VAT Ruling No. 040-00

October 3, 2000 VAT RULING NO. 040-00 DA-334-99 M E M O R A N D U M FOR : Undersecretary CORNELIO C. GISON Department of Finance, Roxas Blvd. corner Vito Cruz Street, Manila FROM : Commissioner DAKILA B. FONACIER Bureau of Internal Revenue Diliman, Quezon City RE : VAT Treatment of the National Power Corporation Contract With Mitsubishi Corporation This refers to your Indorsement dated March 10, 2000, of the letter from the Mitsubishi Corporation dated November 22, 1999, for comment, and to the letter from the National Power Corporation dated September 29, 1999, received by this Office on February 8, 2000, both being addressed to then Secretary of Finance Edgardo B. Espiritu. In effect, both letters request clarification of BIR Ruling No. DA-334-99 dated June 2, 1999, more particularly on the following issues: (a) Whether the sale of services by Mitsubishi Corporation to the National Power Corporation under foreign funded projects should be treated as zero-rated (0%) value added tax (VAT) transaction; and (b) If yes, whether the requirement of prior application to and approval by the Bureau of Internal Revenue (BIR) for effectively zero-rated VAT transactions may be dispensed with and, therefore, give such treatment a retroactive effect upon commencement of the projects (October 14, 1994). It is represented that on October 14, 1994, the National Power Corporation (NPC) and Mitsubishi Corporation (Mitsubishi), a resident foreign corporation registered as a VAT entity, executed Contract No. Sp90DLs-969 whereby Mitsubishi shall furnish, supply, construct, install, test and commission Stage I of the 2 x 300 MW Masinloc Coal-Fired Thermal Power Project at Masinloc, Zambales, Philippines; that Article VII thereof provides among others, thus: "ARTICLE VII TAXES Construction/Erection/Installation Works Portion All forms of taxes (including the value-added tax), . . . that may be imposed by the Philippine Government, . . . which are directly related to the Contract shall be assumed by NPC except corporate income tax, income tax of CONTRACTOR's personnel, taxes imposed on local subcontractors, . . . CONTRACTOR shall be responsible for payment of all taxes, . . . assessed and charged by the taxing authorities of the country of origin for CONTRACTOR's construction equipment which the CONTRACTOR may bring into the country for use in connection with the Contract. NPC shall assume all taxes, . . . (except all fees and insurances relative to the registration of vehicles) that the Philippine Government . . . may impose upon such equipment . . . NPC will not be held responsible whatsoever for the payment of tax obligations of CONTRACTOR's subcontractors under this Contract. A. Supply Portion CONTRACTOR shall assume payment of all taxes . . . assessed and charged by the taxing authority of the country of origin upon production, manufacture, sale or shipment of the material, equipment and supplies to be furnished to NPC under the Contract. NPC will assume payment of all present and future taxes, duties . . . that may be imposed by the Philippine Government . . . on the imported material, equipment and supplies to be supplied to NPC under this Contract."; HTCaAD that said Contract is being financed by loans obtained from the Asian Development Bank (ADB) for US$200 Million, and from The Export-Import Bank of Japan (Japan Eximbank) for Yen equivalent of US$150 Million; that, in compliance to the directive of the Department of Finance to resolve NPC's request for VAT zero-rating and/or exemption in connection with the said Project, the BIR issued Ruling No. DA-334-00-99 dated June 2, 1999, the dispositive part of which states, thus: "In view thereof, and in consideration of the terms and conditions set forth in the said Agreement entered into by NPC and Mitsubishi Corporation which is funded by foreign loans, the transaction entered into by both taxpayers in this specific Masinloc Coal-Fired Thermal Project in Masinloc, Zambales shall be exempt from the payment of VAT arising out of the subject contract." (emphasis supplied) that both parties are, however, of the opinion that, pursuant to the Revised NPC Charter, the sale of services by Mitsubishi to NPC relating to the foreign funded portion of the Project should be treated as zero-rated VAT, rather than VAT-exempt, pursuant to Section 108(B)(3) of the 1997 Tax Code (formerly Sec. 102(a)(3) of the 1977 Tax Code, as amended); that, moreover, if the transaction be treated merely as VAT exempt, Mitsubishi will charged and recover the VAT from NPC who will ultimately pay such additional cost from its own funds because under the applicable foreign loan agreements, NPC cannot apply the proceeds of the loan to the payment of any Philippine tax; that, although Mitsubishi was aware of the requirement of a prior application to and approval by the BIR as a condition for such zero-rated VAT treatment pursuant to Sec. 8(d) of Revenue Regulations No. 5-87 (now mandated by Sec. 4.107-1(d) of Rev. Regs. No. 7-95), it failed to comply thereto; that the reasons therefor were: (a) its belief that obtaining such approval then in 1994 was impossible because the BIR had maintained that any sale to NPC, other than the sale of petroleum products, was subject to 10% VAT, and (b) that the BIR then did not accept, process nor approve any application for VAT zero-rating for such transactions; that, therefore, both parties now argue that the law does not require compliance with the impossible (citing the case of Baretto vs. Tuason, 59 Phil. 845; Province of Cebu vs. IAC, 47 SCRA 447; and Buenviaje vs. Aquino, 