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From a tax perspective, exclusivity and restrictive lists are very common, especially for allowable deductions. This is because tax deductions are akin to tax exemptions that are strictly construed against the taxpayer, and liberally in favor of the government. Entities registered with the Philippine Economic Zone Authority (PEZA) can relate to this exclusivity issue because their entitlement to the five percent gross income tax (GIT) earned from registered activity within the economic zone (Ecozone) in lieu of all national and local taxes comes with a limitation as to what they claim. Under the Republic Act 7916 or the PEZA Law, gross income refers to “gross sales or gross revenues derived from registered business activity within the Ecozone, net sales discounts, sales returns and allowances, and minus cost of sales or direct costs, but before any deduction is made for administrative expenses or incidental losses during a given taxable period.”

The Bureau of Internal Revenue (BIR) issued Revenue Regulations (RR) 2-2005, which provides that for purposes of computing the total five percent tax rate imposed by the PEZA Law, the cost of sales or direct cost shall consist only of the cost or expense items enumerated in said RR. Simply put, RR 2-2005 restricted the allowable deductions from gross income of PEZA-registered entities to the enumerated cost and expenses therein.

However, the BIR subsequently issued RR 11-2005, which amends RR 2-2005 by removing the exclusivity of the enumeration of cost or expense that is allowed as a deduction from gross income. Specifically, this provision was changed from “shall consist only of the following cost or expense item” to “the following direct costs are included in the allowable deductions to arrive at gross income earned for specific types of enterprises.”

Notwithstanding RR 11-2005, which provides for the idea of non-exclusivity, there were varied rulings issued by the BIR, which restricts the allowable deductions of PEZA-registered entities to the exclusive list in RR 2-2005.

This continued to be a grey area over the years since 2005 until we came across a Supreme Court case (G.R. 225266, dated Nov. 16, 2020) which upheld the non-exclusivity of the allowable deductions for PEZA-registered entities pursuant to RR 11-2005. The High Court explained that the word “include” means “to take in or compromise as a part of a whole;” “to contain as a part of something. The participle, including typically, indicates a partial list.” Further, it was held that using the word “including” necessarily conveys the enumeration’s very idea of non-exclusivity.

Due to the amendment introduced in RR 11-2005, the Supreme Court ruled that the enumeration of allowable deductions was made by way of example or illustration of the nature and type of expenses that may be deducted from a PEZA-registered entities’ gross income for purposes of computing the five percent GIT. With the change from “shall consist only of the following cost or expense item” to “the following direct costs are included in the allowable deductions” in RR 11-2005, the Supreme Court emphasized that the intention of restriction on the expenses that may be deducted was removed.

Notwithstanding the ruling on non-exclusivity of the list of allowable deductions, the Supreme Court emphasized that such deletion of the restrictive word “only” should be nonetheless consistent with the PEZA Law. What the PEZA Law only requires is that the costs and expenses must be directly related to the entities’ PEZA-registered activity and are not administrative, marketing, selling and/or operating expenses or incidental losses.

Thus, exclusive or not, the direct relation of the cost and expenses being claimed as a deduction against the gross income must be determined or proven for such cost and expenses to be allowed as deduction from gross income subject to five percent GIT.

Christine Gael C. Dy is a manager from the tax group of KPMG R.G. Manabat & Co. (KPMG RGM&Co.), the Philippine member firm of KPMG International. KPMG RGM&Co. has been recognized as a Tier 1 tax practice and Tier 1 transfer pricing practice by the International Tax Review.

This article is for general information purposes only and should not be considered as professional advice to a specific issue or entity.

The views and opinions expressed herein are those of the author and do not necessarily represent the views and opinions of KPMG International or KPMG RGM&Co. For comments or inquiries, please email ph-inquiry@kpmg.com.