The CREATE Law (Republic Act No. 11534) which took effect in 2021 introduced tax reforms which are thought to benefit the government and the country in the long run. The law rationalized tax incentives granted to enterprises registered with Investment Promotion Agencies (IPAs) while also amending the powers vested upon such agencies. Primarily, the law put a timeline on the incentives by limiting the number of years that Registered Enterprises or REs (those registered with various IPAs such as BoI, PEZA, etc.) may enjoy certain tax incentives, and made the incentives uniform across all IPAs.

To implement the value-added tax (VAT) provisions of the CREATE Law, the Bureau of Internal Revenue (BIR) issued Revenue Regulations (RR) No. 21-2021, defining what transactions are subject to 0% VAT. The RR basically enumerates expenses that would fall under the phrase “direct and exclusive use” in the registered activity. It also imposed administrative requirements (e.g., endorsement from the IPA) before the VAT incentives can be enjoyed.

The RR attracted a lot of inquiries (to say the least) such that affected taxpayers and their suppliers sought clarification as to how the phrase “used directly and exclusively” should be defined. More specifically, what expenses may qualify under this phrase.

As such, the BIR issued Revenue Memorandum Circular (RMC) No. 24-2022 to clarify the phrase. The RMC provided guidance on the documentary support needed for RE suppliers to obtain prior BIR approval for the VAT zero-rating. It also specifically mentioned that legal, accounting and other such services do not qualify as expenses used directly and exclusively in the registered activities of an RE.

Now comes RR 3-2023, which was issued on April 20. In my view, there are the important points which must be (re)considered.

The following services were specifically identified as not “directly and exclusively used” in the registered project or activity of an RE:

1. Janitorial services;

2. Security services;

3. Financial services;

4. Consultancy services;

5. Marketing and Promotion; and

6. Services rendered for administrative operations such as Human Resources (HR), legal and accounting.

This is a sort of “Negative List” of services where 12% VAT may be passed on to an RE by its service providers. Note though that even with this Negative List, the RR still allows the REs a measure of flexibility. As long as the RE is able to provide supporting evidence to the IPA, justifying that the purchase of the above-listed service items can be categorized as “directly and exclusively used” for their registered activities, such expenses may still be entitled to 0% VAT.

Flexibility is key since although the expenses listed above may not qualify as “directly and exclusively used’ in the registered operations of the REs, they are necessary for them to do business in the Philippines. Some of these expenses are even incurred to comply with regulatory requirements. Now, REs will be further burdened by the added cost of the 12% VAT, which will be passed on by suppliers.

The RR also reiterated the guidance provided in RMC 24-2022 for the IPAs when issuing the VAT Zero Rating Certification. As provided in the regulation, “In issuing the 0% VAT certification, the concerned IPA shall be guided by the rule that such local purchases of services are directly attributable to the registered project or activity without which such registered project or activity cannot be carried out. These are costs that are indispensable to the project or activity, i.e., without which the project or activity cannot proceed, and these include expenses that are necessary or required depending on the nature of the registered project or activity of the export enterprise.”

While there are no guidelines yet as to the procedures that REs need to follow if they are going to justify such expenses as directly and exclusively used in their registered activities with the IPAs, the BIR has the right to conduct a post-audit verification of goods/services which were subjected to 0% VAT. However, if a VAT zero rating Certification has already been issued by the IPAs, this should be given great weight. It must be assumed that REs were able to properly support the nature of the relevant expenses as they relate to the definition of the phrase ‘direct and exclusively used.’ Otherwise, the efforts of both the REs and IPAs would be futile.

As before, where the purchased goods or services are used in both the registered project or activity and administrative operations, the RE may apply the best allocation method to allocate such purchases. However, note that if a proper allocation cannot be made, the entire purchase price is subject to 12% VAT.

A welcome development in this regulation is the fact that it will now just be the IPA that issues the 0% VAT Certification. This means that suppliers of REs are no longer required to apply for approval of VAT zero-rating with the BIR, and any pending application will be accorded 0% VAT treatment from the date of filing, as long as a 0% VAT certification has been secured from the IPA. Health Maintenance Organization (HMO) plans acquired by REs for their employees who are directly and exclusively involved in the operations of their registered projects or activities may also be categorized as “directly and exclusively used” in the registered activity. 

Since some HMO plans may also cover dependents of employees, this is a case where the allocation of purchased services, as provided in the preceding paragraph, may apply.

One of the most critical issues is whether RR 3-2023 applies retroactively. PEZA, in its Memorandum Circular No. 2023-31 reiterating the provisions of the RR, said it lobbied for retroactive effectivity. This makes sense given that RR 3-2023 merely clarifies and expounds upon the provisions of RR 21-2021 and RMC 24-2022.

As it is currently worded, however, RR 3-2023 applies prospectively. In fact, the regulations only explicitly discuss what will happen to the pending VAT zero-rating applications. Nothing was mentioned about previously denied applications. I believe this should be revisited. As provided in jurisprudence, the BIR’s administrative requirements should not impair a taxpayer’s right to avail of tax incentives which are clearly provided under the law without any limitations. The law must always prevail.

The views or opinions expressed in this article are solely those of the author and do not necessarily represent those of Isla Lipana & Co. The content is for general information purposes only, and should not be used as a substitute for specific advice.

John Edgar S. Maghinay is a director at the Tax Services department of Isla Lipana & Co., the Philippine member firm of the PwC network.

+63 (2) 8845-272

john.edgar.s.maghinay@pwc.com