MOOG CONTROLS CORPORATION- PHILIPPINE BRANCH v. COMMISSIONER OF INTERNAL REVENUE

REPUBLIC OF THE PHILIPPINES COURT OF TAX APPEALS QlJEZON CITY SECOND DIVISION MOOG CONTROLS CTA Case No. 9077 CORPORATION -PHILIPPINE BRANCH Petitioner, Members: -versus- CASTANEDA, JR., Chairperson CASANOVA, and COMMISSIONER OF MANAHAN, JJ. INTERNAL REVENUE, Respondent. Promulgated: r t= f)J ,._ )(- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - )( D ECISION M.t\NAHAN, J. : This involves a Petition for Review filed on June 23, 2015 by Moog Controls Corporation-Philippine Branch, as petitioner, against the Commissioner of Internal Revenue, as respondent, before the Court in Division. Petitioner seeks the �cancellation and withdrawal of the deficiency income ta)( assessment issued against it for fiscal year ended October 3 , 2009 in the total amount of Php12,206,739.18. THE PARTIES Petitioner is a foreign corporation organized and e)(isting under the laws of Ohio, United States of America. It has been licensed to do business as a branch here in the Philippines under Securities and E)(change Commission (SEC) License No . 1113 dated December 14, 1984. It is engaged in the manufacture, assembly of parts and components and assemblies of electro-hydraulic servo, electronic, pneumatic, oo-._..

DECISION CTA Case No. 9077 Page 2 of20 electric and hydraulic valves, controls, motors and other devices for use in aerospace and industrial applications. I It is also registered with the Philippine Economic Zone Authority (PEZA) with business address at Loakan Road, Baguio City, Philippines. Petitioner as a P-azA-registered export enterprise is entitled to the five percent: (5�/o) preferential tax regime on gross income earned pursuant to Republic Act (RA) No. 7916 (PEZA law), as implemented by Revenue Regulations (RR) No. 11-2005. Respondent is the duly appointed Commissioner of Internal Revenue (CIR) ~ested with the powers and duties, among others, to assess add collect all national internal revenue taxes and to decide, apprbve and grant tax protests. He holds office at the 5th floor, BIRI National Office Building, BIR Road, Diliman, Quezon City. :FACTS As stated in the Joint Stipulation of Facts and Issues (JSFI)2 filed with this Coutt on 11 December 2015, the factual antecedents are as follows:: "4. The BIR issued a( Final Assessment Notice (FAN) and Formal Letter of Demand3i (FLD), both dated August 15, 2014, which were received by pethioner's representative on August 18, 20 14, assessing petitioner! for alleged deficiency income tax for fiscal year (FY) ended Octpber 3, 2009 in the total amount of P12,206,739.18, inclusive of interest up to August 31,2014,4 computed as follows: Assessment No. ELTAD-II-IT-09-0020 Revenue per Income Tax Retu~n P3,428 320,610.00 Less: adjusted Cost of Goods Spld 3,209L377,272.46 Gross Profit 218 943 337.54 Add: Other Income 12,498 078.00 Total Gross Income 231_1_441,415.54 Multiply by tax rate 5% Gross income tax due 1tS72,070. 78 less: Gross income tax paid per, return share (2%) of other agency � 2,069,690.00 1 Joint Stipulation of Facts and Issue$ ("JSFI"), Court Docket, pp. 169-174. 2 JSFI, Court Docket, pp 291-299. � 3 Exhibit "P-S",Court Docket, pp. 21W223; Exhibit "R-5", BIR Records, pp. 306-310. 4 Par. 4, Summary of Admitted Facts, JSFI, Court docket, p. 170. ~

