Some transactions on which no VAT is imposed are referred to as VAT-exempt. Others are zero-rated or effectively zero-rated on which a VAT rate of 0% is imposed.

VAT exempt and zero-rated transactions are not the same. Although both do not cause an obligation to pay VAT, they have different implications with respect to the input and output VAT.

Input VAT cannot be credited against output VAT for VAT exempt transactions. However, input VAT can be credited against output VAT for zero-rated VAT transactions.

The distinction was determinative in an 81 million peso VAT refund case recently decided by the Court of Tax Appeals.

In Melco Resorts Leisure Corp. v. CIR,[1] the taxpayer argued that the BIR had wrongly denied its claim for a VAT refund or issuance of a tax credit certificate of more than 81 million pesos for the year 2016.

Melco is in the business of developing and operating tourist facilities, including hotel casino entertainment complexes with hotel, retail and amusement areas and themed development components, and engages in casino gaming activities.

As a licensee of the government owned and controlled Philippine Amusement and Gaming Corporation, Melco claimed it enjoyed the tax exemptions which the law granted to PAGCOR itself.

Melco also argued that its revenues were generated from gaming operations which are considered zero-rated sales, hence, it is entitled to the refund or tax credit of the excess or unutilized input VAT from said activities.

The CTA agreed with Melco that the benefits extended to PAGCOR under its Charter did inure to the benefit of its licensees and contractees, including exemption from taxes subject to the condition that the 5% franchise tax is paid.

However, although Melco enjoys tax exemptions granted to PAGCOR, that does not entitle Melco to its claimed VAT refund attributable to zero-rated sales.

PAGCOR’s benefits speak of exemption from VAT. This must be distinguished from input VAT attributable to zero-rated sales.

The CTA found that the larger issue was whether or not Melco’s sales can be considered zero-rated.

Only when the sales of a VAT-registered person are zero-rated or effectively zero-rated can it apply for a tax credit certificate or refund of creditable input tax due or paid attributable to such sales.

Section 108 of the 1997 NIRC enumerates the services / activities considered zero-rated or effectively zero-rated sales. It relevantly provides:

(B) Transactions Subject to Zero Percent (0%) Rate. -The following services performed in the Philippines by VAT registered persons shall be subject to zero percent (0%) rate:

(3) Services rendered to persons or entities whose exemption under special laws or international agreements to which the Philippines is a signatory effectively subjects the supply of such services to zero percent (0%) rate;

Melco is engaged in the business of developing and operating tourist facilities, including hotel casino entertainment complexes with hotel, retail and amusement areas and themed development components, without being engaged in retail trade, and to engage in casino gaming activities. These are not zero-rated activities.

Nowhere among the evidence presented by Melco did it show that it is engaged in the sale of goods or services or in transactions which are zero-rated.

Even sales of PAGCOR itself, the entity from which Melco secured its license to engage in gaming operations, are not considered zero-rated. Rather, they are VAT exempt under the laws.

PAGCOR’s tax exemption from the payment of taxes including VAT, which inures to the benefit of its licensees and contractees, does not entitle Melco to claim the input VAT that may have been passed on to it by its suppliers/ sellers, because such privilege belongs only to those which are engaged in VAT zero-rated and not VAT-exempt sales.

With PAGCOR being VAT exempt under a special law, the proper party to seek the subject tax refund or credit should be Melco’s suppliers because it is their supply of services to a VAT exempt entity (PAGCOR and/ or its licensees) which is effectively zero-rated.

The term “effectively zero-rated sales of services” refers to the local sale of services by a VAT -registered person to a person or entity who was granted indirect tax exemption under special laws or international agreement. The right to claim a refund of excess or unutilized input VAT does not belong to Melco because its sales are not to such persons.

Effective zero rating is intended to benefit the purchaser who, not being directly and legally liable for the payment of the VAT, will ultimately bear the burden of the tax shifted by the suppliers.

