LEAR AUTOMOTIVE SERVICES (NETHERLANDS) B.V. - PHILIPPINE BRANCH v. COMMISSIONER OF INTERNAL REVENUE (consol with CTA Case No. 8561)

REPUBLIC OF THE PHILIPPINES COURT OF TAX APPEALS QUEZON CITY SECOND DIVISION LEAR AUTOMOTIVE SERVICES CTA CASE NOS. 8421 & (NETHERLANDS) B.V. - 8561 PHILIPPINE BRANCH, Petitioner, -versus- Members: Castaiieda,Jr., Chairperson Casanova, and Cotangco-Manalastas, JJ. COMMISSIONER OF INTERNAL Promulgated: REVENUE, MAY Z 1 Z015 Respondent. < ){- - - - - - - - - - - - - - - - - - - - - - - - - - -- - - - - - -~- - - - ){ DEC IS I 0 N f f:n- / ... COTANGCO-MANALASTAS,J.: In this consolidated case, Lear Automotive Services (Netherlands) B.V. -Philippine Branch seeks the reversal and setting aside of the decisions of the Commissioner of Internal Revenue dated December 21, 2011 and September 26, 2012 that found it liable to pay the respective amounts of P33,139,425.51 and P21,138,104.97, allegedly representing its deficiency income ta){es and penalties for ta){able years 2007 and 2008. FACTS Petitioner Lear Automotive Services (Netherlands) B.V. - Philippine Branch is a duly registered Philippine branch of Lear Automotive Services (Netherlands) B.V. (hereinafter referred to as "Lear"), a corporation organized and e~sting under the laws of the Netherlands and duly authorized to do business in the Philippines.! Petitioner is registered with the r Bureau of Internal Revenue (BIR), with Ta){ Identification No. 221-676-124-000.2 Its principal office in the Philippines is at 1 Exhibit "A", docket, p. 921. 2 Exhibit "B", docket, p. 923.

DECISION CTA Case Nos. 8421 and 8561 Mactan Export Processing Zone, 3rd Street, Mactan, Lapu- Lapu City.3 Petitioner is engaged in the business of manufacturing, assembling, processing, designing, exporting, buying and selling wholesale automotive wiring harnesses, electric wire assemblies, electric motors, electric switches, terminals and connectors, and other automotive assemblies and fittings. It is also engaged in warehousing and logistic service operations that include consolidating, storing, packaging, exporting, buying and selling automotive parts and components, and ensuring the suitable logistics requirements of its customers.4 As a Philippine Economic Zone Authority (PEZA)-registered enterprise, petitioner is entitled to the five percent (5%) special tax on gross income under Section 24 of Republic Act (RA) No. 7916, as amended by RA No. 8748 (PEZA Law, as amended). 5 Respondent Commissioner of Internal Revenue is the head of the Bureau of Internal Revenue, the government agency officially responsible for the assessment and collection of all national internal revenue taxes, fees and charges. She holds office at the BIR National Office Building, Diliman, Quezon City. Petitioner and Lear entered into an Intangibles Licensing Agreement6, whereby petitioner shall use the intangible property of Lear; which is required for the manufacturing and marketing of automotive wire harness products. As consideration, petitioner shall pay royalties to Lear.7 On April 6, 2005, petitioner, through Joaquin Cunanan & Co., sent a letter to the BIR to confirm whether the royalties paid by petitioner to Lear are deductible from the former's gross sales for purposes of computing its taxable Income subject to 5% tax under the PEZA law, as amended.8 In response, the BIR, through then Deputy Commissioner V Jose Mario C. Buiiag, held in BIR Ruling DA-147-2005 dated April 13, 2005, that: 3 Par. 1, Jointly Stipulated Facts, Joint Stipulation of Facts and Issues (JSFI), docket, p. 165. 4 Exhibits "A" and "A-1", docket, p. 921. 5 Exhibits "D" and "E", docket, pp. 927 and 929-930. 6 Exhibits "J" to "J-5", docket, pp. 1023-1034. 7 Exhibit "J-2", docket, p. 1025. 8 Exhibit "K", docket, pp. 1047-1052.

