CS GARMENTS, INC. v. COMMISSIONER OF INTERNAL REVENUE

I I Republic of the Philippines COURT OF TAX APPEALS Quezon City En Bane CS GARMENTS, INC., EB CASE NO. 287 Petitioner, (CTA Case No. 6520) -versus- Members: ACOSTA, PJ, COMMISSIONER OF INTERNAl CASTANEDA, JR., REVENUE, BAUTISTA, UY, Respondent. CASP..NOVA, and PALANCA-ENRIQUEZ, JJ. Promulgated: JAN 1 ZOOB X--- - - - - - - - - - - - - - - � 1I - //,/.�-:!1�1_'',-7),�<,'�' l� d. { 11 ,".'� .. ,~~l -- - - - - -- - - - - -- -- -- - - -- - - - - -- -- - - -X ':.r:�,.,"J) /::.1, DECISION CASANOVA, J.: This is an appeal to the Court of Tax Appeals (CTA) En Bane by way of a verified Petition for Review, filed by herein petitioner, CS Garments, Inc., under Section 18 of R.A. 9282. The petition is praying that the Decision1 (Assailed Decision) dated Janua1y 4, 2007 rendered by the Second Division of this Court (Second Division) in CfA Case No. 6520 entitled, "CS Garments, Inc.', vs. Commissioner of Internal Revenue' as well as the Resolution 2 (Assailed Resolution) dated May 25, 2007 promulgated also by the Second Division be reversed and set aside in part. In both the assailed Decision and Resolution, the Second Division cancelled the respondent-Commissioner of Internal Revenue's assessment for deficiency expanded withholding taxes for calendar year (CY?~~ 1 Division Rollo., pp. 372-403. 2 Division Rollo. pp. 42 I -423. I

EB NO. 287 I � (CTA CASE NO. 6520) DECISION 1998 amounting to P47,880.00, and partially cancelled the deficiency documentary stamp tax (DST) assessment amounting to P1,963.00. However, the Second Division upheld the validity of the other tax assessments against ~ petitioner amounting to a total of P2,029,570.12, plus' 20% delinquency interest pursuant to Section 249(C)(3) of the Tax Code, computed as follows: INCOME TAX DEFICIENCY TAX VAT -D-ST- at5% at 34% Total 2,029,570.12 Basic Tax Due p 314,194.00 p 145.00 p 817,573.94 p 1,78944 78,548.50 36.25 204,393.49 447.36 25% Surcharge 422,898.52 188,516.00 p 102.02 1,444,865.95 p 925.6 20% Interest 581,258.50 283.27 p 3,162.40 p p JHE FACTS The facts of the case, as culled from the records, are as follows: "PetitiGiier is a domestic corporation duly organized and existing under and by virtue of the laws of the Philippines with principal office at Road A, Cavite Ecozone, Rosario, Cavite. 3 On the other hand, respondent is the duly appointed Commissioner of Internal Revenue of the Philippines authorized under law to perform the duties of said office, including, inter alia, the power to assess taxpayers for allegedly deficiency internal revenue tax liabilities and to act upon administrative protests or requests for reconsideration/reinvestigation of such assessments.4 Petitioner is registered with the Philippine Economic Zone Authority (PEZA) under Certificate of Registration No. 89-064, duly approved on December 18, 1989. As such, it is engaged in the business of manufacturing garments for sale abroad. 5 On November 24, 1999, petitioner received from respondent Letter of Authority No. 00012641 dated November 10, 1999, authorizing the examination of petitioner's books of accounts an~ 3 par. I, Facts Admitted, Division Rollo, p. 125. 4 par. 2, Facts Admitted, Division Rolin, p. 125. 5 par. 3, Facts Admitted, Division Rnllo, p. 125.

F,:B f\10. 287 I ' (CTA CASE NO. 6520) DECISION other accounting records for all internal revenue taxes covering the period January 1, 1998 to December 31, 1998.6 On October 23, 2001, petitioner received five (5) formal demand letters with accompanying AssesSment Notices from respondent, through the Office of the Revenue Director of Revenue Region No. 9, San Pablo City, requiring it to pay the alleged deficiency VAT [Value Added Tax], Income, DST and withholding tax assessments for taxable year 1998 in the aggregate amount of P2,046,580.10/ broken down as follows: Deficiency VAT p 314,194 00 Basic tax due 157,097.00 Add: Surcharge 188 516.00 Interest p 659,807.00 Total Amount Paya/)/e DeficienC}' Income Tax (at Normal Rate of 34%) p 78,639 00 Basic tax due 39,320.00 Add: Surcharge 43 251.00 Interest Tut&i :\mount Payanle ~'Ll10.00 Deficiency Income Tax (at Special Rate of 5%) p 742,574.10 Basic tax due Add: Surcharge 408,416.00 Interest 25,000.00 Compromise Penalty Total Amount Payable p 1,175,990.10 Deficiency DST p 806.00 Basic tax due 403.00 Add: Surcharge 484.00 Interest Total Amount Payable p 1,693.00 Deficiency EWT 22,800.00 Basic tax due 11,400.0~ Add: Surcharge 6 BIR Rollo, p. 129. 7 par. 4, Facts Admitted, Division Rollo, pp. 125-126. 3

