SGV & Co.

September 8, 2009 BIR RULING [DA-(C-193) 497-09] 34 (D), 34 (F), RR2; DA-076-94; DA-55-04 SGV & Co. 6760 Ayala Avenue 1226 Makati City Attention: W. U. Villanueva Principal Gentlemen : This refers to your letter dated April 28, 2009 requesting confirmation of your opinion that: 1. KCPI can write-off in its books the assets in its manufacturing plant in San Pedro, Laguna to the extent of its net book value as of December 31, 2008 and for select assets, to the extent of its net book value as of December 31, 2007; and 2. KCPI can shorten the useful lives of its vehicles to be consistent with the standard worldwide policy of Kimberly Clark Corporation (KCC) limiting the depreciable life of automobiles to only four (4) years, instead of five (5) years. CIcEHS It is represented that Kimberly Clark Philippines, Inc. (KCPI), with Tax Identification Number 000-162-194-000, is a domestic corporation engaged in the manufacture and sale of facial and bathroom tissues, paper towels and napkins for household and away-from-home use, disposable diapers, feminine pads/liners, and baby toiletries; that its principal office is in Makati and its manufacturing site is located in San Pedro, Laguna; that after 46 years of operation, and pursuant to the decision of its parent company, KCC, KCPI closed down its manufacturing facility in San Pedro, Laguna effective end of office hours of December 31, 2008; that the decision to close the mill was reached after considering KCPI's inherent cost disadvantage versus competition and to be consistent with KCC's strategy of restructuring its operations in the Asia-Pacific Region; that KCPI started to rationalize its operations and streamline the business in 2005, initially selling its cigarette paper business and commissioning a third-party toll manufacturer to produce its tissue products; that on January 18, 2008, the KCPI board decided to stop the local manufacture of the Feminine Care line and instead opted to import feminine pads and liners for Philippines market from Kimberly Clark affiliates in Vietnam and Indonesia; that in March 2008, KCC also informed KCPI that the manufacture of products for the remaining lines, the Family Care and Infant Care lines, in San Pedro will also be stopped; that the operation of the San Pedro plant was permanently discontinued as of December 31, 2008; that the Company's Board of Directors, in a meeting held on November 24, 2008, authorized the closure of the manufacturing mill in Laguna effective December 31, 2008; that KCPI was also directed by KCC to abide by its Corporate Financial Instruction (CFI) that establishes the depreciable lives to be used for its vehicles for financial reporting purposes; and that based on the category assignment, automobiles should be depreciated over four years based on straight line, annual depreciation rate of 25%. In reply, please be informed as follows: I. Write-off of assets that have lost their useful value Section 34 (D) (1) of the Tax Code of 1997 provides: "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)(1), 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: EDHCSI "(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. "(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: "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 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.) ITcCaS It is clear 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, we ruled that machines or equipment which are discarded, or the use of which has been abandoned "if charged off in the books and fully explained in the income tax return shall be deductible" from the taxpayer's gross income to the extent of its net book value. TSHIDa Likewise, in BIR Ruling DA-555-04 dated November 8, 2004 we confirmed that losses sustained by Fortune Cement Corporation, 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 in relation to Section 98 of RR 2. Therefore, KCPI can write-off in its books the assets in its manufacturing plant in San Pedro, Laguna to the extent of its net book value as of December 31, 2008 and for its selected other assets, to the extent of its net book value as of December 31, 2007. II. Depreciable lives of vehicles KCPI has been adopting a useful life of five (5) years for the purpose of claiming depreciation deduction for its automobiles. However, it was directed by KCC to adopt its standard worldwide policy limiting the depreciable life of automobiles to only four (4) years, both for tax and financial accounting purposes. The directive, as embodied in the CFI, applies to KCC and all subsidiaries and affiliates of the U.S.-based corporation. Under Section 34 (F), 1997 Tax Code, as amended, a reasonable allowance for the exhaustion, wear and tear (including reasonable allowance for obsolescence) of property used in trade or business is allowed as depreciation deduction, viz. : aCcADT "(F) Depreciation. (1) General Rule. There shall be allowed as a depreciation deduction a reasonable allowance for the exhaustion, wear and tear (including reasonable allowance for obsolescence) of property used in the trade or business. In the case of property held by one person for life with remainder to another person, the deduction shall be computed as if the life tenant were the absolute owner of the property and shall be allowed to the life tenant. In the case of property held in trust, the allowable deduction shall be apportioned between the income beneficiaries and the trustees in accordance with the pertinent provisions of the instrument creating the trust, or in the absence of such provisions, on the basis of the trust income, allowable to each. (2) Use of Certain Methods and Rates. The