BIR Ruling

February 13, 1997 MEMORANDUM FOR: The Commissioner This refers to the protested tax case of ARMCO MARSTEEL ALLOY CORPORATION (ARMCO for brevity) involving the aggregate amount of P5,304,179.00 representing deficiency income tax for 1989 covered by Assessment Notice No. 1189-4894 dated April 14, 1992. aisadc FACTS OF THE CASE ARMCO MARSTEEL ALLOY CORP. is a domestic corporation registered with the Board of Investments as a preferred pioneer enterprise for the production/manufacture of grinding balls and billets. Being a BOI-registered preferred pioneer enterprise, taxpayer is entitled to avail itself of the privilege granted under Section 7(b) of RA 5186 concerning the accelerated depreciation incentive as an allowable deduction. Records show that on October 8, 1987, the Bureau received from the taxpayer a letter dated October 7, 1987 informing the former of its availment of the incentives provided under R.A. 5186. [p. 343] Further, it appears that on February 15, 1990, taxpayer filed with the Bureau BIR Form 1702 (Incentives Availed of Under R.A. 5186), indicating therein its availment of the accelerated depreciation method, together with Armco's ITR and other pertinent documents. [pp. 250-269] The taxpayer's ITR for taxable year 1989 shows a refundable amount of P5,061,899.00. However, due to the loss suffered in the succeeding taxable fiscal year ending October 31, 1990, taxpayer failed to apply the refundable amount as an automatic tax credit, pursuant to Section 69 of the Tax Code, as amended. On February 21, 1991, taxpayer filed with the Bureau the P5,061,899.00 claim for refund, pursuant to the aforesaid provision. [p. 95] On April 3, 1991, due to the Bureau's inaction on its claim, taxpayer filed with the Court of Tax Appeals a Petition for Review entitled Armco-Marsteel Alloy Corp. Petitioner vs. CIR, docketed as CTA Case No. 4592. In the course of the hearing, it was found out that the amount claimed as a refund arose due to BIR's disallowances of the taxpayer's availment of the accelerated depreciation and expenses for repairs and maintenance. In justifying its actions, BIR maintains that to avail of the accelerated depreciation method BIR's approval must first be secured. Moreover, the expenses for repairs and maintenance must not be so enormous to be allowed as a deductible expense. Instead, BIR discovered that the taxpayer is liable for deficiency income tax. Consequently, BIR issued against the taxpayer Assessment Notice No. 1189-4894 involving the amount of P5,309,179.00 representing deficiency income tax for 1989. This was protested by the taxpayer in its letter dated May 7, 1992. (p. 351) cdtech Meanwhile, in the case of Armco-Marsteel Alloy Corp. vs. CIR, the CTA decided in favor of the taxpayer its petition, the dispositive portion of which states, to wit: "WHEREFORE, finding the petition meritorious, respondent Commissioner of Internal Revenue is hereby ordered to refund or in the alternative, issue a tax credit certificate in favor of petitioner, Armco-Marsteel Alloy Corporation, in the amount of P5,061,899.00, representing overpaid income tax for the fiscal year ending October 31, 1989. SO ORDERED. Quezon City, Metro Manila, July 1, 1993." [p. 364] Regarding the protest filed by the taxpayer with the Bureau, the Regional Director, Revenue Region 8, recommended for the cancellation of Assessment Notice No. 1189-4894 dated April 14, 1992 based, basically, on the decision of the CTA. ISSUES The issues in this case are similar to those raised in the Court of Tax Appeals: 1) Whether or not the taxpayer has properly availed itself of the accelerated depreciation incentive; 2) Whether or not taxpayer validly categorized the expenses incurred for repairs and maintenance as allowable ordinary expense. DISCUSSION The controversy relative to the first issue arose due to the conflicting interpretations by the BIR and the taxpayer of Section 7 (b) of RA 5186, which provides, to wit: "Sec. 7 Incentives to a Registered Enterprise . A registered enterprise, to the extent engaged in a preferred area of investment, shall be granted the following incentive benefits. cdll (a) . . . (b) Accelerated Depreciation At the option of the taxpayer and in accordance with the procedure established by the Bureau of Internal Revenue, fixed assets may be (1) depreciated to the extent of not more than twice as fast as normal rate of depreciation or depreciated at normal rate of depreciation if expected life is ten years or less; or (2) depreciated over any number of years between five years and expected life if the latter is more than ten (10) years, and