Once again we wait to see if the Corporate Income Tax and Incentives Rationalization Act or the CITIRA bill (either House Bill No. 4157 or Senate Bill No. 1357) will pass into law this month. The bill is being repackaged for the third time after its predecessor bills were no legislated (TRAIN 2 and TRABAHO). If passed, CITIRA is expected to have a strong impact on Philippine Economic Zone Authority (PEZA)-registered firms.
For PEZA-registered firms availing of the 5% Gross Income Tax (GIT) incentive, the withdrawal of the privilege would eventually mean a reassessment of their direct costs and expenses that would qualify as deductions in light of Revenue Regulations (RR) No. 11-05 — Definition of Gross Income Earned. This makes it an ideal time for companies to prepare for the eventual implementation of CITIRA by conducting simulations and evaluations using their most recent balances.
DEDUCTIBLE EXPENSES FOR 5% GIT UNDER THE EXISTING PEZA LAW
Favorably for PEZA-registered firms under 5% GIT, the Court of Tax Appeals (CTA) in recent years has been consistent with its interpretation that the list of direct costs in RR No. 11-05 is not exclusive but merely enumerates the expenses that are in the nature of direct costs. Thus, PEZA-registered entities may be allowed to deduct expenses which are in the nature of direct costs even if they are not specifically included in the list provided in RR No. 11-05. However, these items must be directly attributable to the entity’s PEZA-registered services/activities.
The same position — that the list of expenses provided by RR No. 11-05 is not exclusive but merely instructive — was carried on in the recent CTA En Banc (EB) Case No. 1809-10 dated Nov. 14, 2019 (Moog Controls Corporation-Philippine Branch vs CIR). Moreover, Moog was able to prove that expenses (i.e., repairs and maintenance, data processing expense, building insurance expense and outside services) claimed under 5% GIT were directly related to its registered activities, and hence allowed as deductions under 5% GIT.
However, it is worth pointing out that while a number of recent court decisions held by the CTA adopted the non-exclusivity of the list of expenses under the mentioned RR, the CTA has also disallowed the inclusion of certain expenses such as accident/life insurance, equipment and uniforms for on-the-job trainees, employee activities (e.g. holy mass for Sto. Nino Feast, Ping-Pong tournament expenses, treadmills for physical fitness clubs), non-technical training and development, the Department of Energy (DoE) electrification fund, general office expenses, business expenses, taxes and licenses for being unrelated to the rendition of PEZA-registered services. (CTA EB Case No. 1207 dated Feb. 3, 2016, East Asia Utilities Corp. vs. CIR)
Needless to say, it is crucial that adequate documents (e.g., journal vouchers, accounts payable voucher, invoices/receipts) are maintained to support that the expenses can be attributed to the rendition of the PEZA-registered activity. (CTA Case No. 8508 dated Sept. 1, 2014, Medtex Corporation vs. CIR)
5% GIT UNDER CITIRA HOUSE AND SENATE BILLS
While both CITIRA versions of the House and Senate seek to lower the regular corporate income tax rate and rationalize the tax incentives currently enjoyed by entities with special registration (e.g., PEZA–registered firms), each bill has its own proposed provision on the continuation of incentives granted before it takes effect as a law.
HOUSE BILL NO. 4157
In the House version, registered activities granted an Income Tax Holiday (ITH) shall be allowed to continue and the incentive may be availed of for the remaining period of the ITH or for only five more years (whichever comes first). This is allowed provided that the 5% GIT shall commence only after the ITH period has lapsed; and further, that the 5% tax on gross income earned shall be allowed to continue for periods based on a schedule that varies depending on how many years the current tax incentive is being enjoyed (up to a maximum of five more years).
After the lapse of the 5% GIT period, the regular corporate income tax rate shall take effect.
At the same time, this version grants ITH, a reduced corporate income tax of 18% or enhanced deductions for commercial operations dependent on location. For example, companies in the NCR can enjoy up to three years ITH and up to two years reduced corporate income tax rate. Areas adjacent to Metro Manila get slightly longer periods, while all other areas can get up to six years ITH and four years reduced corporate income tax. The bill also states that the regular corporate income tax rate will be reduced by 1% every two years from 2022 until 2030.
SENATE BILL NO. 1357
In the Senate version, registered activities only granted an ITH can continue to enjoy the incentive for the remaining period of the ITH. On the other hand, the 5% tax on the gross income of registered activities granted prior ITH (where the ITH will expire within five years once CITIRA takes effect) shall commence only after the lapse of ITH and shall continue for the remaining period (but not to exceed five years). Further, the 5% tax on gross income earned shall, similar to the House version, be allowed to continue for periods based on a schedule that varies depending on how many years the current tax incentive is being enjoyed, up to a maximum of five more years. Interestingly, the Senate version added a provision extending the sunset period for availing of 5% tax on gross income up to seven years for firms that export 100% of output, employ 10,000 Filipino workers in the incentivized activity, or are engaged in “footloose” manufacturing, which are operations outside of Manila that export manufactured goods and have a designated labor to asset ratios for a period of time before CITIRA.
Similar to the House version, the Senate version grants an ITH followed by a special corporate income tax rate (SCIT) or enhanced deduction whose durations are based on the registered enterprise’s location and industry tier, with the caveat that the total period with incentives not last more than 12 years. The Senate version, however, sets the SCIT at 8% of the gross income earned in lieu of all national and local taxes, rising 1% per year until it reaches 10% in 2022 and onwards.
Nevertheless, the determination of what constitutes direct costs will remain relevant during the sunset years of existing registered activities under the 5% GIT prior to CITIRA, and likewise under the new SCIT rates proposed by the Senate in this version.
We should also note that PEZA-registered activities that qualify for registration under the strategic investments priority plan (SIPP) may opt to be governed by the provisions under both House and Senate versions of CITIRA. In such a case, such enterprises will have to surrender their Certificate of Registration, signifying their intent to waive the incentives they previously enjoyed.
WHAT CAN BE DONE IN THE MEANTIME?
At this point, knowing that the 5% GIT regime may slowly fade out of the picture once CITIRA takes effect, it would be prudent for PEZA-registered firms to evaluate the law’s impact on their current and future operations by way of a simulation using the most recent account balances.
PEZA-registered firms should consider the following scenarios:
• The companies continue to avail of their current incentives as PEZA-registered entities.
• The companies opt to waive their privilege to avail of the incentives as PEZA-registered entities:
1. Where the registered activities of the companies qualify for registration under the SIPP.
2. Where the registered activities of the companies does not qualify for registration under the SIPP.
By carefully conducting this gap analysis, PEZA-registered firms will be better able to evaluate if it is better for them to maintain their current incentives or to deregister from PEZA and instead fall under the new provisions of CITIRA. As with many projection matters, advance knowledge and the results of the simulation are often invaluable in helping companies decide on their way forward. By using real data from the company’s most recent balances, the simulations then become even more accurate and relevant to the company’s actual operations.
This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co.
Erickson Errol R. Sabile is a Tax Senior Director from the Global Compliance Reporting Service Line of SGV & Co.