Tax Articles

Cross-Border Doctrine is Dead

By Atty. Irwin C. Nidea Jr. 

Our country must compete with our neighbors in enticing foreign investors. So, economic zones were established in different parts of the country. The Philippine VAT system also followed the Cross-Border Doctrine. Under this doctrine, no VAT shall be imposed to form part of the cost of goods destined for consumption inside the economic zones. A fiction was created where a sale to an enterprise that is in the economic zone is akin to a sale made to a foreign country – a zero percent VAT is imposed. This gave foreign investors the assurance that whatever is sold by a company that is in the customs territory to a company located inside the economic zone is free of VAT.

But this bubble has finally been pierced. In the recently issued RMC 24-2022, the BIR categorically said that “the cross-border doctrine has been rendered ineffectual and inoperative for VAT purposes because CREATE expressly provided that only those goods and services that are directly and exclusively used in the registered project/activity of the Registered Business Enterprise (RBE) qualify as VAT 0% local purchases; b) CREATE and its IRR stated certain parameters for the availment of VAT zero-rating on local purchases of registered export enterprises, regardless of location; and c) VAT zero-rate provisions now provide that the effectively zero-rated sales shall apply only to sales of goods and services rendered to persons or entities who have direct and indirect tax-exemption granted pursuant to special laws or international agreements to which the Philippines is a signatory.

It appears that the BIR now puts emphasis on the phrase “directly and exclusively used” when it comes to VAT zero-rating. Whatever is purchased from a customs territory by an RBE cannot be merely attributable to its registered activity. It must be for direct and exclusive use, otherwise it is vatable.

According to the BIR, “direct and exclusive use” refers to raw materials, supplies, equipment, goods, packaging materials, services, including provision of basic infrastructure, utilities, and maintenance, repair and overhaul of equipment, and other expenditures directly attributable to the registered project or activity without which the registered project or activity cannot be carried out.

The implementation of this policy is going to be a nightmare for RBEs.

According to the BIR, only the portion of the expense directly and exclusively used by a registered export enterprise for its registered project or activity shall qualify for VAT zero-rating on local purchases, excluding those used for administrative purposes. The registered export enterprise concerned should adopt a method to best allocate goods or services purchased, e.g., for utilities, use of separate water and power meters for its registered project or activity or any method that may determine the allocation such an area usage or ratio of utility expense between cost of sales and administrative expenses as reflected in prior year Audited Financial Statements. If the goods or services are used in both the registered project or activity and administration purposes and the proper allocation could not be determined the purchase of such goods and services shall be subject to 12% VAT.

It must also be noted that services for administrative purposes, such as legal, accounting and such other similar services, are not considered expenses directly attributable to and exclusively used in the registered project or activity

Since the cross-border doctrine has been scrapped, the concept of automatic VAT zero-rating of sale to companies inside the PEZA zone no longer exists. Thus, prior approval from the BIR is needed for a sale to be accorded VAT zero-rating. An endorsement of the concerned Investment Promotion Agency (IPA) must also be secured in addition to documentary requirements of the BIR.

The IPA must issue an annual VAT zero percent certification only to registered export enterprises which shall indicate a) registered export activity; b) tax incentives entitlement under agreed terms and conditions with the validity period; and c) the applicable goods and services and other expenditures directly attributable to the registered project or activity without which the registered project or activity cannot be carried out.

All IPAs are also required to submit to the BIR the list of RBEs categorized as export enterprise for purposes of VAT zero-rating.

This RMC has clarified many lingering questions by taxpayers.

But this may also bring a paradigm shift in claims for VAT refund.

Suppliers that are in the customs territory are entitled to file a claim for refund on the input VAT of the goods or services that were sold and considered as “directly and exclusively used” for the registered activities of the RBEs. It is apparent that their possible refundable claim is now limited as it will not include sale that are not for the “direct and exclusive use”. The next question however is, should the supplier now prove direct attribution?

The Tax Code under Section 112 allows for allocation of input VAT when the supplier cannot determine if the input VAT that it is claiming for refund is attributable to zero-rated, vatable or exempt sale. Did CREATE abandon the allocation rule allowed under Section 112 of the Tax Code? Are suppliers now required to specifically identify the input VAT that was directly and exclusively used for zero-rated sale or can a general allocation of the input VAT for the purpose of a VAT refund still hold?

Can RBEs also file a claim for refund for the VAT that were passed on to them, if they can prove that all these purchases were used for their export sales?

There will be many more questions as we traverse the unknowns of CREATE.

Cross-border doctrine is dead according to RMC 24-2022. But as far as I know the PEZA law is not. Even CREATE acknowledged that PEZA Law is alive and that the cross-border doctrine that it spouses still thrives. The question is, will the PEZA law just play dead?