DECISION erA case Nos. 8421 and 8561 "Thus, the treatment of royalties depends on the consideration for which such fees were paid. When the royalties relate to a system or license, royalties are treated as general administrative expenses, which are not inventoriable costs. When, however, royalties are connected with a product design, logo, formula, or process, the payment is capitalized as part of inventories. Therefore, payments for royalties related to the transfer of technical information and manufacturing know-how should be considered as part of the cost of manufacturing the products. (BIR Ruling No. DA- 147-04 dated March 29, 2004; and DA-017-05 dated January 19, 2005). In view of the foregoing, this Office holds that the royalty payments made by LASN9 to Lear in consideration for the transfer of technology necessary for the continued production of LASN's products are part of the cost of finished goods and are deductible from gross sales for purposes of computing its taxable gross income subject to 5% tax under Republic Act No. 7916."10 CTA Case No. 8421 On August 14, 2008, by virtue of Letter of Authority (LOA) No. 200700007073 11 dated July 1, 2008, the BIR sent its First Notice12 to petitioner requesting the submission of petitioner's documents in relation to its investigation. Petitioner received a Notice of Informal Conference from the BIRon January 19, 2011.13 On March 24, 2011, the BIR sent a Preliminary Assessment Notice (PAN)14 to petitioner, finding it liable to pay deficiency income tax and value-added tax (VAT) in the total amount of P241 ,677,782.37. Subsequently, petitioner received a Final Assessment Notice1s (FAN) from the BIR on April 13, 2011, finding it liable for deficiency income tax and VAT for taxable year 2007 in the total amount of P241,677,782.37. Consequently, petitioner protested the FAN on May 11, 2011,16 ~ 9 Petitioner herein. 10 Exhibit "L", docket, pp. 885-887. 11 Exhibit "I", BIR Records, Folder I, p. I. 12 Exhibit "2", BIR Records, Folder I, p. 8. 13 Exhibit "3", BIR Records, Folder I, p. 429. 14 Exhibit "4", BIR Records, Folder I, pp. 759-763. 15 Exhibit "G", docket, pp. 959-965; Exhibit "5", BIR Records, Folder I, pp. 775-779. 16 Exhibit "H", docket, pp. 973-994.

DEOSION CfA case Nos. 8421 and 8561 On January 4, 2012, petitioner received the Final Decision on Disputed Assessment (FDDA)1 7 from the BIR, finding it liable only for deficiency income tax in the amount of P33,139,425.51 for taxable year 2007. As a consequence, petitioner filed a Petition for Review before this Court on February 1, 2012, later docketed as CTA Case No. 8421. In her Answerls filed on March 28, 2012, respondent raised the following special and affirmative defenses: "xxx XXX XXX 7.3.1 The costing of the inventories written-off were disallowed because it has no prior BIR approval nor request for a representative from the BIR was made in order to witness the actual write-off. In a claim for deduction from gross income on account of a taxpayer's destruction of its inventories due to obsolescence, there is a substantiation requirement to be satisfied. That is, the issuance by the BIR of a document that affirms the fact that the subject inventory was indeed destroyed. In the regular and legal course of things, the BIR is simply notified by the taxpayer and a representative is sent by the former on a specified date to witness and attest to the destruction of the inventory. The issuance by the BIR of this document is the only commonsensical requirement that effectively substantiates a claim that inventory was destroyed. Otherwise, the government would be left with no recourse but to accept a regime where taxpayers substantiate self-serving claims through their own records and their own interested witnesses. This attestation by the BIR is the substantiation required under Section 34 of the NIRC. Since there was no prior BIR approval nor was there a request for a BIR representative who would witness the actual write-off as part of the substantiation requirement provided by law, it is respectfully submitted that the cost of inventories written-off were not reliable and cannot be allowed as deduction from petitioner's gross income. Further, there was no clear and convincing evidence as to the costing of the inventories written-off that was presented for verification. 7.3.2 The Royalty Expense was likewise disallowed because Royalty fee is not an allowable item of deduction from gross income to be subjected to the 5% preferential tax rate. Moreso, Royalty fees do not fall within the definition of r 'cost' under the PEZA Law and Tax Code, being a consideration for the license of the property under an 17 Exhibit "1", docket, pp. 1017-1 019; Exhibit "7", BIR Records, Folder 1, pp. 1012-1014. 18 Docket (CTA Case No. 8421), pp. 95-107.

