BIR Ruling [DA-595-04]

November 23, 2004 BIR RULING [DA-595-04] Regulations No. 2 014-02 Japan-PNB Leasing 8/F, PNB Financial Center Pres. D. Macapagal Blvd. Pasay City Attention: Mr. Vicente Ll. Ramirez, Jr. Executive Vice President Gentlemen : This refers to your letter dated March 25, 2004 stating that you are a financing company registered under the laws of the Philippines and is primarily engaged in general financing and financial leasing business, including activities limited to financing companies authorized to operate under the New Financing Company Act of 1998; that since the start of your commercial operations in 1998, you have adopted the Rule of 78 Method in determining the interest income on your loan and financial lease transactions; that under the Rule of 78 Method, the proceeds of the credit extended to your client on an agreed term ranging from 12 to 60 months, shall be net of interest since the interest due thereon shall be deducted in advance, which is booked as follows: Financial Receivable xxx Cash xxx Unearned Interest & Discounts (UID) or xxx Unearned Lease Income (ULI) that the unearned portion of the interest collected in advance (UID) on discount notes and loans and unearned lease income (ULI) or the unearned interest portion of rentals on financial lease transactions, shall be amortized over the agreed term; that the earned portion of the UID/ULI are recognized as income in the company books on a monthly basis using the Rule of 78 Method (otherwise known as the sum-of-months-digit method) based on a computed factor for each method; that however, the Rule of 78 Method is not in accordance with the Statement of Financial Accounting Standards (SFAS) No. 19, Summary of Generally Accepted Accounting Principles for Banks and Financial Intermediaries; neither does it comply with that of SFAS No. 17, Accounting for Leases as adopted from International Accounting Standards IAS 17; that both statements of financial accounting standards issued by the Accounting Standards Council specifically require adoption of the Interest or Annuity Method in recognizing income on loans and financial lease transactions; and that interest income under this method is to be recognized based on outstanding principal balance of the loan or financial lease. Based on the foregoing representations, you now request permission to shift from the Rule of 78 Method to the Interest or Annuity Method of income recognition and the retroactive application thereof starting January 1, 2004. In reply thereto, please be informed that on the basis of the above representations, your company is hereby granted permission to shift its accounting method of determining interest income from Rule of 78 Method to the Interest on Annuity Method provided that the latter truly reflects your income for the period. The change of accounting method from one system to another is allowed under the provision of Section 43 of the Tax Code of 1997, in relation to Section 167 of Revenue Regulations No. 2, the pertinent portion of which provides as follows: "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 with the books of such taxpayer but if no such method of accounting has been 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. . . . "Section 167 of Revenue Regulations No. 2 provides aTADcH ". . . 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 for his purpose. . . . Any approved standard method of accounting which reflects taxpayer's income may be adopted. . . ." With regard to your request that the authority granted be made to retroact to January 1, 2004, since the request for change of accounting method was filed with this Office on March 24, 2004, or within the 90 day period required by Section 168 of Revenue Regulations No. 2, please be advised that the same is hereby granted. Section 168 of Revenue Regulations No. 2 states: "Section 168. Change in Accounting Methods . xxx xxx xxx 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. . . ." 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