CTA Case No. 3843 (Decision)

RIPUBLIC Of THE PHILIPPIKIB COURT OF TAX APPEALS QUIZOK CITY PAPER INDUSTRIES CORPORATION OF THE PHILIPPINES, Petitioner-, - Vei'"SLlS - C.T.A. CASE NO. 3843 COMMISSIONER OF INTERNAL REVENUE, . Respondent. N- - - - ------X D E C:: :r s :r a N Petitioner-, Paper- Industr-ies Cor-por-ation of the Phi 1 i ppines ( P !COP for- shor-t) , is a domestic cor-por-ation duly r-egister-ed with the Boar-d of Investment as a pr-efer-r-ed pioneer- enter-pr-ise for- the pr-oduction/manufactur-e of integr-a ted pulp and paper- mi 11 (E ..,fh:..:::. A, A-1 . & A-2). On Apr-il 21, 1983, PI COP r-eceived fr-om the r-espondent, Commissioner- of Inter-nal Revenue, two demand letter-s both dated Mar-ch 31, 1983, one for- deficiency tr-ansaction ta>: and documentar-y/science stamp ta>: and the other- for- deficiency income tax for- the year 1977, computed as follows: (Exhs. F and G, pp. 23-24 and 171-1721 BIR rec.) 382

DECISION CTA CASE NO. 3843 - 2- Transactien Tax Interest payments en P37, 794,009.90 money market borrowings �� P45, n1,849.oo 35'1. Transactien tax due t tle?recr1 � � � � � � � � � � � � � � � � 16~020,147.00 Add: 25'1. surcharge ������ ~ 005. 0~-.6. 75 Total ............. . P20,025, 183.75 Add: 14'1. int. fr. 1-20-78 to 7-31-8) �� P 7 ,CI93,302. 57 20'1. int. fr. 8-1-8) to ~---31-83 � � 10,675,523.::e 17 i 768,826.15 Rocumentary ~< Science Starn!� Ti\X Total face value of debentures ����������� P100,<XlCl~<X."IO.<X> Documentary Stamps Tax Due (PO �30 >e E:100_, CK.."IO , CX."IO) ( F'2Cl(l ) � � p 150~000.00 Science Stamps Tax Due (F'0.30 X P100,000.0ClCl) P200 _ _ 150.L.OClCl_.oo Total p ::!,()()' 000. 00 Add: Compromise for nen-aff i>:ture ����� _ _ _ __,3C=~). t.."IO ::::.CI(l. 300. (ll) ~094. '&.."''T. 90 TOTPL ~ rx...E ~ CXl....LECTia.E Net income per retum � � � � � � � � � � � � � � � � � � � � P 2ffi, 166.00 Add: l.hallowable deductiens 1) Disall~ deductiens availed of L~der R.A. 5186 ���������� P44,332,98l).(K..) 2) Capitalized interest e:�:penses en fL~ds used for acquisitien of machinery ~, other equipment ���������� 42,840,131.00 3) l.he:<plained financial guarantee e>:pense 1,237,421.00 4) l.hderstatement of sales 2,391,644.00 383

DECISION CTA CASE NO. 3843 - 3- 5) Overstatement of cost of sales � � � � � � � � � � � ~.018.QQ ~4(.16,19~.00 Net income per investigation ������������� P91,664,360.00 Income ta>: due therec:n � � � � � � � � . � � � � � � � � � ::!4 , 7.!4, 559. 00 Less: Tax already as!Sessed per return �00,300.00 Deficiency . � � � � � � � � � � � � � � � � � � � � � � � � � � � � � p:'I'A, 654,201. 00 Add: 14/. int. fr. 4-15-78 to 7-31-81 ������� P11,128,503.56 20"/. int. fr. 8-1-9) to 4-15-81 ........ __1_.!386,242.34 16,014,743.90 ' TOTPL ~ I:x..E MID a::u...ECTIELE ���������� P00,668,~4bo90 - � ' Petitioner protested, on April 26, 1983, the 35/. transaction tax and the documentary & sciehce stamp tax assessments (Exh. F-t.J, and on May 12, 1983, the deficiency income tax assessment (Exh. G-1). However, these protests were not formally acted upon by the respondent. On September 26, 1984, respondent issued warrants of distraint of personal property and levy on real property, in effect, denying petitioner's protest (Exhs. H and H-1, pp. 206 and 208 1 BIR rec.). I S S UE B 1. Whether or not petitioner is 1iable to pay the 35/. deficiency transaction tax pursuant to Presidential Decree No. 1154 including surcharge and interest; 2. Whether or not it is liable to pay the deficiency documentary/science stamp tax plus compromise, and; 384