DECISION CfA Case Nos. 8421 and 8561 Intangibles Licensing Agreement, which should be treated as administrative expense for income tax purposes. Petitioner claimed as part of the costs of its finished goods royalty fees and it deducted said royalty fees from its taxable income on the basis of BIR Ruling DA-147-05. Respondent humbly submits that petitioner's reliance on BIR Ruling DA-147-05 has no legal basis as BIR Ruling DA-147- 05 issued to petitioner cannot be enforced for it has not only expanded, but likewise misapplied the PEZA Law and Revenue Regulations 11-2005 with respect to the deductibility of Royalties. It is to be noted that the basis for the issuance of BIR Ruling DA-147-05 was the Statement of Financial Accounting Standards (SFAS) No. 4, Summary of Generally Accepted Accounting Principles on Inventories. The cost of inventories or finished goods is defined in paragraph 4 of the SFAS, to wit: 'In general, cost is the price paid or consideration given to acquire an asset. As applied to inventories, it represents the direct and indirect expenditures for items purchased, produced or in the process of . production including the cost of production overhead. It constitutes the sum of the applicable expenditures and charges directly or indirectly incurred in bringing the inventory items to their existing condition and location.' Corollary thereto, paragraph 5 of the SFAS provided for the definition of production overhead which reads as follows: 'Production overhead should be included as part of inventory cost; it is composed of costs incurred for production other than direct materials and labor and includes both variable and fixed expenses. Examples are indirect materials and indirect labor, depreciation and maintenance of factory buildings and equipment, and the cost of factory management and administration.' It is noteworthy that the deduction of Royalties represents a loss of revenue to the government and must not rest on vague inference. Section 2, Rule XX of Republic Act 7916 (RA 7916, for brevity), as resonated in Revenue Regulations 11-2005, does not specifically allow Royalty fees as deductible. Rule 1 of RA 7916 provides for the definition of Gross Income as: 'Gross Income' for purposes of computing 0 the special tax due under Section 24 of the Act refers to gross sales or gross revenues derived

DECISION erA Case Nos. 8421 and 8561 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.' Consequently, Section 2, Rule 1 of the Rules and Regulations to Implement Republic Act No. 7916 (the PEZA Law), otherwise known as 'The Special Economic Zone Act of 1995' specifically enumerates the allowable deductions in computing the gross income subject to the preferential tax rate of 5%, thus: RULE XX Gross Income Taxation SECTION 1. xxx SECTION 2. Gross Income Earned; Allowable Deductions. - For purposes of these Rules, Gross Income earned shall be as defined in Section 2(nn), Rule 1 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 fuel 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 It is clear from the foregoing that nowhere in the provisions of the PEZA Law nor in Revenue Regulations No. 11-2005 that the Royalty fees are considered allowable deduction. xxx Worth stressing that any erroneous application and enforcement of tax laws (i.e., misapplication and erroneous expansion of PEZA Law and Revenue Regulations No. 11- 2005) by public officers does not preclude the subsequent correct application of such laws. Thus the Honorable V Supreme Court had the occasion to reiterate the legal principle that estoppel generally finds no application against

