Upon the effectivity of the Corporate Recovery and Tax Incentives for Enterprises (CREATE) Act on April 11, 2021, a new requirement to support the VAT zero-rating of local purchases of registered business enterprises was introduced.
CREATE required registered business enterprises to prove that their local purchases of goods and services are directly and exclusively used in their registered activities to be accorded 0% VAT rating. Several issuances were subsequently published, which placed many taxpayers in limbo because of the seemingly conflicting provisions related to the VAT zero-rating of local purchases.
Almost a month before the anniversary of CREATE, the Bureau of Internal Revenue (BIR) recently issued Revenue Memorandum Circular (RMC) No. 24-2022, which intends to harmonize and clarify the new VAT zero-rating rules and requirements under CREATE.
CROSS-BORDER DOCTRINE NOW ‘INEFFECTUAL AND INOPERATIVE’Before CREATE, Ecozones and Freeport zones were regarded as foreign territories (by way of legal fiction) under RMC No. 74-99 and RMC No. 7-2007. Under the cross-border doctrine, sales to registered business enterprises located within these Ecozones and Freeport zones could be treated as constructive exports subject to 0% VAT.
However, following the effectivity of CREATE, the cross-border doctrine is no longer applicable. This is because CREATE expressly requires registered export-oriented enterprises to prove the direct and exclusive use of their purchases of goods and services in its registered activities, a departure from the old rule which generally anchored zero-rating of purchases on being economic zone locators.
To add, the availment of VAT zero-rating for registered export-oriented enterprises becomes subject to certain parameters regardless of location (i.e., time-bound as it becomes subject to the conditions and period of availment in Sections 295 and 296 of CREATE) under Section 294(E) and Section 295(D) of the Tax Code, as amended by CREATE.
It now provides that the effective VAT zero-rating will only apply to the sale of goods and services rendered to persons or entities which have direct and indirect tax exemptions pursuant to special laws or international agreements to which the Philippines is a signatory.
Based on these developments under CREATE, investors may now consider reassessing incentives that were previously location-based.
CHANGES TO VAT ZERO-RATINGSince the effectivity of CREATE, the VAT exemption on imports and VAT zero-rating of newly registered and existing registered business enterprises (RBEs) only applied to goods and services that are directly and exclusively used in the registered project or activity of registered export enterprises. The phrase “directly and exclusively used in the registered project or activity of registered export enterprises” was explained under Q&A No. 13 of RMC No. 24-2022 as those raw materials, inventories, supplies, equipment, goods, packaging materials, services, including provision of basic infrastructure, utilities, maintenance, repair and overhaul of equipment, and other expenditures that are directly attributable to the registered project or activity, without which the registered project or activity cannot be carried out.
In the case of common expenses, taxpayers were directed to adopt a method to best allocate goods or services purchased (e.g., the use of separate water and power meters among activities). Otherwise, if the proper allocation could not be determined, then the purchase of such goods will be subject to 12% VAT. The RMC also made it clear that services for administrative purposes, such as legal, accounting and other similar services, are not considered directly attributable to and exclusively used in the registered project or activity.
Previously, a VAT zero-rating certificate was the only document that must be provided by a registered export enterprise to their local suppliers. However, RMC No. 24-2022 introduced additional requirements on top of the VAT zero-rating certificate, such as a photocopy of the export enterprise’s BIR Certificate of Registration, a sworn declaration stating that the goods or services being purchased are to be used directly and exclusively in the registered project, and other documents to corroborate entitlement to the VAT zero-rating.
These documents include but are not limited to duly certified copies of the purchase order, job order or service agreement, sales invoices and/or official receipts, delivery receipts. Registered export enterprises should also expect some changes in the VAT zero-rating certificate that will be issued by its Investment Promotion Agency (IPA), which would now include the applicable goods and services meeting the direct and exclusive use criteria.
Registered export enterprises must strictly observe the abovementioned criteria and documentation in order to prove the VAT zero-rating of its local purchases of goods and services. This means that registered export enterprises may need to factor in additional compliance requirements to avail of the VAT zero-rating and be able to sustain a claim of VAT zero-rating if eventually audited by tax authorities.
The role of tax managers, compliance officers, custodians of records, and the like may have to be expanded as well to ensure that the necessary documentary requirements are secured in a timely manner, compliant with the existing requirements under our tax rules, and would still be available in the event of a tax audit.
EXPORTER TAX TREATMENT BEFORE CREATEQ&A No. 23 of the same RMC clarified that registered export enterprises existing prior to CREATE continue to enjoy VAT zero-rating on their local purchases until the expiration of their incentives, as specified in the Implementing Rules and Regulations of CREATE. However, the direct and exclusive use criteria must still be met. Otherwise, sellers of goods and services will be required to pass on the 12% VAT to their registered export enterprise customers within the Ecozone.
The RMC further explained that any input VAT passed on for purchases of goods and services not directly and exclusively used in the registered project or activity may no longer be used to apply for a VAT refund. Instead, the RMC presented three options that a registered export enterprise may avail of:
• A VAT-registered taxpayer enjoying an income tax holiday (ITH) may claim the passed-on input VAT as credit against future output VAT liabilities; or
• Accumulate the input VAT credits and claim for VAT refund upon expiration of its VAT registration (i.e., end of ITH and 5% SCIT incentive commences); or
• Charge to cost or expense account if non-VAT registered
Similarly, existing export enterprises which are already under the 5% gross income tax (GIT) and special corporate income tax (SCIT) were required to change their registration status from a VAT-registered entity to non-VAT within two months from the effectivity of RMC No. 24-2022.
It must be noted, however, that the input VAT charged to cost or expense account may not qualify as a “direct cost” for an export enterprise that is already availing of the 5% GIT or 5% SCIT. In which case, there would be no tax benefit on any input VAT passed on by its local suppliers.
ACTION PLAN MOVING FORWARDWith the effectivity of RMC No. 24-2022, registered export enterprises and their domestic sellers of goods and services must familiarize themselves with the new principles and additional requirements of VAT zero-rating on local purchases.
Given the strict “direct use” requirements, registered export enterprises may consider performing a careful review of their local purchases of goods and services to identify whether or not they meet the criteria. Export enterprises with a more complex business structure (i.e., those with multiple registered activities) and those which incur significant amounts in common expenses may revisit their allocation method among registered and non-registered activities.
Otherwise, without diligent study, a registered export enterprise may face a significant amount of input VAT that it may not be able to recover.
This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the author and do not necessarily represent the views of SGV & Co.
Christiene R. Matic is a director from the Global Compliance and Reporting service line of SGV & Co.