BIR Ruling [DA-476-03]

December 10, 2003 BIR RULING [DA-476-03] R.A. 7916; 117-99 Punongbayan & Araullo 20th Floor, Tower I The Enterprise Center 6766 Ayala Avenue Attention: Atty. Romeo H. Duran Tax Director Gentlemen : This refers to your letter dated June 10, 2002, requesting for a confirmatory opinion on the deductibility of the following expenses for purposes of computing the "Gross Income Earned" (GIE) of Marubun/Arrow (Phils.), Inc. ("Marubun/Arrow"), a PEZA-registered firm: 1. Cost of the company CEO and CFO; 2. Cost of warehouse services (receiving, stocking, picking, & shipping of goods) provided by the Singapore warehouse; 3. Cost of Arrow support services including MIS system support, operations, marketing, asset management & finance; 4. Cost of engineering services provided by Marubun Corp. to support Philippine customers; 5. Shipping costs incurred on shipments to customers (freight-out up to the Port of Manila); 6. Interest expense on working capital; 7. Philippines' share of occupancy expenses for shared employees working in Singapore; 8. Philippines' share of general expenses of shared employees working in Singapore; 9. Philippines' share of the Managing Director's expenses; 10. Cost of sales representative support; 11. Cost of sales manager support; 12. Cost of sales assistant support 13. Cost to insure ocean bound shipments; 14. Cost of Freight-in expense (shipments from vendors); 15. Cost of inventory write-downs and write-offs 16. Cost of customer accounts receivable write-offs; and 17. Bank fees related to Philippine accounts/transactions related to registered activities, such as purchases. In the aforestated letter, it is represented that Marubun/Arrow is registered with the Philippine Economic Zone Authority ("PEZA") as a Facilities Enterprise; that as defined in the Implementing Rules and Regulations of Republic Act (RA) No. 7916, an "Ecozone Facilities Enterprise" refers to a business entity or concern within the Ecozone duly registered with and/or franchised/licensed by the PEZA with or without incentives provided under RA No. 6957, as amended, (the Build-Operate Transfer Law) and/or with or without financial exposure on the part of the PEZA such as contractors/operators of buildings, structures, warehouses, site development and road network, ports, sewerage and drainage system and other facilities for the development, operation and maintenance of the Ecozone and other similar or ancillary activities as may be determined by the Board; that Marubun/Arrow was registered pursuant to PEZA Board Resolution No. 97-366, as amended by PEZA Board Resolution No. 01-210, which authorizes Ecozone Facilities Enterprises to undertake the following activities: (1) Establishment of a warehouse facility for the storage, deposit, safekeeping of goods for subsequent transfer directly to the Ecozone plant of the PEZA-registered export enterprise-owner/consignee thereof; (2) Importation or procurement from local sources and/or from other PEZA-registered enterprises of goods for resale, or for packing/covering (including marking, labelling), cutting or altering to customers" specification, mounting and/or packing into kits or marketable lots thereof for subsequent sale, transfer or disposition directly to PEZA-registered export enterprises, and to export enterprises engaged in the semiconductor and electronic industry which are registered with the BOI or operating at the Clark, Subic Economic Zone and other special economic zones outside the administration of PEZA, for direct export, or for consignment to PEZA-registered export enterprises; (3) a combination of both; that as a PEZA-registered firm, Marubun/Arrow is engaged in trading and warehousing operations, particularly, in the importation, storage, safekeeping, just-in-time delivery of electronic and semiconductor goods, for sale, transfer or disposition to export enterprises; that all clients of Marubun/Arrow are PEZA-registered firms; that among the incentives made available to Marubun/Arrow's warehousing operations is the five percent (5%) special tax rate based on gross income earned (GIE); that Marubun/Arrow is exempt from all national and local taxes, in lieu of the said 5% special tax rate; that the basis for computing the special tax due is Section 24 of RA No. 7916, as amended by RA No. 8748, which states in part: "except for real property taxes on land owned by developers, no taxes, local and nationals, shall be imposed on business establishments operating within the Ecozone; and that in lieu thereof, five percent (5%) of the gross income earned by all business enterprises within the Ecozone . . . ". In reply thereto, please be informed under existing PEZA rules and regulations, the term "gross income" is defined as "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 expenses or incidental losses during a given taxable period. The allowable deductions from gross income are specifically enumerated under Section 2, Rule XX of these Rules." (Section 2(nn), Rule I, Implementing Rules and Regulations, R.A. No. 7916) The enumeration is as follows: 1. Direct salaries, wages or labor expense; 2. Service supervision salaries; 3. Direct materials, supplies used or resold to another Ecozone Enterprise; 4. Depreciation of machinery, equipment and buildings owned