CTA Case No. 4405 (Decision)

,l REPUBLIC OF THE PHILIPPINES COURT OF TAX APPEALS QUEZON CITY PICOP TRADING CORPORATION, C.T.A. CASE NO. 4405 Petiti oner, Promulgated: - versus - AUG 23 1994 COftftiSSIONER OF INTERNAL REVENUE, Respondent. X - - - - - - - - - - - - - - - - - - - - - - - - - - - X. DECISION In this suit petitioner seeks to review the decision o� respondent dated January 8, 1988, denying the protest against the assessments o� de:ficiency income and withholding taxes �or 1985. It appears that petitioner's PI COP Trading Corporation, <PTC> a wholly owned subsidiary o:f Papue� r Industries Corporation o� the Philippines <PICOP>~ i s primarily engaged in the business o:f trading~ at retail and wholesale, paper products. On May 1~ 1982~ petitioner entered into a Distributorship Agreement with PICOP to di s tribute on exclusive basis~ the paper products manufactured by . PICOP which was however terminated on November 1, 1985. On the basis of the report o� investigation o:f the revenue examiner, and having determined that there h a s 798 ..' I ..' ' ~-

DECISION - C.T.A. CASE NO. 4405 -2- be~n due from petitioner, deficiency tax liabilities, respondent, issued a demand letter and assessment notice both dated January 8, 1988, requesting petitioner to pay deficiency income and expanded withholding taxes for 1985 in\~ the amounts of P6,623,930.30 and P114,534.84, respectively, inclusive of increments thereon <Annexes "A" and "AJ", pp. 8-9, CTA rec.; pp. 147-149, BIR rec.) In a letter dated February 26, 1988, petitioner protested the assessments on the ground that the said assessments lack legal and factual basis <Annex "B", pp. 10-15, CTA rec. ; pp. 150-155, BIR rec. ) In a letter date? � August 21, 1989, respondent rendered his final decision on the disputed assessments denying the protest and reiterating the demand for the amounts of P6,623,930.30 and P114,534.84 representing deficiency income and withholding taxes (Annex I! 17, CTA rec.; p. 165, BIR rec.) "C", p � ,. ) Hence this appeal. The issues for r esolution in this controversy are as follows: 1. Whether or not petitioner's sales for 1985 was understated as a result o:f deducting the domex price dif:ference :from its gross sales; 2. Whether or not petitioner' a interest income :for 1985 was understated; 79

DECISION - C.T.A. CASE NO. 4405 -3- 3. Whether or not the slitting and .rewinding expenses are deductible as an expense ~� i tern in 1985 ~ 4. Whether or not petitioner should be assessed deiiciency expanded withholding taxes. Set Iorth are the discussion oi the above issues ad ~~ . ser~at~m. 1. Domex Price Difference - It is the position oi the petitioner that its sales Ior 1985 was not understated by the deduction oi the domex price diiierence Irom gross sales. Justiiying the stand, petitioner asserts that the domex price diiierence serves as an incentive to exporters to procure their packaging materials Irom local sources. To avail oi such incentive scheme, the customers are required to submit prooi that the products were actually exported abroad. It claimed that this price diiierential is a legitimate expense oi PTC. Describing its procedure, it claims that in a sale oi krait paper products to customers, the transaction is taken in the book oi the petitioner as Iollows: Entries made upon sale with sample Iigures: 1. Dr. Accounts Receivable P15,500.00 !\ Cr. Sales <T o r ecord export e al e s account HI a t l ocal pr ice) P15,000.00 �I' Dr . S ales ? 2 ,32 5 . 0 ( .:: r . D "!e x P rice Diii e i P.:nc~� 798

