CTA Case No. 674 (Decision)

" REPUBLIC OF THE PHILI PPINES COuRT OF TAX APPEALS J'vlP.J'.J l L.~ GINN & roMPANY, c. T.A. Petitioner, CASE NO. 674 - versus - COMMISSIONER OF INTERNAL REVENUE; Respondent. X- - - - - - - - - - - X DECISION The petitioner is a corporation duly organized and exi$ting ~nder the laws of the state of Massachus- sets, U. S~ A. It is duly licensed to engaged in busi- ness as publisher in the Philippines , having its prin- cipal _place of business at 2021-A M. H. del Pilar , Manila. It filed its income tax return for,the year 1955 reporting a gross income __of P-142 , 848.63 and total deductions amounting to Pll6 , 346.86 , resulting in a net taxable income of ~26 , 501 . 77. On the basis of said net taxable income , it paid the income tax of ~5 , 300.00 at the rate of 20% prescribed in Section 24 of the National Internal Revenue Code. Upon examination and investigation of petition- er's 1955 income tax return , respondent made a defi- ciency as$essment against petitioner in the sum of P9 , 36l. OO. This deficiency assessment was brought about by the disallowance of the deduction of '46 , 802.00 , consisting of: (1) Overclaimed depreciation of furniture and fixtures ---------------- P 750.00

DECISION - C.I . A. CASE NO. 674 - 2- (2) Proportionate share .. of u. s. expenses -- . 46 ,052. 00 Total --- - - - ----- - --- - P46 , 802, 00 Petitioner contested the assessment , except with respect to the disallowance of overclaimed deprecia- tion of furniture and fixtures the correctness of which is conceded by petitioner. The protest against the deficiency assessment ~aving been overruled , peti - tioner paid the sum of P9 , 36l. OO , and , after filing the necessary written claim for refund , it instituted the instant appeal seeking the refund of P9 , 2ll. OO , representing the income tax paid on the disallowed proportion~te share of u. s. expenses in the sum of P46 ,052. 00. The sole issue raised is whether or not petition- er is entitled to claim as a deduction from its gross ; income in 1955 its proportionate share of the expenses of its parent company incurred in the United States in the sum of ~46 ,052. 00. There is no issue as regards the correctness of the amount of such proportionate ex- penses . A resident foreign corporation is one not organ - ized or created in the Philippines , but engaged in trade or business in the Philippines . The rules for determining the gross income and deductions of resi - dent foreign corporations are the same as for nonresi- dent alien individuals engaQed in trade or business in the Philippines . (See Par. 3716 , P-H Federal Tax Course , 1955. ) They are taxable only on i mcome from sources within the Phi lippines and are entitled to deduct from

DECISION - C. T. A. CASE NO . 674 - 3- their gross income "the expenses , losses , or other deductions properly apportioned or allocated thereto and a ratable part of any expenses , losses , or other deductions which cannot definitely ~ allocated to some item or class of gross income . � (Sec. 37Lb7, Nat. Int. : Rev . Code; Sec. 152 , Rev. Regs . No . 2 , 39 0 , G. 325. ) Section 160 of ~evenue Regulations No . 2 , which is a copy of Section 39. 119 (b)-1 of the u. s. Income Tax Regulations 118 based upon the same law as ours , explains in detail how the �other deductions which can- not definitely be allocated to some item or class of gross income� are to be . apportioned, viz: Section 160. APPORTIONMENT OF DEDUC- TIONS~- From the items specified in sec- tion 37(a) as being derived specifically from sources within the Philippines there shall be deducted the expenses , losses , and other deductions properly apportioned or allocated thereto and a ratable part of any other expenses , losses or deduc- tions which can not definitely be allocated to some item or class of gross income . The remainder shall be included in full as net income from sources within the Philippines. The ratable part is based upon the ratio of gross income from sources within the Philippines to the total gross income, EXN~PLE: A nonresident alien indivi- dual whose taxable year is the calendar year , derived gross income from all sources for 1919 of ~180 , 000 , including therein: Interest on bonds of a domes - p 9 ,000 Divtiicdencdosrpoonrasttioocnk -o--f -a--d-o-m-e-s-~- 4 ,000 Rotyiacltycofroprortahteionuse - o--f -------- 12 , ocx:> patents within the Phi- 11 ,000 Galiinp�pfrionmes sa- l-e--o-f--r-e-a--l -p--ro--p---- 1!36 , 000 erty located within the Philippines -------- - ------- Total - - ----

