Proving Zero-Percent VAT on Local Purchases for Companies in the Philippines: A Comprehensive Legal Analysis

Introduction

In the Philippine tax system, Value-Added Tax (VAT) is a consumption tax imposed on the sale, barter, exchange, or lease of goods, properties, and services, as well as on the importation of goods. Governed primarily by the National Internal Revenue Code of 1997 (NIRC), as amended by various laws including Republic Act (RA) No. 10963 (TRAIN Law), RA No. 11534 (CREATE Law), and subsequent amendments, VAT is generally levied at a rate of 12%. However, certain transactions are subject to zero-percent (0%) VAT, commonly referred to as zero-rating. This distinction is crucial: zero-rated transactions are taxable but at a 0% rate, allowing the seller to claim input VAT credits on related purchases, whereas VAT-exempt transactions are not subject to VAT at all and do not allow such credits.

The focus of this article is on "zero-percent VAT on local purchases" from the perspective of companies (buyers) in the Philippines. In essence, this pertains to scenarios where a company's local purchases of goods or services are not charged the standard 12% VAT by suppliers, because the sale to the company qualifies as a zero-rated transaction under the law. This benefit is typically available to export-oriented or specially incentivized enterprises, such as those registered with the Philippine Economic Zone Authority (PEZA), Board of Investments (BOI), or other similar authorities. Proving entitlement to this zero-rating is essential for compliance, as it involves substantiating the company's status and the nature of the purchases during tax audits, assessments, or disputes with the Bureau of Internal Revenue (BIR).

This article explores all aspects of the topic, including legal foundations, qualifying entities, procedural requirements for proving entitlement, documentation, audit considerations, potential pitfalls, and recent developments as of mid-2025. It aims to provide a thorough guide for legal practitioners, tax advisors, and business entities navigating this incentive.

Legal Foundations of Zero-Percent VAT on Local Purchases

Core Provisions in the NIRC

The NIRC, under Section 106 (for sales of goods) and Section 108 (for sales of services), outlines zero-rated transactions. Relevant to local purchases are provisions that zero-rate sales to certain buyers whose operations are deemed export-oriented or critical to national development. Specifically:

Section 106(A)(2)(a): Zero-rates export sales of goods, including those considered as "constructive exports" (e.g., sales to ecozone enterprises treated as exports).
Section 106(A)(2)(b): Applies to sales of goods to persons or entities exempt from VAT under special laws.
Section 108(B)(3): Zero-rates services performed for persons engaged in international shipping or air transport, or those exempt under special laws.

These provisions are amplified by the CREATE Law (RA 11534, effective 2021), which rationalized fiscal incentives and clarified that sales to registered business enterprises (RBEs) enjoying income tax holidays or enhanced deductions are zero-rated for VAT purposes, provided the purchases are directly attributable to the registered project or activity.

Special Laws Granting Incentives

Zero-rating on local purchases stems from fiscal incentives under special economic laws:

RA 7916 (PEZA Law), as amended: PEZA-registered enterprises in economic zones enjoy VAT zero-rating on local purchases of goods and services necessary for their registered activities. Sales to these entities are treated as export sales, hence zero-rated.
Executive Order (EO) 226 (Omnibus Investments Code): BOI-registered pioneer and non-pioneer enterprises may qualify for VAT zero-rating on local purchases if they are export producers (e.g., at least 70% export sales threshold).
RA 7227 (Bases Conversion and Development Act), as amended: Entities in the Subic Bay Metropolitan Authority (SBMA) or Clark Development Corporation (CDC) freeports receive similar treatment, with local purchases zero-rated if used in export production.
RA 7844 (Export Development Act) and RA 7903 (Zamboanga City Special Economic Zone Act): Extend zero-rating to other zones.
RA 10026: Provides incentives for tourism enterprises, including VAT zero-rating on local purchases for Tourism Enterprise Zones (TEZs).

Under these laws, the rationale is to promote exports and investments by reducing costs, treating local suppliers' sales to incentivized companies as zero-rated to avoid VAT cascading.

Revenue Regulations and Issuances

The BIR has issued regulations to implement these provisions:

Revenue Regulations (RR) No. 16-2005 (Consolidated VAT Regulations), as amended by RR 4-2007, RR 2-2012, and others: Details substantiation requirements for zero-rated sales, including those to ecozone entities.
RR No. 9-2021 (Implementing CREATE Law): Specifies that RBEs must secure a Certificate of Entitlement to Incentives (CEI) from the Fiscal Incentives Review Board (FIRB) or Investment Promotion Agencies (IPAs) to avail of VAT zero-rating on local purchases.
Revenue Memorandum Circular (RMC) No. 24-2022: Clarifies documentation for zero-rating post-CREATE.
RMC No. 5-2019: Addresses VAT treatment for PEZA entities.

These regulations emphasize that zero-rating applies only to purchases directly and exclusively used in the registered activity, not for administrative or non-qualifying purposes.

