CTA Case No. 4328 (Decision)

REPUBLIC OF TilE PIIILIPPINES COURT OF TAX APPEALS QUEZON CITY BPI LEASING CORPORATION,. CTA CASE NO. 4328 (Yor�erly Makati Leasing Finance Corp.) �::;: P1..o�11.�l gated: JUN Z2 1995 Petit i one1~; COMMISSIONER OF INTERNAL REVENJE, Respondent. )C - - - - - - - - - - - - - - - - - - - - )C DECISION This case involves a disputed assessment issued by the respondent against petitioner for alleged deficiency inco�e and documentary stamp ta>e for the ta>eable �years 1977 and 1978, detailed as follows: Deficiency income ta>e assessaent P2,GG9,339.43 Deficiency documentary 394.147.28 staap ta>e assessment P3,063,486.71 TOTAL Deficiency income ta>e assessment P1,793,810.34 Deficiency documentary 372.352.55 staap ta>e assess�ent P2,1661 162.89 TOTAL P5,229,649.60 AMOUNT STILL DUE AND COLLECTIBLE 86b

DECISION - C.T.A. CASE NO. 4328 - 2- Petitioner is a do�estic corporation organized and eMisting under ~he laws of the Philippines and was formerly known by its corporate name of Makati Leasing and Finance Corporation. It is primarily engaged in the leasing of various equip�ent to different kinds of clients and as such, it enters into lease agreements whereby clients pay a certain amount as rent for an agreed period of ti�e. The a�ount it receives from its various clients as a result of such lease agreements is reported as rental inco�e by the petitioner and a certain a�ount is deducted fro� its annual income corresponding to the depreciation of the leased equipment. In a 1etter, dated Apri 1 6, 1983, respondent assessed petitioner for deficiency and documentary stamp taM for the taMable years 1977 and 1978. This was protested by the petitioner in a letter dated May 2, 1983. Respondent on his part, modified the original assessment by merely reducing the ~ssessed but remained firm in the legal foundation upon substantial allt~unt .to be. paid by;the petitioner. As a last administrative recourse, petitioner filed a letter of reconsideration with respondent but this was denied by respondent in a letter, dated October 24, 1988, reiterating therein the amounts due and collectible. 866

DECISION - C.T.A. CASE NO. 4328 - 3- This letter of denial was received by the petitioner on 1988. Subsequently, petitioner sought the assistance of this Court through a petition for revi~w filed on January 25, 1989 praying for the cancellation of the assessments on the ground that they were issued without legal basis. The alleged taH deficiencies described in the assessment letters arose fro� two theories adopted by the eHaminer in the investigation she conducted on petitioner's taH liabilities for the years 1977 and 1978. The theory adopted with respect to the income taH liability of petitioner is that the so-called lease agreements entered into by petitioner with its clients are in reality install�ent sales hence a different taH implication ensues resulting in the deficiency. Quoted hereunder are some of the findings of the revenue eHaminer with respect to the income taH liability of the petitioner. Details of Leasing Activities When a client-lessee needs a particula~ kind of equipment, it goes to the lessor <Makati Leasing and Financing Co.) and the latter acquires the equip�ent desired. A lease agreement is then eHecuted <a sample of the� agreement form is hereto attached). The terms and conditions in the lease contract contain certain terms and conditions which make it entirely different fro� the ordinary contract of lease, so�e of which are.as follows: Bbl

DECISION - C.T.A. CASE NO. 4328 - 4- )()()I )()()( )()()( In form, the transaction is no doubt a lease but in substance, it is one of installment sales. It is well settled that in a conflict between form and substance, the former must necessarily yield to the latter. As regards the documentary stamp ta>e liability of the petitioner, respondent's examiners adopted the theory that the non-negotiable promissory notes executed by petitioner as "certificates of indebtedness" hence, subject to docu�entary ~ta�p tax. The two basic issues that confront this Court in the instant case are the following: 1> Whether or not the lease contracts entered into by petitioner BPI Leasing Corporation are in reality, install�ent sales, thus covered by Section 43 of the Tax Code; 2> Whether or not the non-negotiable promissory notes are to be considered as investment securities or certificates of indebtedness, hence, subject to documentary stamp tax. Pet~tioner disagrees with the respondent's findings ,�' ~ �: . :. ~ ' ' . and maintains that the lease agreements cannot be treated as installment sales and in support of this contention, offered as evidence a specimen or a sa�ple of a "Lease Agreement" ent el~ed into by petitioner to show that the provisions therein prove that these ar~ genuine leases 86b

