Punongbayan & Araullo

April 25, 2007 BIR RULING [DA-255-07] R.A. 8748; DA-493-2006; 207-99 Punongbayan & Araullo 20th Floor, Tower 1, The Enterprise Center 6766 Ayala Avenue, 1200 Makati City Attention: Atty. Romeo H. Duran Tax Principal Gentlemen : This refers to your letter dated March 7, 2007 requesting on behalf of your client, Nanbu Philippines Incorporated (Nanbu), for confirmation of your opinion that the sale of its scraps/rejects falls under the coverage of its registered activity and consequently, income realized therefrom shall be subject to the applicable income tax incentive, i.e., Income Tax Holiday (ITH) or 5% of gross income earned pursuant to Republic Act No. 7916, otherwise known as the Special Economic Zone Act of 1995, as amended by Republic Act No. 8748. It is represented that Nanbu is a domestic corporation organized and existing under Philippine laws and is a duly registered enterprise with the Philippine Export Zone Authority (PEZA) per Certificate of Registration No. 01-004 dated January 18, 2001; that it is operating its business at Cavite Economic Zone, Rosario Cavite; that it was registered with the Bureau of Internal Revenue on January 10, 2001; that Nanbu was formed with the primary purpose of carrying on and engaging in the business "to manufacture, assemble, fabricate, export, trade or sell at wholesale only or otherwise deal in plastics extrusion and injection molding, tooling dye, injected plastic parts and other related products and goods of whatever nature, kind or description and any and all equipment, materials, supplies and components, parts and accessories thereof used or employed in or related to the manufacture of such finished products, and generally to perform any and all acts connected with the business aforementioned or arising therefrom and/or incidental thereto as may be allowed by existing law, rules and regulations"; that in its Registration Agreement dated January 18, 2001 with PEA, the scope of Nanbu's registered activity was limited to the manufacture of extrusion plastic molding such as window frames and other products for homes like plastic main frames, duplicate glass supporter, and handling knobs, for export, at the Cavite Economic zone; that Nanbu was entitled to the incentives granted to non-pioneer firms under R.A. No. 7916, as amended; that however, in a subsequent Supplemental Agreement dated June 14, 2004, PEZA approved Nanbu's application for the grant of Pioneer Status to its registered activity, hence Nanbu became entitled to a six (6) year ITH incentive commencing on the date of start of commercial operations of the project on May 2001 and ending on April 2007; that Nanbu has also filed with PEZA for an extension of the ITH until April 2008; that in another Supplemental Agreement dated January 30, 2004, Nanbu's application for registration of its new activity, i.e., the manufacture of plastic injected parts for household appliances and furniture, was approved as a New Project under PEZA Board Resolution No. 03-312 dated November 21, 2003; that as further provided in said Supplemental Agreement, the New Project is entitled to all incentives granted to non-pioneer enterprises under RA 7916, as amended; that it is also entitled to a new and separate four-year ITH incentive from the start of its commercial operations on January 2004 until December 2007; that upon the expiration of the ITH, Nanbu shall be subject to the 5% preferential tax rate on gross income earned from its registered activities in lieu of all other taxes, national or local, except real property on land owned by developers, pursuant to Section 24 of RA 7916; that the major stages/processes in the manufacture of extrusion plastic molding are: a. Materials (different kinds of resins) loading and mixing; b. Insertion of materials in the machine for pre-heating; c. Additional heating; d. Gelatination; e. Forming and cooling; and f. Cutting and packing. that the production of plastic injected parts involves similar stages except that different machines are utilized; that when the materials undergo the above-mentioned production processes, particularly the gelatination stage, some of the resins unavoidably become deformed and can no longer be re-used; that also, when the molds are changed or there is a change in the color of the materials to be processed, the excess gelatinized materials that get trapped inside the machines need to be removed before new molds or different color resins can be inserted anew into the machines; that these excess gelatinated materials can no longer be re-used; that moreover, when the processed plastic molding/parts are trimmed during the cutting stage, the excess trimmings can no longer be recycled; that in the course of manufacturing the products, it is inevitable that occasionally certain plastics extrusion molding and plastic injected parts would not meet the specific quality and standards required for sale as finished goods; and that after undergoing manufacturing process, the excess gelatinated materials, excess trimmings and plastic parts that do not meet quality control standards as described above, are considered scraps/wastes or rejects which are then sold by the Company. TAECSD In reply, please be informed that Section 4 of Revenue Regulations No. 1-2000 dated November 12, 1999, implementing Section 24 of Republic Act (RA) No. 8748, entitled "An Act Amending Republic Act No. 7916," otherwise known as the Special Economic Zone Act of 1995, provides, viz: "Section 4. Nature of the 5% Tax and Extent of Tax Exemption . The above 5% tax is imposed on "gross income earned" hence, income tax in nature and a national internal revenue law in character. Registered ECOZONE enterprises shall be exempt from all other taxes, national or local, except the real property tax on land owned by developers, pursuant to Section 24 of R.A. No. 7916, as amended by R.A. No. 8748." Inasmuch as the reject or scrap items which, as represented, will inevitably arise at a certain stage of the registered manufacturing activity, the income derived from sale of said reject or scrap items will be included in computing the gross income earned from the registered activities of said PEZA-registered enterprise. Consequently, during the ITH period, income derived from sale of scrap or reject items shall be exempt from income tax; and thereafter, upon expiration of ITH, subject to the 5% preferential income tax rate. (BIR Ruling No. 493-2006 dated August 10, 2006) However, the sale of scrap and reject items shall be subject to 12% VAT during the ITH period. CcTIAH 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