CTA Case No. 3604 (Decision)

REPUBLIC OF THE PHILIPPINES COURT OF TAX APPEALS QUEZON CITY PFIZER, INC., C.T.A. CASE NO. 3604 F'E'ti tion er, -- versus - THE COMMISSIONER OF INTERNAL REVENUE, Res po nd e n t. X- - - - - - - - - X DEC I S I 0 N I n this petitio n fo r- petition er Pfizer~ Inc:., assai l s t h e decision of r-espon d ent Commissio n er of Internal Rr-2 venue dated Septe m bt=~r 21., 1.9E:1 2 denying pet.i tionE?r' s for c:,:mce 1 J. a t.ion o �f the a ~;sess men t .in the amounts of P245,552 . 08 a n d P55,1.37 . 65 as deficiency income tax for- the f .isca 1 year t=?nded Nove mber 30, 1974, a n d wit h holdi n g tax at s ource for the year 1.974, r~ e s pec: t:i ve 1 y. For t h e material facts, petitioner a l leges a n d n"?sponden t .;1 ,Jmi t:s t: h a t: 1. Petitioner is a corporation du ly orga nized and existing u n der a n d by virtu e of t he l aws of t he 390 .,

- DECIS I ON CTA CASE NO . 3604 -2- Philippines t.-J.ith pr-incipal o �f �fice addr-ess at 6th Floor~ Ara za Building~ Paseo de Roxas~ Makati~ t1 e t n:J t�1;:m .i.l a ; .... Respondent is the duly appointed ...:.:.. Commissioner- of In ten1a 1 Revenue who ho 1ds off .ice at the Bur-eau of Inter-nal Revenue Building~ Di liman ~ Quezon City~ t.-Jher� e he may be ser-ved t.-Ji t.h 3. In a lettf?r- dated 1'1ay ~.:;: o~ 1.979 which peti t .ioner- r� ecei ved em August 29 ~ 1. 979 ~ r� esponden t asses se d and demanded fr-om petition e r- a total amount of P 300~6 89.7 3 as alleged deficien cy income a nd withholding taxes for the year- ending November- 30~ 1974 co mputed as follows: ::� y Ended Novembe..r:_ 3Q_~_19"Z1. I.ncomp. T.e..!'i. Net income per retur-n - F'B ~ 4e)O, 875.24 Add: Unallowable deductions: F.:..... 49-'!...s.~~<:>-"Z...� 07 1.. Resear-ch and dev. p~~54,942.31 e :�: p s . - P 30 0~.199.71 F'3, 1 2 4, 230. (H) f~.:...::S..s3..~J.-~~~9 6 � 0 0 2. Other marketing F' 1.72~924.00 exps. - P 8 2 ,926.42 3. Overpriced por-- tion of pur�c hases P 11_~~.s....<r..1.Q. 91. - Net income per- inves- tigation Income ta x due ther-eon Income tax alr-eady paid - Balance 38 1

DEC I S ION CTA CASE NO . 3 604 -3- Add: 14/. int. p.a. f~. - p T.?. ~ 628. 08 3/16/75 - 3/16/78 TOTAL AMOUNT DUE AND CDL.. L.ECT I BLE 19 7 4 Informal dividend - Pfize~ -�- F' 38 ~ 8 2 9 . 33 Corporation (Hcngkong) 35/. withholding tax at sou~ce due the~edn Add: 14/. int. p.a. fr. 1/26/75 - 1/26/78 TOTAL. AMOUNl DUE AND COLLEC . I BLE 4. In a letter- dated CJctobe~ 24~ 1979 vJhich ~espondent ~eceived on CJctobe~ 29~ 1979~ p e t i t i o n e r p~otested the assessment; 5. In a let.tE?r dat.ed Septenlber� 2 l ~ 1.98 2 which petitione~ received on Februa~y 25~ 1983 respondent denied petitione~ � s pretest and his demand for the payment of the deficien c y a ssessment in the amount of P300~689.7 3 ; 6. In assessing petitione~ for- deficiency ;LQ.s;:ome taN for� the yea~ in question~ r�� esponclent disallowed the following:

