Tax Articles

Direct and Exclusive Use in Registered Activity:
Who Determines?

By Atty. Donato U. Vergara, III

Who determines whether a purchase from a local supplier or an importation made by a registered business enterprise (“RBE”) is directly and exclusively used in the latter’s registered project or activity? This is a question that needs to be clarified in view of the condition on the availment of incentives on the VAT zero-rating of purchases.

Among the incentives retained by the Corporate Recovery and Tax Incentives for Enterprises Act (“CREATE”) are the value-added tax (“VAT”) exemption on importation and VAT zero-rating on local purchases. These incentives may be granted to registered projects and activities of enterprises registered with investment promotion agencies.

For the recent months, the said incentive had been put on threat after the Implementing Rules and Regulations (“IRR”) of the Tax Incentives under CREATE adopted RR 09-21. The adoption of RR 09-21 effectively disregarded the VAT zero-rating incentive provided under CREATE. That interruption was halted when the authorities finally deferred the implementation of RR 09-21.

There are still confusions on the application of VAT zero-rating on local purchases by registered business enterprises, even with the deferral of the implementation of RR 09-21. But this uncertainty is with respect to the transactions which are not directly and exclusively used in the registered project or activity by RBEs. The lack of clarity is with respect to which provisions of the Tax Code prevail.

For the purchases made from local suppliers, which are directly and exclusively used in the registered project or activity by RBEs, the rule should be clear. These are subject to zero percent VAT. This treatment should not be affected whichever rules govern - whether the old provisions of the Tax Code on VAT zero-rating [Sections 106 and 108(B)] in relation to the cross-border doctrine remain to be applicable or the new provisions [Sections 294 and 295 on incentives as added by CREATE) prevail. Either rule supports the VAT zero-rating of sales to/purchases by RBEs, especially those located in economic/freeport zones.

In relation, however, to the condition for the enjoyment of the VAT zero-rating of purchases by/sales to RBEs under CREATE, a question needs to be clarified. Who determines whether a specific sale/purchase transaction is directly and exclusively used in the buyer’s registered project or activity? Unfortunately, the law does not provide. Neither does the IRR includes a mechanism in determining whether the goods and services involved are directly and exclusively used in the buyer’s registered activities. The IRR merely defines “direct and exclusive use” as referring to raw materials, inventories, supplies, equipment, goods, services and other expenditures necessary for the registered project or activity without which the registered project or activity cannot be carried out. But it does not provide a system in determining whether or not the subject of a sale is necessary to the customer’s registered project or activity.

With the difference in treatment between goods and services that are and that are not directly and exclusively used in registered activities, without providing sufficient guidelines in separating these two types of transactions, this will certainly result in confusions. I’d like to note that in the past (that is, pre-CREATE), the availment of zero-rating had not escaped controversies. Even when the sales to ecozone or freeport zone locators were zero-rated, without limitation or with very few exceptions, the VAT status of the sales were often questioned during examinations. Revenue examiners would tend to disallow the zero-rating of sales made by local suppliers and leave the suppliers the burden of justifying why their sales to ecozone locators should be zero-rated. Failure to produce sufficient documents and information to substantiate the treatment made would often result in assessment of the suppliers or denial of their refund claims.

Because of these experiences, some suppliers would take the conservative approach by opting to impose the 12% VAT on transactions that otherwise qualify as zero-rated. That in effect negates the benefits supposedly enjoyed by registered enterprises located in economic zones. And that’s not the only effect. The ultimate effect – the passed on VAT is lost in the process. The rules do not allow the ecozone locators to reclaim input taxes through refund, when the related purchase should have been treated as zero-rated. Instead, the remedy is for the buyer to reclaim the VAT component of the purchase from the supplier. But how can the supplier reimburse a tax that had already been remitted to the tax authority?

If these situations happen in transactions where zero-rating should be automatically recognized as in the case where zero-rating is not without condition, what more with respect to situations where there is a need to determine if the sold goods or services will be directly and exclusively used in registered activities? I am sure this requirement would be used to disallow the zero-rating of sales made by the suppliers or to deny the input taxes claimed by the RBE if the supplier chooses to pass on VAT.

These are just among the many scenarios underscoring the need for a structured guideline or mechanism in the determination of what are considered as directly and exclusively used in registered activity. Or better yet, the better option is to return to the previous rule where sales to RBEs are zero-rated without conditions, that is, without distinction as to their use. This is consistent with the cross-border doctrine which frees from VAT goods and services destined outside the Philippines. Since CREATE still recognizes the separate customs territory concept for special economic and freeport zones, the legal fiction that they are considered outside the Philippine should still apply. As a consequence, sales to locators within those zones should be free from VAT.