Qualifying Companies and Transactions

Eligible Entities

Not all companies qualify; eligibility is tied to registration and compliance with incentive-granting authorities:

PEZA-Registered Entities: Ecozone export enterprises, IT enterprises, and logistics services. They must maintain at least 70% export sales for full incentives.
BOI-Registered Entities: Projects under the Investment Priorities Plan (IPP), such as manufacturing for export or strategic industries.
Freeport Entities: SBMA, CDC, Authority of the Freeport Area of Bataan (AFAB), and others.
Other RBEs: Under CREATE, includes registered exporters, domestic market enterprises with export commitments, and priority projects.

Sole proprietorships, partnerships, and corporations can qualify if duly registered.

Qualifying Purchases

Local purchases must be:

Goods (raw materials, supplies, equipment) or services (e.g., utilities, maintenance) directly attributable to the registered project.
From VAT-registered suppliers.
Not for personal use or non-registered activities.

Examples: A PEZA-registered manufacturer can buy raw materials locally at 0% VAT if used for export products. However, office supplies for headquarters might not qualify.

Procedures for Proving Entitlement

Pre-Purchase Requirements

To avail of zero-rating, the buyer (company) must provide the supplier with proof of status:

Certificate of Registration: Issued by PEZA, BOI, or IPA, indicating entitlement to VAT incentives.
Certificate of Entitlement to Incentives (CEI): Mandatory under CREATE for post-2021 registrations.
Annual Endorsement or Certification: For PEZA, an annual VAT zero-rating certification listing qualified suppliers.
BIR Certificate of Registration (Form 2303): Showing the buyer as VAT-registered and incentivized.

The supplier then issues a VAT invoice with "ZERO-RATED SALES" indicated, charging 0%.

Documentation for Substantiation

To prove during BIR audits or internal records:

Sales Invoices/Receipts: Must contain:
- Buyer's name and address.
- Statement: "Zero-rated pursuant to [legal basis, e.g., Sec. 106(A)(2), NIRC and RA 7916]".
- No VAT amount.
Proof of Payment: Bank transfers, checks.
Delivery Receipts/Purchase Orders: Linking purchases to production.
Export Documents: For export-oriented firms, to prove end-use (e.g., export declarations).
Allocation Reports: If purchases are mixed, apportionment records showing exclusive use for qualifying activities.
IPA Endorsements: Annual lists from PEZA for zero-rated.

Records must be kept for at least five years (NIRC Sec. 235).

Application and Approval Process

Registration: Apply to IPA (e.g., PEZA online portal) with business plan, projections.
BIR Ruling: Optional but advisable; request a confirmatory ruling under RR 13-2018 or equivalent for complex cases.
Post-Registration Compliance: File quarterly VAT returns (Form 2550Q), reporting zero-rated purchases as creditable input VAT.

Audit and Verification Considerations

BIR Audit Focus

During audits, BIR uses computer-assisted audit tools to verify:

Matching of supplier's zero-rated sales with buyer's input VAT claims.
Compliance with "direct and exclusive use" rule (via site inspections).
Threshold compliance (e.g., 70% export sales).

Disallowances may occur if documentation is incomplete, leading to 12% VAT assessments plus penalties (25% surcharge, 20% interest p.a., under NIRC Sec. 248-249).

Judicial Precedents

Philippine courts have upheld strict substantiation:

Commissioner of Internal Revenue v. Seagate Technology (Philippines), G.R. No. 153866 (2005): Affirmed zero-rating for PEZA entities, emphasizing proper documentation.
Atlas Consolidated Mining v. CIR, G.R. No. 141104 (2007): Stressed need for export linkage.
Recent CREATE-related cases (e.g., 2023-2024 CTA decisions) reinforce CEI requirement.

Potential Pitfalls and Compliance Risks

Misclassification: Claiming zero-rating on non-qualifying purchases leads to deficiency assessments.
Supplier Non-Compliance: If supplier charges 12% VAT erroneously, buyer may seek refund but faces delays.
De-Registration: Loss of incentives if export thresholds unmet, retroactively applying 12% VAT.
Transfer Pricing Issues: For multinational firms, zero-rated purchases must align with arm's-length principles.
Penalties: Criminal liability for tax evasion if fraud proven (NIRC Sec. 254).

Mitigation: Engage tax consultants, maintain digital records, and conduct internal audits.

Recent Developments (As of July 2025)

Post-CREATE amendments include:

RR No. 3-2023: Streamlined CEI issuance.
RMC No. 15-2025: Clarified VAT treatment for hybrid (export-domestic) enterprises, allowing prorated zero-rating.
Digitalization: BIR's eInvoicing system (mandatory by 2025) requires electronic tagging of zero-rated transactions.
Inflation Adjustments: No rate changes, but enhanced monitoring via data analytics.

Pending legislation (e.g., proposed amendments to PEZA Law) may expand incentives to green industries.

Conclusion

Proving zero-percent VAT on local purchases requires meticulous adherence to legal requirements, robust documentation, and ongoing compliance. For qualifying companies, this incentive significantly lowers costs and enhances competitiveness. However, the burden of proof lies with the taxpayer, underscoring the need for proactive record-keeping and expert advice. Businesses should consult the latest BIR issuances and seek rulings for certainty in this evolving landscape.