CTA Case No. 5993 (Decision)

REPUBLIC OF THE PHILIPPINES COURT OF TAX APP�'EALS QUEZON CITY EN RO N SU BI C POW ER CO RPO RA T I O N, c:r. A. CASE NO. 5993 Petiti oner. - v e r s us - COM M I SS ION ER OF I NT I�RNAL Promul ga ted: REVENUE, Respo ndent. X----- - - -- ---- - -- - ------------------------------------------X DEC I SI ON The case at bar see ks the cancell ati on o r Pclili ollcr's all eged 19% defi ciency lax asscss1ncnL as pe r l;ill<tl /\sscss lll L' Ill No ti ce (1 :/\N) No. 0 I!J-LILI -!J(J-0000.17 1 li<l tcd fvLt y 12, 1999. in the amoun t or P2,880J) 17.25. As represented, Petit io ner is a co rpo rati on du ly organ ized and ex isti ng under Phili ppine Laws. It is reg istered with th e Subic Bay Metropolitan Auth ority (S BMA) as a Subic Bay Freeport (SBF) E nterpri ~;e entitl ed to the 5% preferenti al Lax rate under Republi c Act No . 7227, otherwise known as the " Bases Co nve rsio n and Deve lopment Ac t o r 1992." On April 15, 1997. Petiti oner li led its Annual Inco me Tax Re turn (ITR) cove rin g taxa ble year 1996 showing a net loss o r P7.684.948.00 ([x lii bits " 13'' a11d " 13-1 ''). On May 26, 1999, Petiti oner rece ived l'rom Respo nden t Fo rm al Assessment No ti ce (" FAN") No. 0 19-44-96 -00003 7 1 dated May 12. 1999 lor all eged de lic iency in co me Lax and coverin g taxab le year 1996, co mputed as fo ll ows: 0 6 . 1 ..l ..t..

DEC ISION - CTA CA SE NO. 5993 PA GE 2 I. Tax Due p 1.8 52 ,422 .00 463. 105 .50 2. Add : Surcharge 'i4 0.2X1>.7'i IIllcrc sl 2 .\ 0()() _()() ( 'ollljlJ'!IIlli SL' 1\�I� ;ilt y 1'2/ 1\0,X17.2') 1. Tot <il i\llHHilll l'a y;thk Petiti o ner had ass um ed that th e a lleged defici ency taxes due to the Gove rnm e nt was arri ved at in th e sa me ma nn er as di scussed carl ie r w ith th e reve nue exa min ers durin g th e pre-assess ment stage, in th e to ta l am o unt o r P2,880 ,8 17.25 bro ken clown as f'o ll ows : Per ITR Ad ju stme nts Revenues : P56,360.422 .00 P56 ,360,422.00 Standby fees Energy fees 585,753 .00 585,7 53 .00 Others- Net O&M Supervision fee - SPC 4,144,895 .00 4 ,144 ,89 5.00 O&M Supervision fee- BPC P1 6,26 1,03 1 00 16,26 1,031 00 13,750,087 .00 13,750,087.00 TOTAL REVENUE P6 1 091 070.00 P9 1 102 188.00 Less Direct Costs Cost of sales P22 ,054 ,884.00 P1 5,116,447.00 P 6,938, 437 .00 Lease Payments Salaries & wages 25 ,210 ,968 .00 25, 210,968 .00 Insurance expense Building & grounds 16,147,327 .00 16,147 ,327 .00 Utility expense Depreciation & amortization 1,865 ,67Q.OO 1,865,670.00 Employee benefits Maintenance expenses 709 ,992.00 709, 992 .00 379,040 .00 379 ,040 .00 188 ,810 .00 188 ,810,00 148,276.00 148,276.00 40 33 8.00 40 338.00 TOTAL DEDUCTIONS P66, 745.3 05.00 P49,763. 188 .00 Taxable Income P41 ,339 .000.0Q P- .5.�.6.M 235.0Ql Tax Due p 2, 066, 950 .00 Less : Tax Credits 356 ,424 00) 141 896.00 ( 214. 528.00) Basic Tax Due p 1,852 ,422.00 Add : 25% surcharge 463 ,105.50 540,289.75 20% interest p.a. 25 000.00 Compromise penalty Total Deficiency Income Ta xes p 2. 88 0,81 7.25 J1L QC\_;C~)