term 'reasonable allowance' as used in the preceding paragraph shall include, but not limited to, an allowance computed in accordance with rules and regulations prescribed by the Secretary of Finance, upon recommendation of the Commissioner, under any of the following methods: (a) The straight-line method; (b) Declining-balance method, using a rate not exceeding twice the rate which would have been used had the annual allowance been computed under the method described in Subsection (F)(1); (c) The sum-of-the-years-digit method; and (d) Any other method which may be prescribed by the Secretary of Finance upon recommendation of the Commissioner. DCaEAS (3) Agreement as to Useful Life on Which Depreciation Rate is Based. Where under rules and regulations prescribed by the Secretary of Finance, upon recommendation of the Commissioner, the taxpayer and the Commissioner have entered into an agreement in writing specifically dealing with the useful life and rate of depreciation of any property, the rate so agreed upon shall be binding on both the taxpayer and the National Government in the absence of facts and circumstances not taken into consideration during the adoption of such agreement. The responsibility of establishing the existence of such facts and circumstances shall rest with the party initiating the modification. Any change in the agreed rate and useful life of the depreciable property as specified in the agreement shall not be effective for taxable years prior to the taxable year in which notice in writing by certified mail or registered mail is served by the party initiating such change to other party to the agreement. Provided, however, That where the taxpayer has adopted such useful life and depreciation rate for any depreciable asset and claimed the depreciation expenses as deduction from his gross income, without any written objection on the part of the Commissioner or his duly authorized representative, the aforesaid useful life and depreciation rate so adopted by the taxpayer for the aforesaid depreciable asset shall be considered binding for purposes of this Subsection." In this connection, Section 105, Revenue Regulations No. 2 provides: "Section 105. Depreciation. A reasonable allowance for the exhaustion, wear and tear, and obsolescence of property used in the trade or business may be deducted from gross income. For convenience, such an allowance will usually be referred to as depreciation, excluding from the term any idea of a mere reduction in market value not resulting from exhaustion, wear and tear, or obsolescence. The proper allowance for such depreciation of any property used in the trade or business is that amount which should be set aside for the taxable year in accordance with a reasonable consistent plan whereby the aggregate of the amount so set aside, plus the salvage value, will, at the end of the useful life of the property in business, equal the basis of the property. Due regard must also be given to expenditures for current upkeep." Moreover, Section 109, Revenue Regulations No. 2 also states: "Section 109. Method of computing depreciation allowance. The capital sum to be replaced should be charged off over the useful life of the property, either in equal annual installments or in accordance with any other recognized trade practice, such as an apportionment of the capital sum over units of production. Whatever plan or method of apportionment is adopted must be reasonable and must have due regard to operating conditions during the taxable period. While the burden of proof must rest upon the taxpayer to sustain the deductions taken by him, such deductions must not be disallowed unless shown by clear and convincing evidence to be unreasonable. The reasonableness of any claim for depreciation shall be determined upon the conditions known to exist at the end of the period for which the return is made. If it develops that the useful life of the property will be longer or shorter than the useful life as originally estimated under all the then known facts, the portion of the cost or other basis of the property not already provided for through depreciation allowances should be spread over the remaining useful life of the property as reestimated in the light of the subsequent facts, and depreciation deductions taken accordingly." caCEDA Based on the foregoing, the taxpayer and the Commissioner may agree on the estimated useful life and rate of depreciation of any property. The rate so agreed upon shall be binding on both the taxpayer and the BIR. However, if it develops that the useful life of the property originally estimated under previous factual conditions is no longer reasonable, the law allows the taxpayer to lengthen or shorten the useful life of the property in the light of prevailing factual considerations. We have allowed a change in the useful life and shortening of the years in claiming depreciation deduction in several instances in the past. In BIR Ruling DA 305-07 dated May 17, 2007, we have already confirmed that Nestle Philippines, Inc. can change the useful life of its Trykes from five years to three years in claiming depreciation deduction, both for tax and financial accounting purposes. We said the useful life of the Trykes originally estimated at five years is no longer reasonable given several factual consideration. Thus, KCPI can shorten the useful lives of its vehicles to be consistent with the standard worldwide policy of KCC limiting the depreciable life of automobiles to only four (4) years, instead of five (5) years. 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. AIECSD Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service