BIR Ruling [DA-526-06]

August 31, 2006 BIR RULING [DA-526-06] VAT 043-03 Isla Lipana & Co. 29th Floor Philamlife Tower 8767 Paseo de Roxas Makati City Attention: Mary Assumptions S. Bautista-Villareal Principal Gentlemen : This refers to your letter dated July 4, 2006 stating that your client, Federal Express Corporation-Philippine Branch Office (FEC-Phil.), is the Philippine branch office of Federal Express Corporation (FEC) which is a corporation organized and existing under the laws of the United States of America and engaged in the business of integrated air and ground transportation of time sensitive and time-definite shipments around the world; that FEC-Phil. is registered with the Subic Bay Metropolitan Authority (SBMA) as a Subic Bay Freeport (SBF) Enterprise engaged in air transportation services under Republic Act (R.A.) No. 7227; that as a registered enterprise, FEC Phil. Is entitled to tax and duty-free importation of raw materials, supplies, capital equipment and household and personal items, and is exempted from national and local taxes; that however, it is liable to pay the final tax of 5% based on the gross income as defined under R.A. No. 7227; that FEC-Phil. entered into a Global Service Program Contract (GSPC) with Airfreight 2100 (AF2100) wherein the parties integrated their respective systems of operations to provide a leading, seamless time-sensitive and time-definite, door-to-door international transportation services to customers in the Philippines; that under the GSPC, AF2100 provides door-to-door pick up and transportation of documents, packages and cargo from customers within the Philippines for ultimate delivery abroad; that FEC-Phil. as the air carrier, provides the linehaul air transport services in respect to said outbound shipments picked up by AF2100 from the local shippers and delivers them to their final destination abroad; that the AF2100 delivers the documents, packages and cargo picked up from local shippers to FEC-Phil. in Subic; that however, in certain exceptional instances, delivery is made to airports outside of Subic where FEC-Phil.'s planes sometimes land such as NAIA and Mactan International Airport, although income generated from such outside delivery does not exceed 30% of FEC-Phil.'s entire income from both Subic and the Customs Territory. Based on the foregoing representations, you now request confirmation of your opinion that 1. The phrase "in lieu of paying local and national taxes" stated in Section 12(c) of R.A. No. 7227, otherwise known as the Bases Conversion Development Act, does not refer only to tax on gross income but includes as well, all other internal taxes such as VAT, percentage tax, excise and ad valorem taxes and customs and import duties; 2. Income derived by FEC-Phil. from all sources (i.e., both from the Secured Area and Customs Territory) shall be entitled to the 5% preferential tax, in lieu of all other taxes, local and national, provided its income from sources within the Customs Territory does not exceed 30% of its total income from all sources in accordance with Section 44 of the Rules and Regulations implementing R.A. No. 7227 and Section 4(f) of Revenue Regulations No. 1-95, which implements the tax provisions of R.A. No. 7227; 3. Therefore, since the income derived by FEC-Phil. from sources within the Customs Territory does not exceed 30% of its entire income from all sources, the revenues from the Customs Territory shall not be subject to 10% VAT; and 4. FEC-Phil. may claim as deduction from its gross income earned, depreciation of all its equipment and machineries regardless of usage, for purposes of computing the 5% final tax in accordance with Section 57(B)(2) of the IRR and Section 3(o)(2) of Revenue Regulations No. 1-95. In reply thereto, please be informed as follows: 1. The phrase "in lieu of paying local and national taxes" has been interpreted in numerous rulings to include exemption from the payment of creditable withholding tax ( BIR Ruling No. 085-98 dated June 2, 1998 ) and other business taxes like VAT, percentage tax, excise tax and customs and import duties. cTSDAH 2. Generally, income derived by FEC-Phil. From all sources i.e., both from the Secured Areas and Customs Territory, is subject to the 5% preferential tax rate based on the gross income earned. However, Section 4(f) of Revenue Regulations No. 1-95, implementing R.A. No. 7227, provides that the sale of items produced in the secured area (SBFSEZ) such that if not more than 30% of the production thereat is sold to the Customs Territory, then the entire sales therefrom qualify for the 5% tax on gross income earned, otherwise, the entire sales by a SBFSEZ-registered establishment, like FEC-Phil., shall be subject to the internal revenue tax laws of the Customs Territory. ( BIR VAT Ruling No. 043-03 dated October 13, 2003 ) 3. Inasmuch as the income derived by FEC-Phil. from sources within the Customs Territory does not exceed 30% of its entire income from all sources and therefore subject to the 5% preferential tax rate based on the gross income earned, the revenues derived from the Customs Territory shall not be subject to VAT. ( RMC 74-99 ) 4. Finally, the term "Gross Income Earned" refers to gross sales or gross revenues derived from any business activity, net of returns, discounts and allowances, less costs of sales, cost of production or direct costs of services (depending on the nature of business) but before any deduction for administrative expenses and incidental losses during a given taxable period. On the other hand, Section 57(b)(2) of the Implementing Rules and Regulations provides that "In arriving at the base for which the five (5) percent final tax . . . shall be applied, the following deductions shall be allowable/unallowable: "xxx xxx xxx "(2) For Service Enterprises "Allowable Deductions - Direct salaries, wages or labor expense; - Services supervision salaries; - Raw materials, goods in process or finished goods used or resold; - Supplies and fuels used in rendering services; - Depreciation, lease payments and other expenditures on buildings and equipment . Corollarily, Section 3(o)(2) of Revenue Regulations No. 1-95 defines "Gross Income Earned" as gross sales or gross revenues derived from the business activity within the zone, net of sales discounts and sales returns and allowances and minus costs of sales or direct costs but before any deduction for administrative expenses or incidental losses during a given taxable period. . . . The following deductions shall be allowable for the calculation of gross income earned for specific types of enterprises: xxx xxx xxx (2) Service enterprises xxx xxx xxx Depreciation of machineries, equipment and buildings owned and/or constructed. xxx xxx xxx" From the foregoing provisions, it is undisputed that there is no qualification made as to the usage/nature of the machineries, equipment and/or buildings for purposes of determining the allowable deduction for depreciation. Accordingly, FEC-Phil. should be allowed to claim as deduction from its gross income, depreciation of all its equipment and machineries regardless of their usage and nature. WHEREFORE, in view of the foregoing , this Office hereby confirms your opinion that 1. The phrase "in lieu of paying local and national taxes" does not only refer to tax on gross income but includes all other internal revenue taxes such, as VAT, percentage tax, excise taxes and customs and import duties. 2. Income derived by FEC-Phil. from all sources i.e., both from the Secured Area and Customs Territory shall be entitled to the 5% preferential tax rate, in lieu of other taxes, local and national, provided its income from sources within the Customs Territory does not exceed 30% of its total income from all sources in accordance with Section 44 of the IRR and Section 4(f) of Revenue Regulations No. 1-95. 3. Since the income derived by FEC-Phil. from sources within the Customs Territory does not exceed 30% of its entire income from all sources, the revenues from the Customs Territory shall not be subject to 10% VAT [now 12%]. 4. Finally, FEC-Phil. may claim as deduction from its gross income earned, depreciation of all its equipment and machineries regardless of usage, for purposes of computing the 5% final tax in accordance with Section 57(B)(2) of the IRR and Section 3(o)(2) of Revenue Regulations No. 1-95. 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. cETCID Very truly yours, (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service