DECISION CTA CASE NO. 3604 4- (a) Research and development e:-:penses F'300,199.71 ( b) Marketing expenses p 82,926.42 ( c ) Overpriced portion of P110 , 940.94 purchases Averring that the disallowance of the .i. terns described in paragraph 6 above has no factual and legal basis petitioner appealed to this Court. In its petit.ion review, petit.ioner assigned as errors, and issues, the following: 1. Respondent .in assessing pe titioner for a 11 ege;�d def ic ienc:y incom~____te.li for the year in question erred in disallowing the following: (a) Research and development P300,199.7l e:-:penses 82,926.42 (b) Marketing expenses 110,940.94 ( c ) Overpriced port.ion of t.etr�a c y c 1 ine 2. Res pondent i n assess.ing petitioner for deficiency \.'J.i thho 1 d i!J..Q...._j;_a:-: for the year in question in tr-ea ti.ng the overpriced portion of tetracycline as informal distribution of dividends to Pfizer Corporation, a corporation organized and .. existing under the laws of the State of Ne w York, U.S.A. (Pfi z er New York).

DECI S ION CTA CASE NO. 3 604 - 5- Re�.~E. r c;J:~L~DJ.LJJ..eve 1 opmen t _ Ex pe.D se'-"s=--_ _,P-'30=~0'-''-'1=-_9,_-9''-'�:..7"--1= In disallowing the claimed deduction of - �.:. research .:mc:l development eNpenses of F'300,199.7l, respondent explained in his decision appealed from (E:-:h. 7, pp. 190-.1.9.1., BIR records) that "It is the stand of this Office that since your client (petitioner herein) is manufacturing and selling dr-ugs under estab l ished patent, processes or fonnulas t h at have alr-eady been devE~loped by its p<:l.ren t company, Pfizer New York, U.S.A . , research and development costsj as well as othe r marketing expenses, can no longer be claimed by your- c l i e n t as c:lec:luctiblf-~ e:�:penSf.�~s." This is suppor-ted by the findings o �f the revenue e:�:aminer assigned to inves tigate thi s case in his first indor-s ement dated November .1.3, 1978 (E :�: h. pp. 102- 105, BIR r�ec:or�ds) to the effE?c:t that the drug s e:�:por1 r:> d by petitioner have already been so chemically composed and perfected for outright consumption without the necessi t:y of �further� tr�ials, e:�: perimenting and testing. Against this bac kdrop, it would seem unusual therefore for pE~ti tioner� to have provided for- and development expenses as its business operations do

DECISION CTA CASE NO. 3604 - 6- not apparent 1 y req1~Ti re res ea rch~ e:�:per imen t and development of a product~ formula or improvement of an already existing drug. However~ a perusal of the detailed expense account of this item (Exh. E, p. 45~ BIR records) shows that of the total expenditure of P300,199.71 only the amount of P.t.t.t,459.00 repr�esen ting clinical and investigati6nal expense~ as pointed out by petitioner itself~ would fall under research and development cost. (p. 146, CTA record s .) The ethel'- e:�:penses consisting basically of ad min .i. s tr�;:.~ tion and s uper�vision; scientific and technical; accounting, clerical and secretarial; other.. payroll; sp~cial compensation; social sec uri t.y ta:�:es; compensation insurance; group n::~ pai r.. <:\ncl maintenance supplies; manufacturing supplies; electricity; accounting and other profe ss ional services; posta~le; telephone, telegr-aph and cable; traveling, moving and ent.er�taining expense; memberships, dues and subscriptions; building, off ice and sani tary services; stationery and office supplies; equipment purchased, rented or serviced; company meetings; corporate expen se and mi scellaneous items; general