DECISION - C.T.A. CASE NO. 676 -4- that is , one-fifth of the total gross in- come was from sources within the Philip- pines. The remainder of the g~oss income was from sources without the Philippines. determined under section 37(c). The expenses of the taxpayer for the year amounted to 78 ,000. Of these ex- penses the amount of P8,000 is properly allocated to income from sources within the Philippines and the amount of f40,000 is properly allocated to inc ome from sour- ces without �the Philippines. The remainder . of the expenses, P30,000 cannot be definitely allocated to any class of income. A ratable part there- of, based upon the relation of gross in- come from sources within the Philippines to the total gross inc9me, sh9ll be deduc- ted in computing net income from sourc~s within the Philippines . Thus , there are deducted from the 1!36 ,0QO of gross inc6me from sources within the Philippines ex~ penses am_ounting to 14, 0CO (represent- ing P8 ,000 properly apportioned to the incom~ from sources within the Philip- pines and t6 ,000 , ~ ~atable part Lone- fifth7 9f the expenses which could not be allocated to any item or class of gross income). The remainder , 22 ,~ is the � net income from sources within the Phil- ippin~s. (it is, therefo~ , clear that expenditures made by a foreign corporation in conducting its business are deductible in computing its taxable income from sources within the Philippines only when allocable to the pro- duction of income from sources within the Philippines or where a ratable part of general expenditures is ap- portioned to income from sources within the Philippines. ) (See The Fajardo Sugar Co. of Porto Rico , 20 BTA 980, cited in Par. 16 , 625 , P-H Federal Taxes , 1955.) The contention of respondent that the deduction of a pro- portionate home office expenses of petitioner cannot be allowed as a deduction because �in the very nature of things , it is impossible to check and verify said ex-

DECISION - C. T. A. CASE NO . 674 -5- penses� is without merit . The fact that it is dif- ficult for respondent to check and verify the alleged expenses because the records concerning the same are kept in a foreign country is no justification for the denial of the deduction , otherwise the law would be rendered meaningless . It is , however , essential that there be proof that a portion of such home office ex- penses is allocable to income from sources within the Philippines. In this case , it has been sufficiently proven that a portion of petitioner's home office expenses during the year under review is allocable to income from Philippine sources. (Exhs . C and C-1. ) As cor- rectly stated by counsel for petitioner: �In its business of publishing books , the home office of the petitioner in the United States performs entirely the edi- torial work on the books published in the Philippines. (t. s.n. p. 11) The home of- fice also takes ch a rge of securing permis - sion to reprint copyrighted works of var- ious authors througho~t the world. which phase of the work could not be done in the Philippines . (t . s . n. pp. 16-17) All illustrati9ns , specifications and format of the books are likewise done abroad. (t . s . n. PP� 23- 25) Except for the actual physical process of printing the books in the Philippines, it is the petitioner' s head office that performs all the func- tions relative to the preparation .of a book for publication. "In addition to the technical assis- tance rendered by the home office to its Philippine branch , it also takes direct charge and supervises the accounts of the local operation. Monthly financial re- ports are submitted to the home office which advises the branch office as to the proper procedure of recording its ac- counts . (t.s.n. pp. 26- 29) All general policies are dictated by the home office , _ both on the business and administrative part of its activities in the Philippines. The local office also particiPates in the

