August 30, 2005

BIR RULING [DA-373-05]

RA 7916; RMC 74-99
DA-112-2001
Roxas De Los Reyes Laurel & Rosario
19th Floor, BDO Plaza, 8737 Paseo de Roxas
Makati City
Attention: Atty. Manuel R. Roxas
Gentlemen :
This refers to your letter dated August 31, 2004 requesting in behalf of your
client, Ionics, Inc., for an opinion on the tax consequence of a transaction involving
two of its subsidiaries, Ionics Properties, Inc. ("IPI") and Ionics EMS, Inc. ("EMS")
with another PEZA-registered enterprise.
STDEcA

It is represented that IPI is a domestic corporation organized for the purpose of

acquiring, owning, holding, selling and leasing real properties; that on January 11,
1999, upon application by IPI, its leasing activities were registered with the
Philippine Economic Zone Authority ("PEZA") under Republic Act (R.A.) No. 7916,
as amended, known as the "Special Economic Zone Act of 1995"; that IPI was issued
Certificate of Registration No. 99-01-F by the PEZA and was conferred the status of
an Ecozone Facilities Enterprise; that as such, IPI is subject to the 5% preferential tax
rate on its gross income pursuant to Section 24 of R.A. No 7916, as amended; that on
the other hand, EMS is a domestic corporation organized for the purpose of engaging
in the manufacture, production and export of electronic products; that the
manufacturing activities of EMS, which are purely for export, are registered with
either PEZA or the Board of Investments ("BOI"); that IPI has a parcel of land
located in the Light and Science Park II, Special Economic Zone, Calamba, Laguna,
on which it built a building which was leased to EMS; that since the building leased
by IPI was a mere shell, EMS introduced substantial leasehold improvements
(including an air conditioning system) to make the building suitable for its
manufacturing activities; that with the manufacturing activities conducted by EMS
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coming to an end, IPI and EMS have agreed to terminate their current Contract of
Lease; that since the Contract of Lease was terminated prior to its expiration, EMS
retained title to the leasehold improvements; that another PEZA registered company
is interested in leasing the land and building owned by IPI including the leasehold
improvements owned by EMS; that for this purpose, EMS will lease the leasehold
improvements to IPI and IPI will then lease its land and building and sublease the
leasehold improvements to the PEZA registered company.
In reply thereto, please be informed as follows:
1.

Tax Impact on IPI.

In view of the fact that IPI is an Ecozone Facilities Enterprise, it is exempt

from income tax, capital gains tax, value-added tax and all other national taxes
pursuant to Section 24 of R.A. No 7916, as amended. In lieu thereof, however, IPI is
subject to the 5% tax on its gross income from its leasing activities as computed in
accordance with Subsection (2), Section 2, Rule XX of the Rules and Regulations to
Implement R.A. No. 7916, as amended. Under the aforesaid rules, as an Ecozone
Facilities Enterprise, IPI is entitled to deduct the sublease rental expense it pays to
EMS for the improvements and all other direct expenses enumerated thereunder from
its gross income.
Moreover, since IPI is exempt from income tax, the rental payments it received
are likewise exempt from the creditable expanded withholding tax prescribed under
Revenue Regulations (Rev. Regs.) No. 2-98, as amended.
Furthermore, since IPI is engaged in real estate business, leasing of real
properties is among its registered activities, IPI, therefore, is exempt from payment of
the documentary stamp tax (DST) due on the Contract of Lease it executed with the
other PEZA-registered company. However, applying Sec. 173 of the Tax Code of
1997, as amended, the other party to the Contract of Lease, therefore, shall bear the
burden of paying the DST, except, however, if the other PEZA-registered enterprise is
also engaged in realty (leasing) business, in which case, it shall likewise be exempt
from payment of the DST.
2.

Tax Impact on EMS.

Since the lease by EMS to IPI of the leasehold improvements is not part of the
registered activities of EMS with the PEZA or the BOI, its rental income will be
subject to the ordinary corporate income tax rate of 32%. EMS, however, may claim
as allowable deductions the depreciation of the leasehold improvements and related
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maintenance expenses under Section 34 of the Tax Code of 1997, as amended.

SECcAI

Moreover, since the rental payments made by IPI to EMS are subject to
income tax, the said payments will likewise be subject to the 5% creditable
withholding tax under Rev. Regs. No. 2-98, amended, which IPI shall withhold and
remit to the Bureau of Internal Revenue (BIR).
On the other hand, the rental payments made by IPI to EMS is subject to the
10% value-added tax (VAT) imposed under Sec. 108 of the Tax Code of 1997, as
amended, as implemented under Sec. 4.102-1 of Rev. Regs. No. 7-95. The
preferential treatment extended to PEZA-registered enterprise which in effect grants
exemption to it from national taxes is construed to apply only to its registered
activities [Revenue Memorandum Circular (RMC) No. 74-99, as further clarified by
Rev. Regs. No. 20-2002]. Since leasing of real properties is not among the registered
activities of EMS, its lease of realties to IPI, therefore, is not embraced by the special
rate of 5% in lieu of all taxes.
Likewise, looking at the transaction from the standpoint of IPI, and correlating
the same to Sec. 5(4)(b) of RMC No. 74-99, which provides for the tax treatment of
Intra Ecozone Enterprise Sale of Service, the lease by EMS to IPI of its real properties
seemingly would not qualify to be subject of the zero percent (0%) VAT pursuant to
the "Cross Border Doctrine" of the VAT system. Under the said doctrine, if the
PEZA-registered seller is subject to the regular internal revenue taxes, its sale of
service to another PEZA-registered enterprise shall be subject to zero percent (0%)
VAT since the use for or benefit from such purchase of service shall eventually be
translated into actual export of goods of translated into technical export of goods. The
foregoing rationale used under the "Cross Border Doctrine" will not apply in the
instant case since IPI is not engaged in processing, manufacturing, converting or
repacking of goods that are subsequently exported.
Further, since leasing of realty is not among the registered activities of EMS,
the Contract of Lease between EMS as lessor and IPI as lessee is subject to the
documentary stamp tax imposed under Sec. 194 of the Tax Code of 1997, as
amended.
Please be guided accordingly.

Very truly yours,

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CD Technologies Asia, Inc.

Philippine Taxation 2008

(SGD.) JOSE MARIO C. BUAG

OIC, Commissioner of Internal Revenue

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CD Technologies Asia, Inc.

Philippine Taxation 2008