DECIS I ON CTA CASE NO. 3 6 0 4 - 7- insurance; taxes; rent of premises; depreciation amortization; admittedly allowable deductions. Since these items are clearly and unequivocally ordinary and nec:essar�y e:-:penses in carrying on petitioner's business the amount of P188,740.71 is therefore a deductible expense under Section 30(a) of the Tax Code. On the clinical and inve s tigational expense of P111~459.00~ testimonial evidence to this effect presented by petitioner reveals that: financ .i al / Tes timony of Dioscorro Tatad, ma nager of pe~itioner: H .� �. N Q. In line 41., you have ~~ere "Clinical and Investigation E::pens~2", and opposite to that you have the figure "P.t.t.t,459.00". Can you e:-:pl.3in? A. Well, the ~e clinical and investig - ation ~x penses, these are expenses incur r�ed by the pharmaceutical ~.i ivisir.m in conducting test s of the products in the market, and this inc 1udes cost of the pr-odu c t i t s e 1 �f that. ar-e being �given to the doctors, hos pitals and other c l inician for them to test the product to their patients. And thes e doctors are r�equi reel to submit a report to the medical director on their findings on the pr-oduct as to its efficacy and the result of their tests whether 3So

DEC I SI ON CTA CAS E NO. 3 6 0 4 - 8- t.h~:-?se ar-e good or- \I'Jha tever reac: t.ions are being encoun t.ered by the doc tors in conducting the test.." (TSN~ December 14~ 1984~ pp. 8 - 9~ 11) Dr. Antonio Perla s ~ vice president for me dical af �fair s~ likewise described the petitioner-'s activities as follows: Q. Please e:-:plain what activities does this clinical trial consist of? A. l>-Je have differ-ent kinds of clinical tr-ials. - ... The first one is the registration trial. The purpose of the regis- tration trial is to test the me dicine among Filipinos for sa fety and efficacy as r�equir� ed by the Ministry of Health. After- th.:1t we also have so me clinical tr-ials. We conduct to he 1 p pr��omote the product of the company. WP u s ua 11 y ask physicians to conduct c linical trials to d emon st rate to Filipinos the drugs we have to market are effecti ve and s.:~fe. Bec ause o �f d .i. f fen:?nce s of 1 i ving cnnd .i tions, c limate~ physique, diet s ~ habits~ r�eact.ions, ba c kground and others~ i t cannot be sai d with ce rtainty that drugs and medicines manufactured in the United States for- Amer ic<:~.ns are just as safe and effective for Filipinos living in the Philippines. These dr-ugs and medicines had to be 3J'?

DECIS ION CTA CASE NO . 3 6 0 4 - 9- clinically tried and investigated. Thus as stated by Mr. Ramon Tan of petitioner company (Exh. 3~ pp. 54 -�-60 ~ B I R records) ~ the resear-ch and development expense involved particularly: liaison with leading medical associat.ion.s gr-oup and pr <::\c titioners so that new products can be tried locally; ' H-e pare clinical investigation to d Lerm.i.ne the local experience and r�� E!actions to the new products; sec ure feedback information on the efficacy and safety of medic a l produc t s so that better treatment dosage of drugs can be established; maintain file on current deve lopments r~lating to the drug industry; Since these clinical and inves- ti<] <'l tion s ~ s hovJn abovf:~ ~ were aimed at. di s c:over� .i.n<] o �f new knowlPdqe vJith th�"7? hope that sue:: h know J. edqf.? would be usefu 1 in deve J. oping or :i. rnpr�� ovinq the safety and effi c acy of petitioner's product s whir:. h invar� .i.ab l y brought b e nefits whir:. h la stf.:~ d �for�� mn r� e than nne y~:?ar or�� even year-�s, the amount F'.1.1.1,459.00 the F'300,.199.7.1., as petitioner' s c. ouri st.? 1 admitted, should therefore be capitalized. 398