42 SCRA 210); and that therefore, the said requirement be dispensed with so that the zero-rated VAT treatment will have a retroactive effect beginning at the time of the commencement of the project October 14, 1994. As a comment, please be informed that Sec. 8(b) of Republic Act No. 6395 (the Revised NPC Charter), as amended by Presidential Decree No. 1360 dated April 25, 1978, provides among others, thus: "Sec. 8(b). Foreign Loans . The Corporation is hereby authorized to contracts loans, credits, in any convertible foreign currency, or capital goods, and indebtedness from time to time from foreign governments, or any international financial institution or fund source, or to issue bonds, in such amount and in any foreign currency, on such terms and conditions as it shall deem appropriate for the accomplishment of its purposes and to enter into and execute agreements and other documents specifying such terms and conditions ."(Emphasis supplied.) "xxx xxx xxx "The loans, credits and indebtedness contracted under this subsection and the payment of the principal, interest and other charges thereon, as well as the importation of machinery, equipment, materials, supplies and services, by the Corporation paid from the proceeds of any loan, credit or indebtedness incurred under this Act, shall also be exempt from all direct and indirect taxes, fees, imposts, other charges and restrictions, including import restrictions previously and presently imposed and to be imposed by the Republic of the Philippines or any of its agencies and political subdivisions." (Emphasis supplied) and that Sec. 13 thereof, as amended by P.D. No. 938 dated May 27, 1976, provides among others, thus: "Sec. 13. Non-profit Character of the Corporation, Exemption from all taxes, duties, fees, imposts and other charges by the Government and Government Instrumentalities . The Corporation shall be non-profit . . . the Corporation, including its subsidiaries, is hereby declared exempt from the payment of all forms of taxes, duties, fees, imposts, as well as costs and service fees . . . "(Emphasis supplied) Likewise, the Fiscal Incentives Review Board (FIRB) Resolution No. 17-87 dated June 24, 1987, restored the tax and duty exemption privileges of NPC, except the following: "1. Importation of fuel oil and coal; "2. Commercially funded importations (i.e. importations which include but are not limited to those financed by the NPC's internal funds, domestic borrowing from any source whatsoever, borrowings from foreign-based private financial institutions, etc.) and; "3. Interest income derived from any source. "The NPC shall submit to the FIRB a report of its expansion program, including details of disposition of relieved tax and duty payments for such expansion on an annual basis or as often as the FIRB may require it to do so. This report shall be in addition to the usual FIRB reporting requirements on incentive availment". (Emphasis supplied.) CIcEHS On the other hand, Sec. 102(a)(3) of the Tax Code of 1977, as amended, provides, thus: "Sec. 102. . . . Provided, That the following services performed in the Philippines by VAT-registered persons shall be subject to 0%; (3) Services rendered to persons or entities whose exemption under special laws or international agreements to which the Philippines is a signatory effectively subjects the supply of such services to zero rate."; Please be informed further that on May 2, 1990, the BIR issued VAT ruling No. 097-90 applying the above-mentioned statutory provisions and declaring the services rendered by Marubeni Corporation to the NPC for the rehabilitation of the Sucat Thermal Power Plant Nos. 1 and 4, and the construction of the Malaya Gas Turbine Project, both financed by the Japan Eximbank, effectively zero-rated VAT transactions. Likewise, the Court of Appeals in the case of ABB Power Generation Ltd. vs. Commissioner of Internal Revenue, CTA Case No. 4888 promulgated on February 6, 1996, ruled that the gross receipt of Asea Brown Boveri, Ltd. (ABB Ltd.) from the construction of the NPC Turbine Power Plant in Naga, Cebu, funded by foreign loans, is subject to zero-rated VAT. Moreover, the Supreme Court, in the case of Maceda vs. Macaraig, Jr. (G.R. No. 88291, June 8, 1993, 223 SCRA 217) declared, thus: cEaDTA "A chronological review of the NPC laws will show that it has been the lawmaker's intention that the NPC was to be completely tax exempt from all forms of taxes direct and indirect ." (Emphasis supplied.) In the Memorandum to the Commissioner of Internal Revenue dated January 26, 1998, then Secretary of Finance Roberto de Ocampo, in reviewing BIR VAT Ruling No. 003-98 on the VAT treatment of the sale of electricity to NPC by the San Pascual Cogeneration Co., pursuant to his power granted under Sec. 4 of the Tax Code of 1997, held that: "The NPC Charter clearly provides for NPC's exemption from all taxes direct and indirect. No less than the Supreme Court ruled that it has been the lawmaker's intention that the NPC is completely exempt from all taxes. The Department of Justice and the Office of the Solicitor General have also issued opinions supporting the full tax exemption of the NPC. Even the BIR has ruled that NPC is exempt from direct and indirect taxes." Based on the foregoing, it could be said that the sale of services by Mitsubishi to the NPC under foreign funded projects coursed through the ADB and Japan Eximbank would qualify as effectively zero-rated VAT transaction. It is important to stress, however, that Sec. 8(d) of Rev. Regs. 5-87 provides, thus: "(d) Application for the imposition of zero-rate . Any