CTA Case No. 2005 (Decision)

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F.PURT.Tf! OF TllF. PH1LfP1>1NE8 CUUR'~ OF TAX APPEALS QUEZO~ CJTY LUZON BROKE~AGE CORPORATION, C. T.A. CASE NO . 2005 Petitioner , - versus - THE COMM ISS IO N~R OF INTERNAL REVENUE , Respondent . X- - - - - - - - - - - - - X DE C I S I 0 N This is an appeal from a decision of respondent Commissioner of Internal Revenue dated March 20~ 1969 a s sessing petitioner deficiency income tax for 1961 in the amount of f764, 621. 80 , inclusive of surchar ges , monthly interests , and compromise penalty and denying petitioner ' s protest against the deficiency assessment . It appears that petitioner , Luzon �Brokerage Cor- poration, is a corporation formed by the merger of the Luzon Brokerage Company , Inc . and the Philippine Van Service on November 1, 1961. And this case involves a deficiency income tax assessed agains"t the former � Luzon Brokerage Company, Inc ., before its merger with the Philippine Van Service , into the herein Luzon Brokerage Corporation. The Luzon Brokerage Co ., Inc . w.as formerly a � domestic corporation engaged in the business of trans - portation, brokerage , warehousing , packing and crating , and superintendence . In the ye.ars 1956 , 1957 and 1958 , there was a steady decline in its business and net earnings ; because of this it secured the services of the Columbia Rope Company for the management of its

DECISION - � CTA CASE NO. 2005 2 business. A management co~tract wa s executed by and between t};le Columbia Rope Company and Luzon Brokerage Co., Inc on December 6, 1958 the pertinent provisions of which are hereunder reproduced: 1 . LUZON thus hereby engage the -ser- vices of COL~ffi iAN and ' the latter thus here- by agree to act as the sole and exclusive General Managers of the former; ' 2. COLUl1B IAN will render all the mana- gerial assistance , general guidance and ad- vices on all a~eas . or ma na goefmLeUnZto1 N~; dministra tive and compa ny policie s 3 . COLtn4B I AN shall conduct a revie1.1 of the financial statements of LUZON and the latter shall furnish all the information required by the former . On the ba sis of such review , COLUMB IAN shall render monthly reports and/or comments on the financial statements of LUZON for submission to the parent com- pany of COLUMB IAN' f 4. COL~ffi iAN shall undertake the typing and finalization of the monthly financial sta tements prepared by LUZON; 5. COLUJ:.ffi IAN shall be entitled by way of remuneration from LUZON for its services und er t his co ntract a management fee o 3, mana g e ~ent hly effec t7 i ve December f 000 . 00 mont 1' 1958; , 6. THAT t his a greement shall be effect- ive as of December 1, 1958 , automatically renewed under t he same terms and conditions� for another year upon every expiration, un- less ca ncelled or amended in writing by mutual agreement of both parties . Pursuant to letter of Authority No. 2497 dated January 2, 19P3 res pondent, through Examiner Cl aro M. Silva , investigated the Luzon Brokerage Co., Inc . for income tax liability for the yea r 1961 . Thereafter Examiner Silva recommended the disallowance of some

DECISION � - CTA CASE NO. 2005 3 items claimed as deduction by Luzon Brokerage Co ., Inc . in its income tax return for 1961 . In view there- of respondent assessed the Luzon Brokerage Co ., Inc . the amount of ~53,626 . 36 as deficiency income tax for 1961 , inclusive of 50% surcharge , and deficiency in- terest up to July 17, 1964, computed as follows: ACR- 301353-63/61 Net income per return� � � � � � � � � � � P123 , 862 . 27 Add: Unallowable deductions & addt 11 income: (1) Administrative & General Expenses � � � � � � � � P49 , 500 . 00 (2) Depreciation Office Furniture & rixtures � � � 6, 829 . 81 (3) Losses , Brokerage Dept �� 20 , 690 . 00 (4) Undeclared Income (Mi scellaneous ) � � � � � 13 , 497 . 00 (5) Bad Debts � � � � � � � � 18 , 815. 03 109 , 331 . 8~ Net incom; per inve s tigation� � � � � � � f'233 , 194. 11 Tax due tnereon� � � � � � � � � � � � � � P 61 , 958 . 23 Less: Amount already assessed � � � � � � � 29 , 159 . 0~ B -a 1 an c e � � � � � � � � � � � � , � ~ 32 , 799 . 23 Add: 50% surcharge . � � � � � � � � � � � 16,399. 50 1/2% monthly interest from 4- 17- 62 to 7- 17- 64. � � � � � � � 4, 427 . 6~ TOTAL AHOU~T DUE & COLLECTIBLE . �� � � � � P 53 , 626 . 36 The assessment was protested by the Luzon Brokerage Co., Inc . in a letter� dated September 8, 1964�. In a letter dated October 12 , 1965, respondent gr anted the request for reinvestigation C? nditioned upon the execution of a waiver of the statute of limitation. Luzon Broke rage ' Co., Inc . submitted the . wa iver on March 16, 1966 . On May 18 , 1967, res pondent reiterated the demand for -the payment of the deficiency income tax for 1961, however raising the amount to P64, 700 . 93 comput'ed as follows:

