Salvador Guevara & Associates

May 17, 2007 BIR RULING [DA-305-07] 34 (F); 110; DA-031-03 Salvador Guevara & Associates 815-816, Tower One & Exchange Plaza Ayala Triangle, Ayala Avenue 1226 Makati City Attention: Atty. Maria Rosario L. Bernardo & Atty. Rabiev Tobias M. Racho Gentlemen : This refers to your letter dated March 28, 2007 requesting on behalf of your client, Nestl Philippines, Inc. ("NPI") , confirmation of the following: 1. NPI can change the useful life of its manual tricycles ("Trykes") from five (5) years to three (3) years in claiming depreciation deduction, both for tax and financial accounting purposes, and that NPI can adopt such change starting August 2006. 2. Where the aggregate acquisition cost of the Trykes and other depreciable goods purchased by NPI during any calendar month (excluding the VAT component thereof) exceeds One Million Pesos (Php1,000,000), NPI can spread the input tax on the Trykes evenly on a monthly basis by dividing the input tax by thirty six (36) corresponding to the actual number of months comprising the estimated useful life of the Trykes. It is represented that NPI is a domestic corporation engaged in the manufacture of brand food products and beverages; that to ensure wider retail coverage, NPI allows its distributors to use the Trykes owned by NPI for street selling operations; and that each unit has an estimated cost of P25,000. It is further represented that prior to August 2006, NPI adopted a useful life of five (5) years for the purpose of claiming depreciation deduction for the Trykes; that, however, starting August 2006, NPI has adopted a useful life of 3 years on newly acquired Trykes; and that the change in useful life was based on the following factual considerations: 1. Steering Assembly The nuts (M-15), brackets (only 10 mm), bearing and housing are good only for three years. 2. Bike Frames The standard 1/2 inch-thick pipe used for the bike frame will not stand a five-year continuous use on village roads where the Trykes usually ply. 3. Hand Brake Assembly The hand brake assembly also uses 1/2 inch-thick pipes, which will not stand a five-year continuous use. 4. Roof Frame The roof frame uses 3/4 inch-thick pipes, which will also not stand a five-year continuous use. 5. Pipes The pipes used are not stainless. It is also represented that NPI could not use thicker materials in lieu of the specifications described above, because the added weight of the materials together with the equally heavy cool box in which the Nestl products are stored makes it harder for the vendor to ply his route. Finally, based on the above considerations, it is represented that it has become impractical and unsound to depreciate the Trykes based on a useful life of 5 years; and that with annual refurbishments in the minor parts, wheels and paintings of the Trykes, a 3-year useful life is more reasonable for the purpose of claiming depreciation expense. In reply, please be informed as follows: A. Change in Useful Life Under Section 34 (F), 1997 Tax Code, as amended, a reasonable allowance for the exhaustion, wear and tear (including reasonable allowance for obsolescence) of property used in trade or business is allowed as depreciation deduction. We quote Section 34 (F), 1997 Tax Code, as amended, as follows: "(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. In the case of property held by one person for life with remainder to another person, the deduction shall be computed as if the life tenant were the absolute owner of the property and shall be allowed to the life tenant. In the case of property held in trust, the allowable deduction shall be apportioned between the income beneficiaries and the trustees in accordance with the pertinent provisions of the instrument creating the trust, or in the absence of such provisions, on the basis of the trust income, allowable to each. (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. (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. caHIAS 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." In this connection, Section 105, Revenue Regulations No. 2 provides: "Section 105. Depreciation . A reasonable allowance for the exhaustion, wear and tear, and obsolescence of property used in the trade or business may be deducted from gross income. For convenience, such an allowance will usually be referred to as depreciation, excluding from the term any idea of a mere reduction in market value not resulting from exhaustion, wear and tear, or obsolescence. The proper allowance for such 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 also be given to expenditures for current upkeep." Moreover, Section 109, Revenue Regulations No. 2 also states: "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 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 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 reestimated in the light of the subsequent facts, and depreciation deductions taken accordingly." Based on the foregoing, the taxpayer and the Commissioner may agree 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. However, if it develops that the useful life of the property originally estimated under previous factual conditions is no longer reasonable, the law allows the taxpayer to lengthen or shorten the useful life of the property in the light of prevailing factual considerations. Hence, in BIR Ruling DA-031-03 dated February 3, 2003, this Office allowed the shortening of the depreciable life of a building from 45 to 25 years based on the current net book value of the building, to correspond to the 25-year lease agreement entered into between owner of the building and its lessee. It has been ruled that the remaining estimated useful life of the assets is 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 a 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 (BIR Ruling No. 144-97 dated December 29, 1997). NPI has determined that the useful life of the Trykes originally estimated at 5 years is no longer reasonable given the above-discussed factual consideration's. Based on the foregoing, this Office hereby confirms that NPI can change the useful life of its Trykes from 5 years to 3 years in claiming depreciation deduction, both for tax and financial accounting purposes, and that NPI can adopt such change starting August 2006. B. Amortization of Input VAT Section 110, Tax Code, as amended, 1 states in part: ". . . the input tax on goods purchased or imported in a calendar month for the use in trade or business for which deduction for depreciation is allowed under this Code, shall be spread evenly over the month of acquisition and the fifty-nine succeeding months if the aggregate acquisition cost for such goods, excluding the VAT component thereof, exceeds One million pesos (P1,000,000.00): Provided, however, That if the estimated useful life of the capital good is less than five (5) years, as used for depreciation purposes, then the input VAT shall be spread over such a shorter period . . . ." In this connection, Section 4.110-3, Revenue Regulations No. 16-2005, 2 as amended by Revenue Regulations No. 4-2007, 3 provides as follows: "SEC. 4.110-3. Claim for Input Tax on Depreciable Goods . . . . . (a) . . . (b) If the estimated useful life of a capital good is less than five (5) years. The input tax shall be spread evenly on a monthly basis by dividing the input tax by the actual number of months comprising the estimated useful life of a capital good. The claim for input tax credit shall commence in the month that the capital goods were acquired. Where the aggregate acquisition cost (exclusive of VAT) of the existing or finished depreciable capital goods purchased or imported during any calendar month does not exceed one million pesos (P1,000,000.00), the total input taxes will be allowable as credit against output tax in the month of acquisition. Capital goods or properties refers to goods or properties with estimated useful life greater than one (1) year and which are treated as depreciable assets under Sec. 34(F) of the Tax Code, used directly or indirectly in the production or sale of taxable goods or services. cTADCH The aggregate acquisition cost of depreciable assets in any calendar month refers to the total price, excluding the VAT, agreed upon for one or more assets acquired and not on the payments actually made during the calendar month. Thus, an asset acquired on installment for an acquisition cost of more than P1,000,000.00, excluding the VAT, will be subject to the amortization of input tax despite the fact that the monthly payments/installments may not exceed P1,000,000.00." (Emphasis supplied) Based on the foregoing, it is hereby confirmed that where the aggregate acquisition cost of the Trykes and other depreciable goods purchased by NPI during any calendar month (excluding the VAT component thereof) exceeds Php1,000,000.00, NPI can spread the input tax on the Trykes evenly on a monthly basis by dividing the input tax by 36 corresponding to the actual number of months comprising the estimated useful life of the Trykes. 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, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service Footnotes 1. As amended by Republic Act No. 9337. 2. Dated September 1, 2005. 3. Dated February 7, 2007.