BIR Ruling [DA-064-03]

March 3, 2003 BIR RULING [DA-064-03] 34 (F); RR 2; 144-97 SGV & Co. 6760 Ayala Avenue Makati City Attention: Atty. C.P. Noel Head, Tax Division Gentlemen : This refers to your letter requesting on behalf of Nestle Philippines, Inc. (NPI) for a confirmation that NPI can adopt the estimated remaining useful lives of the fixed assets in computing its depreciation expense, both for tax and financial accounting purposes. The facts as represented are as follows: NPI is a domestic corporation duly registered with the Securities and Exchange Commission (SEC). Its primary purpose is to manufacture, buy or otherwise acquire, import, export, sell, distribute and deal in all kinds of foods, food products, natural products, dietetic products, beverages and articles of human consumption or to be used in conjunction with any articles of food or diet, and without restricting the generality of the foregoing, to produce, manufacture, buy or otherwise acquire, preserve, pack, sell, import and export coffee, coffee extracts, tea, tea extracts, chocolate and cocoa, malted, condensed, skimmed, evaporated and powdered milk products, infant foods, dietetic products, cheese and all dairy products, fruits and vegetable products, meat extract, and juices, soups, spices, food sauces, seasonings and condiments, food relishes, cereals and cereal-food products and by-products, confections and confectionery and each and every component and raw materials or any and all of the aforesaid articles or commodities. Goya, on the other hand, is a subsidiary of NPI and is likewise a domestic corporation duly registered with the SEC, whose primary purpose is to manufacture, process, buy, sell, on wholesale only, deal in, and to engage in, conduct, and carry on the business of manufacturing, processing, producing, packaging, repacking, buying, selling, on wholesale only, distributing, and dealing in, cacao beans, cocoa, chocolate-based products, and its derivatives, and other allied or by-products thereof. On December 19, 2000, Goya sold to NPI its manufacturing facility consisting of buildings, improvements, machinery and equipment used in the production of confectionery products ("fixed assets") located at Marikina City. The aforesaid fixed assets of Goya were sold at a purchase price of Five Hundred Fifty Seven Million Five Hundred Thousand Pesos (P557,500,000.00), payable as follows: a) downpayment in the amount of P111,500,000.00 upon the execution of the Contract; and b) the balance of P446,000,000.00 shall be payable within a period of four years, in equal annual installments of P111,500,000.00 to be paid on or before December 19 of every year without need of demand. On January 30, 2001, NPI and Goya executed a Contract of Lease whereby NPI leases the fixed assets to Goya for the manufacture of quality food products for an initial period of twelve (12) months or one (1) year commencing on January 1, 2001 and shall be renewable on an annual basis upon the agreement of the parties. For the initial lease period, the annual rent shall be Fifty Million Six Hundred Ninety Five Thousand Pesos (P50,695,000.00) which shall be net of the value-added tax (VAT) but inclusive of the expanded withholding tax (EWT) to be withheld by the lessee. The annual rent shall be payable on a quarterly basis and shall be paid by the lessee on or before the first five (5) days of the last month of each quarter without need of demand. TAHIED Prior to the acquisition by NPI from Goya on year 2000 of the said fixed assets, the latter has actually been using it in its manufacturing business for a number of years, and Goya had subjected these buildings, improvements, machinery and equipment to depreciation based on their respective estimated useful lives as determined by the company for tax and financial accounting purposes. On the basis of the foregoing facts, you now request for a confirmation that NPI can depreciate the fixed assets, for tax and financial accounting purposes, on the basis of their purchase price spread over their respective estimated remaining useful lives, as determined by Goya. In reply, please be informed that Section 34(F) of the Tax Code of 1997, provides 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 the 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. In this connection, Section 105 of Revenue Regulations No. 2 provides that 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 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 likewise be given to expenditures for current upkeep. 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 [Section 109, Revenue Regulations No. 2]. (BIR Ruling No. 144-97 dated December 29, 1997) Further, Section 34(F)(3) of the same Tax Code, allows the taxpayer to enter into an agreement with the Commissioner of Internal Revenue on the estimated useful life and rate of depreciation of any property. The rate so agreed upon shall be binding on both the taxpayer and the BIR. Section 34(F)(3) of the Tax Code states that: "(3) Agreement as to Useful Life on Which Depreciation Rate is Based . Where under rules and regulations prescribed by the Secretary of Finance, upon recommendation of the Commissioner, the taxpayer and the Commissioner have entered into an agreement in writing specifically dealing with the useful life and rate of depreciation of any property, the rate so agreed upon shall be binding on both the taxpayer and the National Government in the absence of facts and circumstances not taken into consideration during the adoption of such agreement. The responsibility of establishing the existence of such facts and circumstances shall rest with the party initiating the modification. Any change in the agreed rate and useful life of the depreciable property as specified in the agreement shall not be effective for taxable years prior to the taxable year in which notice in writing by certified mail or registered mail is served by the party initiating such change to other party to the agreement. ISCHET " Provided, however , That where the taxpayer has adopted such useful life and depreciation rate for any depreciable asset and claimed the depreciation expenses as deduction from his gross income, without any written objection on the part of the Commissioner or his duly authorized representative, the aforesaid useful life and depreciation rate so adopted by the taxpayer for the aforesaid depreciable asset shall be considered binding for purposes of this Subsection." Thus, the taxpayer and the Commissioner may agree on the estimated useful life and rate of depreciation of any property. Based on the foregoing, this Office hereby confirms your opinion that NPI can adopt as its basis for depreciation, the estimated remaining useful lives of the fixed assets, as previously determined in the books of Goya, both for tax and financial accounting purposes. The seller, on the other hand, must recognize as income any gains derived by it on the excess of the selling price over the net book value of the fixed assets sold. This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it will be ascertained that the facts are different, then this ruling shall be considered null and void. ECTHIA Very truly yours, Commissioner of Internal Revenue By: (SGD.) JOSE MARIO C. BUAG Deputy Commissioner Legal & Inspection Group