The Supreme Court clarified that income tax holidays granted to businesses operating within special economic zones only apply to income derived from their registered activities. In the case of Commissioner of Internal Revenue v. J.P. Morgan Chase Bank, N.A., the Court ruled that leasing physical plant space and infrastructure is distinct from providing outsourced customer care and business process outsourcing services. Therefore, income derived from such leasing activities is subject to regular corporate income tax, even if the lessor is a Philippine Economic Zone Authority (PEZA)-registered enterprise enjoying an income tax holiday for its registered activities.

Beyond Call Centers: When Leasing Income Loses its Tax-Free Status

This case revolves around the taxability of income derived from the lease of facilities by PeopleSupport (Philippines), Inc., a PEZA-registered Economic Zone IT (Export) Enterprise. J.P. Morgan Chase Bank, N.A. – Philippine Customer Care Center (J.P. Morgan–Philippines) leased physical plant space, infrastructure, and other transmission facilities from PeopleSupport, who was enjoying an income tax holiday. The Commissioner of Internal Revenue (CIR) argued that this leasing activity was separate from PeopleSupport’s registered activity of providing outsourced customer care and business process outsourcing (BPO) services, making the rental income subject to regular corporate income tax. J.P. Morgan-Philippines, on the other hand, contended that the lease was an integral part of PeopleSupport’s BPO services and thus covered by the income tax holiday.

The core legal question was whether the income earned by PeopleSupport from leasing its facilities to J.P. Morgan-Philippines qualified for the income tax holiday granted to PEZA-registered enterprises. This hinged on whether the leasing activity was considered part of PeopleSupport’s registered activity. The CIR argued that the lease of facilities constituted a distinct and unregistered activity. Conversely, J.P. Morgan-Philippines maintained that it was an inherent component of the BPO services provided by PeopleSupport.

The Supreme Court, siding with the CIR, emphasized that tax incentives are a privilege granted by law and must be strictly construed against the claimant. To avail of the income tax holiday, PeopleSupport had to demonstrate that the leasing activity fell within the scope of its PEZA registration. The Court referenced Section 23 of Republic Act No. 7916, or the Special Economic Zone Act of 1995, as amended, which provides fiscal incentives to business establishments operating within economic zones. It also cited Article 39(a)(1), Book VI of Executive Order No. 226, as amended, enumerating the fiscal incentives granted to a registered enterprise.

However, the Court also noted that Rule XIII, Section 5 of the Implementing Rules and Regulations of Republic Act No. 7916 specifies that PEZA-granted incentives apply only to registered operations of the Ecozone Enterprise and only during its registration with PEZA. In other words, tax incentives to which an Ecozone Enterprise is entitled do not necessarily include all kinds of income received during the period of entitlement. Only income actually gained or received by the Ecozone Enterprise related to the conduct of its registered business activity are covered by fiscal incentives. Executive Order No. 226 also provides that the incentives shall only be “to the extent engaged in a preferred area of investment.”

The Supreme Court further scrutinized the scope of PeopleSupport’s registered activity. The PEZA certification confirmed that PeopleSupport was registered to “engage in the establishment of a contact center which will provide outsourced customer care services and [business process outsourcing] services.” The Court differentiated between providing information technology-enabled services and providing information technology facilities, infrastructure, or equipment. The former involves rendering useful labor or work, whereas the latter provides the medium to support business processes. The Court emphasized that PeopleSupport’s registration was for the former, not the latter. PeopleSupport’s registered activity of rendering “business process outsourcing services” refers to provision of information technology-enabled services that support certain business processes of its clients.

According to the Court, the agreement between J.P. Morgan and PeopleSupport focused on providing physical plant space, voice and data infrastructure, workstation infrastructure, and platform and support for inbound telemarketing activities. The Court emphasized that PeopleSupport was not outsourcing its customer care functions or business processes to PeopleSupport. Instead, J.P. Morgan’s own personnel were performing the services using PeopleSupport’s facilities.

