BIR Ruling [DA-037-06]

February 9, 2006 BIR RULING [DA-037-06] 34 (F); 144-97 SGV & Co . 6750 Ayala Avenue 1226 Makati City Attention: Atty. Romulo S. Danao, Jr. Partner, Tax Services Gentlemen : This refers to your letter dated September 20, 2005 requesting in behalf of your client, MANILA PENINSULA HOTELS INC. ("MPHI"), for a ruling on the proper computation of MPHI's depreciation expense for tax purposes upon its adoption of the International Accounting Standards ("IAS") No. 16 for financial statement purposes beginning January 1, 2005. It is represented that MPHI is a corporation duly organized and existing under the laws of the Philippines with business address at Corner Ayala and Makati Avenues, 1226 Makati City; that for both financial accounting and tax purposes, MPHI has primarily adopted the straight line method for depreciating its Property, Plant and Equipment ("PPE") and traditionally classifies its PPE into the following categories: Building and Improvements (depreciating over 50 years or remaining life of the lease); Building Machinery and Equipment (depreciating over 10 years); Furniture, fixtures and equipment (depreciating over 5 years); and Transportation equipment (depreciating over 5 years). It is further represented that IAS No. 16 which have been adopted in the Philippines and became effective on January 1, 2005, requires for financial accounting purposes that "Each part of an item of property, plant and equipment with a cost that is significant in relation to the total cost of the item shall be depreciated separately"; that to comply with this new accounting standard, MPHI engaged the professional services of an independent appraiser, Davis Langdon & Seah Philippines, Inc. ("DLS"), to review its fixed assets records, re-estimate the useful life of each significant and identifiable PPE component, and re-establish its fixed assets ledger in a format that would facilitate the preparation of accounts under the new accounting requirements; that as a result of the work performed by DLS, it was found that the estimated useful lives of most of the assets of MPHI should be shorter than the existing/current estimated useful lives, although there are small number of machinery items whose useful lives have been extended; that in accordance with the requirements of IAS No. 16, the change in useful lives of the assets will be applied retrospectively by MPHI for financial statement purposes; that MPHI will continue to use the straight line method of depreciation both for financial accounting and tax purposes. In reply thereto, please be informed that Section 34(F) of the Tax Code of 1997 states that there shall be allowed as a depreciation deduction a reasonable allowance for the exhaustion, wear and tear (including reasonable allowance for obsolescence) of property used in trade or business. The term reasonable allowance shall include, but not limited to, an allowance computed in accordance with rules and regulations prescribed by the Secretary of Finance, upon recommendation of the Commissioner, under any of the following methods: (a) The straight-line method; (b) Declining-balance method, using a rate not exceeding twice the rate which would have been used had the annual allowance been computed under the method described in Subsection (F)(1); (c) The sum-of the-years-digit method; and (d) Any other method which may be prescribed by the Secretary of Finance upon recommendation of the Commissioner. DCTSEA The proper allowance for depreciation of any property used in the trade or business is that amount which should be set aside for the taxable year in accordance with a reasonable consistent plan whereby the aggregate of the amount so set aside, plus the salvage value, will, at the end of the useful life of the property in business, equal the basis of the property. Due regard must be given to expenditures for current upkeep. (Section 105, Revenue Regulations No. 2) Moreover, the capital sum to be replaced should be charged off over the useful life of the property, either in equal annual installments or in accordance with any other recognized trade practice, such as an apportionment of the capital sum over units of production. Whatever plan or method of apportionment is adopted must be reasonable and must have due regard to operating conditions during the taxable period. While the burden of proof must rest upon the taxpayer to sustain the deductions taken by him, such deductions must not be disallowed unless shown by clear and convincing evidence to be unreasonable. The reasonableness of any claim for depreciation shall be determined upon the conditions known to exist at the end of the period for which the return is made. If it develops that the useful life of the property will be longer or shorter than useful life as originally estimated under all the then known facts, the portion of the cost or other basis of the property not already provided for through depreciation allowances should be spread over the remaining useful life of the property as re-estimated in the light of the subsequent facts, and depreciation deductions taken accordingly. (Section 109, Revenue Regulations No. 2) In BIR Ruling No. 144-97 dated December 29, 1997, involving a request by Goodyear Philippines, Inc. (Goodyear), for confirmation that it be allowed to adopt in computing its depreciation expense, the estimated remaining useful life after rehabilitation of the assets acquired from Sime Darby Philippines based on the independent study of the Asian Appraisal Company Inc. (AACI), the BIR ruled that "The remaining estimated useful life of the assets transferred from Sime Darby has been determined as that period of time, expressed in years, that an asset is expected to perform in a satisfactory manner the function for which it was designed and built, assuming normal and reasonable maintenance. The estimates of remaining life for each item of property had been based, in very large measure, upon the observed condition at the time of appraisal and condition of maintenance, and the consideration of normal rates of depreciation for the type of property. Such being the case, Goodyear may be allowed to adopt in computing its depreciation expense for both tax and financial accounting purposes the estimated remaining useful life after rehabilitation of the assets acquired from Sime Darby and valuated as of October 17, 1996, based on the independent study of AACI." In view of the above, MPHI may compute its depreciation expense for each component of the PPE by dividing the net book value prior to the application of IAS (e.g. net book value as of December 31, 2004) by the remaining useful life as re-estimated by DLS. 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 as null and void. Very truly yours, (SGD.) JOSE MARIO C. BUAG Commissioner of Internal Revenue