the depreciation thereon allowed as a deduction from taxable income: Provided that the taxpayer notifies the Bureau of Internal Revenue at the beginning of the depreciation period which depreciation rate allowed by this Section will be used by it." In resolving Armco's protest, we take deference to the CTA's decision, to wit: "Being a preferred pioneer enterprise registered with the Board of Investments, petitioner availed of the incentives provided under RA 5186 one of which is the use of the accelerated depreciation. In the course of the cross examination of respondent's witness, it was established that petitioner notified the BIR of its availment of the accelerated depreciation. No response was received thereafter from the Bureau. The records will also show that petitioner filed with the Bureau BIR Form No. 1702-E, indicating the nature of incentives availed of, that is, the accelerated depreciation. RA 5186 prescribes a minimum requirement of notification and not approval by the BIR of the availment of the incentive adopting the accelerated depreciation. The option to use the accelerated depreciation is on the pioneer enterprise. Having exercised its power of choice, petitioner's only obligation is to notify respondent of that choice. The law is clear in this regard. Petitioner can validly deduct the accelerated depreciation from its income. The same should not be disallowed. Another item disallowed by the examiner refers to the repairs and maintenance in the total amount of P2,413,193.17. Because of the material amount involved, respondent's examiner contends that the same should be capitalized. The repairs and maintenance cost must be ordinary and necessary business expense in order to be deductible from income. "The cost of incidental repairs, which neither materially add to the value of the property nor appreciably prolong its life and which were made to keep the property in an ordinarily efficient operating condition, may be deducted as an expense." (4 Mertens 372.) Other factors like the purpose for which the expenditures were made is also necessary in determining whether an item of expenditure should be capitalized or not. "If its purpose is merely to keep the property or machine in efficient operating condition and is accordingly in the nature of a maintenance charge, it is ordinarily deductible. If it goes beyond that category, it is ordinarily non-deductible" (Ibid., p. 374) The amount should not be the controlling factor. Substance, not form, should be the controlling factor. cdta In this case, the Notes to Financial Statements of petitioner's audited financial report for the fiscal year 1989 indicates that the cost of maintenance and repairs is charged to income as incurred and significant renewals and settlements are capitalized. (#1 Notes to Financial Statements, p. 47, CTA record.) Most of the items disallowed refer to spare parts, pinion gears, roller bearing, transformers and landed cost can be considered cost of machinery repairs. Spare parts are deemed to be replacement of worn-out parts, the same is true with the rest of the items disallowed. The amount of expenditure standing alone is not sufficient base for determining whether an amount expended for repairs should be capitalized. "The presumption of correctness of assessment being a mere presumption cannot be made to rest on another presumption." (Commissioner of Internal Revenue vs. Benipayo, GR No. L-13656, January 31, 1962; Island Garment Mfg. Corp. vs. Commissioner of Internal Revenue, CTA No. 2070, June 22, 1977; Medina vs. CIR, CTA Case No. 1245, December 27, 1971; Herrera vs. Commissioner of Internal Revenue, CTA Case No. 2060, June 27, 1972; Samson vs. Commissioner of Internal Revenue, CTA Case No. 232, June 30, 1958; Unterbo vs. Commissioner of Internal Revenue, CTA Case No. 363, December 26, 1950.) The disallowance of the aforesaid amount representing repairs and maintenance is erroneous." The above-mentioned CTA decision has succinctly discussed the issues raised before us. RECOMMENDATION/CONCLUSION WHEREFORE, in view of the foregoing it is respectfully recommended that Assessment Notice No. 1189-4894 involving the amount of P5,304,179.00 representing deficiency income tax for 1989 issued against ARMCO MARSTEEL ALLOY CORPORATION on April 14, 1992 be WITHDRAWN and CANCELLED for being without basis in fact and in law. Respectfully submitted: (SGD.) RODULFO L. SALAZAR Chief, Appellate Division I CONCUR: (SGD.) ALICIA L. TOMACRUZ Head Revenue Executive Assistant Legal Service Recommendation-APPROVED: (SGD.) LIWAYWAY VINZONS-CHATO Commissioner of Internal Revenue