DECIS IO N CTA CASE NO. 2005 4 1961 def . income tax per ACR-3013 53- 63/61� � � � � � � � P53 , 626 .36 Add: 5% surcharge ori f>32,_799 . 23 . � 1,639.96 1% mo . int. on P53 , b26 . 36 from 7-18-64 to 5- 18-67� � � 9, 384. 61 Compromise for late payment . ~~ TOTAL AMOUriT DUE & COLLECTI BLE�� f64 ,700.93 Luzon Brokerage Co ., Inc . again protested this assessment in a letter dated July 7, 196?, and requested for further reinvestiga tion and in complia nce '\!Ti th respondent's condition again executed a waiver of the defense of prescription. On Narch 20 , 1969 res pondent re ndered his f inal deci s ion assessing Luzon Brokerage Co ., Inc. the sum of �?4, 621 . 80 as deficiency income tax for 1961, in- clusive of 50% surcharge, 5% monthly interest and compromise penalty for l ate payment , computed as follm'ls: 1961 def . inc. tax (ACR - 301353- 63/61) . . . . . . . . P53 , 626 . 36 Add: 5% surcharge on 32 , 799 . 23 (basic tax) . � � 1, 639 . 96 1% mo. int . on P53 , 626 . 36 fr . 7-1 8-6~- to 7-1 867 . � � 19,305.48 Compromise for l a te payment . �-----5~0~--0~Q TO'r1.L AHOUNT DUE & COLLECTIBLE� � � P74, 621 . 80 As it may be noted t he deficiency asses sment a gai nst the Luzon Brokerag e Co ., Inc was brought about by the disall owance of the items claimed a s deducti ons by petitioner in its i ncome tax retur n for 196 1. Res pondent disallowed the� amount of f->36 , 000 . 00 paid by Luzon Brokerage Co ., Inc. in f avor of Columbia

DECISION CTA CASE NO . 2005 5 Rope Company pursuant to the management contrac~. Respondent contends that the amount is a dividend dis - tribution in the guise of a management fee because the Columbia Rope Company , the recipient of the aforesaid amount , is the controlling stockholder of Luzon Brokerage Co ., Inc . , the expenditure not being ordinary , necessary nor reasonable. For convenience, Luzon Brokerage Co ., Inc . ,.,rill be referred to herein as LBC and Columbia Rope Co . of the Philippines as CRC . From the evidence on record it appears that after the management contract in question C C took charge of the management of LBC, mostly through M. s . Robie, William PendarV.is and John ~ aldroup , respectively General Manager, Assistant General Manager and Comp- troller of CRC . It ,.,as through their effort that the company acquired new customers such as Shell Refining, Bataan Refining , Union Carbide , Standard Brands and others . It also appears that CRC secured loans for LBC and attended to its bids in the American Embassy , Clark Air Force, u.s . Veterans Administration and others; that it took charge of legal and accounting matters and labor problems of LBC . BIR Examiner Silva himself admits that CRC rendered ttso many services" to LBC . The profits of LBC for the fiscal year 1955-56 was 111 , 622 . ~5 , dropped to P71,788 . 74 in the fiscal year 1956- 57 and dipped further to 5, 128 in the fiscal

DECISION - CTA CASE NO . 2005 6 year 1957- 58 � . After the management contract, it rose to P41, 838 . 00 in fi-scal year 1959-60 and P54, 703 . 00 in the 1960-61 fisc~l year . Management contracts between firms are not unco~mon in the business world and the very testimony of Exam- iner Silva confirms this . To say that the contract in question is not ordinary is to lose sight of a pr actice in the business world . From the deteriora- tion in the profits of LBC one can readily see that in 1958 something had to be done with its management . Any business enterprise suffering a decline of its income will have second thoughts of its management . On the other hand , the rise in the profits of the com- .pany shows that the transfer of its management � 1.-laS not in vain. That the compensation was not unreason- able may be gathered from the variety and nature of the task undertaken by CRC which prompted respondent examiner to say that CRC rendered 11 so many services" to LBC . Again, it appears that when Arturo Tanco , then head of a management firm was asked his price for the management of the company he gave a figure much higher than ~3 , 000 . 00 a month . � From all these cir- cumstances it can hardly be questioned that the expenses in question are ordinary, necessary and reasonable . And with this background ' the most natural conclusion one can draw is that the management contract

