CTA Case No. 3354 (Decision)

RIPUBLIC OP THI PRILIPPIMIB COURT OF TAX APPEALS QUIZOM CITY MAKATI LEASING AND FINANCE CORPORATION, Petitioner, - versus - C.T.A. CASE NO. 33S4 COMMISSIONER OF INTERNAL REVENUE, Respondent. >:- - - - -- -- --->: D E C:: I B I 0 N This is an appeal from the decision of respondent Commissioner of Internal Revenue assessing and demanding from petitioner deficiency income tax for the year 1975 in the amount of P1,311,066.12 computed as follows' Net inc:c:xne per retum ��������������� P2' 318' 605.48 Add: Add! tionl:\1 inc one-(F'er adoption of Financing Method Rather than Opera ting Method) ������� � ��������� 2 '6....'"'\J , 961 �9t1 Net inc:c:me per investigation �������� P4,956, 567.38 Ta>t dLte tter'"ecJrl ��������������������� 1,724,798.00 Less: Ta>t a 1ready assessed ��������� 001,512.00 Ba1ar1ce � � � � � � � � � � � � � � � � � � � � � � � � � � � � � 9:2.3 , ~ �(1() Add: 14% int. 'from 4/16/75-4/16/78 � 387,700.12 PI"[J_NT STILL DE AND IXLLECTIELE ���� P1,311 �~~~ and deficiency withholding taxes in the amount of P2,505.34. (�xh. D, p. 5 CTA rec.) From the assessment, on December 1, 1980, petitioner protested and moved for reconsideration 2 '10

DECISION CTA CASE NO. 3354 - 2- of the deficiency income t.:\): stating that "the_ lease ag.r_eemF'nts (Exhs, C .r C-1 G-4, p. 74, CTA rec.) i t has entered intq are p~re anp sim~ le~ses anc;i n.ot installment sales." (Exh. E, pp. 77- 80, CTA rec.) In the meantime, on March 4, 1975, petitioner wrote a letter to respondent Commissioner of Internal Revenue requesting that its books of account kept in accordance with the "operating" method of accounting for leases be changed to another accounting system ~mown as the "financing" method of accounting. (Exh. B-1, pp. 72-73, CTA rec,) The "operating" method of accounting, ">:>:>: the aqqregaj:.e renta..l s from leases are rec9rded -~�n.Q_repprt~d as income over the lives of the leases in amouots equivalef"!t to the provisions of the l.~a?.e contracts and deductions are tak~n from depreciation op the lea~ed equ!_pment_. __ The cost of the leas_~ ~gui_ pment is depreciated over the estimated LIS~ful___g_n a d_~c 1 ining balance basi~. "For ta>:ation purposes, percentage ta>:es are computed on the basis of the gross ren ta 1s due/earned during the ta>:able period. For income tax purposes, net income subject to ta>: is arrived at by ded~ctinq pperating costs (e.g. payroll, interest, percentage taxes and other business expenses, ~nd depreciation of leased equipment, etc. from the qro~~ r~ntal due/earned during the taxable period. (Exh. B-1, p. 72 CTA rec.

DECISION CTA CASE NO. 3354 - 3- "The company desires to change the system of recording its lease transactions in its books of accounts. This new system is known as "financing" method which we are using for internal reporting pLtrposes. Under this method, the gross rentals receivable, estimated market value of the leased equipment, and the estimated income are recorded at the time the lease contract is booked. The estimated income represents the excess of the gross rentals receivable and the terminal market value over the cost of equipment leased. This is recognized as earned over the term of the 1ease using the sum-of-the-months digits method. This procedure results in recognizing the estimated lease income as revenue in proportion to the declining receivable balance. The implementation of the new system shall involve the application of accounting concepts widely Ltsed in the industry and faci 1 i tate the prepara\tion of periodic reports and financial statements. The manner by whic_b. Qercentage ta>tes and il]_come ta>tes are _.J:uw. coro.P~t.ru.t._a.b.e_U_....... ~t:...........lii 11 be uodgr: j;,h~ "op~ratinq" m~thod as explained in the earlier portion of this letter- request. Iax~ise, therefor..g_,__no -~hange will be effected. In reply thereto, the Deputy Commissioner of Internal Revenue, on January 19, 1976 approved the request of petitioner "on condi t ..;!,on that i t shall take effect qeginninq the taxable year 1976." We quote hereunder the Deputy Commissioner's letter of January 19, 1976. Exh. B, p. 71, CTA rec.J

DECISION CTA CASE NO. 3354 - 4- In a letter dated May 29, 1981, (Exh, F, p, 81, CTA rec,) respondent denied petitioner's motion for reconsideration stating thus: REPUBLIKA NG PILIPINAS MINISTRI NG PANANALAPI KAWANIHAN NG RENTAS INTERNAS Lungsod ng Quezon May 29, 1981 Mr. Renate L. De la Fuente 7th Floor, Makati Stock Exchange Bldg. Ayala Avenue, Makati, Metro Manila Re: Makati Leasing & Finance Corp. 1975_Q_~f i,!: ienc;y income tax case Si r : In reply to your letter dated December 1, 1980 protesting our 197~ deficiency income tax assessment in the amount of P1,311,066.12 against your above-named client, please be informed that, after considering the issues raised therein and the records pertinent thereto, this Off ice regrets not being able to give due course to your protest. The lease agreement which yoLir client executes with a lessee- client is, in substance, an installment sale and not a contract of lease. Accordingly, it is hereby requested that you advise your client to settle the aforesaid assessment without further delay. This is our final decision and should you disagree, you may appeal to the Court of Ta>: Appeals within thirty (30) days from date of your receipt hereof; otherwise, this Office will take 2/ u

