The CREATE Act continues to live up to the hype, as taxpayers anxiously await the release of its implementing guidelines. The law is intended to attract foreign investment and boost employment through the introduction of a harmonized set of tax incentives that are available from various Investment Promotion Agencies (IPAs) such as the Philippine Economic Zone Authority (PEZA), Board of Investments, Subic Bay Metropolitan Authority, Clark Development Corp., etc. While the law has drawn flak from export-oriented enterprises due to the sunset provision on existing tax perks, it was still able to address the inconsistent tax benefits from the IPAs.

Aside from the alignment of the tax incentives, the law still allows qualified enterprises to avail of the Income Tax Holiday (ITH) and a Special Corporate Income Tax (SCIT) rate of 5% after the ITH period. The SCIT is similar to the 5% gross income tax (GIT) under the previous incentive regime, which is computed based on the registered enterprise’s gross income.  Perhaps what could be relevant to the export enterprises is how the tax regulators will treat the deductible expenses in computing the 5% SCIT under the implementing guidelines.

There has been an ongoing debate as to which expenses can be deducted under the 5% GIT regime. In the case of PEZA-registered entities, the Bureau of Internal Revenue (BIR) issued two Revenue Regulations in 2005 (RR Nos. 2-05 and 11-05).  RR No. 2-05 provided an exclusive list of deductible expenses, which can be treated as “direct costs.” However, the BIR subsequently issued RR No. 11-05, which removed the exclusivity of the expense list. Instead, the BIR stated that the enumeration provided is merely a set of examples; hence, other types of direct expenses can still be claimed as deductions under the 5% GIT regime.

Despite the update on the regulations, during tax audits, BIR examiners still disallow certain direct expenses that are not included in the enumerated list, following the exclusivity position of RR No. 2-05. The good thing is that in November 2020, the Supreme Court (SC) finally put an end to the issue when it held that the deductible costs and expenses in RR No. 11-05 are non-exclusive (G.R. No. 225266).  As such, other direct expenses not on the list can also be deducted. According to the high court, the BIR would not have changed the original regulation if the intention was to keep the list exclusive. In addition, the position of having the list of expenses as non-exclusive is consistent with the PEZA Law, which states that costs and expenses directly related to the registered activity and are not administrative, marketing, selling, and/or operating expenses or incidental losses shall be allowed as deductions.

Following the SC decision, for as long as the taxpayer can prove that the expense is a direct cost of its registered production/service activity, then it can be classified as an allowable deduction under the 5% GIT regime. In this respect, the accounting rules that provide the proper classification of the cost of goods sold/service would help in determining the “deductible” direct costs.

Further, taxpayers who took the more conservative position of claiming deductions based on the enumeration can amend their previously filed income tax returns to deduct the “other” direct costs. Such an option is available for as long as the taxpayer has not received a letter of authority from the BIR to conduct a tax audit of the tax return that will be amended. Of course, the amendment would also extend the statute of limitations for the BIR to audit the return, so this must also be considered against the potential tax savings. 

While the SC decision is an obvious victory for PEZA-registered companies, there is still a question on whether this position can also be applied to the export-oriented entities operating in other ecozones such as the Subic Freeport Zone (SFZ) and Clark Freeport Zone (CFZ).

Before I answer this question, let me briefly explain that SFZ and CFZ are governed by R.A. 7227 as amended by R.A. 9400, while PEZA is under R.A. 7916. Under the implementing rules of R.A. 9400, which were issued by the Department of Finance (DoF) in February 2008, enterprises registered with SFZ and CFZ can only claim those expenses that are enumerated in the list as deductions in computing the 5% GIT incentive. It takes the same position as BIR RR 2-05. Unfortunately, while the BIR has updated its rule on the non-exclusivity of deductible expenses for PEZA, the DoF has not changed its position for SFZ and CFZ enterprises.

Therefore, unless the DoF relaxes the rules on the allowable deductions to be non-exclusive like PEZA, I believe that the SC ruling does not hold in the case of SFZ and CFZ registered entities.

Considering that the tax regulators are still in the process of drafting the implementing guidelines of the new tax incentives law, I believe that this is the perfect time to revisit the deduction rules for the other ecozone locators and align them with the PEZA rules. Any changes can be easily incorporated since it will only require an amendment of the DoF rules at the administrative level and not the legislative law itself.

Indeed, there is reason to harmonize the rules in favor of the ecozone entities. Not only will it buttress government efforts to attract foreign investment, especially during a period of economic uncertainty, but also eliminate any double standard in our tax system, thereby realizing the purpose for which the CREATE Act was formulated in the first place.

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.

Joel Roy C. Navarro is a director at the Tax Services Department of Isla Lipana & Co., a Philippine member firm of the PwC network.

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