems with the cooperation of taxpayers, particularly in relation to tax base reduction and profit apportionment schemes.While the OECD BEPS Action Plan 13 has not yet been adopted in the Philippines, multinational companies operating in the Philippines and Philippine conglomerates may still be required to comply with the Master File, Local File and Country-by-Country Reporting requirement.Now that the BIR has information on related party disclosures that are not otherwise disclosed in traditional tax returns, we may expect increased traction in the conduct of transfer pricing audits. In view of the upcoming e-Invoicing System implementation by the BIR, taxpayers with related party transactions must be aligned with their transfer pricing policies as they will be providing information to the BIR in real time. Taxpayers should be proactive in examining their transfer pricing risks by preparing contemporaneous transfer pricing documentation.This means a comprehensive approach to systematically address transfer pricing issues and the preparation of robust transfer pricing documentation will be critical to ensure compliance with the arm’s length principle. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the authors and do not necessarily represent the views of SGV & Co.Atty. Ana Katrina C. De Jesus is a tax principal and Atty. Natasha Kim R. Tec is a tax associate director of SGV & Co.

November 2022

A question of trust: Revocable or irrevocable?

Undaunted and unstoppable in the face of uncertainty

What’s new with Philippine investment incentives

Transfer Pricing is here to stay

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