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VAT and income tax on security agencies

Changing the rules on VAT and income tax on security agencies

by Jemelle C. Adraneda

There are new rules to be followed on income and expense recognition and the determination of the VAT and withholding tax base for security services.  The new rules affect both the security agencies and their clients availing of the security services.

Ever since,  it has been assumed that the tax treatment of gross receipts by security agencies was already clear and straightforward.  That is, the full contract price for security services is subject to VAT, income tax and withholding tax and that includes not only the agency’s administrative overhead and profit margin but also the salaries of the security guards.   This has been specifically provided in various ruling issued by the Bureau of Internal Revenue (BIR) even for purposes of the contractor’s tax that the VAT replaced in 1988.

Revenue Memorandum Circular (RMC) No. 39-2007 has completely changed these rules.  The RMC prescribes the tax treatment where the contract between the client and the security agency provides for a breakdown of the agency fee and the salaries of the security guards.  The new rules were based on the premise that in order for an amount received to form part of gross receipts whether for VAT or income tax, it must constitute the gross income of the taxpayer when received or earned.

In the case of security agencies, portion of the contract payments are intended or earmarked as salaries of the security guards and the agency is not free to use it in any other manner.  This is specifically provided in the implementing regulations of Republic Act No. 5487 governing the organization and operation of private security agencies.  Furthermore, the Labor Code requires that the prescribed increases in wage rates of worker (security guards) are to be borne by principals or clients of the service contractors (security agencies) and that the contractor (security agency) shall only be liable in the event that the client fails to pay the prescribed wages.

On these basis, the following tax treatment of security services contracts have been prescribed:

Income and withholding tax.  While the security agency shall record the receipt of payment for the whole contract price, only the agency fee portion of the payment, net of the VAT, shall be recognized as gross income for income tax purposes.  Consequently, the client shall withhold the 2% expanded withholding tax on contractors based only on said agency fee.

The amount representing the security guards’ salaries shall be recognized as a liability of the security agency.   
 
The expense for the security guards’ salaries shall be claimed by the client.  Hence, the client can claim as a deduction from gross income the total amount paid to the security agency, net of the VAT on the agency fee.  The corresponding expenses shall be recorded as “Security Services – Agency Fee” and “Security Services – Security Guards Salaries”.

Value-Added Tax.  The 12% VAT of the security agency will only be computed on the agency fee.  Consequently, the client can claim the input tax on the agency fee as credit against its output VAT, provided that it is supported with a VAT official receipt.

The portion of the contract price representing the salaries of the security guards shall be exempt f rom VAT being payments for services rendered pursuant to an employer-employee relationship as provided under Section 109 of the Tax Code.

The security agency shall issue a VAT Official Receipt only for the amount representing the agency fee.  A non-VAT Acknowledgement Receipt shall be issued for the amount representing the security guards’ salaries.

Withholding on the salaries of security guards.  Although the client shall be the party entitled to claim the expense on the salaries of the security guards, the security agency will be responsible for withholding the tax on compensation income paid to the security guards, being the party who has control over the payment of the salaries.

The security agency shall furnish the client a Notarized Certification indicating the names of the guards employed by the client, their respective TINs, the amount of salaries and the amount of tax withheld from each. This certification, together with, the covering Non-VAT Acknowledgment Receipt, shall serve to substantiate the salaries expense that will be claimed by the client.

There are still questions and concerns that may be encountered when complying especially on the withholding tax procedures. 

As the security agency has been required and authorized to withhold on the compensation of the security guards, it is presumed that it will take over all the other reporting and compliance functions of a withholding agent although these were not specifically indicated in the circular - issuance of the Certificate of Compensation Payment /Tax Withheld (BIR Form No. 2316) to the guards and  submission of the annual alphabetical list of employees that include the security guards.

It is likewise assumed that Form 2316 will not anymore indicate the name of the client as employer considering that a security guard may not always be permanently assigned to just one client.

Although these are logical conclusions, it is always better that these responsibilities are clearly enumerated to avoid any misinterpretation that may unintentionally expose taxpayers to errors and penalties.

The effectivity date was not provided although, again, it may be safe to assume that the new  rules shall be applicable on payments to be made after the issuance of the circular.  Or can it retroact to security agencies who demand, and their clients who agreed, that the taxes be computed only on the agency fee, excluding the salaries of the security guards?

As the BIR begin take into consideration these industry peculiarities and issue these exceptions to the previously general rules, other similarly situated service providers may clamor for similar rules on their transactions with their clients.

For the moment though, these rules specifically apply to security services.  Make sure  that the contracts provide for a specific allocation of the contract price between the agency fee and the salaries of the security guards.  Otherwise, these new rules will not apply.

 (The author is a tax manager at Punongbayan & Araullo, member firm of Grant Thornton International.  For comments and inquiries, you can e-mail the author or call 886-5511.)