DECISION - C.T.A. CASE NO. 4328 - 5- and not installment sales <Exhibit "D">. The findings of the examiner however, pointed to several provisions of the lease agreements which bolstered the theory that such agreements are, in substance and purpose, contracts of sale payable in installments, such provision are quoted hereunder, thus: 1. Section 10 thereof i11pliedly grants to the lessee an option to acqui .~e the equipment upon expiration or termination of the lease by paying the " s t i pu1at ed loss value" agreed upon in the contl~act. 2. Section 11 thereof requires the lessee to pay the insurance on the equip11ent, unlike in ordinary lease where insurance is invariably paid by the owner of the leased property. 3. Section 12 thereof req\.ti l~es the lessee to pay taxes incident to the leased property. The revenue examiner also took notice of the fact that petitioner used two different methods in recording '~e lease transactions and computing the net income for ' . . i,. r..i~. o�~�.=.~�; ,. tax .~.,. -~ .�:.:�,, p urp os e�.. s . lt is the op*nion of the examiner ~-... ' .' . . .� j ~ .� �' � ,l )~tl!'i~ a~~~~lt~ -~~' , by !;hat there sho\.tld .. : � ' ,~ - ' � .� t�'-. :�_ . ' ~ ;. only be one method used for recording the transactions and computing the net income al~ising from these transactions in accordance with Section 37 of the Tax Code. This inconsistency in methods led the examiner to 888

DECISION - C.T.A. CASE NO. 4328 - 6- treat the lease agreements as installment sales as gleaned from her testimony, thus: Q. Madam Witness, you now testify that there is a difference in the method of accounting fol~ transactions under the bookkeeping or accounting books and for ta~ purpose? A. Yes. Q. Would you know if any method which the ta~payer should have used in recording for its transaction in the accounting books? A. The method being used or the � �ethod used then because 1 don't know the method used now, the method used at that time was the financing aet~od for recording the transactions in the books. But for ta~ation purposes, for computing the net income, the method used was the so-called operating therefore the aethods were not the same, one method was for accounting purposes another for ta~ation purposes. Q. Then what would be your basis for determining that for ta~ purposes should also be the financing meth~~-~~ that wo~ld be ~~m~tar to:~nWi~iiment sale~ ' 1 .beh ev/ ~~~ ~'it~~;� .f~~ ..rf?~ordin~ �� the�. t~lu1sa~ti~t1~; ~� ~r,t the �'books must also be the method that should have been used in computing the ta~able income. 1 think 1 remember that Section 38 then of the N1RC which is now Section 37 which, would 1 be allowed to read? JUDGE ACOSTA

DECISION - C.T.A. CASE NO. 4328 - 7- Yes. A. Under Section 38 then which is Section 37 now, the net income should be computed upon the basis of the taxpayer's annual accounting period in accordance with the �ethod of accounting regularly employed in keeping the books of such taxpayer. So the net income should have been computed in accordance with the method of accounting employed in keeping the books. So the method used was financing, so l thought that the method should have been used also for taxation purposes must be financing method. XXX XXX XX)( Q. Then in your opinion and your decision in conducting the examination, Madam Witness, how does this affect your procedure which you have adopted in the examination? A. Of course, this has so�e so-called We find persuasive effect although the main reason. actually why 1 adopted this installment sale method is because of the fact that for accounting purposes the method used was the so-called .�fin~pt~n~ '~~~9~ and as 1 �x~}~\ti~~ b~f~r�~ under the e a flna~�~ri~ �~~Hbd. the. entire aino~itit of :'thii ....~rec-ei valll i beind recorded. in tfttJ: �-~eat"' of the executi~ri;bt. th- � contract. And this is ~,:;y si ~i. i;l:w to the installment sale ll!~ttj~d �. �' � ' � A .o,o"'� that the lease agreements in question are genuine leases and not installment sales contrary to the theory of respondent. 871

