Eighty-Eighth Floor Gifts, Inc.

March 7, 2008 BIR RULING [DA-146-08] RR 11-2005; BIR Ruling No. DA-476-03 Eighty-Eighth Floor Gifts, Inc. 2nd Floor, Sudeco Bldg. Lapu-Lapu City Attention: Mr. Jeffrey John Nelson Gentlemen : This refers to your letter dated December 3, 2007 requesting for a ruling on whether the following cost of Eighty-Eighth Floor Gifts, Inc.'s Graphics Design Department is part of its product's direct cost that is allowable as a deduction from gross income for purposes of computing the 5% gross income tax: 1. Salaries, overtime and 13th month pay 2. Perfect attendance incentives of P1,000.00 a month 3. Meal allowance of P40.00 a day when employee has worked for at least 6 hours a day 4. Employer's share of SSS, Philhealth and HDMF contributions 5. Health care insurance & medical expenses 6. Sick leave and vacation leave converted to cash 7. Cost of transportation service provided to the employees to ensure employees report on time 8. Rent, water, electricity & telephone attributed to the Graphics Department 9. Bond papers, Velum papers, computer & printer supplies and pen markers & drawing supplies HSIDTE 10. Depreciation for computers and printers used by the Graphics Department As represented, Eighty-Eighth Floor Gifts, Inc. is a PEZA registered manufacturing company located at the Mactan Export Processing Zone. It is engaged in the manufacture of Recognition and Award items, including Plaques. Most of these Recognition and Award items are custom-order where foreign customers will send in their designs and logos and most often ideas of the design they want. To meet specific requirements of its customers, Eighty-Eighth Floor Gifts, Inc. has a Graphics Design Department that makes the "Art" or the customized design of the Recognition and Award items. The process of producing the Recognition and Award items is as follows: 1. Once an order comes in, the Graphics Design Department work on the "Art" or custom design and the finished "Art" is printed on a Velum paper. 2. The Velum paper with the "Art" in it is sent to the Photo Developing machine where the "Art" in the Velum paper is copied into a "Blue Mask," a blue film made of plastic. 3. This "Blue Mask" is then pasted on a pre-cut glass or stone or metal where the "Art" is sand-etched. 4. The glass or stone or metal with the etched "Art" is the finished product that is shipped to the customer. In reply, please be informed that Revenue Regulations (RR) No. 2-2005 as amended by RR 11-2005 provides "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. HSTaEC 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 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 xxx xxx xxx" In view of the foregoing, the following are direct costs deductible for purposes of computing gross income: 1. Salaries, overtime and 13th month pay, perfect attendance incentives of P1,000.00 a month, meal allowance of P40.00 a day when employee has worked for at least 6 hours a day, employer's share of SSS, Philhealth and HDMF contributions, health care insurance & medical expenses, sick leave and vacation leave converted to cash and cost of transportation service provided to the employees to ensure employees report on time are allowable deductions under Direct Salaries, Wages or Labor Expenses. These costs form part of direct costs incurred in the operation of the manufacturing business of Eighty-Eighth Floor Gifts, Inc. ScHADI 2. Rent, water, electricity & telephone attributed to the Graphics Department are deductible expenses under Rent and Utility Charges Associated with Building, Equipment and Warehouses Used in Production. 3. Bond papers, Velum papers, computer & printer supplies and pen markers & drawing supplies are deductible under Supplies and Fuels Used in Production. 4. Depreciation for computers and printers used by the Graphics Department is deductible for purposes of computing gross income under 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. 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 as null and void. Very truly yours, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service