DECISION CTA CASE NO. 3843 - 4- ( 3. Whether or not it is liable to pa the deficiency income ta:-: plus interest for the year 1977. As a corollary question, Whether or not the disallowance of the following dedLIC tions were pr�oper, to wit: a. disallowed deductions availed of under R.A. No. 5186 amounting to P44,332,980.00; b. capitalized interest expenses on funds used for the acquisition of machinery and other equipment amounting to P42,840,131.00; c. unexplained financial guarantee expense of P1,237,421.00; d. understatement of sales and overstatement of cost of sales amounting to P2,391,644.00 and P604,018.00, respectively. 4. Whether or not it is liable to pay the 5% development ta>:. ~~7. TRAN~ACTION_IAX The facts SLirrounding the imposition of the 35% transaction tax are as follows: On June 3, 1977, the President of the Philippines signed Presidential Decree No. 1154 380

DECISION CTA CASE NO. 3843 - 5 �- which imposes a final tax of 35% on interests derived from every commercial paper issued in the primary market to be paid by the borrower/issuer. This decree was published on June 16, 1977 in a newspaper of general circulation. Sometime in 1977, PICOP offered to the public P100,000,000.00 worth of debenture bonds with Bancom Development Corporation as the managing underwriter of said bonds. The docLimentary and science stamp taN due thereon was not paid by peti t.ioner� . On October 6, 1977, the BIR rLiled that the issuance of P100,000,000.00 debenture bonds by petitioner do not come within the purview of "commercia 1 papers" subject to the 35% transaction tax prescribed in P.O. No. 1154, as implemented by Revenue Regulatirm No. 7-�77. Provided, the following statement appears, in bold letter, in the bond itself: "ISSUER NOT SUBJECT TO TRANSACTION TAX UNDER P.O. 1154. BONDHOLDER SHOULD DECLARE INTEREST EARNING FOR INCOME TAX". (E .'!(�h. D-1-d.~ pp. 7�-8.~ CTA rec.) Based on the foregoing, it. appears that the P10o,ooo,ooo.oo debenture bonds floated in the market are exempt from the 35% transaction tax. 38G )

DECISION CTA CASE NO. 3843 - 6- On December 23~ 1977, the Securities and Exchange Commission granted PICOP Certificate of Renewa 1 No. R-112 ( 75-2) au thor i zing petitioner to issue commercial papers worth P229~864~000.00 at any one time for a period of one year from December 24~ 1977 to December 23, 1978. Thereafter, petitioner issued pre-serially numbered promissory notes to various banks and financial institutions. Interest payments made by petitioner, on the issued promissory notes~ where the alleged 35% tr-�ansac tion ta:�: was not paid~ tota 1 s as follows: (See Sr:::hedule of !�toney Narket BorroNings and Interest Payments, Uorksheet of BIR examiners, p. 37 1 BIR rer:::.J 1. Banc an Deve1opmen t Corp. P15, 648 ~ 590. (X) 2. Ayala Investment .!1. De?v. Corp. 9,436, 764.(X) 3. State Investment 1-b..\se 4,103,389.00 4. Bank of the Phil. Island 3 ' 5.-:!.6 ' 027 �00 5. Ccmnerc:ial Bank l!t. Tr-ust Co. 3,683, 118o.(X) 6. Ci tic:orp Investment of the Phils. 2,786,799.00 7. Phil. Investment System Org. 1,752, 782.(X) 8. China Banking Corp. 1, 75.3,217.00 9. Phil. Pacific capital Corp. 1,518~570.00 10. A.E.A. Development Corp. 984' 754. (.')() 11. City Trust 383,-.::...s:.::..oo 12. State Financing t~ter - 184.1_506.~ Total Interest Payments ~~~-77L-8<1:9. C)(~ The respondent contends that petitioner should have reported such interest payments in a return (BIR Form 25 . 26A), stating the total interest and taxes paid during the year~ as required under 38 '1

DECISION CTA CASE NO. 3843 - 7- Sections 7 and 8 of Revenue RegLtlation No. 7-77 (June 3, 1977) implementing P.O. No. 1154. Petitioner, on the other hand, questions the legality o �f P.O. No. 1154, which imposes the 351. transaction tax, on the ground that said decree was never published in the Official Gazette. Article 2 of the Ci vi 1 Code pr. ov ides for� the pLtbl ica tion of laws in the Official Gazette, and not elsewhere, as a r�equirement for their effectivity after fifteen days from such publication or� after a different period provided by the legislature. Petitioner c ited the case of Tanada vs. Tuvera, 146 SCRA 446 (December 29 1 1986), where the Supreme Court held that all statutes, including those of local application and private laws, shall be published as a condition for their effectivity which shall begin fifteen days after� publication unless a different effectivity date is fixed by the legislature. Cover�ed by this rule are presidential decrees and e>:ecu ti ve orders promulgated by the President in the exercise of legislative powers. (I bid) Contrary to the allegations of petitioner that P.O. No. 1154 was published only in a newspaper of genera 1 circulation on June 16, 1977, and not in the Official Gazette, this Court finds the 388

