Purchases basis, substantiation, and allocation rules

1. Concept and legal frame

Philippine VAT is a transaction tax on the value added at each stage of the supply chain. A VAT-registered taxpayer generally pays:

VAT payable = Output VAT – Allowable Input VAT

Output VAT: VAT you bill on taxable sales/receipts.
Input VAT: VAT you pay on your purchases/importations of goods, properties, and services used in business.

The core rules are in Title IV of the National Internal Revenue Code (NIRC), principally Sections 110–112 (crediting of input tax; refunds/credits), and implementing regulations (notably the VAT regulations under RR 16-2005, as amended).

2. What qualifies as “input tax” and what does not

2.1 Input tax, in general

Input tax is the VAT properly charged by a VAT-registered supplier on a buyer’s purchase of goods/properties/services, or VAT paid on importation, that is connected with the buyer’s taxable or zero-rated business.

To be creditable, input VAT must be:

VAT that is actually due/paid and properly imposed, and
Supported by compliant VAT invoices/official receipts (ORs) or import documents, and
Not attributable to VAT-exempt activities (or, if common, properly allocated).

2.2 Not creditable (common disallowances)

Input VAT is typically not creditable when:

The purchase is not used in the VATable/zero-rated business (e.g., purely personal, or purely for exempt operations).
The VAT is passed on by a non-VAT seller (i.e., the seller shouldn’t have charged VAT in the first place).
The document is not a valid VAT invoice/OR, is missing required information, or the supplier is not actually VAT-registered at the time of sale.
The input VAT relates to VAT-exempt sales, unless it is properly allocated and only the taxable/zero-rated portion is claimed.
The claimed input VAT is not recorded in the books or VAT subsidiary ledgers in a manner consistent with VAT reporting.

3. Purchases basis: how to compute input VAT from purchases/importations

Input VAT is computed per transaction type, with special rules for certain situations.

3.1 Domestic purchases of goods or properties (local purchases)

Input VAT basis (goods/properties):

Generally 12% of the VAT-exclusive purchase price shown in the supplier’s VAT invoice, if VAT is separately indicated.

Typical computation:

VAT-exclusive price × 12% = input VAT

Key practical point: For goods/properties, input VAT is usually claimable in the period the VAT invoice is issued and the purchase is recognized, subject to invoicing rules and timing discussed below.

3.2 Domestic purchases of services and lease of properties

Input VAT basis (services/lease):

Generally 12% of the VAT-exclusive service fee/rent shown in the supplier’s VAT official receipt (and, under more modern invoicing rules, the document serving as the primary support for services).

Timing is critical for services: Under the traditional Philippine VAT system, VAT on services is tied closely to receipt/billing and payment mechanics (historically anchored to the issuance of the official receipt upon payment). In practice, many taxpayers recognize creditable input VAT for services in the period when the proper document evidencing the VAT on services is issued (often upon payment). The safest approach is to align claiming with:

the period the supplier’s VAT becomes due, and
the period the buyer holds the proper supporting document.

3.3 Importation of goods

Input VAT basis (importation):

VAT paid to customs is computed on the VAT base for importation, typically the sum of:
- customs value/transaction value (or as determined under customs rules),
- customs duties, excise tax (if any),
- and other charges forming part of the dutiable value, as provided by customs and tax rules.

Support: Import entry/BOC documentation and proof of VAT payment are essential; the “input tax” here is the VAT actually paid on importation.

3.4 Purchases of capital goods (equipment, machinery, etc.)

Capital goods are purchases of depreciable assets used in business (not inventory). For VAT:

Input VAT on capital goods is generally creditable like other purchases, but classification matters for accounting, audit trail, and refund claims.
Allocation is required if capital goods are used in both taxable/zero-rated and exempt operations.

(Historically, older rules required amortization/deferment of input VAT on capital goods above a threshold. Later reforms substantially relaxed/removed amortization in many cases. In practice, taxpayers should ensure their treatment matches the prevailing BIR rules for the period involved and that VAT returns/subsidiary ledgers reflect the approach consistently.)

3.5 Special forms of input tax (non-standard sources)

a. Transitional input tax (for those who become VAT-registered)

A person who becomes VAT-registered may claim transitional input tax on beginning inventory, generally computed as the higher of:

2% of the value of beginning inventory (goods, materials, supplies), or
the actual VAT paid on such inventory (if properly supported).