EB NO. 287 I � (CTA CASE NO. 6570) DECISION Interest 13 680.00 Total Amount Payable p 47,880.00 GRAND TOTAL On November 20, 2001, or within the 30-day period prescribed under Section 228 of the Tax Code, as amended, petitioner filed a formal written protest with the respondent assailing the above assessments.8 On January 11, 2002, or within the sixty-day period after the filing of the protest, petitioner submitted to the Assessment Division of Revenue Region No. 9, San Pablo City, additional documents in support of its protest.9 Respondent failed to act with finality on the protest filed by petitioner within the period of one hundred eighty (180) days from January 11, 2002 or until July 10, 2002. Hence, petitioner appealed before this Court via a Petition for Review filed on August 6, 2002 or within thirty (30) days from the last clay of the aforesaid 180-day period."10 The case was raffled to the Second Division of this court for decision. After trial on the merits, the Second Division rendered the Assailed Decision on January 4, 2007 upon which the Second Division cancelled respondent's assessment against CS Garments for deficiency expanded withholding taxes for CY 1998 amuur ltir,.1 to P47,8RO.OO, and partially cancelled the deficiency DST assessment amounting to P1,963.00. However, the Second Division upheld the validity of the deficiency income tax assessments by subjecting the disallowed expenses in the amount of P14,851,478.83 and a portion of the undeclared local sales P1,541,936.60 (amounting to Pl,SOO,OOO.OO) to income tax at the special rate of 5%. The remainder of undeclared local sales of P1,541,936.06 (amounting to P41,936.60) was subjected to income tax at tt1e rate of 34%. The Second Division found that total tax liability of CS Garments amounted t~~ 8 par. 5, Facts Admitted, Division Rollo, p. 126 9 par. 6, Facts Admitted. Division Rollo, p. 126 10 Page 2- 4 ofJanumy 4, 2007 Decision.

EB NO. 287 � I (CfA CASE NO. 6520) DECISION P2,029,570.171 rlus 20% delinquency interest pursuant to Section 249(C)(3), and computed the same as follows: INCOME TAX DEFICIENCY TAX VAT DST at 5% ~134% Total Basic Tax Due p 314,194.00 p 145.00 p 817,573.94 p . 1,789.44 25% Surcharge 20% Interest 78,548.50 36.25 204,393.49 447.36 - - - 188,516.00 p p 581,258.50 102.02 422,898.52 925.6 3,162.40 p 2,029,570.12 283.27 p 1,444,865.95 p On January 29, 2007, CS Garments filed its "Motion for Partial Reconsideration/111 of the said decision. On May 25, 2007, in a resolution 12 the , Second Division denied CS Garments' motion for lack of merit. On June 20, 2007, CS Garments filed before the Court En Bane a "Motion for Extension of Time to File Petition for Review/1 which was granted by the Court En Bane in a Resolution dated June 20, 2007. On July 5, 2007, CS Garments filed the instant Petition for Review13 before the Court En Bane. TUE ASSIGNED ERRORS On the instant petition, CS Garments submits that the Second Division erred in its conclusion that: I. Respondent's Formal Assessment Notices ("FAN 11) comply with the requirements of law. II. The sales generated by petitioner from its participation in the trade fairs conducted by the Cavite Export Processing Zone, ?nd its sales to employees, are subject to 10% VAT. III. The isolated sale of petitioner's company vehicle to its General Manager is subject to 10% VAT. IV. Petitioner had undeclared local sales in the amount of P1,541,936.60 which is subject to normal income tax at the rate of 34%.~ 11 Division Rollo. pp. 405-418. 12 Ibid. 13 E. B. Rollo. pp. 9-30.

EBim. 287 � � (CfA CASE NO. 6520) DECISION V. The expenses incurred by petitioner in connection with advertising, clinic and office supplies, representation, comm1ss1ons, transportation, freight and handling, professional fees, export fees, taxes and licenses and fringe benefit taxes are unallowable under R'\ule XX, Section 2 of the PEZA Rules and Regulations. THE COURT EN BANC'S RULING After a careful and thorough evaluation and consideration of the records of the case, including CS Garments' arguments and allegations, the Court En Bane found that the Second Division did not commit any error in their appreciation of facts and evidence as well as their application of laws and jurisprudence in the Assailed Decision. The conclusion laid down by the Second Division, finding CS Garments liable to the aforementioned deficiency taxes including penalties and interest, was correct. Regarding tl1e first assignment of error, CS Garments alleged that respondent's Formal Assessment Notices failed to comply witl1 the requirements laid down in Section 228 of the Tax Code and Section 3.1.4 of Revenue Regulations No. 12-99. CS Garments claimed that the notices do not state the law nor the facts which gave rise to the deficiency tax assessments and that the same merely gave a brief rundown of figures which CS Garments allegedly failed to pay as well as the total amount for each assessment. We do not agree. '� After scrutinizing the five (5) assessment notices14, the Court En Bane found that the .r:.~c::nd Division '�'vas correct when it ruled the following, to wit: "This Court is convinced that respondent duly apprised petitioner of the factual and legal bases in finding the latter liable to the deficiency income tax on disallowed expenses pursuant to Section 228 of the National Internal Revenue Code (NIRC) of 1997, as amended. As can be seen in the letter of demand dated~ 14 Exhibits)(, }~ ZZ, AA and BB.