DECISION CTA CASE NO. 3843 - 8- a 11 ega tions to be mere conjectures~ for in trLI th and in fact P.O. No. 1154 was actually published in the Supplement to the Official Gazette on September 5, 1977 in Vol. 73 No. 36~ pages 8350-1 to 8350-3. The requirement of publication for the validity of the decree has , therefore, been met. However, with respect to the va 1 id i ty o �f the penalty imposed in Revenue Regulation No. 7-77, .implementing P.D. No. 1154, three conditions must concur in order that r-u 1es and regulationg pr-omulgated by administrative agencies shall have the force of penal law, to wit: ( 1) The delegating statute itself mLISt specificall y authorize the promulgation of penal regulations, cu.s. vs. Gri��and, 220 U.S. 506 (1911JJ; (2) The penalty must not be left to the administrative agency but must be provided by the statute itself, CU.S. vs. Barrias, 11 Phil. 327 (1908JJ; and, (3) The regulation must be published in the Offi cia l Gazette CPeople vs .. Que Po Lay, 94 Phil. 640J. In the case at bar, only the third requirement was present. Revenue Regulation No. 7-77 (June 3, 383

DECISION CTA CASE NO. 3843 - 9- 1977) was published in the Official Gazette on July 4, 1977 in Vol. 73 No. 27, pages 6176 to 6178 and on July 11, 1977 in Vol. 73 No. 28, pages 6458 to 6460. No penalty was pr-escr-ibed in P.O. No. 1154 neither- did the statute author-ize the pr-omulgation of penal r-egulation. Ther-efor-e, the pr-ovision of Sec. 10 of Revenue Regulation No. 7-77 imposing the 2 5/. sur�char-ge and 14/. inter-est for- late payment c annot have the for-ce of a penal law. In summar-y, only the basic 35/. tr-ansaction tax shall be imposed on the following inter-est expenses paid and ac c rued for- the year- 1977, to wit: 1. Bancom Developnent Cor-p. P15,648, 590.00 2. Ayala Investment 8< Dev. Cor-p. 9,4-36,764.00 3 .. St.ate Investment ..o_lse 4,103,389.00 4. Bank c:rf the Phil. Island 3, 536,027.00 5. Conmer..cial Bank 1!~ Tn..tst Co. 3,68.3, 118.(X) 6. Citicorp Investmet"lt of the Phils. 2,786,799.00 7. Phil. Investment System Or-g. 1,752,782.00 8. China Banking Cor-p. 1,753,217.00 9 . Phil. Paci fie Capital C.or-p. 1,518,570.00 10. A.E.A. Developnent Corp. 984,657. (X)* 1.1 � City Trust :383, $.:-...::�� (X) 12. Sta te Financing Center ____!_~' ~~- � (~ Total Inter-est Payrnent.s P45, 771. 752.()() 35/. Tr�ansaction Ta:{ ~-----�-�-----~5/. Tr-ansacticn Ta}( D...1e ~1.~.' (~ ,J.!~ . 20 *[Note: The cor-r-ect ama..1r1t of inter-est eNpense paid to A.E.A. Dev. Corp. is P984,657.(x) (See p. 981 BIR rec.) and not F~,754.~) as appear-ing in the BIR examiner- ' s \.A.Or-ks heet. ] 390

DECISION CTA CASE NO. 3843 - 10 - For failure to affix the necessary documentary and science stamp tax on the P100~ooo,ooo.oo worth of debenture bonds issued in 1977, the BIR assessed petitioner deficiency documentary and science stamp t.:n: amounting to F'300,000.00 plus compromise penalty of P300.00 or a total of P300,300.00. Petitioner, being a registered pioneer enterprise, claims exemption from the payment of a stamp taxes on the issued PlOO,OOO~OOO.OO debenture bonds under Sec. B(a) of Republic Act No. 5186 (as amended by F'. D. No. 1789 otherwise known as the Omnibus Investment Code), and as far as pertinent, is hereby quoted as follows: "Sec. B. Inc;ent_,tves _ _ to �--~--f'ic;n~.r: . ~te.r.:Q.r:,i~. - In addi ti01 to the incentives provided in the preceding secti01, picneer enterprises shall be granted the following incentives benefits: (a) Ta:�~-~Hempti01. - Exempti01 fn::m all ta:�:es under the Nati01al Internal Revenue Code, except incone ta:1, from the date the area of invesbrent is included in the Investment Priorities Plan, to the following extent: " (1 ) Che h.mdred per cent (1CQ%) for the first five years; (2) Seventy-five per cent (75%) for the sh:th thrc:ugh the eight year-s J (3) Fifty per cent (~)%) for the ninth and tenth year-s ; (4) Twenty per cent (20%) for the eleventh and twelfth years; and 39 1

