Affirming the strict interpretation of allowable deductions for PEZA-registered entities

To attract investors to do business in the Philippines, the country has enacted several laws that grant special tax incentives to investors. One of these laws is Republic Act (RA) No. 7916, otherwise known as The Special Economic Zone Act of 1995.  The said law provides tax incentives to entities that will register with the Philippine Economic Zone Authority (PEZA). Among the incentives granted is the five-percent preferential gross income tax (GIT) rate imposed on gross income, in lieu of all national and local taxes, except for real property taxes on land owned by developers.

For purposes of implementing the incentives available under RA No. 7916 (PEZA Law), Revenue Regulations (RR) No. 11-2005 was issued on  April 25, 2011. Section 3 of RR No. 11-2005 defines “gross income earned” as the gross sales or revenues derived from business activity within the ecozone, net of sales discounts, sales returns and allowances and minus costs of sales or direct costs, but before any deduction is made for administrative, marketing, selling and/or operating expenses or incidental losses given during a taxable period. The said section also provides for a list of direct costs that are deductible from gross revenue for purposes of determining the taxable base. For ecozone export enterprises, free trade enterprises and domestic market enterprises, the following costs are allowable deductions:

1. Direct salaries, wages and labor expenses.

2. Production supervision salaries.

3. Raw materials used in the manufacture of products.

4. Decrease in good in process account (Intermediate goods).

5. Decrease in finished goods account.

6. Supplies and fuels used in production.

7. Depreciation of machinery and equipment used in production, and of that portion of the building owned or constructed that is used exclusively in the production of goods.

8. Rent and utility charges associated with building equipment and warehouses used in production.

9. Financing charges associated with fixed assets used in production the amount of which was not previously capitalized.

On May 21, 2013, the Bureau of Internal Revenue (BIR) issued BIR Ruling No. 194-13 where it held that the aforementioned enumeration of allowable deductions is exclusive under the legal maxim unius est exclusion alterius, which means that mention of one thing excludes another thing which was not mentioned.

This is not the first instance that the BIR has strictly interpreted the provision on allowable deductions for purposes of computing the gross income earned of PEZA-registered entities. In BIR Ruling No. 014-12, for the first time, the BIR interpreted that the list of allowable deductions as provided in the IRR and relevant RRs are exclusive. In the said ruling, the BIR held that royalty payments made by a PEZA-registered entity are not deductible for purposes of computing its taxable income under the five-percent GIT based on gross income earned. Since royalty payments are not expressly enumerated in the list, such costs are not deductible.

In BIR Ruling No. 194-13, the BIR disallowed particular costs that were claimed by an export enterprise as deductible cost. According to the BIR, the following costs are not deductible for purposes of computing the gross income earned under RR No. 11-2005.

1. Repair and maintenance costs referring to labor and materials used for machines and facility maintenance in production and manufacturing.

2. Insurance expenses relating to the insurances on importation of incoming raw materials and equipment used in production, as well as insurances against fire and product liability of the raw materials and warehouse used in production.

3. Subcontracting costs pertaining to payments to subcontractors for the performance of the subcontracted functions related to the registered activities.

4. Indirect labor costs referring to the salaries, allowances, and other benefits of quality control, engineering and warehouse production supervisors and leaders.

The BIR explained that because the Implementing Rules and Regulations (IRR) of the PEZA Law, as further implemented by RR No. 11-2005, has specifically enumerated the allowable deductions, then by implication, everything else that is not enumerated therein is excluded. The BIR further explained that a deduction, for income tax purposes, is akin to an exemption, which is construed strictly against the taxpayer. Hence, any exemption claimed by a taxpayer must be supported by a clear grant or provision of law. In the absence, therefore, of any specific grant of exemption, the costs are not deductible. In issuing BIR Ruling No. 194-13, the BIR merely followed the list of allowable deductions as indicated in the IRR as the latter did not provide for any qualification or indication that calls for a liberal interpretation.

In any case, the aforementioned construction of the provisions of the IRR will have a big impact on PEZA-registered entities. It seems that the list under the present IRR is very general and has not caught up with the changes and models of how businesses are being conducted.

As long as the list provided in the IRR of the PEZA Law is not amended to accommodate current business models, then BIR will also maintain the same strict interpretation. Given that the BIR is merely adhering to the existing PEZA rules, it is unlikely for the BIR to liberalize its interpretation. Thus, a possible alternative solution to the current predicament of the affected PEZA-registered companies is to push for amended rules providing for an updated list of allowable deductions for each specific industry sector.

 April Rose B. Javier is a supervisor from the tax group of Manabat Sanagustin & Co. (MS&Co.), the Philippine member firm of KPMG International.

This article is for general information purposes only and should not be considered as professional advice to a specific issue or entity.

The view and opinions expressed herein are those of the author and do not necessarily represent the views and opinions of KPMG International or MS&Co. For comments or inquiries, please email [email protected] or [email protected].

Manabat Sanagustin & Co. will hold a one-day seminar on tax and corporate laws and regulations issued by the Bureau of Internal Revenue, Securities and Exchange Commission, Department of Finance, including Supreme Court and Court of Tax Appeals decisions/resolutions entitled 2014 Tax and Corporate Updates on Jan. 29, 2014 from 9 a.m. to 4:30 p.m. at Mandarin Oriental, Makati City. The speakers for the seminar are from MS&Co.’s roster of experienced tax professionals, namely, Tax Principals Herminigildo Murakami and Maria Georgina Soberano, and senior manager for tax Evelyn Garcia-Cantre

This session will be helpful to finance heads or officers, controllers, accounting or treasury personnel, and compliance or legal officers in further understanding the current updates that will enhance and equip them in managing tax and corporate strategies for taxable year 2014.
Interested parties can call (02) 885-7000 local 768 and 473.

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