(Philippine tax law perspective; general information only, not legal advice.)

1) The core idea: “deemed sale” is mainly a VAT concept

In Philippine tax practice, the phrase “deemed sale” most commonly refers to transactions that the National Internal Revenue Code (NIRC) treats as if a sale occurred even when there is no ordinary sale to a customer—primarily for Value-Added Tax (VAT) purposes.

The policy reason is straightforward: if a VAT-registered business has claimed input VAT on purchases/importations of goods, the government expects output VAT when those goods are ultimately “disposed of,” even if the disposal is via distribution, retirement, or conversion to non-business use.

Closing inventory becomes a focal point when a business stops, changes VAT status, transfers ownership, or distributes assets. In such cases, the law can treat the remaining inventory as sold for VAT purposes, triggering output VAT.

2) Legal anchors in the NIRC (VAT)

A. VAT on sale of goods: baseline rule

VAT is imposed on the sale, barter, exchange, or lease of goods or properties in the course of trade or business, as well as on importation.

B. Deemed sale of goods (key provision)

The NIRC includes a special rule on “transactions deemed sale” for goods. The most relevant to closing inventory is the situation where a VAT-registered person retires or ceases business—the remaining goods on hand are treated as deemed sold.

Other common deemed-sale triggers include:

Transfer, use, or consumption not in the course of business (e.g., personal use or non-business use)
Distribution or transfer to shareholders/investors as share in profits or property dividends (in substance, a transfer of goods without a traditional sale)
Consignment where goods are effectively transferred under conditions treated by regulations as sale
Change of ownership of a business (subject to specific rules and structuring)

Bottom line: When a VAT-registered entity ends operations or otherwise disposes of inventory outside a normal taxable sale, the law may impute a sale and impose output VAT.

3) What exactly is “closing inventory” in this context?

For deemed sale, closing inventory generally refers to goods held for sale or for use in production that remain on hand at the relevant cut-off date, such as:

Merchandise inventory (trading goods)
Finished goods
Work-in-process (depending on characterization and documentation)
Raw materials/supplies that are treated as “goods or properties” under VAT rules, especially if they were acquired with input VAT and are part of saleable/production inventory

It can also include certain supplies if treated as goods held for business and later diverted to non-business purposes, though the practical focus is usually on inventories that would otherwise be sold to customers.

4) When does deemed sale apply to closing inventory?

Scenario 1: Retirement or cessation of VAT-registered business

This is the classic closing-inventory deemed sale.

Typical triggers:

Shutting down operations
Permanent cessation of business
Cancellation of VAT registration because the taxpayer stops business (or becomes non-VAT for other reasons)

Effect: Remaining inventory is deemed sold on the date of retirement/cessation (or on the effective date tied to cancellation/closure as administered).

Scenario 2: Cancellation of VAT registration / shift to non-VAT status

A business may remain operating but cease to be VAT-registered (e.g., electing/qualifying to be a non-VAT taxpayer under thresholds and rules, or changing business model).

Tax concern: Input VAT may have been claimed on inventory. When the taxpayer exits VAT, the system often requires a “closing” output VAT via deemed sale of goods on hand (and/or other adjustments under rules).

Scenario 3: Distribution of inventory to owners/shareholders

If goods are distributed:

As property dividends
As part of profit sharing
As part of liquidation distributions (assets distributed to shareholders upon winding up)

…VAT deemed sale concepts may apply because inventory is leaving the business without a typical taxable sale to a customer.

Scenario 4: Transfer of a business / change in ownership

Rules can become fact-sensitive:

Asset sale (sale of inventory/assets) is ordinarily a real sale subject to VAT if seller is VAT-registered and the transfer is in the course of business.
Transfers incident to certain reorganizations (e.g., qualifying tax-free exchanges, mergers) may have special income tax and VAT outcomes if statutory conditions are met.

This area must be handled carefully because “deemed sale” can overlap with actual sale rules, and exemptions/reliefs (if any) are compliance-sensitive.

5) VAT consequences: what is taxed, at what rate, and on what base?

A. What tax is imposed?

Output VAT is imposed on the deemed selling price of the goods deemed sold.