DECISION CTA CASE NO. 3843 - 1.1 -- ( 5) Ten per cent ( 10'Y.) for the thirteenth thro...1gh the fifteenth year�s. XXN Respondent avers that the e>:emptions granted in Sec. 8(a) R.A. No. 5186 applies only to the e>:tent in which it is engaged in registered operations, i.e. with regard to its integrated pulp and paper project only. (E:>::h. A-3). [Section 1 , Rule IX of the Basi c Rule s and Regulations to Implement the Intent and Opinions the Investment s Incentive s Ac t (R.A. .5186)1. The bor-rowing o �f funds from the public is not one of those included in its regi s tered operations. We agr� ee with respondent. For while i.t is true, pursuant to Sec. 8(a) of R.A. No. 5.186, as .inc orpo ra ted in Art. 46(a) Chapter II of Title IV of P . D. No � .1789, otherwise known as the Omnibus Investment Code, a corporation registered with the BOI is exempt from all internal revenue ta>:es e :�:c ept .income ta:�: on a graduated basis. However, the above e>:emption privilege which include<JS e :�:emption fr�om documentary stamp ta:�:, shall cover only �the direct ta>: l .i.ab .ili.ties of the corpor�ation as may be imposed in connection with the operation of the regi s tered pioneer project and shall exclude 392

DECISION CTA CASE NO. 3843 - 12 - such taxes as may be transferred or passed on to it either by business practice or mere contractual arrangement. (Sec. 6 .� Rule IV, Rules and Regs. implementing P.D. 1789). Sure 1y, the issuance of convertible debenture bonds is not synonymous to the manufacture o �f an integr-a ted pu 1 p and paper m.ill. / An e :�:amina tion of the debenture bond certificate issued by petitioner shows that a space was provided at the bottom margin, where the amount o �f documentary and science stamps ta:{es are to be written, the same to be affi>:ed on the stub of every debenture bond certificate issued. (E ."<�h. D). The 1 iabi l.i ty of an instr-ument to stamp ta:-:, and the amount of the ta>:, are determined by the form and face thereof and cannot be affected by proof of facts outside of the instrument itself. (U.S. vs. Isha�, 17 Hall, D96, 84 U.S. 496). The provision for documentary and science stamp tax in the certi f .ica te i tse 1 f is equi va 1en t t.o notice .i. f not an admission that petitioner is 1 iable to pay the documentary and science stamp tax for the issu~nce of the debenture bonds. As regards the P300.00 penalty, Section 251 of the National Internal Revenue Code provides for a 39 3

DECISION CTA CASE NO. 3843 - 13 - fine of not less than twenty pesos nor more than three hundred pesos against any person who fails to affi>: the corr�ect amount of documentary stamps to any ta:-:ab 1e doc:umen t ~ instrument or paper. Thus, the imposition of P300.00 penalty is proper. INCOME TAX ASSESSMENT: a. Disallowed deductions availed of under R.A. No. 5186 amount- ing to P44,332,980.00 On aanuar�y 18, 1977~ a merger agreement was entered into between PICOP~ as the surviving c:or� poraticm~ and RLtstan Pulp and Paper� Mills~ Inc:. (RPPMI) and Rustan Manufacturing Corporation (RMC)~ as the absorbed corporations. The merger agreement provided the transfer, assignment and c onveyance of all the r� ights~ privileges~ powers and franchise s as well as all the properties~ real~ personal and mixed~ of the absorbed corporations in favor of PICOP. On June 7, 1977~ PI COP trans �ferred it~ 2,891~476 fully paid common shares and 148,848 preferred shares in exchange for the outstanding shares of RF'PM I and RMC. F' I COP a 1 so assumed the obligations of RPPMI in favor of the Development Bank of the Philippines (DBP) amounting to

DECISION CTA CASE NO. 3 843 - 14 - P68~240~340.00 by issuing 6,824~034 preferred shares in its favor. Later- ~ i.n August of the same year, all the outstanding shares of stock in RMC were sold by PICOP to San Miguel Corporation for P38,900,000.00 with a gain of P9~249,849.00. On November 30 ~ 1. 977 RPPM I was d i sso 1 ved but the f ina 1 approva 1 of the merger agreement by the BOI came only on January 12, 1978. (Notes to Financial Statement:.;;: , De c ember ."31f 1978 and 1977, p. 84, BIR re c .J . PI COP by vi rt.ue of the 1et ter ru 1 ing of the BOI dated February 2 1, 1977 (Exh. J-1) deducted in .1977 the previous lo s ses of RF'F'MI as well as the ba 1 an c e of its 1975 net opera t..i.ng 1 oss carry-over- amounting to P44 ~ 196 ~ 106. 00 and P136~874.00 respe c t i vely, or a total of P44,3 32 ~980.00 pursuant to Sec. 7(r.:: ) of R.A. No. 5186. (� .)(�h. Ef p,. 84 , BIR re c .J. The pertinent portion of said ruling reads as follows: 2> E:u;;;!;:;e.__~JJ.L . .Q...9_t_.J:~--~U_c;~LJ..Q. ca~.rY 9.Y:.~..r___tt_~__..J..9��.�__...91. __f\t.~g;_t.~. --.PrJ.:..gr:.___tp_ the _ 1�9~..! �Lt.2.?.91!.-..!!:.~_gl_qf....._..t.tg__t9.tj:,. g.r.._.~-~!::.!~- at.._t~Lt:.!.~ t.~. ....t~_...(.:f.).........<;..QD.P?.D. !.~........2.tiJ..!__. _@..9_. . _~oor~t~L. l..�9..t;\..! P�'I~?.OO.~.tt..t:t~; 3 ) After BOI approval of the merger, PICCF' can no longer apply for- the registration o �f 395

