TOLEDO POWER COMPANY v. COMMISSIONER OF INTERNAL REVENUE

REPUBLIC OF THE PHILIPPINES Coon al Tax APPeals QUEZON CITY 11188 DN/11011 TOLEDO POWER COMPAN Y, CTA CASE NO. 757 1 Petitioner, Members: - versus - BAUTISTA, Chairperson PALANCA-ENRIQUEZ, and COTANGCO-MANALASTAS, JJ. COMMISSIONER OF INTERNAL Promulgated: REVENU E, MAY 13 2011 Respondent. pA,e,F"~a--f2... ~-'tnr>�- � X- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - X DECISION BAUTISTA, J.: Before the Court is the Petition for Review filed by Toledo Power Company on February 6, 2007, seeking the cancellation of the Formal Letter of Demand for alleged deficiency value-added tax (VAT) covering taxable year 2002 and for failure to pay annual registration fee . Petitioner Toledo Power Company is a general partnership duly organized and existing under and by virtue of the laws of the Philippines .l 1 Exhibits "A" and "B"

DECISION CfA Case No. 7571 It is registered with and authorized by the Energy Regulatory Commission (ERC) to operate facilities used in the generation of electricity. It is likewise registered with the Bureau of Internal Revenue (BIR) as a VAT taxpayer with Tax Identification No. 003-883-626-000 .2 Petitioner is principally engaged in the business of power generation and the subsequent sale thereof to the National Power Corporation , private electric utilities and electric cooperatives, and the carrying on of all businesses incident thereto, including but not limited to the sale of the by-products of power generation .3 Respondent Commissioner of Internal Revenue is the chief of the Bureau of Internal Revenue, the government agency charged with the assessment and collection of all national internal revenue taxes, fees and charges, and the enforcement of all forfeitures , penalties and fines connected therewith. Petitioner filed an administrative claim for refund and issuance of tax credit certificate of its unutilized input value-added tax on domestic purchases of goods/services and importation of goods related to zero- rated sale of services in the amount of P14,254,013.27. As a result of said application , respondent issued Letter of Authority No. 00077 453 dated February 2, 2004 to examine petitioner's books of accounts and accounting records.4 2 Exhibits "C" and "D" 3 Par. 1.4, Admitted Facts, Joint Stipulation of Facts and Issues (JSFI), docket, pp. 156-157 4 Par. 1.7, Admitted Facts, JSFI, docket, p. 157

DECISION CTA Case No. 7571 Based on petitioner's claim for refund or tax credit for taxable year 2002, a Preliminary Assessment Notice (PAN) , dated January 25, 2006, was issued by respondent and was received by petitioner on February 9, 2006. The PAN alleged that there are disallowed input taxes of P4,567,588 .93 and unrecognized output VAT on sales amounting to P18,736,441 .50, which resulted in deficiency VAT payable of P19,173,254.49, inclusive of increments; and that the failure to pay the annual registration fee for taxable year 2002 resulted in deficiency registration fee of P1,027 .50, including surcharge and interest.s On April 12, 2006, petitioner received a Formal Letter of Demand with Details of Discrepancies and Assessment Notices, all dated April 3, 2006, assessing petitioner for the following deficiency taxes:6 Assessment No. 83- VAT-13-2002 -2006 -3-083 I. VALUEADD ED TAX Per Applica tion o f Tax Credit/Refund p (14,254,013.27) (as appea ring a lso p e r VAT Return as of December 31 , 2002) Less : Findings per investigation Disallowed Input Tax p 4,567, 588.93 45,83 1. 17 Unrecognized VAT Output VAT Output per Investigation p 349 ,861.22 VAT Output per return on Sales Discrepancy 304 ,030 .05 Sa les per ITR Gross 632,223,5 11 .00 5, 159,579.00 Less : Sa les re t. & disc. 627 ,063 ,932.00 Net Sales 3.460,054.00 Add: Other Income 630 ,523 ,986 .00 439 ,660,958.77 Total Sales 190,863,027 .23 Less: Export Sa les per VAT Re turn 3.498,6 12.23 187,364.4 15.00 Vo ta b le Sa les Less: Vo ta b le Sales p er Investigation Vota b le Sa les w ith missing invoices 5 Exhibit "L" 6 Exhibit " M"

