Update for PEZA firms

Update for PEZA firms by: Elbert Cruz

Previously, the Bureau of Internal Revenue (BIR) consistently ruled that royalties arising from the Technical Service Agreement relating to licensed know-how in the manufacture of a company’s products are rightfully part of the cost of finished goods and should therefore be deductible from the gross income of a PEZA-registered export enterprise.

However, the release of BIR RULING No. 014-2012 on January 4, 2012 revoked all existing rulings to the effect that royalty payments made by a PEZA-registered company under a Trademark License Agreement are now NOT DEDUCTIBLE from gross revenues for purposes of computing its taxable income under the 5% preferential tax rate based on the gross income earned.

Section 2, Rule XX of the PEZA Implementing Rules and Regulations (IRR) provides for the following allowable deductions of ecozone export enterprises:

   • Direct salaries, wages or labor expenses;
   • Production supervision salaries;
   • Raw materials used in the manufacture of products;
   • Goods in process (intermediate goods);
   • Finished goods;
   • Supplies and fuels used in production;
   • Depreciation of machinery and equipment used in production and buildings owned or constructed by an ecozone      enterprise;
   • Rent and utility charges associated with building, equipment and warehouses, or handling of goods;
   • Financing charges associated with fixed assets.

The BIR ruled that the abovementioned enumeration is EXCLUSIVE. Thus, under the maxim expressio unius est exclusio alterius, the mention of one thing implies the exclusion of another thing not mentioned. If a statute enumerates the things upon which it is to operate, everything else must necessarily, and by implication, be excluded from its operation and effect (Tolentino v. Paqueo 523 SCRA 377). Likewise, where the terms are expressly limited to certain matters, it may not, by interpretation or construction, be extended to other matters (Sarmiento III vs. Mison, 156 SCRA 549). The rule proceeds from the premise that the legislature would not have made specified enumerations in a statute had it not intend to restrict the meaning and to confine the terms of the statute to those expressly mentioned (Romuladez v. Marcelo, 497 SCRA 89).

Simply stated, since the royalty payments do not form part of the allowable deductions of a PEZA enterprise, royalties may no longer be considered as direct costs for purposes of computing the 5% gross income tax (GIT), in lieu of all national and local taxes.

We can infer from this ruling that the BIR did not take into consideration the accounting principle that the treatment of royalties depends on the consideration for which such fees were paid. When the royalties relate to a system or license, royalties are treated as general and administrative expenses, which are not part of the cost of the product/inventory. On the other hand, when the royalties are connected with the product design, logo, formula, or process, then the payments thereof form part of the cost of the product/inventory. This was the reason why payments for royalties related to the transfer of technical information and manufacturing know-how were considered as part of the cost of manufacturing the products in the previous rulings (BIR Ruling No. DA-057-2006 dated February 23, 2006).

We note that this new ruling revokes previously issued rulings of the BIR. Once again, we can expect that examiners will use this ruling in their examinations and assessments against PEZA-registered enterprises which claim deductions from their gross income which are not included in the list of allowable deductions on gross income under the PEZA IRR. We note that taxpayers relied on previous rulings of the BIR and had in good faith assumed that such rulings are correct. Now that the rules have changed , the issue is how the change will be applied by the BIR. At the very least, this new ruling should not be applied retroactively to the detriment of the taxpayers who depended on these rulings for guidance in computing their tax liability under the 5% GIT regime.