DECISION CTA CASE NO. 3843 - 15 -- the r-egister-ed capacity of Rt...tstan because with the appr-oved mer-ger-, such n~g.ister-ed capacity of Rust.an t.r-ar1s�fer�r-ed to PICXF' wi 11 have the same n?.gist.r-at:..i.cr1 date as that of Rt...tstan. In th.ig; case, :!;&_._.Qr-ev,io...ts _.!9�.~_.of -'3b!�..~Sl[l-� ~Y-....--~ carr-.t_~_QY~.r_JlY......f'J_Q;;,f.'_s___~_~\~--~:!:..~b. __'!;,t@_ mer.ggr.... E:.J..~. . . .~2.2:l,~ --�-~ll........t.~_.r.!g.b_t.~_e.o_cL_gpJ ig~t:tml!L.Qf 5\,.\?..t~. ,......-........~!.PJ.~_t._~--��----~~r::.s......_t.f.!. . . ._. _t,t~.----.P.?.C~.Qf! Pr.~~r.::.:.!:JgL_fqr.:::......_!;~r.:J::YJ..o..g......_c;:!~.l?..r....._.Q.f.........g,~!;b____~..9�~. II (l.hder-scor-.ing supplied). Respondent, on the other- hand, maintains that the net oper-ating los s sustained by a taxpayer- can on 1y be car-r- .ied over- and deducted in subsequent year�s by the 2.~1!1~.. ta:�: payer� , citing the cases of Standard Paving Co., vs. Coaai ss i oner o~ Internal Revenue [190 F(2J 330J and Stanton BreNery Inc. vs. CoJtHtti ss i oner of' In tern a I Revenue [ 176 F (2dJ 573J. In the cas e at bar-, r-espondent alleged that the losses incur-r-ed by RPPMI cannot be car-r-ied over- as a deduction to petitioner� ' s g r�oss .income, for- the simple r-eason that they ar-e not the same taxpayer-. While it is tr-ue that under- the 1939 amendment to the U.S. Inter-nal Revenue Code, a successor- cor-por-ation was not entitled to a deduction on ac c ount of the net oper-ating losses of its pr-edecessor-, the 1954 Code, however-, made some inr-oads into this doctr-ine. It. has set out definite statutor-y r-ules cover-ing the car-r-y-over- of net oper�ating loss wher-e the assets of the 39G

DECISION CTA CASE NO. 3843 - 16 - predecessor corporation were acquired in a tax free transaction such as in connection to a statutory merger or consolidation. Nevertheless, the 1954 Code also provides special limitations on the net operating loss carry-overs in two situations: 1. Where the change in ownership of the 11 1 oss 11 corpor-ation is due to a pure hase of i t.s stock or to a decrease in its outstanding stock, and there has been a change in its trade or business, the net-operating loss may be disallowed in �full; 2. Where the change in ownership is due to a r-eorgani z ation, the net operating loss carry-over may be disallowed in part. By virtue of this change in the law, the succession to the net operati.ng loss carry-overs has become mandatory and not elective wher�e tt1ese statutory rules are met. (Vol � .5 .� 1�1ertens 1 LaN of Federal Income Taxation, Chap. 29.11 1 p. 101). In the instant case, the limitations mentioned above does not exist. Although there was an increase in ownership, the successor corporation continues to carry on its prior business activities SLtbstantially undiminished with no change in its 39 'i

DECISION CTA CASE NO. 3 843 - 17 - trade or business. Neither was there a change of ownership due to a reorganization. Respondent further averred that the incentive~ granted under Section 7 of R.A. No. 5186 shall be avai 1 ab 1 e on 1 y to the e>: tent in whi.c h they are engaged in registered operations~ citing Section 1 of Ru 1e I X a �f t.he Basic: Ru 1es and Regu 1at ions t.o Implement the Intent and Provisions of the Investment Incentives Act~ R.A. No. 5186. Wr2 d.isagr. ee with respondent. The purpose of the mer�ger was to ra tiona 1 i. ze the container� boar�d indus try and not to take advantage of the net 1asses in c: urr. ed by RPPMI prior- to the stock swap. Thus~ when stock of a corpar�ation is purchased in order to take advantage of the car�para tion' s net operating loss incurred in years prior to the pur-�c hase ~ the corporation ther�ea f ter entering in to a trade or business different from that in which it was previously engaged, the net operating loss carry-over may be entirely lost. CIRC (1954), Sec. 382(a), Vol. 5, Hertens, LaN of Federal Income Ta .!<\�at .ion .� Chap. 29.11a .� p. 103.1. Further-more, once the BOI approved the merger agreement, the registered capacity of Rustan shall be transferred to PICOP, and the previous losses of Rustan may be 39(3