DECISION - p 2,325.00 C.T.A. CASE NO. 4405 - 4- <To set-up provision �or domestic price di��erence> Limiting the ex�mination to the above entries, the examiner naturally conclude that petitioner understated its sales in 1985. However, it asserts that had the '\~ examiner examined the entries covering payments o� customers exports �or the above transaction, he would have arrived to a dif�erent conclusion, thus: 3. Dr. Cash in Bank P13,175.00 Cr. Accounts Receivable <To record partial collection o� account) P13,175.00 In e��ect according to petitioner, what was le�t in the transaction a�ter the three entries is a debit balance accounts receivable at P2,325.00 and a credit balance �or domex price di��erence in the same amount. + This balance remained open in the books o� PTC until the ' customer exporter liquidated the domex price di��erence,. thru the submission o� export documents to PTC. Upon t receipt of said documents, PTC issues a credit note to t customer-exporter and makes the �allowing entry: 4. Dr. Domex price di1ference P2,325.00 Cr. Accounts receivable <To record credit note - for liquidation of pr " e d i .ere :nce ) P2 , 3 25. 0 0 c o ;ple�te d t.r.r~naec.~tio:� an d lte�aed ~-h e cu s .cni!ler ~ � acco u d:. "''r om t hr 798

DECISION - C.T.A. CASE NO. 4405 -5- :for~going, petitioner claims that i t never intended and in :fact, did not deprive the government o:f revenues. Petitioner :further contends that a domestic transaction involves di:f:ferent stages, the selling �o:f krJ~~ paper, to a converter <re:ferred to as customer- exporter), the manu:facture, then the delivery o:f boxes, by the converter to his customer, the act o:f exporting and the submission o:f export documents to the converter which in turn, submits the same to PTC. The process requires a lead time o:f at least 6 months. In other words, a single transaction may ' start in a particular year and end in another, which could not have been yet i subject o:f de:ficiency assessment :for understated sales and submits that the de:ficiency assessment in the amount o:f P9,863,047.30 should be set aside. .' On the other hand, respondent contends ,., 1 As stated in the examiners report, the P9,863,049.30 (net credit balance :for 1985) otherwise. �,. . amount o:f �represen~s I mere provision :for price adjustments to customer- exporter. The original entry to take up said provision was a debit to 'Sales-Kra:ft ~aper' and a credi t to 'Domex S ubse que n t ent� 'lfas ad he n C I" e di'C ~-~te w L iss e � to custome r - ). -o��'":"'"r .for r etr te? b a se~ n1 lrJ 800 l'

DECISION - C.T.A. CASE NO. 4405 -6- Boart;( � o:f Investment <BOI> by debiting 'Domex Price Di:f:ference' and crediting 'Accounts Receivable-Trade'. Hence, Sales-Kra:ft Paper was reduced by the provision made not yet liquidated during the year in the amount o:f P9,A~3,049.30." We agree with respondent. It is to be noted that :from the entries made by petitioner, the accounts receivable was not reduced by the provision :for domex price. In :financial accounting, revenue means "gross increase in assets or gross decrease in liabilities recognized and measured in con:formity with generally accepted accounting principles that result :from thQSe types o:f pro:fit-directed activities o:f an ': enterprise that can change equity." <Pls. see Statement o:f Financial Accounting Standards No. 1, p. 40). BaseCI on this de:finition, petitioner has obviously understated its sales since it recognized a gross increase in assets while the sale vas lessened by the domex price di:f:ference. Petitioner could have done better had it explained to the Court the treatment of domex price di:fference at the end of "1985. However~ what vas explained during the hearing vas the event therea:fter: <Please see T.S.N., September 25~ 1990, pp. 2 3-26>. ll 2. Deferred int.erest. income - 80 i

DECISION - C.T.A. CASE NO. 4405 -7- Petitioner contends that the de�erred interest income in the amount of P4,597,716.00 should not be included as part of petitioner's gross income for it is more of imaginary income than a taxable one. Thus for actually 198 ~~) only thos e interest and penalties collected were reported as interest income. In the same year, interes t and penalties condoned were not taken up as expense by petitioner, justi�ying this treatment, on the ground that it is not a lending company which earns interest income in the ordinary course of business. In fine, it is argued that said amount of P4,597,716.00 is not a taxable income because there was no actual flow of wealth into the taxpayer at the end of the taxable year. In any event, interest income sought to be taxed was subsequently r eported as income when collected and the remaining balance was not reported as expense when condoned. It added that the procedure was consistently ,,, applied in prior and subsequent years, thus, there was no loss o� r evenue on the part of the government. 'l We disag r ee with petitioner. Income arising from late payment of accotints shou i ~ t. he recogn ize d becaus e the earni n g process had already been co r�l e t .e d . Si n ce peti t i o ner tas adop ted the acc r u al meth d o~ a cc ou nting , t.h e int .erest. i:r: c ome is sup p c�se d "'<�.� 80 2

