Bernaldo Mirador & Directo Law Offices

December 28, 2007 BIR RULING [DA-698-07] 34 (A) (1) (a) Bernaldo Mirador & Directo Law Offices Unit 1807, Cityland Condominium 10-Tower 1 6815 Ayala Avenue cor. H.V. dela Costa St. Makati City Attention: Atty. Perfecto E. Mirador, Jr. Partner Gentlemen : This refers to your letter dated July 12, 2007 requesting on behalf of your client, Pepsi-Cola Products Philippines, Inc. (PCPPI), for confirmation of opinion that the marketing equipments to be distributed to its retailers and sales outlets are income tax deductible expense contemplated under Section 34 (A) (1) (a) of the 1997 Tax Code, as amended. The facts as you represented are as follows: PCPPI is a domestic corporation duly registered with the Securities and Exchange Commission (SEC) primarily engaged in the manufacture, sales and distribution of carbonated soft drinks and other non-alcoholic beverages to retail, wholesale, restaurants and bar trades. Its principal office is located at Km. 29, National Road, Tunasan, Muntinlupa City and has various plants, business units and sales offices in strategic parts of Luzon, Visayas and Mindanao. As part of its marketing strategy, PCPPI has been acquiring and distributing marketing equipments, without any cost and as promotional items to the wholesalers, retailers and sales outlets under certain conditions ( e.g. volume of average daily/monthly sales of PCPPI products, exclusively for storage of PCPPI products, etc.). The marketing equipment, consisting of ice coolers, powered coolers, jet sprays and dispensers are being used by the customers of PCPPI to store and dispense the PCPPI products that they have purchased. You are of the opinion that the cost of the marketing equipment to be distributed by PCPPI to the wholesalers, retailers and outlets as promotional items qualify as ordinary and necessary business expense under Sections 34 (A) (1) (a), 98, 100 and other related rules and regulations implementing the provisions of the 1997 Tax Code, as amended. In reply, please be informed that pursuant to Section 34 (A) (1) (a) of the Tax Code of 1997, as amended, for income tax purposes an ordinary and necessary expense paid or incurred during the taxable year that is directly attributable to the operation and/or conduct of trade of the taxpayer shall be allowed as deduction from gross income, thus: HICEca "Section 34(A)(1)(a). In General . There shall be allowed as deduction from gross income all the ordinary and necessary 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, . ." Relatively, 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) laid down the requisites of deductibility of an expense, and it proceeds as follows: "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." In BIR Ruling No. DA-298-05 dated July 1, 2005, this Office, citing the above Supreme Court cases, held as follows: "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." Furthermore, it was held by the Supreme Court, quoting some US Supreme Court decisions and authorities, "an item of expenditure, in order to be deductible under this section of the statute providing for the deduction of ordinary and necessary business expenses, must fall squarely within the language of the statutory provision. This section is intended primarily although not always necessarily, to cover expenditures of a recurring nature where the benefit derived from the payment is realized and exhausted within the taxable year. Accordingly, if the result of the expenditure is the acquisition of an asset which has an economically useful life beyond the taxable year, no deduction of such payment may be obtained under the provisions of the statute. In such cases, to the extent that a deduction is allowable, it must be obtained under the provisions of the statute which permit deductions for amortization, depreciation, depletion or loss." From the foregoing, this Office posits that the said marketing equipments composed of ice coolers, powered coolers, jet sprays and dispensers are properly classifiable as ordinary and necessary expenses contemplated under Section 34 (A) (1) (a) of the Tax Code of 1997 based on the following grounds, to wit: a) PCPPI has to purchase and distribute the marketing equipment regularly and habitually because these are needed by the wholesalers, retailers and sales outlets in storing and dispensing the products of PCPPI; b) The distribution of the marketing equipment is necessary in the development of PCPPI's business because it will result to more products being sold; c) The purchase and distribution of the marketing equipment by PCPPI are indispensable in its trade or business because such are also being done by its competitors and other industry players; and d) By physically delivering the marketing equipment to its customers, PCPPI conveys the ownership thereof. The ownership of a marketing equipment, which is a personal property with no title or certificate of ownership, is effectively passed on to the recipient retailers or sales outlet by mere delivery. ETDaIC It can be said that the marketing equipments fall under the category of necessary expense, as the same are appropriate and helpful in the development of the taxpayer's business. Likewise, the same fall under the category of ordinary expenses as such involve payments or acquisitions, which are normal in relation to the business of the taxpayer and the surrounding circumstances. By the very nature of PCPPI's products, softdrinks and other non-alcoholic beverages are best saleable when cold and the coolers and other marketing equipments are indispensable, aid in promoting sales and ultimately in increasing its market share in the industry. Furthermore, the fact that the marketing equipments are meant to be distributed or delivered to the customers and not to be retained by PCPPI for use in its trade or business ( e.g., manufacturing equipment, furniture and fixtures and any similar fixed asset), PCPPI will not claim, for income tax purposes any depreciation deduction. As such, the marketing equipments to be distributed by PCPPI to its retailers and sales outlets are income tax deductible expense contemplated under Section 34 (A) (1) (a) of the 1997 Tax Code, as amended, subject however to the substantiation requirements. This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it will be ascertained that the facts are different, then this ruling shall be considered as null and void. Very truly yours, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service