BIR Ruling [DA-065-99]

February 5, 1999 BIR RULING [DA-065-99] Taikisha Philippines Corporation 2/F PDCP Bank Bldg. 371 Gil Puyat Avenue Makati City Attention: Mr . Enrico Concepcion General Manager Gentlemen : This refers to your letter dated January 19, 1999 requesting for a ruling to the effect that the sale of services by a construction company to a PEZA-registered export-oriented company, enjoying income tax holiday (ITH) under its registration agreement pursuant to Article 39 of the Omnibus Investments Code, for the construction of the latter's building within the ecozone, is subject to the 10% value-added tax. It is represented that Taisei Philippines Construction, Inc. (TPCI), Kinden Philippines Corporation (KPC) and Taikisha Philippines, Inc. (TPI) were engaged by Fujitsu Computer Products, Philippines (FCPP) for the construction of its building within the economic zone in Tanauan, Batangas; that each of the mentioned construction corporations are tasked to work on different phases of the project; that TPCI, KPC and TPI are corporations duly organized and existing under Philippine laws, primarily engaged in construction business, and with principal office addresses at 6/F Champaca II Bldg., Alfaro St., Salcedo Village, Makati City, 7QB ODC International Plaza, 219 Salcedo St., Legaspi Village, Makati City and 2/F PDCP Bank Bldg., 371 Gil Puyat Ave., Makati City, respectively; that TPCI, KPC and TPI are all VAT-registered corporate taxpayers; that FCPP is a corporation duly registered and existing under Philippine laws with principal office address at Special Export Processing Zone, Camelray Industrial Park, Canlubang, Calamba, Laguna; that it is an export oriented company duly registered with the Philippine Export Zone Authority (PEZA) under Certificate of Registration No. 95-35 dated March 23, 1995 which was issued pursuant to PEZA Board Resolution No. 95-042 dated February 27, 1995; that on March 13, 1998, the PEZA Board under Resolution No. 98-858 granted FCPP application for registration of its new activity, particularly, the manufacture of aluminum media for computer Hard Disk Drives as a New Project entitled to a four-year Income Tax Holiday (ITH) from the start of its commercial operations; that said grant of ITH was duly reiterated in the Second Supplemental Agreement entered into between PEZA and FCPP on July 3, 1998; that FCPP commenced its commercial operations in August 1999; and that TCPI, KPC and TPI commenced the construction of FCPP's building sometime in July 1998 and the same is still ongoing; and that the contract price is billed in Philippine Peso. In reply, please be informed that pursuant to Section 105 of the Tax Code of 1997, in relation to Section 108(A) thereof, any person who in the course of trade or business, sells, exchanges or renders services, shall be assessed a value-added tax equivalent to ten percent (10%) of the gross receipts derived from the sale or exchange of such services. The value-added tax, being an indirect tax, may be shifted or passed on to the buyer of the services. Section 108 further provides that the phrase 'sale or exchange of services ' means the performance of all kinds of services in the Philippines for others for a fee, remuneration or consideration, including, among others, those performed or rendered by construction and service contractors. On the other hand, pursuant to Section 108(b) of the Tax Code of 1997, which reads as follows, viz: "SEC. 108. Value-added Tax on Sale of Services and Use or Lease of Properties. "xxx xxx xxx "(b) Transactions Subject to Zero Percent (0%) Rate. The following services performed in the Philippines by VAT-registered persons shall be subject to zero percent (0%) rate: "(1) Processing, manufacturing or repacking goods for other persons doing business outside the Philippines which goods are subsequently exported, where the services are paid for in acceptable foreign currency and accounted for in accordance with the rules and regulations of the Bangko Sentral ng Pilipinas (BSP); "(2) Services other than those mentioned in the preceding paragraph, the consideration for which is paid for in acceptable foreign currency and accounted for in accordance with the rules and regulations of the Bangko Sentral ng Pilipinas (BSP); "(3) 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 zero percent (0%) rate; xxx xxx xxx." sale of services to persons under the above enumerated instances, is subject to zero percent (0%) rate. It should be noted that the first situation contemplates sale of services, like processing, manufacturing or repacking of goods which are subsequently exported, for other persons doing business outside the Philippines, i.e., exporters, and which services are paid for in acceptable foreign currency and accounted for in accordance with the rules and regulations of the BSP. Thus, the services covered are limited to those which are directly and indirectly inputted to the product exported. The second situation contemplates sale of services other than those enumerated above as well as other similar services, to a non-resident client, and which services are paid for in acceptable foreign currency and accounted for in accordance with the rules and regulations of the BSP . Considering that FCPP is a resident corporation, the construction services rendered to it by Taisei, Kinden and Taikisha will not qualify under this category. Finally, the third situation contemplates sale of services 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. In the above enumeration, the sale of services by TCPI, KPC and TPI to FCPP for the construction of the latter's building within the economic zone in Tanauan, Batangas could have qualify under Item No. 3, if not for a fact that FCPP's grant of incentive under its registration with the PEZA is limited only to Income Tax Holiday, i.e., four-year ITH from the start of its commercial operations. Furthermore, while so stated that the provisions of the Omnibus