DECISION CTA CASE NO. 3843 - 18 -- cat- ried over by F'ICOF' by operation of law. [BOI ruling dated February 21, 1977 (Exh. J - iJJ. It is clear therefrom, that the deduction availed of under Se ction 7(c) of R.A. No. 51.86 was only b. Capitalized interest expense on funds used for acquisition of machinery and other equipment amounting to P42,840,131.00. F' e t..i. tion e r� bor. r o wed loans from for�eign cred ito rs i n 1969, 1.972 and 1.977 for the purpose of pur e: ha si ng ma c hiner�y and equipment needed in its operAtion. The interest payments made in 1977, covering these loans , were disallowed by respondent on the g r ound that the payment of interests should be c apitali ze d, since it r. epresen ted interest e)�: pen s e �f o l~ loans in c urred and obtained for the pu r po s e of ma c hinery and equipment for operationg, thu s , �for. m.i.ng par"t. of c apital e)�:pendit. ur� e~ On the ot.her� hand, pet..i. t.ioner maintains that � the dedu c tion was pur�s uant to Section 30 of the National Int.er�nal Revenue Code because the mac hiner. y and equipment obtained from J.oang acquired in 1969 and 1972 were already operating as of 1.973 ; and those acquired from loans incurred in 1977 were used only after December 31, 1977. 39J

DECISION CTA CASE NO. 3843 ... 1.9 - The gener� a 1 rule is that any amount of interest paid or accrued within the taxable year on indebtedness may be deducted from gross income. The requisites .in or�der� that interest may be deductible requires: (1.) that there should be an indebtednegs; (2) that the indebtedness must be a legal liability to pay the interest. In the case o �f Central Real Estate Co. vs. Co~~issioner of Internal Revenue, 47 F2d 1037, the Court said: " '- The prov.isia1 pennitt.ing proper adjustment to be m.,~de for any e:�:pendi ture or i ten of loss pn:Jpet'"lY char�geable t.c::J capital acco...tnt clear�ly means such it.ens as add to the value of Ue prnper..ty. > It 1-'D..tld be .impracticable for� C'.c~1gr�ess to en_yllnerat.e in detail what tl"lC)SE> i tens m.i~~ht: l'JE!~ but taxes and inter�est: do not fall into tl�,.,~t class> and no di.Hicul ty pr. esents i t:sel f in dealing w.it.h them spec:ific:ally. All t.he r�evenue acts have specifically provided for� the deduction of t.a:-:es and .inter�est frnn gn:JSs inccme annually wh.i.le dea~.ng gener�all y w.i th other i terns o �f e:�:pense. __ I �f C',cJngr. ess had intended to give the ta:�:p<::\yer� the pr�.i.vi lege of adding taNes and in t.er�est: to cost, .it wo...tl d have been very easy to have said !"":>O . As the Act. does not so provide, the ca1r.: J.us.i~ is inescapable that. D::ngress did not so inte:nd .)' The c:ot..wts and the Boar�d followed this view and frequently held under revenue acts prior to the 1.924 Act~ as well as thnse which fnllowed, that~- called carrying c harges were not capital items. It was held that t:a:�:es dt..tr"ing the per�iod of building � 400

DECISION CTA CASE NO. 3843 - 20 - operations were not carrying charges (for purposes of computing invested capita 1). Inter�est during the construction of a dam was not a part o �f the cost as basis f or the deduction of a loss under the 191.8 Revenue Act. In ter��es t paid dur� ing the c nn s t:. r�uc: t .i. on a plant was not a c:api t.a l e :�: pend i tur� e. {'Se c . :? .t. :.?.'2.5 .� Vo.l � .3A .� f'lerten:..=: .� L.aN of Federa.l In c ome Taxation, Chap. 2.t, p. 6211. RespcmdE'nt failed tn mention in his citation n �f LJ � S � I n c om e TE:\ :-: F\ e g u 1 a t i em 1 . 2 6 6 - .1. ( b ) t h a t t he taxpaye r has the option to treat the taxes and carrying charges as chargeable to the capital account (either a s a component of nriginal cost or other� basis~ C) I'" as an adjustment to basis)~ notwiths tanding that they are expressly deductible . e:�: <':lm.i.nei'" S' findings that the mac: hi ner� y and equipment purchased from thes e loans were u s ed for organizational a nd pre- operating purposes cannot be gi ve n we.i.qht beca u se dt..tr� i.nq the year� in question~ 1.977~ t:.he co r� por.. a tion was no longer in .its orqanizational or pre - operational stage. Clearly~ t.I1E�~n~ is no valid r�eason to compel petitioner t.cl ca pitalize interest expense from funds used for acquisition nf machinery and equipment. Thus, the -I disallowance of P42~840~131..00 was improper. 40 1

