VAT Ruling No. 053-03

December 15, 2003 VAT RULING NO. 053-03 Sec. 106, NIRC of 1997; Article 1602, Civil Code; RA 7916 000-00 Angara Abello Concepcion Regala & Cruz Law Offices ACCRA Building, 122 Gamboa St., Legaspi Village Makati City Attention: Attys. Senen Y. Glinoga and Tesi Lou S. Guanzon Gentlemen : This refers to your letter request dated April 11, 2003 requesting on behalf of your client, Takata (Philippines) Corporation (Takata for brevity) for a ruling confirming that the sale of equipment by Takata to an affiliated foreign financing company, in connection with a "Sale-Leaseback Financing" (sale/leaseback for brevity) is not a sale in contemplation of the law on value-added tax (VAT for brevity) and, therefore, not subject to the VAT. The facts, as you represent, are as follows: Takata was incorporated on 11 April 1997 as a wholly-owned subsidiary of Automotive Safety Systems Worldwide Pte., Ltd. of Singapore (now known as Takata Asia), which is a wholly-owned subsidiary of a financing corporation, Trec (Holland) Amsterdam B.V. (TREC for brevity), which in turn is a wholly-owned subsidiary of Takata Corporation of Japan. [Takata (Japan) for brevity]. Takata was organized primarily "to engage in the business of designing, manufacturing, processing, importing, buying and selling, installing or otherwise dealing in: safety devices, equipment, and systems of all classes and descriptions, including those for motor vehicles and airplanes; component parts of such safety devices, equipment and systems; software and analysis systems relating thereto; . . . ." In 15 April 1997, Takata was registered as an Ecozone Export Enterprise under Republic Act No. 7916 otherwise known as "The Special Economic Zone Act of 1995" (RA 7916 for brevity). As a registered ECOZONE entity, Takata was granted tax and duty exemption in connection with its registered activity. In order to facilitate start-up of its operations in the Philippines, Takata initially acquired various machineries and equipment for use in its production (collectively referred to as the "Equipment") from Takata (Japan). The purchase was made under credit terms which required the payment of the purchase price within sixty (60) days from installation thereof. The entire project involved a series of importations of the Equipment, from 1999 to 2001, amounting in the aggregate to approximately P643.5 million. Pursuant to its PEZA registration, the Equipment were imported into the Philippines duty and tax-free under Section 24, Chapter I of RA 7916 as implemented by Section 1, Rule XV of the Rules and Regulations (IRR for brevity). Due to the substantial cost of the Equipment and the restricted credit terms that required payment within the period of sixty (60) days from installation of the Equipment, Takata was compelled to finance the payment of the purchase price to Takata (Japan). In order to avail of a longer term and more favorable financing, given Takata's debt-to-equity ratio and projected cash flow, Takata negotiated a "sale/leaseback" financing from TREC. To pave the way for the "sale/leaseback" financing, Takata had to go through the process or formality of selling the Equipment to TREC and then simultaneously leasing back the same from TREC under an operating lease concept. The proceeds from the financing or sale were remitted by TREC in payment of Takata's obligation directly to Takata (Japan), the original supplier of the Equipment. Under the operating lease arrangement, Takata pays rentals to cover the equivalent of the principal and the interest payment of the financing extended by TREC, subject to the creditable withholding tax on the lease. At the end of the lease term, Takata would "reacquire" from TREC these Equipment at a price equivalent to their residual value (cost less accumulated depreciation). In reality, therefore, the sale was only a nominal one (sale by fiction, as it were, or incidental sale), since at the end of the lease, Takata would ultimately "reacquire" the Equipment. In reply, please be informed that Sections 105 and 106 of the National Internal Revenue Code (Tax Code) of 1997 provides as follows, to wit: "SEC. 105. Persons Liable. Any person who, in the course of trade or business, sells , barters, exchanges, leases goods or properties, renders services, and any person who imports goods shall be subject to the value-added tax (VAT) imposed in Sections 106 to 108 of this Code. "xxx xxx xxx." "SEC. 106. Value-added Tax on Sale of Goods or Properties. "(A) Rate and Base of Tax. There shall be levied, assessed and collected on every sale, barter or exchange of goods or properties, a value-added tax equivalent to ten percent (10%) of the gross selling price or gross value in money of the goods or properties sold, bartered or exchanged, such tax to be paid by the seller or transferor. (Emphasis supplied) "xxx xxx xxx." Based on the foregoing, to be subject to VAT there must be an actual sale, meaning a sale not only in form but in substance as well, applying the time honored doctrine in taxation of substance over form . In this case, there was no sale in substance because the contract is one of equitable mortgage under Article 1602 of the Civil Code of the Philippines, viz : "Art. 1602. The contract shall be presumed to be an equitable mortgage, in any of the following cases: "xxx xxx xxx." "(2) When the vendor remains in possession as lessee or otherwise; "xxx xxx xxx." "(6) In any other case where it may be fairly inferred that the real intention of the parties is that the transaction shall secure the payment of a debt or the performance of any other obligation. AaIDCS "In any of the foregoing cases, any money, fruits, or other benefit to be received by the vendee as rent or otherwise shall be considered as interest which shall be subject to the usury laws. The Equipment is merely the collateral or security for the payment by TREC of its purchase price to Takata (Japan). This is obvious from the facts as represented. In the first place, Takata shall retain possession of the Equipment as lessee; and in the second place, it may be fairly inferred that the real intention of Takata and TREC is that the transaction shall secure the performance of the obligation of Takata to Takata (Japan). These are badges of an equitable mortgage, which sufficiently raise the presumption that the contract is in fact an equitable mortgage. Such being the case, the sale by Takata to TREC pursuant to the "sale/leaseback" financing arrangement shall not be subject to VAT. This ruling is issued on the basis of the foregoing facts as represented. However, if upon investigation it shall be disclosed or discovered that the facts are different, then this ruling shall be without force and effect insofar as the parties herein are concerned. Very truly yours, (SGD.) GUILLERMO L. PARAYNO, JR. Commissioner of Internal Revenue