GENERALLY, customs rules and regulations apply only when foreign goods previously entered into the export or free trade zone are taken out of the zone into the country. With the implementation of the Post Entry Audit (PEA) system, a question for companies located in PEZA zones and other free trade zones (e.g. Subic, Clark) is whether these companies are covered by the custom audit system. Assuming that the PEZA companies are covered by PEA, will the customs audit be limited to compliance issues relating to sales made to domestic companies outside of the zone?
In general, the PEA system allows customs to audit companies to check on compliance with customs rules and regulations within 3 years from date of importation and specifically, to verify the correctness of the taxes and duties paid on such importation. Likewise, the system provides that importers should keep specific import records and business information within the 3-year period. Failing to keep the records required exposes the company to possible fines and penalties. Considering that most PEZA-located companies are engaged in export production and that PEZA zones are treated as separate customs territories, are these companies indeed covered by the PEA? Can customs conduct compliance audit of such companies?
Export Processing Zones and Free Trade Zones. Under RA 7916 (otherwise known as the Special Economic Zone Act of 1995), as amended by RA 8748, an Export Processing Zone (EPZ) has the following characteristics:
- It is a specialized industrial estate located physically and/or administratively outside customs territory.
- It is predominantly oriented to export production.
- Enterprises located in EPZs are allowed to import capital equipment and raw materials free from duties, taxes and other import restrictions.
In contrast, a Free Trade Zone (FTZ) is described as follows:
- It is an isolated policed area adjacent to a port of entry (as a seaport) and/or airport.
- It is where imported goods may be unloaded for immediate transshipment or stored, repacked, sorted, mixed, or otherwise manipulated without being subject to import duties.
- The movement of imported goods from the free trade area to a non-free trade area in the country shall be subject to import duties.
Domestic Sales Outside of the Zone. Section 26 (Domestic Sales) of RA 7916, provide that “Goods manufactured by an ECOZONE enterprise shall be made available for immediate retail sales in the domestic market, subject to payment of corresponding taxes on the raw materials and other regulations that may be adopted by the Board of the PEZA.”.
The implementing rules also provide that merchandise of foreign origin which has not undergone any processing, manufacturing or manipulation while in the ECOZONE, shall, when sent to the customs territory, be subject to the laws and regulations governing imported merchandise. Further, where said foreign merchandise is combined with or made part of any domestic article, the duties and taxes to be assessed on the final product shall be based on the value of such imported merchandise (except when the final product is exempt) and internal revenue taxes on the value added.
In theory therefore, only the foreign merchandise component of the goods processed and manufactured in the zone and subsequently entered into the Philippine customs territory shall be subject to duties and taxes. Section 3, Part V of the implementing rules specifically provides that “the duties and taxes to be assessed on the final product shall be based on the value of such imported merchandise (except when the final product is exempt) and internal revenue taxes on the value added”.
In practice, however, customs has varying ways of arriving at the duty treatment of processed raw materials. Some ports will collect only on the foreign merchandise while other collect taxes and duties even on the value-added activities performed within the zone.
Customs Audit of PEZA activities. Based on our own understanding of the PEA law and implementing rules, PEZA companies are accordingly not exempt from the coverage of the PEA law. The remaining concern is to what extent is the customs audit applicable on PEZA activities. First, PEZA companies are certainly covered by the record keeping requirements. Second, domestic sales of processed goods outside of the zone will likewise be the subject of customs audit. In fact, we would assume that the duty treatment of processed materials together with the inventory of raw materials will be the main area of the audit.
Considering, however, that customs does not have clear rules and guidelines on the valuation treatment of processed materials coming from PEZA zones, we are concerned that such issue will be a contentious one when customs audits a company. To manage possible risks of non-compliance in case of an audit, it is important for PEZA companies to secure an advance customs ruling on such issue. Otherwise, PEZA companies will have major disagreements with auditors once customs starts the audit of domestic sales of PEZA companies.
The author is an international trade, indirect tax (customs) and supply chain expert. He is the Editorial Board Chairman of Asia Customs & Trade, an online portal on customs and trade developments affecting global trade and customs compliance in Asia. He was also Bureau of Customs Deputy Commissioner for Assessment and Operations Coordinating Group (2013-2016). For questions, please email at firstname.lastname@example.org and email@example.com