Clarification on the allowable deductions for a PEZA-registered

enterprise

FOR THE PAST decades it has been the policy of the government to
encourage direct foreign investments in the Philippines to boost the
economy and to provide jobs for the people. To implement this
policy, Republic Act No. (RA) 7916 or the Philippine Economic Zone
Authority (PEZA) law was enacted with provisions for incentives to
foreign investors, to entice them to pour investments into the
Philippines. Under RA 7916, PEZA-registered enterprises shall enjoy
income tax holiday or 5% tax on their gross income in lieu of all
national and local taxes except for real property tax.
RA 7916 does not specifically define gross income for purposes of
computing the 5% tax imposed on PEZA enterprises, but gross
income was defined under Section 2 (nn) Rule I of the implementing
rules and regulations (IRR) of RA 7916 as gross sales or revenues
derived from business activity within the economic zone (ecozone),
net of sales discounts, sales returns and allowances minus cost of
sales or direct cost, but before any deduction is made for
administrative expenses or incidental losses during the taxable
year. The IRR also lists down the allowable deductions from the
gross income in Sections 2 to 4 of Rule XX. The list of allowable
deductions provided under the PEZA IRR is designed to guide
ecozone enterprises on the types of expenses that are allowed to
be claimed as deductions, to avoid the instance where an
enterprise claims too many deductions in order to lower the gross
income or the tax base for the 5% tax.
The Bureau of Internal Revenue (BIR), in implementing the
provisions of RA 7916, issued Revenue Regulations No. (RR) 02-05,
which provide for an exclusive list of expenses, which shall form
part of the cost of sales or direct cost for purposes of computing the
gross income of ecozone enterprises. However, RR 02-05 was
superseded by RR 11-05, which provides for the list of allowable
deductions from the gross income of ecozone enterprises -- but
unlike the previous regulation, RR 11-05 does not expressly provide
that the list enumerated shall be the only expenses that shall be
allowed for deductions, giving the impression that the list is not
exclusive, and that expenses incurred that are directly related to
the registered activity of an ecozone enterprise may also be
claimed as deductions.
The intent to interpret the list of allowable deductions in the new

regulation as not exclusive was manifested in numerous BIR rulings

issued after the issuance of RR 11-05. The said rulings expressly
allowed claims for other expenses which are not included in the list
provided under the regulation if these are deemed necessary
expense incurred by the ecozone enterprise in connection to its
registered activity.
However, the view of the BIR on the allowable deductions
drastically changed in 2012, when it issued BIR Ruling No. 14-2012,
where the royalty payments made by a local manufacturing
company to its parent company under their Trademark License
Agreement are disallowed as deduction from gross revenues for
purposes of computing taxable gross income. In the said ruling, the
BIR expressly ruled that the list of allowable deductions provided
under the PEZA IRR is exclusive; thus, royalty payment not
enumerated therein shall be disallowed as a deduction.
Furthermore, in said ruling, the BIR revoked all existing rulings
which are inconsistent thereto. The BIR has been espousing this
interpretation to this date.
Today, there is an indication that the present circumstance of
ecozone enterprises will change for the better. The Court of Tax
Appeals (CTA) in the recent decision in East Asia Utilities Corp. vs.
CIR CTA Case No. 8179, dated May 21, 2014, has enunciated the
proper interpretation on the allowable deductions provided under
the PEZA IRR and RR 11-05. The Court pronounced that the list of
allowable deductions as provided under RR 11-05 is not exclusive
but merely enumerates the expense that can be considered as
direct cost, i.e., a PEZA-registered enterprise may be allowed to
deduct expenses that are in the nature of direct cost, even though
the same are not included in the list. Moreover, the Court
unequivocally declared that in determining whether an expense is
part of direct cost, said expense must be directly attributed to the
performance of the companys PEZA-registered activity.
The current decision of the CTA is a welcome development to PEZAregistered enterprises and provides hope for a relief from the
restrictive view of the BIR on what comprise allowable deductions
for purposes of computing the gross income of ecozone enterprises.
While it is understandable that claims for deductions should have
clear guidelines since the low tax rate may be abused, it should not
be at the price of limiting the claims to an unreasonable list -- thus,
eventually defeating the purpose for which the PEZA law was
created.
Although the clarification provided under the CTA decision is a
timely aid to the cause of ecozone enterprises, a more
comprehensive review and amendment of the PEZA law and its IRR
would be more beneficial to enterprises. It must be remembered

