Cleared: Taxation of advances/deposits made to GPPs

In employing the services of a general professional partnership (GPP), its clients are at times required to deposit or advance money to be used during the period of engagement.  Under the old rule, deposits received by the GPP are not considered as income; rather, they are treated as fund subject to liquidation while the advances are to be paid by the GPP’s client. When third party establishments issue official receipts/invoices in the name of the GPP for the necessary expenses incurred on behalf of its client, there are instances when these expenses are claimed by both the GPP and its client as deductions from their respective gross income. As a result, double claim of deduction arises. 

To clarify the issue on who has the right to claim the expenses as deductions, the Bureau of Internal Revenue issued Revenue Memorandum Circular No. (RMC) 89-2012 dated  Dec. 27, 2012, which took effect immediately. The circular clarifies the tax implications, recording of deposits or advances, as well as accounting and liquidation of pertinent expenses specific to GPPs.

When can a GPP or its client claim the expenses as deductions? For income tax purposes, the new circular states that when the official receipt/invoice is issued by third-party establishments in the name of the GPP, the GPP shall record the expenses it incurred and paid on behalf of its client as its own expenses and claim it as deductions from its gross income. In this circumstance, the GPP’s client can no longer claim the same expenses as deductions even though the same have been incurred on his behalf. Conversely, provided all the payments made by the client to the GPP are substantiated by official receipts, the same should be treated as professional fees.

When a deposit or advance money is paid to the GPP by its client, an official receipt shall be issued and the same shall be booked as income of the GPP. The recording of the deposits/advances shall depend on the method of accounting used by the GPP. It shall be recorded as service income if the GPP is utilizing cash basis of accounting. However, the same shall be treated as unearned income or liability if accrual basis is employed. On the part of the GPP’s client who is using a cash basis of accounting, the deposits/advances shall be recorded as outright expenses. Nevertheless, it shall be treated as deferred expense or pre-payments if its client opts to use accrual method of accounting. In recording of deposits, the GPP and its client shall include VAT.

A summary and computation of all the expenses incurred shall be made upon liquidation. In a case where the deposit/s exceeds the total expense and such excess is returned to the GPP’s client, the GPP shall record such liquidation (return of the excess) in accordance with the rules provided either as a service income or deposits from its clients depending on the accounting method used by the GPP. A corresponding VAT shall be imposed on such amounts notwithstanding the method of accounting being utilized. On the other hand, the GPP’s client shall record the liquidation upon receipt of the excess deposit as professional fees plus the corresponding VAT when cash accounting is being employed. In case where accrual accounting is utilized, the record shall be made as an adjustment to the deposits made to the GPP plus the equivalent VAT.

In case there is insufficiency of deposits, the GPP shall be paid by its client to cover the balance of the actual expenses incurred. The GPP shall issue an official receipt and record the same either as service income or accounts receivable depending on the method of accounting used. On the other hand, the additional deposit shall be recorded by its client as a modification to the professional fees or to the deposits made to GPPs. All circumstances shall include the corresponding VAT.

When no deposit is made, the GPP normally advances for the necessary expenses incurred on behalf of its client. When the official receipt/invoice evidencing payments made to a third-party establishment is in the name of the GPP, it shall be recorded as an expense plus the recognition of income in case of accrual accounting. Then, upon collection of these expenses from the client, the transaction shall be recorded by the GPP as service income if cash basis of accounting or collection of accounts receivable if accrual basis of accounting. Both payments made to third party establishments and collection of expenses should be recorded with the corresponding VAT due thereon.

On the other hand, regardless whether the method used is cash or accrual, the client of the GPP should record such payment as professional fees plus VAT.

RMC 89-2012 aims to settle the issues between the GPP and its client in dealing with the recording of deposits and advances. Moreover, with the policies and guidelines laid down in the new circular, both parties will be able to clearly determine who among them is entitled to deduct such expenses to their own gross income, hence, avoiding a double claim of deduction.

Katrine R. Foronda is a supervisor from the Tax Group of Manabat Sanagustin & Co. (MS&Co.), the Philippine member firm of KPMG International.

This article is for general information purposes only and should not be considered as professional advice to a specific issue or entity.

The view and opinions expressed herein are those of the author and do not necessarily represent the views and opinions of KPMG International or MS&Co. For comments or inquiries, please email [email protected] or [email protected].