CTA Case No. 2591 (Decision)

REP'OBt.tr. OF Till! PrlJLTl'PIN~ COURT OF TAX APPEALS O l' F.ZON CITY SM ITH KLINE & FRENCH OVERSEAS co. (Philippine Branch)~ Petitioner, .,.. versus - C . T.A. CASE NO . 2591 COMMISSIONER OF INTERNAL REVENUE, Respondent. X- - - - - - - - - - - - - - - X DEC I S I 0 N Suit brought by petitioner Smith Kline & French Overseas Co. � (Philippine Branch) _for recovery of the amoun t of ~32 4, 255.00 as alleged 1overpaid income tax for 1971 after no action was taken by respondent Commissioner of Internal Revenue on its claim for refund . As borne out by the pleadings submitted by the parties and records of the Bureau of Internal Revenue pertaining to this case, it appears that petitioner is a resident foreign corporation organized and exist- ing under the laws of the State of Delaware, U.S.A., and duly licensed to transact business in the Philippines. It is engaged in the importation, manufacture and sale of drugs, pharmaceuticals and chemicals. Petitioner is a Philippine br anch of a United States corporation bearing the same name , with home office in Philadelphia , SG

DECISION - CTA CASE NO. 2591 - 2- Pennsylvania, U.S .A. On April 17, 1972, petitioner filed its income tax return for taxable year 1971 declaring therein a net taxable income of Pl,489,277.00 and paid an income tax as reflected thereon in the amount of P5ll,246.80 (Exh. "A", p. 55, BIR records) as follows: OR No. ~ Amount 6000077 E 4-17-72 P255,623.50 6000798 E 8-14-72 9,947.20 Ta:x Debit Memo 8-ll-72 245,676.30 Ref. No. 00079 El5ll,247 .00 (Exhs. "B", "B-1" & "C", pp. 62-63, BIR records.) Among the deductions claimed by petitioner from gross income is the amount of p501,040.00, the equivalent of $77,060.00 which was certified by the Treasurer of the main office as its share in 1971 of the Philippine operations in home office unallocated over- head expenses, in accordance with the "service agree- ment" between petitioner and the head office. (Exh. "2", p. 65, BIR records.) Subsequently, petitioner amended its income tax return for 1971 reflecting thereon the sum of / Pl,427,484.00 ($219,547.00) as its share in home office unallocated overhead expenses, resulting in a reduced income tax liability of Pl86,992.00 and showing an verpayment of P324, 255.00. (E:xh. "D", pp . 7-9, BIR records .) The overpayment arose from the adjustment

DECISION - CTA CASE NO. 2591 - 3- of petitioner's deduction from gross income of its share in the home o f fice unallocated overhead expenses t;c:f P501,040.00, as shown in its original return, to _1,427 ,4 84.00. It .appears that sometime in October , 1972, petitioner received from Peat, Marwick, Mitchell & Co., the corporation's international independent auditors, an authenticated certification that the Philippine branch 's (or petitioner's) .share in home office unallocated overhead expense for the year ended December 31, 1971 amounted to $219,547.00 which is equivalent to Pl,427,484.00. (Exhs. 11 G" & 11 G-2", p. 4, BIR records.) On March 1, 197~, petitioner filed with respondent, together with the amended income tax return for 1971, a formal claim for the refund of the amount of ~324,255.00, which represents the difference between the tax previously paid of ~511,247.00 and the tax lia- bility of ~186,992.00, computed on the basis of the deduction of pet itioner's share of home office overhead expense of ~1,427,484.00. (Exh. 11 E", p. 10, BIR records.) Since no action was taken by respondent on its claim for refund, petitioner instituted the instant appeal with this Court on April 2, 1974. Is petitioner legally entitled to the refund or tax credit of the amount of ~324,255.00 as overpaid or erroneously paid income tax for the year 1971?