This is a one-time “entry” input tax intended to avoid cascading VAT when a business crosses into VAT registration.

b. Presumptive input tax (for certain industries)

Certain specified processors/manufacturers using primary agricultural inputs may claim presumptive input tax, commonly computed as a fixed percentage (commonly 4%) of the gross value of purchases of primary agricultural products used as inputs, subject to the specific statutory coverage and conditions.

c. Creditable VAT withheld by government (final withholding VAT system on sales to government)

On sales to Philippine government entities, a portion of VAT is often withheld (commonly described as a final withholding VAT mechanism). The amount withheld is creditable to the seller as part of its VAT computation, subject to documentation (withholding certificates, proof of remittance, and proper invoicing).

4. Substantiation: documentary requirements and compliance standards

Input VAT is only as strong as its paper trail. In Philippine VAT audits, “allowability” is frequently won or lost on compliance with invoicing/receipt rules.

4.1 Core substantiation rule

No valid VAT invoice/official receipt (or import document), no input tax credit.

The supporting document must generally show:

Supplier’s name/business name, address, and TIN
Buyer’s name (or “cash”/generic, as allowed) and TIN (where required/when buyer is VAT-registered and the rules demand it)
Date of transaction
Description of goods/properties/services
Quantity and unit cost (for goods), or nature of service
VAT-exclusive amount, VAT amount shown separately, and total consideration
Supplier’s VAT registration status/annotation (as required)
Serial number and BIR authority details required for valid invoicing

4.2 The supplier must be VAT-registered (at the time of the sale)

A common audit issue: the buyer presents an invoice with “VAT” but the supplier was:

not VAT-registered, or
had a cancelled/suspended VAT registration, or
was under a regime where charging VAT was improper.

In those cases, the “VAT” is typically treated as part of cost/expense, not creditable input VAT.

4.3 Matching input VAT to the correct period and return

Philippine VAT reporting is period-based (monthly/quarterly compliance framework depending on the return type applicable to the period). Good practice (and often essential in audits/refund claims) includes:

Recording purchases in VAT subsidiary ledgers (purchases journal with VAT breakdown)
Reconciling:
- purchases per books,
- input VAT per VAT returns,
- withholding certificates (if applicable),
- and supplier/customer lists (relief/SLSP or its successor reporting, if required for the period)

4.4 “Business use” and deductibility linkage

While VAT creditability is not identical to income tax deductibility, auditors often look for:

proof the purchase is for business,
proper classification (inventory vs capital asset vs expense),
and whether the expense is connected to taxable operations.

For borderline items (e.g., entertainment, company cars, mixed-use utilities), the more the taxpayer can document business purpose and allocation, the more defensible the claim.

4.5 Importation support

For import VAT claims, maintain:

import entry and internal revenue declarations,
proof of VAT payment to the Bureau of Customs,
shipping documents (BL/AWB), supplier invoices,
and internal receiving reports linking import to inventory/assets.

5. Allocation rules: taxable vs zero-rated vs exempt, and the “common input tax” formula

Allocation is the heart of correct input VAT computation for mixed businesses.

5.1 The three buckets of sales and their impact on input VAT

Taxable (12%) sales/receipts
- Output VAT applies.
- Input VAT attributable to these sales is creditable.
Zero-rated sales/receipts
- Output VAT is 0%.
- Input VAT attributable to these sales is creditable, and if unutilized, may be eligible for refund/tax credit under the rules.
VAT-exempt sales/receipts
- No output VAT.
- Input VAT attributable to exempt sales is not creditable (it becomes part of cost/expense).

5.2 Direct attribution vs common input VAT

a. Directly attributable input VAT

If an input is clearly traceable to a specific activity:

Direct to taxable/zero-rated → creditable
Direct to exempt → not creditable; treat as cost/expense

Examples:

Raw materials used only for a VATable product line → creditable
Supplies used only for an exempt product line → not creditable

b. Common input VAT (shared inputs)

If an input supports both creditable (taxable/zero-rated) and exempt activities (e.g., rent, utilities, shared services, shared equipment), it is “common” and must be allocated.

5.3 Allocation method (proportional allocation)

A standard approach under VAT regulations is proportional allocation based on sales mix:

Creditable portion of common input VAT = Common input VAT × (Taxable + Zero-rated sales) ÷ Total sales (Taxable + Zero-rated + Exempt)

Non-creditable portion = Common input VAT × (Exempt sales) ÷ Total sales → treated as cost/expense

Key points in applying the formula

Use consistent definitions of “sales/receipts” for the period (gross selling price/gross receipts, as relevant).
Keep a clear schedule:
- total input VAT,
- less: directly attributable to exempt,
- equals: common input VAT pool,
- allocate common pool using the ratio.