DECISION 10% 18,736,44 1.5 23,349,861.60 CTA Case No. 7571 Page 4 of 15 4,5 47 ,924 . 17 p 9,095,848.33 5,780,916.94 VAT Rate 10,328,841 .11 VAT Deficiency p 19,424,689.44 Add: 50% surcharge 20% interest (01 /26/03 to 03/30/06) Total VAT Deficiency Assessment No. 83-VAT-13-2002-2006-3-084 II. ANNUAL REGISTRATION FEE Basic Registration Fee p 500 Add: Surcharge p 125 741.39 1,241 .39 Compromise Penalty 200 Interest (02/01 /02 to 03/30/06) 416.39 Total Deficiency Registration Fee p On May 12, 2006, petitioner filed with responden t its protest on said assessments J On July 26, 2006, petitioner received a letter from the BIR dated July 10, 2006, requesting documentary evidence for proper evaluation of the merits of the protest and attaching the composition and reasons for the disallowed input taxes amounting to P4,567,588.93 .8 Since respondent failed to resolve petitioner's protest, petitioner filed a Petition for Review before this Court on February 6, 2007. In his Answer9 filed on April 27, 2007, respondent raised the following Special and Affirmative Defenses: "4. After a thorough investigation, for the taxable year 2002, the bulk of the company's income came from sale of electricity, which is zero-rated vat. However, the company also have income subject to vat rea lized from the sale of scrap to various buyers. 7 Exhibit "I" 8 Par. 1.10, Admitted Facts, JSFI, docket, p. 159 9 Docket, pp. 87-92

DECISION CTA Case No. 7571 5. A 10-day Preliminary Notice dated June 16, 2005 was sent informing the taxpayer that their claims of excess input tax in the total amount of P14,254,013.27 was decreased to P8,181 ,626.89 due to disallowances on the input taxes . As a reply, subject taxpayer submitted some of the official receipts to substantiate the disallowances. Thus, a re-evaluation and/or re-verification was made, and the disallowances on the input tax was reduced to P4 ,567 ,688 .93. 6. A comparison on the supported schedule of sales and VAT Returns revealed an unrecognized output tax in the total amount of P45,831 .17. The gross sales per income tax return with its financial statements and the sales recognized per vat returns showed a discrepancy of sales which was treated as sales subject to vat. This discrepancy was substantiated by the missing invoices and/or official receipts which, per verification on the schedule of sales, were not all recorded. Thus, it resulted that instead of refundable VAT subject taxpayer is now liable for the value-added tax deficiency in the total amount of P12,582,741.52. 7. To inform the taxpayer on the result of the re-evaluation and/or re-verification , a preliminary notice dated October 28, 2005 was served on subject taxpayer giving it 5 days to refute the findings. However, subject taxpayer asked for an extension with in which to support its allegations up to Nov. 29, 2005. On the given definite schedule, subject taxpayer submitted its comments on the findings and reconciliation of gross receipts vs. amount per VAT return . 8. The three-year prescription of the government's right to assess is not w ithout exceptions. Section 222(a) of the 1997 Tax Code, as amended, specifically provides the following, to wit: 'SEC. 222. Exceptions as to Period of Limitation of Assessment and Collection of Taxes. (a) In the case of a false or fraudulent return with intent to evade tax or of failure to file a return , the tax may be assessed , or a proceeding in court for the collection of such tax may be filed without assessment, at any

DECISION CfA Case No. 7571 time within ten (1Ol years after the discovery of the falsity, fraud or omission: Provided , that in a fraud assessment which has become final and executory, the fact of fraud shall be judicially taken cognizance of in the civil or criminal action for the collection thereof. (b) XXX XXX xxx' (underscore supplied) Corollarily, under Section 248 (B) of the same Code, the following is being provided: 'SEC. 248. Civil Penalties.- XXX XXX XXX (B) In case of willful neglect to file the return within the period prescribed by this Code or by rules and regulations, or in case a false or fraudulent return is willfully made, the penalty to be imposed shall be fifty percent (50%) of the tax or of the deficiency tax, in case any payment has been made on the basis of such return before the discovery of the falsity or fraud : Provided , that a substantial under declaration of taxable sales, receipts or income, or a substantial overstatement of deductions, as determined by the Commissioner pursuant to the rules and regulations to be promulgated by the Secretary of Finance, shall constitute prima facie evidence of a false or fraudulent return: Provided, further, that failure to report sales, receipts or income in an amount exceeding thirty percent (30%) of that declared per return, and a claim of deductions in an amount exceeding thirty percent (30%) of actual deductions, shall render the taxpayer liable for substantial underdeclaration of sales, receipts or income or for overstatement of deductions, as mentioned therein ." (underscores supplied) Upon examination and evaluation , there are sales subject to vat of Toledo Power Corporation with missing invoices which amounted to P187,364,415.00 which represent 98% of the total sales subject to vat for the

