BIR Ruling [DA-061-06]

February 27, 2006 BIR RULING [DA-061-06] RR 16-2005; DA-508-2004; VAT Ruling No. 3-2002 Hanjin Heavy Industries and Construction Co., Inc . 2nd Floor, Eurovila Condominium, Herrera corner Legaspi Street Makati City Attention: Mr. Shim Jeong Sup President Gentlemen : This refers to your letter dated September 30, 2005, requesting confirmation of your opinion that the proposed transactions between HHIC-PHIL, Inc. and HHIC and supplier-sellers of materials relative to their supply of services and construction supplies/materials, respectively, to the former for the construction of Hanjin shipyard within the Subic Bay Freeport and Special Economic Zone (SBFSEZ) are subject to value-added tax at zero-percent (0%) rate. Background HHIC-PHIL, Inc. is corporation organized for the following primary and secondary purposes, to wit: (1) For export, to engage in manufacture & outfitting for ships & vessels; ship component fabrication; procurement, fabrication & erection of steel structures for whatever purposes; general shipbuilding & ship repair; engineering services for shipbuilding & ship repair; and any all businesses necessary for a shipyard operation; and (2) Manufacture & installation of plants & industrial facilities; general construction; except locally funded Gov't projects ." HHIC-PHIL has identified SBFESZ as the location of its shipyard to be known as Hanjin Project. Its shipbuilding business has also been identified in the BOI Investment Priority Projects (IPP). The Hanjin shipyard will produce ocean-going vessels with a capacity of 5,000 containers or its equivalent capacity and will be sold exclusively to its buyers outside the Philippines. On February 16, 2006, it has filed its application for registration with the Securities and Exchange Commission (SEC) as evidenced by Republic of the Philippines-SEC OR No. 5362939. On the same date HHIC-PHIL, Inc. which has its principal address at Redondo Peninsula, Green Beach, SBFZ has been issued pending full compliance of registration requirements, a Temporary Certificate of Registration by the Subic Bay Metropolitan Authority (SBMA). HHIC (formerly Hanjin Engineering & Construction Co. Ltd.) is a foreign corporation organized and existing under the laws of Korea. It was originally issued SEC License No. 790 dated December 12, 1977 under the name Hanil Development Co., Ltd. to carry out specific public works contracts with the Department of Public Highways. On January 20, 2000, SEC License No. 790 was further amended to expand its corporate purpose, i.e., to undertake construction and development projects and allied activities of the Philippine Government and/or any of its political subdivisions, agencies, branches, or subsidiaries , which are foreign funded. On May 11, 1994, upon approval of the SEC, it changed its corporate name to Hanjin Engineering & Construction Co. Ltd. On January 20, 2000, it amended its corporate name to Hanjin Heavy Industries and Construction Co., Ltd. (HHIC) under Amended SEC License No. F-790. As borne in its Articles of Incorporation, HHIC-PHIL is 99.95% owned by HHIC. They have proposed to undertake the development and construction of the Hanjin shipyard (alternatively to be known as Hanjin Project). The former shall be the owner and the latter, as the provider-contractor of development and construction services for the Hanjin Project. Since HHIC-PHIL is still in the process of registration, the parties have proposed to include certain provisions in the proposed agreement designating HHIC as its management and purchasing agent with respect to the following:, to wit: 1. HHIC will represent HHIC-PHIL in all its transactions entered into within the customs territory in connection with the construction of the Hanjin Project; 2. HHIC will procure goods and construction supplies/materials from subcontractors-suppliers and second tiers which are located outside the SBFEZ, mainly for the Hanjin Project; 3. HHIC will advance payments for the goods and construction supplies/materials procured in relation to the Hanjin Project, which shall be indicated as a separate item in its regular/progressive billing to HHIC-PHIL as "reimbursable costs." 4. HHIC will handle and receive the delivery of the goods and construction supplies/materials to the project site and will ensure its timely delivery, as well as the correct quality and quantity of the goods and supplies to be delivered; 5. HHIC will ensure that ownership over the goods and construction supplies is transferred to HHIC-PHIL-Hanjin Project on a turnkey basis- incidence of turnkey is deemed to have occurred either under any of the following: (a) at the time of delivery to the project site; (b) payment to the suppliers; (c) completion of Hanjin Project where goods are still in transit or have not been delivered on time; and 6. that the payment to HHIC by HHIC-PHIL shall be in acceptable foreign currency or its equivalent conversion inwardly remitted to the Philippines and accounted for in accordance with the rules and regulations of the Bangko Sentral ng Pilipinas (BSP). IETCAS It is also expected that the suppliers of goods and construction supplies/materials shall deliver the supplies and materials to the Hanjin