BIR Ruling [DA-298-05]

July 1, 2005 BIR RULING [DA-298-05] BIR Ruling No. 165-90; Sec. 34 (A) (l), NIRC Law Offices of Siguion Reyna Montecillo & Ongsiako 4th & 6th Floors, Citibank Center 8741 Paseo de Roxas Makati City Attention: Attys. Jose Lis C. Leagogo and Julie Ann S. Terrado Gentlemen : This refers to your letter dated June 6, 2005 requesting on behalf of your client, Subic Bay Distribution, Inc. (hereinafter referred to as "SBDI"),confirmation on the following: "1. that the storage fees paid by SBDI pursuant to the Storage and Terminaling Cost Sharing Agreement is a valid deductible business expense; and "2. that SBDI has no duty to withhold from income payments to either CSBTI or SBFCI. It is represented that SBDI is a corporation duly organized and existing under the laws of the Philippines, with office address at 19C Tower One, Ayala Triangle, Ayala Ave.,Makati City; that it was incorporated on April 20, 1996, primarily to maintain and operate terminal and depot facilities and related miscellaneous equipment for petroleum or petroleum related products and to distribute and sell the same on wholesale basis; that on December 15, 1999, SBDI entered into Storage and Terminaling Cost Sharing Agreement with Subic Bay Fuels Co.,Inc. (hereinafter referred to as "SBFCI"),a Subic Bay Freeport (SBF)- registered enterprise; that pursuant to the aforementioned cost sharing agreement, effective January 1, 2000, SBDI shall share the monthly costs and reimburse SBFCI for actual charges corresponding to 800,000 out of the 2,400,000 barrel total storage allocation to SBFCI under the original Storage, Terminaling and Throughput Agreement with Coastal Subic Bay Terminal, Inc. (hereinafter referred to as "CSBTI");and that under the above set-up, SBDI shall pay storage fee to SBFCI for the use of the petroleum storage facility of CSBTI located at Subic Bay Freeport Zone. OPINION To support your position, you proceeded to discuss the following: 1). Storage fee as a valid deductible business expense The test of deductibility, as laid down by the Supreme Court in the cases of Atlas Consolidated Mining and Development Corporation vs. CIR (102 SCRA 246) and Esso Standard Eastern, Inc. vs. CIR (175 SCRA 149) ,must be the gauge in allowing or disallowing the expense, thus: "We come, then, to the statutory test of deductibility where it is axiomatic that to be deductible as a business expense, three conditions are imposed, namely: (1) the expense must be ordinary and necessary ,(2) it must be paid or incurred within the taxable year ,and (3) it must be paid or incurred in carrying a trade or business .In addition, not only must the taxpayer meet the business test, he must substantially prove by evidence or records the deductions claimed under the law, otherwise ,the same will be disallowed." (Underscoring supplied). In said cases, the High Court interpreted the terms "ordinary and necessary" and thus ruled that an expense will be considered "necessary" where the expenditure is appropriate and helpful in the development of the taxpayer's business, and "ordinary" when it connotes a payment, which is normal in relation to the business of the taxpayer and the surrounding circumstances. It further clarified that the term "ordinary" does not require that the payments be habitual or normal in the sense that the same taxpayer will have to make them often; the payment may be unique or non-recurring to the particular taxpayer affected. There is no hard and fast rule on the matter. The right to a deduction depends in each case on the particular facts and the relation of the payment to the type of business in which the taxpayer is engaged. The intention of the taxpayer often may be the controlling fact in making the determination. Anent the above, the BIR ruled that the share of a resident foreign corporation in the promotion and advertising costs of a domestic corporation an ordinary and necessary expense deductible in computing the net income of the former subject to income tax, 1 to wit: "... all ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business are deductible from gross income pursuant to Section 29(a)(1)(A) of the Tax Code, as amended (now ____) and as implemented by Section 65 of Revenue Regulations No. 2. Expenses which are 'ordinary and necessary' generally contemplate expenses which are directly connected with and proximately resulting from carrying on the business and must be shown to be appropriate and helpful in the development of the taxpayer's business for the acquisition or pursuit of income or profit (Gancayco vs. CIR, 1 SCRA 980). Thus, the share of TCCEC in the cost of the electric coolers and ice coolers which are to be distributed to dealers-retailers of softdrinks as promotional items are considered ordinary and necessary expenses deductible in computing the net income of TCCEC subject to income tax ." Using the guidelines enunciated above, you posited that SBDI's payment of storage fee to SBFCI is an ordinary and necessary expense since the use of storage facility is normal, appropriate, and helpful in relation to the business of SBDI, hence, the storage fee expense for such use was or is being legitimately incurred in carrying on its business. ETIHCa Moreover, the payment of storage fee is based on a valid, fair, and reasonable cost sharing agreement. Finally, the storage fee expense was duly supported by invoices and official receipts issued in the name of SBDI. 2) SBDI has no duty to withhold a creditable withholding tax (CWT) from payment of storage fee to CSBTI. The Storage and Terminaling Cost Sharing Agreement pertains to the cost sharing between SBDI and SBFCI of the monthly cost of storage and terminaling wherein the former shall reimburse the latter for actual charges paid to CSBTI under the original Storage, Terminaling and Throughput Agreement between SBFCI and CSBTI. In short, the income payment to CSBTI comes directly from SBFCI and not from SBDI, hence, it is SBFCI who has the duty to withhold the CWT on such income payments. You further contended that, assuming that SBDI has the duty to withhold from said income payments to CSBTI or even from income payments received by SBFCI from the SBDI, if any, from the Cost Sharing Agreement, the withholding of CWT will not apply since both latter companies are SBF-registered enterprises and therefore, exempt from creditable withholding tax pursuant to Section 2.57.5(B)(2) of Revenue