DECISION 3,104,535.00 5,174,225.00 CTA Case No. 9077 6,397 ,845. 78 Page 3 of20 5,808,893.40 per 1702Q I 1702 P12,206, 739.18 Income tax due Add: interest up to 8-31-20!14 Total deficiency income t;tx 5. In the Details of Discrepancies, the BIR stated that: Revenue Regulations 11-2005 was issued to implement the tax incentive provision Qf RA 7916 and Rule XX of the Rules & Regulations to lnp.plement RA 7916 (PEZA). The enumerated/listed allo}vable deductions, under Revenue Regulations 11-2005 anfi Rule XX of the Rules & Regulations to Implement RA 7916 (PEZA), are exclusive under the maxim expressio unius est exclt/tsio alterius, the mention of one thing implies the exclusion of $.nother thing not mentioned, as ruled in BIR Ruling No. 014i-12 dated January 4, 2012 of the Commissioner of Internl:l-1 Revenue. BIR Ruling No. 014-12 revoked all other existin~ rulings inconsistent thereto, hence the BIR Rulings you pre$ented were not considered.s 6. Based on the Details of Discrepancy, attached to the FLD dated August 15, �2014, the deficiency income tax assessment of P12,206,7J9.18, inclusive of interest, resulted from the disallowance by ~he BIR of the following reported cost of sales as deductions in Cjomputing the 5�/o income tax liability of petitioner for FY ended October 3, 2009, to wit: 6 Item of Expense Amount in USD 1. Repairs & Maintenance $1,861,447.00 2. Data ProcessitJ.g 673,186.00 3. Insurance 284,503.03 4. Outside Servi~es 141.29 Total $2,819,277.32 7. On September 12,2014, through R.G. Manabat & Co., petitioner duly filed its protest 7 dated September 11, 2014 against the FAN and FLD. & s Par. 5, Summary of Admitted Fact~, JSFI, Court Docket, pp. 170-171; Exhibit "P-5", Court Docket, p. 220; Exhibit "R-5"j, BIR Records, p. 309. 6 Par. 6, Summary of Admitted Facts, JSFI, docket, p. 171. 7 Exhibit "P-8", Court Docket, pp. 237-244. B Pars. 6 and 7, Summary of Admitteql Facts, JSFI, Court Docket, p. 171. ~~

DECISION CTA Case No. 9077 Page 4 of20 8. The BIR issuep a Final Decision on Disputed Assessment9 (FDDA) date~ June 5, 2015, denying petitioner's protest and supplemental:position papers against the deficiency income tax assessment fpr FY ended October 3, 2009 in the total amount ofP12,206,i39.18, inclusive of interest, for lack of factual and legal bases.1o 9. The last paragraph of the FDDA provides that: xxx This is our final dedsion. If you disagree, you may appeal this final decision to the Court of Tax Appeal (sic) or to the Commissioner of Internal Revenue through request for reconsideration within thirty (30) days from date of receipt hereof, otherwise our sEI.id deficiency income tax assessment shall become final, execptory and demandable. II 10. In denying the pwotest of petitioner, the BIR, through the FDDA, reiterated its position in the FAN and FLD, and ruled that: xxx The enumerated/listed allowable deductions, under Revenue Regulations No, 11-2005 and Rule XX of the Rules & Regulations to Implem~nt RA 7916 (PEZA), are exclusive under the maxim exprelssio unius est exclusio alterius, the mention of one thing irrjlplies the exclusion of another thing not mentioned, as rul~d in BIR Ruling No. 014-12 dated January 4, 2012 of the Commissioner of Internal Revenue. The BIR Ruling No. 014,.12 revoked all other existing rulings inconsistent thereto, hdnce the BIR Rulings you presented were not considered.l2 11. Petitioner's protest was denied based on: a. No BIR Ruling wa$ specifically requested nor issued by the BIR to petitior\ler and it cannot rely on the rulings issued to other taxpayers; b. Any deduction for, income tax purposes, by its nature, is equated to e~emption, hence construed strictly against the taxpay!er; 9 Exhibit "P-6", Court Docket, pp. 221l-227; Exhibit "R-7", BIR Records, pp. 415-418. 1o Par. 8, Summary of Admitted Fact~, JSFI, Court Docket, p. 171. llPar. 9, Summary of Admitted Fads, JSFI, Court Docket, pp. 171-172; Exhibit "P-6", Court Docket, p. 227; Exhibit "R-7~, BIR Records, p. 415. 12Par. 10, Summary of Admitted Fac~s, JSFI, Court Docket, p. 172; Exhibit "P-6", Court Docket, p. 224; Exhibit "R-7", BIR Records, p. 418. ~