B. VAT rate

Use the standard VAT rate applicable at the time (currently 12% in general).

C. Tax base: “gross selling price” / “market value”

For deemed sale, regulations typically require valuation at market value (often framed as the gross selling price that would apply had the goods been sold in an arm’s length transaction).

In practice, valuation is commonly supported by:

Latest sales invoices for identical/similar items
Price lists
Replacement cost / current acquisition cost
Appraisals (less common for ordinary inventory, more common for unique goods)

Practical compliance point: Taxpayers should be consistent and documentable; BIR scrutiny often focuses on undervaluation of deemed sale inventory.

6) Documentation and compliance: what the BIR typically expects

Because deemed sale can occur without a buyer, compliance becomes about self-reporting supported by schedules and internal documentation.

A. Inventory listing and valuation schedule

Commonly prepared:

Detailed inventory count as of the cut-off date (SKU, description, quantity, unit cost, unit selling price/market value)
Summary schedule by category
Basis of valuation and supporting documents

B. Invoicing / official documentation

Even without an external buyer, taxpayers commonly create internal documentation akin to:

A memorandum of deemed sale
A summary invoice document (depending on administrative practice)
Journal entries that recognize output VAT

C. VAT return reporting

Output VAT from deemed sale is included in the VAT return for the period covering the deemed sale date (monthly/quarterly depending on filing rules applicable to the taxpayer).

D. Closure / registration obligations

When ceasing business, taxpayers usually deal with:

BIR registration updates (closure of books, surrender of invoices/authority, etc.)
Final returns and compliance checks
Possible audit exposure (closure often triggers review)

7) Relationship with input VAT: what happens to remaining/unused input taxes?

This is a frequent pain point.

A. Input VAT already claimed on inventory

If input VAT was previously claimed on goods now deemed sold, the system is conceptually balanced by imposing output VAT on deemed sale.

B. Excess input VAT position

If a taxpayer has excess input VAT (input VAT > output VAT), outcomes can depend on:

Whether the taxpayer has zero-rated sales (refund/credit rules are specialized)
Whether the excess is attributable to capital goods (subject to special rules)
Whether the taxpayer is simply closing with no zero-rated basis (refundability is not automatic)

Practical reality: Closing businesses often find that recovering excess input VAT is difficult unless they fall under specific statutory refund/credit situations and comply strictly with procedural requirements.

8) Income tax treatment: closing inventory is not automatically “deemed sold,” but can become taxable depending on what happens to it

A critical distinction:

VAT law can treat closing inventory as deemed sold upon cessation.
Income tax law does not use “deemed sale” as broadly for closing inventory in a simple cessation. Instead, income tax consequences follow realization principles, accounting for what actually happens (sale, distribution, withdrawal, liquidation, etc.).

However, closing inventory becomes income-tax relevant because ending inventory affects Cost of Goods Sold (COGS) and because withdrawals/distributions can be treated as taxable events.

A. Sole proprietors / individuals: withdrawals for personal use

If inventory is withdrawn for personal use or non-business purposes, the BIR typically treats it as a constructive sale for income tax purposes (and for VAT if VAT-registered), requiring recognition of income at an appropriate value to prevent artificial reduction of taxable income through inventory/COGS mechanics.

Why: If you simply remove inventory without recording revenue, ending inventory falls, COGS rises, and taxable income drops—an obvious tax leakage.

B. Corporations: distribution as property dividend

If a corporation distributes inventory to shareholders as a property dividend, key tax considerations can include:

Dividend tax on the recipient (depending on shareholder type and applicable rules/rates)
Withholding obligations (as applicable)
Potential corporate-level income tax consequences under constructive realization doctrines often applied in practice when property is distributed at fair market value (especially where the property has appreciated)

C. Liquidation of a corporation

Liquidation typically involves:

The corporation disposing of assets or distributing them to shareholders; and
Shareholders being treated as having sold/exchanged their shares for the liquidation proceeds (a capital gains/loss computation at the shareholder level generally applies).

