Tax Articles

CREATE VAT Confusion

By Atty. Irwin C. Nidea Jr.

The implementation of Revenue Regulations 9-2021 is in suspended animation. What happens now? Some believe that everything goes back to the rules before RR 9-2021 was issued. But some are more cautious, knowing that Corporate Recovery and Tax Incentives for Enterprises Act (CREATE) has clearly laid down the limitations on what can be considered as zero-rated.

The first school of thought sees that everything goes back to what it was before, which means that the cross-border doctrine as we know it remains. An Ecozone company, although located inside Philippine territory, is considered existing in a foreign soil. Thus, sale to an Ecozone company, even without being actually exported, is considered constructively exported and is considered value-added tax zero-rated.

What is the effect of this school of thought on local suppliers of Ecozone companies? If you are a local supplier that is located outside the Philippine Economic Zone Authority, you must not pass on VAT to a PEZA-registered entity. That is the general rule. In other words, an Ecozone company should not allow its suppliers to impose VAT on it because of the cross-border doctrine. If it does, the Ecozone company cannot recover the input VAT from the government. It can, however, file a claim for refund against its supplier.

The second school of thought sees that CREATE is now the prevailing law. It explicitly states that to be considered zero-rated, purchases by an Ecozone company must be “directly and exclusively used” for its registered activity. There is now a limitation of what can be considered as VAT zero-rated. It is not a zero-sum game anymore. With CREATE, suppliers and buyers must determine if what is being bought or sold will be directly and exclusively used for the registered activity of the Ecozone company.

Did CREATE diminish the cross-border doctrine? It is important to note that the PEZA Law was not amended by CREATE. The PEZA Law and the SC cases of Seagate and Toshiba state that ALL purchases by a PEZA entity are VAT zero-rated. There is no exception. But CREATE is now limiting it to those that are directly and exclusively used by an Ecozone company for its registered activities.

The Implementing Rules of CREATE broadly defines “directly and exclusively used” in the registered project or activity as referring to raw materials, supplies, equipment, goods, services, and other expenditures necessary for the registered project or activity without which the registered project or activity cannot be carried out.

The definition as it is now, will cause lots of confusion, and tax assessments in the future. The taxpayers will now be left with the burden of proving that what was sold to Ecozone companies fall within the definition of direct and exclusive use and are consequently zero rated.

What if what is purchased is not “directly and exclusively used” for the registered activity of a PEZA company? What will happen with the VAT that is passed on to it? Can it file a claim for refund for these or it has no choice but to just consider it as part of cost? Yes, it can. But the Ecozone company must prove two points—that what was passed on to it is not directly and exclusively used for its registered activity AND that the same is attributable to its zero-rated sales. How can an input VAT that is not “directly and exclusively used” for a registered activity be considered as attributable to the same? This is a paradox that must be clarified by our legislators.

The Tax Code speaks of attribution. The Court of Tax Appeals (CTA) in the case of Toledo states that “directly” and “entirely” as stated in Section 112 of the Tax Code does not mean that only those purchases of goods that form part of the finished product of the taxpayer can be subject of an input VAT refund.

According to the CTA, it is significant to note that the Tax Code did not limit input taxes to those purchases that only form part of the finished product of the taxpayer. To the extent possible, words must be given their ordinary meaning. The word “attribute,” the adjective form of which is “attributable,” is defined in the dictionary as “to explain as to cause or origin.” In other words, “creditable input tax due or paid attributable to such sales” simply means that the input tax is connected with the zero rated or effectively zero-rated sales.

So, the Tax Code might have a brewing conflict with CREATE. Should we abide by the definition of the CTA in Toledo that does not limit zero-rating only to those that are directly and exclusively used but considers all purchases as attributable to zero-rated sale?

In another case, however, the CTA has a different view which may be consistent with CREATE. It ruled that boarding houses that serve as housing of the PEZA company employees cannot be considered as “attributable” to the registered activity. The PEZA company is engaged purely in export sale of nickel. According to the CTA, materials used to construct the laborer’s row houses, dormitories and foreman’s duplex are not attributable to export sales. But a dissenting opinion said that the construction of these facilities is indispensable in the pursuit of its registered activity, moreso, as the PEZA company’s plant is located in a far-flung area, where public transport is scarce.

If housing of employees is not considered as attributable to the zero-rated sale, what else cannot be considered as such, especially now under CREATE? Are the gasoline and the cars used by employees to go to the mining site pass the criteria of CREATE for zero-rating? If not, what will happen to the input VAT that will be passed on to Ecozone companies?

The deferral of RR 9-2021 puts taxpayers in limbo. Should taxpayers still consider all sales to Ecozone entities zero-rated or should they now apply the “direct and exclusive use” rule under CREATE? Did CREATE diminish the cross-border doctrine? What is the categorical meaning of “direct and exclusive use” vis a vis the attribution rule? The government cannot afford to just throw in general definition of these terms. Vagueness will result in subjective interpretations, which will further dampen a plague-stricken economy.