5.4 Allocation for capital goods and long-lived assets

If a machine/building improvement is used for both taxable and exempt operations:

Apply allocation on a reasonable basis (often the same proportional method, or usage-based allocation if measurable).
Document the basis (floor area, machine hours, production volume, headcount, etc.) and apply consistently.

Because capital goods often attract large input VAT, allocation is a common audit trigger—documentation and consistency matter.

6. Input VAT crediting mechanics, carryover, and limitations

6.1 Crediting and carryover

When input VAT exceeds output VAT for a period:

The excess is generally carried over to the next period(s) as “excess input VAT.”

This is common for businesses with:

seasonal purchases,
capital expenditures,
significant zero-rated sales,
or thin margins.

6.2 Refund or tax credit of unutilized input VAT (especially for zero-rated)

For taxpayers with zero-rated sales, unutilized input VAT attributable to such sales may be claimed as:

a VAT refund, or
a tax credit certificate (depending on the regime applicable at the time).

This is highly procedural. Typical requirements include:

proof of zero-rated sales,
complete purchase invoices/ORs and import documents,
allocation schedules,
reconciliations to VAT returns and books,
and compliance with the prescriptive period (commonly framed as a two-year rule tied to the quarter of sales, subject to the governing law and jurisprudence for the claim period).

Refund claims are documentation-intensive; even “small” invoicing defects can cause disallowance.

7. Compliance blueprint: how to compute input VAT defensibly (step-by-step)

Step 1: Classify sales for the period

Split sales/receipts into:

12% taxable
zero-rated
exempt

Step 2: Summarize purchases and importations

Create a purchases schedule with columns:

supplier, TIN, document no., date
nature (goods/services/capital goods/import)
VAT-exclusive amount
VAT amount (input VAT)
tagging: taxable-only, zero-rated-only, exempt-only, or common

Step 3: Validate substantiation

For each material line item:

confirm supplier VAT-registration (as evidenced in documents/registrations for the period),
confirm VAT is separately indicated,
confirm required invoice/OR information is present,
confirm booking in the right period and in VAT subsidiary ledgers.

Step 4: Directly attribute where possible

Credit input VAT directly related to taxable/zero-rated sales.
Disallow (capitalize/expense) input VAT directly related to exempt sales.

Step 5: Compute common input VAT and allocate

Identify common input VAT pool.
Apply proportional allocation:
- creditable portion → input VAT claim
- non-creditable portion → cost/expense

Step 6: Compute VAT payable or excess input VAT

Output VAT – allowable input VAT = VAT payable (or excess input VAT)

Step 7: Prepare audit-ready reconciliations

Reconcile:

Purchases per books vs purchases per VAT schedules
Input VAT per schedules vs input VAT claimed in VAT returns
Withholding VAT certificates (if any) vs credit claimed
Import VAT proofs vs import input VAT claimed

8. Frequent problem areas (and how rules apply)

8.1 “VAT passed on” by non-VAT sellers

Even if the buyer paid an amount labeled “VAT,” it is generally not creditable if the seller is not VAT-registered or not legally allowed to charge VAT. Treat it as part of cost/expense.

8.2 Mixed-use overhead (rent, utilities, shared payroll services)

Treat as common input VAT and allocate using the prescribed ratio, unless a better measurable basis exists and is consistently applied.

8.3 Invoices/ORs with missing details

Missing required information can lead to disallowance. For significant vendors, ensure documents consistently show:

VAT separately stated,
correct TINs and names,
compliant serial/authority information,
correct description and amounts.

8.4 Zero-rated sellers claiming refunds without clean allocation

Refund claims fail most often due to:

weak linkage of purchases to zero-rated sales,
incomplete VAT invoice/OR compliance,
lack of reconciliations to returns/books,
and allocation schedules that do not track directly attributable vs common inputs.

9. Practical drafting notes for contracts and procurement (VAT-proofing)

To protect input VAT claims, procurement and payables processes commonly embed:

vendor onboarding requiring proof of VAT registration and compliant invoicing,
rejection rules for noncompliant invoices/ORs,
explicit contract clauses requiring VAT to be separately stated and supported by valid VAT documents,
periodic supplier validation and reconciliation routines.

10. Summary rule-set (the “three pillars”)

Purchases basis: Input VAT is computed from VAT properly charged on domestic purchases or paid on importation, including special input tax mechanisms (transitional/presumptive/withheld VAT) where applicable.
Substantiation: No compliant VAT document (and no VAT-registered supplier / no import proof), no credit.
Allocation: Input VAT attributable to exempt activities is not creditable; common inputs must be allocated using the prescribed proportion (or a documented reasonable basis applied consistently).