DECISION CTA Case Nos. 8421 and 8561 the State when it acts to rectify mistakes, errors, irregularities, or illegal acts, of its officials and agents, irrespective of rank. xxx XXX XXX XXX 10. Well-settled is the rule that tax assessments are entitled to the presumption of correctness and made in good faith. The taxpayer has the duty to prove otherwise. In the absence of proof of any irregularities in the performance of duties, an assessment duly made by a Bureau of Internal Revenue examiner, and approved by his superior officers will not be disturbed. All presumptions are in favor of the correctness of tax assessments (Sy Po vs. Court of Tax Appeals). Dereliction on the part of petitioner to satisfactorily overcome the presumption of regularity and correctness of the assessment will justify the judicial upholding of said assessment notices." CTA Case No. 8561 Petitioner likewise received two notices from the BIR, pursuant to Letter of Authority (LOA) No. 20090000752219 dated April 15, 2010, requesting the submission of petitioner's documents in relation to the BIR's examination of petitioner's books of accounts and other accounting records for all internal revenue taxes for taxable year 2008. On February 6, 2012, petitioner received a Preliminary Assessment Notice (PAN)20 from the BIR, informing it that it was found liable for deficiency taxes in the total amount of P1,691,740,832.09. Petitioner then contested the PAN on February 21, 2012 via letter dated February 20, 2012 addressed to the BIR Large Taxpayers District Office-Cebu. On May 2, 2012, petitioner received a Formal Letter of Demand from the BIR, finding it liable for deficiency taxes for taxable year 2008 in the total amount of P35,665,416.95.21 Petitioner then filed a protest letter on May 30, 2012.22 On September 27, 2012, petitioner received the FDDA23 y from the BIR, finding it liable for deficiency income tax, among other deficiency taxes, for taxable year 2008. After payment 19 Exhibit "R-9", BIR Records, Folder 2, p. 1. 20 BIR Records, Folder 2, pp. 602-606. 21 Par. 3, Petition for Review, docket (CTA Case No. 8561), p. 7; Exhibit "Q", docket, pp. 1120-1123. 22 Par. 4, Petition for Review, docket (CTA Case No. 8561), p. 7; Exhibit "R", docket, pp. 1130-1143. 23 Exhibit "S", docket, pp. 1144-1148.

DECISION CTA Case Nos. 8421 and 8561 by petitioner or cancellation by respondent of the other tax assessments, the deficiency tax assessment for taxable year 2008 was reduced to P21,138,104.97.24 Petitioner sought judicial redress by filing a Petition for Review before this Court on October 24, 2012, later docketed as CTA Case No. 8561. In her Answer2s for CTA Case No. 8561 filed on February 12, 2013, respondent argued, among others, that petitioner was properly apprised of its deficiency income tax liabilities, that BIR Ruling No. 014-2012 is applicable to the present case, and that the presumption under the law is in favor of the correctness of tax assessments. Consolidated Cases The assessments under CTA Case No. 8421 and CTA Case No. 8561 are as follows: For taxable year 2007 SQecial Rate Regylar Rate 1,759,234,964.00 3,164,792.00 Taxable Income per Return Add: Disallowance 54,058,006.00 311641792.00 32614351578.00 L 1 0 7 16 7 7 . 2 0 (1) Cost of Inventory Scrapped 2113917281548.00 108,094,104.60 1 0 6 19 8 6 A 2 7 . 4 0 (2) Royalty Expense 8910691426.54 53,884,727.26 19,024,678.06 Taxable Income per Investigation 3511841699.28 1411141747.45 33.139.425.51 Income Tax Due Thereon Special Rate 5% Regular Rate 35% Income Tax Due 1,036,143,325.00 1,523,161.00 Less: Tax Credits/Payments 25418021119.00 1,523,161.00 Payments 1,290,945,444.00 35% Share of other agencies Deficiency Income Tax 5% 533,106.35 Interest- 04/16/2008 to 12/31/2011 64,54 7,272.20 5331106.00 Deficiency Income Tax Due 5118071166.00 12,740,106.20 r0.35 For taxable year 2008 .23 813971998.77 0.58 Taxable Income per Return 21.138.104.97 Add: Disallowance Royalty Expense Taxable Income Rate Amount Due Paid per ITR Income Tax Due Add: Interest 4.14.2009-7.30.2012 Total Income Tax Due 24 Par. 5, Petition for Review, docket (CTA Case No. 8561), pp. 7-8. 25 Docket (CTA Case No. 8561), pp. 111-118.