DEC ISION- C' T t\ C t\SI �: NO . ) <)t)l 1';\( il �: .l (Paragraph 3 of Petiti on for Rev iew as admitted in Parag raph I of the Answer; Para graph 5. .Joint Stipulation ol' Fact s: 1-:xhibit "/\" <tnd "/\- 1") . On .June 15. 1999, Petiti oner, th ro ugh its ex ternal auditors. fil ed ' Yith the Respondent, through the Regional Di rec tor of Revenue Region No. 4 in San Fernando, Pampanga, its protes t letter dated .June 14. 1999. pursuant to Sec ti on 228 of the Tax Code. as amended. Said protest letter spec ifi ed the fac tual and legal bas is of the protes t against sa id alleged de fi ciency 5% tax assess ment, and fu rther requested th at the said defici enc y tax assess ment be withdrawn and cance ll ed (Paragraph 4 o r Petiti on fo r Rev iew as admitted in Parag raph I o r the Answer; Paragra ph 4 .J oint Stipul ati on of Fact s). As of December 12. 1999. whi ch is the one hundred eighti eth ( 180111) day from the date that Petiti oner had fil ed its protest. Res pondent had not ye t ac ted upon th e protest aga in st the all eged defi ciency tax assess ment aga in st Petiti oner (Parag raph 5 of the Petiti on for Rev iew as admitted in parag raph I of the Answer: Paragraph 5, .J oint Stipul ati on or Facts). On .January I0. 2000. Petitioner lilccl with thi s Co urt the in stant Petition lo r Rev icvv contestin g the de fici en cy ta x assess ment of' P2. XXO .X17.25. Petiti oner presents the propos iti on as reaso n of' the Pet iti on !'or Rev iew th at it is not liabl e for the defi ciency inco me tax assess ment fo r the yea r 1996 in the amount of P 2 J~ XO . X 17.25 on th e fo ll ow ing ground s, thu s: ( 1) the assess ment is null and vo id under Secti on 228 of the Tax Code for failure of the Respondent to menti on or disc lose th e fac tual and lega l basis of the assess ment:

I>Lt' ISION- CTt\ Ct\ SL NO. 5lJ<.J3 PAGE 4 (2) the pa yments/o perati onal maintenance supervi sion ICes recei ved by Petiti oner from Subic Power Co rporati on (SPC) in the total amount or PI (J .2(J I,0] 1.00, ami l'rom 13atangas Powe r Corporation ( HPC) in the total am ount of P 1 3 .7 5 0 . 0~0 . 00 . a' a res ult of th e ir separate Operati on and Maintenance Supervision Agreements (0 & 1\1 Agreements), are reimbursements for its actual ex penses incurred for the operation and maintenance o f their respecti ve Subi c and Batan gas power plant l~l c iliti cs without any mark-up or pro fit , hence . do not con stitute inco1ne. allll thcre rore shuuld not he subjected to the 5'Yu ta x on gross income earned ; (3) the disa ll owed cost of sa les amounting to Pl 5, 11 6,447.00 , whi ch is a portion of the restoratio n costs of the Subic power stati ons is a d eci~ctibl e ex pense for 1996 as the Energy Co nversion Agreement hct wcc 11 J>ctiliuncr ;ttld Natiutl;tl Po wer Curpur;ttiott (N/\ J>O('Oiq was va lid onl y until the end o r 199 7 and that sa id restorati on costs were bein g in curred by the Petiti oner on the asse t whi ch it did not even possess ac tual ownership, hence, there is no bas is to capitalize the restorati on costs of th e power stati ons and amorti ze sa id am ount ove r the plant 's estim;1tcd liiC. tmt s. it co ncluded that lo r purposes of matching cost aga inst reve nues. it correctl y treated restoration costs as ex pense for the year 1996, the year in whi ch they arc incurred; (4) the di sa ll owed insurance ex pense amounting to P l, S65,6 70.00 is a direct cost, it being a co ntractual obli gati on and an integral part o r the power pl ant 's direct expenses without whi ch Pctitiot1 cr co uld not have pursued its S BM !\ registered acti vity, as such. a deductibl e ex pense to r purposes of the 5% tax on gross inco me earned in the sa me manner that deprec iati on. lin ancing charges, rent and util ity charges lo r mac hineri es. equipment and building arc all owed as deducti ons; ;tnd (5) the di sa ll owa nce by Respo nd ent o r the tax cred its amountin g to p 141 ,896. 00 , on ground that th e same i; on interest inco me o r a Subi c Bay Freeport Enterpri se rrom bank depos its subj ect to the 5% preferential tax rate, was not supported by ev idence, hence, it submitted that there is no legal and/o r fa ctual bas is to reduce its allowabl e tax credits, as the same we re not tax credits on any tax imposed on interest income but taxes withheld by NAPOCO R creditabl e to any 5% tax li ability of Petiti oner. dul y supported by withholding tax certifi cates.

