Commissioner of Internal Revenue vs. Cebu Toyo Corporation

A PEZA-registered enterprise that opts to avail of the income tax holiday incentive under Executive Order No. 226 (Omnibus Investment Code) is subject to VAT at 0% rate on its export sales and is entitled to a refund or tax credit of unutilized input taxes, as distinguished from a PEZA enterprise that opts for the 5% preferential tax rate under Republic Act No. 7916 which enjoys total VAT exemption but cannot claim input tax refunds.

The case involves the tax treatment of export-oriented enterprises operating within the Mactan Export Processing Zone (MEPZ) and the interplay between the Special Economic Zone Act of 1995 (RA 7916), the National Internal Revenue Code (NIRC), and the Omnibus Investment Code of 1987 (EO 226). Specifically, it addresses whether PEZA-registered enterprises automatically qualify for VAT exemption or may alternatively be subject to zero-rated VAT on exports, thereby entitling them to refunds for input taxes paid on purchases used in zero-rated export sales.

• Cebu Toyo Corporation is a domestic corporation engaged in the manufacture of lenses and optical components used in television sets, cameras, and compact discs, with its principal office located at the Mactan Export Processing Zone (MEPZ) in Lapu-Lapu City, Cebu.
• Respondent is a subsidiary of Toyo Lens Corporation, a non-resident corporation organized under Japanese law, and is registered with the Philippine Economic Zone Authority (PEZA) pursuant to Presidential Decree No. 66.
• Respondent is registered with the Bureau of Internal Revenue (BIR) as a VAT taxpayer and sells approximately 80% of its products to its mother corporation pursuant to an Agreement of Offsetting, with the remainder sold to various enterprises within the MEPZ.
• Both categories of sales are considered export sales subject to VAT at 0% rate under Section 106(A)(2)(a) of the National Internal Revenue Code.
• For the period April 1, 1996 to December 31, 1997, respondent filed quarterly VAT returns showing total input VAT of P4,462,412.63.
• On March 30, 1998, respondent filed an application for tax credit/refund of VAT amounting to P4,439,827.21 representing excess input VAT payments for the said period.
• The CTA found that only Y274,043,858.00 covering sales to Toyo Lens Corporation were actually offset against respondent's related accounts receivable and accounts payable as shown by the Agreement for Offsetting dated August 30, 1997, and that sales to MEPZ enterprises amounted to Y136,473,908.05 out of total export sales of Y700,654,606.15.
• Respondent availed of the income tax holiday incentive under Executive Order No. 226 for four years starting from August 7, 1995, as reflected in its 1996 and 1997 Annual Corporate Income Tax Returns.

• Respondent, as a PEZA-registered enterprise, is exempt from national and local taxes including VAT under Section 24 of Republic Act No. 7916 and Section 109 of the NIRC, and therefore cannot claim any refund of input taxes.
• Registration as a VAT taxpayer was erroneous and did not confer upon respondent any right to claim recognition of input tax credits or refunds.
• Since respondent's business is not subject to VAT, the capital goods it purchased are deemed not used in a VAT taxable business and therefore it is not entitled to a refund of input taxes pursuant to Section 4.106-1 of Revenue Regulations No. 7-95.
• Taxes paid and collected are presumed to have been made in accordance with law, and claims for refund are strictly construed against the claimant as these partake of the nature of tax exemption.

• As a VAT-registered exporter of goods, it is subject to VAT at the rate of 0% on its export sales that do not result in any output tax, and therefore the unutilized VAT input taxes on purchases of goods and services related to such zero-rated activities are available as tax credits or refunds.
• It availed of the income tax holiday under Executive Order No. 226 for four years from August 7, 1995, making it exempt from income tax but not from other taxes such as VAT, and its export sales are subject to 0% VAT rather than being VAT-exempt.
• It established through a report certified by an independent Certified Public Accountant that the input taxes it incurred were directly attributable to its export sales, and since it had no output tax against which said input taxes may be offset, it is entitled to a refund or tax credit.
• Proof of inward remittance was not required by law for its sales to MEPZ enterprises, and BSP approval was not required for its Agreement of Offsetting as it may be categorized as an inter-company open account offset arrangement.
• It had complied with the substantiation requirements under Section 106(A)(2)(a) of the Tax Code and was entitled to the refund of unutilized VAT input tax.

• Procedural Issues:
  • N/A
• Substantive Issues:
  • Whether a PEZA-registered enterprise that availed of the income tax holiday under Executive Order No. 226 is subject to VAT or exempt therefrom under Section 24 of Republic Act No. 7916.
  • Whether respondent is entitled to a refund or tax credit of unutilized input VAT attributable to its zero-rated export sales.