DECISION erA case Nos. 8421 and 8561 In the Resolution dated February 21, 2013, this Court granted petitioner's motion to consolidate CTA Case No. 8421 with CTA Case No. 8561. During trial, petitioner presented Mr. Anthony C. Cheng26 - Finance Director of petitioner, Ms. Helena Agnes Valderama27 - professor at the Virata School of Business, University of the Philippines Diliman, and Mr. John Duncan28- Tax Manager of Lear from 200 1 to 2005 as its witnesses. Petitioner likewise made its Formal Offer of Evidence.29 In the Court's Resolution3o dated December 6, 2013, the Court admitted Exhibits "A" ' "C"-AD-eDpoepsiotsioitnio",n""' D"",A"-D1"-'De p"Bo"s i' t i o"nB"-, Deposition", "B-1", "C", "E", "E-Deposition", "F", "F-Deposition" - "F-12-Deposition (inclusive of submarkings)", "G", "G-Deposition" - "G-6- Deposition", "H", "H-Deposition" - "H-21-Deposition (inclusive of submarkings)", "1", "!-Deposition"- "1-2-Deposition", "J", "J- Deposition"- "J-11-Deposition (inclusive of submarkings)", "J- Duncan" - "J-Duncan-25 (inclusive of submarkings)", "K", "K- Deposition" - "K-2-Deposition", "L", "L-Deposition" - "L-2- Deposition (inclusive of submarkings)", "N", "N-Deposition", "0", "0-Deposition" "0-16-Deposition (inclusive of submarkings)", "P", "P-Deposition" - "P-10-Deposition", "P-1", "Q-Deposition" - "Q-9-Deposition", "R-Deposition" - "R-13- Deposition (inclusive of submarkings)", "S-Deposition", "S-5- Deposition", "T-Deposition" - "T-9-Deposition (inclusive of submarkings)", "U-Deposition"- "U-21-Deposition (inclusive of ""sGBubBGm-"5,a"r'"kHi"nHBgB"s,-)3"a-'nA"dY"'""'II"""C.YC-3"H1'o"w"' De"DvZe""r',- E""DZx-Dh5i-6b1"i"'t's"A""VEA-ED""-'ep""AoEsAiE-t4i-o"l"n' '""B-"FB"FV""--' 3-Deposition (inclusive of submarkings)", "W-Deposition" - "W- !-Deposition (inclusive of submarkings)", and "X-Deposition" (inclusive of submarkings)" were denied for failure of petitioner to show whether these pieces of evidence were originals, certified true copies or photocopies. On December 26, 2013, petitioner filed its Motion for Reconsideration (of the Resolution dated December 6, 2013).31{ 26 Minutes ofthe Hearing dated September 5, 2012, docket, p. 256. 27 Minutes of the Hearing dated September 4, 2013, docket, p. 875. 28 Minutes of the Hearing dated September 23, 2013, docket, p. 884. 29 Docket, pp. 902-920. 30 Docket, pp. 1420-1421. 31 Docket, pp. 1423-1434.