Regulations (Rev. Regs.) No. 2-98, as amended by Rev. Regs. No. 14-02. The exemption from creditable expanded withholding tax of SBMA accredited/registered enterprises has been consistently sustained by the BIR in several BIR rulings On the basis of the above, you concluded that SBDI does not have the duty to withhold from the storage fee paid to SBFCI. BIR REPLY We hereby rule as follows: 1) Pursuant to Section 34(A)(1)(b) of the Tax Code of 1997, as amended, " there shall be allowed as deduction from gross income all ordinary expenses paid or incurred during the taxable year in carrying on or which are directly attributable to, the development, management, operation and/or conduct of the trade, business or exercise of a profession, including," among others, "(iii) a reasonable allowance for rentals and/or payments which are required as a condition for the continued use or possession, for purposes of the trade, business or profession, of property to which the taxpayer has not taken or is not taking title or in which he has no equity other than that of a lessee, user or possessor ." Subparagraph (b) of same Sec. 34(A)(1) further provides that no deduction from gross income shall be allowed under Subsection A unless the taxpayer shall substantiate with sufficient evidence, such official receipts or adequate records: (a) the amount of the expense being deducted, and (ii) the direct connection or relation of the expense being deducted to the development, management, operation and/or conduct of the trade, business or profession of the taxpayer . Indeed, in the aforementioned cases of Atlas Consolidated Mining and Esso Standard Eastern , Inc ., supra ,the High Court had enunciated the following rule to allow the deduction of an expense from the gross income, to wit: " We come, then, to the statutory test of deductibility where it is axiomatic that to be deductible as a business expense, three conditions are imposed, namely: (1) the expense must be ordinary and necessary, (2) it must be paid or incurred within the taxable year, and (3) it must be paid or incurred in carrying a trade or business. In addition, not only must the taxpayer meet the business test, he must substantially prove by evidence or records the deductions claimed under the law, otherwise, the same will be disallowed ." It further clarified that an expense will be considered "necessary" where the expenditure is appropriate and helpful in the development of the taxpayer's business, and "ordinary" when it connotes payment, which is normal and in relation to the business of the taxpayer and the surrounding circumstances. Moreover, the term "ordinary" does not require that the payments be habitual or normal in the sense that the same taxpayer will have to make them often; the payment may be unique or non-recurring to the particular taxpayer affected. In fine, even the High Court held that there is no hard and fast rule on the matter. The right to a deduction depends in each case on the particular facts and the relation of the payment to the type of business in which the taxpayer is engaged. The intention of the taxpayer often may be the controlling fact in making the determination. HIaSDc This Office, citing an earlier Court's decision, 2 had previously ruled that "expenses which are 'ordinary and necessary' generally contemplate expenses which are directly connected with and proximately resulting from carrying on the business and must be shown to be appropriate in the development of the taxpayer's business for the acquisition or pursuit of income or profit." 3 Thus, in consideration of the fact that the use of storage and terminal facility is directly connected and necessary in carrying on its business, the payment of storage fee by SBDI for the use thereof is an ordinary and necessary expense the same being normal, appropriate and helpful in relation to such business. Moreover, since the payment of storage fee is based on a valid, fair, and reasonable cost sharing agreement between SBDI and CSBTI, and duly supported by invoices and official receipts issued in the name of SBDI, the same is deemed to have been legitimately incurred by SBDI in carrying on its business. Accordingly, the payment of storage fee as a necessary and ordinary expense directly attributable to the business of SBDI is an allowable deduction from the gross income of the said taxpayer pursuant to Section 34(A)(1) of the Tax Code of 1997, as amended. 2. Sec. 2.57.5 of the Rev. Regs. 2-98, as amended by Rev. Regs. No. 6-2001 and 14-02, provides that "Sec. 2.57.5. Exemption from withholding . The withholding of creditable withholding tax prescribed in these Regulations shall not apply to income payments made to the following: xxx xxx xxx (B) Persons enjoying exemption from payment of income taxes pursuant to the provisions of any law general or special, such as but not limited to the following: xxx xxx xxx (2) Corporations duly registered with the Board of Investments, Philippine Export Processing Zone and Subic Bay Metropolitan Authority enjoying exemption from income tax pursuant to E.O. 226, as amended, R.A. 7916, as amended, the Omnibus Investments Code of 1997, and R.A. 7227, respectively; . . ." Applying the foregoing, this Office has consistently ruled that income payments to SBMA accredited enterprises located within the Subic Bay Freeport Zone and enjoying exemption from income tax by virtue of Republic Act No. 7227, otherwise known as the "Bases Conversion and Development Act of 1992, shall be exempt from creditable expanded withholding tax. In consideration of the fact that since both CSBTI to whom SBDI pays the storage fee on a reimbursement of cost basis and SBFCI who is the lessor of the storage and terminal facility, are both SBF-registered enterprises enjoying exemption from income tax pursuant to Republic Act No. 7227, the payment of storage fee by SBDI is not subject to creditable expanded withholding tax pursuant to the aforequoted Sec. 2.57.5 of the Rev. Regs. 2-98, as amended by Rev. Regs. No. 6-2001 and 14-02. Accordingly, SBDI is not under any obligation to withhold the CWT prescribed in the aforementioned regulations on its payment of storage fee. This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation it shall 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 Footnotes 1. BIR Ruling No . 165-90 dated September 3, 1990. 2. Gancayco vs. CIR , supra . 3. BIR Ruling No. 165-90, supra .