DECISION - C.T.A. CASE NO. 4328 - 8- Thi~ issue has already been settled by the Court of Appeals in a case involving the same parties entitled Com�issioner of Internal Revenue vs. Makati Leasing and Finance Corp., et. al. (now known as BPI Lea!l.ing Corporation>, CA-GR SP No. 23578, November 25, l99Z which affirmed this Court's decision in the Case entitled Makati Leasing and Finance Corporation vs. Co��i&sion�r of Internal Revenue, CTA Case No. 3354, October 25 9 1990. The Court of Appeals junked the theory that these lease agreements are in reality installment sales wh�n it ruled, thus: After due consideration and evaluation of the facts and the applicable statutory provisions, We have found no sufficiently valid and convincing reasons warranting reversal or modification of the appealed judglllent. Firstly, the appellee was duly licensed to do business under R.A. No. 5980 and was inter alia engaged in the leasing of various types of equipments during the taxable year mentioned in the assessment. Conformably with the intent of 1:t"'e: Fo!1~-;-act.~!l~ p.:n~~~r,s, f1lJf?.s ag�~ee�ents were t!J\!. Pr'f,!PfWe�:f. 1n. tf.:t" fp.t"'ll!l of lease contracts ~~i~h ~~elle~ out. _the appellee's equipment bein~ l~p~ed, the l~ase period and the rentals to ~e p~'~ by the lessees. The basic features ~f a 1~~~~ are concedely pres~nt. -< '~ � ... ' .: ', I SecgbAly, the additional jp�~~~,for year ��J 1975 wa~ -~rrived at simply by ca~~j~diDg that the 1 eases were practically;:� . �: ~i es on installments" from the adopti~~ b~ ~~B~ii~e on the "financing method" of reporting/recording rental income instead of the so-called "operating method" generally used in the leasing b~Jsiness. Evidently, thp .~Pven>.1�1':' P><Rminer q.;n.��" ��ll?c:is:iv~ !"i!?:iQh~-; to thE fac�t th.~

DECISION -- C.T.R. CASE NO. 4320 - 9� - under the �financing �ethod" the "gross rentals rec~ivable... are recorded at the ti�e the lease contract is booked" Ce.g., in a lease for a ter� of 5 years, the rentals accruing and payable during that period are reported i��ediately upon eMecution of the contract as receivables -- si�ilarly, We take it, to the method used in install�ent sales>. Such approach ignored the basic features of a lease of equip�ent that would distinguish it fro� an install�ent sale. With regard to the contention of the respondent that there are provisions in these lease agree�ents that would point out to the fact that these are in reality contracts of sale, the aforementioned decision has this to say: Appellant has argued that the appellee~s lease agree�ents included "eHtraordinary terms� such as; section 10, granting the lease an �option" to acquire the leased equipment by paying the stipulated �Joss value", section 11, requiring the lessee to pay the insurance premiums due on the leased equipment; and section 12, with respect to the payment by the lessee of taMe~ incident to the lease, to support the conclusion that such leases were in substance install�ent sales. It would suffice to say that these, in Our view, are peripheral aspects that would not obliterate or destroy the essential nature of the lease agree�ents between appellee and its contracting parties. In the pm~chase of real property, for instance, it is now a practice for the owner-seller to ask the buyer to pay the capital gains taH due, but, it cannot be seriously contended that the transaction is no longer that of sale. The sa�e is true with respect to the payment of insurance premiums by a lessee of t~eal pt~opet~ty, if he is willing to assume that burden as part of the agree�ent. Those items in effect are added costs incident to the sale/lease. As to section 10, as pointed out by the appellee in its answer, the "option" pe�~tains to the owne�~-lesso�~ and not to the lessee. ~~ ,. ' ol0

