VAT Ruling No. 089-02

December 17, 2002 VAT RULING NO. 089-02 R.A. 7916 BIR Ruling 008-99 P. Imes Corporation Cavite Economic Zone Rosario, Cavite Attention: Florafe M. Bantayan Director and Controller Finance Gentlemen : This refers to your letters, dated January 30, 2002 and dated May 22, 2002, requesting for a ruling on the value added tax (VAT) consequences of your transaction with your Parent Company, the International Manufacturing and Engineering Services Co., Ltd., Japan (IMES-J, for brevity). It is represented that P. IMES is a domestic corporation duly organized and existing under the laws of the Republic of the Philippines; that, it is duly registered with the Philippine Economic Zone Authority (PEZA), pursuant to R.A. No. 7916, as amended, known as "The Special Economic Zone Act of 1995; that, it is doing business at the Cavite Economic Zone; that, it is engaged in the manufacture of computer products; that, it is 100% owned and controlled by IMES-J; that, starting the year 1995, P. IMES purchased fixed assets, consisting of equipment and machineries for use in the manufacture of its PEZA-registered products; that, the acquisition of these equipment and machineries was financed by loans obtained from banking institutions; that, P. IMES suffered foreign exchange losses and incurred interest expenses incident to the said asset acquisition, as follows: Foreign exchange losses from 1996 to 2000 P289,979,770.00 Interest expenses from 1995 to 2000 P72,819,690.67 That, on October 2000, Royal Asia Appraiser appraised P. IMES' fixed assets; that, these fixed assets are used in different projects, most of which are registered under the regime of the 5% special tax incentive, in lieu of all taxes, pursuant to R.A. No. 7916 while the rest are registered under the regime of the Income Tax Holiday (ITH) incentive, pursuant to E.O. No. 226, in relation to R.A. No. 7916; that, in order to save P. IMES from complete impairment of capital and further losses due to foreign exchange losses, P. IMES sold the said fixed assets to IMES-J on July 31, 2001; that, at the same time, however, IMES-J consigned these fixed assets back to P. IMES, for a consideration; and that the same are currently being used by P. IMES in its manufacturing operations. Based on the foregoing, it is your opinion: 1. That, the sale by P. IMES of its aforementioned fixed assets to IMES-J shall be entitled to the benefit of the zero percent (0%) VAT, based on the Cross Border Doctrine of the VAT System; 2. That, the sale by P. IMES of its fixed assets used for the manufacture of products registered under the five percent (5%) preferential tax regime, shall be subject to the 5% special tax, based on gross income earned, in lieu of all taxes; and 3. That, the sale by P. IMES of its fixed assets used for the manufacture of products under the Income Tax Holiday (ITH) regime shall be covered by the said ITH. In reply, please be informed as follows: 1. Sale Of Fixed Assets Of The Project Registered Under The Regime Of 5% Special Tax Incentive . This transaction is governed by the provisions of R.A. No. 7916, as amended. Hence, P. IMES' gross income earned therefrom shall be subject to the 5% special tax, in lieu of all taxes, pursuant to Section 24, R.A. No. 7916, as amended. Thus, it has been held in BIR RULING NO. 008-99, dated January 19, 1999, as follows: "Such being the case, and since R.A. 7916 is a special law which grants exemptions from payment of national taxes to PEZA-registered business establishments operating within the Ecozone, except payment of the preferential tax rate of 5% on the gross income earned, the gross income earned on the sale by KPC of its factory building located within the Ecozone in the course of winding up its registered business within the Ecozone is subject to the 5% preferential tax rate based on the gross selling price minus the depreciated cost of the building as of the date of cessation of commercial operations." Since the sale of fixed assets by a PEZA-registered enterprise in the course of winding up its business activities is embraced by the said 5% special tax regime, it stands to reason that