BIR Ruling [DA-097-05]

March 30, 2005 BIR RULING [DA-097-05] 34 (F), 109 RR 2 048-96; DA-119-03 SGV & Co . 6760 Ayala Avenue Makati City Attention: Atty. J.A. Osana Tax Division Gentlemen : This refers to your letter dated February 17, 2005, requesting on behalf of your client, UEM-MARA Philippines Corporation (UEM-MARA for brevity) for an authority to change the method of computing depreciation of its R-1 Expressway-Phase 1 Project from straight line method to double declining method effective taxable year 2004. It appears that UEM-MARA is a domestic corporation organized for the primary purpose of handling the design, construction and financing of the R-1 Expressway-Phase 1 and the R-1 Extension Expressway-Phase 2 (collectively known as the Manila-Cavite Toll Expressway Project) and the C-5 Link Expressway-Phase 3, under a Build-Operate Transfer (BOT) Program; that it has its principal office at The Corporate Business Center, 151 Paseo de Roxas, Makati City. On 1994, the Philippine and Malaysian governments entered into a Memorandum of Understanding for a joint and cooperative implementation of critical infrastructure projects in the Philippines; that in this connection, the Public Estates Authority (PEA),and two Malaysian entities, Majlis Amanah Rakyat (MARA) and United Engineers (Malaysia) [UEM],entered into a Toll Operation Agreement in 1996; that pursuant to the Toll Operation Agreement, UEM and MARA incorporated in the Philippines an entity called UEM-MARA, which represents UEM and MARA under the said Toll Operation Agreement; that under the Toll Operation Agreement, PEA is responsible for the operation and maintenance of the expressway, while UEM-MARA is responsible for the design and construction, and the financing of the expressways. The R-1 Expressway-Phase 1 Project consists of the upgrading of works done on the existing R-1 Expressway in 1997 to mid-1998 from the Airport Road Junction to Zapote; that the completed toll road has the following features: dual three (3) lane carriageway; 6.475 kilometers total length; fully lighted; fully landscaped and with a 20 lane toll plaza constructed across the main line mid-way of the alignment; that the road had been operational since May 1998 with a project cost of US$ 27.3 Million. For project depreciation purposes, UEM-MARA makes use of an estimated useful life of 35 years 1 for the road and adopted the Straight Line Method of depreciation. However, even prior to the construction of the R-1 Expressway-Phase 1, Halcrow Fox/Transplan, an independent engineering consultant, conducted a study and submitted a report to UEM-MARA, showing, among others, an increasing projected cost for the repair and maintenance of the road from its completion and up to the termination of the Toll Operation Agreement. Upon serious consideration of the increasing cost for the repair and maintenance of the road, UEM-MARA believes that the Straight Line Method is no longer reasonable and would like to adopt the Double Declining Balance Method in computing the depreciation of the Expressway. In reply, please be informed that on the basis of the above representations, UEM MARA is hereby granted permission to change its method of computing depreciation for the R-1 Expressway-Phase 1 Project from straight line method to double declining balance method effective taxable year 2004, pursuant to Section 34(F) of the Tax Code of 1997, the pertinent portion of which provides, viz : "(F) Depreciation. (1) General Rule. 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. .." (2) Use of Certain Methods and Rates. The term `reasonable allowance' as used in the preceding paragraph 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." (Emphasis supplied.) xxx xxx xxx In this connection, Section 109 of Revenue Regulations No. 2 provides: "Section 109. Method of Computing Depreciation Allowance. 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 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 the 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." (Emphasis supplied.) Depreciation is a cost allocation process that systematically and rationally allocates acquisition costs of operational assets to periods benefited by their use. In this connection, the AICPA Committee on Accounting Procedure has stated, "The declining balance method is one of those which meets the requirements of being `systematic and rational.' In those cases where the expected productivity or revenue-earning power of the asset is relatively greater during the earlier years of its life, or where maintenance or charges tend to increase during the later years, the declining-balance method may-well provide the most satisfactory allocation of cost ." 2 It should be noted that under the double declining balance method, the economic useful life of the asset is not shortened or changed. However, the method allows higher amount of depreciation to be taken in the earlier life of the asset which gradually declines over the life of the asset. The purpose of UEM-MARA's change of its depreciation method is for the company to adopt one that is reasonable and has due regard to the operating conditions of the business during the taxable period. As stated earlier, the declining balance method provides the most satisfactory allocation of costs where the maintenance or charges tend to increase during the later years. Given the existing conditions in the operation of the R-1 Expressway-Phase I Project, UEM-MARA is expected to incur increasing cost for the repair and maintenance of the road, toward the later part of the Toll Operating Agreement and until its termination, in order to keep it in good operating condition. Hence, considering that using the double declining method of depreciation is reasonable and warranted and will conform to the best accounting practice in UEM-MARA's trade or business, this Office hereby grants authority to UEM-MARA to change its method of computing depreciation for the R-1 Expressway-Phase 1 Project from straight line method to double declining balance method effective taxable year 2004. (BIR Ruling Nos. 048-96 dated April 10, 1996 and DA-119-03 dated April 14, 2003.) cSaADC 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. Very truly yours, Commissioner of Internal Revenue By: (SGD.) JOSE MARIO C. BUAG Deputy Commissioner Legal and Inspection Group Footnotes 1. In concurrence with the 35-year term of the Toll Operation Agreement. 2. Intermediate Accounting, Smith & Skousen, 1992 Ed.,p. 497 .