Tax Articles

Attribution of Input Taxes to Zero-Rated Sales

By Atty. Fulvio D. Dawilan

A new principle in relation to the value-added tax (VAT) refund system is emerging to the effect that only input taxes directly attributable to the zero-rated sales may be the subject of a claim for refund, and that if a taxpayer is engaged in purely zero-rated sales, the recovery of input taxes through refund is not available. I say this is a new principle because there is no similar interpretation espousing similar view in
previous decisions by the Courts.

The proponents of this principle take refuge in the very provision of Section 112(A) of the Tax Code, which provides for the rules governing the refund of input taxes attributable to zero-rated sales. There is no argument that for an input tax to be refundable under the said provision, one of the requisites is that it must be attributable to zero-rated or effectively zero-rated sales. As such, if the input taxes are incurred for transactions or activities that are not related to zero-rated sales, these cannot be the subject of a refund.

The confusion lies in the interpretation of the word “attributable.” The proponents interpret this to mean that the input taxes should be directly attributable to zero-rated sales. They argue that refundable input taxes must be used in the manufacture or exportation of zero-rated sales. They further claim that the second proviso in Section 112(A) provides for the proportional allocation of the input taxes if the claimant taxpayer is engaged in both zero-rated or effectively zero-rated and taxable or exempt sales. Accordingly, if the taxpayer is only engaged in zero-rated sales and does not generate output taxes against which input taxes incurred can be utilized, the provision does not apply and the taxpayer’s option to apply for refund is not available.

With all due respect, I take exception to this interpretation. The law does not refer to the words “directly attributable” or “used in zero-rated sales” in describing the input taxes that may be the subject of a refund. The refundable input taxes as described in the law pertain to creditable input taxes attributable to zero-rated sales to the extent that they had not been applied against output taxes.

And what are the sources of these input taxes that may be the subject of a refund? That is more clearly articulated in Section 110 of the Tax Code. Generally, the said provision allows all input taxes incurred in relation to a taxpayer’s business to be creditable against output taxes. These include input taxes incurred or paid on importation or local purchases of goods, properties or services, including lease or use of properties. These creditable input taxes are not limited to those incurred in the purchase of goods used in the manufacture of products. In fact, these include input taxes on purchases of services. Input taxes on purchases of goods for conversion into or intended to form part of finished products is just one of them.

In short, the law does not discriminate against input tax incurred on a purchase that does not form part of the taxpayer’s product. All input taxes are creditable without distinction as to where the related purchase was used. There is no exclusion or inclusion rule for input taxes by reason of the use of the related purchase.

There is only a need to classify input taxes when a taxpayer has transactions subject to VAT and not subject to VAT, otherwise, referred to as mixed transactions. In such case, a taxpayer shall be allowed to claim input taxes (a) that are directly attributed to transactions subject to value-added tax, and (b) a ratable portion of any input tax which cannot be directly attributed to either activity. Thus, for a taxpayer with mixed transactions, there are two types of input taxes that may be used as credit against output taxes—(a) those that are directly attributed to VATable transactions (including transactions which are zero-rated) and those that are allocated for the reason that the input tax cannot be directly identified to either type of sale. This applies only in mixed transactions. If the taxpayer is not engaged in mixed transactions, there is no need to apply this rule and the totality of the input taxes shall all be attributed to that single type of sale. Thus, the input taxes of a taxpayer engaged solely in zero-rated sales are all attributable to his zero-rated sales.

The apportionment of input taxes on mixed transactions is best illustrated in the examples provided in Section 4.110-4 of Revenue Regulations 16-05. Based on this rule, a VAT-registered person who is also engaged in transactions not subject to VAT shall be allowed to recognize input tax credit on transactions subject to VAT as follows: 1) All the input taxes that can be directly attributed to transactions subject to VAT may be recognized for input tax credit; and 2) if any input tax cannot be directly attributed to either a VAT taxable or VAT-exempt transaction, the input tax shall be pro-rated to the VAT taxable and VAT-exempt transactions and only the ratable portion pertaining to transactions subject to VAT may be recognized for input tax credit.

The illustrations clearly show that all input taxes incurred by a taxpayer are attributed for each type of sale by using the above rule, that is, by direct identification and those that cannot be directly identified with a specific type of sale is attributed through allocation based on the amount for each type of sale. With respect specifically to zero-rated sales, the input taxes attributable to such sales are computed in the same manner. In essence, the input taxes attributable to zero-rated sales consist of both (a) the input tax directly attributable to such sale and (b) the ratable portion of the input tax not directly attributable to any activity (input tax attributable to zero-rated sales = input tax directly attributable + ratable portion of input tax not directly attributable to any activity). And the table summarizing these illustrations also classified these input taxes under the column for “Input VAT for Refund.”

Clearly, the input taxes that may be the subject of a refund may refer either to the input taxes directly attributable and those allocated to zero-rated sales. This is the essence of Section 110 of the Tax Code, including Subsection (B), which gives the taxpayer the option to apply for a refund and further referring to Section 112 for compliance with the other refund rules. The input taxes described as refundable under Section 112 are the same as the input taxes described in Section 110. The second proviso of Section 112 merely echoes the same allocation rule. And it does not limit the refundable input taxes only to those directly attributable to zero-rated sales. The only limitation is that they were not applied against output taxes. Neither does the refund option exclude those purely engaged in purely zero-rated sales. The allocation rule simply does not apply to them.