Punongbayan & Araullo

February 6, 2008 BIR RULING [DA-071-08] Punongbayan & Araullo 20th Floor, Tower 1 The Enterprise Center 6766 Ayala Avenue Makati City Attention: Atty. Raymund S. Gallardo Tax Partner Gentlemen : This refers to your letter dated July 30, 2007 stating that your client, Toms Manufacturing Corporation (Toms), is a domestic corporation organized and existing under the laws of the Philippines and is a duly registered enterprise with the Philippine Export Zone Authority (PEZA) per Certificate of Registration No. 97-082 dated December 1, 1997; that it is operating its business at Daiichi Industrial Park-SEPZ, Maguyam, Silang, Cavite; that it was registered with the BIR on April 6, 1998; that Toms availed of the income tax holiday for the first four (4) years of its commercial operations, which lasted until April 2002; that beginning May 1, 2002, Toms became entitled to the 5% preferential tax rate on gross income imposed on PEZA registered entities; that Toms was formed with the primary purpose of carrying on and engaging in the business of manufacturing goods such as molds and plastic products and to trade the same on wholesale; that in the course of manufacturing the above-mentioned products, it is inevitable that occasionally certain molds and plastic products would not meet the specific quality and standard required to be sold as finished goods, hence they are regarded as rejects or scraps; and that these scrap item sales represent an estimated three percent (3%) of the Company's registered revenue. Based on the foregoing representations, you now request for an opinion as to whether the sale by Toms of its scrap molds and plastic products arising from the manufacture of its products is subject to the 5% preferential tax rate imposed under Republic Act (RA) No. 7916 or to the 35% corporate tax under Section 27 of the Tax Code of 1997, as amended. In reply thereto, please be informed that Section 24 of RA No. 7916, as amended by Section 4 of RA 8748, provides "Section 24. Exemption from National and Local Taxes . Except for real property taxes on land owned by developers, no taxes, local and national, shall be imposed on business establishments operating within the ECOZONE. In lieu thereof, five percent (5%) of the gross income earned by all business enterprises within the ECOZONE shall be paid and remitted as follows: (a) Three percent (3%) to the National Government; (b) Two percent (2%) which shall be directly remitted by the business establishments to the treasurer's office of the municipality or city where the enterprise is located." SaHcAC Prescinding from the above provisions, it is undisputed that PEZA registered entities are subject to the 5% preferential tax rates on gross income earned on its registered activity. The 5% preferential tax is a commutation of all the national and local taxes that are otherwise due from business and enterprises operating within the ECOZONE. This incentive is available to all the registered activities of entities inside the ECOZONE. In the instant case, the registered activity of Toms per PEZA Registration Agreement shall be limited to the manufacture of plastic injection parts and assemblies for audio components and other electronic equipments for export and the importation of raw materials, machinery, equipment, tools, goods, wares, articles, or merchandise directly used in its registered operations at the DIP-SEZ. The process of manufacturing its product is a registered activity for which Toms was authorized to engage in. The reject or scrap items which inevitably arise at a certain stage of its registered activity are incidental to such activity. They are merely by-products of the same registered activity and do not arise as a result of a separate manufacturing process. The reject or scrap items are part of the same manufacturing process that arise given the physical and mechanical limitations of the machines used in the registered manufacturing operations. Therefore, these scraps are the by-products of one and the same manufacturing process which produces the finished goods. The term "Rejects/Seconds" shall mean finished or semi-finished products or raw materials which are defective or inferior in quality, such that any further processing or manipulation thereof is not technically or economically feasible for the purpose for which they are originally intended. (Sec. II (bb), Rule I, Implementing Rules) Since the manufacturing of Tom's product is a registered activity and the reject or scrap items only inevitably resulted at a certain stage, the sale thereof will definitely fall under the registered activity. Accordingly, the sale of these scrap or reject items constitutes acts connected with the registered activity for which Toms was given authority to do business by PEZA under its Certificate of Registration and therefore Toms is entitled to the 5% preferential tax rate on the sale of reject or scrap items imposed under Section 24 of RA No. 7916, as amended. Provided that the sale of scrap/rejects shall be considered in determining the 70-30 threshold representing export sale and domestic sale respectively. Provided, further, that where they are sold to customs territory, the same shall be subject to VAT as constructive importation of buyers from customs territory. ADaSEH This is fortified in BIR Ruling No. DA 493-2006 dated August 10, 2006, where this Office ruled that ". . . the sale of Hitachi Cable Philippines, Inc. of its reject or scrap items inevitably arising at a certain stage of the manufacturing activity falls under the same registered activity subject to the 5% preferential tax rate pursuant to Section 24 of RA No. 7 91 6, as amended by RA 8 74 8." WHEREFORE, in view of the foregoing , this Office holds that the sale of scrap or reject items constitutes acts connected with Toms' registered activity and consequently entitled to the 5% preferential tax rate imposed under Section 24 of RA 7916, as amended by RA 8748. 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 and void. Very truly yours, (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service