that, at the time the PEZA law was enacted, the target industries for
investment were in manufacturing, which is apparent from the type
of expenses that can be claimed as direct cost.
Nevertheless, due to the changes brought about by development,
the PEZA enterprises are no longer limited to or focused on
manufacturing but also include business process outsourcing and
information technology enterprises, which have greatly increased in
number in the Philippines. Clearly, due to the increase of types of
registered activity a PEZA enterprise may engage in, it is
unreasonable and unfair to limit the claims for deductions on those
listed in the IRR of the PEZA law as reproduced in RR 11-05 since
there are expenses listed therein which may not be applicable for
certain ecozone enterprises. Likewise, there are expenses directly
related to registered activities that are not in the list since
registered activities are new and were non-existent at the time that
the PEZA law and IRR were passed. In order to finally address the
issue on the allowable deductions, we believe it is high time for the
PEZA law to be revisited and amended accordingly, taking into
consideration the nature of the industries that are allowed to be
registered as a PEZA enterprise.
In sum, while the aforementioned CTA decision may be considered a
victory for ecozone enterprises, they should keep in mind that the
decision may still be reversed by the Supreme Court on appeal. The
key to finally settling this issue is to review existing laws and
regulations to make it applicable and responsive to the needs of the
changing times.

Tax planning strategies

Now that the annual tax filing season is over, it is about time to
revisit your tax planning strategy for the next year. This becomes
more relevant since the deadline for the first quarter income tax
return is fast approaching. Tax planning involves weighing various
tax options to determine the most beneficial way to conduct a
business. One should bear in mind that tax planning aims not only
to save on taxes but also to reduce or eliminate tax exposures
during tax examinations. These days, the Bureau of Internal
Revenue (BIR) is very aggressive in its campaign to increase
collections, and it is crucial to employ the right tax planning
strategies.
Below are some strategies you may consider:
Maximize allowable deductions. Deductible expenses must be
supported with documents such as official receipts and sales
invoices. For example, some deductible expenses require specific
documentation like a board resolution for bad debts and a BIR
notification for casualty losses. In addition, the correct tax must be
withheld if an expense is subject to withholding tax, otherwise such
expense may be disallowed as a tax deduction.
For taxpayers claiming itemized deductions, avail of the net
operating loss carry-over (NOLCO) if there is any. This must be
properly stated on prior year financial statements and income tax
returns. NOLCO can be claimed within 3 taxable years from the year
of loss on a first-in, first-out basis.
Take advantage of available tax credits. Creditable
withholding tax certificates are proof of advance income tax
payments deductible from annual income taxes. Claims for

withholding tax credits should be supported by creditable

withholding tax certificates (BIR Form No. 2307) issued by clients or
customers. Thus, ensure that these certificates have been secured
from clients or customers.
Consider minimum corporate income tax from prior years which
may be credited against the normal income tax due. Similar to
NOLCO, this can be claimed within 3 taxable years immediately
succeeding the year in which the same is paid.
Know your donees. Charitable contributions made to accredited
donee institutions may be fully deductible subject to certain
conditions. Donors claiming charitable contributions as deductions
must submit a Certificate of Donation (BIR Form 2322) which
contains a donee certification and a donors statement of values.
Such contributions may also be exempt from donors tax subject
also to certain conditions.
Decide which method of deduction is more advantageous,
Optional Standard deduction (OSD) or Itemized
Deduction. OSD pertains to an amount of deduction not exceeding
40% of the gross income of corporate taxpayers during the taxable
year. OSD would be better when there is less cost of sales/service
because it uses a higher tax base for OSD computation which would
result to lower income tax due. If your proof of allowable deductions
is not sufficient or you have no documents at all, OSD is the
prudent choice. Note, however, that your choice of method of
deduction to adopt in the first-quarter return shall be irrevocable for
the same taxable year.
Decide which option to take with regard to excess income
tax payments. Taxpayers who have incurred excess income tax
payments may opt to: (1) carry-over the excess credit to the next
taxable year/quarter; (2) refund the excess amount of taxes paid or
apply for the issuance of tax credit certificate (TCC). Once you
choose the option to carry-over it becomes irrevocable. In making
the decision to refund, consider the cost of the refund vis--vis the
amount to be refunded as well as the time it will take to claim the
refund. Be aware that any application for refund will expose the
taxpayer to an audit investigation.
Avoid taxing the non-taxable income. Check the proper
treatment of the items of income in your gross sales or gross
receipts to avoid paying taxes on non-taxable items like unrealized
foreign exchange gains and others.
Monitor unappropriated retained earnings in relation to
your paid-up capitalization to avoid penalties. Unappropriated
retained earnings are not allowed to exceed paid-up capital. The Tax