DEC ISI ON- CTA CAS E NO. 599 3 PA GE 5 Respondent disputes the asseveration s or Pcti l ioncr and rai sed the hcrei n Speci aI and i\llirmati vc Defen ses, thus: "J . Prior to the iss uance or the assess ment. Petitioner was inl(mned oJ the proposed assessment and the basis thcrcul' whi ch it protested . lienee, the requirem ent under Section 22:' ol� the lax Cod e that the taxpa yer shall be informed of the law and th e l~1ct s on which the assessment is made, is deemed to ha ve been compli ed with . 4. The am ount o r P30,0 I I, 118 .00 paid by Subic Power Co rporati on (SPC) and Batangas Power Corporati on (BPC) as reimbursements for the all eged actual costs incurred by Petiti oner in the performance of its obligations under the Operation & Maintenance Supervision Agreement (0 & M) is not deductible, as it is a l~1c t that SPC, BPC and Petiti oner arc all operated and/or co ntrolled by Enron Development Corporation, a U.S . based company, whi ch l~1ct makes tb csc com panics intcr-rclatcd. It is no secret that " reimbursement" or so-ca ll ed ac tual costs is a common practice appli ed by compani es for the purpose of reducin g, avo iding, or altogether escapin g the payment o r taxes. 5. Contrary to the all egati on of Petitioner that the restoration costs of the power pl ants were charged in full against income as costs of sale, since there is no discernibl e future benefits whi ch it may derive, the l~1c t is that Petiti oner agreed to th e restorati on in ord er to corner a much bi gger contrac t fo r the constructi on or another power plant now operated by Subi c Powe r Co rporati on. Obviously, Petiti oner deri ved th e benefit of a bi gger contrac t when it agreed to do the restorati on. l-I enee, the cos ts should be capitali zed. 6. While in surance may be a necessary expense, it docs not necessaril y mean a direct cost th at may be deductible from gross income. i\ s a matter o f l~1c t , Revenue Regul ati ons No. 1-95, as amended , explicitl y c:-;c ludcd as allo w;111le deduction !'rom gross income " insurancc c:-; pcnsc" other tk111 those incurrcd i11 the importati on o f goods. 7. With respect to the ta x credit claim ed by Petiti oner, suffi ce it to say that it is totall y unsupported by documents or other ev idence. X. The assessment was iss ued in <lccordan cc with la w and rcgulatio11 S. 1 0S0

DEC ISION- CTA CASE NO. 5993 PAGE6 9. All presum ptio ns arc in l~tvo r or the correctness or tax assess ments." The issues that co me to lore lor the co nsiderat ion o r the Co urt, as stated in the Joi nt -. Stipulati on of f acts and Issues submitted to the Court by the parti es on April 19, 2000 (p. 63, docket) arc as ta ll ows: " I. Whether or not l'ctiti o11er, as required under Section 22X o r the Tax Code, has been inlo rmed in writing o r the law and the f~1 c ts on whi ch the assess ment was made; 2. Whether or not the amount Petiti oner claimed as reim bursements lo r alleged actual costs incurred in the perfo rmance of obli gati ons under the 0 & M Agreements with Subic Power Co rporati on and Batangas Power Co rporation, is part of Peti tioner's gross income; 3. Whether or not the restorati on costs or power pl ants claim ed by Petiti oner as costs o r sale in the amount or I' 15, I 16,447 .00 arc ded uctible expenses; 4. Whether or not the in surance claimed by Peti tioner in the amount of P1,865,670.00 is ded ucti ble li�01n F::titioncr's gross income earned; and 5. Whether or not there is basis fo r Petitio ner's cla im fo r tax cred it in the amount of P 141 ,896.00." It seemed to the Court that there was no compli ance on the part of Respo ndent of Section 228 of the Tax Code and Section 3. 1.4 of Revenue Regul ations No. 12-99. The said prov ision of law and regul ati on clearl y provides that: "Sec. 228 . Protesting ofAssessment.- When the Co mmi ssioner or hi s dul y authorized representative fi nds that proper taxes shoul d be assessed, he shall first noti fy the taxpaye r of his fi ndi ngs: Provided, huwever, That a pre-assess ment noti ce shall not be required in the fo ll owing cases. (a) When the finding Jo r any dc lic icncy tax is th e result or mathematical error in the computation of the tax as appeari ng on the face of the return ; or