EB NO. 287 � � (CTA CASE NO. 6520) DECISION October 15, 2001 and the attached Schedule of Discrepancies, respondent provided a detailed breakdown of the disallowed expenses which resulted to the said assessment. Likewise, respondent cited Rule XX, Section 2 of the Rul\s and Regulations of Republic Act No. 7916 as legal basis for the disallowances. At a glance, respondent likewise complied with Section 228 of the 1997 NIRC, as amended, in arriving at the assessments for deficiency EWT, DST and VAT for taxable year 1998. Although in the letters of demand respondent may not have specified the legal provisions supporting his conclusion, it is sufficient that the nature of taxes allegedly unpaid by petitioner is indicated therein. One would know with certainty the applicable provisions of law pertaining to DST on lease agreements, 10% VAT on local sales, 5% EWT on rental expenses with reference to the figures in the form of numerical representations stated in the letters of demand. The phrase "in writing" under Section 228 is not exclusively confined to written words but includes figures. "Writings" consist of letters, words, or numbers, or their equivalent, set down by handwriting, typewriting, printing, photostating, photographing, magnetic impulse, mechanical or electronic recording, or other form of data compilation. 15 In whatever form and manner, as long as the taxpayer is informed how the assessment was made, then, there is no violation of Section 228 of the 1997 NIRC, as amended. It bears stressing that in the protest, petitioner did not question the infirmity of the assessment notice and letter of demand involving the 10% VAT on local sales. Well-settled is the rule that the Court cannot take cognizance of matters raised for the first time on appeal. 16 Further, the Court cannot give credence to petitioner's assertion that the deficiency income tax assessment on the alleged undeclared local sales is devoid of factual and legal bases. It must be pointed out that it was petitioner who offered the Schedule of Other Income17 demonstrating the breakdown thereof giving rise to the assessment for deficiency income tax on local sales of P1,541,936.60 at the rate of 34%. Without the supporting~ 15 Black' Lml' Dictionary, Sixth Edition, page 1609 cited in .)'ubic Power Corporation vs. Commissioner of Internal Revenue, CTA Case No. 6059, Me~)' 8, 2003 16 Victorias Milling Company, Inc. vs. Court ojAppeals, 333 SCRA 663 17 Exhibit 11.

1!:8 NO. 287 � � (CTA CASE NO. 6520) DECISION documents proffered by petitioner, respondent would not have ascertained its liabilities pertaining to income tax on local sales and the other tax deficiencies. Considering that in its protest, petitio~er did not question the validity of the assessment for deficiency VAT under Section 228 of the 1997 NIRC, as amended, the Court sees no reason why it is raising the same infirmity concerning tl1e assessment for deficiency income tax on local sales as both taxes refer to the same tax base. Thus, the mere fact that petitioner intelligently rebutted respondent's assessments for deficiency 5% income tax on disallowed expenses, 34% income tax on local sales, EWT, DST and VAT, demonstrates respondent's compliance with Section 228 of the 1997 NIRC, as amended." Anent tl1e s~Yvnd assignment of error, CS Garments claimed that the deficiency VAT assessment arising from the sales generated by it in trade fairs as well as its sales to employees are devoid of legal basis. CS Garments argued that since it is a PEZA-registered enterprise, its local sales to buyers from Customs Territory are considered technical importations made by buyers who are the ones liable for the corresponding taxes on such sales. We do not agree. To reiterate, in CS Garments' protest-letter18 dated November 19, 2001, petitioner stated that "[t]he alleged local sales being subject to VAT were generated by the company for the year 1998 from its participation in the trade fairs conducted by the Cavite Export Processing Zone Authority as well as its sales to its employees". Furthermore, petitioner admitted that "[t]hese sales were made to buyers located in the Customs Territory". Although a Zone Export Enterprise, like the petitioner, is generally engaged in exporting its finished product, it is not prohibited from making domestic sales pursuant to Section 26 of Republic Act No. 7916 entitled ':.4n Act Providing For The Legal Framework_a 18 Exhibit V.

