VAT on Ecozone Transactions (by Tata Panlilio)

The Bureau of Internal Revenue (BIR), in connection with the recent amendments to the VAT law, is in the process of drafting a Revenue Memorandum Circular (RMC) which aims to provide guidelines on the taxation of sales, lease or exchange of goods, property and services to, within and without the PEZA special economic zones (Ecozones) and the Subic Bay Freeport Zone (SBFZ).
R.A. 7916, better known as “The Special Economic Zone Act of 1995” expressly provides that “[T]he Ecozone shall be managed and operated by the PEZA as a separate customs territory.” Similarly, R.A. 7227 entitled “The Bases Conversion and Development Act of 1992” clearly states that “[T]he Subic Special Economic Zone shall be operated and managed as a separate customs territory ensuring the free flow of goods and capital within, into and exported out of the Zone xxx.”
Currently, the tax treatment of sales of goods and services to and by a PEZA-registered enterprise within and without the Ecozone is governed by RMC 74-99, the bases for which are the principles of “separate customs territory” and the “Cross Border Doctrine” of the VAT system.
These principles were clearly interpreted in a February 11, 2005 decision of the Supreme Court (SC) which ruled that in an Ecozone, being a separate customs territory, the legal fiction of a foreign territory is created. Consequently, sales made by a in the customs territory (i.e. outside the Ecozone) to a PEZA-registered entity are considered exports to a foreign country. Conversely, sales by a PEZA-registered entity to a person in the customs territory are deemed imports from a foreign country. Since the SBFZ is also operated as a separate customs territory, the same principles are applicable.
Under the “cross-border” principle of the VAT system, no VAT shall form part of the cost of goods destined for consumption outside of the territorial border of the taxing authority. If export of goods and services from the Philippines to a foreign country are free of VAT, then the same rules, in general, hold for such exports from the national territory to an Ecozone.
In the same case, the SC confirmed that RMC 74-99 “clearly and correctly provides that any sale of goods, property or services VAT-registered supplier from the customs territory to any Ecozone-registered enterprise – regardless of the class or type of the latter’s PEZA registration – is legally entitled to a zero-rate.”
A perusal of the latest version of the draft RMC indicates that it will continue to recognize the principle of “separate customs territory” and adopt the substance of RMC 74-99 on the following transactions:

1. sale of goods or services by a VAT-registered supplier from the customs territory to a PEZA or SBMA- registered that is enjoying the income tax holiday (ITH) incentive or the 5% special tax regime as well as those that are not entitled to such incentives but are subject to taxes under the 1997 Tax Code (i.e. certain service enterprises);
2. sale of goods or services by a VAT-exempt or non-VAT registered supplier from the customs territory to a PEZA or SBMA-registered entity;
3. sale of goods by a PEZA or SBMA-registered enterprise to a buyer from the customs territory (i.e. domestic sales). The draft RMC also confirms that PEZA or SBMA-registered enterprises can generate income from such domestic sales up to 30% of its total income and provides for the tax treatment of income from sales in excess of the prescribed threshold;
4. sale of services by a PEZA or SBMA-registered enterprise to a buyer from the customs territory; and
5. intra-ecozone sale of goods and services

In addition, the draft RMC reiterates that no prior BIR approval is necessary for suppliers to be entitled to VAT zero-rating. It also provides guidelines on how VAT-registered suppliers can recover input taxes on their sales to PEZA or SBMA-register ed enterprises as well a s on the options for BIR registration of the Ecozone enterprises.
With the clear pronouncements of the Supreme Court, the eventual promulgation of the RMC, is a step in the right direction which will confirm that the government is serious in strengthening the international competitiveness of Philippine Ecozones through definitive and consistent application of the tax laws.
(The author is a tax manager at Punongbayan & Araullo, member firm of Grant Thornton International. For comments and inquiries, e-mail Cristina.D.Panlilio@pna.ph or call 886-5511.)