Pepsi-Cola Products Philippines, Inc.

September 12, 2008 BIR RULING [DA-(C-061) 212-08] 34 (A) (1); 165-90 Pepsi-Cola Products Philippines, Inc. Km. 29 National Rd. Tunasan, Muntinlupa City Attention: Mr. Redentor R. Gabinete Gentlemen : This refers to your letter dated May 16, 2008 requesting for a confirmation of opinion that the expenses incurred by Pepsi-Cola Products Philippines, Inc. (PCPPI) in the Initial Public Offering (IPO) of its common shares through the Philippine Stock Exchange (PSE) qualify as ordinary and necessary expenses under Section 34 (A) (1) of the 1997 Tax Code, and will not fall within the definition of "capital expenditure", as stated in Section 120 of Revenue Regulations (RR) No. 2. TEHDIA It appears that PCPPI was registered with the Securities and Exchange Commission (SEC) on March 8, 1989, and is authorized to engage in manufacturing, sales and distribution of carbonated soft drinks and non-carbonated beverages at retail and wholesale and to restaurants and bar trades. Prior to the listing of PCPPI shares in the PSE on February 1, 2008, PCPPI had an authorized capital stock of P750,000,000.00 divided into 5,000,000,000 common shares with a par value of P0.15 per share. It had a total issued and outstanding capital stock of P496,948,407.90 divided into 3,312,989,386 common shares with a par value of P0.15 per share. On February 1, 2008, 1,142,348,680 common shares of PCPPI were offered to the public by way of listing at the PSE. The shares sold consist of 380,782,893 new shares issued by way of primary offering and 761,565,787 existing shares sold by certain existing shareholders by way of secondary offering. All shares were offered for sale through the PSE at a price of P3.50 per share. During the listing process, PCPPI had incurred several expenses relating to the initial public offering of original issue of shares. These expenses consist of PSE listing fees, SEC registration fees, underwriters' fees, commissions and professional fees. You are of the opinion that these expenses relating to the IPO of PCPPI qualify as ordinary and necessary expenses under Section 34 (A) (1) of the 1997 Tax Code. 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 are deductible from the gross income. It is likewise, your position that while the expenses may be ordinary and necessary, such are not to be treated as capital expenditures, for income tax purposes. In reply, please be informed that "ordinary and necessary" expenses generally contemplate expenses which are directly connected with and proximately resulting from carrying on the business. They must be shown to be appropriate and helpful in the development of the taxpayer's business for the acquisition or pursuit of income or profit. In the case of Collector of Internal Revenue vs. The Philippine Education Co., Inc. (G.R. No. L-8505 dated May 30, 1956 citing Merten's Law of Federal Income Taxation Vol. IV), the Supreme Court ruled that: ". . . ordinarily, an expense will be considered necessary where the expenditure is appropriate and helpful in the development of the taxpayer's business"; "it is sufficient that the expense were incurred for purposes proper to the conduct of the corporate affairs or for the purpose of realizing a profit or of minimizing a loss"; "the term 'ordinary' as used in these statutes 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 nonrecurring to the particular taxpayer affected . . . . " The issue involved in said case is the deductibility of the fee paid by respondent to the accounting firm Dalupan, Sanchez & Co. in preparing and proving its war damage claim. The petitioner argued that the fee is not a deductible expense because respondent is a corporation engaged in the purchase and sale of textbooks, magazines, office and school supplies, and a variety of other merchandise and commodities and that it was never normally and customarily engaged in filing petitions for war damage compensation, thus the same was not incurred in the kind of business transactions in which respondent is normally and customarily engaged. However, the Supreme Court declared that the fee is deductible. The Supreme Court proceeds that in order that respondent must be able to carry on its business, respondent not only must have sufficient assets but must preserve the same and recover any that should be lost. The fee in question was paid by the respondent to recover its lost assets occasioned by the war and thereby to be so rehabilitated as to be able to carry on its business. Applying the foregoing, we posit that IPO-related expenses are necessary in the pursuit of PCPPI's business. The listing of said shares in the local stock exchange is aimed to expand its access to capital needed to achieve its strategic goals of increasing its current market share and diversifying its product portfolio. As described in the Prospectus for Offering of its primary and secondary shares in the stock market, PCPPI plans to use the net proceeds from the offering to finance its planned capital expenditures for fiscal year 2008 and 2009. If the planned utilization of the additional funds are pursued, necessarily, the volume of the company's sales will increase. Hence, it can be said that the listing of the shares and consequently, the incurrence of the related costs and expenses are necessary. Furthermore, it is usual for corporations to raise capital for its expansion or working capital requirements through borrowings. Expenses incurred in pursuit of such borrowings are acceptable deductions for income tax purposes. More specifically, it is recognized that interest incurred by a taxpayer arising from an indebtedness incurred by it in the acquisition of the property from which it derived the income subject to tax is recognized to be a deductible expense. 