For inventory, liquidation can create a combination of:

VAT deemed sale or taxable transfer rules (if VAT-registered and inventory is transferred/distributed)
Corporate income tax exposure if distribution is treated similarly to a transfer at fair market value under tax principles applied to property distributions
Shareholder-level tax on liquidation proceeds (depending on shareholder classification and basis)

This is an area where structuring and documentation are crucial because multiple taxes can stack.

9) Other Philippine taxes that may intersect (depending on facts)

A. Withholding taxes

Deemed sale itself is not a “payment to a supplier,” so typical EWT mechanics differ. But in distributions/dividends:

Dividend withholding may apply
Documentation and remittance rules can apply if distributions are treated as dividends or other taxable transfers

B. Donor’s tax

If inventory is transferred gratuitously (i.e., without adequate consideration) to a person other than in ordinary business, donor’s tax can be implicated. In business closure contexts, transfers to owners/shareholders are usually analyzed under dividends/liquidation rather than donative intent, but gratuitous transfers outside that frame can raise donor’s tax issues.

C. Local business tax and regulatory closure

Not a national tax, but closing out inventory and stopping operations often requires local government (LGU) closure steps and clearances that indirectly affect timing and documentation.

10) Special situations and common fault lines

A. Going concern sale vs. closure

If a business is sold as a going concern (fact-dependent), parties sometimes assume “no VAT on inventory” because “it’s not really a sale of goods.” This assumption is risky.

An asset sale that includes inventory is normally within VAT if the seller is VAT-registered and the transfer is in the course of business.
Certain reorganizations may have tailored outcomes, but relying on labels without meeting statutory conditions invites assessments.

B. Mergers, consolidations, and tax-free exchanges

Philippine law recognizes certain tax-free exchanges and reorganization concepts for income tax, and VAT may have parallel rules or administrative positions for qualifying transfers. These are highly technical, condition-heavy, and documentation-driven. If conditions are not satisfied, the transfer can be treated as a taxable sale (or trigger deemed sale consequences in closure/cancellation scenarios).

C. Timing risk: “effective date” of cessation

VAT deemed sale exposure depends on when cessation/retirement is recognized. Businesses sometimes stop operations informally long before formal closure. For tax purposes, mismatched timing can cause:

Late reporting
Penalties
Disputes on valuation date (and thus the base)

D. Valuation disputes

The BIR commonly challenges:

Very low “market value” assigned to goods
Obsolete/slow-moving claims without proof
Missing or inconsistent inventory records

A defensible approach usually includes:

Physical count records
Clear obsolescence policy and evidence (damage reports, aging schedules, attempts to sell)
Consistent pricing support

11) Penalties and audit exposure

Deemed sale on closing inventory is a frequent assessment area because it is:

Easy to miss during closure
Often material
Highly dependent on taxpayer-prepared schedules

Potential exposures include:

Deficiency VAT (output VAT on deemed sale)
Surcharges and interest
Compromise penalties for invoicing/recordkeeping failures
Possible income tax adjustments if withdrawals/distributions were not properly recognized

12) Practical illustration (conceptual)

A VAT-registered trader ceases business with ₱5,000,000 of inventory at supportable market value.

VAT deemed sale base: ₱5,000,000
Output VAT (12%): ₱600,000

This ₱600,000 is reported as output VAT in the applicable VAT return period. If the taxpayer has remaining input VAT, it may offset subject to rules, but any leftover excess input VAT is not automatically refundable unless it falls within specific statutory refund/credit scenarios and strict procedures are followed.

13) Key takeaways

Deemed sale on closing inventory is principally a VAT rule designed to “close the loop” on input VAT previously claimed.
The most common trigger is retirement/cessation of a VAT-registered business (and related VAT registration cancellation).
Valuation and documentation are where most disputes happen—inventory schedules, support for market value, and clear timing.
Income tax consequences depend on what happens to the inventory (sale, withdrawal, distribution, liquidation) and should be analyzed separately from VAT.
Business transfers, reorganizations, and liquidations can involve multiple overlapping taxes (VAT, income tax, dividend/liquidation tax, and sometimes donor’s tax), making proper structuring and compliance critical.