DECISION CTA CASE NO. 33~4 - 5- the necessary action to enforce the collection of the aforesaid assessment. Very truly yours, (SGD.) RUBEN B. ANCHETA Acting Commissioner Hence, petitioner appealed to this Co~rt. The only issue posed for our determin~tion is whethe~ or not respondent Commissioner of Internal Revenue erred in considering the lease contract as sales contract entered into by petitioner Makati Leasing and Finance Corporation, wherein it availed of 'depr_!'?ciation deductions in 1975 as installment sales. Respondent contends that petitioner's lease contract is, in substance Ci\nd purpose, an installment sale; hence, it is covered by Section 43 of the Tax Code as amended. It further claims in his Answer (p. 2 8, CTA rec.J that: "6. While petitioner maintained its books of accounts under the operating method, in its 1 inane ial statements, it used the financing method. Under the "operating method", the entire rent income is recorded as income and depreciation of the leased equipment is claimed as deduction therefrom. Under the "financing method" only a portion of the amount received is considered income and the rest is treated as part of the cost. Depreciation is not claimed as deduction, the equipment being considered sold under the installment basis; 2; t

DECISION CTA CAS~ NO. 33~4 - 6- "7. Some of the terms and conditions of petitioner's lease agreement are different from those of the ordinary contr act of lease, to wit: 1.) The lessee is r�equi red to pay the insurance premium on the equipment; 2.) The lessee, according to the agreement, is required to pay 11 i.\ll license fees, registration fees, assessment, charges and taxes imposed upon the owne rship � � �.� sale, possession or use of the equipment �.��� " "8. In determining the real the purpose, character of a contract, to it by the rather� than the name given parties, governs;" On the other hand, petitioner contends thti\t petitioner is 1icensed Ltnder the F inti\nce Company Act since October, 1974, and is engaged in the 1easing of equipment, barges, motor vehic 1es and other articles. It further contends that, as lessor, leases to a lessee, an equipment or article for an agreed period of time and rental, with the lessee being obligated to return to petitioner the leased equipment or article upon the termination of the lease contract. The distinction between a lease and a sale is clear in law. And We agree with petitioner when he said in his Petition for Review that - 2 '/o

DECISION CTA CASE NO. 33~4 - 7- ">: >: x. A lease is a contract whereby one of the parties (lessor) binds himself to give to another (lessee) the equipment or us e of a thing for a price certain and for a period (Art. 1463, Civil Code of the Philippines). On the other hand, a sale is a contract whereby one of the parties (seller) obligates himself to transfer ownership of and to deliver a determinate thing to another (buyer) who obligates himself to pay for the said thing a price certain in money or its equivalent (Art. 1438, Civil Code of the Phi 1ippines). In the former case, title remains with the lessee. "A contr.act is the law between the parties and it is what the parties so characterize it. The contracts in question do not even give the lessee an option to purc hase the leased equipment .and he is obl !gated to return the same upon the termination of the lease. "The contracts in qL~estion are all lease contracts, intended and so designated by both parties to be such contracts. "9. That the Bureau of Internal Revenue authorized petitioner to use the "operating method of accounting' for computing income taxes on petitioner's leasing activities. "10. That the Bureau of Internal Revenue will collect the same amount of income ta>:es under the operating method of accounting, wherein the taxpayer is allowed to deduct depreciation, as in the f inane ing method, wherein on 1y a portion � of the amount received by the taxpayer is considered income while the other portion . is tre.ated as p.art of cost or a return of capital." (pp. 2-3, CTA rec.) We are of the opinion and so hold that the

DECISION CTA CASE NO. 3334 - 8- petitioner is engaged in leasing properties. This intention can be gathered from the lease contracts and agreements entered into between petitioner Makati Leasing and Finance Corporation and the lessees Liwayway Marketing Corporation. <Exh. c, p. 74, CTA rec.) Petitioner Makati Leasing and Finance Corporation, in 1975 or at the time in question, is sti 11 under the "oper&\ting " method of accounting, @nd not under the ''financing" method of accounting, of which petitioner is granted to use only in the year 1976. Hence, for ">lXX income ta>t purposes, the net income subject to tax of petitioner (Makati Leasing and Finance Corporation) is arrived at by deducting operating costs >:xx and other business expenses, and d~preciation of leased eguipment 1 etc. from the gross rentals due/earned during the ta>:able period." <Exh. B- 1, p. 72, CTA rec.) The additional income of P2,637,981.90, for adopting the "financial" method of accounting, rather than the "operating" method in 1975, which was added to the net income of P2,318,605.48 by the Commissioner of Internal Revenue is therefore not in order. (Exh. F., p. 77, CTA rec.) And so also with the 14'l. int. from 4/16/75 4/16/78 in the 2b u

DECISION CTA CASE NO. 3354 - 9- amount of P387,780.12 <E xh. E, p. 77, CTA rec.) which is not imposable. From the assessment and demand from petitioner for payment of deficiency withholding taxes at source from the first, second and fourth quarters of 1975, amounting to P2,505.34, petitioner agrees to pay the same. <Exh. E, p. 77, CTA rec,) WHEREFORE, eMcept for the amount of P2,505.34 withholding taM for 1975 which petitioner is liable thereto, the assessment and demand for defici~tncy income taM of P1,311,066.12 for the year 1975 against petitioner is hereby annulled and withdrawn. Without pronouncement as to costs. SO ORDERED. Quezon City, Metro Manila, October ,5, 1990. Judge 2b.l

DECISION CTA CASE NO. 3354 - 10 - CHR.T:J:F:J:CAT:J:ON I hereby certify that this decision was reached after due consultation between the members of the Court of Ta x Appeals in accordance with Section 13 , Article VIII of the � ROAQUIN Judge Appeals 28~