• Procedural:
  • N/A
• Substantive:
  • PEZA-registered enterprises have two distinct options under Section 23 of RA 7916: (1) to avail of an income tax holiday pursuant to Executive Order No. 226, thereby exempting them from income taxes for a specified period but subjecting them to other internal revenue taxes such as VAT at 0% rate; or (2) to avail of tax exemptions under Presidential Decree No. 66 and pay only the preferential tax rate of 5% under RA 7916, which effectively exempts them from VAT.
  • Respondent availed of the income tax holiday under EO 226 for four years starting August 7, 1995, as clearly reflected in its 1996 and 1997 Annual Corporate Income Tax Returns, thereby making it subject to VAT at 0% rate rather than VAT-exempt.
  • Zero-rated sales are taxable transactions subject to VAT at 0% rate where no output tax is due, but the input tax on purchases related to such sales may be allowed as tax credits or refunded; this is distinct from exempt transactions which are not subject to VAT and where no input tax credit is allowed.
  • As a VAT-registered person engaged in export sales subject to 0% VAT, respondent is entitled to a refund or tax credit of unutilized input taxes attributable to such zero-rated sales, computed at P2,158,714.52.
  • The Court of Tax Appeals' determination of the refundable amount is affirmed with very slight modification from P2,158,714.46 to P2,158,714.52.

• Distinction Between Zero-Rated and Exempt Transactions — Zero-rated transactions are taxable transactions subject to VAT at 0% rate where the seller is entitled to tax credit or refund of input VAT; exempt transactions are not subject to VAT and the seller is not entitled to any input tax credit. The Court enumerated three distinctions: (a) a zero-rated sale is a taxable transaction but does not result in an output tax while an exempted transaction is not subject to the output tax; (b) the input VAT on purchases of a VAT-registered person with zero-rated sales may be allowed as tax credits or refunded while the seller in an exempt transaction is not entitled to any input tax on his purchases; and (c) persons engaged in zero-rated transactions are required to register while registration is optional for VAT-exempt persons.
• Tax Incentive Options for PEZA-Registered Enterprises — Under Section 23 of RA 7916, ecozone enterprises may choose between fiscal incentives under PD 66 (5% preferential tax on gross income in lieu of all taxes including VAT) or under EO 226 (income tax holiday but subject to other national taxes including VAT at 0% for exports). The choice of incentive determines whether the enterprise is VAT-exempt or subject to zero-rated VAT.
• Purpose of Zero-Rating — The purpose of applying a zero percent rate on a taxable transaction is to exempt the transaction completely from VAT previously collected on inputs, ensuring that goods are provided free of VAT.

• "Taxable transactions are those transactions which are subject to value-added tax either at the rate of ten percent (10%) or zero percent (0%). In taxable transactions, the seller shall be entitled to tax credit for the value-added tax paid on purchases and leases of goods, properties or services."
• "An exemption means that the sale of goods, properties or services and the use or lease of properties is not subject to VAT (output tax) and the seller is not allowed any tax credit on VAT (input tax) previously paid."
• "In principle, the purpose of applying a zero percent (0%) rate on a taxable transaction is to exempt the transaction completely from VAT previously collected on inputs. It is thus the only true way to ensure that goods are provided free of VAT."
• "The Supreme Court will not set aside lightly the conclusions reached by the Court of Tax Appeals which, by the very nature of its functions, is dedicated exclusively to the resolution of tax problems and has accordingly developed an expertise on the subject, unless there has been an abuse or improvident exercise of authority."

• Sea-Land Service, Inc. v. Court of Appeals — Cited for the principle that the Supreme Court will not set aside lightly the conclusions reached by the Court of Tax Appeals which is dedicated exclusively to the resolution of tax problems and has developed an expertise on the subject, unless there has been an abuse or improvident exercise of authority.

• Section 106(A)(2)(a) of the National Internal Revenue Code — Defines export sales subject to 0% VAT rate, including sales paid for in acceptable foreign currency or its equivalent in goods or services and accounted for in accordance with BSP rules.
• Section 230 of the National Internal Revenue Code — Provides for the forfeiture of cash refund and tax credit, cited regarding the prescriptive period for filing claims for refund.
• Section 23 of Republic Act No. 7916 (Special Economic Zone Act of 1995) — Provides that business establishments operating within ecozones shall be entitled to fiscal incentives under PD 66 or under EO 226 (Omnibus Investment Code).
• Section 24 of Republic Act No. 7916 — Provides for exemption from taxes under the NIRC for business establishments operating within the ecozone, subject to 5% preferential tax on gross income.
• Section 109 of the National Internal Revenue Code — Enumerates exempt transactions including those exempt under special laws, except those under specific presidential decrees.
• Section 4.106-1 of Revenue Regulations No. 7-95 — Governs refunds or tax credits of input tax on zero-rated sales, including the requirement that only the proportionate share of input taxes allocated to zero-rated sales can be refunded where the taxpayer is engaged in both zero-rated and taxable sales.
• Section 4.103-1 of Revenue Regulations No. 7-95 — Defines exemptions from VAT and provides that VAT-registered purchasers of VAT-exempt goods are not entitled to any input tax credit despite the issuance of a VAT invoice or receipt.
• Executive Order No. 226 (Omnibus Investment Code of 1987) — Grants income tax holiday incentives to registered enterprises for four or six years depending on registration status.
• Presidential Decree No. 66 — Law creating the Export Processing Zone Authority providing for tax exemptions including VAT exemption subject to 5% preferential tax.