DECISION CTA Case No. 7571 taxable year 2002. In other words, only 2% of the total sales subject to vat had been substantiated with invoices during the investigation . Clearly, there exists a substantial underdeclaration of taxable sales, receipts or income which constitute a prima facie evidence in this case of a false and fraudulent return , thus granting this Bureau the right to assess within 10 years after discovery of the falsity, fraud or omission pursuant to Section 222 of the 1997 Tax Code, as amended ." On June 27 , 2007, petitioner filed a Reply lO thereto. Pre-trial conference was scheduled on August 23, 2007 . On September 25, 2007, the parties filed their Joint Stipulation of Facts and Issues, which was approved on October 1, 2007 .11 During trial , both parties presented documentary and testimonial evidence in support of their respective claims and contentions. On October 19, 2010, the Court submitted the case for decision, considering respondent 's Memorandum 12 filed on September 6, 2010 and petitioner's Memorandum 13 filed on October 11 , 2010 .1 4 The following are the stipulated issues 15 for our resolution : "2.1 Whether or not the Respondent has lost its right to assess the alleged deficiency value-added taxes and annual registration fees by reason of prescription. 2.2 Whether or not the Petitioner underdeclared its votable receipts amounting to P187,364,415.00, or by an amount exceeding 30% of that declared in its 2002 VAT returns . 10 Docket, pp. 107-114 11 Docket, p. 179 12 Docket, pp. 1152-1160 13 Docket, pp. 1169-1208 14 Docket, p. 1210 15 Docket, pp. 159-160

DECISION CTA Case No. 7571 2.3 Whether or not Respondent's Letter of Authority includes the authority to examine Petitioner's other tax liabilities and compliance. 2.4 Assuming arguendo that Petitioner's (sic) right to assess deficiency VAT has not prescribed, whether or not the Formal Letter of Demand is void for failure to inform the Petitioner of the facts on which the assessment was based . 2.5 Assuming arguendo that Petitioner's (sic) right to assess deficiency VAT has not prescribed, whether or not Petitioner properly reported its votable sales in its 2002 quarterly VAT returns. 2.6 Assuming arguendo that Petitioner's (sic) right to assess deficiency VAT has not prescribed, whether or not sales of generated power by Petitioner for taxable year 2002 are subject to zero percent (0%) VAT pursuant to the EPIRA, its implementing rules and regulations and the Tax Code of 1997. 2.7 Assuming arguendo that Petitioner's (sic) right to assess deficiency VAT has not prescribed , whether or not Petitioner failed to pay the annual registration fee for taxable year 2002 amounting to P1,241 .39 including interest and surcharge ." Petitioner asserts that respondent has lost the right to assess the alleged deficiency value-added taxes and annual registration fees by reason of prescription. It contends that Section 203 of the National Internal Revenue Code (NIRC) provides that respondent is given the power to assess taxes within three (3) years after the last day prescribed by law for the filing of the return. It reasons that since it did not sign any waiver of the defense of prescription for internal revenue tax liabilities for taxable year 2002, the assessment has already prescribed .