EB NO. 287 I � (CfA CASE NO. 6520) DECISION And Mechanisms For The Creation Operation Administration And Coordination Of Special Economic Zones In The Philippines/ Creating For This Purpose/ The Philippine Economic Zone Authority (PEZAJ And For Other Purposes'; which '? provides as follows: "SECfiON 26. Domestic Sales. - Goods manufactured by an ECOZONE enterprise shall be made available for immediate retail sales in the domestic market, subject to payment of corresponding taxes on the raw materials and other regulations that may be adopted by the Board of the PEZA. However, in order to protect the domestic industry, there shall be a negative list of industries that will be drawn up by the PEZA. Enterprises engaged in the industries included in the negative list shall not be allowed to sell their products locally. Said negative list shall be regularly updated by the PEZA. The PEZA, in coordination with the Department of Trade and Industry and the Bureau of Customs, shall jointly issue the necess<1ry implementing n1les and guidelines for the effective implementatiu�n of this section." (Emphasis supplied) .�(, Pursuant to the above-quoted provision of Republic Act No. 7916, the Board of Directors of the Philippine Economic Zone Authority (PEZA) promulgated the ''Rules and Regulations to Implement Republic Act No. 791 b~ othe1wise known as the Special Economic Zone Act of 1995'~ Section 5 of Rule VIII thereof provides that domestic sales shall be subject to all applicable rules and regulations including the payment of customs duties and internal revenue taxes, thus: "SECfiON 5. Domestic 53/e. - Finished products of registered Export or Free Trade Enterprises not included in the negative list shall be made available for domestic sale in the customs territory or retail stores/shopping malls within the commercial/tourist or other authorized areas of the ECOZONES, subject to all applicable rules and regulations including th~ t l)' I '�

EB NO. 287 � � (CTA CASE NO. 652u) DECISION payment of customs duties and internal revenue taxes, to the applicable provisions of the Retail Trade Nationalization Law, as amended, and to such other regulations or limitations as may be adopted by the Board." (Emphasis supplied) ~ ~ r� Moreover, the aforementioned rules and regulations further provides, in Section 3 of Rule X thereof that "[m]erchandise or goods may be taken into or brought out of the restricted areas of the ECOZONES only upon prior approval or permit by the PEZA in accordance with its documentation and security procedures~~. Indeed, domestic sales are allowed subject to certain conditions to be complied with by the Zone Export Enterprise particularly regarding the payment of internal revenue taxes and customs duties and the documents required for the entry and exit of goods to and from the "restricted areasff of the ECOZONES. More particularly, Section 4 of Rule X requires the accomplishment of PEZA r prescribed forms and the submission of the documents relative to the r importation, exportation or entry of the goods into the customs territory: "SECTION 4. Prescribed Forms. -The application for the I entry or exit permit of goods shall be filed by the ECOZONE Export or Free TrJde Enterprise nr entity concerned in the form prescribed by the PEZA. � The PEZA shall require the submission of shipping, commercial and other pertinent documents relative to the importation, exportation, or entry into the customs territory of said goods." (Emphasis supplied) Finished products of a Zone Export Enterprise, such as herein petitioner, I may therefore be introduced into tl1e customs territory in three (3) different ways, these are: (1) importation, (2) exportation, or (3) entry. j; f: The finished goods locally sold by petitioner in the Cavite Export ~.. Processing Zone Trade Fair an<j its finished goods sold to its employees were introduced into the customs territory by "entry/~ It is not disputed that t:he{t?2. 10

EB NO. 287 � � (CfA CASE NO. 6520) DECISION finished goods were sold at the trade fair to the public at large. Consequently, such sales are "domestic sales". Parenthetically, petitioner attached photocopie_s of an Informal Import . t; ' Entry Declaration (Bureau of Customs Form 177), BOC official receipt for the duties and taxes paid on the importation, ancl Application for permit to bring goods from the zone into the customs territory (PEZA Form 8106) to its Supplemental Protest19 dated January 9, 2002 to prove that the alleged local sales were in fact importations made by the buyers from the Customs Territory. However, the Informal Import Declaration and Entry is undated and in the name of PEZA TRADE FAIR, the BOC Official Receipt is in the name of the petitioner and dated 3/5/01, and the Application for Permit to Bring Goods From the Zone Into the Customs Territory dated 09 1\lovember 2000 shows petitioner as the Consignee/Importer. It is significant to note that the documents submitted do not correspond to the taxable year in question which is 1998 only. Similarly, the sales made by the petitioner to its employees cannot be considered as an "impo1tation" because the PEZA Rules and Regulations has a particular provision regarding "sales to employees" requiring prior written permission from the PEZA. However, petitioner failed to show proof that it was authorized by the PEZA to sell its finished goods to its employees pursuant to Section 9 of Rule X of the PEZA Rules and Regulations which provides: "SECTION 9. Written Permission. - Products made in the restricted areas of the ECOZONES, samples thereof and/or imported raw materials shall not be given nor sold by an Export or Free Trade Enterprise to its visitors, worl<ers, or employees without prior written permission from the PEZA." (Emphasis supp/ied)~t?J- 19 Exhibit IV.