DECISION - CTA CAS E NO. 2591 - 4- There is no question of, and respondent does not quarrel with, the right of petitione r herein, as a resident foreign corporation transacting business in the Philippines, to deduct from its gross income "the expenses, losses, and other deductions properly appor- tioned or allocated thereto, and a ratable part of any expenses , losses, or other deductions which cannot definitely be allocated to some item or class of gross income ." (S e e Sec . 37 (b)'� National Internal Revenue Code) ~ And Section 160 of Revenue Regulations No. 2 (Income Tax Regulations) , _explaining in detail how th e "other deductions which cannot definitely be allocate d to some item or class of gross income" are to be appor- tioned, prescribes : "Sec . 160. Apportionment of deductions.- From the items specified in section 37(a) as being derived specifically from sources w{th- in the Philippines there shall be deducted the expenses, losses, and other deductions proper- ly apportioned or allocated thereto and a ratable part of any other expenses, losses or deductions which can not definitely be alloca- ted to some item or class of gross income . The remainder shall be included in full as net income from sources within the Philippines. The ratable part is based upon the ratio of gross income from sources within the Philippines to the total gross income. Example: A nonresident alien individual whose taxable year is the calendar year, derived gross income from all sources for 1939 of ~180,000, including therein: u~ n ,J

DECISION - CTA CASE NO. 2591 - 5- Interest on bonds of a domestic corporation ------------------- --~ ~ 9,000 Dividends on stock of a domestic corporation ---------------------- 4,000 Royalty for the use of patents 12,000 qithin the Philippines -------- - ~- Gain from sale of real property located within the Philippines - -- 11,000 Total that is, one-fifth of the total gross income was from sources within the Philippines, The remainder of the gross income was from sources without the Philippines, determined under section 37 (c) �. The expenses of the taxpaye r for the year amounted to P78,000. Of these expenses the amount of P8,000 is properly a llocated to income from sources within the Philippines and the amount 6f P40,000 i s properly allocated to income from sources without the Philippines. ��J The re mainder of the expense, ~30,000, can- not be definitely allocated to any class of income . A ratable part thereof, based upon the relation of gross income from sources within fue Philippines to the total gross income, shall be deducted in computing net income from sources within the Phi lippines . Thus, there are deducted from the P36, 00 0 of gross income from sources within the Philippines expenses amounting to Pl4,000 (representing PB,OOO properly appor- tioned to the income f r om sources within the Philippine s and P6, 000, a ratable part /one fifth7 of the expenses which could not be allocated to any item or class of gross income) . The remain- der, P22,000, is the net income frcim sources within the Philippines . Thus, expenditures made by a foreign corporation in conducting business are deductible in computing its taxable income from sources within the Philippines when allocable to the production of income from sources within the Philippines or where a ratable part of the general expenditures is apportioned to income within

DECISION - CTA CASE NO. 2591 -6- the Philippines . The net income of a resident foreign corporation, like petitioner herein, is therefore de- terrnined by deducting from the items of gross income specified in Section 37(a) of the National Internal Revenue Code treated as income from sources within the Philippines, the expenses, losses, and other deductions properly apportioned or allocated thereto a n0 a ratable part of a~xpenses , losses, or other deductions which cannot def in_i t.ely be _al!_c;:>ca ted to some i tern or clas s of qro~inco~~� The remainder, if any , is include d in full as net income from sources within the Philippines. (Sec. 37(b) ~National Internal Revenue Code .) Th is has already been explained by this Court in Ginn & Co. vs. Commissioner of Internal Revenue , CTA Case No . 674, May 21, 1963, where the right of a resident fore ign corporation to deduct from gross income its share of home office overhead expenses allocable to income from the Philippines was susta ined. The collision of the parties occurs howeve r at the proposition of whether petitioner is entitled to claim as deduction from gross income the amoun t of ~501,040.00 ($77 ,0 60.00) .or the sum of ~1,427 ,484.00 ($219,5 4 7.00) .as its share in the horne office unallocated overhead expenses for the year ended December 31, 19 71. Petitioner contends that its share of the horne 91

