Prior to the implementation of the Corporate Recovery and Tax Incentives for Enterprises Act (the CREATE Act), the Philippines adhered to the "cross-border doctrine", under which ecozones and freeport zones were considered foreign territories, even if they were situated within the Philippines. In effect, the sale of goods and services by a VAT-registered seller to registered enterprises in ecozones and freeport zones was treated as a constructive export subject to a VAT zero rating. According to the Philippine Bureau of Internal Revenue (BIR) in its recent Revised Memorandum Circular (RMC) No. 24-2022, the cross-border doctrine was rendered ineffectual and inoperative for VAT purposes under the CREATE Act. This appears to confirm the BIR's position that the cross-border doctrine will no longer apply, despite the fact that ecozones and freeport zones are recognised and managed as separate customs territories under the law creating them, and even though such provisions were not repealed by the CREATE Act.
Based on current law and regulations, only goods and services directly and exclusively used in the registered project or activity of a registered business enterprise (RBE) qualify for a VAT zero rating.
Meaning of "direct and exclusive use"
Under Revenue Regulations (RR) No. 21-2021, "direct and exclusive use in the registered project or activity" refers to such "raw materials, supplies, equipment, goods. packaging materials, services, including provision of basic infrastructure, utilities, and maintenance, repair and overhaul of equipment, and other expenditures" that must be "directly attributable to the registered project or activity without which the registered project or activity cannot be carried out". RMC No. 24-2022 further clarified that expenses for administrative purposes are excluded from the definition and that registered export enterprises should adopt a method for allocating local purchases between those used in the registered export enterprise's registered project or activity and for administrative purposes. If the local purchases are used in both the registered export enterprise's registered project or activity and for administrative purposes and the proper allocation cannot be made, the local purchase will be subject to the 12% VAT.
RMC No. 24-2022 also defined the term "other expenditures" as costs that are "indispensable" to the project or activity, which include expenses that are necessary or required to be incurred depending on the nature of the registered project or activity of the export enterprise. The RMC expressly mentioned that services for "administrative expenses", such as legal, accounting and other related services, are not considered expenses directly attributable to, and exclusively used in, the registered project or activity. This appears to ignore the fact that some of these services, such as legal services, may be "indispensable" as defined under the RMC to the registered project or activity.
Notably, similar to the definition in the amendment to the implementing rules of the CREATE Act, RMC No. 24-2022 also uses the term "directly attributable" to describe what is meant by other expenditures that are "directly and exclusively used" in a registered export enterprise's registered project or activity. The use of the term "directly attributable to and exclusively used" appears to be less restrictive than the term "direct and exclusive use" and could cover a broader range of expenditures. However, the term "attributable" is not found in the CREATE Act. Thus, it is still unclear how the BIR will view the VAT treatment of local purchases during an audit if a registered export enterprise claims that a local purchase of goods or services is VAT zero-rated, as it is directly attributable to its registered project or activity, even if it is not directly and exclusively used in such project or activity.
For the purchase of goods or services to be zero-rated, prior to the transaction, a registered export enterprise purchaser must provide their suppliers with a photocopy of:
- its BIR certificate of registration (BIR Form No. 2303);
- its certificate of registration and VAT certification issued by the concerned investment promotion agency; and
- a sworn declaration stating that the goods or services being purchased shall be used directly and exclusively in the registered export enterprise's registered project.
The supplier must also secure prior approval from the BIR in order that their sales to the registered export enterprises will be agreed the VAT zero rating. Without the prior approval of the BIR, the supplier runs the risk of having its VAT zero-rated sale subjected to VAT. The supplier will also be required to submit the approved application for VAT zero rating if it files a claim for refund of the input VAT under section 112(A) of the Tax Code.
Input VAT recovery
In cases where VAT is erroneously passed on by a local supplier to a registered export enterprise, the latter can seek reimbursement from the former, and the previously issued invoice or receipt to the registered export enterprise must be returned to the local supplier for cancellation and replacement.
If VAT is paid or incurred for purchases not directly and exclusively used in the registered project or activity of the registered export enterprise, the registered export enterprise may:
- claim the VAT as an input VAT credit under section 110 if it is also enjoying the income tax holiday incentive;
- file a claim for VAT refund upon expiration of its VAT registration if the registered export enterprise has no sales subject to VAT; or
- charge the VAT to a cost or expense account if it is non-VAT registered.
If the RBE is categorised as a domestic market enterprise (DME), it is not entitled to the VAT zero rating on its local purchases. Sales of goods or services to a registered DME are subject to 12% VAT. The registered DME may recover the input VAT by:
- deducting the input VAT against its output VAT if it is VAT-registered;
- filing a claim for a refund if it has zero-rated sales; or
- charging the VAT to a cost or expense account if it is not VAT-registered.
RMC No. 24-2022 also clarifies the VAT treatment for the sale of goods and services during the effectivity of RR No. 9-2021 (ie, from 27 June 2021 to 30 June 2021) and sales during the effectivity of RR No. 9-2021 but covered by the retroactive application of RR No. 21-2021 (ie, from 1 July 2021 to 27 July 2021). RR No. 9-2021 implemented the provision in Republic Act No. 10963, or the Tax Reform for Acceleration and Inclusion Law (the TRAIN Law), subjecting to 12% VAT certain transactions that were previously subject to 0% VAT. Sales of goods and services that transpired from 27 June 2021 to 30 June 2021 are subject to 12% VAT. In the case of sales that transpired from 1 July 2021 to 27 July 2020, the seller and the purchaser have the option to treat the transaction as either subject to 12% VAT or revert the transaction from being subjected to 12% VAT to the zero rating.
It is expected that industries will welcome the BIR's efforts to remove uncertainties on the VAT treatment of transactions by registered export enterprises, and the transitory provisions and various issues pertaining to the applicability and coverage of VAT zero-rating transactions under RR No. 21-2021.
Nonetheless, registered export enterprises and their suppliers may still have concerns regarding the implementation of the changes to the VAT incentives brought about by the TRAIN Law and the CREATE Act with the issuance of RMC No. 24-2022. Registered export enterprises would likely wish to be able to use the VAT incentive and may be more inclined to argue that an expenditure qualifies for VAT zero rating, while suppliers may be more inclined to adopt a cautious approach since the wrong VAT treatment can result in deficiency VAT assessments against the suppliers. The RMC also does not provide much by way of guidance where a service incurred is arguably related or is attributable to a registered activity. For example, legal advice sought in connection with a lease contract of a registered export enterprise locating in an ecozone or research and development costs incurred for the enhancement of a registered project or activity would appear to be directly used in the registered business or activity of the enterprise. In the meantime, affected taxpayers will have to be guided by the rules and procedures set out in RMC No. 24-2022 to minimise non-compliance issues.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.