SGV & Co.

December 3, 2009 BIR RULING [DA-(IL-038) 726-09] R.A. 8748; DA-493-06; DA-071-08; DA-031-07 SGV & Co. 6750 Ayala Avenue 1226 Makati City Attention: Lucil Q. Vicerra Principal Tax and Customs Services Gentlemen : This refers to your letter dated August 27, 2009 requesting on behalf of your client, NEC Tokin Electronics (Philippines) Inc. ("NEC Tokin" for brevity), for a confirmation of your opinion that, as PEZA-registered enterprise enjoying the 5% preferential tax rate, its revenue or income from the sale of scrap products is subject to the same preferential rate. Furthermore, you request for affirmation of your opinions that scrap sales made to PEZA-registered entities located within the ECOZONE are exempt from Value-Added Tax; while scrap sales made to entities in the customs territory are subject to 12% VAT on technical importation, which shall be the tax liability of the buyer. It is represented that NEC Tokin is a corporation duly organized and existing under Philippine laws registered with the Securities and Exchange Commission under Certificate of Registration No. A200209728 issued on June 18, 2002 and VAT-registered with Tax Identification Number (TIN) 218-682-431-000. Its principal office address is at 1 Ring Road, Light Industry and Science Park (LISP) II, Barangay La Mesa, Calamba, Laguna. It is registered with the Philippine Economic Zone Authority (PEZA) as an Ecozone Export Enterprise pursuant to the provisions of Republic Act No. 7916 under Certificate of Registration No. 02-043 dated August 19, 2002. Under the Registration Agreement, NEC Tokin's registered activity "shall be limited to the manufacture of electro mechanical device as relay and others, and the importation of raw materials, machinery, equipment, tools, goods, wares, articles or merchandise directly used in its registered operations". Likewise, its Amended Articles of Incorporation states that the primary purpose for which it was incorporated is "to engage in, operate, conduct and maintain the business of designing, engineering, manufacturing, importing, exporting, buying and selling (on wholesale within the Philippines), or otherwise dealing in electronic components (including, without limitation, electromechanical devices) of all classes and descriptions, and any and all other assemblies, units components, parts, and other equipment and products, relating to such electronic components or designing, engineering, manufacturing and testing of such electronic components." It is also represented that in the manufacture of electro mechanical devices, NEC Tokin uses such raw material as coils, plated armature, core and yoke, which are processed and assembled to arrive at the finished product. In the course of this process, it is inevitable that scrap materials are produced, which are no longer suitable for further processing and will no longer be usable in any way by the company. In order to dispose of these processed scrap, NEC Tokin sells them to third parties. Some of these entities are likewise PEZA-registered companies located within the Ecozone, while some are domestic companies located within the customs territory. In reply, please be informed as follows: Section 24 of Republic Act (R.A.) No. 7916, otherwise known as the Special Economic Zone Act of 1995, as amended by Section 4 of R.A. No. 8748, entitled "An Act Amending Republic Act No. 7916", provides: CDHacE "Section 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." Likewise, Section 4 of Revenue Regulations No. 1-2000 dated November 12, 1999, implementing RA No. 7916, as amended by R.A. No. 8748 states: "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." From the above provisions, it is undisputed that PEZA-registered entities are subject to the 5% preferential tax rates on gross income earned on its registered activity. The 5% preferential tax is a commutation of all the national and local taxes that are otherwise due from business and enterprises operating within the ECOZONE. This incentive is available to all the registered activities of entities inside the ECOZONE. (BIR Ruling DA-071-08 dated February 6, 2008) Moreover, the sale of scrap or reject items shall be deemed included in NEC Tokin's registered activity. This Office, in BIR Ruling No. DA-493-06 dated August 10, 2006, has ruled that: "Inasmuch as the reject or scrap items which, as represented, will inevitably arise at a certain stage of the manufacturing activity, the sale of such reject or scrap items will fall under the same registered activity subject to the 55 preferential tax rate pursuant to Section 24 of R.A. 7916, as amended by R.A. 8748." Again, in BIR Ruling No. DA-071-08 dated February 6, 2008, this Office had occasion to rule as follows: "The process of manufacturing its product is a registered activity for which Toms was authorized to engage in. The reject or scrap items which inevitably arise at a certain stage of its registered activity are incidental to such activity. They are merely by-products of the same registered activity and do not arise as a result of a separate manufacturing process. The reject or scrap items