DECISION - CTA CASE NO. 2591 - 7> - office unalloqated overhead e xpenses is Pl,427,484.00 as determined by its international independent auditors on the basis of the percentage of Philippine gross income to worldwide gross income of the corporation, pursuant to Section 37(b) ~supra, as implemented by Section 160 of Revenue Regulations No . 2, supra. To substantiate the correctness of said amount, petitioner submitted as Exhibit "G'', p. 4, BIR records, the state- rnent of the corporation's international auditors that since its gross income from the Philippines for the year ended December 31, 1971 was P7,143,155 .00 ($1,098,617.00) ~hile the overall gross income of the corporation as a whole was $6,891,052.00, petitioner's share of the horne office unallocated overhead expenses amounted to Pl,427,484.00 ($219,547.00) ._ On the other hand, respondent submits that peti- tioner's deductible share in the horne office unallocated overhead expenses is only P501,040.00 since said amount was arrived at pursuant to the "se rvice agreement" executed by and between petitioner and its home office. Respondent also contends that petitioner has not pre- sented evidence showing that its horne office expenses chargeable to Philippine operations is more than P501,040.00. The contention of respondent that petitioner's share in the home office unallocated overhead expenses

DECISION - CTA CASE NO . 2591 - 8- is only ~501,040 . 00 since this was the amo u nt fixed in the "service agreement" is viithout merit. The fact t hat such was the amount charged against petitioner by the main 6ffice as its share of the ho me office unallocated overhead expenses is no reaso n why it can- no t claim as deduction the amount allowed by the law. As aptly stated by petitioner: "A close scrutiny of the tr easux:e.t:'s certification indicates that it is dated January 11, 1972. The year end of both pe- titioner and the horne office is the same - December 31 , 1971. From these fac t s, it is evident that when the treasurer issued the certification on January 11 , 1972, there we~e yet no audited financia l state- ments of both petitioner and the ho rne office, since it is of common knowledge tha t audited financial statements are generally completed 3 or 4 months after the close of the account- ing period. This is the reason why corpo- rate taxpayers are given up to the 15th day o f the 4th month after the close of the taxable year within which to file their income tax returns accompanied with audited financial statements . There being no financial state- ments yet when the certification was issued on January 11, 1972 , the treasurer could not have correctly compu ted petitioner ' s share in horne office overhead expenses in a c cordance with the gross income formula presc ribed in Section 16 0 of the Regulations, sinc e he was not in possession of all the necess a ry figures or information f o r the c omputation , such as petitioner's 1971 gross income, wordwide gross income, and home office unallocated ove rhead expenses. These figures became available only after the audited financial statemen ts were completed . If at all , therefore , what the treasurer certified to on Janu ary 11, 1972 as having bee n charged by home office t o petitioner as the latter's share, was a mere estimate, which did not necessarily reflect the correct and fi nal ratable share of petitioner. 93

DECISION - CTA CASE NO . 2591 -9 - "Mo r e over , an absurd and unreasonable con- sequence would result from respondent 's pos ition that since petitioner had already previously deducted $77,060 (P50l,0 40) which was certified by the home of fi ce trea su rer, petitione r can no longer claim more than the said amount. It is absurd a nd unreasonable because it completely would deny to a taxpayer an opportunity to correct an obvious error that causes it damage or pre- judice. This has never been the intention of the law. In fact, it is a well a c c epted practice among corporate taxpayers to 'file "tentative" tax r eturns and financial statements just to beat the tax filing deadline , wh ere the statements are not yet completed a s of the due date. A final o r a me n ded return is late r fi led. This is to affor d such taxpayers the oppor tunity to correct whatever errors may have been comm itted i n rushing the sta tements and returns in an at tempt to bea t the deadline . I n fact, e ven without indicating that the returns and statements filed are tenta t ive, a taxpayer can always amend such returns and statements in order to correct whatever error may have been commit ted or in order to reflec t the true and corr e ct figur es . The f act t herefore , that the home off ice treasurer had previously certi fied a c e r ta in amount a s pet itioner's share, a nd that petitioner has previously claimed t he same as deduction does not me an that petitioner can no longer correct t he same if it turns out to be erroneous. " (See Memor andu m for Petitioner , pp . 37-38, CTA rec.) ~ Even more , a tax being a forced charge , imposition, or contri bution, it operates in inv itum, and is in no way dependent upon the will or contractual assen t, express or implied, of the persons taxed. (51 Am . Jur. 38-39.) It is exacted pursuant to legislative authority in the exercise of t he taxing power. (Id. pp . 71-75.) The question therefore as to who shall pay any given tax and what shall be the basis thereof are determined by law, the operation of which can not be affected by the provisions of a contract to which the Government