DECISION CTA CASE NO. 3843 - 21 - c. Unexplained Financial, Guarantee and Interest Expense of P1,237,421.00 The respondent disallowed the deductions of une>:plained financial, guarantee and interest e~:pen s e for 1977, to wit: (BIR Hork s heet, p. 37, BIR rec.) o_~.t~ ~~�h Y.Q,!~!'::If.!r ..l:Q...!'_ Oct. 5, 1977 12714 p._::.._~l,421.00 Register of Deeds Oct. 5, 1977 12716 Cash Oct. 6, 1977 12771 7,000.00 Cash Oc:t. 6, 19'77 500 , (IIXI � ()() Cash 12772 - -�-402,,!~.212.~ <:X,:~ e.~_,_~~~~~�!_~~~~ The basic principles governing deductions area 1) The ta>:payer seeking a deduction must point to some specific provisions of the statute in which that deduction is authorized~ 2) He must be able to prove that he is entitled to the deduction which the law allows; and 3 ) Adequate records should be kept to support deductions. (1955, Ph. Fed. Tax Course, par-. 190l.). V It is required that the claimed deduction be supported by adequate evidence or records, otherwise the same will be disallowed. Accor-dingly, the mere allegation of the taxpayer that an i tern of e:-:pense is ordinary and necessary 40~

DECISION CTA CASE NO. 3843 - 22 - does not justify its deduction. (8asilan Estate vs. Coa11issioner of Internal Revenue~ L-22492~ Septeaber 5~ 1967). No records are available to support the abovementioned expenses. The vouchers merely showed that the amounts were paid to the Register of Deeds and simp 1y Cash account. Without the supporting papers such as the invoices or official receipts of the Register of Deeds, these voucher�s standing alone cannot prove that the payments made were for- the accrued e:�:penses in question. The best evidence of payment is the off ic ia 1 receipts issued by the Register of Deeds. The test.imony of petitioner's witness that the official receipts and cash vouchers were shown to the Bureau of Internal Revenue wi 1.1 not Sl.l f f ice .i.�f no records could be presented in CClur-t prcJper mad::ing and petitioner- failed to -1 .i. dent..i. �f .i.c: at .i.CHl � As substantiate the deduction of F'1~237,421.00, respondent's disallowance of the said amount should be sustained. d. Understatement of sales and overstatement of cost of sales amounting to P2,391,644.00 and P604,018.00, respectively. The BIR examiners investigation showed that the arnoun t. of sa 1es reported by petitioner in its 40 3

DECISION CTA CASE NO. 3843 - 23 . ~. income tax return for 1977 were understated and the cost of s ales overstated, as per the following computations: ( B I R E,'I;' am i n e r 's Wor k she e t .� p � .38, B.TR rec.). P.Jales per books of ac:co.Jnts: F'ape1r � ����� F'537~656~71.9.00 T.i.mbf.:>r-� � . . . . -�~9-~!_-~9..!l?Zl?..~. ~~2 F'803, 206 ~ 495.00 S:\ les per Im:orne Tax: Paper.. � . . � � � P5.37 ~ 6~'16 ~ 719. 00 Timber --~~~,!~.,.+..~~-~-~~=! ._e.r~.:>.,.sn1,f?..~!.! .Q~.~ Difference . . . . . . . . . . . . . . . . . . . . . . ~:::-_-:_-_-~.J:~~%~-~~::~:~~ C'..ost of Sales, F'er-� Income F'607~246,084.00 Cost of Sales, Per� Books / Accord .ing to pet.i. t.i.oner. the d.i. f ference can be very well explained by the adjustments made at -, year -- end in the f.i.nanc.ial r�eport. ~ From the testimony of pet .it.ioner� 's witness, it appears that it h as been the pra ct ice of petitioner� to record its ex port sales (in U.S. Dollars) on the basis of a pre- determined fixed dollar exchange rate at the beginning of each year. At the end of the year, its auditors determine the actual process of export sa 1es this time converted .in to Ph.i l.i.ppine Pesos. The average of the recorded fixed exchange � rate and the actual rate upon receipt of the process from 40 4