'�' � � EB NO. 287 (CfA CASE NO. 6520) DECISION Since petitioner violated the above-quoted provision requiring a written permission from the PEZA before it can sell its finished product to its visitors, workers, or ' its sales to its employees sh~ll likewise be considered as employees, "'? "domestic sales" that is subject to the payment of internal revenue taxes in the same way as petitioner's sales at the local trade fairs. It both cases, petitioner was not able to show that it is exempt from the payment of the value-added tax. It is well-settled that exemptions from taxation are not favored and tax statutes are to be construed in strictissimi juris against the taxpayer and liberally in favor of the taxing authority. "Laws must receive sensible interpretation to promote the ends for which they are enacted. They should be so given reasonable and practical construction as will give life to them, if it can be done without doing violence to reason. Conversely, a law should not be so construed as to allow the doing of an act which is prohibited by law nor so interpreted as to afford an opportunity to defeat compliance with its terms, create an inconsistency, or contravene the plain words of the law. Interpretatio t7enda est ut res magis valeat quam pereat or that interpretation as will give t11e thing efficacy is to be adopted."20 To agree with the petitioner's argument that it is not liable because it is not the importer would result to an absurdity. It could not be the intention of the law to run after all buyers of petitioner's finished goods at a trade fair because it is impracticable. As to the third assigned error, petitioner-CS Garments pointed out that the sale of its motor vehicle, a Mercedes Benz, to its General Manager, Mr. Claus Sudhoff arnountlll� to P1,600/JOO.OO. is not subject to VAT since its was not : made in the ordinary course of its trade or business. Petitioner alleged that f: � before a, particular transaction may be subject to VAT, it is important to \determine the taxpayer's role or link in the production chain of tl1at particular product or service. Where the sale, barter or exchange of that particular produc~~ . '� 20 AGPALO, Statutmy Construction, Third Edition, /995, p. 202. 1. �(.~,

EB NO. 287 � � (GA CASE NO. 6520) DECISION or service is not made in the course of trade or business, such transaction may not be made subject to VAT. It further alleged that since its primary business is to engage in the manufacture of garments for sale abroad, the sale of its used ~'? company car does not have a direct relevance to petitioner's primary business of manufacturing of garments. The argument is without merit. Section 105 of the NIRC of 1997, as amended, states that: "SEC. 105. Persons Liable. -Any person who, in the course of trade or business, sells, barters, exchanges, leases goods or properties, renders services, and any person who imports goods ~ shall be subject to value-added tax (VAT) imposed in Sections 106 " to 108 of this Code. XXX XXX XXX "The phrase 'in the ordinary course of trade or business' means the regular conduct or pursuit of a commercial or an economic activity, including transactions incidental thereto, by any person regardless of whether or not the person engaged therein is a non-stock, non-profit private organization (irrespective of the disposition of its net income and whether or not it sells exclusively to members or their guests), or government entity. (Emphasis supplied) Based on the foregoing, the VAT is imposed on a sale or transaction entered into by a person in the course of any trade or business. A transaction will be characterized as having been entered into by a person in the course of trade or business if it is: (1) regularly conducted; and (2) undertaken in pursuit of a commercial or economic activity. Likewise, transactions that are made incidental to the pursuit of a commercial or economic activity are considered as entered into in the course of trade or business. "Incidental" means something else as primary; something necessary, appertaining to, or depending upon another, which is termed the principal. 21 Hence, an isolated transaction is no~. 21 DEOFER/0, JR. AND MAMALATEO, The Value AddedT'ax In 1f1e PhiltjJpines, First Edition, pp. 81-82. .l ,�~j

EB ,NO. 287 � � (CfA CASE NO. 6520) DECISION necessarily disqualified from being made incidentally in the course of trade or business. Here, petitioner's primary business is the maQufacturing of garments for ' sale abroad. In carrying-out its business, petitioner acquired and eventually solei a Mercedes Benz to its General Manager Mr. Sudhoff. Prior to the sale, the motor vehicle formed part of petitioner's capital assets, specifically under the account, "Property, Plant and Equipment". The Rules on International Accounting Slet11Udr1b (IAS)16 defines Property, Plant and Equipment as follows: "6. Definitions Property, plant and equipment are tangible assets that: (a) are held by an enterprise for use in the production or supply of goods or services, for rental to others, or for administrative purposes; and (b) are expected to be used during more than one period." (Emphasis supplied) Therefore, the sale of the motor vehicle is an incidental transaction because the said vehicle was purchased and used in furtherance of petitioner's business. Once an activity has been identified as a business, any supply[sale] made while carrying it on is likely to be made in the course or furtherance of business. No distinction is made between capital and revenue items. Thus, a supply[sale] in the course or furtherance of business includes: (1) the disposition of the assets and liabilities of a busines:,-; (2) the disposition of a business as going concern; and (3) anything done in connection with the termination or intended termination of a business. 2~ 22 Ibid, p. 83. 14 ,,�'