Project site (HHIC-PHIL shipyard) inside SBFSEZ, indicating that the purchased goods and construction materials are for HHIC-PHIL and for the use in the Hanjin Project. The arrangement concluded that HHIC will provide an equivalent to 100% of services to the Hanjin Project while the subcontractors-suppliers will provide and deliver 100% of construction supplies/materials produced specifically for Hanjin Project. The payment for the construction services to be rendered by HHIC to the Hanjin Project shall be made in acceptable foreign currency in the Philippines, while the payment of HHIC for the construction supplies and materials purchased from the suppliers, and subject of reimbursement by HHIC-PHIL shall be also be in foreign currency or its equivalent converted in accordance with the BSP rules and regulations. Discussion of Various Laws Incentives Granted to a SBFEZ-registered enterprise Section 12(c) of Republic Act (RA) No. 7227 provides to the effect that in lieu of paying the five percent (5%) of the gross income earned by all businesses and enterprises within the Subic Special Economic Zone, no taxes, local or national, shall be imposed within Subic Special Ecozone. The Tax Code of 1997, as last amended by RA No. 9337, and as implemented by Revenue Regulations (Rev. Regs.) No. 16-2005 With respect to the sales of services, pertinent provisions of Rev. Regs. No. 16-2005, implementing RA No. 9337 provides as follows: "Section 4.108-6. Effectively Zero-Rated Sale of Services . The term " effectively zero-rated sale of services " shall refer to the 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. Under these regulations, effectively zero-rated sale of services shall be limited to local sales to persons or entities that enjoy exemptions from indirect taxes under subparagraph (b) nos. (3), (4) and (5) of this Section. The concerned taxpayer must seek prior approval or prior confirmation from the appropriate offices of the BIR so that a transaction is qualified for effective zero-rating. Without an approved application for effective zero-rating, the transaction otherwise entitled to zero rating shall be considered exempt." Subparagraph (b)(3) of Section 4.108-5 refers to the services rendered by a VAT-registered person 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 zero percent (0%) rate. As regards sale of goods, Sec. 4.106-5(a)(5) of Rev. Regs. No. 16-2005 provides that the sales by a VAT-registered persons shall be subject to zero percent (0%) rate if it is one of the transactions considered export sales under Executive Order (E.O.) No. 226, otherwise known as the Omnibus Investments Code of 1987, and other special laws. Said E.O. 226 provides that even without actual exportation, the following, among others, shall be considered constructively exported, (2) sales to export processing zones. In fine, the transactions between a buyer from ecozones, or SBFSEZ in this particular case, and a VAT-registered supplier-seller of goods and services from customs territory have been characterized by the Supreme Court in the case of Comm. of Internal Revenue vs. Seagate Technology (Philippines) , G.R. No. 153866. February 11, 2005, to wit "Sales made by a VAT-registered person in the customs territory to a PEZA-registered entity are considered exports to a foreign country; conversely, sales by a PEZA-registered entity to a VAT-registered person in the customs territory are deemed imports from a foreign country. An ecozone indubitably a geographical territory of the Philippines is, however, regarded in law as foreign soil. This legal fiction is necessary to give meaningful effect to the policies of the special law creating the zone. If respondent is located in an export processing zone within that ecozone, sales to the export processing zone, even without being actually exported, shall in fact be viewed as constructively exported under EO 226. Considered as export sales, such purchase transactions by respondent would indeed be subject to a zero rate. "Since the purchases of respondent are not exempt from the VAT, the rate to be applied is zero. Its exemption under both PD 66 and RA 7916 effectively subjects such transactions to a zero rate because the ecozone within which it is registered is managed and operated by the PEZA as a separate customs territory . This means that in such zone is created the legal fiction of foreign territory. Under the cross-border principle of the VAT system being enforced by the Bureau of Internal Revenue (BIR), no VAT shall be imposed to form part of the cost of goods destined for consumption outside of the territorial border of the taxing authority. If exports of goods and services from the Philippines to a foreign country are free of the VAT, then the same rule holds for such exports from the national territory except specifically declared areas to an ecozone." As to whether or not the legal fiction creating PEZA ecozones as foreign country/jurisdiction be made to apply to SBFEZ which is covered by RA 7227 and not by PEZA law, the Court in the above Seagate Ruling, supra , further quantified the extent of incentives granted to PEZA-registered enterprises, to wit: " Sixth , the exemption from local and national taxes granted