person claiming that its sales of goods or services are effectively zero-rated under Sections 100 and 102 shall file an application in a form prescribed therefor with the Commissioner of Internal Revenue justifying the imposition of zero-rate on the said transactions. Upon approval, his status as a zero-rated taxpayer shall remain valid until revoked." Likewise, the amendatory Rev. Regs. No. 7-95, Sec. 4.107-1(d) provides, thus: SDTcAH "Sec. 4.107-1(d) Application for effective zero-rating . Except for actual export sale, other cases of zero-rated sales in Sec. 4.102-2(c) shall require prior application with the Revenue District Office for effective zero-rating. Without an approved application for effective zero-rating, the transaction otherwise entitled to zero-rating shall be considered exempt ." The regulations dictate such process to ensure that the government will refund only those taxes qualified to be refunded pursuant to a basis recognized by law. (VAT Ruling No. 008-00) Zero-rated sales to the government creates an opportunity for some evasion such as when traders would show sales that did not actually take place, or when some of the sales invoices therefor had been deliberately overstated. (Value Added Tax by Alan A. Tait) Unfortunately, Mitsubishi did not show proof of any approved application for effective zero-rating to comply with the said requirement prior to its letter herein aforementioned. Its justification is not tenable considering that the series of legislations, rulings and court decisions as aforementioned afforded its every right to apply for effective zero-rating treatment of the subject transaction. It even had the remedial right to appeal in case of an unfavorable ruling either to the CTA or to the Department of Finance. That was what ABB Ltd. did with BIR VAT Ruling No. 063-91 declaring its foreign funded sale of services to NPC subject to 10% VAT; and what the NPC did with BIR VAT ruling No. 003-98 declaring the supply of electricity by San Pascual Cogeneration Co. to the NPC subject to 10% VAT. Premises considered, this Office, therefore, concludes that the sale of services by Mitsubishi to the NPC under the aforementioned foreign funded projects should have qualified as an effectively zero-rated VAT transaction; but, due to its failure to comply with the requirement of prior application and approval for effective zero-rating, it must be treated merely as a VAT-exempt transaction under Section 103(u) of the Tax Code of 1977, as amended (now Sec. 109(q) of the Tax Code of 1997). (SGD.) DAKILA B. FONACIER Commissioner of Internal Revenue 1st Indorsement March 10, 2000 Respectfully referred Commissioner DAKILA B . FONACIER , Bureau of Internal Revenue, BIR Building, Diliman, Quezon City, for comment, the attached letter of Mr . NAOYUKI NOBE , General Manager , Mitsubishi Corporation dated November 22, 1999 in connection with the Contract with the National Power Corporation (NPC) for the Furnishing Supply, Construction, Installation, Testing and Commissioning of Stage I of the Two (2) 300 MW Masinloc Coal-Fired Thermal Power Project at Masinloc, Zambales (Contract No. Sp90DLs-969). HTDAac (SGD.) SOLOMON S. CUA Undersecretary November 22, 1999 Hon. Edgardo B. Espiritu Secretary Department of Finance Roxas Boulevard Manila Re : Contract between the National Power Corporation (NPC) and Mitsubishi Corporation for the Furnishing, Supply, Construction, Installation, Testing and Commissioning of Stage I of the Two (2) 300 MW Masinloc Coal-Fired Thermal Power Project at Masinloc, Zambales (Contract No. Sp90DLs-969) ("Masinloc Project") Dear Sir : We write in connection with the letter dated 20 September 1999 of NPC President Mr. Federico Puno which was received by your office on October 09, 1999. In said letter NPC requested for a clarification of BIR Ruling No. DA 334-99 dated June 2, 1999 regarding the VAT treatment of the Masinloc Project and for a confirmation that the sale of services between Mitsubishi Corporation and NPC, which is funded by foreign loans, should be characterized as zero-rated rather VAT exempt. As contractor of NPC, we respectfully request that your office act favorably on NPC's request and issue a confirmation that our sale of services to NPC under foreign funded projects like the Masinloc should be characterized as zero-rated sales. If the transaction is considered merely VAT exempt, we will charge and recover the VAT from NPC. Such additional cost due to taxes will be paid by NPC from its own funds because under the applicable foreign loan agreements, NPC cannot apply the proceeds of the loan to the payment of any Philippine tax. Moreover, we understand that the BIR requires that a prior application and approval for zero rating be filed with the BIR as a condition for zero rate treatment. Please note that since our foreign funded projects with NPC commenced, the position of the BIR had always been that any sale to NPC, other than the sale of petroleum products, was subject to 10% VAT and, consequently, the BIR did not accept, process nor approve applications for VAT zero rating. In this regard, we respectfully request that if our sale to NPC is characterized as zero rated, the zero rate treatment should be made effective upon the commencement of the projects and the requirement of prior application with and approval by the BIR be dispensed with since, considering the BIR position at that time, it was impossible for Mitsubishi Corporation to obtain a prior approval for zero rating. We trust this request will merit your kind consideration. Very truly yours, (SGD.) NAOYUKI NOBE General Manager