Whether the PTFI is Engaged in the Sale of Non-Food Agricultural Products in their Original State or in the Sale of Services

July 26, 1994 BIR RULING NO. 118-94 103 (a) 000-00 118-94 The Law Offices of King Capuchino Tan & Associates 2nd Floor, Belman Building Quezon Avenue cor. Cordillera Sts. Quezon City Attention: Atty . Lincoln L . Tan, Jr . Gentlemen : This refers to your letters dated August 30, 1993, January 10 and March 10, 1994 requesting a ruling as to whether your client, Provident Trees Farms, Inc. (PTFI), is engaged in the sale of non-food agricultural products in their original state or in the sale of services. Documents submitted show that PTFI was organized in 1968 primarily to engage, among others, in the exploitation and development of timber and agricultural lands subject to applicable laws of the Philippines; that it is registered under SEC Registration No. 11639; that on February 16, 1989, PTFI registered as a non-VAT taxpayer under Registration Certificate No. 4B2-32A 000059; that its line of business is that of a "Manufacturer/Producer"; that on February 23, 1987, an agreement was entered into by PTFI and Phimco Industries, Inc. under the following terms and conditions, to wit: "1. That the Supplier (PTFI) hereby undertakes to sell and supply the Dealer (Phimco) nineteen thousand (19,000) cubic meters of logs of all matchwood species that are cut and gathered from its concession area abovementioned." "2. That the price for which the dealer (Phimco) shall pay the logs subject of this agreement shall be the prevailing market price in the locality at the time of the delivery of the said logs." "3. That this agreement to supply the volume of logs abovementioned which expired December 1986, shall be in full force and effect for another period of ten (10) years ending December 1996, renewable for a similar period by mutual agreement of the parties." that on December 23, 1991, it entered into another agreement with Phimco wherein the following were agreed upon: "1. Phimco will finance the operations of Provident in the amount representing the cost of capital expenditures necessary in the plantation establishment, maintenance and harvesting of gubas trees and other allied species; "2. Phimco agrees and undertakes to pay Provident each year one-half (1/2) of the yearly expenses to be incurred by Provident in the plantation establishment and maintenance and the indirect production cost of logs therefrom, to be determined by Provident and agreed to by Phimco based on the actual costs; "3. Phimco undertakes to purchase from Provident the harvested gubas trees and other species at cost of production plus 15% FOB Butuan; "4. Phimco shall have the first option to acquire all the gubas trees and other species growing and to be grown by Provident at the prices computed in the manner stated in paragraph 3." that the above agreement shall be effective January 1, 1992 and to last for twenty (20) years but may be terminated by giving one year notice by either party; that in 1991 up to the present PTFI has continuously supplied matchwood and hardwood harvested from its plantation site not only to Phimco, but also to at least twenty-four (24) other persons/entities as follows: cdt NAME ADDRESS 1. United Wood Products Butuan City 2. Canumay Wood Corporation Manila 3. Industrial Timber Corporation Butuan City 4. Industrial Plywood Group Corp. Agusan Pequeo, Butuan City 5. A G & P Butuan City 6. Forest Products Research & Dev. Institute College Laguna 7. Far East Timber Butuan City 8. Phimco Export Trading Manila 9. Ventura Plywood Philippines Butuan City 10. M.R. Board, Inc. Greenhills, San Juan, Metro Manila 11. CVC Industries, Inc. Butuan City 12. Pacwood, Inc. Butuan City 13. Manwood Industries, Inc. Butuan City 14. Super Mahogany Plywood Corp. Butuan City 15. VGE Mini-Sawmill San Nicolas, Talacogon, Agusan del Sur 16. Far East Timberland Corporation Butuan City 17. Freedom Woodcraft Butuan City 18. Bashier Box Factory Butuan City 19. Timber Woodcraft Butuan City 20. May-May Mini-Sawmill Butuan City 21. James Tan Zillovia Talacogon, Agusan del Sur 22. Avenue Best Lumber Butuan City 23. Ronwood Mini-Sawmill Butuan City 24. Far East Timberland Butuan City that on October 26, 1993, PTFI signed with Land Bank of the Philippines a P100 Million ADB loan to finance its industrial tree plantation program under the Industrial Forest Management Agreement (IFMA) it entered into with the Department of Environment and Natural Resources (DENR) (Newspaper clippings of the news item on the PTFI loan, Philippine Star, October 29, 1993 issue; Philippine Daily Inquirer, October 29, 1993 issue; Manila Bulletin, October 27, 1993 issue); that on May 25, 1993 this Office thru the then Industry Audit Division issued a Pre-Assessment Notice Against PTFI involving the amount of P12,217,539.60 representing deficiency VAT inclusive of surcharge and interest thereon for the year 1991; that the said Pre-Assessment Notice arose from the following findings of this Office: "1. The only product PTFI engaged in is matchwood and its only customer is Phimco Industries, Inc. "2. The product of PTFI is procured by farming, felling and transporting matchwood upon order of PHIMCO and not for the general market. "3. The product of PTFI