DECISION CTA Case No. 9077 Page 5 of20 c. BIR Ruling No. l4-12 dated January 4, 2012, BIR Ruling No. 081-12'dated February 15,2012, BIR Ruling No. 112-12 dated, February 22, 2012, BIR Ruling No. 140-12 dated February 27, 2012 and BIR Ruling No. 194-13 dated May 21, 2013, all issued by the Commissioner of Ipternal Revenue, ruled that the list of allowable deductipns to arrive at the gross income earned subject to the 5o/o preferential rate is exclusive; d. BIR Ruling No. 141-12 dated January 4, 2012 was not considered in th~ CTA case of East Asia Utilities Corporation us. Commissioner ofInternal Revenue; and e. No retroactivity of ruling can be spoken of insofar as petitioner is conc~rned as there was no ruling issued specifically in its f$.vor on this issue.13 12. Respondent BIR maintains that the enumeration of allowable deductions und~r the PEZA Law and RR No. 11-2005 is exclusive. Hence, it denfed the foregoing direct costs claimed xx: by petitioner as they were not among those explicitly enumerated in Rule of the Implementing Rules and Regulations (IRR) of RA No;. 7916 and RR No. 11-2005.14 13. Through its a"4thorized representative, petitioner received respondent's FDDV\ on June 5, 2015."15 On September 21, 2p15, respondent filed his Answer 16 and interposed the followi:qg special and affirmative defenses: ~'PETITIONER CANNOT: RELY ON BIR RULINGS ISsutn UPON REQUEST BY OTHER T4"XPAYERS. 5. Petitioner, in ~he first instance, claims that it I may depend on previ<i>us BIR Rulings upon which it relied upon in good fafth. Let it be stressed however, that it (sic) not disJ!>uted that the aforesaid BIR 13 Par. 11, Summary of Admitted Fact~, JSFI, Court Docket, pp. 172-173; Exhibit "P-6", docket, p. 226; Exhibit "R-7", BIR R�cords, p. 416. 14 Par. 12, Summary of Admitted Fact$, JSFI, Court Docket, p. 173. 15 Par. 13, Summary of Admitted Fact$, JSFI, Court Docket, p. 173. 16 Court docket, pp. 94-98. ~

DECISION CTA Case No. 9077 Page 6 of20 Rulings mentioned il) the Petition, were not issued in its favor. 6. Clearly, petitioner is remiss from the foregoing argument.� It is an elementary rule that a taxpayer cannot rely pn BIR Rulings issued upon the request of other t8.XIpayers; logically, because said rulings were issued ,for the inquiring person's own guidance and clarificfi.tion as to the nature of tax and how it is applied to it, or its transactions. 7. Furthermore1 the foregoing BIR Rulings are not general intertpretative rules issued by respondent; to the cdntrary these are private rulings at the request of an ibquiring taxpayer. At the risk of being repetitive, re~pondent maintains petitioner cannot rely of (sic) ru[ings issued to other taxpayers. 8. Similarly, th~ doctrine of operative fact has no application in th~s case. In the Taganito Case cited by petitioner, "there must be a rule or ruling issued by the Comm~ssioner that is relied upon by the taxpayer in good faith." As previously discussed, it is beyond contestation that petitioner has no BIR Ruling issued in its favor, but instead, baselessly relied on another's IBIR Ruling. Accordingly, its argument, that BIR l~.uling No. 014-12 should only be applied prospectiv�ly, must fail. THE ENUMERATIQN OF ALLOWABLE DEDUC�0NS IN RULE XX OF THE IMPL MENTING RULES AND REGULATI NS OF RA NO. 7916 AND RR NQ. 11-2005 ARE (sic) EXCLUSIVE. 9. Tax exemptiolll.s are limited to those granted by law. 10. In the cast:i of Commissioner of Internal Revenue v. Isabela Cultural Corporation, G .R. No. 172231 dated Februarjy 12, 2007, the Supreme Court heldthat: ~

DECISION CTA Case No. 9077 Page 7 of20 "Corollarily~ it is the governing principle in taxation that tax exemptions must be construed in strictissimi juris against the taxpayer and liberally in favor qf the taxing authority; and one who claims an ex~mption must be able to justify the same by the clearest grant of organic or statute law. 11. Similarly, lin the case of Commissioner of Internal Revenue v. yulieta Ariete, G.R. No. 164152 dated January 21, qo10, citing CIR v. CA 338 Phil 322, 330 (1997), th~ Supreme Court also held that "the general rule of r~quiring adherence to the letter in construing stat).ltes applies with particular strictness to tax laws and provisions of a taxing act are not to be extend~d by implication." 12. In this case, petitioner seeks the inclusion of certain expenses fl.S allowable deductions under RR 11-2005 and Rule XX of the Rules and Regulations to Implement RA 7916. 13. However, it is clear from the foregoing law and regulation that the items sought to be allowed as deductions are not iqcluded therein, for purposes of computing its taxalJJe income subject to the 5�/o preferential tax rate. 14. In Commis!Sioner of Internal Revenue v. American Express International, Inc., G.R. No. 152609 dated June 29, 2005, the Supreme Court declared that, "thou~h vested with the power to interpret the provisiqns of the Tax Code, and not bound by predecessor's acts or rulings, the Bureau of Internal Revenue Commissioner may render a different construction to a statute only if the interpretation is in' congruence with the law. Otherwise, no amount of interpretation can ever revoke, repeal or modify what the law says." 15. Respondent's interpretation under BIR Ruling No. 014-12, di$allowing items not included in the enumeration und~r RR 11-2005 and Rule XX of the Rules and Regulations to Implement RA 7916, is consistent with the s~d law and regulation under the 0'~ __,