EB NO. 287 � (CfA CASE NO. 6520) DECISION Moreover, under Rule XV of the PEZA Rules and Regulations, petitioner is prohibited from selling or otherwise disposing of capital equipment acquired under the incentives granted to an ECOZONE Export and Free Trade Enterprise. '1 Section 1 (A) (2) of Rule XV provides as follows: : "SECTION 1. Exemption from Duties and Taxes on Merchandise. -- xxx A. Importation of Capital Equipment 1. XXX XXX XXX 2. Sale or Disposition of Capital Equipment - Any sale, transfer, assignment, donation or other form of disposition cf originally imported capital equipment/machinery including spare parts, brought into the ECOZONE duty and I tax-free, within five (5) years from elate of acquisition shall require prior approval of the Board. XXX xxx xxx >-.'XXXXX XXX If the ECOZONE Export or Free Trade Enterprise sells, transfers or disposes of these machinery, equipment and spare parts without prior approval of the Board within five (5) years from elate of acquisition , the ECOZONE Export or Free Trade Enterprise and the vendee, transferee, or assignee shall be solidarily liable to pay twice the amount of the tax exemptions granted. Any sale, transfer, assignment, donation or other form of disposition of capital equipment, brought into the ECOZONE duty and tax-free, after five (5) years from date of acquisition shall require prior approval of the PEZA Director-General." (Emphasis supplied~

EB NO. 287 t � {CTA CASE NO. 6520) DECISION The Deed of Absolute Sale23 covering the subject vehicle shows that the vehicle is a 1996 model of Mercedes Benz E-320 and that the Deed of Absolute Sale is dated 30 September 1998.. Clearly, the subj_~ct vehicle was sold by the .. > petitioner within the five-year period from acquisition date without any proof that said sale was witt1 the approval of the Board. Petitioner sl1ould have been made liable for twice the amount of tax exemptions granted pursuant to the afore- quoted provision, in addition to the deficiency value added tax. In other words, this Court En Bane agrees with the Second Division when it ruled the abovementioned discussion. The VAT liability of CS Garments amounted to P581,258.50, computed as follows: r-------------------------------------------------------- Local Sales p 1,541,936.60 Add: proceeds from sale of PPE 1,600,000.00 p 3,141,936.60 Rate of \1.t.T - - - - 10% 314,194.00 Basic Tax Due p Add: 25% Surcharge 78,548.50 20% Interest 188,516.00 Total deficiency tax' due and payable p 581,258.50 [Excluding interest pursuant to Section 249 C (3) of the 1997 Tax Code] The deficiency DST in the amount of P283.27 was also correctly recomputed by the Second Division, hence it still stands. With regard to petitioner,s undeclared sales, which is the fourth issue in this case, in the amount of P1,541,936.60, We rule that the no error was committed by the Second Division when it clecicled the following and We reiterate, viz: "Relevant provisions of Section 5(1) of Rfv1C 74-99 read as follows: . SECTION 5. Tax Treatment Of Sales Made By A PEZA Registered Enterprise. - .(/J-.- 23 Exhibit D. .l f.-}'

EB NO. 287 . � (CTA CASE NO. 6520) ' DECISION (1) Sale of goods (i.e., merchandise), by a PEZA- registered enterprise, to a buyer from the Customs Territory (i.e., domestic sales). -- xxx The registered enterprise's "gross income earned" therefrom shall be ~ubject to the 5% special tax pursuant to Sec. 24 of R.A. No, 7916: Provided, however, that its sales in the Customs Territory do not exceed the threshold allowed or permitted for such sales, pursuant to: the pertinent provisions of the PEZA rules and regulations: Provided, further, that for income tax purposes, if such sales should exceed the aforesaid threshold, its income derived from such excess sales shall be imposed with the normal income ta>C pursuant to the provisions of Title II, NIRC: Provided, further, that in computing for the income tax due on such excess sales, its net income from such I, excess sales sl1all be determined in accordance with the method of general apportionment pursuant to the provisions of Sec. 50, NIRC, (i.e., compute its total net income from total sales, then, compute its net income from such excess sales by general apportionment, as follows: Excess sales divided by total sales times total net income from total sales equals net income from excess sales). Per Letter of Authority No. 98-0531 issued by PEZA on August 24, 1998, petitioner's authority to sell in the local market was limited to the sale of export seconds and overruns of men's and bovs' shi1ts, the quantity of which should not exceed one percent (1%)'of its actual export volume in 1997, or 6,423 pieces or a total value of Pl.S million, whichever is lower.24 Since no data was available as regards petitioner's actual export volume in 1997, this CoUit shall consider the volume of 6,423 pieces with a total value of Pl.S million as the prescribed threshold amount for petitioner's 1998 local sales. Following the provisions of Section 5(1) of RMC 74-99, out of the sales amount of P1,541,936.60 subject of the deficiency '* 34% income tax assessment, only the excess local sales amount of P41,936.60 shall be charged with a 34% income tax. The amount ,.,.. of Pl,SOO,OOO.OO shall be imputed with tl1e preferential income tax rate of 5%. Hence, in the absence of documentary evidence~ 2-l 8/R Records, page 2.

