Percentage Tax vs. VAT in the Philippines: Which Applies to Your Business?

Value-added tax (VAT) and percentage tax are two different business taxes under the National Internal Revenue Code, and a business generally pays one or the other, not both, on its sales. The key difference is the threshold: businesses with gross sales or receipts exceeding the VAT threshold are subject to VAT, while those at or below the threshold generally pay percentage tax instead. Under the Tax Reform for Acceleration and Inclusion (TRAIN) law, the VAT threshold is set at Three million pesos (P3,000,000).

This article explains the difference between percentage tax and VAT in the Philippines, who is required to pay which, and the practical steps for compliance.

What Is Value-Added Tax (VAT) in the Philippines?

VAT is a tax on the consumption of goods and services, imposed on the sale, barter, exchange, or lease of goods or properties and the sale of services in the course of trade or business. It is a national internal revenue tax collected by the Bureau of Internal Revenue (BIR).

The National Internal Revenue Code of 1997, as amended by the TRAIN law (Republic Act No. 10963), lists VAT among the sources of national internal revenue taxes. The VAT is generally passed on to the end consumer, but the business is responsible for collecting and remitting it to the BIR.

A business becomes liable to VAT when its gross sales or gross receipts exceed the VAT threshold. Under the TRAIN law, the VAT threshold is Three million pesos (P3,000,000). Once a business crosses this threshold, it must register as a VAT taxpayer and charge VAT on its sales.

What Is Percentage Tax?

Percentage tax is a business tax imposed on persons engaged in certain businesses or occupations, as provided under the National Internal Revenue Code. It is a separate and distinct tax from VAT.

The most common percentage tax is the 3% percentage tax on gross sales or gross receipts, which applies to businesses whose gross sales or receipts do not exceed the VAT threshold. This tax is imposed under Section 116 of the National Internal Revenue Code, as amended.

Under the TRAIN law, self-employed individuals and professionals whose gross sales or receipts do not exceed the VAT threshold may opt to be taxed at 8% on gross sales or receipts in lieu of the graduated income tax rates and the percentage tax under Section 116. This is an important option for small businesses.

Percentage Tax vs. VAT: The Main Differences

The table below summarizes the key differences between percentage tax and VAT in the Philippines:

Feature	Percentage Tax	Value-Added Tax (VAT)
Basis	Gross sales or gross receipts	Gross sales or gross receipts
Rate	Generally 3% (Section 116)	12% (standard rate)
Applicability	Businesses with gross sales/receipts at or below the VAT threshold	Businesses with gross sales/receipts exceeding the VAT threshold
Pass-on to consumer	Generally not passed on; a business expense	Passed on to the buyer or consumer
Creditable input tax	Not applicable	Yes, the business can claim input VAT credits

A business cannot be subject to both VAT and percentage tax on the same sales. The VAT threshold is the dividing line.

Who Is Subject to Percentage Tax?

Under Section 116 of the National Internal Revenue Code, as amended, a percentage tax of 3% is imposed on the gross sales or gross receipts of persons engaged in business, including those engaged in the sale of services, who are not subject to VAT.

In practice, this means:

• Small businesses with annual gross sales or receipts of P3,000,000 or less are generally subject to the 3% percentage tax.
• Self-employed individuals and professionals whose gross sales or receipts do not exceed the VAT threshold may choose between the 8% income tax option or the graduated income tax rates plus the 3% percentage tax.

Who Is Subject to VAT?

A business becomes subject to VAT when its gross sales or gross receipts exceed the VAT threshold of P3,000,000. Once a business exceeds this threshold, it is required to:

1. Register as a VAT taxpayer with the BIR.
2. Charge 12% VAT on its sales of goods, properties, or services.
3. File VAT returns and remit the VAT collected to the BIR.
4. Claim input VAT credits on its purchases, which can be deducted from the output VAT due.

It is important to note that the VAT threshold is based on gross sales or gross receipts, not net income. A business that is close to the threshold should monitor its sales carefully.

How to Determine Which Tax Applies to Your Business

To determine whether your business should pay percentage tax or VAT, follow these steps:

1. Calculate your annual gross sales or gross receipts. Include all sales of goods, properties, or services, and other operating income.
2. Compare your total to the VAT threshold of P3,000,000.

• If your total is P3,000,000 or less, you are generally subject to percentage tax under Section 116.
• If your total exceeds P3,000,000, you are subject to VAT.

3. Consider your options. If you are a self-employed individual or professional with sales at or below the threshold, you may opt for the 8% income tax in lieu of the graduated rates and the percentage tax.
4. Register accordingly with the BIR. Your registration determines which tax returns you must file.

Frequently Asked Questions

Is the 3% percentage tax the same as VAT? No. The 3% percentage tax under Section 116 applies to businesses whose gross sales or receipts do not exceed the VAT threshold. VAT is a 12% tax that applies once a business exceeds the P3,000,000 threshold.

Can a business choose to be a VAT taxpayer even if its sales are below the threshold? In general, VAT registration is mandatory once a business exceeds the threshold. A business below the threshold is subject to percentage tax, unless it qualifies for and elects the 8% income tax option.

What happens if my business exceeds the VAT threshold during the year? Once your gross sales or receipts exceed P3,000,000, you are required to register as a VAT taxpayer and charge VAT. You should monitor your sales and register with the BIR promptly to avoid penalties.

Practical Takeaways

• Know your threshold. The P3,000,000 VAT threshold determines whether you pay VAT or percentage tax.
• Monitor your gross sales. Track your sales or receipts throughout the year, not just at year-end.
• Choose the right tax option. Self-employed individuals and professionals below the threshold may opt for the 8% income tax in lieu of the graduated rates and percentage tax.
• Keep proper records. Maintain accurate books of accounts and issue official receipts or invoices as required by the BIR.
• Consult a tax professional. The rules on VAT and percentage tax can be complex, especially for businesses near the threshold.

This article is general information and not legal advice. For your specific situation, consult a lawyer or ask ASG Legal AI.