The Philippine Economic Zone Authority (PEZA) is one of the country’s most efficient and top performing government agencies. It operates under the Department of Trade and Industry, which is tasked to encourage foreign direct investments through environment friendly economic zones located in different parts of the country.
As one of the investment promotion agencies, PEZA administers the incentives provided under Republic Act (RA) 7916 (also known as “The Special Economic Zone Act of 1995” or PEZA Law), which grants special tax incentives to PEZA-registered enterprises. Among those incentives is the 5 percent preferential tax on the gross income derived from registered activities of PEZA-registered enterprises, which is in lieu of all national and local taxes.
For purposes of the 5 percent preferential tax, the ter m “gross income” as defined in the Implementing Rules and Regulations (IRR) of RA 7916 refers to the gross sales or gross revenues derived from business activity within the economic zone, net of sales discounts, sales returns and allowances, and minus the costs of sales or direct costs. But that is before any deduction is made for administrative expenses or incidental losses during a given taxable period.
In Revenue Regulations (RR) 02-05, which implemented the tax incentives provisions of RA 7916, the Bureau of Internal Revenue (BIR) provided a list of expenses that PEZA-registered enterprises may deduct for purposes of the 5 percent preferential tax rate. RR 02-05 provides that only the cost or expenses enumerated therein may be deducted in computing the 5 percent tax, which means the list is exclusive.
In an apparent softening of its position, the BIR issued RR 11-05 amending Section 3 and other pertinent provisions of RR 02-05 on the scope of allowable deductions for PEZA-registered enterprises. The restated phrase now says “the following direct costs are included in the allowable deductions . . .” The change in the wording as interpreted by the BIR in its various rulings issued after issuance of RR 11-05 means that the allowable deductions are not exclusive. Thus, according to the BIR, as long as the costs can be attributed to activities involved in producing the product, they are allowed as deductions for purposes of computing the 5 percent final tax.
However, in BIR Ruling No. 14-2012 and the subsequent rulings issued to date, the BIR stipulated that the enumerations under RR 11-05 are exclusive. Also noteworthy is that BIR Ruling 14-2012 even made a pronouncement revoking all existing rulings inconsistent with the interpretation that the list of allowable deductions is exclusive. Suddenly, the allowable deductions of PEZA-registered enterprises have again been limited to those enumerated on the list, thereby increasing the gross income tax liability of PEZA-registered enterprises. Consequently, many PEZA-registered enterprises were issued deficiency tax assessments due to the disallowance of their expense deductions claimed as direct costs, which are not included in the list under RR 11-05.
Appeals questioning the BIR’s interpretation were filed by PEZA-registered enterprises upon these tax assessment cases and reached the Court of Tax Appeals.
In one of its recent decisions, the CTA en banc held that the list of direct costs that PEZA-registered enterprises may deduct to arrive at their gross income is not exclusive, i.e., the list is intended merely as a guide in determining whether an expense may be treated as an allowable deduction for purposes of computing the 5 percent gross income tax (CTA EB No. 1207, February 3, 2016). In other words, other expenses incurred by PEZA-registered enterprises that are in the nature of direct cost, even if they are not included in the list under RR 11-05, may still be claimed as deduction as long as they are directly related to the taxpayer’s registered activity/ies.
The CTA’s decision is a welcome development for PEZA-registered enterprises. However, they can only hope that if ever the tax controversy reaches the Supreme Court (SC), the SC will affirm the CTA’s decision and finally put to rest this tax issue, providing clarity to the widespread confusion regarding the manner of determining the 5 percent tax on PEZA-registered enterprises.
For PEZA-registered enterprises, the battle does not end there, though, as they face other tax issues.
Some of the issues that bear pointing out are the conditions/restrictions imposed by the BIR on the entitlement to VAT-zero rating of PEZA-registered enterprises on their local purchase of goods and services, the scope of their local tax exemption and exemption from documentary stamp taxes, and other national internal revenue taxes of PEZA-registered enterprises under the 5 percent tax regime. As such, PEZA companies may also want to look into these tax issues and start challenging the BIR and LGU’s interpretations and implementations of the tax incentives before the Courts.
These tax issues that the PEZA companies are facing are very discouraging to current and future PEZA companies as these reflect the lack of consistency in the government’s policies toward foreign investments. As the country pursues its goal of getting a fair share of foreign direct investments, it would do well for the government to resolve these tax issues as soon as possible.
The author is an Assistant Tax Manager with the Tax & Corporate Services division of Navarro Amper & Co., the local member firm of Deloitte Southeast Asia Ltd., a member firm of Deloitte Touche Tohmatsu Limited—comprising Deloitte practices operating in Brunei, Cambodia, Guam, Indonesia, Lao PDR, Malaysia, Myanmar, Philippines, Singapore, Thailand and Vietnam.