DECISION CTA case Nos. 8421 and 8561 In the Resolution32 dated February 19, 2014, the Court admitted Exhibits "V-Deposition" - "V-3-Deposition (inclusive of submarkings)", "W-Deposition" - "W-1-Deposition (inclusive of submarkings)", and "X-Deposition (inclusive of submarkings)". On the other hand, respondent presented Revenue Officers Ferly Ann B. Paez33 and Ms. Vivian F. Pollisco34 as witnesses. On April 4, 2014, respondent filed her Formal Offer of Exhibits (with Motion to Admit)35, and on May 23, 2014, the Court issued a Resolution admitting Exhibits "1" to "20". In the same Resolution, the Court ordered the parties to submit their respective memoranda. The case was submitted for decision on July 15, 2014,36 considering petitioner's Memorandum37 filed on July 10, 2014 and respondent's failure to file her memorandum. ISSUES The parties submitted the following issues38 for resolution of the Court: I. Whether prior BIR approval andI or the presence of a representative from the BIR is necessary before an inventory write-off could be made and claimed as deduction for income tax purposes. II. Whether BIR Ruling DA-147-2005 remains 1n effect and therefore whether it protects the petitioner from income tax liability arising from the V Royalty Fees paid by petitioner under the Intangibles Licensing Agreement. 32 Docket, pp. 1447-1448. 33 Minutes of the Hearing dated December 9, 2013, docket, p. 1422. 34 Minutes of the Hearing dated February 26,2014, docket, p. 1463. 35 Docket, pp. 1468-1482 36 Resolution dated July 15,2014, docket, p. 1546 37 Memorandum for the Petitioner, docket, pp. 1494-1544 38 Jointly Stipulated Issues, JSFI, docket, p. 167

DECISION CfA case Nos. 8421 and 8561 III. Assuming arguendo that BIR Ruling DA-147- 200S was revoked with the issuance of the Final Assessment Notice in 2011, whether it still operated with protective effect with respect to the income tax liability of petitioner for the years prior to such revocation, including for the year 2007, the taxable year subject of the assessment in this case. IV. Whether the Royalty Fees may be considered as part of cost of sales as an allowable deduction for purposes of computing the S 0lo gross income tax. v. Whether petitioner is liable for deficiency income tax for taxable year 2007 in the aggregate amount of Thirty-Three Million One Hundred Thirty- Nine Thousand Four Hundred Twenty-Five Pesos and S1/100 (P33,139,42S.S1) including penalties, surcharges and interest. There are two main issues to be resolved by the Court, namely: (1) whether petitioner's royalty fees to Lear may be considered as an allowable deduction for purposes of computing the So/o gross income tax; and (2) whether petitioner's inventory write-off could be claimed as a deduction for income tax purposes. DISCUSSION /RULING Whether petitioner's royalty fees to Lear may be considered as an allowable deduction for purposes of computing the 5�lo gross income tax Petitioner argues that it relied on BIR Ruling DA-147- 200S dated April 13, 200S, where it was held that the royalties paid are deductible from gross sales for purposes of computing its taxable gross income subject to S 0lo tax under the PEZA V Law, as amended. As such, it included its royalty payments to Lear as part of the cost of finished goods.

DECISION CfA Case Nos. 8421 and 8561 On the other hand, respondent contends that Section 2 of Rule XX of the Rules and Regulations to Implement the PEZA Law does not mention royalty fee as an allowable deduction and as such, it cannot be considered as an allowable deduction. The Court agrees with petitioner. Section 2 of Rule XX of the Rules and Regulations implementing Republic Act No. 7916 (the PEZA Law) provides: "RULE XX Gross Income Taxation XXX XXX XXX SECTION 2. Gross Income Earned; Allowable Deductions. - For purposes of these Rules, Gross Income earned shall 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" On February 15, 2005, the BIR issued Revenue Regulations (RR) No. 2-2005, the pertinent parts of which are quoted as follows: "SECTION 7. Gross income earned.- xxx For purposes of computing the total five percent (5%) tax rate imposed by Republic Act No. 7227, Republic Act No. 7903, Republic Act No. 7922 and Republic Act No. 7916, the V cost of sales or direct cost shall consist only of the following cost or expense items which shall be computed