DECISION CTA CASE NO. 3 8 43 ... 24 -- export sales is computed in order to arrive at the adjusted sales at year-end. This adjusted bases of sa J. es was the basis used for income ta:-: purposes. (t.s.n., October 17, .t~"98.'5 .� pp. 2(1-25). ( Peti t:ioner wou 1d want. Us to believe its audit.on:;; adjusted the amount of sales at year-end to its correct value as reported in its 1977 income tax return and audited financial statement~ i f so~ why did l t not carr�y the same adjustments in its books <Tf accounts?_ Sur�el y ~ then:.? wot.1ld have been no discrepancy if proper adjustments were truly made. The same adjustments would have been recorded in the books also, so as to properly show the tr�ue and correct amount of sales and cost of sales. ;:As the BIR examiners have cor� r�ec t 1 y observed, which We quote hereunder: " tley could have sutxni tted the corn::><::: t.ed f.i.gt.wes as adjusted by them which int.i.a lly u!=.".es a pre--determined r�ate at the beginning and cc:ntinued thn::x..1gho..1t the year. 011 y at year� B1d co.Jld the ccxnp.::"V1y' s aud.i tors det:.ennine with accur�acy the actual dollar pn:x:e-.:'ds of the export sales hence~ these adjustments. Again, these facts co...lld have tJe.en presented to the undersigned for� proper evaluatic:n at the pre--as~.,essment level of this ca~-e. Tt1!?. recor�ds st~~ that. nc:ne was ccxnpl ied with." On the basis of the foregoing, We see no reason why We ought to subscribe to petitioner's position. 405

DECISION CTA CASE NO. 3843 - 25 -� The 5% corporate development tax is a tax imposed in addition to the corporate income taH. This tax is assessed on every corporation whose net income for the taxable year exceeds 10% of its net worth (in the case of a domestic corporation) or net a s sets in the Philippines (.in case of a resident fore ign corporation); or in the case of a close ly- held cor- poration~ the 5% corporate development tax shall always be due~ regardless of the rate of return on its net worth. NIRC; Sec. 1, Rev. Reg. No. 11 - 77). For purposes of determining whether the net income c:if a corpora ti.on e:�:ceeds 10% of the net wor� th~ the ter"m "net worth" means the stockholders' equity represented by the excess of the total assets over liabilities as reflected in the corporation's balance sheet prepared in accordance with generally accepted accounting principles employed in keeping the books of the corporation. (Se c . 2, Rev. Reg. 11-77). _.-Pet.i. tioner having failed to dispute and c ontrovert the findings of respondent with respect to the unexplained financial guarantee expense, understatement of sales and overstatement of cost 406

DECISION CTA CASE NO. 3843 -� 26 �- o �f s a 1 e s ~ the Court. has no other� a 1 tern<:~ ti ve than to hold petitioner liable for deficiency income tax for the year 1977~ computed as follows1 Net inc:ane per r�etum � � . � . � � � . . � � � � � � � � � F' 2::.8, 166. 00 P-K-.id: l..nallowable deductions;; .1.) Lhe:-:plained Hnanc:i.al guar�antee e}:pense ����� F'l ~237 ~421.00 2) Lhden;;taternent of s:...ales " ............... " 2~391. ~644.(X) 3) OverstatE'fi'IE.'Ilt of cost of sales -�-�����QQ.4_,..Q_.l,I;I_,._QQ _1._,._;;?.~_,._1&_~-~-~~?. Net incane as adjusted E1.,..15'J_,_~.49..~..1!~ Incane tax due therecn P1 ~ 561 ~ 9"37 .15 Less: Ta:-: already assessed per return -�-------'~-~--'-~~~-gQ Deficiency incane ta:-: P1.,481.~579.15 Add: 14/. int. fr. 4- 15--78 to 7 - 31-�80 20/. int. �fr. 8 - 01--80 to 4-�15-81 f.~:_19._,.�.9..!..~ --�----~-R.s95'.Q..!.Q.!. F2~166~675. 76 Add: :2<)/. int. fr. 3 - 31--83 to 3 --31-�86 .J.:.!\.~~;~~,..~;~!R.! .4.9 P3~466~681.21 Add: 1.0/. surcharge ------- ~'-9.9�.�J.:? lDTPL f'-Y'O.J\fT I:X..E PM> CXl..LECT I ELE However~ 1 petitioner shall not be liable to the (..._. 51. corporate development because its net income~ after adding the disallowed deductions~ does not e:-:ceed 10/. o �f its net wor� th or total stockholder's equity of P464~749~528.00~ the net 1� income for 1.977 being only P4~491~249.00. WHEREFORE, the findings of respondent, Commissioner of Internal Revenue, is hereby modified. Petitioner is ordered to pay respondent 40 7

DECISION - CTA CASE NO. 3843 -� 27 -� the total amount of P20,133,762.33, itemized as follows: ~1. Transaction Tax ������������ P16,020,113.20 Doc:unentary & Science Stamp Tax �� 300,300.00 Deficiency Income Tax 1l.Je ������� -�-~!1~-!_~JI.~~-!!.~ Cost against petitioner. SO ORDERED. Que z on Ci.ty~ WE CONCUR: "- c. ROAQUIN Associate ,Judge CERTIFICATION I hereby certify that this decision was reached after due consultation among the members of the Court of Tax Appeals in accordance with Section 13, Article VIII of the Constitution. F'resi.di Judge Court of Tax Appeals 408