DECISION CTA Case No. 9077 Page 8 of20 principle of strict in~erpretation and Expressio Unius Est Exclusio Alteri11s. Accordingly, under her authority to revers~ and/ or modify its previous rulings, the present interpretation corrected (sic) prevented injustice tp the government. 16. At this juncture, it must be stressed that when assessments ajre assailed, the burden of proof is upon the complai:qing party. It is incumbent upon the complaining party to show that the assessment was erroneous, in order to relieve himself from it. 17. Failure to present proof of error in the assessment will justify judicial affirmation of said assessment (Delta Motors Co. vs. Commissioner, CTA Case No. 3782, 2 J May 1986; Commissioner of Internal Revenue vs. ~ourt ofAppeals, et al., G.R. Nos. 104151 and 105563, 10 March 1995). '' Thereafter, a Notice of Pre-Trial Conference17 was issued by the Court on Septemb�r 22, 20 15, setting the case for pre- trial conference on Octqber 15, 2015, but later reset to November 26, 2015 18 , upon respondent's motion 19 . Accordingly, petitioner's Prre-Trial Brief'2� was filed on October 7, 2015, while respondent's :Pre-Trial Brief'21 was filed on October 9, 2015. Pre-Trial Conference ensued. Thereafter, the parties submitted theirJSFJ22 on lDecember 18,2015. On January 19, 2016, the Court issued a Pre-Trial Order 23 approving and adopting the parties' joint $tipulations and terminating the pre- trial. During trial, petitioner presented its Finance Manager, Mr. Richard P. Villarico, as it& lone witness.24 Petitioner formally 17 Court Docket, pp. 100-101. 18 Order dated October 13, 2015, Co~rt Docket, p. 148. 19 Motion to Defer Pre-Trial Conference filed on October 9, 2015, Court docket, pp. 143- 145. 2o Court Docket, pp. 127-136. 21 Court Docket, pp. 137-145. 22 Court Docket, pp. 169-174. 23 Court Docket, pp. 182-185. 24 Minutes of the Hearing dated February 10, 2016, Court Docket, p. 201; Exhibit "P-11", Court Docket, pp. 105-113; Exhibit"P-12", Court Docket, pp. 190-194. ~

DECISION CTA Case No. 9077 Page 9 of20 offered Exhibits "P-1" to "P-12" ,25 which were all admitted in evidence, except for Exh~bit "P-4", in the Resolutions26 dated March 29, 2016 and Jun(t 1, 2016. On June 27, 2016, petitioner filed a Manifestation with Tender of Excluded Evidelllce27, which was noted by the Court in the Resolution28 dated f\.ugust 5, 2016. On the other�hand, n,espondent presented Revenue Officer Meliza C. Wepee as his l<t>ne witness. 29 Respondent formally offered Exhibits "R-1" to "R-8-1" ,3o which were all admitted in evidence in the Resolutiort31 dated December 2, 2016. This case was declar~d submitted for decision on January 12, 20 17, considering the filing of the petitioner's Memorandum 32 on Nov�mber 22, 2016 and respondent's Memorandum33 on Januaty 9, 2017.34 ISSUES The parties submit1ed the following issues 35 for this Court's disposition: 1. Whether the allow~ble deductions enumerated in Rule XX of the IRR of RiA No. 7916 and RR No. 11-2005 are exclusive. 2. Whether petitioner' is liable to pay the assessed amount ofP12,206,739.18 ~s deficiency income tax for FY ended October 3, 2009. 25 Formal Offer of Evidence filed on F�bruary 19, 2016, Court Docket, pp. 202-207. 26 Court Docket, pp. 260-261 and pp. 318-319, respectively. 27 Court Docket, pp. 320-325. 2s Court Docket, p. 338. 29 Minutes of the Hearing dated October 10, 2016, Court Docket, p. 349; Exhibit "R-8", Court Docket, pp. 152-158. 30 Formal Offer of Evidence filed on 0�tober 10, 2016; Court Docket, pp. 343-347. 31 Court Docket, pp. 373-374. 32 Court Docket, pp. 357-370. 33 Court Docket, pp. 375-382. 34 Court Docket, p. 384. 35 Submitted Issues for Trial, JSFI, Cqurt Docket, p. 173. ~