DECISION CTA Case Nos. 8421 and 8561 in accordance with Generally Accepted Accounting Principles (GAAP) :" (Emphasis supplied) The BIR issued RR No. 11-2005 on April 25, 2005, removing the exclusivity of the items enumerated as direct costs under RR No. 2-2005, to wit: "For purposes of computing the total five percent (5%) tax rate imposed, the following direct costs are included in the allowable deductions to arrive at gross income earned for specific types of enterprises:" Section 2 of Rule XX of the PEZA Implementing Rules enumerates the allowable deductions for purposes of computing the 5�/o tax rate on gross income of PEZA-registered enterprises. It is noteworthy that the Rules did not limit, but merely enumerated the allowable deductions. Subsequently, RR No. 2-2005 limited the direct costs to the enumeration of allowable deductions therein. As it stands, RR No. 11-2005 removed the exclusivity of the allowable deductions from gross Income. In East Asia Utilities Corporation us. Commissioner of Internal Revenue39 , this Court discussed the PEZA Law, as amended, in relation to RR Nos. 2-2005 and 11-2005 vis-a-vis the allowable deductions, in this wise: "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 expenses that can be considered as direct costs. PEZA-registered enterprises may be allowed to deduct expenses which are in the 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 of direct cost is the direct relation of such item in the rendition of the PEZA-registered services. If the item of cost or expense can be directly attributed in providing the PEZA-registered services, then it should be treated as direct cost." Thus, there is no merit in respondent's argument that royalty fees are not considered as allowable deduction for purposes of computing the So/o tax on gross income of petitioner. Applying RR No. 11-2005 and the ruling of thisV 39 CTA Case No. 8179, May 21,2014

DECISION CTA Case Nos. 8421 and 8561 Court in the East Asia case, any item of cost or expense which is directly attributable to the rendition of the PEZA-registered services shall be treated as direct cost. Moreover, it should be noted that BIR Ruling DA-147- 2005 is binding upon respondent. In the case of Commissioner of Internal Revenue vs. Philippine Health Care Providers, Inc. 40, the Supreme Court explained the binding effect of a BIR Ruling, viz.: "In ABS-CBN Broadcasting Corp. v. Court of Tax Appeals, this Court held that under Section 246 of the 1997 Tax Code, the Commissioner of Internal Revenue is precluded from adopting a position contrary to one previously taken where injustice would result to the taxpayer. Hence, where an assessment for deficiency withholding income taxes was made, three years after a new BIR Circular reversed a previous one upon which the taxpayer had relied upon, such an assessment was prejudicial to the taxpayer. To rule otherwise, opined the Court, would be contrary to the tenets of good faith, equity, and fair play. This Court has consistently reaffirmed its ruling in ABS-CBN Broadcasting Corp. in the later cases of Commissioner of Internal Revenue v. Borroughs, Ltd., Commissioner of Internal Revenue v. Mega Gen. Mdsg. Corp., Commissioner of Internal Revenue v. Telefunken Semiconductor (Phils.) Inc., and Commissioner of Internal Revenue v. Court of Appeals. The rule is that the BIR rulings have no retroactive effect where a grossly unfair deal would result to the prejudice of the taxpayer, as in this case." Here, the BIR, through BIR Ruling DA-147-2005, confirmed that the royalties paid by petitioner to Lear are considered as deductions. Hence, respondent cannot adopt a position contrary to her position in BIR Ruling DA-147-2005 by the mere expediency of issuing a deficiency assessment. To allow this would cause undue prejudice to petitioner which merely relied in good faith on the subject Ruling. Considering the foregoing, the Court rules that petitioner's royalty payments to Lear should be considered as V an allowable deduction for purposes of computing the 5o/o tax on gross income. 40 G.R. No. 168129, April24, 2007.

DECISION CTA Case Nos. 8421 and 8561 Whether petitioner's inventory write-off could be claimed as a deduction for income tax purposes Petitioner sets up a prov1s1on for obsolescence with respect to inventories which were not sold for a period of time. Such inventories may be reworked or discarded if reworking is no longer feasible. When the inventories are discarded, petitioner writes off the costs of these inventories and claims them as deductions. Here, petitioner wrote off the costs of inventories amounting to P54,058,006.00 and claimed it as deductions. 41 Section 34(D)(1) of the National Internal Revenue Code (NIRC) of 1997, as amended, provides: "SEC. 34. Deductions from Gross Income. - xxx XXX XXX XXX (D) Losses. - (1) In General. - Losses actually sustained during the taxable year and not compensated for by insurance or other forms of indemnity shall be allowed as deductions: (a) If incurred in trade, profession or business; XXX XXX XXX (2) Proof of Loss. - In the case of a nonresident alien individual or foreign corporation, the losses deductible shall be those actually sustained during the year incurred in business, trade or exercise of a profession conducted within the Philippines, when such losses are not compensated for by insurance or other forms of indemnity. xxx" Based on the afore-quoted provision, an ordinary loss may be deducted from gross income, provided the following requisites are present: (1) the losses are actually sustained during the taxable year; (2) said losses are not compensated for by insurance or other forms of indemnity; and (3) they V must be incurred in the exercise of trade, profession or business. 41 Pars. 9 and 10, Petition for Review, docket, pp. 8-9.

