Pepsi-Cola Products Philippines, Inc.

September 14, 2007 BIR RULING [DA-489-07] Pepsi-Cola Products Philippines, Inc. Km. 29 National Road Tunasan, Muntinlupa City Attention: Atty. Redentor R. Gabinete Tax Director Gentlemen : This refers to your letter dated May 25, 2007 stating that Pepsi-Cola Products Philippines, Inc. (PCPPI) is a domestic corporation organized and existing under Philippines laws; that it is engaged in manufacturing, sales and distribution of carbonated soft drinks and other non-alcoholic beverages to retail wholesale, restaurants and bar trades; that it has plants, business units and sales offices in strategic cities and municipalities in Luzon, Visayas and Mindanao; that the taxable year of PCPPI begins on July 1 of each year and ends on June 30 of the following year; that to facilitate consumption of PCPPI's soft drinks and other non-alcoholic beverages, returnable containers bought from its suppliers are being used for the sale and distribution of soft drinks and other non-alcoholic beverages; that PCPPI sells only the contents of soft drinks and non-alcoholic beverages; that for such purpose, returnable containers are being used by PCPPI under 'deposit scheme'; that under such scheme, PCPPI requires its distributors/dealers or retailers or consumers to deposit certain amounts, which are approximately the residual values of the returnable containers; that upon return of such returnable containers, the deposit values are being returned or refunded to the distributors/dealers, retailers or consumers; that at present, the glass bottles and cases are capitalized in the books of accounts at their deposit values; that these deposit values pertain to the amounts at which PCPPI is obliged to pay to the customer upon the return of the bottles and cases, and are recorded as liabilities of PCPPI; that the excess of the purchase cost of the bottles and cases over the deposit values is deferred and amortized over the estimated useful lives principally determined by their actual historical breakage; that the bottles are amortized over five years and the cases over seven years, using the straight line method; that the amortized amounts are then expensed off, both for accounting and income tax purposes; and that an allowance is provided for the excess, unusable and obsolete returnable bottles and cases based on the specific identification method. TcDAHS The Change in Accounting Method PCPPI intends to change the method of accounting, for income tax purposes, for the excess of the purchase cost of the returnable bottles and cases over the deposit values. Instead of capitalizing and amortizing them over five or seven years, PCPPI is proposing to charge them off against operations, for income tax purposes. PCPPI will capitalize only the amount pertaining to the deposit values and such amount will not be amortized. The amount pertaining to the deposit values shall be reduced by the breakages and the return of the bottles and cases. Under the present income tax treatment, effectively, the cost of such returnable containers after taking into consideration the deposits, obsolete, unusable and non-returned containers, are being expensed over the useful lives (five years for bottles and seven years for cases) of the said returnable containers. PCPPI finds no disagreement over such treatment for financial accounting purposes based on the ongoing presumption that the accounting periods benefit from the use of such returnable cases. The accounting principles require that the same be capitalized and amortized. In reality, such does not actually happen. The useful lives are mere estimated useful lives and the actual scenario has no assurance that the bottles and cases will last that long on account of many factors. ICcDaA The returnable containers are personal properties and as such, ownership thereof transfers upon delivery or tradition. By the payment of the deposits, the retailers and sales outlets basically acquire full control on the disposition of such returnable containers in the conduct of their respective business operations. They may or may not return said bottles as they have already paid the deposits. On the same token, such returnable containers can be or may have been damaged, rendering the same unfit for use in the hands of the distributors, retailers or sales outlets. In short, PCPPI losses control over the said returnable containers. It only relies on the deposits paid and the declarations of the retailers and sales outlets upon deliveries as to the condition of such bottles. PCPPI does not become aware of any immediate update on the condition of such returnable containers to warrant an outright adjustment in its books of accounts. It would be nearly impossible to fully account for all such returnable containers on a very frequent basis due to the volume thereof and since these are scattered all over the entire archipelago. From the foregoing scenario, it can be concluded that the present treatment of amortizing the excess of cost over the deposit values does not clearly reflect PCPPI's true income during the taxable year. Returnable containers continue to appear in the books, but not knowing that in reality, they are already unaccountable, for reasons that may affect computation of income and expenses for income tax purposes. Accordingly, there are potential understatements of income and expense items in such a situation and this can be detrimental both to the government and PCPPI. IDSaAH Based on the foregoing representations, you now request permission that PCPPI be allowed to