DECISION CTA Case No. 9077 Page lO of20 Petitioner's Arguments Petitioner posits the theory that the allowable deductions provided under RR No. 1 ~-2005 and Rule XX of the IRR of RA No. 7916 also known as the PEZA law are not exclusive but merely serve as a guide in determining the expenses which can be considered as direct c~sts that may deducted in computing the 5o/o Gross Income T~ (GIT) applicable to PEZA-registered enterprises. Petitioner further contends that the criterion in determining whether the ~tern should be considered as a direct cost is its direct relation t� the rendition of the PEZA-registered services, i.e., if the item. of cost or expense can be directly attributed in providing tlh.e PEZA-registered services, then it should be treated as d~rect cost and therefore deductible notwithstanding that it is not included in the list. It maintains that to rule for the exclus~vity of the list under RR 11-25 is to give a limited and narrow interpretation of the PEZA law and would defeat the very P1jlrpose of the incentives granted to PEZA-registered enterpris<es. In support of the alpove theory, petitioner relies on the decision of this Court in Di!Vision in the case of East Asia Utilities Corporation vs. CIR 36 where it ruled that the allowable deductions enumerated under RR No. 11-2005, as amended are not exclusive. Respondent's Counter-AJtguments Respondent belies th� theory of petitioner and asserts that the enumeration of allowaple deductions in Rule XX of the IRR of the PEZA law and RR Np. 11-2005 is exclusive. He points to the relevant provisions of the IRR of the PEZA law and RR 11- 2005 and contends that it is clear that the items sought to be allowed as deductions are not included therein for purposes of computing its taxable income subject to the 5o/o preferential tax rate. In addition, respond~nt insists that petitioner has not adduced substantial eviderlce to prove that the alleged items are indeed direct costs that are allowed to be deducted to arrive at 36 CTA Case No. 8179, May 21, 2014, ~

DECISION CTA Case No. 9077 Page 11 of20 the gross income earned on which the 5�/o preferential tax rate shall be imposed. RUL!NG OF THE COURT We agree with the petitioner that the enumeration of the allowable deductions und�r RR No. 11-2005 and Rule XX of the IRR of the PEZA Law is not exclusive. To support this conclusion, an analytical glimpse of the history of the PEZA law and its IRR relative to ~he allowable deductions for PEZA registered enterprises is instructive. The PEZA law (RA Nq. 7916) and later amended by RA No. 8748 was enacted with the! objective of enticing foreign investors to put up businesses in tlhe Philippines. Foremost among the incentives under the PEZA! law are the Income Tax Holiday (ITH) granted for a duration of three (3) to (6) years subject to certain conditions and the five pe!rcent (So/o) preferential gross income tax (GIT) rate, in lieu of aV national and local taxes, upon the expiration of the ITH. Gross income is defined in Section 2(nn) of Rule I of the IRR of the I!>EZA Law, as follows: SECTION 2. Definition ofTerms.- xxx XXX XXX XXX nn. "Gross Incomf!" for purposes of computing the special tax due under S~ction 24 of the Act refers to gross sales or gross revenues qerived from business activity within the ECOZONE, net of $ales discounts, sales returns and allowances and minus copts of sales or direct costs but before any deduction is mad~ for administrative expenses or incidental losses during q. given taxable period. The allowable deductions from "gross income" are specifically enumerated under Section 2, Rule XX of these Rules. (underscoring supplied) Section 2 of Rule XX of the IRR of the PEZA Law enumerates the allowable qeductions: SECTION 2. Gro$s Income Earned; Allowable Deductions. - For purposes of these Rules, Gross Income Earned shall be defined iq Section 2(nn), Rule I of these Rules subject to the following aHowable deductions for specific types of enterprises:~

DECISION CTA Case No. 9077 Page 12 of20 1. ECOZONE ~xport Enterprises, Free Trade Enterprises and Domes~ic Market Enterprises Direct salaries, wages or labor expenses Production su~ervision salaries Raw materials used in the manufacture of products Goods in proce~s (intermediate goods) Finished goods Supplies and fl.jlels used in production Depreciation of machinery and equipment used in production, an~ buildings owned or constructed by an ECOZONE Enterprise Rent and utilitjy charges associated with building, equipment and: warehouses, or handling of goods Financing charf5es associated with fixed assets To implement the for~going provisions, the BIR issued RR No. 2-2005 on February 1p, 2005 which states: SECTION 7. Gross income earned.- xxx For purposes of c~mputing the total five percent (5%) tax rate imposed by Rep~blic Act No. 7227, Republic Act No. 7903, Republic Act No. 7922 and Republic Act No. 7916, the cost of sales or direct cos~ shall consist only ofthe following cost or expense items which shall be computed in accordance with Generally Accepted Acaounting Principles (GAAP): (italics ours) Subsequently, the albove prov1s1on was amended by RR No. 11-2005 in June 23, 2005, to read as follows: For purposes of c<t>mputing the total five percent (5%) tax rate imposed, the folfpwing direct costs are included in the allowable deductions to� arrive at gross income earned for specific types of enterpri$es: (italics ours) This Court had the occasion to interpret the foregoing difference in the wordings of the RR 2-2005 and the amendatory RR 11-2005 ~n the case of Commissioner of Internal Revenue vs. East Asia Utilities Corporation 37 , where the CTA En Bane ljlpheld the Court in Division's ruling38 in the following manner: 37 CTA EB No. 1207, February 3, 20lp. 38 Supra, note 36. ~

