COMMISSIONER OF INTERNAL REVENUE v. LANCASTER PHILIPPINES, INC.

.) REPUBLIC OF THE PHILIPPINES Cuurt l~[Tax Appeals QUEZON CITY ENBANC COMMISSIONER OF l NTERNAL C.'f.A. EB NO. 352 REVENUE, (C.T.A. CASE NO. 6753) Petitioner, Present: -versus- ACOSTA, Presiding Justice, CASTANEDA, JR., BAUTISTA, UY, CASANOVA, and PALANCA-ENRIQUEZ, JJ. LANCASTER PHlLlPPlNES, Promulgated: INC., Respondent. APR 3. 0 2008 4J.o!f?t'Y~~v~~ r /,\3?.:r ~ , X------------------------------------------------------------------------------------ X DECISION PALANCA-ENRIQUEZ, J.: THE CASE This is a Petition i~)r Review filed by the Commissioner of Internal Revenue (hereafter "petitioner") under Section 11 of RA 9282 {An Act Expanding the Jurisdiction of the Court of Tax Appeals), in relation to Rule 43 ofthe 1997 Rules ofCivil Procedure, as amended, which seeks to reverse and set aside the Decision dated September 12, 2007 granting the 453

C.T.A. EB NO. 352 2 (C.T.A. CASE NO. 6753) DECISION Petition for Review rendered by the First Division of this Court in C.T.A. Case No. 6753, the dispositive pm1ion of which reads as follows: "IN VIEW OF THE FOREGOING, the subject Petition for Review is hereby GRANTED. Accordingly, respondent is ORDERED to CANCEL and WITHDRAW the deficient.:y income tax assessment issued against petitioner under Formal Letter of Demand and Audit Result/ Assessment Notice No. LTAID II IT-98-00007 dated October 11, 2002, in the amount of P6,466,065.50, covering the fiscal year from April I, 1998 to March 31, 1999. SO ORDERED." The Commissioner of Internal Revenue's Motion for Reconsideration was denied by the First Division in its Resolution dated December 12, 2007, the dispositive portion of which reads as iollows: "WHEREli'ORE, finding no compelling reasons to justifiably amend or overturn this Court's Decision of September 12, 2007, respondent's "Motion for Reconsideration" is hereby DENIED for lack of merit. SO ORDERED." THE�FACTS The facts are not in dispute: Petitioner is the duly appointed Commissioner of Internal Revenue mandated by law and vested with the authority to administer, enforce and 454

C.T.A. EB NO. 352 3 (C.T.A. CASE NO. 6753) DECISION implement national internal revenue laws, as well as related statutes and their implementing rules and regulations. Respondent Lancaster Philippines, Inc., on the other hand, IS a corporation duly organized and existing under the laws of the Republic of the Philippines engageJ iu the production, processing and marketing of tobacco since 1963. It is a subsidiary of Lancaster Leaf Tobacco � Company of Lancaster, Pennsylvania, U.S.A. On September 1~, 2002, petitioner sent a Preliminary Assessment Notice (PAN) dated September 16, 2002 to respondent, demanding payment of its deficiem.:y income taxes in the amount of P6,466,065.50. On October 3, 2002, respondent filed its reply to the PAN, contending, among others, that for the past decades, it had utilized an entire tobacco-cropping season in determining its total purchases which .. covers a one (1) year period irom October up to September of the following year. Respondent further alleged that it has adopted the 6- month timing difference to conform to the matching concept and the said method has been installed as part of its system and it has been consistently applying the same in its accounting books. fJiJ 455

C.T.A. EB NO. 352 4 (C.T.A. CASE NO. 6753) DECISION On November 6, 2002, respondent received a Formal Letter of Demand and Audit Result/Assessment Notice LTAlD II IT-9S-00007, both dated October l 1, 2UU2, reiterating respondent's income tax liability ofP6,466,065.50 and demanding from respondent to pay the same. On December 2, 2002, respondent filed a formal protest, contesting the deficiency tax assessment made by the petitioner. Therealter, on January 27, 2003, respondent filed with the petitioner its "Supplemental Protest" together with the documents supporting its arguments. Due to petitioner's inaction to respondent's protest, on August 21, 2003, respondent filed a "Petition for Review" with this Court, docketed as C.T.A. Case No. 6753. In his Answer, Lhe Commissioner of Internal Revenue interposed the following special and atii.nnative defenses: "4. In the exantinalion of the books of accounts and peniuent documents of peLiLiouer, overslated purchases were added back to taxable income for purposes of computing the income tax due for the year. Though it was beiog contested by petitioner, alleging that pertinent Purchase lnvoice Vouchers of February and March I 998 should form part of its purchases, it was disallowed for being in violation of Seclion 43 of Lhe Tax Code which requires that the taxable income should be compuled upon the basis of Lhe taxpayer's annual accounting period (1iscal or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer. Furthennore, it did not comply 456