and/or constructed; 5. Financing charges associated with fixed assets; and 6. Rent and utility charges for buildings and capital equipment Based on R.A. 7916 and its implementing rules and regulations, this Office confirms your opinion on the deductibility or non-deductibility of the following costs and expenses of Marubun/Arrow for purposes of determining the taxable GIE: EcDSHT 1. Cost of company CEO and CFO Salaries of CEO and CFO are not direct costs in the operation of the trading and warehousing businesses of Marubun/Arrow. These expenses are primarily administrative expenses which are not deductible from gross income in computing the taxable GIE. 2. Cost of warehouse services (receiving, stocking, picking and shipping of goods) provided by the Singapore warehouse Prior to the importation of goods by Marubun/Arrow, the goods are gathered and stored in a Singapore warehouse. The cost of warehousing is for the account of Marubun/Arrow. Thus, the cost of the Singapore warehouse services are deductible from gross income of Marubun/Arrow since these costs are incurred in bringing in the goods that are imported by Marubun/Arrow. (Paragraph 7, SFAS No. 4 Inventories, as revised in 2000) . These expenses are deductible whether or not the same have been included as part of the invoice cost or charged separately as an allocation to Marubun/Arrow by Marubun/Arrow Singapore (MAS). There is no income tax and no final withholding tax implications because the warehousing services were rendered offshore. 3. Cost of Arrow (Singapore) support services including MIS system support, operations, marketing, asset management and finance Marubun/Arrow has an arrangement with Arrow (Singapore) for the provision by the latter of computer technical support and administrative services to the former. The cost of these support services do not form part of the direct cost incurred in the operation of trading and warehousing businesses of Marubun/Arrow, hence, these are not deductible . There are also no income tax and no final withholding tax implications because the support services were rendered offshore. 4. Cost of engineering services provided by Marubun Corp. (Japan) to support Philippine customers Marubun/Arrow has an allocation from Marubun/Arrow Singapore for engineering services performed by Marubun (Japan). The engineering services pertain to engineering designs for commodity and customized products. This cost of engineering services do not form part of direct costs incurred in the operation of the trading and warehousing businesses of Marubun/Arrow, hence, these are not deductible . There is likewise no income tax and no final withholding tax implications because the allocated costs were for engineering services rendered offshore. 5. Shipping costs incurred on shipments to customers These are selling expenses which are not deductible from gross sales in determining the GIE. 6. Interest expense on working capital Only interest expense related to the acquisition or lease of fixed assets used in trading activities are deductible. 7. The following administrative expenses are not deductible : a. Philippines' share of occupancy expenses for shared employees working in Singapore, b. Philippines' share of general expenses of shared employees working in Singapore c. Philippines' share of the Managing Director expense d. Cost of sales representative support e. Cost of sales manager support f. Cost of sales assistant support 8. Cost to insure ocean bound shipments This cost is part of cost of sales cases where it relates to inbound shipments and is therefore deductible from gross revenues in computing for the GIE. However, insurance for outbound shipments is a selling expense which is not deductible for purposes of computing the GIE. 9. Cost of freight-in expense (shipments from vendors) This cost is part of cost of sales (part of landed cost of materials) and is therefore deductible in computing for the GIE. 10. Cost of inventory write-downs and write-offs Losses attributable to sale of inventory at reduced prices, i.e. ; write-downs, as well as write-offs resulting from the destruction of inventory, have the effect of reducing the taxable GIE. The inventory losses are taken up as direct costs. Write-downs refer to reduction in the value of unsold inventory. These are not deductible and will have no effect on GIE until the inventory is actually sold. Write-offs refer to losses resulting from the destruction of inventory which cannot be sold even at reduced prices due to obsolescence or deterioration of the inventory. 11. Cost of customer accounts receivable write-offs This is an administrative expense which is not among those enumerated as deductible. Therefore, this expense is not deductible in computing for the GIE. 12. Bank fees related to Philippine accounts/transactions Financing charges associated with fixed assets, that is, interest expense, bank fees and other associated charges relating to the acquisition or lease of fixed assets used in trading and warehousing are deductible in computing the GIE. This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it will be ascertained that the facts are different, then this ruling shall be considered void. Very truly yours, (SGD.) JOSE MARIO C. BUAG Deputy Commissioner Legal & Inspection Group