DECISION CTA Case No. 7571 Petitioner furth er asseverates that the provision raised by respondent, which is Section 248(8) of the NIRC, cannot be given effect since said p rovision does not extend the period within which respondent con assess taxes. Petitioner points out that said provision is captioned "Civil Pe nalties. " As worded, the only legal effect of having a prima facie evidenc e of a false or fraudulent return under Section 248(8 ) of the NIR C is the imposition of a surcharge equivalent to fifty percent (50%) of the ta x or of the deficiency tax. Lastly, it a sserts that the assessment is void for failure of respondent to cl e arly and properly inform petitioner of the facts and the low on which the assessment is mode. It claims that the details of the disallowed in put taxes should be stated in the Formal Letter of Demond and not a nywhere else so that it may be given sufficient time to effectively protest a nd furnish respondent with competent and valid supporting docu m e nts. Respondent co unters that its right to assess has not yet prescribed . It con te nds that the three-year period to assess is not w ithout exceptions . He maintains that Section 222(o) of the NIRC provides that in cas e o f a false or fraudulent return with intent to evade tax or of failure to file a return , the tax may be assessed at any time within ten (10) yea rs after discovery of the falsity, fraud or omission . Responden t o ve rs that only 2% of the total soles subject to VAT hod been substa ntia te d with invoices during investigation . He asserts ~

DECISION CTA Case No. 7571 that there exist substantial underdeclarations of taxable sa les, receipts or income which co nstitute a prima facie evidence of false and fraudulent return; thu s giving respondent the right to assess within ten years from discovery of the falsity, fraud or omission . Section 228 16 of the NIRC provides that the taxpayer must be informed in writing o f the law and the facts upon which a tax assessment is based; o therwise, the assessment is void . To implemen t this provision, the BIR issued Revenue Regulations (RR) No. 12-99 17, Sectio n 3.1.4 of which states: "3. 1.4 Formal Letter of Demand and Assessment Notice. -The formal letter of demand and assessment notice shall be issued by the Commissioner or his duly authorized representative . The letter of demand calling for payment of the ta xpa yer' s deficiency tax or taxes shall state the facts, th e la w, ru les and regulations, or jurisprudence, on which th e ass essment is based, otherwise, the formal letter of dema nd and assessment notice shall be void xxx" (Emphasis supplied) In the present c ase, the Formal Letter of Demand with Details of Discrepancies and Assessment Notice issued against petitioner are not valid . Said notices failed to state the legal and factual bases of the assessment for defic ie ncy value-added tax in violation of Section 228 of the NIRC . 16" SEC. 228. Protesting of Assessment - When the Commissioner or his duly authorized representative finds that proper ta xes should be assessed, he shall first notify the taxpayer of his findings: XXX XXX XXX The taxpayer shall be informed in writing of the law and the facts on which the assessment is made; otherwise, the assessment sha ll be void." 17 "Implementing the Provisions of the National Internal Revenue Code of 1997 Governing the Rules on j Assessment of National I nternal Revenue Taxes, Civil Penalties and Interest and the Extra-judicial Settlement of a Taxpayer's Criminal Violation of the Code Through Payment of a Suggested \'\. Compromise Penalty" ~

DECISION CTA Case No. 7571 A careful perusal of the facts stated in the Details of Discrepancies shows that th e details stated therein are not sufficient to afford petition er the o p portunity to intelligently answer the assessment as well as prepa re doc umentary evidence to support its protest. Respond e nt fa il ed to indicate the basis of the disallowance of the input taxes a m o unting to P4,568,588.93. Further, respondent neglected to state the schedule or the composition of the supposed disallowed input tax, VAT output per investigation , and the votable sales per investigati o n. In fact, in C om missioner of Internal Revenue vs. Enron Subic Power Corpora tio n 18, the Supreme Court held that-- "The law requires that the legal and factual bases of the a ssessment be stated in the formal letter of demand and assessment notice. Thus, such cannot be presumed . Otherwise, th e express provisions of Article 228 of the NIRC and RR No. 12-99 would be rendered nugatory. The alleged 'fac tu a l b ases' in the advice, preliminary letter and 'audit w orking p a p e rs ' did not suffice. There was no going around the ma nd ate of th e law that the legal and factual bases of th e a ssessme nt be stated in writing in the formal letter of deman d a c c o mpanying the assessment notice. We note that the old law merely required that the taxpayer be no tified of the assessment made by the CIR . This was c ha ng e d in 1998 and the taxpayer must now be informed not o nly of the law but also of the facts on which the assess me nt is mad e . Such amendment is in keeping with the c onstitutiona l principle that no person shall be deprived o f pro p erty without due process . In view of the absence of a fa ir opportunity for Enron to be informed of the legal a nd fa ctual bases of the assessment against it, the assessm e nt in question was void . We reiterate our ruling in Reyes v. Alm a nzar, et. a/. : 18 G.R. No. 166387, Janua ry 19, 2009

