Philippine DMEs Navigating VAT Zero-Rating: Court Ruling vs. New Legislation

By Frenz Angelie B. Hechanova Every so often, a court decision appears to open a door that we thought had already been closed. But just as taxpayers begin to assess what that opening means, Congress may step in and rebuild the doorway altogether. This appears to be the case for domestic market enterprises (DMEs) in relation to the value-added tax (VAT) zero-rating of their local purchases. Under Sections 294(E) and 295(D) of the Tax Code, as amended by the Corporate Recovery and Tax Incentives for Enterprises (CREATE) Act, registered business enterprises (RBEs) are granted VAT exemptions on imports and VAT zero-rating on local purchases of goods and services that are directly and exclusively used in their registered project or activity. However, the implementing rules and subsequent issuances of the Bureau of Internal Revenue (BIR) — specifically Revenue Regulations (RR) No. 21-2021 and Revenue Memorandum Circular (RMC) Nos. 24-2022 and 49-2022 — effectively limited the VAT zero-rating incentive on local purchases to registered export enterprises (REEs), excluding DMEs from the benefit. In a 2025 decision, the Supreme Court declared that the implementing rules and related issuances went beyond the CREATE Act, and were therefore ultra vires, to the extent that they confined VAT zero-rating on local purchases of goods and services to REEs. The Court underscored the longstanding doctrine that implementing rules and regulations must remain consistent with, and cannot go beyond, the law they seek to implement. Because the CREATE Act referred to RBEs broadly, without distinguishing between REEs and DMEs, administrative issuances could not validly introduce such distinction. For many DMEs, the ruling was a welcome clarification. It reaffirmed that the imposition of taxes, as well as the grant and withdrawal of tax exemptions, only rests on the legislative enactment, not administrative interpretation. That said, the story did not end with the court decision. The Corporate Recovery and Tax Incentives for Enterprises to Maximize Opportunities for Reinvigorating the Economy (CREATE MORE) Act subsequently amended Section 295(D) of the Tax Code and has now expressly recognized that DMEs may be entitled to VAT zero-rating on local purchases of goods and services directly attributable to their registered project or activity. In doing so, however, the law has narrowed the scope of the incentive. Under CREATE MORE, entitlement is no longer a question of whether DMEs were covered at all. Instead, the focus has now shifted to a more nuanced inquiry: whether the DME falls within the high-value category. The issue has now evolved from one of coverage to qualification. This timing and distinction raises practical significance. For periods governed by the CREATE Act before the effectivity of CREATE MORE, affected DMEs may consider the Subic Bay ruling as support for VAT zero-rating on qualified local purchases, subject to the usual substantiation requirements. For periods after CREATE MORE, however, the amended law must be considered, particularly the limitation of the incentive to high-value DMEs. Generally, high-value DMEs refer to those with P15-billion investment capital and engaged in the import-substituting sectors or with export sales of $100 million (or its equivalent in an acceptable foreign currency) during the preceding year. The changes affect day-to-day business operations. DMEs outside the high-value category may need to revisit contracts, pricing structures, cost projections, and invoicing practices, as purchases once treated as zero-rated may become subject to 12% VAT, depending on the period and circumstances. For DMEs operating on thin margins or long-term contracts, the resulting upfront VAT costs can affect cash flow, even where the tax is ultimately recoverable. Suppliers face similar considerations. Before applying VAT zero-rating, they must secure proof of entitlement to mitigate reporting and compliance risks. Otherwise, they need to treat sales to non-qualified DME-buyers as subject to 12% VAT and issue the proper VAT invoice. Failure to document entitlement to incentives could expose both parties to compliance issues and potential deficiency assessments. Ultimately, the Supreme Court decision and CREATE MORE must be read together rather than against each other. The Supreme Court interpreted the law as it then stood; Congress subsequently amended the law. For taxpayers, the lesson is not only to ask whether an enterprise is registered, but also when the transaction occurred, what law was then in force, whether the purchase is attributable to the registered project or activity, and whether the DME qualifies under the current statutory requirements. In tax, timing matters as much as the rule itself. The views or opinions expressed in this article are solely those of the author and do not necessarily represent those of Isla Lipana & Co. The content is for general information purposes only, and should not be used as a substitute for specific advice. Frenz Angelie B. Hechanova is a manager at the Tax Services department of Isla Lipana & Co., the Philippine member firm of PricewaterhouseCoopers global network. [email protected]