DECISION- When a discrepancy has been determined between the tax CT/\ C/\S I: NO. 59t>J withheld and the amount actually remitted by the PAGL 7 withholding agent, or (b) (c) When the taxpayer who opted to claim a refund or ta~. credit of excess creditable withholding tax for a taxable period was clctcrmincd to have carried over ancl automatically appl icd the same amount claimed against the estimated tax liabilities for the ta xa ble quarter or quarters of the succeeding taxable year; or (d) When the excise tax due on excisable articles has not been paid; or (c) When an article locally purchased or imported by an exempt person, 'such as, but not limited to, vehicles, capital equipment, machineries and spa �e parts, has been sold, traded or transferred to non-exempt persons. The taxpayer shall be informed in writing of the law and the facts on which the assessment is made; otherwise, the assess ment shall be void. (emphasis supplied). XXX XXX XXX '� HEVENUE REGULATIONS NO. 12-99 "Sec. J.1.4 Formal I ,dlt'l' of Demand and Asst�ssmcnl Nolicc. The formal letter of demand and assessment notice shall be issued by the Commissioner or his duly authorized represe ntati ve. The letter of demand calling for payment of the taxpayer 's dcliciency tax or taxes shall state the facts, the law, rules and regulations, or jurisprudence on which the assess ment is based, otherwise, the formal letter 01. demand and assessment notice shall be void. The same shall be sent to the taxpayer only by registered mail or by personal delivery. If sent by personal delivery, the taxpayer or his duly authorized representative shall acknowledge receipt thereof' in the duplicate copy or� the letter or dem;tttd. showing the l(lllowin g: (a) !lis name ; (b) signature; (c) designation and authority to act fur and in behalf of the taxpayer, if acknow ledged received by a person other than the taxpayer himself, and (d) date of receipt thereof. " (underlining supplied)

DEC ISION- CTA CA SE NO. 5993 PA GES T he law is clear and unambi guous. The Respond ent is mand ated to inform and di sc lose to th e tax pa ye r i11 w ritin g th e f~1du a l nature <llld th e legal bas is o r th e assess men t. Failure to compl y w ith th e sam e w ill re nder the assess me nt null and void . In the case at ba r, Responde nt mere ly iss ued a fo rmal assessment and indi cated there in th e supposed tax, s urcharge, interest and compromi se pena lty d ue the reo n. The Reve nu e Offi ce rs o f' the Respondent in th e iss uance o r the Fina l Assess ment No ti ce di d not prov ide the Petiti oner w ith the written bases of th e law and fac ts on w hi ch th e subj ect assessm ent is based . Respond ent did not bother to ex pl ai n how it arrived at s uch an assessme nt. M oreso, he fa il ed to me nti on the specili e prov ision of the Tax Coue or rul es and regulations which were no t complied w ith by Peti tio ner. Stated othe rw ise, the Form a l Assess ment No ti ce (Ex hi bi t " /\" ) onl y itemi zed th e deducti ons di sa ll owed and inc luded th e same in th e gross inco me a nd imposed th e preferenti a l tax rate of 5% on so me items catego ri zed by Petiti oner as costs, w ithout prov iding th e fac ts and bas is in law of th e d isallowance and de fi ciency tax assessment. The Respondent's w itness himself, Mr. Edison del Agua, th e BIR Revenue Examiner who co ndu cted the examina ti on on the boo ks o f th e Pe titi o ner admitted that, he was not aware o f the SIR-issued regul ati on co ncernin g the manner o f issuing assessment noti ces or Reve nue Regul atio ns N o. 12-99, v iz : " Atty. Mo nte ro: Q. Mr. Witness, arc yo u awa re o r th e prov is ion of Reve nu e Regul a ti ons No. 12-99? Mr. Agua A. I am not ...