DECISION CTA Case No. 9077 Page 13 of20 "It is clear from the amendment made under RR No. 11- 05 that the list is not meant to be all-inclusive but merely enumerates the expens~s that can be considered as direct costs. PEZA-registered �nterprises may be allowed to deduct expenses which are in tpe nature of direct costs even though the same are not included in the list. The criteria in determining whether the item of cost or expense should be part <l>f direct cost is (sic) the direct relation of such item in the rendition of the PEZA-registered services. If the item of cost or efpense can be directly attributed in providing the PEZA-registered services, then it should be treated as direct cost." Again in Commissioner of Internal Revenue vs. Lear Automotive Services (Neth~rlands) B. V. - Philippine Branch39, the Court En Bane upheld the Court in Division's ruling that "Section 2 of Rule XX of the PEZA Implementing Rules enumerates the allowable qieductions for purposes of computing the 5�/o tax rate on gross iqcome of PEZA-registered enterprises. It is noteworthy that the Rules did not limit, but merely enumerated the allowable ~eductions. Subsequently, RR No. 2- 2005 limited the direct cqsts to the enumeration of allowable deductions therein. As it &tands, RR No. 11-2005 removed the exclusivity of the allowable deductions from gross income." In fine, the Court is of the position that RR 11-05 effectively amended the provisions of RR 02-05 where the words "consists only'' were delet~d and replaced with the words "the following direct costs are i)ncluded in the allowable deductions xxx". This suggests, a~ ruled by the Court in the two aforequoted decisions, tha~ the allowable deductions from gross income of PEZA-registered ~nterprises enumerated in the IRR of the PEZA Law and RR No. 2-2005, as amended by RR No. 11- 2005, are not exclusive. If a particular cost or expense is directly related to the PE~A-registered activity, then it should be treated as a direct cost includible in the allowable deductions from the gross income.4o In the instant case, tpe deficiency income tax arose from respondent's disallowance pf certain deductions claimed as part of petitioner's cost of sales in the amount of USD2,819,277.32, broken down as follows: 39 CTA EB No. 1346, June 2, 2016. 40 Lear Automotive Services (NetherlanCis) B. V. - Philippine Branch vs. Commissioner of Internal Revenue, CTA Case Nos. 84j21 & 8561, Resolution dated July 29, 2015.~

DECISION CTA Case No. 9077 Page 14 of20 Item of E'4pense Amount in USD 1. Repairs & M~intenance $1,861,44 7.00 2. Data Proces~ing 673,186.00 3. Insurance 284,503.03 4. Outside Services 141.29 Total $2,819,277.32 In the FLD /FDDA, respondent explains that the list of allowable deductions under RR No. 11-200S and Rule XX of the IRR of the PEZA Law, t(J> arrive at the gross income earned subject to the S 0lo GIT rate, is exclusive. Considering that petitioner's above-listed deductions are not included in the list of allowable deductions, then these deductions were disallowed from petitioner's claimed cost of sales resulting in a higher tax base for the So/o GIT rate. In support of the disallowance, respondent cited BIR Ruli1;1g No. 014-12 dated January 4, 2012, which ruled that the enumeration of allowable deductions under Section 2 of Rule XX of the PEZA IRR is exclusive. Based on the foregotng, the exhibits presented41 and the parties' stipulations42 , pt:jtitioner has established that it is a PEZA registered enterpris� and is entitled to the So/o preferential tax rate on its gross incorp.e earned pursuant to RA No. 7916, as amended. Having settled the legal aspect of this case, the Court shall determine whether the expenses (disallowed by respondent) and claimed as part of petition~r's cost of sales are indeed allowable deductions for the purpqse of computing the gross income subject to the S 0lo prefer�ntial tax rate. It is imperative to determine whether petitioner was able to prove that the disallowed deductions were directly incurred or are directly related to the manufacture and assembly of the registered products in order to debunk the allegations embodied in the subject assessments. To prove that the disallowed deductions claimed by petitioner are direct co~ts of its PEZA-registered activity, petitioner presented its witness, Mr. Richard P. Villarico, to testify on the nature of these costs and expenses, to wit: 41 Exhibits "P-2" and "P-3", Court Docket, pp. 215-216. 42 Pars. 1 and 2, Summary of Admitted Facts, JSFI, Court Docket, pp. 169-170.0�t