DECISION - CTA CASE NO . 2005 7 in question is not a dis guiseq. distribution o:f divi- dends . Respondent contends that under Section 44 o:f the Revenue Code he has the power to alloca te gross income or deduction between organiza tions , trades or business owned or controlled by same interest if such is ne- cessary to prevent evasion of taxes or clearly to reflect the income of such organization. Respondent , however , has not shown tha t there was such an evasion and neither ha s he shown that the payment of the ma- nagement fee prevented the income of the two companies from being reflected clearly . It may well be noted i n this conhection that Robie , Pe ndarvis a nd Waldroup who bore the brunt of the management opera tion of LBC are not salaried employees or officers of LBC and if they had been, the income of LBC v.rould have been reduced to that extent . Having been saved. from paying them i ndividually for their services by entering in- stead in a management contract with CRC , it can scarce- ly be said that LBC distorted its net income by pay- ing CRC for management services . The next item cla imed as deduction by LBC is the amount of Y13 , 500 . 00 . Of this amount T7 , 5oo . oo corres pond to the audit fee paid to the a ccounting � firm of Sycip, Gorres and Velayo to determine the assets and l~abili ties of LBC as of June 30 , 1961 for purposes of its impending merger with the Philippine Van Service .

.. DECI ION - CTA CASE NO . 2005 8 The remaining amount of P6 ,ooo . oo , was paid to Atty . San Luis by LBC as attorney ' s fees for legal services rendered in the preparation of documents necessary for the merger of LBC and Philippine Van Service . Peti- tioner contends that the professional fees having been received and paid in connection with its. business in 1961, such expense is deductible . Res-pondent , on one hand , contends that this amount is not deductible as business expense . We find respondent ' s position to be correct and in this respect suffice it to quote the following authority: The deductibility of an expenditure as a business expense is based on the theory that such expenditure is properly part of the cost of operating the business for the year in which it was paid or incurred . If , hovTever, an expenditure is paid or incurred to acquire an asset, the useful life of which is -substantially longer than the tax- able year, such expenditure is ge-nerally treated as being a capital item and not deductible as a business expense . Expend- itures for organizing , recapitalizing , merging or dissolving a business enterprise may properly be said to be .s.JJ.i generis . On the ?ne hand , none of them can hardly be cons1dered as part of the cost of operating tfie business for the taxable year in which they were paid or incurred . On the other hand , it is arguable that no ca- pital asset is acquired by the taxpayer which, as a business enterprise, is being organized , recapitalized , merged or dissolved . It is well established, however, that ex- penditnras in conoec.t ion JtLith orga nj zj o~ , � recapitaJ izini! or merging as buslness en- terprise are genflra 1 J..x ca;Rita J expenditures., and , therefore , not ded~~tible as. business exuenses. Such expenditures have been characterized as bei'ng 11 something intangible with an indefinite life . 11 � Conversely ,

DEC ISION - CT.A CASE NO. 2005 9 expenditures in cormection \vith dissolving or liquidating a business enterprise are generally considered deductible as business expens-es . (4 Mertens , Law of Fede.r.al Income Taxation, Sec . 25. 35; pp . 119-120, 1960 Ed .; Underl1nin~ sup~l1ad .) Another amount cla imed a s deduction is a 20% de- preciation on its fixtures , furnitures and office equiprnents in the total amount of i"'6, 829 . 81 . Said rate of deprecia tion is based on the ground that the equipments were allegedly used a l most 12 hours every- day a nd that the office bei ng in Port Area, Ma nila ,. dust and sea breeze ea sily cause deterioration of the fixtures, furni~ures and thus the five years life given to the s a id ma chines and equi pments is fair and just . Respondent f or his part insists on a r a te of 10% equi- valent to 10 years of life . The proper rate of de precia tion to our mind , is 10% as urged by res pondent . This r a te is in a ccordance with the rates of depreciatio n prescribed in Bulletin "F11 of the u.s. Federal Internal Revenue Service which ha s a strong persuasive ef fect in this jur is diction as the same has been the result of l ong a nd scie ntific study . (Limpan Invest~ent Corpora tion v . Comm . of Int . Rev ., G. R. l o. L- 21570 , Jul y 26, 1966 .) Moreover the very witness of petitioner a dmits that some furnitures and equipments in use � by the Compa ny are more tha n . 10 years old . On the other hand t here is no definite evidence of fur nitures and equi pments disca r ded before