This distinction was critical in the Court’s decision. It meant that the arrangement was essentially a lease of facilities, which fell outside the scope of PeopleSupport’s registered activities. Consequently, the income derived from this leasing activity was subject to regular corporate income tax. Moreover, the Court highlighted that PeopleSupport was registered as an Economic Zone Information Technology (Export) Enterprise, not as an Information Technology Facilities Provider/Enterprise.

The Court also cited Article II of PeopleSupport’s Registration Agreement, which stipulated that any new or additional product line, even if directly or indirectly related to its registered activity, required separate approval from PEZA. The Supreme Court emphasized that tax incentives partake of the nature of tax exemptions. They are a privilege to which the rule that tax exemptions must be strictly construed against the taxpayer apply. One who seeks an exemption must justify it by words “too plain to be mistaken and too categorical to be misinterpreted.”

FAQs

What was the key issue in this case?	The key issue was whether the income derived by PeopleSupport from leasing facilities to J.P. Morgan-Philippines qualified for the income tax holiday granted to PEZA-registered enterprises, specifically whether this leasing activity was considered part of PeopleSupport’s registered BPO activities.
What is an income tax holiday?	An income tax holiday is a fiscal incentive granted to registered enterprises, exempting them from income taxes for a specified period. It is intended to encourage investment and support economic growth by allowing businesses to recoup initial investments.
What is a PEZA-registered enterprise?	A PEZA-registered enterprise is a business entity registered with the Philippine Economic Zone Authority (PEZA) to operate within a designated economic zone. These enterprises are often entitled to various fiscal incentives, including income tax holidays.
What is the difference between IT-enabled services and IT facilities?	IT-enabled services involve the rendering of useful labor or work through information technology, while IT facilities refer to the physical infrastructure that supports these services. Providing the former is a registered activity, while providing the latter is not.
Why did the Supreme Court rule against J.P. Morgan-Philippines?	The Supreme Court ruled against J.P. Morgan-Philippines because the leasing of facilities by PeopleSupport was deemed a separate activity from its registered BPO services. Thus, the income derived from this leasing activity did not qualify for the income tax holiday.
What is the significance of PEZA registration?	PEZA registration is crucial because it determines eligibility for fiscal incentives, such as income tax holidays. However, these incentives only apply to income derived from the enterprise’s registered activities.
What does strict construction against the taxpayer mean?	“Strict construction against the taxpayer” is a legal principle that tax exemptions and incentives are interpreted narrowly and in favor of the taxing authority. The taxpayer must clearly demonstrate that they meet all the requirements for the exemption or incentive.
What was PeopleSupport’s registered activity with PEZA?	PeopleSupport was registered with PEZA to engage in the establishment of a contact center providing outsourced customer care and business process outsourcing services. This did not include the leasing of physical facilities.
What is the key takeaway from this case?	The key takeaway is that tax incentives granted to PEZA-registered enterprises are strictly limited to income derived from their registered activities. Any income from activities outside the scope of registration is subject to regular corporate income tax.

The Supreme Court’s decision underscores the importance of clearly delineating the scope of registered activities for businesses operating within economic zones. This case serves as a reminder that tax incentives are privileges that must be strictly construed and that businesses must ensure their activities fall squarely within the scope of their PEZA registration to avail of these benefits. This ruling is really about clarifying what is and isn’t considered a ‘registered activity’ for tax purposes. For this case, the details of the agreement between the companies show that it wasn’t about outsourcing services but simply leasing a space. It sets a precedent for companies to take a closer look at how their services are categorized and taxed within economic zones.

For inquiries regarding the application of this ruling to specific circumstances, please contact ASG Law through contact or via email at frontdesk@asglawpartners.com.

Disclaimer: This analysis is provided for informational purposes only and does not constitute legal advice. For specific legal guidance tailored to your situation, please consult with a qualified attorney.
Source: COMMISSIONER OF INTERNAL REVENUE VS. J.P. MORGAN CHASE BANK, N.A., G.R. No. 210528, November 28, 2018