We’ve all been there: you owe a client some money, and instead of receiving their payment, you just ask them to give you the excess from what you owe. This is known as Offsetting or Netting.

Offsetting or Netting presupposes a situation where two parties are both debtors and creditors of each other– you owe each other money and you expect to receive money from one another.

Under Philippine Law, offsetting can be termed as “Compensation”. The Civil Code provides that two reciprocal obligations are extinguished if both are of equal value, and extinguished to the concurrent amount if of different values. Thus, as a civil law concept, an offsetting is allowed even without their consent as this takes place by operation of law.

However, in a tax perspective, the BIR categorically prohibits this practice in businesses because it prevents these from declaring the true values of its income and expenses. An Offsetting dissuades business owners from filing deductible expenses because they do not have to issue official receipts or withhold other related taxes to reduce their gross income. Hence, BIR states that business owner who offsets shall be allowed to claim the deducted amounts as a deductible expense.

Revenue Memorandum Circular (RMC) No. 61-2016 provides:

“The practice of offsetting due to/due from and/or payable/receivable transactions of taxpayers and consequently the accounting and recording of the same and its related transactions in the books of the parties is strictly prohibited for taxation purposes. Thus, at all times, the accrued receivables or payables arising from sale or lease of goods or properties or the performance of service, shall be recognized at gross for income and value-added tax or percentage tax purposes.”

Under RMC No. 61-2016, taxpayers must not only recognize their receivables or payables as it accrues but also at gross. This means you have to separately record your incomes and expenses at the moment you receive these, bare and without any deductions.

To fully understand the implications of Offsetting, the RMC provides for three illustrations:

1. A manufacturer sells its goods to a supermarket in exchange for a service fee for the display in the store of the latter. The manufacturer issues a sales invoice but the supermarket records its purchases net of service fees by recording these as “discounts”. These “discounts” are not the discounts contemplated by law for VAT purposes. Hence, these should be considered as the supermarket’s revenue.
2. In a telecommunications industry, companies interconnect their service networks with one another for a revenue sharing arrangement. Here, parties bill each other for interconnection fees, access charges on voice and data transmissions that pass through each network. The interconnection, sharing and access charges should be recorded as gross revenue of the companies that receive it, and expenses by the company paying it.
3. A bank lends to a person who is also a deposit account holder. As such, the bank earns interest income from the loan and interest expense from the deposit account. Here, the bank must declare all the interest income it got from the loan for purposes of percentage taxes, without touching or offsetting the amounts it recorded as expenses in paying the interests of the

In essence, business owners have to treat each transaction separately both for accounting and tax purposes, regardless if parties have their own personal agreement to offset the amount.

Business owners cannot under-declare their income; otherwise, they run the risk of being audited by the BIR. On the other hand, all expenses have to be properly supported by documents (e.g. invoices, official receipts) and appropriate withholding taxes must be remitted with the BIR before they can use these to deduct their income which will be the basis for imposing tax.