.. DECISION - C'rA CASE NO . 2005 10 10 years . The next item is the amount of P20 , 690 . 00 advanced by Luzon Brokerage Co ., Inc . for the Phil~ppine Refining . Company as wharfage fees in connection with . the latter ' s importations . Luzon Brokerage Co ., Inc . failed to obtain reimbursement from the Philippine Refining Com- pany because the latter claimed that it is not liable for wharfage fee since the goods were unloaded in private piers . Respondent does not dispute the fact that this amount is considered a loss to LBC but contends that same should have been claimed in 1959 , the year in which the P h i l i p- p i n e Refining Compav~ notified the LBC of its ' refusal to reimburse same . It appears ho\ITever that the Philippine Refining Company filed a claim for refund before the Bureau of Customs in 1960 with the under- standing that LBC would follow- up the claim and get � the refund but same was denied by the Commissioner of Customs in a letter dated . December 5, 1960 on the ground that it was filed out of time . It is quite obvious that it was only upon the rejection of said claim that the loss became a close and completed transaction. This is evidently a case where the taxpayer tried to exhaust his remedies to recover the loss as required by lm.r (Plaridel Surety and Insurance Company v . Commissioner of Internal Revenue , G. R. No ~ L- 21520 , December 11 , 1967) . ~lie now come to the alleged bad debts of P18 , 815. 03 .

DECISION - CTA CASE NO . 2005 11 This amount is composed of three items to wit: ( 1) Adjustments in billings � � � � P13,019.15 (2) Losses in the delivery p 5,1 24. 00 of goods ������ � � � fi � 671. 88 (3) Bad debts � � � � � � � � � � � Adjustments to the 11Accounts Receivable" account in the ampunt of P13,019.15 were made by petitioner in its books to correct the said account due to erroneous billings to its customers . The erroneous billings arose . from discrepancies in the weight of the cargo as appear- ing in the shipping manifest and the actual weight of the said cargo as later verified and in some cases� from questionable charges which the customers refused to pay . As a result of these discrepancies , the billings against the customers were reduced, so that in the Qooks of the petitioner , there remained unpaid balances after payments on the reduced billings were made against .the accounts receivables entered in the books based on the original billings . These unpaid balances were corrected by petitioner by dire ctly crediting the 11Accounts Receivable" account so that these adjustments were not reflected in the financictl statement, thus giving rise to respondent ' s allegations that these were actually bad debts written off. In his testimony, petitioner ' s witness , Hr . Castro , explains the procedure of correcting such bi.llings by their issuance of credi t memos . Ho,vever , the invest- igating examiner claims not to have been shown such

DECISIO N . CTA CASE NO. 2005 �,' 12 credit memos but as explained by the witness s a id documents v1ere destroyed during a typhoon tha t lashed the LBC office and we are s a tisfied with this explana- t ~ on. � The second item in the amount of ? 5,124. 00 re - presents the claim made by the Bure au of1Puplic Schools aga inst petitioner for the cost of milk damag ed due . to loss a nd s poilage during its delivery to diff erent public schools in the Phi l i ppines . Since petitioner is re spo nsi ble ~or the safe delivery of goods , it had to settle the claim for the cost of the damaged milk . This was treated by petitioner in its books by reversing the rece ivables due fro m the Bureau in the amount of ? 5, 124. 00 . As �these losses in tra nsit were char geable to petitio ner, t hey should be a llowed a s pro per deduct- ions from gross income . \H th r es pect to the amount of P671. 88 which pur- ports to r epre s ent bad debts it appears tha t its break- down wa s explained by Ca stro as follows: Q. You a lso me ntioned that one other item cons t i t uting t his bad debts deduc t ion pertains to bad debts proper in the .. amount of 671 . 88. NO\v \vill you kindly refer aga in to t hi s memora ndum mar ked Exh i bi t 0 a nd c ite an example of actual � bad debts which was char ged by pe t ition- er in 1961? A. This account of Li m Tua n in t he amount of P2 . 61� the next one is the a ccount of S. G� . Linusco in the amount of 1>18 . 00 ; then. J . H. Figueras - ~1 3 . 20 ; Nr . Darn- bosch - the amount is ? 482 . 57; Essex ~nterprises - r 12 . 65; Amado Cornejo - ? 12 . 00; Ruf ina s . Cruz- 31 . 98 ; Robert

