BIR Ruling [DA-033-04]

January 19, 2004 BIR RULING [DA-033-04] 41; DA 420-00 Jimenez Gonzales Liwanag Bello Valdez Caluya & Fernandez SOL Building, 112 Amorsolo Street Legaspi Village Makati City Attention: Atty. Jose V.E. Jimenez and Atty. Mary Jane A. Delgado Gentlemen : This refers to your letter dated December 1, 2003 stating that your client, Calamba Steel Center, Inc. (CSCI) formerly known as JS Steel Corporation, was incorporated on October 23, 1989 for the purpose of engaging in the business of manufacturing, importing, exporting, buying, selling or otherwise dealing in, at wholesale of such goods as (of a steel service center) slitted, leveled, sheared, roll formed, treated and processed coated/uncoated ferrous and non-ferrous flat products in coils, strips, sheets, plates channels and the like and other products of iron, steel, manganese and their products and by-products, etc.,and any and all equipment, materials, supplies used or employed in or related to the manufacture of such finished products; to manufacture, import, export, buy, sell, on wholesale act as a general assets and warehousemen, treat and deal in any articles or things consisting or partially consisting of iron, steel, manganese, copper, zinc, lead and other metals, and to build, establish, fabricate, buy, sell, own, and operate such kinds of mills, plants and establishments, and to buy, sell, own and operate such real estate, except land, as may be necessary for or incidental to carrying out the purpose and business of the corporation to carry on the business of iron founders, mechanical and manufacturers of machinery and implements, steel, iron and brass founders, metal works, boiler makers, millrights, machinists, smiths wood workers, builders, painters, gas makers and general merchants; that since its incorporation, CSCI has been using the Moving Average method in the valuation of its inventory; that it would now appear that under said method, changes in current replacement costs of inventory are not reflected correctly because such costs are averaged with the older costs of the inventory; that as a result therefore, the cost-profit analysis on inventory of the corporation does not reflect the prevailing market conditions; that CSCI desires a change in its inventory costing method to First-In-First-Out (FIFO) effective January 1, 2004; that the accounting cycle of said corporation is on a calendar basis; and that the FIFO inventory valuation method is an accounting practice which best conforms to the accounting practice in the trade or business of CSCI as the aforesaid method will provide a realistic value in the light of the conditions prevailing at the balance sheet date as the valuation will also clearly reflect the income of the said corporation. Based on the foregoing representations, you now request on behalf of your client, CSCI, for an authority to change its accounting method on inventory posting from Moving Average to FIFO method effective January 1, 2004. In reply, please be informed that on the basis of the above representations, CSCI is hereby granted permission to change its accounting method of inventory costing from Moving Average to FIFO method pursuant to the provisions of Section 41 of the Tax Code of 1997, in relation to Section 145 of Revenue Regulations No. 2, the pertinent portions of which provide, viz : "Section 41. Inventories. Whenever in the judgment of the Commissioner, the use of inventories is necessary in order to determine clearly the income of. any taxpayer, inventories shall be taken by such taxpayer upon such basis as the Secretary of Finance, upon the recommendation of the Commissioner, may, by rules and regulations, prescribe as conforming as nearly as may be to the best accounting practice in the trade or business and as most clearly reflecting the income. "If a taxpayer, after having complied with the terms and conditions prescribed by the Commissioner, uses a particular method of valuing its inventory for any taxable year, then such method shall be used in all subsequent taxable years unless: SIHCDA "(i) with the approval of the Commissioner, a change to a different method is authorized; or "(ii) the Commissioner finds that the nature of the stock on hand (e.g.,its scarcity, liquidity, marketability and price movements) is such that inventory gains should be considered realized for tax purposes and, therefore, it is necessary to modify the valuation method for purposes of ascertaining the income, profits, or loss in a more realistic manner: Provided, however, That the Commissioner shall not exercise its authority to require a change in inventory method more often than once every three (3) years: Provided, further, That any change in an inventory valuation method must be subject to approval by the Secretary of Finance." "Section 145. Valuation of Inventories. The law provides two tests to which each inventory must conform. (1) it must conform as nearly as possible to the best accounting practice in the trade or business, and (2) it must clearly reflect the income. It follows, therefore that inventory rules can not be uniform but must give effect to trade customs which come within the scope of the best accounting practice in the particular trade or business. In order to clearly reflect income, the inventory practice of a taxpayer should be consistent from year to year, and greater weight is to be given to consistency than to any particular method of inventory or basis of valuation, as long as the method or basis used is substantially in accord with these regulations, an inventory that can be used under the best accounting practice in a balance sheet showing the financial position of the taxpayer is, as a general rule, regarded as clearly reflecting his income." Considering that the purpose of CSCI's change on its accounting method will best conform to its accounting practice as said valuation will clearly reflect the income of the said corporation, this Office hereby grants authority to CSCI the use of FIFO method in its inventory costing. This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation it will be disclosed that the facts are different, then this ruling shall be considered null and void. Very truly yours, (SGD.) JOSE MARIO C. BUAG Deputy Commissioner Legal and Inspection Group