BIR Ruling No. 042-10

August 27, 2010 BIR RULING NO. 042-10 Section 34 (F); BIR Ruling Nos. 144-97; DA-031-03; DA-305-2007 Salvador & Associates Attorneys-at-Law 815-816, Tower One & Exchange Plaza Ayala Triangle, Ayala Avenue Makati City Attention: Attys. Maria Rosario L. Bernardo Ronald V. Bernas and Adan T. Delamide Gentlemen : This refers to your letter dated January 18, 2010 stating that Nestle Philippines, Inc. (NPI) with Tax Identification No. (TIN) 000-421-786-000 is a domestic corporation engaged in the manufacture of brand food products and beverages. NPI proposes to change the useful lives of its assets in claiming depreciation deduction, both for tax and financial accounting purposes based on the experience of the technical community and the feedback received by the Engineering Department of NPI as a result of NPI's annual review procedures. The proposed changes in useful lives of NPI's assets and the reasons for the proposed changes are as follows: Asset Current Proposed Reason for the Change in Useful Life Useful Life Useful Life Office Printer 3 5 Based on experience, office printers are not relatively affected by obsolescence compared to other IT equipment such as laptops and desktops. The advent of emails and portable hard drive storages has considerably lowered the utilization of office printers. Ice Cream Freezing 10 15 Based on the review and and Hardening experience of the technical Tunnels community, these assets can be classified as low to medium or static equipment. Therefore, they have longer useful lives as compared to assets classified as high speed equipment running at 100 cycles per minute such as conveyors, pumps, mixers and filling machines. Ice Cream Variable Fixed at 5 To standardize and simplify Moulds from 3 to 5 classification of moulds. Electricity 20 15 As compared to standby Generating Sets electricity generators (EG), which used for prime will continue to have a useful life power generation of 20 years, EG sets used for regularly prime power generation have faster wear and tear since the assets are continuously running 24/7 to provide primary source of electricity. In connection therewith, you are requesting confirmation that NPI can change the useful life of the assets described above in claiming depreciation deduction, both for tax and financial accounting purposes, and that NPI can adopt such change for existing and newly acquired assets starting January 1, 2010. ICHcTD In reply thereto, please be informed that under Section 34 (F) of 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. Section 34 (F) of 1997 Tax Code, as amended, is quoted as follows: "(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-digits method; and (d) Any other method which may be prescribed by the Secretary of Finance upon recommendation of the Commissioner. (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. CAScIH 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." 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. Hence, in BIR Ruling No. DA-031-03 dated February 3, 2003, this Office allowed the shortening of the depreciable life of a building from 45 to 25 years based on the current net book value of the building, to correspond to the 25-year lease agreement entered into between the owner of the building and its lessee. It has been ruled that the remaining estimated useful life of the assets is determined as that period of time expressed in years that an asset is expected to perform in a satisfactory manner the function for which it was designed and built, assuming normal and reasonable maintenance. The estimates of remaining life for each item of property had been based, in a very large measure, upon the observed condition at the time of appraisal and condition of maintenance, and the consideration of normal rates of depreciation for the type of property. (BIR Ruling No. 144-97 dated December 29, 1997) DEacIT In BIR Ruling No. DA-305-2007 dated May 17, 2007, this Office allowed NPI to change the useful life of its manual tricycles from 5 years to 3 years in claiming depreciation deduction, both for tax and financial accounting purposes, considering the condition of the parts of the assets, the purpose for which they were designed and built and the company's annual refurbishment practices. Based on the foregoing, this Office hereby confirms that NPI can change the useful life of the assets described above in claiming depreciation deduction, both for tax and financial accounting purposes, and that NPI can adopt such change for existing and newly acquired assets starting January 1, 2010. 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 as null and void. Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue