BIR Ruling

May 29, 1996 MEMORANDUM FOR: The Commissioner SUBJECT : This refers to the protested assessments of Merrill-Lynch Philippines, Inc., involving the amounts of P705,501.36; P1,109,378.24; P3,334,668.95; representing deficiency broker's tax for the years 1979, 1980, 1986, inclusive of increments, covered by Assessment Notices Nos. FAN-4-79-89-002229; FAN 4-80-89-002228 AND FAN-4-86-89-002227 respectively, all dated November 16, 1989. cdt FACTS AND BASES OF THE ASSESSMENTS : Records show that Merrill Lynch Philippines, Inc. [MLPI] is a domestic corporation which was established on March 29, 1968; that on July 1, 1968, MLPI [then known as Merrill Lynch, Pierce, Fenner & Smith Philippines, Incorporated] entered into an Agreement with Merrill Lynch Fenner & Smith International, Limited [ML International], a Canadian corporation with principal office in New York, New York, U.S.A. whereby MLPI will use its best efforts to cultivate and promote the interest of Merrill Lynch, Pierce, Fenner & Smith, Incorporated [ML DELAWARE] and other Merrill Lynch companies outside of the Philippines including Merrill Lynch Futures, Inc. [MLNY] a New York based futures commission merchant or broker in the Philippines and to maintain adequate facilities for the receipt and expeditious transmission to MLNY of orders to buy and sell securities and/or commodities on the Exchanges in the United States and such other places as may be agreed upon from time to time; and that as compensation to MLPI for services under the said Agreement, ML International agreed to pay MLPI an amount equal to the aggregate amount of all current operating expenses so incurred by MLPI plus fifteen percent (15%) thereof, which service fee has been subjected by MLPI to the then contractor's tax. Prior to its Order dated August 27, 1986, the Securities and Exchange Commission [SEC] has duly licensed MLPI as a Commodity Futures Trading Advisor [CFTA] which under Rule 33 of the Rules Governing Commodity Futures Exchanges, Futures Commission Merchant, Floor Brokers, Commodity Futures Associations, Commodity Pool Operations and Commodity Advisors, promulgated by the SEC, performs the following services, for compensation or profit: (1). Advising others, either directly or through publications or writings (a). to the value of commodities (b). as to the advisability of trading in any commodity for future delivery, subject to the rules of the particular commodity futures exchange (2). Issuing or promulgating analysis or reports concerning commodities. The same Rules further state that the term commodity futures trading advisor does not include any broker or futures commission merchant. However, in its said August 27, 1986 Order, the SEC denied (MLPI's application for the renewal of its license to operate as a CFTA and ordered MLPI to cease and desist its activities as CFTA and, if it so desires, to register as a futures commission merchant [FCM] with the Commissioner. A copy of the said Order of the SEC was then referred to the then Minister of Finance, Jaime V. Ongpin, for appropriate action on the tax implications thereof. Based thereon, a Letter of Authority No. 005400 dated February 10, 1987 covering the taxable year 1986 and unverified prior years not covered by tax amnesty were issued to the examiners of the Tax Fraud Division to verify MLPI's books of accounts for all internal revenue tax purposes. Pursuant to the said L/A, examiners from the Tax Fraud Division submitted on September 28, 1988 their report of investigation dated August 26, 1988 wherein they recommended no deficiency income tax assessments for the years 1979, 1980 and 1986 but recommended instead the issuance, of a deficiency broker's tax assessments for the said taxable years, shown to have been issued on November 16, 1989, computed as follows: 1986 1980 1979 Gross Receipts per return P40,734,365 P7,658,078 P4,581,471 Additional tax due thereon 3% [7% minus 4%] P1,222,030.97 P229,742.37 137,444.13 Add: Surcharge [25% & 50%] 916,523.23 172,306.78 103,083.09 Interest 1,196,114.75 707,329.09 464,974.14 Total Amount due & payable P3,334,668.95 P1,109,378.24 P705,501.36 A perusal of the report of investigations submitted