DECISION CTA Case No. 7571 Verily, taxes are th e lifeblood of the Govern me nt a nd so should be collected without unnecessary hindrance. However, such coll ec ti o n should be mad e in accordance with law as a ny arbi trariness will negate the very rea so n for the Govern ment itself." Moreover, Section 203 of th e NIRC provides that respondent only has three years to a ssess and c ollec t a n internal revenue tax, to wit : "S EC. 203 . Period of Limita tion Upon Assessment and Collection. - Except as pro vided in Section 222, internal revenu e taxes sha ll b e assessed within three (3) years after the last d ay prescribe d by law for the filing of the return, and no proceeding in court without assessment for the collectio n o f such taxes sh a ll be begun after the expiration of such p eriod; Provided , That in a case where a return is filed beyond lhe period presc ribed by law, the three (3)- year period shal l be counted fro m the day the return was filed . For pu rp oses of th is Sec tion, a return filed before the last day presc ribed by law for the filing thereof shall be consid ered a s fil ed on suc h last d ay." Pursuant to the a fore-q uoted provision , the three-year period to assess comm en ces from th e date of ac tual filing of the return or from the last day prescri bed by law for the filing of such return , whichever comes later. A pplying the ru le to the present case, the last day to file and pay valu e-ad d ed tax is o n the twe nty-fifth day following the close of each taxabl e q ua rter. So if the re turn was filed beyond the period prescribed by law, the three-yea r period shall be counted from the day the return wa s filed . Thus, respond ent had until the following dates within which to assess petitioner for th e subject deficiency value- added tax for taxable yea r 2002:

DECISION CTA Case No. 7571 Year Exhibit Date Filed Last Day to Last Day to 2002 File Return Assess 1st Qtr E 4/25/02 04/25/02 2nd Qtr F 7/25/02 07/25/02 04/25/05 3rd Qtr G 10/25/02 10/25/02 07/25/05 4th Qtr H 1/27/03 19 01/27/03 10/25/05 01/27/06 Clearly, the Formal Letter of Demand and Assessment Notice both dated April 3, 2006 and received by petitioner on April 12, 200620 are beyond the three-year prescriptive period within which respondent could make an assessment for deficiency VAT for taxable year 2002. Assuming however that the three-year period will not apply due to respondent's allegation of fraud , the Court still cannot take cognizance of the same due to respondent's failure to prove the existence of fraud . Mere allegation is not evidence and is not equivalent to proof. Hence, it is important that respondent's allegation of fraud be proven during trial. Since the assessment issued by respondent is invalid, it cannot in turn be used as a basis to collect tax. As to the annual registration fee assessment, the Court finds that the imposition of the same is clearly misplaced . Section 236(B) of the NIRC provides that the annual registration fee in the amount of five hundred pesos for every separate or distinct establishment or place of business shall be paid on or before the last 19 January 25, 2003 fell on a Saturday 20 Exhibit " M"

DECISION CTA Case No. 7571 day of January. In this case, petitioner's annual registration fee should be payable on or before January 31 , 2002. A review of the BIR revenue official receipf2l (ROR 2000-01464910 dated January 30, 2002, for payment of Annual Registration in the amount of P500.00) and Payment Form22 (BIR Form No . 0605 dated January 30, 2002, for payment of Annual Registration in the amount of PSOO.OO) clearly proves that petitioner paid its annual BIR registration fee for taxable year 2002. WHEREFORE, premises considered , the instant Petition for Review is hereby GRANTED. Accordingly, the assessments for deficiency value- added tax and annual registration fee issued by respondent are hereby CANCELLED . SO ORDERED . WE CONCUR: !;:~c~ AMELIA R. COTANGCO -MANALASTAS Associate Justice Associate Justice 21 Exhibit " P" 22 Exhibit "Q"

DECISION CfA Case No. 7571 ATTESTATION I attest 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's Division. 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's Division. L--u.~ ERNESTO D. ACOSTA Presiding Justice