EB NO. 287 f ' (CTA CASE NO. 6520) DECISION establishing it properly declared the total sales of P1,541,936.60 in its 1998 incor1,;e tax return, petitioner shall be held liable to pay the corresponding income taxes due. 1125 "\ ' With regard to the fifth issue, petitioner claimed that the Second Division committed an error when it ruled that the expenses incurred by petitioner in connection with advertising, clinic and office supplies, representation, commissions, transportations, freight and handling, professional fees, export fees, taxes and licenses and fringe benefit taxes are unallowable under Rule XX, Section 2 of the PEZA Rules and Regulations because there is no hard and fast� rule on t11e right to a deduction which depends in each case on the particular facts and the relation of the payment to the type of business in which the taxpayer is engaged. It further argued that the intention of the taxpayer often may be the controlling fact in making the determination. It concluded that each of the disallowed items of expenses of petitioner was direct cost in the manufacture of its finished products. We are not persuaded. Again, We reiterate that pursuant to Section 24 of Republic Act No. 7916, the preferential tax rate of 5% is imposed on Gross Income earned by an ECOZONE enterprise. Gross Income is in turn defined in Section 2(nn), Rule I of the "Rules and Regulations to Implement Republic Act No. 7916, otherwise known as The Special Economic Zone Act of 1995" [PEZA Rulesl as follows: "Gros5: Income" for purposes of computing the special tax due under Section 24 of the Act refers to gross sales or gross revenues derived from business activity within the ECOZONE, net of sales discounts, sales returns and allowances and minus costs of sales or direct costs but before any deduction is made for administrative expenses or incidental losses during a given taxable period. The allowable deductions from "gross income" are specifically enumerated under Section 2, Rule XX of these Rules.@__ 25 Page 23-24 of.January 4, 2007 Decision. 18

.EB NO. 287 f � (CTA CASE NO. 6520) DECISION Section 2, Rule XX of the PEZA Rules enumerates the specific deductions for ECOZONE Export Enterprises as follows: �~ I SECTION 2. Gross Income Earned; Allowable Deductions. - For purposes of these Rules, Gross Income earned shtall be as defined in Section 2(nn), Rule I of these Rules subject to the following allowable deductions for specific types of enterprises: 1. ECOZONE Export Enterprises, Free Trade Enterprises and Domestic Market Enterprises- Direct salaries, wages or labor expenses Production supervision salaries Raw materials used in the manufacture of products - Goods in process (intermediate goods) Finished goods - Supplies and fuels used in production Depreciation of machinery and equipment used in production, and buildings owned or constructed by an ECOZONE Enterprise Rent and utility charges associated with building, equipment and warehouses, or handling of goods Financing charges associated with fixed assets Based on the foregoing, for purposes of computing the 5% preferential tax, gross sales/revenues may be reduced only by sales discounts, sales returns and allowances, costs of sales or direct costs or any of the enumerated allowable deductions under Section 2, Rule XX of the PEZA Rules. Apparently, petitioner's claimed deductions for advettising, representation and entertainment, transportation and travel, professional fee, export fees, taxes and licenses should be disallowed because these expenses do not qualify as direct costs nor are they among the specified allowable clecluct:ions under the PEZA Rules..tJP- '

EB NO. 287 f t (CTA CASE NO. 6520) DECISION The same holds true with respect to petitioner's claimed deductions for clinic and office supplies. Contrary to petitioner's assertion, the supplies referred to under the PEZA Rules relate to those utilized in th~ production of goods. Regarding the claimed deduction for commissions in the amount of P6,852,410.60, the same sl1all likewise be denied. Commissions are entirely different from sales discounts. The word "commission" involves the meaning that a sum of money is paid to an agent for effecting a sale to a third person or defined as a percentage or allowance to a factor or agent for transacting business for another. 26 Clearly, for a commission to be due, there must be a service rendered. Un the other hand, discounts are generally classified as either cash or trade. Tracie discounts are given to induce purchases by volume and cash discounts are offered to induce prompt payment. Volume and time are therefore the factors considered to enjoy discounts. Under our VAT law, particularly, Section 106(D)(2) of the NIRC of 1997, sales discounts granted and indicated in the invoice at the time of sale and the grant of which does not depend upon the happening of a future event do not form part of the taxable base. Clearly, what the law contemplates as deductions from the 'gross sales are trade discounts. The same rule applies for purposes of computing the tax base for income tax either at the regular rate of 34% or special rate of 5%. 27 As earlier stated, commissions cannot be treated as trade discounts deductible from gross sales to arrive at the gross income earned by a PEZA entity. As regards the claimed deduction for freight and handling, based on the PEZA Rules,. the allowable deductions from gross sales/revenues may either be \, directly or indirectly related to the manufacturing of a product and form part of inventory costs. Thus, the allowable deduction for the handling of goods_~- 26 Words and Phrases, Permanent ed. 7A 27 Commissioner (!f lntemal Revenue vs. Central Luzon Drug Corporation, G. R. No. 159647, April 15, 2005