by the examiners show that they relied principally on the order dated August 27, 1986 of the SEC as well as on the Resolution dated March 15, 1988 of the Court of Appeals in recommending the assessments of MLPI for deficiency broker's tax. LexLib GROUNDS OF THE PROTEST In its protest letters dated December 13, 1989 and March 30, 1990 against the validity of the deficiency broker's tax assessments for the years 1979, 1980 and 1986 in the amounts of P705,501.36, P1,109,378.24, P3,334,668.95, respectively, MLPI's thru counsel alleged that the 1979 and 1980 assessments were already barred by prescription the same having been issued beyond the 5-year prescriptive period provided for under Section 318 [now Section 203] of the Tax Code then in force. Moreover, the said assessments have no legal and factual basis as the factual findings of the SEC that MLPI is acting as a Futures Commodity Merchant do not support a finding that it is a broker under the Tax Code for the following reasons: 1). The activities undertaken by MLPI were in pursuance of its agreement with ML International dated July 1, 1968 whereby MLPI agreed to use its best efforts to cultivate and promote the interest in the Philippines of Merrill Lynch, Pierce, Fenner and Smith Incorporated; 2). MLPI merely provided advise to MLNY's customers with respect to commodity futures, as well as communication facilities for the transmission to MLNY of the orders or instruction of its customers. After MLPI received the orders of MLNY's customers, MLPI mechanically transmitted such orders through order tickets containing details of the order, to MLNY which either accepts or rejects the order. 3). MLPI did not enter into any brokerage contract with MLNY's customers, nor did MLPI receive any compensation, as broker's commission or otherwise, from MLNY's customers. 4). MLPI could not legally bind MLNY with respect to the acceptance of orders of MLNY's customers to sell or purchase commodity futures. DISCUSSION A. Deficiency Broker's Tax Assessment for the Years 1979 and 1980 in the amounts of P705,501.36 and P1,109,378.24, respectively. Anent the issue of prescription relative to the 1979 and 1980 deficiency broker's tax assessments, there is no doubt that the corresponding assessments which were issued on November 16, 1989 were issued beyond the prescriptive period provided for under Section 318 of the Tax Code then in force, which reads: "Sec. 318. Period of Limitation Upon Assessments And collection . Except as provided in the succeeding section, internal-revenue taxes shall be assessed within five years after the return was filed, and no proceeding in court without assessment for the collection of such taxes shall be begun after the expiration of such period. For the purposes of this section, a return filed before the last day prescribed by law for the filing thereof shall be considered as filed on such last day: Provided, that this limitation shall not apply to cases already investigated prior to the approval of this Code." It is not disputed that MLPI has been filing its quarterly percentage tax returns for which it has duly paid the contractor's tax due thereon. The examiners, however, claimed that "the percentage tax returns filed for the said taxable periods are false, taxpayer having manifested itself as a contractor when, in fact, it is a commission merchant/broker". For said reason, the examiners have imputed the 50% fraud penalty imposed under Section 72 of the Tax Code then in force. In the case of Commissioner of Internal Revenue vs . Air India and the Court of Tax Appeals , G.R. No. L-72443, January 28, 1988, 157 SCRA 648, the Supreme Court held that: " The 50% surcharge or fraud penalty provided in Section 72 of the National Internal Revenue Code is imposed on delinquent taxpayer who willfully neglects to file the required tax return within the period prescribed by law, or who willfully files a false or fraudulent tax return . . . [emphasis supplied] The willful neglect to file the required return or the fraudulent intent to evade the payment of taxes, considering that the same is accompanied by legal consequences, cannot be presumed. (CIR vs. Air India, supra) The fraud contemplated