Consequences of Exceeding the Local Sales Threshold for PEZA-Registered Export Companies (Philippine Context)

Executive summary

PEZA-registered export enterprises are expected to sell at least 70% of their output to foreign markets (or to other export-oriented enterprises for further export). “Local” or “domestic” sales are generally capped at 30% of total sales/value of production (for service exporters, 70% of gross receipts must come from foreign clients). Exceeding that threshold can trigger loss or suspension of fiscal and non-fiscal incentives, reclassification as a domestic market enterprise (DME), assessments for back duties/VAT/excise on inputs used for local sales, administrative fines, and even cancellation of PEZA registration. There are limited pathways to cure or mitigate, but they require prompt disclosure, payment of the correct duties/taxes, and—in some cases—Board approval or re-registration.

Below is a practitioner-oriented deep dive.

1) Legal framework & key definitions

Primary statutes and rules (high level):
- The Special Economic Zone Act (RA 7916, as amended) and PEZA’s rules define export vs. domestic market enterprises, privileges, and compliance.
- The CREATE Act (RA 11534) reframed incentives. For tax, today’s registered export enterprises (REEs) may enjoy an Income Tax Holiday (ITH) followed by either Enhanced Deductions (ED) (for new projects) or transitory 5% Special Corporate Income Tax (SCIT) (for eligible existing projects), plus VAT zero-rating on local purchases directly and exclusively used in the registered project.
- Customs and VAT rules govern how tax- and duty-free importations are treated when outputs are sold locally.
Export enterprise (manufacturing): At least 70% of production is exported (by value).
Export service enterprise: At least 70% of gross service income from non-resident clients paid in acceptable foreign currency or its peso equivalent via banking system.
Domestic/Local sale: Sale to the Philippine customs territory that is not treated as “deemed export.”
Deemed export (commonly recognized categories): Sales to another PEZA-registered export enterprise for export production; sales to customs bonded warehouses, or to other ecozones/freeports (e.g., Subic, Clark) for exportation; and certain transactions recognized under PEZA/BOC circulars. These do not erode the export ratio.

Practice tip: Always segregate (a) direct export shipments, (b) deemed-export inter-enterprise sales, and (c) true domestic sales to the Philippine market, then compute the 70:30 against total sales or gross receipts for the compliance period stated in your Registration Agreement/Performance Commitment (commonly a fiscal-year basis).

2) What counts toward the 30% local sales cap?

Counts toward the cap: Actual sales to Philippine customers for end-use in the domestic market (including related parties in the Philippines) and any service revenue from resident clients that does not qualify as export service income.
Does not count toward the cap: Sales classified as deemed exports (see above) and exports by a local customer that purchases from you under a bonded/PEZA-approved scheme where exportation is proven.

Documentation is decisive. Keep:

Customer status (PEZA/BOI registration, bonded warehouse accreditation)
Approved Authorities to Issue (ATIs), local sales clearances, or equivalent internal PEZA/BOC approvals
Export declarations/Bills of Lading for onward export by your customer

3) Immediate tax/customs effects of any local sale (even within 30%)

Even when within the 30% allowance, local sales typically require you to:

Pay customs duties, VAT, and excise (if applicable) on the imported raw materials and components consumed in the items sold locally (or post-entry adjust the proportion).
Pay VAT on the local sale itself (unless a specific zero-rating exemption applies, which is rare for sales to non-export domestic buyers).
Secure PEZA/BOC clearances (e.g., local sales permits, withdrawal authorities) and make inventory drawdowns from bonded records to reflect the domestic disposition.

Failure to do these on time can result in surcharges, interest, and penalties, plus customs post-audit findings.

4) What changes once you exceed the 30% local sales threshold?

A) Incentives & registration status

Breach of export commitment. PEZA may issue a show-cause order and can suspend or cancel incentives for the registered activity.
Reclassification. You may be reclassified as a Domestic Market Enterprise (DME) for the affected period or prospectively. As a DME, you generally lose export-enterprise incentives, including:
- VAT zero-rating on local purchases tied to the export-registered project (going forward you may have to treat them as subject to 12% VAT, with limited input VAT recovery if VAT-registered).
- Duty and tax exemption for importations (you may be required to import tax-paid going forward).
- Income tax incentives (end of ITH/ED/SCIT for the export project; regular 25% corporate income tax applies unless you qualify for a separate registered domestic activity).
Clawback risk. For the period of non-compliance, expect potential recapture (collection) of forgone customs duties, VAT/excise on inputs, and—if misapplied—income tax incentives, with surcharges and interest.

B) Customs & inventory consequences

Regularization of imported inputs. You must liquidate bonded imports used for the excess local sales and pay corresponding duties/taxes.
BOC post-clearance audit exposure. Exceeding the cap often triggers audit flags for under-declared local dispositions, shrinkage, or book-to-physical variances.

C) VAT repercussions

Loss of zero-rating privileges tied to REE status (for purchases “directly and exclusively used” in the registered export activity).
Assessments on previously zero-rated local purchases if the tax authority alleges they were not directly/exclusively used in export activity or were diverted to domestic sales (possible deficiency VAT plus penalties).

D) Administrative sanctions

Fines/penalties under PEZA’s schedule for:
- Exceeding local sales limits without prior approval
- Late/incorrect reports (Monthly Performance, AFS, Incentives Reporting)
- Failure to secure local-sales clearances
Permit impacts: Suspension of LOAs, import permits, or gate passes until regularized.