1 In this manner, there is no reason why expenses related to generation of funds to be used for capital expansion through equity should be treated differently. It is the purpose of the expenditure that should be the controlling factor in determining whether an expense shall be deemed necessary and not the transaction from which said expenses arose. cAaDHT Pursuant to RR No. 2, no deductions for capital expenditures shall be allowed. Specifically, the pertinent provision of the regulations read: "SEC. 120. Capital expenditures. No deduction from gross income may be made for any amounts paid out for new buildings or for permanent improvements or betterments made to increase the value of the taxpayer's property, or for any amount expended in restoring property or in making good the exhaustion thereof for which an allowance for depreciation or depletion or other allowance is or has been made. Amounts expended for securing a copyright and plates, which remain the property of the person making the payments, are investments of capital. The cost of defending or perfecting title to property constitutes a part of the cost of the property and is not a deductible expense. The amount expended for architect's services is part of the cost of the building. Commissions paid in purchasing securities are a part of the cost of such securities. Commissions paid in selling securities are an offset against the selling price. Expenses of the administration of an estate, such as court costs, attorney's fees, and executor's commissions, are chargeable against the "corpus" of the estate and are not allowable deductions. Amounts to be assessed and paid under an agreement between bondholders or shareholders of a corporation, to be used in a reorganization of the corporation, are investments of capital and not deductible for any purpose in return of income. In the case of a corporation, expenses for organization, such as incorporation fees, attorney's fees and accountants' charges, are ordinarily capital expenditures; but where such expenditures are limited to purely incidental expenses, a taxpayer may charge such items against income in the year in which they are incurred. A holding company which guarantees dividends at a specified rate on the stock of a subsidiary corporation for the purpose of securing new capital for the subsidiary and increasing the value of its stockholdings in the subsidiary may not deduct amounts paid in carrying out this guaranty in computing its net income, but such payments may be added to the cost of its stock in the subsidiary." It should be noted that these rules set that the following expenses shall be capitalized: (1) Creation or acquisition of a property, tangible or intangible, that provides benefit to the taxpayer for a period extending beyond the year the expense was incurred; (2) Enhancement of the value of a property that the taxpayer possesses or owns; or (3) Expenses for the organization of a corporation. The listing of PCPPI's shares of stocks does not create an asset for the company nor will it give rise to a benefit which it shall enjoy beyond the year of listing. On the contrary, the primary benefit of the listing had expanded access to capital and can be only clearly realized in the year of listing when the primary and secondary shares are offered to the public. While it is true that the benefits from having wider access to capital may be enjoyed by PCPPI in succeeding years, there is no certainty at this point whether such benefit can be realized, there being no definite plans on its part to tap again the public for additional capital. In BIR Ruling No. 165-90 dated September 3, 1990, this Office opines that the cost incurred by a company in support of promotion or advertising project of its distributors can not be considered as a capital expense since the taxpayer, in contributing its share in the cost of capital equipment to be acquired pursuant to the project, does not acquire an asset for itself because it does not take title, ownership or possession thereof. Thus, the share of the company in the project is considered ordinary and necessary expenses deductible in computing the net income subject to income tax. Moreover, it can be said that PCPPI's listing in the local stock exchange will enhance visibility, credibility and public profile, which in effect will give rise to positive results, such as expanded business relationships, increased recruiting power and employee commitment. AaCEDS Accordingly, this Office hereby opines that the expenses incurred by PCPPI in the IPO of its common shares through the PSE qualify as ordinary and necessary expenses under Section 34 (A) (1) of the 1997 Tax Code, and as such should be excluded from the meaning of capital expenditure, as stated in Sec. 120 of RR No. 2. 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 null and void. Very truly yours, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service Footnotes 1. Katuparan Realty Corporation vs. CIR, CTA Case No. 4373, February 14, 1993.