The Court of Tax Appeals concluded that Melco’s claim for VAT refund of alleged excess unutilized input tax cannot be granted because Melco is not engaged in zero-rated activities under the tax code.

The CTA’s ruling in Melco aligns with the Supreme Court’s 2004 ruling in Contex Corporation v. CIR.[2]

Contex was a company that manufactured hospital textiles and garments and other hospital supplies for export at the Subic Bay Freeport Zone. Having been duly registered with the Subic Bay Metropolitan Authority, it was a VAT exempt entity.

Contex had purchased various supplies and materials necessary in the conduct of its manufacturing business. The suppliers of these goods shifted the VAT burden on the purchased items to Contex, which led the latter to pay input taxes of over a million pesos.

Acting on the belief that it was exempt from VAT, Contex applied for tax refund or tax credit of the VAT it paid, but the BIR denied its claim.

The Supreme Court ultimately upheld the denial. It discussed the distinction between VAT exempt and zero-rated sales in this way:

(a) VAT Exemption. An exemption means that the sale of goods or properties and/or services and the use or lease of properties is not subject to VAT (output tax) and the seller is not allowed any tax credit on VAT (input tax) previously paid.20 This is a case wherein the VAT is removed at the exempt stage (i.e., at the point of the sale, barter or exchange of the goods or properties).

The person making the exempt sale of goods, properties or services shall not bill any output tax to his customers because the said transaction is not subject to VAT. On the other hand, a VAT-registered purchaser of VAT-exempt goods/properties or services which are exempt from VAT is not entitled to any input tax on such purchase despite the issuance of a VAT invoice or receipt.

(b) Zero-rated Sales. These are sales by VAT-registered persons which are subject to 0% rate, meaning the tax burden is not passed on to the purchaser. A zero-rated sale by a VAT-registered person, which is a taxable transaction for VAT purposes, shall not result in any output tax. However, the input tax on his purchases of goods, properties or services related to such zero-rated sale shall be available as tax credit or refund in accordance with these regulations.

Under Zero-rating, all VAT is removed from the zero-rated goods, activity or firm. In contrast, exemption only removes the VAT at the exempt stage, and it will actually increase, rather than reduce the total taxes paid by the exempt firm’s business or non-retail customers. It is for this reason that a sharp distinction must be made between zero-rating and exemption in designating a value-added tax.

The Supreme Court ruled that Contex’s claim for exemption from VAT for its purchases of supplies and raw materials was incongruous with its claim that it is VAT-Exempt, for only VAT-Registered entities can claim Input VAT Credit/Refund.

Under the BIR’s Consolidated Value-Added Tax Regulations, sales by VAT-registered persons to entities registered with the Subic Bay Metropolitan Authority are subject to 0% VAT.

Since the transaction is deemed a zero-rated sale, Contex’s supplier could claim an Input VAT credit with no corresponding Output VAT liability. No Output VAT should have been passed on to Contex.

Nonetheless, although Contex should not have been liable for the VAT burden inadvertently passed on to since it was on a zero-rated sale on the part of the supplier, Contex was not the proper party to claim the VAT refund from the BIR.

Contex was registered as a NON-VAT taxpayer and thus exempt from VAT. As an exempt VAT taxpayer, it was not allowed any tax credit on VAT (input tax) previously paid. Even if exemption from the burden of VAT on Contex’s purchases had existed, Contex was still not entitled to any tax credit or refund because it was an exempt VAT taxpayer.

Rather, it was Contex’s suppliers who were the proper parties to claim the tax credit and accordingly refund Contex the VAT they had erroneously passed on to it.

Distinctions between VAT exempt and zero-rated transactions are not merely academic. They have very real and very substantial consequences for the bottom line.

Atty. Francesco Britanico

[1] CTA Case No. 9811, October 28, 2021.

[2] G.R. No. 151135, July 2, 2004.