Is the foreign soil theory for economic zones dead? Should everybody protect themselves and pass on the 12 percent value-added tax (VAT) to registered enterprises? Should the government be collecting what it will anyway be obliged to refund? What are the real costs of this new direction – or this confusing policy?
PEZA-registered and export enterprises were initially perplexed by Revenue Regulations 9-2021, then caught off-guard by the new BIR advisory that followed it. The advisory said that no further applications for VAT zero rating shall be entertained and prior rulings will expire on June 27, 2021. Generally, it was read to be saying that everyone will need to pass on VAT to registered business enterprises.
Because of these new BIR regulations, the PEZA itself reluctantly issued an advisory to its zone administrators to pass on the VAT in the meantime, even on lease rentals (thus, even on property used for manufacturing operations). Expect all suppliers to copy what the zone administrators will do.
To be fair, our incentive laws are not too bad. Neighboring countries may offer longer income tax holiday periods. They also have substantial discounts on income tax as part of their incentives. But we have the five percent gross income tax (GIT), in lieu of all national and local taxes. Under the Corporate Recovery and Tax Incentives for Enterprises (CREATE) law, it will sunset in 10 years for old and new registrants alike, but we still have that as a differentiation to control tax-related costs of registered enterprises while they enjoy it.
Also, the original PEZA law, Section 8 in particular, mandated that ecozones be managed and operated as a separate customs territory. The Supreme Court chimed in, saying that this mandate created a fiction that ecozones are foreign territory. This accepted and previously implemented rule simplified a number of issues related to duties and VAT on goods supplied and services rendered to registered enterprises in the zone.
Certain things now muddle the rule. When the earlier TRAIN law was being passed, a provision expressly said that sale and delivery of goods to registered enterprises within a separate customs territory shall be zero-rated. However, this specific provision was vetoed by the President. This may have raised doubts as to the effect of the veto (that is, since this has been vetoed, the separate customs territory rule is also abandoned). It must not be overlooked, however, that Section 8 of the PEZA law was not amended either by the TRAIN law or the CREATE law. If it was not amended, then such law along with the Supreme Court decisions that enshrined it remains valid.
The CREATE law, however, punched a hole in this foreign soil fiction when it limited the duty-free importation to goods that are “direct costs” of the registered enterprise.
Moreover, the CREATE law still allowed but qualified VAT exemption on purchase of goods and services to those which are “directly and exclusively used in the registered project or activity” of the enterprise. On these CREATE provisions, I submit two salient observations: (1) the law did not limit the VAT exemption to purchases forming part of “direct costs” (unlike the duty exemption on imported goods), and (2) the “registered project or activity of the registered enterprise” could not literally be referring to the manufacturing activity or client service alone.
No company can solely exist on manufacturing goods or providing services. They need funding for operations. They need personnel to find and hire the people who will work in factories or deliver services. They need accounting people to record transactions, safeguard assets, provide data and comply with government regulations. These may not be direct costs but are all indispensable to the registered activity. If the CREATE law meant to limit exemption of VAT on purchases which are “direct costs,” why didn’t it say so, and why didn’t the BIR regulations say so? On the other hand, if the law never intended any VAT exemption on purchases, why did it say the contrary?
Note that under the CREATE law, except for real property taxes, the five percent tax is still in lieu of all national and local taxes, including VAT on purchases. An enterprise subject to five percent GIT cannot recover the VAT because they are VAT-exempt. Any VAT unduly passed on to them will form part of their cost. While the five percent GIT is a good regime, the 12 percent VAT cost from the local supply chain will be a very onerous and quite an unexpected (new) disincentive. Who under the CREATE law can protect the registered enterprises?
Export enterprises now fear about their refund chances as the President vetoed the CREATE law provision requiring the government to process VAT refund within 90 days because it is administratively unrealistic. But why collect something that the government will be legally obliged to return? That may build cash flow for the government, but does that build trust?
In this big VAT mess, there are real costs involved to exporters. The 12 percent additional cost on purchases can wipe out thin margins. It will cost us our credibility on how we implement our laws. There will be costs on our attractiveness as an investment destination while other economies, like India, become strong options. Export business is after all not after the domestic market, hence quite portable.
We hope the pandemic spirit of coming together for the common good can still prevail and policy will be reconsidered. But beyond that hope, it is not helplessness – there are legal remedies and judicial institutions that can level the playing field. Better to have investors that fight to stay here, than those that bear it but then plan to get out of here.
Atty. Alexander B. Cabrera is the chairman emeritus at Isla Lipana & Co./PwC Philippines. He is the chairman of the Integrity Initiative, Inc. (II, Inc.), a non-profit organization that promotes common ethical and acceptable integrity standards. Email your comments and questions to ph_aseasyasABC@pwc.com.