BIR Ruling [DA-373-05]

August 30, 2005 BIR RULING [DA-373-05] RA 7916; RMC 74-99; DA-112-2001 Roxas De Los Reyes Laurel & Rosario 19th Floor, BDO Plaza, 8737 Paseo de Roxas Makati City Attention: Atty . Manuel R . Roxas Gentlemen : This refers to your letter dated August 31, 2004 requesting in behalf of your client, Ionics, Inc., for an opinion on the tax consequence of a transaction involving two of its subsidiaries, Ionics Properties, Inc. ("IPI") and Ionics EMS, Inc. ("EMS") with another PEZA-registered enterprise. STDEcA It is represented that IPI is a domestic corporation organized for the purpose of acquiring, owning, holding, selling and leasing real properties; that on January 11, 1999, upon application by IPI, its leasing activities were registered with the Philippine Economic Zone Authority ("PEZA") under Republic Act (R.A.) No. 7916, as amended, known as the "Special Economic Zone Act of 1995"; that IPI was issued Certificate of Registration No. 99-01-F by the PEZA and was conferred the status of an Ecozone Facilities Enterprise; that as such, IPI is subject to the 5% preferential tax rate on its gross income pursuant to Section 24 of R.A. No 7916, as amended; that on the other hand, EMS is a domestic corporation organized for the purpose of engaging in the manufacture, production and export of electronic products; that the manufacturing activities of EMS, which are purely for export, are registered with either PEZA or the Board of Investments ("BOI"); that IPI has a parcel of land located in the Light and Science Park II, Special Economic Zone, Calamba, Laguna, on which it built a building which was leased to EMS; that since the building leased by IPI was a mere shell, EMS introduced substantial leasehold improvements (including an air conditioning system) to make the building suitable for its manufacturing activities; that with the manufacturing activities conducted by EMS coming to an end, IPI and EMS have agreed to terminate their current Contract of Lease; that since the Contract of Lease was terminated prior to its expiration, EMS retained title to the leasehold improvements; that another PEZA registered company is interested in leasing the land and building owned by IPI including the leasehold improvements owned by EMS; that for this purpose, EMS will lease the leasehold improvements to IPI and IPI will then lease its land and building and sublease the leasehold improvements to the PEZA registered company. In reply thereto, please be informed as follows: 1. Tax Impact on IPI . In view of the fact that IPI is an Ecozone Facilities Enterprise, it is exempt from income tax, capital gains tax, value-added tax and all other national taxes pursuant to Section 24 of R.A. No 7916, as amended. In lieu thereof, however, IPI is subject to the 5% tax on its gross income from its leasing activities as computed in accordance with Subsection (2), Section 2, Rule XX of the Rules and Regulations to Implement R.A. No. 7916, as amended. Under the aforesaid rules, as an Ecozone Facilities Enterprise, IPI is entitled to deduct the sublease rental expense it pays to EMS for the improvements and all other direct expenses enumerated thereunder from its gross income. Moreover, since IPI is exempt from income tax, the rental payments it received are likewise exempt from the creditable expanded withholding tax prescribed under Revenue Regulations (Rev. Regs.) No. 2-98, as amended. Furthermore, since IPI is engaged in real estate business, leasing of real properties is among its registered activities, IPI, therefore, is exempt from payment of the documentary stamp tax (DST) due on the Contract of Lease it executed with the other PEZA-registered company. However, applying Sec. 173 of the Tax Code of 1997, as amended, the other party to the Contract of Lease, therefore, shall bear the burden of paying the DST, except, however, if the other PEZA-registered enterprise is also engaged in realty (leasing) business, in which case, it shall likewise be exempt from payment of the DST. 2. Tax Impact on EMS . Since the lease by EMS to IPI of the leasehold improvements is not part of the registered activities of EMS with the PEZA or the BOI, its rental income will be subject to the ordinary corporate income tax rate of 32%. EMS, however, may claim as allowable deductions the depreciation of the leasehold improvements and related maintenance expenses under Section 34 of the Tax Code of 1997, as amended. SECcAI Moreover, since the rental payments made by IPI to EMS are subject to income tax, the said payments will likewise be subject to the 5% creditable withholding tax under Rev. Regs. No. 2-98, amended, which IPI shall withhold and remit to the Bureau of Internal Revenue (BIR). On the other hand, the rental payments made by IPI to EMS is subject to the 10% value-added tax (VAT) imposed under Sec. 108 of the Tax Code of 1997, as amended, as implemented under Sec. 4.102-1 of Rev. Regs. No. 7-95. The preferential treatment extended to PEZA-registered enterprise which in effect grants exemption to it from national taxes is construed to apply only to its registered activities [Revenue Memorandum Circular (RMC) No. 74-99, as further clarified by Rev. Regs. No. 20-2002]. Since leasing of real properties is not among the registered activities of EMS, its lease of realties to IPI, therefore, is not embraced by the special rate of 5% in lieu of all taxes. Likewise, looking at the transaction from the standpoint of IPI, and correlating the same to Sec. 5(4)(b) of RMC No. 74-99, which provides for the tax treatment of Intra Ecozone Enterprise Sale of Service, the lease by EMS to IPI of its real properties seemingly would not qualify to be subject of the zero percent (0%) VAT pursuant to the "Cross Border Doctrine" of the VAT system. Under the said doctrine, if the PEZA-registered seller is subject to the regular internal revenue taxes, its sale of service to another PEZA-registered enterprise shall be subject to zero percent (0%) VAT since the use for or benefit from such purchase of service shall eventually be translated into actual export of goods of translated into technical export of goods. The foregoing rationale used under the "Cross Border Doctrine" will not apply in the instant case since IPI is not engaged in processing, manufacturing, converting or repacking of goods that are subsequently exported. Further, since leasing of realty is not among the registered activities of EMS, the Contract of Lease between EMS as lessor and IPI as lessee is subject to the documentary stamp tax imposed under Sec. 194 of the Tax Code of 1997, as amended. Please be guided accordingly. Very truly yours, (SGD.) JOSE MARIO C. BUAG OIC, Commissioner of Internal Revenue