Tax Articles

VAT incentives have undergone significant changes over time. Prior to the CREATE Law, the cross-border doctrine was in effect. With the enactment of the CREATE Law, the principle of "direct and exclusive use" replaced this doctrine. Now, with the introduction of CREATE MORE, the concept of "directly attributable" has superseded the more stringent "direct and exclusive use" requirement.

Let’s take a closer look at how these changes have evolved and explore how some companies may be able to avoid the VAT implications of RMC 5-2024 as CREATE MORE comes into effect.

Before the CREATE Law, the cross-border doctrine governed companies registered in economic zones. These zones were treated as separate customs territory, akin to foreign countries. Therefore, when a company within an economic zone sold goods or services to a local company outside the zone, it was treated as though the sale occurred between a company in the economic zone and one in a foreign country, such as the Netherlands or France. Similarly, when a company within the economic zone made a purchase from a company outside the zone, the transaction was treated as an import from a foreign country, such as the Netherlands or France.

To address some inefficiencies in the previous system, where most transactions of an ecozone company were not subject to VAT, the government introduced the CREATE Law. This law replaced the cross-border doctrine by limiting VAT zero-rating or exemptions to goods and services that are "directly and exclusively used for the registered activity of a registered export enterprise."

Under this framework, only the purchase of raw materials necessary to produce a finished product qualifies for zero-rating. For instance, if an ecozone company exports a car, only the parts required to manufacture the car, such as the engine and wheels, are exempt from VAT. Services like finance, accounting, janitorial, and legal are not considered directly and exclusively used for the registered activity. Consequently, services such as accounting or finance-related digital services are subject to VAT, as they do not meet the criteria for direct and exclusive use in the registered activity.

What is the impact of this? Ecozone companies often accumulate input VAT since their sales are primarily zero-rated. With no output VAT to offset the input VAT, their only option is to file for a refund. However, as you may be aware, filing for a refund in this country may take more than a while.

This is one of the reasons why the CREATE Law was seen as insufficient, leading policymakers to introduce CREATE MORE. CREATE MORE adopts a more flexible approach, introducing the concept of "directly attributable." This concept strikes a balance between the broader interpretation of the cross-border doctrine and the "direct and exclusive" use principle. It allows for purchases to be considered zero-rated even if they are not part of the finished product being exported.

For example, goods and services like legal, accounting, janitorial, and security services are now considered zero-rated. The more liberal interpretation of "direct attribution" suggests that the law’s intent is to treat nearly all goods and services as zero-rated or exempt, similar to the VAT zero-rating and exemptions under the cross-border doctrine.
As you can see, under CREATE MORE, the key test is whether the goods and services are "directly attributable" to zero-rated sales, as opposed to the cross-border doctrine, where the focus is on territorial boundaries.

The next question is, who determines what is “directly attributable”? According to the law, it is the Investment Promotions Agency (IPA), such as the Philippine Economic Zone Authority or the Board of Investments, among others. But the BIR might oppose this and argue that since this is revenue activity, it is the BIR and not the IPA that has jurisdiction in determining what is “directly attributable” to a registered activity to be considered VAT zero-rated or exempt from VAT. The implementing rules must be categorical in saying that the determination by IPAs shall be binding upon the BIR

Unlike the cross-border principle where zero-rating or exemption applies to all companies inside the economic zone, the VAT incentives under CREATE MORE only apply to registered export enterprise (REE) and high value domestic market enterprise (HVDME) and not to an ordinary domestic market enterprise.

Based on the draft Implementing Rules of CREATE MORE, an REE includes Information Technology (IT) or Business Process Outsourcing (BPO) resulting in the direct exportation, and/or sale of its manufactured, assembled, or processed product. It can also be an IT or BPO service to another registered export enterprise that will form part of the final export product or export service of the latter, of at least seventy percent (70%) of its total production or output.

The definition of REEs and the VAT incentives provided under CREATE MORE offer an opportunity for REEs purchasing services from non-residents to avoid the VAT implications of RMC 5-2024. As you may know, this RMC imposes VAT on payments for services rendered by non-resident foreign corporations (NRFCs), even if the services are provided entirely outside the Philippines, as long as the utilization or consumption occurs within the Philippines. With the advent of CREATE MORE, it can be argued that if an REE (such as an IT or BPO company) "imports" digital or other services and can demonstrate that these services are directly attributable to its registered activities, such "importation" would be exempt from VAT. Please note that this may be possible because the current rule is based on the "directly attributable" framework, not the "directly and exclusively used" principle. "Imported" digital or other services may be VAT-exempt if purchased by IT and BPO companies classified as REEs.

Aside from this, there may be other tax saving opportunities that can be considered because of CREATE MORE. The new law will open more possibilities as it gives more elbow room for businesses to grow.