DECISION CTA CASE NO. 3 604 10 - These e:�:penses "consi st o"f outlay s paid to r�ec::; ear-c h age~nc .i.es "for� e:�: p 1 ora tory st ud y ~ r�esear-ch stu d y, .in --depth interviews~ med ica l surveys, e:-:~?c:ution tE-)St a nd c:o mmE?nts o �f specia l groups of med .ic:a l per-scmne 1 on' spec .if .ic or par-t.icu 1. ar- drr�ugs s u ch as the n~::~w mini press, c:o mbant.r- .i. n , con tn"'mine, v .i.s.ine ~ "fa s.i.gyn, c:afiel and geopen conducted the basic pur� pos e of furthe r- improving t. ht'? quality and e f ficiency of the ( E:-: h. p. 104~ BIR r ecords .) Whil e petition e r ' s witness te s t .i~ied : Q. How about the other mark eti ng e:-:pense which was di sa ll owed, can you e:-:plain the n ature of this e:-:pen se? A .. We l J., these arr�e e:�:pe n sr:.~s being paid to adver�t.i s.i. ng c:o mpa.n .i.es to co n due: t te s ts al s o in the mad::f.~ t, espt>cia lly when there are new products to be mar k e ted by the marketing divi sion. B~?�fon�~ they dec .ide to 1 aunc h a r:wodu c: t , th ey havr:~ to conduct t e~s t s wh~:~t h er� thesE~ pr� oduc t s are adaptab l F.? here, so they engage the services of thes~ ~dver-tising companies to do the job. (TSN, December 14, 1984~ pp . 12- 13) - �.:.. petitioner's E:�:hibit "F" (p . 4 2- 4 3, BIR r� ecor-ds) s hows that such e:-:penses were paid to research organizations/companies primarily for in-depth 399

DECISION CTA CASE NO. 3 604 - 11 - :i.nter-v.i.e..,.Js on cer� t..~in dr-ugs~ :i.nt.r-oduct:..i..on o �f new dr-ugs, r-esear-ch ser-vice for- explor-atory studies on dJ�.. uqs~ medical SUI'""VI�o~ys ~ concept and package clr-ug ar-tl-'Jnr�� k, e:�:E.?cut.ion for� tw.i..nq.ing about. significant impr-ovem~:~n ts o-f the quality and pet:i tiCHH:"t"' ' S pn)duct:s. Since these marketing expenses ar-e in the nature of search or- c r itical in v estigation in bringing about a significant impr-ovement to petitioner- ' s pr-oducts~ the> br,:~np �f.i.c:ic:\1 ��?ffec::t~:; o �f vJhich would e>:tend to fu t.ur�� E� per�� iods, the amount. F'82~926.42 r� epr-�r-:-~sen t.i.ng suc h e:-: pensE?.s shnu 1 cl be c:<::lpital.iz.f:? d. It appear-s t h at for- the fiscal per-iod of 1974, pPti t:..i.uncr.. pur� c hc:\sPd Hongkonq~ noted by r-espondent.' s e:-: aminE>r ~ 7 4.1 , 68:::;. k i. 1oq r.. am s o �f tetr.. acycline:-~ .:~t a t.ot<.:\1 pr-�:.i.r::e o�f P ::'~~~' ::~:,Bl.l."/4. Respondent's examiner- also discover-ed that for the same year-� ~ Pf .i zer, Hnng kon<] a 1 so sn l d to laJ arner- C h ilcott. 800 k.i.loq_t�� g.rns o �f tet.r-;:;>.c:yc: l i ne at. a t.ot,~l pr-�ir::e of F'Z?9, 400. BO. Compar.in<;,J these sales, r-espondent's examiner- s ur-mised that the nve I'- p r� iced 400

.. DEC I SI ON CTA CASE NO . 3 604 - 12 - por-tion pur-c hase s in the s um of P110~940.94 fr-om Pfizer-~ Hongkong in 1974 (p. 98~ BIR r-ecords) is a built- in amount in petitioner's pr-icing system with Pfizer-~ Hongkong~ acting as the medium wher-eby infor-mal dividends wer-e r-emitted~ to the e xte nt of the ~Nc:ess !' to the par�en t. comp.:~ny ~ Pfizer- Cor-por-ation of New Yor-k. Ther-e is entirely no factual basis for� the a 11 ega tion that Pfizer-~ Hong kong~ is ac tinq as a medium thn.1ugh which dividend s wer�e channeled to pet..i ticmer- � parent company~ Pfizer- Cor-por-ation of New Yor-k. Honqkong~ was never� stoc kholder� of petitioner- dur-inq the period in que:~stion. (t.s.n.~ December- 14~ 1984~ p. 16.) AC_,' a matter- of fact~ i t was Pfi ze r- Cor-por-ation of New York~ a cor-poration organi zed under the law s of the St.<"' t:.e of U.S.A.~ which was the stockholder- of petitioner-. (E :-:h. "J" ~ p. 68~ CT{) r-E'!CCH"d S . ) An assessment fixes and determines the tax liability of a taxpayer-. Hence~ the assessment mu st be based on actu <:;~. l fact s . I t should not be bc:\ se cl on me r-e pF� ~~sumpt.i.on or- a ss umption no matter- how r-easonable or logical said pr-esumption may be � .. 401