DECISION CTA Case No. 9077 Page 15 of20 16) Q: Can you disc4ss the nature of these allowable deductions? A: Repairs and Maintenance E"pense - This deduction represents the expenses incurred by MCC-Philinpine Branch in connection with the preservatipn of its specialized machinery and equipment, as well as its manufacturing plant used f<Dr its business operations in Baguio City. These machinery, equipment and manufact!Uring plant are solely used for the manufacturing and assembly of the specialized aidine parts produced by MCC- Philippine Branch. Data Process.ng Expense - This represents the allocated cparge to production incurred by MCC-PhilippiQ,e Branch in connection with its Moog Busine~s Systems ("MBS"), which is applied by the Moog-Group globally. The MBS is a mechani11 sm designed to monitor the process of pro4luction from the time the work commences frqm a small piece up to the time it is finally as~embled into an airplane part. The MBS records all information all throughout the process, including the source and lot numqer of the raw materials; the machine numQer, operation number, and the work station where they were done; and also the person whco performed the job, as well as the instructi01n given at that particular segment of the production process. The MBS ensures that in the event for instance of an airplane accident or mishap and the relevant authority of amy country is determining the cause of an ac�ident, MCC-Philippine Branch and/ or our Hefid Office will be able to trace, identify, and prrovide detailed information and records of each and every aircraft part that MCC-Philippin� Branch has produced, sold and incorporat�d in the aircraft. This ability to monitor in d~tail and the retention of these records and information for at least 10 years is mandatory and non-negotiable with our clients, especially considering that the~

DECISION CTA Case No. 9077 Page 16 of20 Philippine p\ant in Baguio manufactures highly speciallzed aircraft controls. Building IJlsurance Expense This represents in~urance expenses allocated by MCC-Philippine Branch to the portion of the building, madhinery and equipment devoted for the manufacture, assembly, and fabrication of parts and components for use in aerospace and industrial applications, which is the PEZJ\-registered activity of MCC- Philippine Branch. The portion of the insurance allocated to administrative function, or that portion of the insurance expense not pertaining to actual operation of MCC-Philippiqe Branch's PEZA registered activity was not claimed as deduction in computing MOC-Philippine Branch's 5% gross income earned. Outside Sen(ices - This represents the payments and fees made by MCC-Philippine Branch in contjlection with the procurement of the appropriate accreditation by the proper authorities (like the civil aeronautics/aviation board) before it is allowed to enter into any transactions with clients and customers. Needless to say, this deduction represents the costs incurred without which no transaction could be cons-qmmated and no sales could be generated by the Company.43 Records would show that aside from the above testimony of Mr. Villarico, petitioner presented a supplemental letter together with some supporting documents which was prepared and submitted by its exterpal auditor to the BIRon November 11, 2014.44 In this letter, petitioner, through its external auditor, attempts to convince the revenue officers that the above-mentioned items are all direct costs of petitioner in the pursuit of its PEZA-related activities. After a review of the statements contained in Exhibit "P-9" and supporting document~ attached thereto, we find that the D'" - 43 Exhibit "P-11 ", Court Docket, pp. 1019-110. 44 Exhibit "P-9, Court Docket, pp. 245-251.

DECISION CTA Case No. 9077 Page 17 of20 costs related to "Repairs q.nd Maintenance" should form part of its costs of sales in the determination of its taxable income subject to the 5�/o preferential tax rate on gross income earned. Suppletorily, Section 27 (A) of the 1997 NIRC, as amended, defines cost of goods manufactured or sold to include "all costs of production of finished goods, such as raw materials used, direct labor and manufacturing overhead, freight cost, insurance premiums and other costs incurred to bring the raw materials to the factory or' warehouse." Necessarily, from s1;1ch definition, the criteria used to determine whether the co$t or expense is part of the direct cost is its direct relation in the rendition of PEZA-registered services. If the item of cost or extpense can be directly attributed in providing the PEZA-regi$tered services, then it should be treated as direct cost. 45 We find that the costs of expense incurred for the repair and maintenance of petitioner's machinery and other equipment may be classified as direct cost. As to the other item~ claimed by petitioner, there was no evidence presented to establish the fact that these deductions are indeed direct costs. Consequently, without submitting documentary evidence to !support its claim, the Court cannot ascertain the nature of these deductions. It must be empha$ized that to be entitled to a tax deduction, the taxpayer must competently establish the factual and documentary bases df its claim.46 Deductions for income tax purposes partake of thle nature of tax exemptions; hence, if tax exemptions are strictlty construed, then deductions must also be strictly construed.47 Corollary to this rule is the principle that when a taxpayer clai~s a deduction, he must point to some specific provision of the ~tatute in which that deduction is authorized and must be al(:>le to prove that he is entitled to the deduction which the law atJows. 48 In sum, we provide below the computation of petitioner's basic deficiency income tax liability for FY ended October 3, 2009, taking into cons1ideration the evidence we have considered above, thus: 45 East Asia Utilities Corporation vs. Commissiloner of Internal Revenue, CTA Case No. 8179, May 21, 2014. 46 H. Tambunting Pawnshop, Inc. vs. dommissioner of Internal Revenue, G.R. No. 173373, July 29, 2013. 47 CommissionerofinternalRevenue V.$. General Foods, (Phils.)Inc., G.R. No. 143672, April 24, 2003. 48 H. Tambunting Pawnshop, Inc. vs. Commissioner of Internal Revenue, G.R. No. 173373, July 29, 2013. ~

