By: Mark Anthony P. Tamayo on April 26, 2018

Business entities engaged in the manufacture of finished products for eventual export typically source the majority of their raw material (RM) inputs from foreign suppliers. These purchases will, upon their importation, be subject to the payment of customs duties and import taxes (generally, value added tax or VAT). Said payments, however, may be recovered through the filing of a formal claim for refund (by way of duty drawback and an application for VAT refund) with the revenue authorities (customs or tax authorities, as the case may be) upon subsequent export of their finished products.

The refund process, though, is somewhat tedious and costly, especially if done on a regular basis, as it entails the detailed evaluation of the claim (by revenue officers or by the courts) taking into consideration, among others, the various supporting documents required to be submitted by the claimant.The process has thus been a major area of concern for taxpayer-importer claimants.

The designation of “free zones” on certain areas in the Philippines with the status of a “separate customs territory”to a certain extent, addresses this situation. Our incentive laws provide “free zone” areas that essentially allow the free flow or movement (for qualified registered entities)of defined imported articles under a simplified import-export procedure with minimum interference from the government.

Free Zone treated as a Separate Customs Territory

A “free zone” means a part of the territory of a country where any goods introduced are generally regarded, in so far as import duties and taxes are concerned, as being outside the customs territory. It is essentially a geographic and carved area where goods may be landed, stored, handled, manufactured or reconfigured, and re-exported under specific customs regulation and generally not subject to customs duty and taxes on importation.

Free zones have, in many developing countries, been part of their economic landscape. Their basic goals are to attract investment and create employment in a way that would have a significant impact on the socio-economic well being of local communities. These zones are often used by multinational companies for setting up factories to produce goods.The specific sets of available incentives aimed at attracting investors into the district generally include specially defined fiscal and non-fiscal incentives.

Free zones in the Philippines include, among others, the special economic zones (SEZ) registered with the Philippine Economic Zone Authority under RA No. 7916, as amended, duly chartered or legislated SEZ and freeports such as Clark Freeport Zone, Poro Point Freeport Zone, John Hay SEZ and Subic Bay Freeport Zone under RA No. 7227, as amended by RA No. 9400.

Under its concept, the government allows the admission of goods into the zone on duty and tax free with the understanding that upon their conversion into finished products, the same will be shipped out from the Philippines. While the goods are in the zone, they remain outside the customs jurisdiction.

Others would view this concept as an unfair subsidizing in favor of big businesses. But the main benefit, as viewed internationally, is basically to attract foreign investments by striking a balance between ease of doing business and raising revenue.

Technical importation/cross border doctrine

A free zone is managed and operated as a separate customs territory, thus creating the fiction that the zone is a foreign territory (CIR vs Seagate Technology (Philippines), G.R. No. 153866, Feb. 11, 2005 and CIR vs Toshiba Information Systems (Philippines) Inc., G.R. No. 150154, August 9, 2005). Thus, sales by a zone registered entity to a local buyer in the customs territory shall be treated as a “technical importation” that would trigger the payment of duties and taxes. In such case, the buyer in the customs territory will be regarded as the importer.

Conversely, the sale of goods by a local supplier (outside the zone) to a purchaser in the zone shall be treated as an exportation from the customs territory – the sale, as a consequence, being treated as a cross border transaction for which no VAT should be imposed on goods to be consumed outside the country.

The Supreme Court, in the case of Commissioner of Internal Revenue vs Toshiba Information Equipment (Phils.), Inc., cited above, further elucidates this principle and stated that “the Philippine VAT system adheres to the ‘cross-border doctrine’ where no VAT shall be imposed to form part of the cost of goods destined for consumption outside the territorial border of the taxing authority.”

Whether or not the above VAT treatment of such sale would apply in light of the recently enacted TRAIN (Tax Reform for Acceleration and Inclusion) Law remains a contentious issue for some.

It will be recalled that the President has, among others, vetoed the zero-rating of sales of goods and services to a separate customs territory, citing that “it goes against the principle of limiting the VAT zero-rating to direct exporters.”

Notably, the BIR issued Revenue Regulations (RR) No. 12-2018, dated March 15, 2019, implementing the VAT provisions of the TRAIN. It essentially provides that such sale shall be subject to the 12 percent VAT (and no longer 0 percent VAT). This VAT treatment, however, is conditioned upon the successful establishment and implementation of an enhanced VAT refund system that grants and pays refunds of creditable input tax within ninety (90) days from the filing of the VAT refund application with the BIR.

Thus, assuming the conditions are met, the sale shall now be subject to 12 percent VAT, which can be passed on by the local supplier to the zone registered entities who can later on recover the same through the filing of a refund claim.

Other legal issues may eventually arise, though, such as: Will cross-border doctrine still apply? Will the legal fiction of treating these free zones as a foreign territory still apply? Will previous decisions rendered by our courts on the matter be deemed abandoned? Will there be a need to amend prior existing laws on this? The answers to all these questions will certainly be enlightening and interesting.

#Freezones #Specialeconomiczone #technicalimportation #crossboarderdoctrine #separatecustomsterritory

Mark Anthony P. Tamayo is a CPA-lawyer and a partner of Mata-Perez, Tamayo & Francisco Law Offices (MTF Law). He is also a law professor and recognized professional lecturer. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. If you have any question or comment regarding this article, you may email the author at info@mtfcounsel.com or visit MTF website at www.mtfcounsel.com.

From the The Manila Times Website  April 26, 2018

http://www.manilatimes.net/basic-concept-of-a-free-zone/394950/