DECISION CTA case Nos. 8421 and 8561 In the present case, petitioner failed to submit any evidence to prove any of the above-enumerated requisites for claiming ordinary loss as a deduction. Therefore, the Court is constrained to declare that petitioner's inventory write-off cannot be claimed as a deduction for income tax purposes. Consequently, petitioner is liable to pay basic deficiency income tax for taxable year 2007 in the amount of P2,702,899.16, computed as follows: Taxable Income per Return Special Rate Regular Rate Add: Disallowance P1,759,234,964.00 p 3,164,792.00 (1) Cost of Inventory Scrapped 54,058,006.00 3,164,792.00 1,813,292,970.00 1,107,677.20 (2) Royalty Expense 91,772,325.70 Taxable Income per Investigation 90,664,648.50 Income Tax Due Thereon 89,069,426.54 53,884,727.26 p 2.702.899.16 Income Tax Due 35,184,699.28 Less: Tax Credits/Payments Payments Share of other agencies Deficiency Income Tax WHEREFORE, premises considered, the instant Petition for Review is hereby PARTIALLY GRANTED. Accordingly, the deficiency income tax assessment for taxable year 2008 in the amount of P21,138,104.97 is hereby CANCELLED, while the deficiency income tax assessment for taxable year 2007 is hereby PARTIALLY UPHELD. Petitioner is ORDERED TO PAY basic deficiency 5% gross income tax for the year 2007 in the amount of THREE MILLION THREE HUNDRED SEVENTY-EIGHT THOUSAND SIX HUNDRED TWENTY- THREE AND 95/100 PESOS (P3,378,623.95), inclusive of the twenty-five percent (25o/o) surcharge imposed under Section 248(A)(3) of the NIRC of 1997, as amended, computed as follows: Basic Tax 25% Surcharge Total Deficiency Income Tn:x (5%) P2, 702,899.16 P675,724.79 P3,378,623.95 In addition, petitioner is ORDERED TO PAY: a. Deficiency interest at the rate of twenty percent (20�/o) per annum on the basic deficiency income tax of P2,702,899.16 computed from April 15, 2008 until full V payment thereof pursuant to Section 249(B) of the NIRC of 1997;and

DECISION CfA case Nos. 8421 and 8561 b. Delinquency interest at the rate of 20�/o per annum on the amount of the P3,378,623. 95, representing the basic deficiency income tax of P2,702,899.16 and 25o/o surcharge of P675,724.79, computed from January 4, 201242 until full payment thereof pursuant to Section 249(C)(3) of the NIRC of 1997, as amended. SO ORDERED. ~1- ~ ~./$-- AMELIA R. COTANGCO-MANALASTAS Associate Justice WE CONCUR: C ~~ - \r.J\2'.Vo..JFa-...-..eI (On Official Business) C. CASTANED , JR. CAESAR A. CASANOVA Associate Justice Associate Justice 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. (2..._~~C~/~. JUANITO c. CASTANEfSA, JR. Associate Justice Chairperson CERTIFICATION Pursuant to Article VIII, Section 13 of the Constitution and the Division Chairperson's Attestation, 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 Di � ion. Presiding Justice 42 Exhibit "1", docket, pp. 1017-1019; Exhibit "7", BIR Records, Folder 1, pp. 1012-1014.