C.T.A. EB NO. 352 5 (C.T.A. CASE NO. 6753) DECISION with the generally accepted accounting principle of proper matching of cost and revenue. 5. Purchases of leaf tobac(;O fi�om traders were reflected in the Purchase Invoi(;e Vouchers (PlY's). LFS ac(;Qunts, on the other hand, are company-ftmdetl utlvauces to various farmers for the planting and harvesting of tobacco leaf lor the company. To tinance said advances, the company has an existing inter-company foreign currency denominated loau. Siw.;e no breakdown of monthly Cost of Sales transactions were provided and only an incomplete Tally Sheets listing of the fam1ers were madt available, the credits to LFS accounts were considered as the value of leaf tobacco purchased from various farmers. After evaluating the PlY schedules submitted and the credits to LFS accounts based on the General Ledger abstract, discrepancies were noted amounting to P 11,496,770.18 representing purchases lor the months of Feb~uary & March 1998. 6. The assessments were issued in accordance with the law and regulations. 7. All presumptions are in lavor of the correctness of tax assessments." On October 24, 2003, Lancaster Philippines, Inc. filed its Reply, maintaining that the posting of its Purchase Invoice Vouchers (PlY) as part of its purchases for the taxable year 1998, is in accordance with Section 43 ofthe Tax Code, as amended, and with the generally accepted j accounting principle of proper matching 6f cost and revenue. On September 12, 2007, the First Division rendered judgment in the terms earlier set forth. On October 2, 2007, the Commissioner of Internal Revenue petitioner filed a "Motion for Reconsideration."~ 457

C.T.A. EB NO. 352 6 (C.T.A. CASE NO. 6753) DECISION On November 14, 2007, an "Opposition to the Motion for Reconsideration" was 1i led by Lancaster Philippines, Inc. On November 22, 2007, the Commissioner of Internal Revenue filed a "Reply to the Petitioner's Opposition to Respondent's Motion for Reconsideration". In a Resolution dated December 12, 2007, the First Division denied the Commissioner of Internal Revenue's "Motion for Reconsideration" for lack of merit. Hence, this Petition For Review raising the sole: ISSUE WHETHER OR NOT RESPONDENT LANCASTER PHILIPPINES, INC. JS LIABLE FOR DEFICIENCY INCOME TAX ASSESSMENT IN THE AMOUNT OF P6,466,065.50 CUVElUNG THE FISCAL YEAR FROM APRIL 1, 199g TO MARCH 31, 1999. On January 24, 20t)l:'), without necessarily giving due course to the petition, We required respondent to file its comment, not a motion to dismiss, within ten (10) days from notice. On February 18, 2008, respondent filed its Comment. Hence, the petition is now deemed submitted for decision. f)lY 458

C.T.A. EB NO. 352 7 (C.T.A. CASE NO. 6753) DECISION TliE COURT EN BANC'S RULING The petition Is devutd uf merit. Petitioner CIR'S Arguments Petitioner mainlaim; that respondent is liable for deficiency income tax amounting to P6,466,065.50 for fiscal year April 1998 to March 1999; that respondent made an overstatement of purchases amounting to P11,496,770.18 for taxable year 1998, in violation of Sections 43 and 45 ofthe NIRC of 1997, as amended, in relation to Revenue Regulations No. 2; that respondent's application of the six-month timing di1lerem:e to conform to the matching of cost and revenue, in relation to its accounting method to determine its income, is without petitioner's approval; and petitioner's examiners did not exceed their authority in investigating respondent's taxable period not covered by the Letter of Authority. Respondent Lancaster Philippines, Inc.'s Counter-Argument Respondent counltr-argues that despite respondent's consistent use of the timing difference, petitioner did not issue any assessment for the 459