P. IMES' sale of its fixed assets to its parent company, which the latter consigned back to P. IMES for its continued use in its PEZA-registered operations, must likewise be embraced by the said special tax regime. Consequently, this sale transaction is embraced by the 5% special tax, based on gross income earned therefrom by P. IMES, in lieu of all taxes. Pursuant to Sec. 24, R.A. No. 7916, as amended by R.A. No. 8748, and as implemented by Revenue Regulations No. 1-2000, promulgated November 12, 1999, 3% of the 5% special tax shall be remitted directly to the BIR while the remaining 2% thereof shall be paid directly to the concerned City or Municipality, as follows: "SEC. 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." 2. Sale Of Fixed Assets Of The Project Registered Under The Income Tax Holiday (ITH) Incentive. This transaction shall be governed by the provisions of the National Internal Revenue Code of 1997 rather than by the provisions of the PEZA law. Thus, the CTA held in the case of Intel Philippines Technology, Inc., 1 based on existing BIR rulings, as follows: "Based on the aforequoted Section 23 of RA 7916, a PEZA registered enterprise has the option to choose between two sets of fiscal incentives. One is that which is provided for under Presidential Decree No. 66, as amended, and Section 24 of RA 7916 which includes 5% preferential tax on gross income earned which is in lieu of national and local taxes; and second, as those provided for under Book VI of Executive Order No. 226, including but not limited to an income tax holiday (ITH) of 4 to 6 years depending on whether or not an entity is registered as a pioneer or nonpioneer enterprise. If an ecozone enterprise chooses the 5% preferential tax, it is exempt from payment of all national and local taxes. However, if an ecozone enterprise chooses the income tax holiday, it is only exempt from payment of the income tax but still subject to other national internal revenue taxes including the value-added tax. The difference between these 2 sets of fiscal incentives were explained by the Bureau of Internal Revenue in VAT Ruling Nos. 037-98; 043-98; 027-99; and 063-99. ( Read-Rite Philippines, Inc. (formerly Sunward Technologies Phils., Inc. vs. Commissioner of Internal Revenue, CTA Case No. 5659, September 29, 2000; see also Commissioner of Internal Revenue vs. Seagate Technology Philippines, CA-G.R. SP No. 61189, June 18, 2001; Commissioner of Internal Revenue vs. Cebu Toyo Corporation, CA-G.R. SP No. 60304, July 6, 2001; and Commissioner of Internal Revenue vs. Hitachi Computer Products (Asia) Corporation, CA-G.R. SP No. 65482, October 16, 2001, all affirming the corresponding CTA decisions/resolutions )." This rule has been reiterated in VAT RULING No. 047-2002, dated August 5, 2002, in the case of Sumifleland Realty, Inc . The tax consequence of the above transaction follows: (a) Income tax. P. IMES' income from the above mentioned sale transaction is exempt from income tax because of its Income Tax Holiday incentive. (b) Value Added Tax. The aforementioned sale transaction by P. IMES is subject to 10% VAT, also pursuant to VAT RULING No. 047-2002, the pertinent portion of which reads: "Accordingly. Since . . . the sale . . . was made during the period FPIF is enjoying Income Tax Holiday, such sale transaction is subject to 10% VAT ." Your opinion that the above mentioned sale transaction, in the hands of P. IMES, may be entitled to the benefit of the zero percent (0%) VAT, based on the Destination Principle of the Cross Border Doctrine 2 of the VAT System, is not legally tenable considering that the said fixed assets did not cross the Philippine border for use or consumption outside of the Philippines. On the contrary, the same remain and are being used by P. IMES in its Philippine operations. Very truly yours, (SGD.) JOSE MARIO C. BUAG Deputy Commissioner Legal & Inspection Group Footnotes 1. INTEL TECHNOLOGY PHILIPPINES, INC., petitioner, vs. COMMISSIONER OF INTERNAL REVENUE, respondent. [C.T.A. CASE NOS. 5901 & 5942. March 1, 2002.) 2. See VAT RULING No. 034-98, dated November 16, 1998, in the case of NNA Philippines Co., Inc.