BIR Ruling [DA-555-04]

November 8, 2004 BIR RULING [DA-555-04] Baniqued & Baniqued Suite 803, 8/F Jollibee Centre San Miguel, Ortigas Center Pasig City Attention: Atty. Carlos G. Baniqued Atty. Laura Victoria A.S. Yuson-Layug and Atty. Kathleen L. Saga Gentlemen : This refers to your letter dated October 5, 2004 stating that your client, Fortune Cement Corporation (FCC), is a corporation organized and existing under Philippine laws; that FCC is engaged in the business of manufacturing and selling cement; that on the other hand, Premier Cement Corporation (Premier) is a wholly-owned subsidiary of FCC; that Premier is a domestic corporation engaged in the manufacture and distribution of cement; that on June 4, 2004, the Securities and Exchange Commission (SEC) approved the statutory merger of Premier into FCC; that consequently, all assets and liabilities of Premier were transferred to and vested in FCC by operation of law; that Premier (now FCC) has an existing cement plant in Cebu; that the plant is very old and was previously utilized by Premier for the purpose of manufacturing and producing white cement; that the plant was last rehabilitated in 1980; that while the plant was in operation, Premier had only a 27% market share notwithstanding that it was the sole domestic producer of white cement; that the imported white cement, principally from Malaysia, accounted for 63% of the market share; that moreover, its retail price for white cement was only 48% of that of the market leader; that because of its unrealiable product quality, especially with respect to strength and product consistency, it had very low product recognition, even in Cebu where it was located and where it should have had an exceedingly high market share; that the inaccessibility of the plant (i.e., only accessible by sea since the road conditions were difficult) likewise contributed to its insignificant market share; that because of declining market conditions for white cement, Premier's product quality and its high full production cost, the plant's quarry operation and clinker production were suspended in 1996; that from 1996 to 2000, the plant only operated when there were orders, and operation was then limited to grinding of its remaining clinker stock; that in 2001, Premier sold its white cement trading business and the operation of the plant has since ceased; that in its existing state, and unless rehabilitated, the operation of the plant may cause serious environmental hazard on account of the plant's excessive dust emissions; that the cost to rehabilitate the plant to correct this major environmental hazard entails a substantial capital outlay which would likely exceed any projected revenue from the plant's rehabilitation; that the rehabilitation is likewise not economically feasible due to the oversupply of white cement in the ASEAN region and cost efficiency of simply importing white cement from Malaysia; that because of the region's oversupply of white cement vis--vis a declining low demand, exportation of the plant's products is likewise not viable, moreover, exportation would require additional investments on new longer wharves with higher draft in order to accommodate larger ships; that the plant's capacity (40,000 tons per year) cannot be expanded without unreasonable costs; that the earnest efforts to sell the plant were all in vain since there were no other known industries that could make use of such a small capacity plant; that considering the enormous cost of upgrading the plant and making it operational, it was decided that the plant's operations be discontinued permanently; and that the plant was eventually abandoned and permanently discarded. Based on the foregoing representations, you now request confirmation of your opinion that the write-off of Premier's (now FCC) cement plant in Cebu, which plant has been permanently abandoned and discarded, is deductible for income tax purposes pursuant to Section 34(D) of the Tax Code of 1997 in relation to Section 98 of Revenue Regulations No. 2. In reply thereto, please be informed that Section 34(D)(1) of the Tax Code of 1997 provides that "Sec. 34. Deductions from Gross Income. Except for taxpayers earning compensation income arising from personal services rendered under an employer-employee relationship where no deductions shall be allowed under this Section other than under Subsection (M) hereof, in computing taxable income subject to income tax under Sections 24(A); 25(A); 26; 27(A), (B) and (C); and 28(A)(l), there shall be allowed the following deductions from gross income: "xxx xxx xxx "(D) Losses. "(1) In General. Losses actually sustained during the taxable year and not compensated for by insurance or other forms of indemnity shall be allowed as deductions: "(a) If incurred in trade, profession or business; "(b) Of property connected with the trade, business or profession, if the loss arises from fires, storms, shipwreck, or other casualties, or from robbery, theft or embezzlement. The Secretary of Finance, upon recommendation of the Commissioner, is hereby authorized to promulgate rules and regulations prescribing, among other things, the time and manner by which the taxpayer shall submit a declaration of loss sustained from casualty or from robbery, theft or embezzlement during the taxable year: Provided, however, That the time limit to be so prescribed in the rules and regulations shall not be less than thirty (30) days nor more than ninety (90) days from the date of discovery of the casualty or robbery, theft or embezzlement giving rise to the loss. SCDaET "(c) No loss shall be allowed as a deduction under this Subsection if at the time of the filing of the return, such loss has been claimed as a deduction for estate tax purposes in the estate tax return. "xxx xxx xxx" Corollarily, Section 98 of Revenue Regulations No. 2 provides that "Section 98. Loss of Useful Value. When through some change in business conditions, the usefulness in the business of some or all of the capital assets is suddenly terminated, so that the taxpayer discontinues the business or discards such assets permanently from use of such business, he may claim as deduction the actual loss sustained . In determining the amount of the loss, adjustment must be made, however, for improvements, depreciation and the salvage value of the property. This exception to the rule requiring a sale or other disposition of property in order to establish a loss requires proof of some unforeseen cause by reason of which the property has been prematurely discarded, as, for example, where an increase in the cost or change in the manufacture of any products makes it necessary to abandon such manufacture, to which special machinery is exclusively devoted, or where new legislation directly or indirectly makes the continued profitable use of the property impossible . This exception does not extend to a case where the useful life of property terminates solely as a result of those gradual processes for which depreciation allowances are authorized. It does not apply to inventories or to other than capital assets. The exception applies to buildings only when they are permanently abandoned or permanently devoted to a radically different use, and to machinery only when its use as such is permanently abandoned . Any loss to be deductible under this exception must be charged off in the books and fully explained in returns of income." (emphasis supplied) It is clear from the foregoing, that in order for a loss to be deductible, the following requisites must be met: (1) the loss must be of the taxpayer; (2) the loss must be actually sustained and charged off within the taxable year; (3) the loss must have been incurred in trade, business or profession; (4) the loss must be evidenced by a closed and completed transaction; and (5) the loss must not have been compensated for by insurance or other forms of indemnity. ( Manotok Realty Incorporated vs. Commissioner of Internal Revenue , CTA Case No. 5485, October 18, 1999) In BIR Ruling No. 076-94 dated February 21, 1994, this Office ruled that ". . . client's machine or equipment which are discarded, or the use of which has been abandoned in 1990 if charged off in the books and fully explained in the income tax return shall be deductible from your client's gross income for 1990 to the extent of its net book value. WHEREFORE, in view of the foregoing , this Office hereby confirms your opinion that losses sustained by your client, FCC, arising from the write-off of its cement plant which has been permanently abandoned or discarded are deductible for income tax purposes pursuant to Section 34(D) of the Tax Code of 1997 in relation to Section 98 of Revenue Regulations No. 2. 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. cDHCAE Very truly yours, (SGD.) JOSE MARIO C. BUAG Deputy Commissioner Legal & Inspection Group