C.T.A. EB NO. 352 8 (C.T.A. CASE NO. 6753) DECISION previous fiscal years, nor assessment for the fiscal year following the fiscal year in questiou. Well settled is the rule that an audit process to which a particular taxpayer may be subjected begins when a Letter of Authority is issued by the Commissioner of Internal Revenue. The Letter of Authority is an official document that empowers a Revenue Officer to examine and scrutinize a taxpayer's books of accounts and other accounting records, in order to determine the taxpayer's correct internal revenue tax liabilities. In this regard, Revenue Audit Memorandum Order (RAMO) No.2- 95 provides that a Letter of Authority authorizes or empowers a designated revenue oJ1icer to examine, verify and scrutinize a taxpayer's books and records, in relation to intemal revenue tax liabilities for a particular period (RAMO 2-95, Vfll [C)) [b] fb.2}). In this case, the Leller of Authority No. 000012289, dated September 30, 1999, which was the basis of the BIR to examine respondent's books of account clearly stated that the examination covers only the taxable year 1998 (kxhibit "A"). The Letter of Authority reads as follows: 460

C.T.A. EB NO. 352 9 (C.T.A. CASE NO. 6753) DECISION "LElTER OF AUTHORITY SEP 30 1999 LANCASTER PHILS. INC. 11th Fir. Metro Uank Plaza Makati City SIRIMADAM/GEN'l 'LEMEN: The bearer(s) hereof RO's Irene Goze & Rosario Padilla to be supervised by G11 Catalina Leny Barrion of the Special Team created pursuant to RSO 770-99 is/are authorized to examine your books of at;counts aud other accounting records for all internal , revenue taxes tor the period ti-om taxable year, 1998 to ____, 19_. He is/ They are provided with the necessary identification card(s) which shall be presented to you upon request. It is requested that all facilities be extended to the Revenue Officer(s) in order to expedite the examination. You will be duly informed of the results of the examination upon approval of tlte report submitted by the aforementioned Rewnue Officer(s). Very truly yours, (SGD.) BEETHOVEN L. RUALO" In the Preliminary Assessment Notice issued by the Bureau of Internal Revenue on September 16, 2002, it is also clearly stated that the investigation is for the year 1998. Pertinent portion of the Preliminary Assessment Notice reads as follows: {UU 461

C.T.A. EB NO. 352 10 (C.T.A. CASE NO. 6753) DECISION "September 16, 2002 The President LANCASTER PHlLS., INC. 24/F Discovery C-.::ulrc, 23 ADU Ave., Ortigas Center, Pasig City Sir: Please be inionneJ that atier investigation of your income tax liabilities for year Jl)l)8 pursuant to Letter of Authority No. 12289 dated September 30, ll)lJ9, there has been found due from you, deficiency taxes as :,huwu htrtuuder. Assess1uent No. LTAID IllT-98-00007 INCOME TAX: -o- Taxable Income per ITR 11.496,770.1 K Add: Adjustments -Disallowed purchases P 11,496.770.1 K Adjusted Taxable Income per investigation P2, 913, 676.40 INCOME TAX DUE-Basic Aprili-December 31, IY91! 948,483.54 (9112 X Pli,4%,T70.1!! X 34'%) January 1-Man,;h 31, IY9lJ p 3,880,159.94 (3112 X p 11,496,770.18 X 33%) 2,560,905.56 25,000.00 Income tax still dut: per inv~.;stigation Interest (6/15/99 to 10/15/02) .66 p 6,466,065.50 Compromise Penalty TOTAL DEFICIENCY INCOME TAX DE'J'AII.S OF DISCREPANCIES Assessment No. LTAID II IT-98-00007 A. INCOME TAX (1'3,880,159.94)- Taxpayt:r's fiscal year covers April 1998 to March 1999. Vt:rili~.:ation of the books of accounts and pt:rlim:nt documents disclosed that there was an overstatement of the pun;hases tor the year. Purchase Invoice Vouchers (PIVs) for February and March 1998 �purchast:s amounting to P11,496,770.11! were included as part of purchases for taxable year 1998 in violation of Sec. 45 of the National Internal Revenue Code in relation Sec. 43 of the same and Revenue Regulations No.2 which stales that the Crop-Basis method of reporting income may bt: used by a farmer engaged in producing crops which take more than one (I) year from llu: time of planting to the timt: of gathering and disposing of fjAtf 4sz�

C.T.A. EB NO. 352 II (C.T.A. CASE NO. 6753) DECISION crop, in such a ca~c. the entire cost of producing the crop must be taken as deduction in llu; ycat iu which the gross income fi�om the crop is realized and that tlt~c: taxul>h: iucume should be computed upon the basi:; of taxpayer's annual accounting period, (liscal or calendar year, as the case may be) in ac.:ordance with the mtlhod of accounting regularly employed in keeping with the uuob uf taxpayer. Furthermore, it did not comply with the generally uccepted a.::wunting prin.:iple of proper matching of cost and revenue." XXX XXX." It is clear from the aforcquoted assessment notice, that the income tax due was computed on the basis of respondent's transactions/purchases made during the fiscal year April 1, 1998 to March 31, 1999, which is beyond the 1998 taxable year indicated in the Letter of Authority. Thus, the First Division aptly ruled: "Records reveal that respondent's alleged authority to examine petitioner's books of acwunts which eventually led to his issuance of an assessment of ddicicucy income taxes against petitioner was pursuant to the Letler of Authority (LOA) No.00012289 dated September 30, l~NlJ. The said LOA was issued giving the rcvtnue examiners of the J3urcau uf Internal Revenue the authority to exatuine the books of accounts of petitioner for the taxable year 1998. ln this case, given that pdilioner adopts a fiscal year which starts from April 1 and end March 31 the tollowing year, it follows then that the taxable year 1998 referred Lo in LOA is the fiscal year covering the period from April 1, 19l)'J to Man;h 31, 1998. To rule otherwise would effectively allow respondent to examine petitioner's books of accounts not only those covered lor the year 1998, but extends to those made during the year 1999. Hence, per LOA No.00012289, the revenue examiner's authority to investigate petitioner's books was limited only to its transactions covering the fiscal period from April 1, 1997 to March 31, 1998." 463

C.T.A. EB NO. 352 12 (C.T.A. CASE NO. 6753) DECISION Upon a careful review of the evidence on record, We concur with the above findings of the i"irst Division that the subject deficiency income tax assessment of P6,466,065.50 against herein respondent should be considered without force and dfect due to the fact that said deficiency assessment issued by p~,;LiLioner covered not only the taxable year 1998, but extended to taxable year 1999 which is beyond the period covered in the Letter of Authority. Petitioner's contention that respondent violated Sections 43 and 45 of the NJRC of 1997, as amended, and Revenue Regulations No. 2, when respoadent made an overstatement of its purchases for the fiscal year covered from April 1, 199g to March 31, 1999, by including purchases made for the months of February and March 1998 in the amount of Pll ,496,770.18, is likewise devoid of merit. Sections 43 and 45 of the NIRC of 1997, as amended, provide as follows: "SEC. 43. General Rule-The taxable income shall be computed upon the basis of the taxpayer's annual accounting period (fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; xxx" 464

C.T.A. EB NO. 352 13 (C.T.A. CASE NO. 6753) DECISION "SEC. 45. Period for which Deductions and Credits Taken- The deductions provided lor in this Title shall be taken for the taxabk year in which 'paid or accrut:d' or 'paid or incurred,' dependent upon the method of accounting upon the basis of which the net income is computed, unless in order to clearly reilect the income, the deductions should be taken as of ditll:rcnt period. xxx" A careful examination of the evidence on records clearly shows that there is no violation made by the respondent. First, the respomlenl JiJ not deviate from its original accounting period it employed in keeping its books, which in this case, is covered by the fiscal year. Second, respondent's usage of the crop year basis as its accounting method is in accordance with the law, as provided in Section 45 of Revenue Regulations No. 2, which provides as follows: "SEC. 45. Gross Income of Farmers- xxx If a tarmer is eugaged in producing crops which take more than a year from the. Lime of planting to the time of gathering and disposing, the income therelfom may be computed upon the crop basis; but in any such cases the entire cost of producing the crop must be taken as a deduction in the year in which the gross income from the crop is realized." Corollary thereto, Revenue A~(dit Memorandum 2-95 deJines the crop year basis accounting method as follows: "II. Accounting Methods 465