DECISION - C. T. A. CASE NO . 674 -6- Pension Plan and the Profit Sharing Trust Plan of the company of which the employees in the Philippines are members . This plan is entirely financed by the company and all benefits accrue to the members . {t.s . n. PP� 29-30 , Exhibit I and I - 1) In addition to such pension plan , the home office in- sures its employees in the Philippines at its own expense (t. s . n. pp. 30- 31)." (Page 2 , Memorandum for the Petitioner. ) Assuming that a portion of home office expenses are allocable to income from sources within the Philip- pines , it is argued on behalf of respondent that the expenses in question are not ordinary a!"ld necessary expenses within the meaning of Section 30(a) of the Revenue Code . Among such expenses are the general and administrative expenses , advertising expenses and the expenses in connection with profit sharing and pension plans. Sections 65 and 118 of Revenue Regula- tions No. 2 , quoted below , sufficiently answer respond- ent's contention. Section 65. BUSINESS EXPENSES. - Busi- ness expenses deductible from gross in- come include the ordinary and necessary expe~ditures directly connected with or pertaining to the taxpayer ' s trade or busi- ness. The cost of goods purchased for re- sale , with proper adjustment for opening and closing inventories , is deducted from gross sales in computing gross income. Among the items included in business ex - penses are management expenses , commissions , labor, supplies , incidental repairs , operat- ing expenses of transportation , equipment used in the trade or business , traveling ex- penses while away from home solely in the pursuit of a trade or business , adverising and other selling expenses , together with insurance premiums against fire , storm , theft , accident , or other similar losses in the case of a business , and renal for the use of business property. A taxpayer is entitled to deduct the necessary expen- ses paid in carrying on his business from his gross income from whatever source. Section 118. PA~lliNTS TO EMPLOYEES '

DECISION - C.T.A.. CASE NO . 674 -7- PENSION TRUSTS.- An employer who adopts or has adopted a reasonable pension plan , actuarially sound , and who establishes , or has established , and maintains a pen- sion trust for the payment of reasonable pensions to his employees shall be al- lowed to deduct from gross income reason- able amounts paid to such trus t , in ac- cordance with the pension plan {including any reasonable amendment thereof) , as followss (a) If the plan contemplates the payment to the trust , in advance of the time when pensions are granted , of amounts to provide for future pensions payments , then (1) reasonable amounts paid to the trust during the taxable year representing the pension liability appli- cable to such year, determined in accord- ance with the plan , shall be allowed as a deduction for such year as an ordinary and necessary business expense , and in addition (2) one - tenth of a reasonable amount transferred or paid to the trust during the taxable year to cover in whole or in part the pension liability appli- cable to the years prior to the taxable year , or sG transferred or paid to place the trust on a sound financial basis , shall be allowed as a de~uction for the taxable year and for each of the nine succeeding taxable years. (b) If the plan does not contem- plate . the payment to the trust , in ad- vance of the time when pensions are granted , of amounts to provide for future pension payments, then (1) reasonable amounts paid to the trust during the tax- able year representing the present value of the expected future payments in res- pect of pensions granted to employees retired during the taxable year shall be allowed as a deduction for such year as an ordinary and necessary business expense , and in additon {2) one -tenth of a reason- able amount transferred or paid to the trust during the taxable year to cover in whole or in part the present value of the expected future payments in respect of pen- sions granted to employees retired prior to the taxable year, or so transferred or paid to place the trust on a sound finan - cial basis , shall be allowed as a deduc- tion for the taxable year and for each of the nine succeeding taxable y~ars~

DECISION - C. I . A. CASE NO . 674 / - 8- IN VlEW OF THE FOREGOING , we find petitioner's claim for refund in order. Accordingly, respoodent is ordered to refund to petitioner the sum of P9 , 2ll.go , without pronouncement as to costs. SO ORDERED. Manila , May 21 , 1963. OOMAN M. UMALI Associate Judge I CONCUR: ~~ Presiding Judge Associ ate Judge AUGUSTO M. LUCit~O did not take part.