DECISION - CTA CASE NO. 2591 - 10 - is not a party . This is of course without prejudice to the right, if any, of a party to the agreemen t to demand re imbu rsement from the other party. But s uch right of reimbursement is independent of, and foreign to , the right of the Government to collect the tax in the manner and under the conditions prescribed by law . (Finley J . Gibbs vs. Collector of Internal Re- venue , L-14166 , Collector of Internal Revenue vs . Finley Gibbs, L- 1432 0, April 28, 1962 , 114 Phil . 1105 . ) Since the tax and the obligation to pay the same are all created by statute, so are its amount and basis governed by statute , we see no reason why petitioner cannot legally claim as deduction from its gross income the sum of Pl,427 , 484.00 as its ratable share in the horne office unallocated expenses for taxable year 1971 which is the correct amount it is legitimately entitled to claim under the law. We likewise find the argument of respondent that petitioner has not submitted evidence showing that its horne office expenses chargeable to Philippine operations is more than P501 ,0 40 . 00 without merit. As indic ated earlier , the statement of petitione r 1 s share of horne office unallocated overhead expenses for the year ended December 31 , 1971 , certified to by Peat, Marwick , Mitchell & Co ., fue corporation 1 s international in- dependent auditors , was submitted by petitioner as evidence , marked and admitted as Exhibits "G" and "G-2" . (pp . 4- 5 , BIR records . ) Said statement was authenticated by Consul Vicente G. Reye s of the Republic

DECISION - CTA CASE NO. 2591 - ll - of the Philippines in and for the Consular Distric t of New York, U.S. A. (Exh. "G-1", p . 6, BIR rec.) �. And the facts and figures declared and shown in the said statement have never been ques t ioned or disputed by respondent. We are therefore of the persuasion that the evidence presented more than s uff i ciently prove that the amount of Pl,427,484.00 represented petitioner 's corr ect 1971 ratable share in the home office unallocated expenses, the same having been computed in accordance with the gross income formula prescr ibed in Section 160 of Revenu~ Regulations No. 2. Accordingl y , under Section ,� 37( e ) of the National Internal Revenue Code, in re- lation to Section 160 of Revenu e Regulations No . 2, petitioner has the right to claim the amou nt of Pl,427,484.00 as deduction from its gros s income for taxable year 1971 . Petitioner having amended its 1971 income tax return in order to cla im the said amount as deduction, it is therefore entitled to t he refund of the amount of P324,255.00 as overpa id income tax for the year 19 71. WHEREFORE, respond en t Commis sioner of Internal Revenue is hereby ordered to refund to, or grant a tax credit in favor of, petitioner Smith Kline & French Overseas Co. (Philippine Branch) .the amount of P324,255.00. Withou t pronouncement as to costs. 9G

DECISION - CTA CASE NO. 259 1 - 12 - SO ORDERED . Quezon City , Metro Manila , March 21, 1980 . ~R ~ � � �~ -~ AMANTE Ac ting Presiding Judge I CONCUR: ---. ~OAQUIN ssociate Judge