Written by Joel Roy C. Navarro, 27 March 2008
With the April 15 income tax filing deadline fast approaching, taxpayers reporting income on a calendar year basis are up on their sleeves preparing their 2007 income tax returns. Taxpayers are already feeling the pressure, given the various tax and accounting issues that have arisen due to the barrage of revenue issuances released by the Bureau of Internal Revenue (BIR) in the last several months, coupled with the adoption of new accounting rules and standards.
Among the taxpayers affected are the registered enterprises operating within the special economic zones (ecozones) of the Philippine Economic Zone Authority (PEZA) which enjoy the 5% preferential income tax rate.
Concomitant to their income tax obligation is the issue of the proper VAT treatment of services rendered to them by persons or entities located outside the Ecozone ( i.e., whether said services are subject to 12% or 0% VAT).
This is not actually a new issue, as the same had been raised several times in the past and on which, several clarificatory rulings have already been issued by the BIR.
However, notwithstanding such issuances, it continues to be a nagging issue because many believe that such rulings are inconsistent with the law, rules and regulations and jurisprudence on zero-rated VAT transactions.
To review, our VAT Law, which was first adopted and promulgated under Executive Order No. 273 effective Jan. 1, 1988, adheres to the Destination Principle or the Cross-Border Doctrine as basis for the jurisdictional coverage of the VAT. Under this principle/doctrine, the onus of taxation is in that country where goods, properties and services are ultimately destined, used or consumed.
Thus, under our VAT law, goods, properties and services destined to, used or consumed in the Philippines (i.e. imported goods) are subject to the 12% VAT whereas those destined, used or consumed outside the Philippines (i.e. exported goods) are subject to the zero-percent VAT. (CIR vs. American Express International, Inc., G.R. No. 152609, 2005; VAT Ruling No. 057-03 dated Dec. 15, 2003).
Confusion in zero-rating arises, however, when the performance of a particular type of service is equated with consumption of its output abroad.
The Supreme Court in the American Express case clarified that the consumption contemplated by law does not imply that the service must be done abroad in order to be zero-rated. Under the destination principle, even if the services are rendered both in the Philippines and abroad, zero-rated VAT would still apply provided the performance of service has a "substantial connection" to the place where the person or entity is under jurisdiction (outside the Philippines).
Section 108(B) of the National Internal Revenue Code enumerates the transactions that are subject to 0% VAT. The transactions enumerated are generally export in nature. Included in the list of zero-rated transactions are "services rendered to persons or entities whose exemption under special laws or international agreements to which the Philippines is a signatory effectively subjects the supply of such services to 0% VAT.
Services rendered to enterprises registered and operating within special ecozones fall under this enumeration since ecozones by fiction of law, are considered foreign territories, and therefore sales of goods and services to entities located in said foreign territories are deemed export sales. (Commissioner of Internal Revenue vs. Seagate Technology Philippines, G.R. No. 153866, 2005, BIR Ruling No. DA-061-06)
The application of the destination principle in respect to sale of services to enterprises located inside ecozones (which are considered foreign territories by legal fiction) administered by the PEZA is more clearly spelled out in Revenue Memorandum Circular (RMC) No. 74-99, specifically in Section 3(3) thereof which in part states, "In the final analysis, any sale of goods, property or services made by a VAT-registered supplier from the Customs Territory to any registered enterprise operating in the ecozone, regardless of the class or type of the latter’s PEZA registration, is actually qualified and thus legally entitled to the zero percent (0%) VAT. x x x while all sales of services to the said enterprises, made by VAT-registered suppliers in the Customs Territory, shall be treated effectively subject to 0% VAT, pursuant to Section 108(B)(3), NIRC, in relation to the provisions of RA No. 7916 and the "Cross Border Doctrine" of the VAT system."
This provision clearly infers that the services rendered to enterprises located within the ecozone are entitled to zero-rated VAT whether or not the services are rendered inside the ecozone.
In other words, even if the services to the PEZA entity are rendered in the Customs Territory zero-rated VAT shall still apply for as long as the services are directed to persons or entities registered with the PEZA and operating inside the ecozone. This interpretation is further supported by the fact that there is no provision in RMC 74-99 which states, directly or indirectly, that the services should be rendered within the ecozone in order to be treated as VAT zero-rated.
Moreover, under Revenue Regulations (RR) No. 16-2005, as amended, the term "effectively zero-rated sales of services" is defined as a local sale of services by a VAT-registered person to a person or entity who was granted indirect tax exemption under special laws or international agreement.
The use of the term "local sale of services" in this provision clearly indicates that the place of performance of the zero-rated services to the PEZA entity is in Philippine territory which could be in the Customs Territory or inside the ecozone.
Notwithstanding these provisions, however, the BIR in several rulings issued qualified that the 0% VAT shall apply to services rendered to ecozone entities only if the services are actually rendered inside the ecozone. The BIR justified its position on the basis that 5% gross income tax incentive of PEZA entities apply only in respect to said entity’s operations within the ecozone. (BIR Ruling No. DA 177-07, BIR Ruling No. DA 367-07).
The BIR’s basis of anchoring the 0% VAT on the tax incentives of ecozone enterprises is not clear.
The 0% VAT treatment of sales of goods and services to PEZA entities operating within the zone, as contemplated under the law and regulations, is based on the premise that this transaction is considered an export sale applying the cross-border doctrine/destination principle and not on the premise that said services are related to the PEZA entity’s registered operations.
In fact, this interpretation is even unfavorable to the PEZA enterprises who are supposed to be enjoying the 5% gross income tax incentive in lieu of all other local and national taxes but are now effectively required to absorb the VAT passed on by their suppliers located in the customs territory.
The BIR’s position on this issue should be revisited. The thrust should be the proper application of the cross border doctrine/destination principle in respect to transactions with enterprises operating within the ecozones regardless of the incentives granted to them under their registration.
In other words, zero-rating is not anchored on the registered activity on the enterprise.
However, securing a new ruling from the BIR on this issue on an industry level might be more practical than on an individual basis which might not ensure success.
