Samsung Electronics Philippines Manufacturing Corporation

June 4, 2008 BIR RULING [DA-339-08] RR 11-2005; DA 658-06 Samsung Electronics Philippines Manufacturing Corporation Block 6, Calamba Premiere International Park, Barangay Batino, Calamba City, Laguna Attention: Mr. Sang Ho Park Chief Financial Officer Gentlemen : This refers to your letter dated May 30, 2008 requesting confirmation of your opinion that quality control and training expenses related to production which are incurred by your company, Samsung Electronics Philippines Manufacturing Corporation (SEPHIL), are deductible from gross revenue for purposes of computing the 5% gross income tax (GIT). TCaEIc It is represented that SEPHIL [formerly Philippines Samsung Electronics Corporation (PSEC)] is a corporation duly organized and existing under Philippine laws with office address at the Calamba Premiere International Park-Special Economic Zone. It is registered with the Philippine Economic Zone Authority (PEZA) as an Ecozone Export Enterprise under Registration Certificate No. 01-011 dated February 9, 2001 and enjoys the 5% preferential tax on gross income earned in lieu of the payment of all other local and national taxes on its registered activity consisting of the design, manufacture, and sale of electronic products, including optical disk drive products, their components and parts. It is further represented that SEPHIL incurs quality control and training expenses related to the production process briefly described as follows: a. Quality Control SEPHIL incurs expenses in quality control which are considered by the company as direct cost attributable to production. b. Training of Production Employees SEPHIL provides in-house, foreign and local training courses to production employees. ACcaET It is your opinion that the foregoing expenses are direct costs incurred in manufacturing your registered products and should be deductible from gross revenues for purposes of computing the 5% GIT. In reply, please be informed that Section 24 of R.A. No. 7916, otherwise known as the "Special Economic Zone Act of 1995", as amended by R.A. No. 8748, provides that "SEC. 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. EICDSA xxx xxx xxx" "Gross income earned" is defined under Section 3 of Revenue Regulations (RR) No. 11-2005 as: "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." aETADI Gross sales/revenues xxxx Less: Sales Discounts xxxxx Sales Returns/Allowances xxxxx Direct costs (cost of sales) xxxxx Other Manufacturing Costs xxxxx xxxx Gross taxable income xxxx ==== It is apparent from the foregoing that to compute for the gross income, there is a need to identify the cost of sales or direct costs which may be deducted from gross revenues. Article 24 of Executive Order 226, otherwise known as the Omnibus Investments Code of the Philippines, provides that the Generally Accepted Accounting Principles (GAAP) governs in determining the direct costs, thus: "Art. 24. "Production Cost" shall mean the total of the cost of direct labor, raw materials, and manufacturing overhead, determined in accordance with generally accepted accounting principles, which are incurred in manufacturing or processing the products of registered enterprise." AEIHaS It is beyond doubt that the provisions of the Omnibus Investments Code are applicable to PEZA-registered enterprises. Section 23 of 7916 provides: "Sec. 23. Fiscal Incentives. Business establishments operating within the ECOZONES shall be entitled to the fiscal incentives as provided for under Presidential Decree No. 66, the law creating the Export Processing Zone Authority, or those provided under Book VI of ExecutiveOrder No.226, otherwise known as the OmnibusInvestmentsCodeof1987." The GAAP in the Philippines in determining the cost of a product/inventory is embodied in Philippine Accounting Standard No. 2 (PAS/IAS 2). Paragraph 34 thereof requires that there shall be a corresponding recording of the cost of production for every product or inventory sold. Paragraph 10 of the same standard further provides that the cost of the product/inventory shall include all the costs incurred in producing the product, thus: "The cost of inventories shall comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition." aTIEcA Moreover, Paragraphs 12 and 15 of the same PAS/IAS state: "12. The costs of conversion of inventories includes costs directly related to the units of production, such as direct labour. They also include a systematic allocation of fixed and variable production overheads that are incurred in converting materials into finished goods. Fixed production overheads are those indirect costs of production that remain relatively constant regardless of the volume of production, such as depreciation and maintenance of factory buildings and equipment, and the cost of factory management and administration. Variable production overheads are those indirect costs of production that vary directly, or nearly directly, with the volume of production, such as indirect materials and indirect labour." xxx xxx xxx 15. Other costs are included in the cost of inventories only to the extent that they are incurred in bringing the inventories to their present location and condition. For example, it may be appropriate to include non-production overheads or the costs of designing products for specific customers in the cost of inventories." TEAICc From the foregoing, only costs directly attributable to manufacturing the product shall be considered part of the cost of the product/inventory. Rev. Regs. 11-2005 recognizes the fact that all direct costs relating to finished goods shall be allowed as deductions for purposes of computing the five percent (5%) tax for ECOZONE Export Enterprises. Section 1 of the said Regulations provides that the following direct costs are included in the allowable deductions to arrive at gross income: 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 CIaHDc 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 It will be noted that the Regulations specifically included "decrease in finished goods account". This means that all costs which formed part of the finished goods shall be treated as direct cost, hence, deductible for purposes of computing the 5% gross income tax. In the case of SEPHIL, the direct cost of the finished goods included quality control and training of its production employees. EHCaDS In view of the foregoing, this Office holds that the quality control and training expenses incurred by SEPHIL that are related to production are part of the cost of the finished goods and are deductible from gross sales for purposes of computing its taxable gross income subject to 5% tax under Republic Act 7916. 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. CSHEca Very truly yours, (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service