�' DECISION - C.T.A. CASE NO. 4328 10 - Such provisions, We �ay add, fall well within the contracting parties' freedo� to agree on stipulations or terms as may be deemed convenient, so long as they are not contrary to law, mot~als, good customs, public ordet~ o.-� policy <Article 130&, Civil Code>. These can hardly affect the principal purpose and/or intent of the parties in the execution of the contt"act. The variance in the �ethods used by petitioner in recording the lease transactions and computing per~entage and income taxes was approved by the respondent himself in a letter, dated January 19, 197&, <Exhibit "F"> in response to petitioner's request <Exhibit "E"> to us� the financing method in recording its lease transactions in its books of accounts and retaining the use of the operating method in the co�putation of it! income and This letter approval is quot�d, thu�t Gentlemen: This has reference to your letter uf March 4, 1975 requesting for permission to ahange your accounting method in recording leasing transactions from the "operating method" of accounting for leases to the "financing" method. l n reply� . thereto, . ~ ~, �Oi'Ve the htmot~ to :infpr~~~��voii .. th.t.:� attt?�~~� v�~tifi~a~ion condueted by th'i~'' Offii8e; � th1~' Offi~�~�'tiiu;� it~hided to g..-i:lnt your aforesaid request on the condition that it shall take effect beginning the taxable y�ar 197&. Very truly yours, Deputy CONRADO P. DlAZ Revenue Commissioner of Internal <Exhibit "F" > 8?4

DECISION - C.T.A. CASE NO. 4328 - 11 - The second issue which presents to Us a question of whether or not non-negotiable promissory notes issued by the petitioner shall be considered as certificates of indebtedness subject to documentary sta�p taM is rendered stamp taM liability of the petitioner for the years 1977 and 1978 are covered by the compro�ise agree�ent into between BPI Leasing Corporation and the then Commissioner of Internal Revenue, Ml~. Jose U. Ong, dated July &, 1990 (EMhibit "H" >. This fact was admitted by respondent's witness, Mr. Lilian Hefti in her testimony given on September 28, 1993, thus: CROSS EXAMINATION BY ATTY. PADILLA Q. EKaminer Hefti, let us start with the simple ones. On the business taK, you assessed deficiency documentary taKes, right? A. Yes. Q. And your theory was that these non- negotiable promissory notes should be taKed as investment securities? A. Yes. '':.: Q. But you are aware of course that the Commissione�~ co111promised these? ~ ........ A. Yes, I am aware of that. Q. You are aware also that the taMpayer entered into a compromise settlement?

DECISION �� - 12 - C.T.A. CASE NO. 4320 A. Yes. A. Yes, as far as docy�entary sta�p taH is concernf!d. Q. So that finishes the business taM aspect of the case. A. As a matter of fact it is not only this company that entered into a compromise with respect to this issue. I think this i~ an industrial probleM, so th� entire industry entered into a compr~om i se. Q. Including the banks? A. Including the banks. <Underscoring supplied) the decision of the t~e~pondent Co�Missioner of Internal Revenue assessing petitioner BPI Leasing Corporation for deficiency income taM and documentary stamp taM for the years 1977 and l'J70 is hereby reversed, without pronouncement as to costs. :ORJ)E~D. PQ . . . ', �.. ~ �. ' ... ' 878

DECISION C.T.A. CASE NO. 4320 - 13 - WE CONCUR: GRUDA J\tdge CERT II:-:- ICAT ION I hereby cer~tif'y that this deci"ii.on wa~ r'eaehed after due con~ultation aMong the �e�bers of the Court of TaK Appeals in accordance with Section 13, Artcile VIII of the Constitution. ~.;. ~ lOL C'~ �.JN:SiTO D. ACOSTA l=~t~e~iding Judge ~o\lrt pf Tax Appeals 8'(~;