would not be in existence if not upon order of Phimco. "4. There is no open market of which matchwood can be bought or sold. "5. Contract entered into between Provident Tree Farms, Inc. and Phimco Industries, Inc. wherein Phimco is committed to make advances equivalent to one-half of the yearly expenses to be incurred by the Company for land and other improvement in its tree farming operations in the province of Agusan del Sur and Oriental Mindoro, in consideration for the advances, Phimco is granted the first option to acquire all the matchwood logs and product at price on cost plus basis for a period of twenty-five (25) years. For every cubic meter of logs delivered from stands planted with Phimco's assistance, 50% of the purchase price per cubic meter is applied against the advances." cdtech that based on the foregoing findings, the Examiner is of the opinion that PTFI is engaged in the sale of services, thus, subject to VAT under Section 102 of the Tax Code; but that, on the contrary, you are of the opinion that PTFI is a non-VAT entity and is not engaged in the sale of services, for the following reasons: "1. PTFI is engaged on various products like matchwood, hardwood, seeds, seedlings and others. "2. Matchwood is harvested from plantation site preparation activities. Sale of matchwood is not limited to Phimco but also to plywood mills. Plywood mills use matchwood logs as plywood core. "3. Matchwood products would be in existence even without the order of Phimco. As stated in item #2 above, matchwood products are obtained also from site preparation. Since the Company's main line of business is tree plantation, there will always be a matchwood production whenever there is tree plantation. In 1991, matchwood harvested from site preparation was 4,000 cubic meters as compared to 14,000 cubic meters matchwood harvested on plantations. "4. Matchwood logs have an open market. With the acute shortage of timber, logs of any kind for that matter has a market. Log supply is a recurring problem of the timber industry. "5. The contract to supply logs entered by PTFI with Phimco Industries, Inc. is merely a commitment by Phimco to make advances equivalent to one-half of the yearly plantation expenses and in return Phimco will have the first option on PTFI's matchwood production. PTFI has been continuously receiving said advances from Phimco." In reply, please be informed that in the case of Commissioner vs. Engineering Equipment and Supply Co ., 64 SCRA 590, the court laid down the rule that if the contract calls for the transfer of a thing not in existence and which would never have existed but for the order of the party desiring to acquire it, it is a contract of services; but if the contract calls for the article ordered by the purchaser to be exactly such as the taxpayer makes and keeps on hand for sale to anyone and no change or modification of it is made at the customer's request, it is a contract of sale, even though it may be entirely made after the customer had ordered it. Article 1467 of the Civil Code also provides that if the goods are manufactured specially for the customer and upon his special order and not for the general public, it is a contract for a piece of work (sale of service). Applying the foregoing criteria in the instant case, the aforesaid agreements entered into between Phimco and PTFI appears to be a contract of sale and not a contract for services, considering that both agreements call for the articles ordered (19,000 cubic meters of logs of all matchwood species and gubas trees and allied species) by Phimco to be exact such as what the PTFI produces, harvests and keeps on hand for sale to anyone, as shown by its sales invoices to twenty-four (24) other persons/entities above enumerated, and no change or modification of such products is made at the customer's request including those sold to Phimco. Moreover, it has also been established by PTFI that it is the primary producer of matchwood and hardwood logs which are being harvested from its plantation site as shown by the P100 Million ADB loan it signed with Land Bank of the Philippines to finance its industrial tree plantation program under the Industrial Forest Management Agreement (IFMA) it entered into with the Department of Environment and Natural Resources (DENR). (Newspaper clippings of the news item on the PTFI loan; Philippine Star, October 29, 1993 issue; Philippine Daily Inquirer, October 29, 1993 issue; Manila Bulletin, October 27, 1993 issue) Such being the case, and since you have satisfactorily proven by documentary evidence that your client, PTFI, is engaged in the sale of non-food agricultural product (matchwood and hardwood) not only to Phimco, but to the general public, this Office is of the opinion as it hereby holds that although, majority of the production of PTFI of matchwood is sold to Phimco in exchange for the latter's commitment to advance payment of the price of the logs to PTFI, the same does not make PTFI a mere contractor or supplier of service. Hence, PTFI-being engaged in the sale of non-food agricultural products in their original state is exempt from the coverage of VAT pursuant to Section 103(a) of the Tax Code, as amended. Very truly yours, LIWAYWAY VINZONS-CHATO Commissioner of Internal Revenue