E) Non-fiscal facility privileges

Import/Customs processing priority and simplified procedures can be suspended if you are no longer in good standing as an export enterprise.

5) When is exceeding the cap permissible (or mitigable)?

Prior Board/PEZA approval. In specific cases (e.g., supply chain disruptions, force majeure, public interest, or to address critical domestic shortages), PEZA/its Board may allow temporary increases in local sale percentages subject to conditions (time-bound, volume-capped, pay taxes/duties on local dispositions, additional reporting).
Project split or new registration. If your domestic demand is structurally higher, consider:
- Registering a separate DME project/site (with proper physical/logical separation) for domestic sales; or
- Amending your registration so the export commitment is realistic and compliant.
Deemed-export structuring. Where commercially viable, route sales to export-qualified buyers (other REEs/bonded facilities) so they do not count against the 30% cap—but only when the buyer’s onward export and status are properly documented.

6) Computation mechanics & common pitfalls

Measurement period: Usually annual, aligned with the company’s Performance Commitment or Registration Agreement. Some approvals use a fiscal year; ensure your internal dashboards mirror PEZA’s measurement period.
By value, not just volume. Export ratio is typically computed by value of sales/production, not units.
Service exporters: Use gross receipts; book foreign-client revenue correctly (e.g., no PEZA credit if work is for a local client even if paid in foreign currency).
Related-party domestic sales: Still local if end-use is in the Philippines.
Misclassification of deemed exports: The burden of proof is on the seller. Keep the chain of documents (buyer’s status, permits, proof of export).
Zero-rating misuse: Purchases claimed as zero-rated must be directly and exclusively used in the registered export activity. Mixing into local sales invites VAT assessments.

7) Consequence map (quick reference)

Area	Consequence on Exceeding 30% Local Sales
PEZA incentives	Suspension/withdrawal of ITH/ED/SCIT for export project; possible reclassification as DME
Customs duties	Payment/recapture of duties on imported inputs consumed in excess local sales; post-clearance audit exposure
VAT	Local sales subject to 12% VAT; risk of deficiency VAT on mis-zero-rated purchases; loss of zero-rating privilege prospectively
Non-fiscal	Suspension of simplified import procedures, LOAs, and other facility privileges until compliant
Administrative	Fines, show-cause orders, possible permit/operations disruptions, and—in extreme cases—cancellation of PEZA registration
Income tax	Potential recapture if export-only incentives were claimed while failing the export test; then default to regular 25% CIT (unless you separately qualify)

8) Remediation checklist (if you are already over the cap)

Freeze further local releases (unless critical) and quantify export ratio year-to-date vs. commitment.
Segregate and prove deemed-export sales to pull them out of the denominator for local sales.
Compute customs/VAT due on imported inputs embedded in the excess local sales; file voluntary disclosures with PEZA/BOC and pay to stop interest/penalties from compounding.
Rectify VAT: output VAT on local sales; review zero-rated purchases—reclassify or self-assess where needed.
Engage PEZA early: seek retroactive/temporary approval (if available) or work through reclassification with a forward-looking compliance plan.
Adjust registration: consider a DME arm or an amended export commitment; implement physical and accounting ring-fencing between export and domestic lines.
Tighten reporting: align internal KPIs to the same measurement period PEZA uses; build an early-warning dashboard for the 70:30 threshold.

9) Preventive controls & governance

Monthly export-ratio tracker (by value) tied to ERP invoices and bonded inventory withdrawals.
Contract screening of new customers to classify export/deemed-export/local at onboarding.
Permit calendar for local sales approvals and periodic reconciliations with PEZA/BOC filings.
Bill of materials (BOM) mapping to allocate imported inputs to domestic vs. export SKUs for accurate duty/VAT computation.
Policy on zero-rating: procurement must certify “direct and exclusive use” and finance must verify against production runs.
Internal audits ahead of PEZA/BOC/BIR reviews.

10) FAQs

Q1: If I breach the 70% export requirement in one year but recover next year, will incentives automatically resume? Not automatically. You’ll need to regularize past liabilities, settle penalties, and obtain PEZA confirmation of restored compliance. Some incentives may only apply prospectively after reinstatement.

Q2: Can we net “deemed exports” even if the buyer is in the Philippines? Yes—if the buyer is a qualified export/bonded entity and onward export is proven per PEZA/BOC rules. Paperwork gaps convert them into local sales.

Q3: Does selling to another PEZA locator always avoid the cap? No. It must be an export enterprise buying for export production (or a qualifying deemed-export situation). A PEZA DME buyer does not convert your sale into deemed export.

Q4: Do we owe income tax incentives back if we go over 30%? Typically you face customs/VAT consequences first. But if your status for the period no longer qualifies as an export enterprise, income tax incentives can be challenged and regular CIT may apply. Facts and your Registration Agreement matter.

Q5: Is there a formal process to increase the local sales cap? Only through PEZA/Board approval for exceptional, time-bound cases. Treat it as discretionary and prepare strong justification and compliance undertakings.

Closing note

Because facts differ by industry, registration terms, and timing (especially under CREATE’s transition rules), outcomes turn on your Registration Agreement, Performance Commitment, and your actual documents (permits, export proofs, and invoices). For a concrete risk map, prepare a data-driven export-ratio computation for the relevant period and align it with your bonded inventory and VAT positions, then engage PEZA proactively.