Investments Code are deemed incorporated in the Registration Agreement, a perusal of the incentives granted thereunder, specifically Title III re: Incentives to Registered Enterprises revealed that exemption from value-added tax is not among the incentives being granted to the registered enterprises in a preferred area of investment. Moreover, the exemption from value-added tax cannot be claimed as one of the incentives included in the ITH. The case is different if FCPP enjoys the regime of 5% tax in lieu of all other taxes under the PEZA law. In that case, it is exempt from all other taxes, national and local, in lieu of payment of the 5% tax. Likewise, the VAT component of the cost of construction cannot be considered to have been inputted to the goods being exported by FCPP. It should be noted that the improvements are capitalized and are accounted as assets which, over the years, are duly depreciated. The depreciation expense is taken up in the books as factory overhead which cannot be solely and directly attributed to the production of computer wares of FCPP. The indirect costs that should be considered as part of the costs of the product should be limited to the costs of services which are related to the production of the computer products. The construction cost of an Export or Free Trade Enterprise such as FCPP in this case, is not an operating expense but a capital expenditure. Thus, the VAT component in the construction service which are being passed on to it by its contractors should not be taken as a separate item, but should be considered as part of the cost of construction contract. At the outset, the item, but should be considered as part of the cost of construction contract. At the outset, the VAT component of the construction contract is not readily identifiable to the product to be produced. Pursuant to Rule XV re: Incentives to Ecozone Export and Free Trade Enterprises (which FCPP is duly categorized), implementing R.A. No. 7916, otherwise known as "The Special Economic Zone Act of 1995", and pertinent portion of which states: "Section 1. Exemption from Duties and Taxes on Merchandise . Merchandise, raw materials, supplies, articles, equipment, machineries, spare parts and wares of description brought into the ECOZONE Restricted Area by an ECOZONE Export or Free Trade Enterprise to be sold, stored, broke, up, repacked, assembled, installed, sorted, cleaned, graded or otherwise processed, manipulated, manufactured, mixed with foreign or domestic merchandise whether directly or indirectly related in such activity, shall not be subject to customs duties and internal revenue laws and regulations of the Philippines nor to local tax ordinances. . ." Further, Sections 6 and 7 of the same Rule XV provide, as follows: "SEC. 6. Other Incentives under the Code. "A. Income Tax Holiday . . . "E. Additional Deduction for Labor Expense. For the first five (5) years from registration, a qualified ECOZONE Export or Free Trade Enterprise shall be allowed to deduct from its taxable income an amount equivalent to fifty per cent (50%) of the wages corresponding to the increment in the number of direct labor for skilled and unskilled workers subject to the following conditions: "xxx xxx xxx. "2. The ECOZONE Export or Free Trade Enterprise does not avail of this incentive simultaneously with the income tax holiday incentive. "SEC. 7. Incentives under the Decree. An ECOZONE Export or Free Trade Enterprise not availing of the incentives under Section 6 herein may avail of the incentives under the Decree subject to the regulations that shall be prescribed by the Board and by the Department of Finance/Bureau of Internal Revenue. dctai Conversely, a PEZA-registered enterprise availing of the ITH can still avail of other incentives under the following: 1) Section 1, Rule XV, PEZA Implementing Rules & Regulations (IRR), and also covered by Section 106(A)(2)(a)(5) of the Tax Code of 1997, for the goods to be sold, stored, broken up, assorted, installed, sorted, cleaned, graded, or otherwise processed, manipulated, manufactured or mixed with foreign or domestic by an Export or Free Trade Enterprise; and 2) under Section 108(b)(1) of the Tax Code, for services which are directly related to the activity of processing, manufacturing, repacking, assembling, installing, sorting and similar activities which are directly related to the production of goods subsequently exported and which services are paid for in foreign currency and accounted for in accordance with the BSP's rules and regulations. The purchase of goods and/or services by a PEZA-registered under the foregoing circumstances is subject to zero percent (0%) VAT. Categorically, a PEZA-registered availing the ITH cannot simultaneously avail of such other incentives under the PEZA law, although it may still be qualified for zero percent (0%) VAT under the Tax Code but subject to the conditions stated thereunder. The provisions of Section 7 of Rule XV, PEZA IRR, clearly speaks of an enterprise enjoying a "5% in lieu of all taxes" regime. In that case, it may still qualify for zero percent (0%) rate VAT under Secs. 106(A)(2)(c) and 108(b)(3) of the Tax Code. Considering, however, the FCPP is an enterprise enjoying an ITH incentive regime, which has an existing construction contracts with various VAT-registered corporations, the consideration of which are paid for in Philippine Peso, it cannot legally qualify for VAT zero-rating under any of the above-cited provisions. Such being the case, its contractors, TPCI, KPC and TPI can passed on the 10% value-added tax to FCPP, which amount shall form part of the cost of the construction contract. (BIR Ruling Nos. 127-96 dated November 27, 1996155-98 dated October 21, 1998) This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it shall be disclosed that the facts are different, then this ruling shall be considered null and void. Very truly yours, (SGD.) SIXTO S. ESQUIVIAS IV Deputy Commissioner Legal & Enforcement Group