� '' ,I DECISION - CTA C!SE NO . 2005 13 Corominas - 54. 49; B. Basco - ~38 . 63 ; and Desco - ?5. 75. Petitioner tried to collect the aforesaid credits short of filing actions in Court for collection but could not get payment . Considering the small amounts involved in said credits petitioner was justified in not filing cases for collection which vmuld only entail more expenses vli th but little prospects of eventual collection (El Porvenir Rubber Products; Inc . v . Comm. of Int . Rev ., C. T. A. Cases Nos . 1702 & 1705, July 26 , 1969; Coll . of Int . Rev . v . Goodrich International Rubber Co ., G. R. No . L- 22265, Dec . 22 , � 1967) � .The l as t item of P13 , 1+97 . 00 involves tvro separate transactions . One refers to a ~ale on February 1961 by the LBC of three (3) trucks to the Philippine Van Service for F7, 500 . 00; the other appears to be an amount of ?6 ,ooo . oo which was a management fee from the Philip- pine Van Service for the period fr�om Januar y to June , 1961. These credits were not paid by the LBC in view of the merger of said companies . With the merger , LBC ~ransferred a ll its assets and liabilities to the hilippine Van Service , and the latter acquired all the assets and assumed all the liabilities of LBC and to record same said credits of LBC were reversed in the book entries by debiting the income previously reported and crediting the account of Phil i ppine Van Service . Clearly the said two items cannot be considered a s income of LBC for the fiscal year ending October 31,

DECISION - CTA CASE NO . 2005 1961 there having been a confusion or mer ger of the cha r a cter of debtor and creditor on October 30 when the merger took effect (Art . 1271, Civil Code of the Philippines ). With res pect to 50% fr aud penalty i mposed by res - ' pondent Commissioner of Inter nal Revenue , we. find that same is not supported by sufficient evidence . Fraud is not to be pr~sumed a nd it i s incumbent upon res pond- ent to prove its existence by clear and convi ncing evi dence which is lacking in this ca se (Collector of Internal Revenue v . Alberto D. Benipayo , G. R. No. L- 13656 , Jan. 31, 1962 ; Re public of the _Phili ppines v . Ker & Co ., Ltd ., G. R. No. L- 21609, Sept . 29 , 1966) . With re spect to the �50 . 00 compromise penalty imposed by respondent , the same ca nnot be i mposed aga inst petitioner '\�rithout its agr eement and conform- ity . (Coll . of Int . Rev . v. University of Sto . Tomas et al ., G�� Nos . L-11 274 and L-11 280, Nov. 28 , 1958 ; The Coll . of Int . Rev., v . Bautista , et al ., � G. R. Nos . L- 12250 and L- 12259 , Hay 27 , 1959 ; The Phil . Int . Fair , Inc . v . Coll . of Int . Rev., G. R. Nos . L-1 2928 . a nd L- 12932 , March 31, 1962 .) On the basis of our findings , petitioner ' s lia bility is here by computed a s f ollows: Net income per return. � .� � � � � � � � � ? 123 , 862 . 27 Add : Unal lowable deductions 1) Professional fe es - P13 , 500 . 00 2) Depreciation 6, 829. 81 . 20,329 .8l

DECIS ION . CTA CASE NO . 2005 'I 15 r et income per i nvestiga tio.n ������ � P144 ,2 192 . 08 Tax due the reo n ���� �������� � 35 258 . 00 Less: Amount already assessed � � � � � � 22 , 129 . 00 BAaddlant%cem�on�th�ly�i�nt�er�es�t ��� � � � � � � P 6, 099 . 00 from 4/17/62 to 7/17/64. � � � � � � � � � 823 . 3~ Deficiency income tax due � � � � � � � � ~ 6, 922 . 3 Add 5% surcharge on ?6 , 099 . 00 . � � � � � 304. 95 1% monthly interest on ~ , 922 . 36 from 7/18/64 to 7/18/67 . � � � � � � � 2, 492 . Q2 Total amount due & collectible WHEREFORE, the decision of respondent Commissioner of Internal Revenue appealed from is her eby modified . Petitioner is hereby ordered to pay respondent the sum of �9 , 719 . 36 as defic~ency income tax , inclusive of deficiency interest and surcharges as prescribed in Section 51 (e) of the Tax Code as amended . Without pronouncement as to costs . SO ORDERED Quezon City , July 29, 1974. fL- t~~ RAMON L . AVANCE1A Associate Judge WE CONCU"R: ROM.AN Ivi . Presiding Judge fl ~ ~~ � -L~AO iR~NLV~AR~ Associate Judge