change its accounting method, for income tax purposes, on the treatment of the excess of the purchase cost of the bottles and cases over their deposit values, from the current practice of amortizing the same throughout the useful lives of the respective returnable containers to charging such entire excess as deductible expense on the taxable year of acquisition. In reply thereto, please be informed that Section 43 of the Tax Code of 1997 provides that "Sec. 43. General Rule . The taxable income shall be computed upon the basis of the taxpayer's annual accounting period (fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been so employed or if the method employed does not clearly reflect the income, the computation shall be made in accordance with such method as in the opinion of the Commissioner clearly reflects the income. . . . ." Corollarily, Sections 166, 167 and 168 of Regulations No. 2, otherwise known as the Income Tax Regulations, provides that "Sec. 166. General Rule . The method of accounting regularly employed by the taxpayer in keeping his books, if such method clearly reflects his income is to be followed with respect to the time as of which items of gross income and deductions are to be accounted for. If the taxpayer does not regularly employ a method of accounting which clearly reflects it. . . ." DHECac "Sec. 167. Methods of Accounting . It is recognized that no uniform method of accounting can be prescribed for all taxpayers, and the law contemplates that each taxpayer shall adopt such forms and systems of accounting as are in his judgment best suited to his purpose. Each taxpayer is required by law to make a return of his true income. He must, therefore, maintain such accounting records as will enable him to do so. Any approved standard method of accounting which reflects taxpayer's income may be adopted. Among the essentials are the following: (1) In all cases in which the production, purchase, or sale of merchandise of any kind is an income producing factor, inventories of the merchandise on hand (including finished goods, work in process, raw materials and supplies) should be taken at the beginning and end of the year and used in computing the net income of the year in accordance with Sections 144 to 151 of these regulations; (2) Expenditures made during the year should be properly classified as between capital and income; that is to say, expenditures for items of plant, equipment, etc., which have a useful life extending substantially beyond the year should be charged to a capital account and not to an expense account; and DTEScI (3) In any case in which the cost of capital assets is being recovered through deductions for wear and tear, depletion, or obsolescence, any expenditure (other than ordinary repairs) made to restore the property or prolong its useful life should be added to the property account or charged against the appropriate reserve and not to current expenses." "Sec. 168. Changes in Accounting Methods . The true income, computed under the law shall in all cases be entered in the return. If for any reason the basis of reporting income subject to tax is charged, the taxpayer shall attach to his return a separate statement setting forth for the taxable year and for the preceding year the classes of items differently treated under the two systems, specifying in particular all amounts duplicated or entirely omitted as the result of such change. A taxpayer who changes the method of accounting employed in keeping his book shall, before computing his income upon new method for purposes of taxation, secure the consent of the Commissioner of Internal Revenue. For purposes of this action, a change in the method of accounting employed in keeping books means any change in the accounting treatment of items of income or deductions, such as a change from cash receipts and disbursements method to the accrual method, or vice versa; a change involving the basis of valuation employed in the computation of inventories (see Sections 144 to 151 of these regulations); a change from the cash or accrual method to the long-term contract method, or vice versa; a change in the long-term contract method from percentage of completion basis to the completed contract basis or vice versa (see Section 44 of these regulations); or a change involving the adoption of, or a change in the use of, any other specialized basis of computing net income such as the crop basis. Application for permission to change the method of accounting employed and the basis upon which the return is made shall be filed within 90 days after the beginning of the taxable year to be covered by the return. The application shall be accompanied by a statement specifying all amounts which would be duplicated or entirely omitted as a result of the proposed change. Permission to change the method of accounting will not be granted unless the taxpayer and the Commissioner of Internal Revenue agree to the terms and conditions under which the change will be effected." CScTDE IN VIEW OF THE FOREGOING, this Office grants PCPPI's request to change its accounting method, for income tax purposes, for the bottles and cases purchased by PCPPI effective July 1, 2005, on the treatment of the excess of the purchase cost of the bottles and cases over their deposit values which will be charged off as an income tax deduction during the year of purchase, in order to truly reflect its income for tax purposes. 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. EScAID Very truly yours, (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service