Unearned Gross Profit on Installments Receivables

May 12, 1980 BIR RULING NO. 049-80 Messrs. A. M. Sison Jr. & Associates 6th Floor, Rufino Building 6784 Ayala Avenue Makati, Metro Manila Gentlemen : This refers to your letter dated July 17, 1979, behalf of your client, Summa Sales Merchandising Co., R-600 Rufino Bldg., Makati, Metro Manila, stating the following facts: The above named taxpayer is engaged among others, in selling household appliances on installment and reports its income on said transactions on installment basis. In view of present liquidity problems, it intends to sell its installments receivables from customers, which terms range from 18 to 30 months, to a bank at a discount without recourse. cdti "As one of the conditions of the sale, the bank requires to taxpayer, even after the sale to undertake, in behalf of the bank without any fee, the actual collection of the installments receivables sold, and remit the same to the bank. The reason for this requirement is that the installments receivables are so numerous and the customer so scattered throughout the country that the bank collection facilities cannot cope to undertake the usual door-to-door collections, whereas the taxpayer has an existing collection set-up." Based on the foregoing facts, you now request for ruling on the following questions: "1) Is the unearned gross profit on the installments receivables considered earned upon the sale of said installments receivable and hence, must now be declared for income tax purposes? "2) If the answer to question No. 1 is yes, can the taxpayer, in order to properly match cost against revenue, accrue and deduct from said gross profit a provision for future cost of collections, which the taxpayer is required under the contract of sale of the installments receivable to perform in subsequent years (18 to 30 months)? The provision for future cost of collection would be based on the experience of the taxpayer for the past three years." In reply, I have the honor to inform you as follows: 1. The first question is answered in the affirmative. Since the installment receivables were sold without recourse, which means that the bank has no recourse against your client in case of its failure to collect the receivables, in effect, your client had already received payment of the merchandise sold; hence the gross profit is deemed realized by your client. 2. Since under your client's contract with the bank, your client will undertake the collection of the installment receivables without any fee, wherein it will incur collection costs and considering that your client will declare the gross profit, for income tax purposes in the year deemed earned, this Office believes that your client can, likewise, claim in the same year, provision for future collection costs as deduction in its income tax return so as to properly match income as against its related expenses generating said income, subject to the following conditions: a. Any amount representing future collection costs which was claimed as deduction but was not spent by your client within the period varying from 18 to 30 months, during which the receivables are to be collected should be declared as income in its income tax return which covers the end of said period. For this purpose, your client should account for said provisions for future collection costs by maintaining records of the receivables disposed off which shall be used by this Office in determining whether the corresponding amounts set up to cover the collection thereof are properly adjusted once the obligation to collect has expired. cd b. The amount for reserves for cost of future collection to be set up by your client must not exceed the total of the average of three (3) years past cost of collection experience. cdta Very truly yours, EFREN I. PLANA Acting Commissioner