In the Philippine construction and service industry, understanding the nuances of the National Internal Revenue Code (NIRC), as amended by the TRAIN Law and the CREATE Act, is critical for compliance. For contractors, the intersection of Expanded Withholding Tax (EWT) and Value-Added Tax (VAT) creates a specific set of obligations that affect cash flow and reporting.
I. Expanded Withholding Tax (EWT) for Contractors
The Expanded Withholding Tax is a system where the payor (the client) deducts a certain percentage from the payment made to the payee (the contractor) and remits it directly to the Bureau of Internal Revenue (BIR). This serves as a credit against the contractor's final income tax liability.
1. Applicable Rates
Under Revenue Regulations (RR) No. 2-98, as amended by RR No. 11-2018, the following rates generally apply to contractors:
- General Engineering and Building Contractors: Payments made to "contractors"—which includes those engaged in demolition, waterworks, and various repair services—are subject to a 2% EWT.
- Subcontractors: The same 2% rate applies to payments made to subcontractors by the main contractor.
- Other Service Contractors: This category is broad and includes janitorial, security, and even certain technical services, all generally pegged at 2%.
2. The Responsibility of the Payor
The client (withholding agent) is legally mandated to:
- Withhold the tax upon accrual or payment, whichever comes first.
- Issue BIR Form No. 2307 (Certificate of Creditable Tax Withheld at Source) to the contractor. This document is the contractor’s "proof of payment" to be used as a deduction against their quarterly and annual Income Tax Returns (ITR).
II. Value-Added Tax (VAT) Computation
Contractors are classified as "sellers of services." Under Section 108 of the Tax Code, they are subject to a 12% VAT based on gross receipts, not on gross sales or billings.
1. The "Gross Receipts" Rule
Unlike sellers of goods who are taxed upon the transfer of ownership (billing), contractors are only liable for the output VAT once they have actually or constructively received the payment.
The Formula:
2. Deducting Input VAT
Contractors can offset their Output VAT (tax on their billings) with Input VAT (tax they paid to suppliers for materials, equipment rentals, or utility bills).
Note on Government Contractors: If the client is a government entity, a 5% Final Withholding VAT is usually deducted. Under the TRAIN Law, this 5% acts as a final settlement of the VAT component for that specific transaction, which can significantly alter the computation of creditable input taxes.
III. Summary Table: Compliance Requirements
| Feature | Expanded Withholding Tax (EWT) | Value-Added Tax (VAT) |
|---|---|---|
| Nature | Advance Income Tax | Consumption Tax |
| Current Rate | Generally 2% | 12% |
| Tax Base | Gross Amount (excluding VAT) | Gross Receipts (Actual Collection) |
| Evidence | BIR Form 2307 | Official Receipt (OR) |
| Timing | Upon payment or accrual | Upon collection of cash/check |
IV. Critical Compliance Reminders
The Importance of the "Base"
When computing EWT, the tax must be applied to the base price excluding VAT.
- Example: If a contractor bills PHP 1,120,000 (inclusive of 12% VAT), the 2% EWT is applied to the PHP 1,000,000 base. The client pays the contractor PHP 1,100,000 and provides a Form 2307 for PHP 20,000.
Timing of Recognition
For VAT purposes, the issuance of a Billing Statement or Sales Invoice does not trigger the VAT liability for a service contractor; only the issuance of an Official Receipt (OR) upon collection does. However, for EWT, the obligation to withhold arises as soon as the expense is recognized in the books (accrued), regardless of whether the cash has changed hands.
Penalties for Non-Compliance
Failure to withhold or remit these taxes can lead to:
- Surcharge: 25% (or 50% in cases of fraud).
- Interest: 12% per annum (under the TRAIN Law).
- Compromise Penalties: Based on the schedule of the BIR.
- Disallowance of Expense: If EWT is not withheld, the entire payment might be disallowed as a deductible expense for the client's income tax purposes.