DECISION - C.T.A. CASE NO. 4405 -8- be .reported in the period earned rather than when the cash was received or paid. Hence, we :find :for respondent. 3. Slitting and rewinding expenses in the amount o:f P 120, 919. 34. The amount represents expense incurred between November 1 2 to December 4, 1985, a:fter termination o:f the Distributionship Agreement. However, the same was disallowed by respondent. Since the expenses were actually incurred and billed to petitioner :for having paper rolls slit and rewinded in the year involved, <see BIR recs., pp. 92-107). These expenses are deemed deductible business expenses. The termination o:f the contract between PICOP and PTC is immaterial since these expenses. were incurred to :ful:fill unterminated trans~ctions arising there:fro~ � 4. Deficiency expanded .,it.hholding tax. p 114, ~�34 . 84 After a care:ful consideration o:f the records o:f the case, we :find that the petitioner indeed :failed to withhold the required withholding taxes on payments to ope:r�at.o r s o:f stevedoring, waiehousing, and t r ansportation �! c ontractors for c a r riage of good s. Thus, pursuant to I;, ~�4 ( e} of t.he Tax Co de, �e i tictn e r i 1 �ab l e tc� ~)'. tha lax r~ ui r d to be e d u ci'2 80 3

., DECISION - C.T.A. CASE NO. 4405 -9- surQ~arge and an interest o� 20X per annum �rom the time the tax is r equired to be withheld until the date o� assessment. A recomputation o� the 1985 income tax as well as the de�ic iency expanded withholding taxes are in ord(~ to wit: � Reco1putation of 1985 deficiency inco.e tax: Jlet inco.e/lloss} per return IP 521,885.00) Add: Unallowable deductions and additional inco.e a. do.ex price difference P9,863,049.30 b. deferred interest 4,597, 716.81 c. representation and entertain.ent 30,000.00 14,490,766.11 Ret inco.e per Court co1putation P13,968,881.11 lnco~e tax due thereon (Sec. 241 P4,879,108.39 Add: Interest on deficiency (Sec. 51tdiJ fro� 4-16-86 to 1-8-88 14,879,108. 39 X 20% X 633/3651 1,692,315.40 TOTAL AftOUNT DUE AND COllECTIBLE P6,571,423.79 1985 Deficiency Expanded Withholding Tax Delivery expenses P2,142,457. 87 Freight expenses 6,384,252.91 Arrastre t stevedoring 894,643.16 Warehousing and storage 136,915.20 Total P9,558,269.14� 1% Expanded withholding tax due p 95,582.69 less: A1ount already paid 13,037.55 Deficiency expanded withholding tax p 82,545.14 Add: Surcharge and interest (Sec. 54(eiJ Surcharge (82, 545.14 x 2SXJ 20,636.28 20% Interest fro� 10-31-85 to 1-8-88 ((82,545. 14 X 20X X799/365) 36,138.94 p 139, 320. Jb� TOTAL DEFICIENCY TAXES DUE AMO COllECTIBLE P6,710,744.15 �con-ected by t.ht> Court due to error in footi ng. Wh ere� o r e the dec is ion appe aled � r om is hereb y Pet i' .i e r PI COP 1 rading Corp rati o n is he ld li~b e 1or d e 1 icien c y in c o me �~' e x pan ed wi t h ho djng 804

DECISION - C.T.A. CASE NO. 4405 - 10 - tax~~ in the amount o1 P6,571,425.79 and P139,320.36, respectively, or in the aggregate amount o1 P6,710,744.15 1or the year 1985 inclusive o1 surcharge and interest. With costs. ,~~ SO ORDERED. Q~lQ,~ ERNESTO D. ACOSTA Presiding Judge WE CONCUR: ~~7~ ;t Ju:~ RAHOH 0. DE Associate CERTIFICATION I hereby certi1y that this decision was reached after due consultation among the members o� the Court of Tax Appeals in accordance with Section 13 Article VIII of the Constitution. P:res idi :cur-~:- 1 Ta x 805