Baniqued & Baniqued

August 29, 2008 BIR RULING [DA-(TAR-002) 186-08] Baniqued & Baniqued 8/F Jollibee Centre San Miguel Avenue Pasig City Attention: Atty. Laura Victoria A.S. Yuson-Layug Atty. Madeline L. Zialcita-Villapando and Atty. Bernadette V. Quiroz Gentlemen : This refers to your letter dated July 25, 2008 stating that your client, Jardine Schindler Elevator Corporation (JSEC), is a corporation organized and existing under Philippine laws; that JSEC is engaged in the business of manufacturing, assembling, selling, distributing and installing any and all kinds of elevators and escalators and, in connection therewith, buying, selling, manufacturing, fabricating, dealing in, exchanging, importing, exporting and/or procuring all necessary and/or appropriate raw material, machinery, containers and other articles, goods, wares and items of every nature and description whatsoever; that it is likewise engaged in and undertaking the servicing, repair and maintenance of such elevators and escalators; that JSEC is contracted to install elevators and escalators in buildings in the process of construction; that as the contracts for the construction of buildings are completed beyond a one (1) year period, JSEC's contracts for the installation of elevators and escalators are ordinarily similarly completed beyond a one (1) year period; that consequently, JSEC accounts for revenues for the installation of elevators and escalators on the basis of the percentage of completion method of accounting for long-term contracts based on costs incurred; that under said method, the revenues are measured principally by reference to the relationship (as a percentage of) of contract costs incurred for work performed up to the balance sheet date and the total estimated costs for each contract as determined by project engineers; that the contract costs are recognized when incurred; that JSEC likewise performs maintenance and repairs services on escalators and elevators; that considering that the performance of maintenance and repairs services do not involve long-term contracts as defined in Section 48 of the Tax Code of 1997, revenues from maintenance and repair services are recognized by JSEC based on the accrual method of accounting; and that consequently, JSEC recognizes revenues for tax purposes under the following methods: (1) percentage of completion method of accounting for installation of elevators and escalators based on costs incurred, and (2) accrual method of accounting for maintenance and repairs services on escalators and elevators. DEHcTI Based on the foregoing representations, you now request confirmation of your opinion that revenues generated by JSEC in connection with the manufacture, assembly, sale, distribution and installation of elevators and escalators may be accounted for using the percentage of completion method of accounting based on costs incurred pursuant to Section 48 of the Tax Code of 1997 in relation to Section 44 of Regulations No. 2. In reply thereto, please be informed that Section 48 of the Tax Code of 1997 provides that "SEC. 48. Accounting for Long-term Contracts. Income from long-term contracts shall be reported for tax purposes in the manner as provided in this Section. As used herein, the term 'long-term contracts' means building, installation or construction contracts covering a period in excess of one (1) year. Persons whose gross income is derived in whole or in part from such contracts shall report such income upon the basis of percentage of completion. The return should be accompanied by a return certificate of architects or engineers showing the percentage of completion during the taxable year of the entire work performed under contract. There should be deducted from such gross income all expenditures made during the taxable year on account of the contract, account being taken of the material and supplies on hand at the beginning and end of the taxable period for use in connection with the work under the contract but not yet so applied. If upon completion of a contract, it is found that the taxable net income arising thereunder has not been clearly reflected for any year or years, the Commissioner may permit or require an amended return." In the same manner, Section 44 of Revenue Regulations No. 2 provides that "Section 44. Long-term Contracts. Income from long-term contracts is taxable for the period in which the income is determined, such determination depending upon the nature and terms of the particular contract. As used herein, the term 'long-term contracts' means building, installation, or construction contract covering a period in excess of one year. Persons whose income is derived in whole or in part from such contracts may, as to such income, prepare their returns upon the following reasons: (a) Gross income derived from such contracts may be reported upon the basis of percentage of completion. In such case there should accompany the return certificate of architects, or engineers showing the percentage of completion during the taxable year of the entire work performed under contract. There should be deducted from such gross income all expenditures made during the taxable year on account of the contract, account being taken of the material and supplies period for use in connection with the work under the contract but not yet so applied. If upon completion of a contract, it is found that the taxable net income arising thereunder has not been clearly reflected for any year or years, the Commissioner of Internal Revenue may permit or require an amended return. ISAcHD (b) Gross income may be reported in the taxable year in which the contract is finally completed and accepted if the taxpayer elects as a consistent practice to so treat such income, provided such method clearly reflects the net income. If this method is adopted there should be deducted from gross income all expenditures during the life of the contract which are properly allocated thereto, taking into consideration any material and supplies charged to the work under the contract but remaining on hand at the time of the completion. Where a taxpayer has filed his return in accordance with the method of accounting regularly employed by him in keeping his books and such method clearly reflects the income, he will not be required to change to either of the methods above set forth. If a taxpayer desires to change his method of accounting in accordance with paragraphs (a) and (b) above, a statement showing the composition of all items appearing upon his balance sheet and used in connection with the method of accounting formerly employed by him, should accompany his return." Finally, Revenue Audit Memorandum Order No. 1-00 states that II. Accounting Methods D. Percentage of Completion Basis is a method applicable in the case of a building, installation or construction contract covering a period in excess of one year whereby gross income derived from such contract may be reported upon the basis of percentage of completion. In determining the percentage of completion of a contract, generally one of the following methods is used: 1. The costs incurred under the contract as of the end of the tax year are compared with the estimated total contract costs; or 2. The work performed on the contract as of the end of the tax year is compared with the estimated work to be performed. In such case, the return should be accompanied by a certificate of the architect or engineer showing the percentage of completion during the taxable year of the entire work performed under contract. There should be deducted from such gross income all expenditures made during the taxable year on account of the contract, account being taken of the materials and supplies on hand at the beginning and end of the taxable period for use in connection with the work under the contract but not yet so applied. ESTcIA Beginning January 1, 1998 income from long-term contracts are required to be reported using this method only. In applying the rationale of the above-mentioned provisions, the Court of Tax Appeals (CTA) in the case of Sual Construction Corporation vs. Commissioner of Internal Revenue, CTA Case No. 6342, May 11, 2004, ruled that "Before we delve on the above issues, it must be pointed out that petitioner's claim is based on Completed Contract Method of Income Recognition. This accounting method is applicable to contractors in the construction of building, installation of equipment and other fixed assets, or other construction work covering a period in excess of one year. However, under Republic Act No. 8424, which took effect on January 1, 1998, contractors are no longer allowed to adopt this method of reporting their income derived in whole or in part from long-term contracts (Revenue Audit Memorandum Order No. 1-00). As prescribed by Section 48 of R.A. No. 8424, the percentage of completion method is now the only method of accounting recognized for long-term contracts. . ." WHEREFORE, in view of the foregoing, this Office hereby confirms your opinion that JSEC may use the percentage of completion method of accounting based on costs incurred in recognizing revenues from the manufacture, assembly, sale, distribution and installation of any and all kinds of elevators and escalators, which services are ordinarily completed beyond a one (1) year period, pursuant to Section 48 of the Tax Code of 1997, in relation to Section 44 of Regulations No. 2 and RAMO 1-00. 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.) JAMES H. ROLDAN Assistant Commissioner Legal Service