DECISI ON CTA CASE NO . 3 604 - 13 - (Coll ec t o r of Internal Revenue v s . Benipayo ~ 4 !3Cr\A 182. ) At any rate~ the records show that for the year .1974 involved in this case~ petitioner purchased from different suppliers tetracycline at unit costs ranging , from $32.80 to $ 3 5.43 per The r-ecor-�ded unit cost of tetr�acyc 1 ine pur-chased f� ��om Pfi z er-, Hongkong~ is $3:3.00 which is the r-�ange. It seems evident, therefore~ that i s no question that petitioner purchased the product at arm's length or at its fair market value. (p . .179, BIR records.) Thi s a s sessment of P55, .t T l. 6 ~~ a s wi thho 1 ding t .;D: at. sour-ce fot�- .1974 was based on respondent's view that the over-�priced por.. t.i.on of t .etr-.:\cyc 1 ine const .H :. uted infor-m;.':\1 d.ist.r� .i.bution of dividends by petitioner to Pfizer, Hongkong. Having reached the conclusion that .ther.. e could be no such infor-mal dividend, this assessment cannot be sustained. 40~

DECISION CTA CASE NO. 3604 - 14 - ~QD..!;..l!:,!.?...! .Q.D... light of the above~ petitioner ' s In the de �f ic i ency .income ta :-: for the f .i sc,::\ 1 year ended November 3 0~ 1974 is therefore computed a s follows: E:.:L~c a !._Y_e a r :_..f- n ~j erl_~_g_y_!?. m .b~r 3_~~--;!. 97 4.. J..m;.o 111-~---I!~~:!.. Net income per return - P8.460~875.24 Add: Unallowable deductions 1. Research and d~v~- lopment expenses P111~459.00 2 . Other marketing e ;.:pen s P <::~ EfL..{2 5 ~--:;s-~5~.~.1> 4. Net income per inves- -- P3~0.19~34.1.00 t .i. c:Ja t .i. on -- __-;.__ ,._c; . ~..!. ..s 3Q~....'!..QO Income tax due thereon Income tax already paid p 68~035.00 Balance Add .14% int. p . a. from 3/16/75 to 3/16/78 TOTAL AMOUNT DUE AND -- p=== =9=....~.... 609 � ?'_0 COLLECTIBLE Pfizer, Inc. is Accordingly, petitioner ordered to pay to respondent Commissioner of Internal Revenue the amount of P96,609.70 as deficiency income tax for the fiscal year ended November 30, 1974, plus surcharges and interest incident to delinquency pursuant to Section 51 (e) of the applicable National Internal Revenue Code, as amended. 403

DECISION CTA CASE NO. 3604 - 15 - WHEREFORE, the decision appealed from is modified as indicated in the above opinion of the Court. With costs. SO ORDERED. Quezon City~ Metro Manila~ June 3~ 1988. AMANTE Pres iding Judge I CONCUR: (on official leave ) CONSTANTE C. ROAQUIN Associate Judge 404

DECISION CTA CASE NO . 3 604 - 16 - CERT I F I C AT I 0 N I hereby certify that th.i. s deci sion was reached after due consultation among the members of the Court of Tax Appeal s in accordance with Section 13~ Article VIII of the Constitution. AMANTE ILLER Presiding ,Judge Court of Tax Appeals 405