DECISION CTA Case No. 9077 Page 18 of20 Revenue per Income Tax Return p 3 428 320,610.00 p 3,209 377,272.46 Less: Adjusted Cost of Goods Sold Add: Substantiated Amount tj>f Repairs and 359,512.00 3 209 736,784.46 Maintenance Expense (See Schedule 1 beloW) Gross Profit p 218 583 825.54 Add: Other Income 12 498,078.00 Total Gross Income p 231,081 903.54 ��- Multiply by tax rate . 5% Gross Income Tax Due p 11,554 095.18 Less: Gross Income Tax Paid per Return 2% Share of Other Aqency p 2,069 690.00 Per BIR Form 1702Q/1702 3,104 535.00 5,174 225.00 6,379 870.18 Basic Deficiency Income Tax p Schedule 1: Substantiated Amount qf Repairs and Maintenance Expense: Invoice i Amount Supplier Number Date (Net of VAT} Machinebanks' Corporation MESCO Inc. 112130 March 30, 2009 p 92 302.00 49 Nicklaus Machinery Corporation 177353 February 24 2009 264 860.00 50 3917 March 02, 2009 2 350.00 51 Total p 359,512.00 WHEREFORE, premises considered, the instant Petition for Review is hereby PAR'ltiALLY GRANTED. Accordingly, the deficiency income tax asse~sment for fiscal year ended October 3, 2009 is AFFIRMED WI!I'H MODIFICATIONS. Petitioner is ORDERED TO PAY the ~aunt of SEVEN MILLION NINE HUNDRED SEVENTY-FOXR THOUSAND EIGHT HUNDRED TRU~TY SEVEN PESOS ND SEVENTY-THREE CENTAVOS (P7,974,837. 73), inclusiv~ of the twenty-five percent (25%>) surcharge imposed under Section 248(A)(3) of the NIRC of 1997, as amended, computed as follows: Tax Type Basic tax 25% Surcharge Total Gross Income Tax (5%>) P6,379,870.18 P1,594,967.55 P7,974,837.73 " 9 Exhibit "P-9", Court Docket, p. 247. 50 Exhibit "P-9", Court Docket, p. 248. ~ 51 Exhibit "P-9", Court Docket, p. 249.

DECISION CTA Case No. 9077 Page 19 of20 In addition, petition�r is ORDERED TO PAY: (a) Deficiency interest at the rate of twenty percent (20o/o) per annum on the basic deficiency income tax computed from February 15, 2010 untiJ full payment thereof pursuant to Section 249(B) of the NIRC of 1997, as amended; and (b) Delinquency interest at the rate of 20o/o per annum on the total amount ofP7,974,837.73 and on the 20�/o deficiency interest which have accrued as afore-stated in (a), computed from June 8, 2015 unti~ full payment thereof pursuant to Section 249(C) of the NIRG of 1997, as amended. SO ORDERED. ~~7-~ CATHERINE T. MANAHAN Associate Justice WE CONCUR: CA~SANOVA Associate Justice ~f. &!,:'Aiin~JR. Associate Justice A'ltrESTATION I attest that the con�lusions in the above Decision were reached in consultation before the case was assigned to the writer of the opinion of the Court's Division. Jl~�-.4. e.~~~ , Q JlJANITO C. CASTANEifA,' JR. Associate Justice

DECISION CTA Case No. 9077 Page 20 of20 C~RTIFICATION Pursuant to Article VIII, Section 13 of the Constitution and the Division Chairperson'$ Attestation, it is hereby certified that the conclusions in the above Decision were reached in consultation before the cefise was assigned to the writer of the opinion of the Court's Division. Presiding Justice