DI �:C' ISION - CT/\ ('t\SI �: NO . )lJlJ.\ I't\ (II �: lJ Atty. Montero: Q. On the manner or protesting assessment and issuance o r Assessment Notices, Mr. Witness? Mr. ;\gua: A. I have heard of that regul ation but I have not read the contents, Sir" (TSN of Mr. Edi so n del Agua, .January 9. 2001, p. 37) Thu s the FAN that was iss ued could not have compli ed with Re ve nue Regulati ons No. 12-99 as the Revenue Officer who iss ued the s211e was not even aware of th e applicable regulations. Moreover in the ease entitled Sun nyvale Development Corporation Y:; . Co mmissionu of Intemal Revenue, CTA Case No. 5730, January 4, 2001, the Comt ruled that: "x x x But it is required that ' the ta xpaye rs shall be info rmed in writing of" the law and the l~1cts on which the assess ment IS made, otherwise, the assessment shall be void'(Scc. 228) It is evident from the record in this case, that the assessment notice issued by the Respondent against Petitioner for deficiency donor's tax did not indicate how the tax base of P3,206,230.87 was arri ved at and why it was being subjected to donor's tax x x x. The accompanying demand letter also failed to state the law and the f~1c ts on which the assessment was based x x x. Hence. the same is void in accordance with Section 228 or the Tax Code, as amended ." It further ruled that: "It bears stressing that not only the assessment for deficiency donor's ta x is round to be void but the assessments for cleiici cncy income x x x. For the income tax assessment, the assessment notice did not indicate the reaso ns for disallowing the amounts of ded uctions pertaining to taxes and licenses, depreciation , association clues and mi scellaneous expense." (emphasis supplied)

DECISION- CT/\ CASE NO. 5993 PAG E 10 This Court likewise ruled in the case or Abbott Laboratories, In c. vs. Co mm iss ion er of Interna l Reve nu e CTA Case No. 5718, February 16,2001 that:� "Section 22S or the 1997 Tax Code in part provid es thus: ' The taxpayers shall be informed in writin g of the laws and the facts on which the assessment is made, otherwise, th e assessment shall be void.' Clearly, Section 228 of the Nationa l Internal Revenu e Code requtres the respondent to inform the taxpayer in w riting of the law and th e fact s on which the assessment is made; otherwise the assessment shall be void. As thu s worded, the res pondent has the bounden duty to inform th e taxpa ye r not only of the law but more importantly, th e surro unding circumstances supporting the assess ment, lor it is onl y throu gh a detailed appraisal o f its basi s that the taxpa ye r ma y be able to di spute the impos iti o n o r agree w ith it. " Thus, the Court find s that the Final Assessment Notice (Exhibit "A") and demand letter sent to Petitioner, do not meet th e requirements of a written notice provided under Section 228 of the Tax Code, as amended, and the requirements of th e form prescribed in Annex "8" ofRevcnue Regulations No. 12-99 . Consequently, the assessment against the Petitioner should be considered void as ex plicitl y pro vided for in Section 22S of the Tax Code, as amended, and Section 3.1.4 of Rev enue Regul ations No. 12-99. Having thus held that the subject assessment iss ued by Res pond e nt against Petitioner null and void, the Co urt find s it unnecessary to del ve into, and pass upo n, th e other issues presented by the parties. I N T H E LI GHT OF ALL T H E FO R EGO ING , the instant Pet ition for Rev iew is hereby G R ANTED. Accordingly, the assessment iss ued by the Respondent aga inst the Petitioner for the year 1996, particularl y Formal Assessment Notice No. 019-44-96-

DEC ISION - CTA CA SE NO . 5993 PA GE II 0000371 dated May 12, 1999 lo r dcli ciency inco me tax amounting to P 2,8 ~W,8 17 .25 i:1 hereby ORDERED CANCELLED and WITHDRAWN. SO ORDERED. I CONCUR: L~ LS(~ o~ ERNESTO D. ACOSTA Pres idin g Jud ge CERTIFICATION I hereby ce rtify that the above decision was reached after du e co nsultati on with the members of the Co urt o r Tax Appeals in acco rdance with Secti on 13, Article Vlll of the Constituti on. ~�- G>. ~~ ERNESTO D. ACOSTA Pres iding Judge