EB NO. 287 ' t . (eTA CASE NO. 6520) DECISION referred to under "rent and utility charges associated with building, equipment and warehouses, or handling of goods" applies only to costs attributed to the production of goods. Any handling expenses incurred in the sale of finished ~ products are disallowed under tt1e law. In the instant case, petitioner failed to offer any documentary evidence for this Court to ascertain that indeed the amount of P 4,471,804.09 can be attributed to production costs and not to selling expenses. As to the fringe benefit tax, the same shall be considered valid deduction for purposes of computing the 5% preferential tax if it has been paid/incurred in relation to direct labor or production employees. For petitioner's failure to establish that the fringe benefit tax of P306,140.70 was paid in relation to its direct labor cost, the same shall be denied. Again, to recapitulate, petitioner is liable to pay deficiency 5% income > taxes on its undeclared local sales of P1,500,000.00 and on the disallowed expenses of P14,85l,478.83 and deficiency 34% income tax on its remaining undeclared local sales of P41,936.60, in the aggregate amount of P1,448,028.35, computed as follows: DeficiencyIncome Tax (at Special Rate of5%} p 29,080,558.00 Net income per return 1,500,000.00 Add: Undeclared local sales Disallowances per examiner's p 201,900.00 recommendation 13,998.30 Advertising Clinic Supplies 597,562.03 Office Supplies 550,265.03 Representation and Entertainment 6,852,410.60 Commission 1,176,994.72 Transportation & travel 4,471,804.09 Freight & Handling professional Fee 61,177.00 Export Fees 126,103.66 Taxes & Licenses 493,122.70 Fringe Benefit Tax 306,140.70 Net taxable income per audit 14,851,478.83 E_15 .432.03Q.ft3 ~ 21 \

EB NO. 287 I t (CTA CASE NO. 6520) �. DECISION p 2,271,601.84 1,454,027.90 p 817,573.94 Income Tax Due (5%) 204,393.49 Less: Tax payment 422,898.52 Deficiency Basic Tax Add: 25% Surcharge p 1,444,865. 95 20% Interest Total Amount Due and Payable Deficiency Income Tax (at Regular Rate of p 1,541,936.60 \ 34%) 1,500,000.00 Undeclared Local Sales Less: Undeclared Local Sales subjected to 5% tax E______1_1.936.6Q Undeclared Excess Local Sales Taxable Net Income p p 5,263.05 Undeclared Excess Local Sales 41,936.60 Divided by Total Sales 190,404,800.60 Multiplied by Net Income 23,895,832.60 Tax Rate Deficiency Basic Tax 34% Add: 25% Surcharge p 1,789.44 20% Interest Total Amount Due and Payable 447.36 925.60 _p_ _], 162.4Q TOTAl DEFICIENCY INCOME TAX DUE AND PAYABLE f_j,.~8Jl28.35 In sum, the Court En Bane finds no cogent justification to disturb the findings and conclusion spelled out in the assailed January 4, 2007 Decision and May 25, 2007 Resolution of the CTA Second Division. What the instant petition seeks is for the Court En Bane to view and appreciate the evidence in their own perspective of things, which unfortunately had already been considered and passed upon. WHEREFORE, the instant Petition for Review is hereby DISMISSED for lack of merit. Accordingly, the January 4, 2007 Decision and May 25, 2007 Resolution of the CTA Second Division are hereby AFFIRMED in toto. SO ORDERED. ~ 22

.I EB NO. 287 t (GA CASE NO. 6520) i DECISION ' CAESAR A. CASANOVA Associate Justice WE CONCUR: 't~lfz. ~ ERNESTO D. ACOSTA Presiding Justi .fa iiAN~ ITO CG. .CA~S~TAoN~E.DK.,'~QR: . / / I ~ lI ~lI- BAUTISTA Associate Justice /Associate Justice I I AEsRs~~~~t.iceUY CERTIFICATION Pursuant to Article VIII, Section 13 of the Constitution, it is hereby certified that the conclusions in the above decision were reached in consultation before the case was assigned to the writer of the opinion of the Court. t_. ~--IA.. CL..--vL ERNESTO D. ACOSTA Presiding Justice