�_,.,, ) J C.T.A. EB NO. 352 14 (C.T.A. CASE NO. 6753) DECISION XXX XXX. F. Crop Year Uasis is a method applicable only for tarm~rs engaged in the production of aops which take more than a year from the time of planting to the process of gathering and disposal. Expenses paid or incurred are JeJuctiblt in the year the gross incomes ti�om the sale of the crops are n.:alizt.::d." Considering that respondent IS engaged in the production of tobacco, it applied the crup year basis in determining its total purchases for each fiscal year. Thus, respondent's total cost for the production of its crops, which includes its purchases, must be taken as a deduction in the year in which the gross income is� realized. Thus, We agree with the following ratiocination of the First Division: "Evident from the foregoing, the crop year basis is one unusual method of accounting wherein the entire cost of producing the crops (including purchases) Htu:st be taken as a deduction in the year in whid1 the gross income trow Lhc crop is reallzea. Since the petitioner's <.;rop year starts in October and ends in September of the following year, the same does not cuindde with petitioner's fiscal year which starts in April and ends in March of the following year. However, the law and regulations consider this peculiar situation and allows the costs to be taken up at the time the gross income from the crop is realized, as in the instant case." Respondent's fiscal period is from April 1, 1998 to March 31, 1999. On the other hand, its crop year is from October 1, 1997 to September 1, 1998. Accordingly, in applying the crop year method, all the purchases made by the respondent for October 1, 1997 to September ~ 466

C.T.A. EB NO. 352 15 (C.T.A. CASE NO. 6753) DECISION I, 1998 should be dedudeJ li'om the fiscal year ending March 31, 1999, since it is the time when the gross income from the crops is realized. As further explained by the First Division: "Clearly, for the fiscal period April!, 1998 to March 31, 1999, petitioner's corresponding crop year was trom October!, 1997 to September 1, 1998. ln this regard, all purchases made by the petitioner for the period cover from October 1, 1997 to September 1, 1998 related to the said crop year are then deductible in its fiscal year ending March 31, 1999. While the purchases in question were made during the months of February a11d March of 1998, the same is still considered deductible costs for the fiscal year ending March 31, 1999, in order to conform to the generally accepted accounting principles of matching of cost and revenue." For all the foregoing, We therefore conclude that the assessment in question is invalid. The Letter of Authority No. 000012289 which granted the revenue officer the right to audit the books of herein respondent, which resulted to the subject assessment, only authorized the revenue officer to investigate respondent's tax liabilities for the _year 1998. The overstated purchases made by respondent m the amount of P11,496,770.18, which resulted to the alleged tax deficiency of P6,466,065.50, should b~ deducted for the fiscal year ending March 31, 1999. Clearly, therefore, the subject assessment amounting to (}P 467

C.T.A. EB NO. 352 16 (C.T.A. CASE NO. 6753) DECISION P6,466,065.50 is clearly without factual and legal basis, for having been issued beyond the period (;Overed in the Letter of Authority. Finding no reversible error, We a11irm the assailed Decision dated September 12, 2007 and Resolution dated December 12, 2007 of the First Division. WHEREFORE, prenuses considered, the present PetiLion for Review is hereby DENIED DUE COURSE, and, accordingly DISMISSED for lack of merit. SO ORDERED. O' - LG-~nP-A L~A~N C~A &�~ ~ -ENRI QVEZ Associate Justice WE CONCUR: ~~~~ CL...v'--- ERNESTO D. ACOSTA Presiding Justice ~~C?.~~~~~ ~. Associate Justice <JuANITO C. CASTANED:K, JR. ~ Associate Justice CAESAR A. CASANOVA (On Official Business) Associate Justi(;e ERLINDA P. UY Associate Justice 468

CJT.A. EB NO. 352 17 (C.T.A. CASE NO. 6753) DECISION CER'I,IFICA TION Pursuant to Section 13, Article VIII of the Constitution, it is hereby certified that the above Decision has been reached in consultation with the members of the Cuun En Bane before the case was assigned to the writer of the opinion of the Court. !),~-~- o~ lfRNESTO D. ACOSTA Presiding Justice 469