by law is actual and constructive. It must be intentional fraud, consisting of deception willfully and deliberately done or resorted to in order to induce another to give up some legal right. Negligence, whether slight or gross, is not equivalent to the fraud with intent to evade the tax contemplated by the law. It must amount to intentional wrong doing with the sole object of evading the tax. [Aznar vs. Court of Tax Appeals, G.R. No. L-20569, August 23, 1974, 58 SCRA 519]. In this particular case, MLPI has been filing its quarterly percentage tax returns and has paid the corresponding contractor's tax due thereon. The same have not been questioned by the Bureau until now on the basis of the SEC Order dated August 27, 1986. The records likewise show that the assessments were solely based on the difference of the tax rates of the contractor's tax which MLPI paid and the broker's tax which the examiner sought to assess. Fraud cannot be inferred where an assessment of a deficiency tax is based solely upon the books and records of the taxpayers (Bohol Land Transportation Co. vs. CIR, CTA Case No. 261, September 25, 1957, aff'd in L-13009 and L-13462, April 29, 1950, 58 O.G. 2407) Accordingly, the imposition of the 50% fraud penalty is improper. As such, the five-year prescriptive period under Section 318 of the old Tax Code then in force is applicable in this case. As the assessment notices for deficiency broker's tax for the years 1979 and 1980 were issued only on November 16, 1989, which is well beyond the said five-year prescriptive period, the same are already barred by prescription. B. Deficiency Broker's Tax Assessment for the year 1986 in the Amount of P3,334,668.95 A review of the pertinent Orders/Resolutions of the SEC on the matter of MLPI's Renewal of Permit/License to Operate as a Commodity Futures Trading Advisor [SEC-EB Case No. 145] as well as the Resolution promulgated on March 15, 1988 of the Court of Appeals leaves us no other conclusion than to consider MLPI as a broker subject to the broker's tax of 7% imposed under Section 174 of the Tax Code then in force. Hence, the only issue that needs to be resolved in this regard is the imposition of the 50% fraud penalty. Pursuant to its Service Agreement with Merrill Lynch, Pierce, Fenner & Smith International, Limited which was executed on July 1, 1968, MLPI's service fee is "an amount equal to the aggregate amount of all current operating expenses so incurred by MLPI plus fifteen percent (15%) of such amount". Pursuant thereto, MLPI reported the amounts of P40,734,366.40 as gross receipts for percentage tax purposes for the year 1986 for which it paid the amount of P1,629,374.64 as contractor's tax. The examiners from the Tax Fraud Division, upon verification of MLPI's books and other accounting records for the year 1986, likewise adopted the gross receipts per percentage tax returns as the tax base in computing the deficiency broker's tax for the said year. They, however, subjected the same to the 50% fraud penalty on the ground that it erroneously paid the 3% contractor's tax instead of the 7% broker's tax then imposed. For reasons discussed in item 1 above, it is submitted that there is no valid justification for the imposition of the 50% fraud penalty. Recommendation In view of the foregoing, it is respectfully recommended that: 1. The 1979 and 1980 deficiency broker's tax assessments in the amounts of P705,501.36 and P1,109,378.24, respectively, be withdrawn and cancelled as the same have been barred by prescription. 2. The 1986 deficiency broker's tax assessments in the amount of P3,334,668.95 be modified by removing the imposition of the 50% fraud penalty as follows: Gross Receipts per return P40,734,365.00 Broker's tax due P2,851,405.55 Less: Tax paid 1,629,374.63 Balance: Tax due P1,222,030.92 Add: 25% surcharge 305,507.73 20% interest per annum 1/21/87 to 5/21/96 2,750,486.09 Total amount due and collectible P4,278,024.74 Respectfully submitted: (SGD.) RODULFO L. SALAZAR Officer-In-Charge Appellate Division I CONCUR: (SGD.) ALICIA P. CLEMENO Assistant Commissioner Legal Service RECOMMENDATION APPROVED: (SGD.) LIWAYWAY VINZONS-CHATO Commissioner of Internal Revenue