BIR Ruling [DA-135-06]

March 17, 2006 BIR RULING [DA-135-06] R.A. 7916; 206-00; VAT 043-03 SGV & Co . 6760 Ayala Avenue 1226 Makati City Attention: Mr. Romulo S. Danao, Jr. Partner, Tax Services Gentlemen : This refers to your letter dated September 14, 2005 requesting for a ruling, on behalf of your client REACH Networks Philippines, Inc. (REACH), on the tax consequences of the sale of Data Centre Assets by Reach to IP Converge Data Center, Inc. (IP Converge). It is represented that REACH is a corporation duly organized and existing under and by virtue of the laws of the Philippines, with registered office and principal place of business at the 34th Floor, RCBC Plaza, Tower 2, Ayala Avenue, Makati City; that it provides wholesale data and bandwidth services to its customers and is also registered with the Philippine Economic Zone Authority (PEZA); that IP converge on the other hand, is a corporation duly organized and existing under and by virtue of the laws of the Philippines, with principal office address at Unit 4 Building B, Karrivin Plaza, 2316 Pasong Tamo Extension, Makati City; that it is a wholly-owned unit of the Internet firm IPVG Corporation, which is a public company engaged in rendering innovative technology to the media and entertainment industry as well as interactive services through the creation of secondary distribution channels; that at the time it was still entitled to ITH, REACH purchased various office and telecommunications equipment needed for its business which became part of REACH Data Center's assets; that as a PEZA-registered enterprise, said purchases of equipment were either exempt from VAT or subject to zero percent VAT pursuant to Revenue Memorandum Circular No. 74-99; that on September 13, 2005, REACH entered into an agreement with IP Converge for the sale of selected assets of REACH's Data Centre, which consist mostly of office and telecommunications equipment; that at the time of said sale, REACH was already subject to the 5% tax on gross income; and that in consideration of REACH's sale, delivery and transfer of the Date Centre Assets, IP Converge will 1) pay a defined cash amount on dates determined in the agreement; 2) provide REACH with 60 months of co-location service on 27 racks of co-location space at no cost to REACH, and 3) provide REACH with 60 months of office space of 110 square meters within the premises on the 34th Floor of RCBC Plaza, also at no cost to REACH. In reply, please be informed that Section 24 of Republic Act (RA) No. 7916 provides: SEC. 24. Exemption ,from Taxes Under the National Internal Revenue Code . Any provision of existing laws, rules and regulations to the contrary notwithstanding, no taxes, local and national, shall be imposed on business establishments operating within the ECOZONE. In lieu of paying taxes, five percent (5%) of the gross income earned by all businesses and enterprises within the ECOZONE shall be remitted to the national government. . . . aSTcCE Since PEZA-registered enterprises enjoy the preferential tax rate of 5% on the gross income earned, which shall be in lieu of local and national taxes pursuant to Section 24 of RA No. 7916, the sale of the Data Centre Assets by REACH to IP Converge will be subject to the 5% final tax on gross income earned. ( BIR Ruling No. 008-99 dated January 19, 1999; BIR Ruling DA-206-00 dated April 4, 2000 ) In addition, Section 3 of Revenue Regulations No. 2-2005, as amended by Revenue Regulations No. 11-2005, defines "gross income earned" to implement the tax incentive provision in Section 24 of RA 7916, as follows: SEC. 3. Gross Income Earned . For purposes of implementing the tax incentive of registered Special Economic Zone (ECOZONE) enterprises in Section 24 of Republic Act No. 7916, the term "gross income earned" shall refer to gross sales or gross revenues derived from business activity within the ECOZONE, net of sales discounts, sales returns and allowances and minus costs of sales or direct costs but before any deduction is made for administrative, marketing, selling and/or operating expenses or incidental losses during a given taxable period. For purposes of computing the total five percent (5%) tax rate imposed, the following direct costs are included in the allowable deductions to arrive at gross income earned for specific types of enterprises: 1. ECOZONE Export Enterprises, Free Trade Enterprises and Domestic Market Enterprises : Direct salaries, wages or labor expenses Production supervision salaries Raw materials used in the manufacture of products Decrease in Goods in Process Account (Intermediate goods) Decrease in Finished Goods Account aESTAI Supplies and fuels used in production Depreciation of machinery and equipment used in production, and of that portion of the building owned or constructed that is used exclusively in the production of goods Rent and utility charges associated with building, equipment and warehouses used in production Financing charges associated with fixed assets used in production the amount of which were not previously capitalized 2. ECOZONE Developer/Operator, Facilities, Utilities and Tourism Enterprises : Direct salaries, wages or labor expense Service supervision salaries Direct materials, supplies used Depreciation of machineries and equipment used in the rendition of registered services, and of that portion of the building owned or constructed that is used exclusively in the rendition of registered service Rent and utility charges for buildings and capital equipment used in the rendition of registered services Financing charges associated with fixed assets used in the registered service business the amount of which were not previously capitalized. From the foregoing, it is clear that the 5% preferential tax rate applies to gross sales or gross revenues derived from business activity within the ECOZONE, but that direct costs (costs of sales) are deductible from gross sales/revenues for purposes of computing a PEZA firm's taxable gross income subject to the 5% final tax. EISCaD Finally, considering that your operations at the PEZA are subject to the 5% tax on gross income earned in lieu of all other taxes, national or local, it follows that the VAT regime under the National Internal Revenue Code (NIRC) does not apply, and therefore, the sale of the Data Centre Assets is not subject to VAT ( VAT Ruling No. 043-03 dated September 9, 2003 ). 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, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service