are part of the same manufacturing process that arise given the physical and mechanical limitations of the machines used in the registered manufacturing operations. Therefore, these scraps are the by-products of one and the same manufacturing process which produces the finished goods. The term "Rejects/Seconds" shall mean finished or semi-finished products or raw materials which are defective or inferior in quality, such that any further processing or manipulation thereof is not technically or economically feasible for the purpose for which they are originally intended. (Sec. II (bb), Rule I, Implementing Rules) Since the manufacturing of Tom's product is a registered activity and the reject or scrap items only inevitably resulted at a certain stage, the sale thereof will definitely fall under the registered activity. Accordingly, the sale of these scraps or reject items constitutes acts connected with the registered activity for which Toms was given authority to do business by PEZA under its Certificate of Registration and therefore, Toms is entitled to 5% preferential rate on the sale of reject or scrap items imposed under Section 24 of R.A. No. 7916, as amended . . . ." The scrap materials appears to be by-products of NEC Tokin's manufacturing process and/or incidental to the company's production of finished goods and are not result of a separate process. Considering NEC Tokin's registered activity include "manufacture of electro mechanical device as relay and others, and the importation of raw materials, machinery, equipment, tools, goods, wares, articles or merchandise directly used in its registered operations", the proceeds generated in the sale of said scrap materials shall form part of its gross income subject to the 5% preferential tax rate mainly because it was found that such materials were inevitable results of the company's registered activities. With regard to the scrap sales made to other PEZA-registered entities located in the ECOZONE, Section 4.105-1 of Revenue Regulations No. 16-2005, implementing Republic Act (R.A.) No. 9337, provides that: "Sec. 4.105-1. Persons Liable. Any person who, in the course of his trade or business, sells, barters, exchanges or leases goods or properties, or renders services, and any person who imports goods, shall be liable to VAT imposed in Section 106 to 108 of the Tax Code. cEaACD "However, in the case of importation of taxable goods, the importer, whether an individual or corporation and whether or not made in the course of his trade or business, shall be liable to VAT imposed in Section 107 of the Tax Code." Section 5 (3) of Revenue Memorandum Circular (RMC) 74-99 dated October 15, 1999 provides that the sale of goods by a PEZA-registered enterprise to another PEZA-registered enterprise shall be exempt from VAT, pursuant to Section 109 (q) of the Tax Code of 1997, in relation to Section 24 of R.A. No. 7916, as implemented by Section 1, Rule VIII, Part V, of the PEZA implementing rules and regulations. Applying the above-cited provisions and in relation to Section 24 of R.A. No. 7916, as amended by R.A. No. 8748, the sale of scrap materials by NEC Tokin to another PEZA-registered enterprise shall be exempt from the 12% value-added tax. As to sales of reject or scrap materials within the customs territory, Section 5 (1) of RMC No. 74-99 states that: SECTION 5. Tax Treatment of Sales Made by a PEZA Registered Enterprise. (1) Sale of goods ( i.e., merchandise), by a PEZA-registered enterprise, to a buyer from the Customs Territory ( i.e., domestic sales). This case shall be treated as a technical importation made by the Buyer. Such Buyer shall be treated as an importer thereof and shall be imposed with the corresponding import tax/es ( i.e., VAT or VAT plus excise tax, as the case may be), pursuant to Sec. 107, Title IV and Title VI, NIRC, in relation to Sec. 26, R.A. No. 7916, as implemented by Sec. 2, Rule VIII, PART V of the PEZA rules and regulations entitled "Rules and Regulations to Implement Republic Act No. 7916." In BIR Ruling DA-031-07 dated January 19, 2007, this Office opines that the sale of goods by a PEZA enterprise to a buyer from custom territory is treated as technical importation made by the buyer. In such event, the buyer is considered as importer thereof and shall be liable for the corresponding value-added tax on importation. In the instant case, the buyer of scrap materials is deemed the importer and shall be liable for the corresponding VAT on the said importation. WHEREFORE, in view of the foregoing, this Office holds that the sale of scrap or reject items constitutes acts connected with NEC Tokin's registered activity and consequently entitled to the 5% preferential tax rate imposed under Section 24 of RA 7916, as amended by RA 8748. Moreover, NEC Tokin's scrap sales made to PEZA-registered entities located within the ECOZONE are exempt from VAT while scrap sales made to entities in the customs territory are subject to 12% VAT on technical importation and that the buyers, not NEC Tokin, shall be responsible for the payment thereof. 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