Code imposes a 10% penalty tax on improper accumulations.

Avail of Tax Treaty relief for transactions involving
residents of tax treaty countries. Transactions covered by a tax
treaty may avail of tax exemption or preferential tax rates as the
case may be. This however, is subject to the requirement of the tax
treaty relief application (TTRA) to confirm the entitlement of the
taxpayer to the relief. In exception to this, a recent Supreme Court
decision states that the failure to strictly comply with filing a TTRA
before the taxable event would not deprive a taxpayer of the
benefits of a tax treaty. Despite this, the better practice is still to file
a TTRA even after availing of the tax treaty benefit to avoid issues
with the BIR.
Despite the importance of tax planning, it has taken a backseat to
the costly and burdensome requirements of tax regulations which in
reality pass the burden of tax administration. Taxpayers have been
busying themselves trying to comply with the countless BIR
reportorial requirements and have minimal to nil time to do tax
planning. But advance tax planning is vital and may save a
taxpayer a lot of needless worry and risk in the long run.

The said 2004 ruling opined that to avoid the absurdity of a situation
where, among others, an employee covered under a BIR-approved
retirement plan would be subject to tax but not if he is not covered
under a retirement plan or if the retirement plan is not a BIRapproved plan, the BIR provided the following rules: (1) If the
retirement benefits received under a BIR-approved retirement plan
covered by RA 4917 is equal to or less than the minimum retirement
benefit provided by RA 7641, said benefits shall be exempt from
income tax to prevent an absurd situation where the retirement
benefits will be exempt if an employer does not have such a
retirement plan or if the retirement plan is not approved by the BIR.
(2) If the retirement benefits received under a BIR-approved
retirement plan covered by RA 4917 exceed the minimum
retirement benefit provided by RA 7641, the employee must comply
with the conditions of RA 4917 in order that his retirement benefits
may be tax-exempt.
Then again, BIR Ruling No. 234-13 which is the more recent ruling,
did not mention the qualification stated in BIR Ruling (DA-151-04).
Instead, the BIR maintained that the age and length of service
requirements under the Tax Code must be complied with to avail of
the tax exemption on the retirement benefits.
Based on this recent 2013 issuance, it appears that the age and
length of service requirements imposed under the Tax Code are
deemed by the BIR as minimum requirements for retirement
benefits to qualify for income tax exemption. On the other hand, a

retirement plan may provide for a retirement date more than the
minimum requirement by the Tax Code. In such case, the employee
must comply not only with the minimum requirements provided in
the Tax Code but also with the higher retirement date set forth in
the retirement plan to avail of the income tax exemption. (BIR
Ruling No. 52-2000 dated Oct. 30, 2000)
In view of the foregoing, we believe that it will be prudent for
employers to review their respective retirement plans and ensure
that they comply with the minimum requirements for retirement
benefits for employees to be entitled to income tax exemption
granted by the Tax Code. Indeed, while it is true that retirement laws
should be liberally construed and applied in favor of the retiree to
achieve its humanitarian purposes, it seems that the exclusion of
the retirement benefits from gross income follows the rule on strict
interpretation against tax exemptions.

a)
Expenses
b)
Salaries
c)
Interest *
d)
Travel
e)
Rental expenses
f)
Entertainment expenses *
g)
Taxes *
h)
Losses
i)
Bad Debts *
j)
Depreciation
k)
Depletion of Oil and Gas Wells and Mines
l)
Charitable Contributions and Other Contributions *
m) Research and Development
n)
Pension Trusts
o)
Premium payments on health/ or hospitalization insurance *
p)
and other expenses that may be allowed as itemized
deductions by the NIRC