On filing prior applications for VAT zero-rating of sales

The Bureau of Internal Revenue (BIR) recently issued an advisory informing taxpayers that the Large Taxpayers Service and Assessment Service will continue to receive and process applications for Value Added Tax (VAT) zero rating on the sales of goods and services by suppliers of Registered Business Entities (RBEs), who were granted incentives by Investment Promotion Agencies (IPAs) under special laws. The said advisory also informed the taxpaying public that they need to follow the existing guidelines and procedures for these applications to be processed, which refer to Revenue Memorandum Order (RMO) No.7-2006 issued in 2006.
The Tax Incentives Management and Transparency Act (otherwise known as the Republic Act No. 10708, or the TIMTA Law) defines RBEs as any individual, partnership, corporation, Philippine branch of a foreign corporation, or other entity incorporated and/or organized and existing under Philippine laws, and is registered with an IPA. IPAs include the Board of Investments (BoI), the Philippine Economic Zone Authority (PEZA), the Bases Conversion and Development Authority, and the Subic Bay Metropolitan Authority (SBMA), among others.
The Philippines adheres to the destination principle for VAT. Under this principle, goods and services are taxed only in the country where these are consumed. Therefore, exports are zero-rated, but imports are taxed.
Various court rulings have explained that applying the destination principle to the exportation of goods means that the automatic zero-rating would be a primary benefit for the seller/exporter, who is directly and legally liable for the VAT. Such practice makes the seller internationally competitive by allowing the refund or credit of input taxes that are attributable to export sales. On the contrary, effective zero-rating is intended to benefit the purchaser/supplier of the exporter who, not being directly and legally liable for the payment of the VAT, would ultimately bear the burden of the tax shifted by the suppliers.
RBEs are given full relief from VAT, with the goal of making the Philippines a prime location of internationally competitive economic zones. This is in line with our country’s goal to be an exporting nation under Republic Act (RA) No. 8944 (Export Development Act of 1994).
Looking back, RA No. 9337 or the Reformed Valued Added Tax Law, amended portions of the 1997 Tax Code, but maintained that sales to export-oriented enterprises, and export sales under Executive Order (EO) No. 226, otherwise known as the Omnibus Investment Code of 1987, and other special laws are still subject to zero percent VAT. Subsequently, the BIR issued RR No. 16-2005 dated Sept. 1, 2005, or more commonly known as the Consolidated VAT Regulations of 2005, which require that, except for Export Sale under Sec. 4.106-5(a) and Foreign Currency Denominated Sale under Sec. 4.106-5(b), other cases of zero-rated sales need prior application with the appropriate BIR office for effective zero-rating.
Thereafter, the Commissioner of Internal Revenue at that time issued Revenue Memorandum Order (RMO) No. 7-2006, prescribing the regulations to implement the processing of applications for effective zero-rating. Thus, without an approved application for effective zero-rating, the transaction otherwise entitled to zero-rating shall be considered exempt.
Hence, it is important to understand that approval for VAT zero-rating is required only for effectively zero-rated transactions based on RMO No. 7-2006.
At that time, effectively zero-rated transactions include:

1. Sale of raw materials or packaging materials to export-oriented enterprises, whose export sales exceed 70% of total annual production;

2. Export sales under Executive Order No. 226 and other special laws;

3. Sale of goods, supplies, equipment, and fuel to persons engaged in international shipping, or international air transport operations;

4. Sales to persons or entities whose exemption under special laws or international agreements, to which the Philippines is a signatory, effectively subjects such sales to zero-rate;

5. Services rendered to persons or entities whose exemption under special laws or international agreements effectively subjects the supply of such services to 0% rate;

6. Services rendered to persons engaged in international shipping, or international air transport operations, including leases of property for use, and;

7. Services performed by subcontractors and/or contractors in processing, converting, or manufacturing goods for an enterprise whose export sales exceed 70% of total annual production.

For the first, second, and seventh items, these transactions are still subject to 0% VAT under the RA No. 10963 or the Tax Reform for Acceleration and Inclusion (TRAIN) Act, but will be subject to 12% VAT upon the satisfaction of the conditions, which include the establishment of an enhanced VAT refund system.
In 2007, the Secretary of Finance issued RR No. 4-2007 which considered as constructive exports all sales to export processing zones pursuant to RA No. 7916 (Special Economic Zone Act), as amended by 7903 (Zamboanga City Special Economic Act), 7922 (Cagayan Special Economic Zone Act) and other similar export processing zones; and sales to enterprises duly registered with SBMA pursuant to RA No. 7227. Thus, RR No. 4-2007 changed the classification of sales to enterprises registered with SBMA, PEZA, the Clark Development Authority, and other export processing zones under the said provision, from effectively zero-rated sales to automatic zero-rated sales, giving the same treatment to sales made to BoI-registered enterprises. To note, sales made to BoI-registered enterprises were already treated as subject to automatic zero-rating, hence no prior application was needed.
Moreover, RR 4-2007 also deleted the entire provision on the requirement of prior application for VAT zero-rating for all transactions. Others insisted that deleting the provision was an oversight in the drafting of the said regulations. What they perhaps failed to notice was that a change in the nature of the zero-rating of the sales to export processing zones from being effectively zero-rated, to automatic zero-rating, would actually mean that no prior application would be needed, since automatic zero-rating does not require prior application, unlike an effective zero-rating.
Given the landscape, could tax advisories have the same effect as BIR revenue regulations, which overturn RR 4-2007? Could it be treated like a Memorandum Circular issued merely for the internal administration of the BIR?
It also bears noting that as early as 2005, the Supreme Court held that BIR regulations additionally requiring an approved prior application for effective zero-rating cannot prevail over the clear VAT nature of transactions as can be perused from the supporting documents. It emphasizes that, other than the general registration of a taxpayer as a VAT taxpayer, the law does not require an additional application to be made for such taxpayer’s transactions to be considered effectively zero-rated.
The Supreme Court also held that the additional requirement grants unfettered discretion to officials or agents who, without fluid consideration, are bent on denying a valid application; and that administrative convenience cannot thwart legislative mandate.
It would be beneficial then for the BIR to consider revisiting this tax advisory, if only to further support the ease of doing business which is one of the main thrusts of the current administration’s 11-point Economic Plan for the Philippines.
This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the authors and do not necessarily represent the views of SGV & Co.
 
Cherry Liez O. Rafal-Roble is a Tax Senior Director of SGV & Co.