BIR Ruling [DA-745-06]

December 29, 2006 BIR RULING [DA-745-06] Section 34 (D); RR 2; No. 45-91 Isla Lipana & Co. 29th Floor Philamlife Tower 8767 Paseo de Roxas 1226 Makati City Attention: Atty. George J. Lavadia Principal, Tax Services Gentlemen : This refers to your letter dated February 28, 2006 requesting on behalf of your client, PIC Philippines, Inc. (PIC), for confirmation of your opinion that inventory devaluations on account of hog deaths are ordinary business losses under Section 34 (D) (1) (a) of the Tax Code and not casualty losses under Section 34 (D) (1) (b) of the same Code. It is represented that PIC is a domestic corporation engaged in the business of reselling, trading, or dealing with farmers or hog raisers on wholesale basis including the production of breeders through the use of biotechnology techniques and the raising of hogs for sale. It is registered with the Bureau of Internal Revenue (BIR) under Taxpayer Identification No. 216-292-537-300. PIC currently maintains its hog inventory in three (3) farms located in Panabo City, Davao del Norte; San Pablo City, Laguna; and Lopez, Quezon, respectively. From fiscal years ending June 30, 2002 to 2005 (FY 2002 to 2005), PIC suffered hog deaths of approximately 7,530. 97.41% of all hog deaths are attributable to the deaths of piglets which are classified as suckling pigs, nursery piglets or finishing pigs. From being newly-born to six months of age, these piglets have naturally low resistance and immunity which render them highly vulnerable to disease and illness. aIAcCH Suckling pig deaths account for almost 50% of total pig mortality. The leading causes of deaths are biological weaknesses, cannibalism by the lactating sows, starvation, cold weather, suffocation due to trampling. On the other hand, nursery piglet deaths constitute twenty-five percent (25%) of all hog deaths and are due to diarrhea, respiratory illnesses, atropic rhinitis, stress, heart attack, overcrowding, meningitis, pneumonia, tail biting. Lastly, finishing pigs, which comprise twenty-three percent (23%) of all hog deaths, fall victims to heart failures caused by extreme heat, fighting, diarrhea, poor conditioning, stress, meningitis and pneumonia. The annual mortality rate from FYs 2002 to 2005 averages 5.46% of total pigs. The inventory value of such deaths since FY 2002 amounts to approximately P14,975,897.00. Consistent with the pig mortality rates, pigs up to six (6) months of age account for a very substantial portion, i.e. at least eighty-eight percent (88%), of the value of total hog deaths. In reply, please be informed that Section 34 (D) of the Tax Code provides, viz: "(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. xxx xxx xxx." Losses under Section 34 (D) (1) (a), i.e. normally incurred in the trade, profession or business, are considered ordinary losses while losses under Section 34 (D) (1) (b), i.e. arising from fires, storms, shipwreck, or other casualties, are considered casualty losses. Although both losses are qualified as allowable deductions from gross income, their distinction lies mainly in the additional requirement for deductibility in the case of casualty losses. The last paragraph of Section 34 prescribes the submission of a declaration of loss to the Bureau of Internal Revenue within ninety (90) days but not earlier than thirty (30) days from the date of discovery of the casualty giving rise to the loss. AaSHED In determining whether a loss is an ordinary loss or a casualty loss, the Unnumbered BIR Ruling dated November 21, 1996 is instructive, viz: "The issue to be resolved therefore is not whether the said expense was supported by the required certification but whether said inventory losses were incurred in the normal business operation of herein taxpayer." Thus, the main issue to be resolved is whether or not the hog deaths suffered by PIC constitute ordinary losses. As narrated above, the annual average mortality rate of hogs in PIC is approximately 5.46% of total inventory. The deaths are due to natural causes such as biological weaknesses, cannibalism by the lactating sows, starvation, cold weather, suffocation due to trampling, diarrhea, respiratory illness, atropic rhinitis, heart attack, overcrowding, tail biting, extreme heat, fighting, poor conditioning, stress, meningitis and pneumonia. This inherent reality in the business of hog-raising is confirmed by industry statistics which reveal that Philippine hog farms experience hog deaths at an annual average of 3.843% of total hog population 3.843% with the highest at 10.742% and a lowest at 1.105%. For this matter, Section 100 of Revenue Regulations No. 2 (Income Tax Regulations) specifically provides, viz: "Section 100. Losses of farmers . Losses incurred in the operation of farms as business enterprises are deductible from gross income. . . . . A farmer engaged in raising and selling stock, cattle, sheep, horses, etc. is not entitled to claim as a loss the value of animals that perished from among those animals that were raised on the farm, except as such loss is reflected in an inventory if used. . . . ." Consistent with Section 34 (D) of the Tax Code and implicitly recognizing the common and natural occurrence of mortalities in the business of raising of animals, the foregoing provision allows those engaged in the raising and selling of animals to claim animal deaths as operating losses as deductions from gross income. TCEaDI However, a separate deduction for losses cannot be claimed for the value of animals that were already accounted for or implicit in the ending inventory valuation. In other words, losses from hog deaths accounted for through inventory devaluations (adjustments) cannot be further deducted from gross income. Otherwise, the same loss will effectively be recognized twice in the books resulting in the understatement of gross income. In the same unnumbered BIR Ruling cited above, it was held that ordinary losses are considered allowable deductions under the Tax Code, viz: "As it was actually ascertained/established that the alleged inventory losses occurred from the normal business operation of the taxpayer . . ., we can properly allow the deduction of this expense under Section 29(d)(2) of the Tax Code." In any case, the animal deaths due to the causes stated above are not considered casualty losses. Section 5 of Revenue Regulations No. 12-77 (Re: Substantiation requirement for losses arising from casualty, robbery, theft or embezzlement) implementing Section 29 (now Section 34) of the Tax Code, as amended, defines "casualty" as the complete or partial destruction of property resulting from an identifiable event of a sudden, unexpected, or unusual nature. It denotes accident, some sudden invasion by a hostile agency, and excludes progressive deterioration through steadily operating cause. ( BIR Ruling No. 45-91 dated March 13, 1991 ) As mentioned above, hog deaths suffered by PIC are due to natural causes which cannot, in any way, be construed as "casualties" contemplated under Section 34 (D) (1) (b) of the Tax Code in relation to RR 12-77 for the simple reason that such causes are not "sudden, unexpected, or unusual" events. Therefore, this Office is of the opinion and hereby confirms that inventory devaluations on account of hog deaths are considered ordinary losses under Section 34 (D) (1) (a) of the Tax Code of 1997 and not casualty losses under Section 34 (D) (1) (b) of the same Code. 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 as null and void. Very truly yours, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service