Domestic Market Enterprises are Entitled to Zero-Rated VAT

The enactment of Republic Act No. 11534, or the Corporate Recovery and Tax Incentives for Enterprises (CREATE) Act, aimed to rationalize tax incentives and spur economic recovery. A critical component of these incentives involves the Value-Added Tax (VAT) regime, specifically the entitlement of registered business enterprises (RBEs) to VAT zero-rating on local purchases. However, administrative issuances implementing the CREATE Act initially restricted this zero-rating privilege primarily to registered export enterprises (REEs), thereby excluding domestic market enterprises (DMEs). A recent judicial pronouncement, most notably in The Subic Bay Freeport Chamber of Commerce, Inc. and Benjamin E. Antonio, III v. Department of Finance, et al., (G.R. No. 266016, February 4, 2025), has definitively invalidated these restrictions, affirming that DMEs are statutorily entitled to the VAT zero-rating incentive under the CREATE Act.

Republic Act No. 11534 defines a Registered Business Enterprise (RBE) broadly, encompassing both registered export enterprises (REEs) and domestic market enterprises (DMEs). Both RBE types are entitled to Value-Added Tax (VAT) exemption on importation and VAT zero-rating on local purchases of goods and services that are directly and exclusively used in their registered project or activity.

Specifically, Sections 294(E) and 295(D) of Republic Act No. 11534 clearly entitle all RBEs, including both REEs and DMEs, to VAT zero-rating on their local purchases of goods and services used exclusively in the registered project or activity. A domestic market enterprise is defined as an RBE that refers to any enterprise other than an export enterprise. In the Subic Case, the Supreme Court held that Subic Bay Freeport Chamber of Commerce (SBFCC), registered as an enterprise enjoying a 5% gross income tax (GIT) benefit under the CREATE Act. Enterprises enjoying the 5% GIT benefit are still treated as regular taxpayers insofar as VAT compliance is concerned. The entitlement to VAT zero-rating on local purchases is an incentive provided by the CREATE Act.

In the Subic Case, the Supreme Court elucidated that despite the clear mandate of the CREATE Act, the implementing rules and regulations (IRR) and subsequent revenue circulars sought to limit the application of the VAT zero-rating incentive. The Department of Trade and Industry (DTI) and the Department of Finance (DOF) issued rules limiting the VAT zero-rating entitlement on local purchases solely to REEs.

For instance, Rule 18, Section 5 of the CREATE IRR, and associated issuances like Revenue Regulations No. 21-2021 (RR No. 21-2021), Revenue Memorandum Circular No. 24-2022 (RMC No. 24-2022), and Revenue Memorandum Circular No. 49-2022 (RMC No. 49-2022), were interpreted to restrict the incentive. Under these restrictive interpretations, RBEs categorized as Domestic Market Enterprises were not entitled to VAT zero-rating on local purchases. Consequently, sales of goods or services to a registered domestic market enterprise were subject to VAT at the twelve percent (12%) rate. Petitioner in the Subic Case argued that this exclusion created an irreparable injury to DMEs, forcing them to absorb the VAT passed on to them by local suppliers, resulting in additional costs or expenses.

The initial restrictive interpretation, which limited the VAT zero-rating to REEs, was issued by the Secretary of Finance on December 3, 2021, through RR No. 21-2021. Further, DMEs were prohibited from obtaining VAT zero-rate certificates, leading to their sales being subject to the regular 12% VAT rate on local purchases.

The challenge to these administrative issuances was brought before the Supreme Court. Thus, in the Subic Case, the Supreme Court asserted that the Court of Tax Appeals (CTA) holds jurisdiction over cases involving the constitutionality or validity of tax laws, rules, and regulations. Judicial review of tax regulations is warranted when the exhaustion of administrative remedies is either not required or deemed futile. The Supreme Court has noted that if a case involves the validity of the CREATE IRR or related BIR issuances, the CTA has jurisdiction. Moreover, the Supreme Court has ruled on the validity of tax laws and regulations, having jurisdiction to resolve all tax problems, even in cases where local tax issues directly challenge the constitutionality of a regulation (Banco De Oro v. Republic, G.R. No. 198756, August 16, 2016).

Consequently, the Supreme Court declared that Rule 18, Section 5 of the Implementing Rules and Regulations of Republic Act No. 11534 (CREATE Act), Revenue Regulations No. 21-2021, Revenue Memorandum Circular No. 24-2022, and Revenue Memorandum Circular No. 49-2022, are VOID. This invalidation applies insofar as the issuances limit the VAT zero-rating on local purchases of goods and services exclusively to registered export enterprises.

The rationale for the decision hinged on the principle that the power to grant and withdraw tax exemptions is exclusive to the legislative domain. The State’s inherent power to tax is vested exclusively in the Legislature, and the imposition of taxes, as well as the grant and withdrawal of tax exemptions, must be pursuant to a legislative enactment (Purisima v. Lazatin, 801 SCRA 395 (2016)). By limiting the zero-rating incentive to REEs, the respondents (DOF and BIR) arrogated power reserved exclusively to Congress, thereby violating the doctrine of separation of powers.

The Court emphasized that the administrative issuances were unconstitutional because they deprived DMEs of tax incentives by limiting VAT zero-rating, whereas the CREATE Act itself made no such distinction between REEs and DMEs. The ruling affirms that the executive branch, through revenue memorandum circulars, cannot amend or expand the statutory requirements or provisions.

The Supreme Court’s decision in the Subic Case confirms that the initial administrative attempts to exclude DMEs from the VAT zero-rating incentive contradicted the express provisions of Republic Act No. 11534 (CREATE Act). The judicial declaration of voidness regarding Rule 18, Section 5 of the CREATE IRR and related BIR issuances restores the VAT zero-rating privilege to DMEs during the transitory period. This ruling serves as a vital affirmation that administrative agencies cannot promulgate rules that effectively contravene or limit the intent clearly laid out by legislative enactments. The result ensures that all RBEs, including DMEs, can benefit from the full range of VAT incentives granted by the CREATE Act.

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