under RA 7227 are ipso facto accorded to ecozones. In case of doubt, conflicts with respect to such tax exemption privilege shall be resolved in favor of the ecozone." and that "Wisely accorded to ecozones created under RA 7916 was the government's policy spelled out earlier in RA 7227 of converting into alternative productive uses the former military reservations and their extensions, as well as of providing them incentives to enhance the benefits that would be derived from them in promoting economic and social development." In short, the SBFSEZ-registered enterprises who are considered as doing business are exempt from the imposition of any internal revenue taxes, including the VAT because of the legal fiction that ecozones are foreign territory, and therefore sales by a VAT registered person from customs territory to said ecozones are considered export sales subject to the zero percent (0%) VAT. By virtue of that transactions, VAT-registered sellers from customs territory are allowed to claim for refund or apply for TCC of the input VAT pertaining to such sales. Because of the zero rating of the transaction, VAT is totally washed out making the transaction really exempt from VAT. Although this exemption puts the government at an initial disadvantage, the reduced tax collection ultimately redounds to the benefit of the national economy by enticing more business investments and creating more employment opportunities. 1 The Contract between HHIC-PHIL and HHIC The proposed Contract covers both the provision for the supply of development and construction services by HHIC to HHIC-PHIL, as well as the special arrangement wherein HHIC shall act as general and purchasing agent for HHIC-PHIL/Hanjin Project; the purchasing agent in respect to the transactions of HHIC-PHIL within the customs territory and to the procurement of goods and construction materials and supplies. cITaCS The proposed Contract defining HHIC's obligation to develop and construct the Hanjin shipyard should be read in the light Article 1713 of the NCC, wherein the law characterizes what a contractor is, i.e ., the contractor may furnish a) both material and labor; and b) or only labor. Under Art. 1714, NCC, the contractor may furnish both work and material. In such case, the contract may be considered or is equivalent to a sale of [goods/capital goods] which is not the intention of the parties in the instant case. The proposed Contract also embodies the arrangement that HHIC shall procure goods and construction materials and supplies on behalf of HHIC-PHIL for the Hanjin Project, using its fund the amount of which shall be billed later to HHIC-PHIL/Hanjin Project as "reimbursable costs." Article 118, in relation with Article 1912, both of the New Civil Code of the Philippines indeed allows stipulation to the effect that an agent may advance the necessary funds, to: "Art. 1886. Should there be a stipulation that the agent shall advance the necessary funds, he shall be bound to do so except when the principal is insolvent." Also apparent in the proposed contract is the turnkey provision, defining the ownership of the goods and construction supplies and materials procured or to be procured by HHIC during the subsistence of the Contract. In short, with all the provisions outlining specific duties and obligations of HHIC, as a consequence of its duty to account, it cannot dispute its principal's title to the property in his possession. (2 C.J. 744) Moreover, under Article 1891 of the NCC, "every agent is bound to render an account of his transactions to deliver to the principal whatever he may have received by virtue of the agency, even though it may not be owing to the principal. Every stipulation exempting the agent from the obligation to render an account shall be void." The arrangement as specified in the proposed Contract is clear enough as to the extent of responsibilities and obligations of HHIC as agent of HHIC-PHIL. Thus, the tax liability of HHIC must be understood in the light of the agreement between the parties. Ruling In consideration of the agreement between HHIC and HHIC-PHIL, the sale by local suppliers and sub-contractors of goods/supplies to HHIC-PHIL, HHIC acting as agent of the latter, shall be effectively subject to VAT at zero percent (0%) rate. Likewise, the construction services to be rendered by HHIC to HHIC-PHIL shall effectively be subject to zero percent (0%) VAT. Premises being considered, the construction services to be rendered by HHIC, as well as the procurement of goods/supplies to be delivered by the local supplier and sub-contractors to the Hanjin Project via HHIC, as agent of HHIC-PHIL, the same being intended to be rightfully belonging to the principal, HHIC-PHIL are effectively subject to value-added tax at zero percent rate, pursuant to Sections 106(A)(2)(a)(3) and 108(B)(3) of the Tax Code of 1997, as amended by Republic Act No. 9337. This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation it will be disclosed that the facts are different, then this ruling shall be considered null or void. Very truly yours, (SGD.) JOSE MARIO C. BUAG Commissioner of Internal Revenue Footnotes 1. Comm. of Internal Revenue vs. Seagate Technology (Philippines), supra .