BIR Ruling [DA-275-05]

June 21, 2005 BIR RULING [DA-275-05] SGV & Co. 6760 Ayala Avenue Makati City Attention: W. U. Villanueva Principal, Tax Services Gentlemen : This refers to your letter dated May 4, 2005 stating that your client, East Asia Utilities Corporation (EAUC), a wholly-owned subsidiary of El Paso Philippines Energy Company, Inc. (EPPEC), a domestic corporation primarily engaged in the generation and sale of energy with principal office address at Barangay Ibo, Mactan Export Processing Zone, 6015 Lapu Lapu City, Cebu; that it is duly registered with the Bureau of Internal Revenue (BIR), Revenue District Office No. 123, with Tax Identification No. 004-760-842-000; that the Company operates a 50.164 megawatt (MW) bunker "C" diesel-fired power generating plant, which provides electric power to the Mactan Economic Processing Zone (MEPZ); that EAUC is registered with the Board of Investments (BOI) on March 15, 1993 entitled to incentives which include, among others, an income tax holiday (ITH) for a period of six (6) years, which expired on December 31, 1999; that after expiration of its ITH incentive from BOI, and pursuant to its registration as an Ecozone Utilities Enterprise under the provisions of R.A. No. 7916, the Company enjoyed exemption from national and local taxes, and in lieu thereof, is subject to a special tax of 5% on gross income; that EAUC applies Straight Line Method in computing depreciation of its assets (except for the power plant and related equipment) such as office furniture, fixtures and equipment, transportation equipment and other plant assets; that for the power plant and related equipment, the Company is currently using Output/Unit of Production Method of Depreciation computed based on the estimated number of kilowatt-hours to be generated over the remaining life of the power plant; that EAUC and its affiliates in the Philippines, i.e. Cebu Private Power Corporation, East Asia Diesel Power Corporation and Duracom Mobile Power Corporation were instructed by their ultimate Philippine parent company, EPPEC, to change their method of computing the depreciation of their respective power plant from Output/Unit of Production Method to Straight Line Method to align with the current method utilized by other affiliated power companies worldwide; that for reporting purposes, the change will simplify the Company's and the group's accounting procedures resulting in reliable and accurate figures in the financial statements; and that the change to Straight Line Method will also allow the Company and its affiliates to adopt the generally used and widely accepted method of computing depreciation in the power industry. In connection therewith, you now request authority to change the method of computing depreciation of the Company's power plant and related equipment from Output/Unit of Production Method to Straight Line Method effective January 1, 2005. In reply thereto, please be informed that Section 34(F)(1) of the Tax Code of 1997 provides that there shall be allowed as 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 regulations prescribed by the Secretary of Finance, under any of the following methods: (1) The straight-line method; (2) 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); (3) The sum-of-the-years-digit method; and (4) Any other method which may be prescribed by the Secretary of Finance upon recommendation of the Commissioner. TIaCHA Corollarily, Section 109 of Revenue Regulations No. 2, otherwise known as the Income Tax Regulations, 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 installment or in accordance with any other recognized trade practices, 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 and 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." 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. (Sec. 105, Revenue Regulations No. 2) [cited in BIR Ruling No. DA10-98 dated January 21, 1998, DA267-98 dated June 24, 1998; and DA413-04 dated July 30, 2004] In applying the above-cited provisions of law, this Office in BIR Ruling No. DA 119-03 dated April 14, 2003 ,ruled that "...considering that DPI will in essence be claiming increased depreciation charges during its ITH, the retroactive application thereof is hereby granted since no tax benefit therefrom accrues to DPI, and government collections will not be prejudiced because of such change." later in BIR Ruling No. DA413-04 dated July 30, 2004 ,it was likewise ruled that ". . . Solid Shipping Lines Corporation, is hereby allowed to use the appraisal fair market values of their property, plant and equipment used in business as determined and reported by an independent appraiser and depreciate the same based on their remaining useful life as re-estimated in the light of the subsequent facts or the straight-line method of depreciation pursuant to Section 109 of Revenue Regulations No. 2." Considering that the Straight Line Method will accurately determine the depreciation allowance for the power plant barges hence, better clearly reflect the true income of EAUC, as the change is made to align the method of depreciation of its Philippine affiliate companies with the current method applied by related companies in other countries. The change to Straight Line Method of depreciation will also simplify the Company's and the group's accounting procedures and conform to the generally used and accepted method of depreciation in the power industry. ISDCHA SUCH BEING THE CASE, your request for the change in the Country's method of computing depreciation allowance for its two (2) power plant barges and related equipment from output/Unit Production Method to Straight Line Method effective January 1, 2005 is hereby GRANTED. 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 & Inspection Group