Stranded Input VAT
By: Atty. Irwin C. Nidea, Jr.
"The CREATE MORE law has been in effect for approximately six months, and it has already drawn renewed attention from foreign investors. The incentive framework it introduced has encouraged stakeholders to reassess the benefits available to Registered Business Enterprises (RBEs) under Investment Promotion Agencies (IPAs)."
 Irwin C. Nidea Jr. +632 8403-2001 loc.330 |
The CREATE MORE law has been in effect for approximately six months, and it has already drawn renewed attention from foreign investors. The incentive framework it introduced has encouraged stakeholders to reassess the benefits available to Registered Business Enterprises (RBEs) under Investment Promotion Agencies (IPAs).
Under CREATE MORE, RBEs are classified into three categories:
• Registered Export Enterprises (REEs) - Enterprise engaged in manufacturing, assembling, or processing activity, including services that result in the direct exportation of goods or services; with minimum 70% of production directed to export.
• High Value Domestic Market Enterprises (HVDMEs) – with more than 15 billion peso capital or US$100 million export sales threshold.
• Domestic Market Enterprises (DMEs) – registered under an IPA but do not qualify as an REE or HVDME.
REEs and HVDMEs that are duly registered with an IPA are entitled to both VAT and duty-free importation incentives. In contrast, DMEs are granted only the duty-free importation privilege. This distinction reflects the relative economic contribution of each enterprise type.DMEs generally cater to the domestic market, either by supplying REEs and HVDMEs or by selling directly to unregistered local entities. Unlike REEs, DMEs do not export, and unlike HVDMEs, they do not meet the required capital investment threshold of at least PHP 15 billion. Hence, the scope of their incentives is more limited.
Previously, registration with an IPA conferred the benefit of being treated as operating within a "cross-border" zone—essentially outside the customs territory. This legal fiction created a blanket application of incentives. Under CREATE MORE, however, this “bubble” has been effectively dissolved. Incentives are now granted on a transactional basis, directly linked to the actual economic contribution of the activity or transaction. This shift represents a more targeted and performance-based approach to investment promotion.
Moreover, RBEs across all categories—REEs, HVDMEs, and DMEs—are also allowed to sell to the domestic market. The question that follows is: How are these local sales treated for VAT purposes? This has become a critical consideration for RBEs navigating compliance and strategic planning under the new law because of the recently issued revenue regulations. Sale of RBEs to the “local” market is subject to VAT. The reporting of the VAT on the sale, however, is now given a different compliance framework.
The responsibility for remitting VAT on local sales RBEs has shifted—at least for business-to-business (B2B) transactions. In these cases, it is now the buyer who is obligated to pay and remit the VAT, with the applicable form and reporting requirements varying depending on whether the purchase involves goods or services, and whether the seller is an economic/freeport zone locator or a BOI-registered enterprise. Meanwhile, the seller’s invoicing and compliance obligations still depend on whether it is VAT-registered and on the income tax regime it enjoys.
For business-to-consumer (B2C) transactions, the BIR recognizes that shifting the VAT remittance to the buyer is not administratively feasible. Thus, the RBE-seller remains responsible for paying VAT, highlighting an inconsistency in the implementation of the rule.
This scheme becomes more problematic when applied to DMEs. These DMEs do not enjoy VAT zero-rating on purchases and thus accumulate input VAT on both imports and local buys. If the responsibility for VAT remittance shifts to the buyer, DMEs will have no output VAT liability against which these input taxes can be credited. This results in stranded input VAT that cannot even be refunded, as the sales are not zero-rated.
The Bureau of Internal Revenue (BIR) is aware of the compliance gap created by the current VAT treatment of local sales by RBEs, particularly DMEs, and is reportedly exploring measures to address the issue. One possible approach under consideration is to revert the VAT remittance obligation back to DMEs. Doing so would restore their output VAT liability, which is essential to offset the significant input VAT they accumulate—especially since DMEs are not exempt from VAT on importation.
In contrast, REEs and HVDMEs benefit under the current rules for B2B transactions, where the buyer assumes responsibility for VAT remittance. However, this setup also introduces a practical downside: local buyers may hesitate to transact with REEs and HVDMEs due to the additional administrative burden not typically required when purchasing from non-RBE suppliers.
It is understandable that the government aims to streamline compliance for RBEs as part of its broader strategy to reduce red tape and attract greater foreign direct investment. However, the real challenge lies in ensuring that this objective does not come at the expense of practical implementation. The BIR, together with the IPAs, must find the right balance—one that upholds a fair and workable VAT credit mechanism for RBEs, while also avoiding a system so complex that it discourages local market participation.
The author is a senior partner of Du-Baladad and Associates Law Offices.
The article is for general information only and is not intended, nor should be construed as a substitute for tax, legal or financial advice on any specific matter. Applicability of this article to any actual or particular tax or legal issue should be supported therefore by a professional study or advice. If you have any comments or questions concerning the article, you may e-mail the author at This email address is being protected from spambots. You need JavaScript enabled to view it. or call 8403-2001 local 330.