Domestic market enterprises regain their VAT zero-rating privileges

Have you ever wondered what goes through someone else’s mind when they wish to turn back time? You might say that you want to rectify past mistakes or explore whether their current circumstances might have turned out differently. More often than not, people tend to imagine themselves going back in time to somehow alter their present. Personally, I tend to advise against these ideas, as dwelling on what-could-have-beens often leads to frustration and prevents us from appreciating the beauty and value of one’s current life.

Still, if you were given the chance to revisit the past to clarify certain matters, would you take it? Would you turn back time?

Just as in the case of Subic Bay Freeport Chamber of Commerce, Inc. vs. Department of Finance, etc. (Subic Bay Freeport Case), the entitlement of Registered Business Enterprises (RBEs), specifically Domestic Market Enterprises (DMEs), to VAT-zero rating for local purchases has been revisited by the Supreme Court to provide clarity in the application of the law.

In this case, petitioners Subic Bay Freeport Chamber of Commerce (SBFCC) and Benjamin Antonio, as taxpayers, filed a Petition for Declaratory Relief with an Application for Writ of Temporary Restraining Order and/or Preliminary Injunction against respondents the Departments of Finance (DoF) and Trade and Industry (DTI), the Bureau of Internal Revenue (BIR), Revenue District Office No. 19 (RDO 19) of the Subic Bay Freeport Zone, and the Subic Bay Metropolitan Authority (SBMA), collectively referred to herein as respondents.

The petitioners alleged that the Implementing Rules and Regulations of Republic Act (RA) No. 11534 or the Corporate Recovery and Tax Incentives for Enterprises Act (CREATE IRR), particularly Rule 18, Section 5, Revenue Regulation (RR) No. 21-2021, Revenue Memorandum Circular (RMC) No. 24-2022, and RMC No. 49-2022, are invalid and unconstitutional after the issuances unjustly excluded DMEs from availing of tax incentives. Specifically, it effectively limited the application of VAT zero-rating for local purchases only to Registered Export Enterprises (REEs), excluding DMEs, such as SBFCC, making a distinction between DMEs and REEs when in fact there is none under the CREATE Act. Mainly, the petitioners contend that so long as an enterprise is a registered business, like SBFCC, it is entitled to VAT-zero rating on local purchases.

Now, before we proceed with the Supreme Court’s (SC) decision, let us first walk down memory lane and recount the creation and nature of SBFCC.

As outlined in the case, the Subic Special Economic Zone was created pursuant to Section 12 of RA No. 7227, or the Bases Conversion Development Act of 1992, to be operated and managed as a separate customs territory. Pursuant to SBMA’s issued Certificate of Registration and Tax Exemption, it granted tax incentives and exemptions to these entities, subject to certain conditions. Due to these incentives, SBFCC registered with the SBMA as a freeport enterprise to conduct business within the Subic Bay Freeport Zone (SBFZ).

It should be noted that upon passage of the CREATE Act, SBFCC has been classified as an RBE, specifically a DME, being an enterprise registered with the IPA, such as the Philippine Economic Zone Authority (PEZA). This finds support under the CREATE Act, which defines RBEs as corporations or other entities organized and existing under Philippine law and registered with an Investment Promotion Agency (IPA). Further, an RBE may be classified as a Registered Export Enterprise (REE) or a DME. DME refers to any enterprise registered with the IPA apart from export enterprises.

Under the CREATE Act, SBFCC, being an RBE, should be entitled to VAT exemption on imports and VAT zero-rating on local purchases of goods and services directly and exclusively used in the registered project or activity of the RBEs.

However, the DTI and the DoF, on implementing the CREATE IRR, limited the entitlement to VAT zero-rating on local purchases to REEs. As provided under Rule 18, Section 5 of the CREATE IRR, which implements Section 311 of the CREATE Act, VAT zero-rating on local purchases only applies to goods and services directly attributable to and exclusively used in the registered project or activity of REEs located inside ecozones and freeports. Additionally, Revenue Regulations (RR) No. 21-2021, implementing Sections 294(E) and 295(D), Title XIII of the National Internal Revenue Code (Tax Code), as amended by the CREATE Act, RMC No. 24-2022, and RMC 49-2022, further provided that the VAT zero-rating incentives apply only to REEs, excluding DMEs.

DMEs claimed irreparable injury by virtue of the law and BIR issuances because of their exclusion from the VAT zero-rating incentive. In effect, the VAT passed on to the DMEs by local suppliers was to be absorbed as part of their costs or expenses. Further, the petitioners contended that their sales were subject to the regular 12% VAT rate. These effects conflicted with the nature of DMEs as belonging to a separate customs territory, by virtue of which they should be exempt from VAT.

The SC likewise revisited CREATE Act and RA No. 10963 or the Tax Reform for Acceleration and Inclusion (TRAIN Law) and found that under Sections 294(E) and 295(D) of the CREATE Act, all RBEs, which include REEs and DMEs, are entitled to VAT zero-rating on their local purchases of goods and services directly and exclusively used in the registered project or activity. The SC concluded that the rule is consistent with the nature of SBFZ as a separate customs territory.

Also, the SC made mention of the time-old Cross Border Doctrine and Destination Principle, which states that no VAT may be imposed to form part of the cost of goods destined for consumption outside of the territorial border of the taxing authority. Thus, the sales made by suppliers from a customs territory to a purchaser located within the freeport zone are considered exports; hence, they are subject to zero percent VAT.

As a further argument, the court held that, pursuant to TRAIN, sales by VAT-registered persons to registered enterprises within a separate customs territory are subject to a zero percent rate.

Thus, the court ruled that Rule 18, Section 5 of the CREATE IRR and RR No. 21-2022, RMC No. 24-2022, and RMC No. 49-2022, insofar as they limited the VAT zero-rating on local purchases of goods and services to REEs, are ultra vires, or exceeding their legal authority. They altered the provisions of the underlying law — the CREATE Act — by carving out DMEs from those entitled to the VAT zero-rating incentive. Hence, the relevant provisions of the law and BIR issuances were declared void and unconstitutional.

If we are to consider the case above, reevaluating the past — such as previously implemented laws — can often lead to greater clarity and justification. However, there still exists the element of risk. In fact, this case came close to being dismissed for failure to exhaust administrative remedies. Therefore, if you were given the chance to turn back time, knowing the risk involved, would you still take it?

Let’s Talk Tax is a weekly newspaper column of P&A Grant Thornton that aims to keep the public informed of various developments in taxation. This article is not intended to be a substitute for competent professional advice.

Justine Bea D. Alano is an associate from the Tax Advisory & Compliance practice area of P&A Grant Thornton, the Philippine member firm of Grant Thornton International Ltd.