Security Deposits for Future Maintenance Services Subject to Income Tax Only Upon the Performance of Said Service

April 13, 1998 BIR RULING NO. 035-98 37-000-00-035-98 Sycip Gorres Velayo & Co. 6760 Ayala Avenue Makati City 1226 Attention: Atty . Jose A . Osana Tax Partner Gentlemen : This refers to your letter dated January 15, 1997 requesting for clarification on whether or not the fees received in advance by FANUC Philippines Corporation (FPC) from FANUC Ltd. (FANUC), a resident of Japan, for future maintenance services as embodied in their Maintenance Service Agreement (Agreement) are not subject to income tax until the services are finally rendered. prcd It is represented that FANUC is a duly organized corporation in accordance with the laws of Japan, while FPC is a duly registered domestic corporation with the SEC; that FANUC is engaged in the manufacture and sale of various products like CNC Systems, laser products, cell controllers, robots, reboshots, etc.; that for every sale of its products to customers, FANUC extends a warranty agreement for the maintenance and upkeep thereof; that in the Philippines, FANUC has entrusted your client, FPC, to provide the maintenance service necessary to carry out the individual warranty agreements extended to customers here; and that for this purpose, a Maintenance Service Agreement was entered into by and between FANUC and FPC; that as a matter of practice and convenience, FANUC deposits to FPC a specified amount everytime it is able to sell its products to a Philippine buyer; that this deposit of maintenance fees will cover the estimated total service expenditures and commission fees of FPC for the whole duration of the warranty agreement extended by FANUC to a Philippine customer; that in cases of non-liquidation or non-usage of the deposit, any excess is remitted back to FANUC in Japan; that FPC adopts the accrual method of accounting; and that as it receives the advance payments from FANUC for future maintenance services, FPC books the same as "advance or deposit" and everytime that FPC finally renders the services under the Maintenance Service Agreement, a portion of the deposit equivalent to the commission is transferred to earned income. In reply, please be informed that Section 43 of the Tax Code of 1997 provides that the taxable income shall be computed upon the basis of the taxpayer's annual accounting period (fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping with the books of such taxpayer. An accrual basis taxpayer is required to accrue income in a taxable year when all events have occurred which fix the right to receive such income and the amount thereof can be determined with reasonable certainty. LLphil If the advance payments made pursuant to a Maintenance Service Agreement are security deposits in the nature of a trust, for the faithful performance of certain future services on the part of FANUC pursuant to its Warranty Agreements with its Philippine buyers, FPC, being FANUC's service agent to provide said services in the Philippines, realizes no taxable income in the year the advance payment is received. However, if the conditions which make the advance payment or deposit the earned income of FPC, then FPC realizes a taxable income to the extent of the advance payment or deposit already earned. In view thereof, this Office is of the opinion, as it hereby holds, that the aforesaid advance payments, being in the nature of security deposits for future maintenance services, are not subject to income tax in the year of receipt, but should be considered earned income subject to income tax upon the performance or rendition of said service. 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. LexLib Very truly yours, (SGD.) LIWAYWAY VINZONS-CHATO Commissioner of Internal Revenue