Deductibility of Ordinary and Necessary Expenses

September 3, 1990 BIR RULING NO. 165-90 29 (a) (1) (A) 085-89 165-90 Gentlemen : This refers to your letters dated March 5 and 20, 1990 stating as follows: "The Coca-Cola Export Corporation, (TCCEC for short) is a resident foreign corporation engaged in the manufacture of concentrates for softdrinks of specific brands, such as: "Coca-Cola", "Sprite", Mello Yello", (collectively referred to hereinafter as "COCA-COLA BRANDS"), "Royal Tru-Orange" and "Royal Flavors" (hereinafter collectively referred to as "SAN MIGUEL BRANDS"). The concentrates are sold to the exclusive bottler, COCA-COLA BOTTLERS PHILIPPINES, INC. (CCBPI, for short) a domestic corporation whose capital stock is 70% owned by San Miguel Corporation, and 30% owned by the Home Office of TCCEC, CCBPI manufactures the concentrates into softdrinks. The concentrates manufactured by TCCEC which are specifically intended for softdrinks carrying the particular "COCA-COLA BRANDS" because there are secret special formula involved. "Before the beginning of each year, TCCEC and CCBPI agree on a Cooperative Marketing Budget (hereinafter referred to as the "BUDGET"), which is a budget for the Promotion and Advertising expenses of the softdrinks for the ensuing year. The promotion and Advertising expenses of the softdrinks carrying "COCA-COLA BRANDS" are shared by TCCEC and CCBPI. TCCEC does not share in the expenses for the Promotion and Advertising of the softdrinks carrying the "SAN MIGUEL BRANDS". The "BUDGET" may be revised during the year of implementation depending upon the needs of the business, but always upon mutual agreement of TCCEC and CCBPI. The "BUDGET" is being implemented by a working group composed of representatives from both TCCEC and CCBPI. Any promotion or advertising project is submitted to the working group for evaluation. If the group determines the project to be beneficial to the business, a commitment is made and the project is then launched. The expenses for the project is advanced by either TCCEC or CCBPI who submits an accounting therefor to the other for reimbursement of the latter's share. "Among the items in the "BUDGET" are cost of electric coolers and ice coolers, which are to be distributed to dealers-retailers of softdrinks as promotional items. As in the other items, these electric coolers and ice coolers may be purchased by either TCCEC or CCBPI and the cost thereof are accounted for and shared by TCCEC and CCBPI based on the agreed sharing in the BUDGET. Whether the electric coolers and ice coolers are purchased by TCCEC or CCBPI, TCCEC does not take possession or hold control thereof. The same are delivered by the supplier directly to CCBPI who undertakes the distribution thereof to the dealers-retailers of softdrinks. Neither does TCCEC direct its distribution which are in the discretion of CCBPI. TCCEC merely checks that the electric coolers and ice coolers are in fact, actually distributed to dealers-retailers to determine, that the agreed purpose of the expenditure is complied." In connection therewith, you now request a ruling as to whether the share of TCCEC in the cost of the electric coolers and ice coolers which are to be distributed to dealers-retailers of softdrinks as promotional items deductible as business expense in the year incurred, or should it be treated as capital expense and only the depreciation thereof is deductible in computing its net income subject to income tax. In reply thereto, please be informed that the cost of acquiring equipment, machinery, fixtures or other items having a useful life substantially beyond the taxable year are considered as capital expenditures (par. 25, 34 Vol. 4A Mertens) However, although the electric coolers and ice coolers have useful life exceeding one (1) year, the share of TCCEC in the costs of such electric coolers and ice coolers can not be considered as a capital expense since TCCEC in contributing its share in the cost of the electric coolers and ice coolers pursuant to the cooperative promotion and advertising arrangement with CCBPI does not acquire an asset for itself because it does not take title, ownership or possession thereof. The said articles are delivered by the suppliers thereof directly to CCBPI and the latter distributes the same to the independent dealer-retailers of softdrinks as promotional articles. TCCEC merely checks that the same are in fact actually distributed to the dealers-retailers to determine that the agreed purpose of the expenditures is complied with. Moreover, all ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business are deductible from gross income pursuant to Section 29(a)(1)(A) of the Tax Code, as amended and as implemented by Section 65 of Revenue Regulations No. 2. Expenses which are "ordinary and necessary" generally contemplate expenses which are directly connected with and proximately resulting from carrying on the business and must be shown to be appropriate and helpful in the development of the taxpayer's business for the acquisition or pursuit of income or profit (Gancayco v. CIR, 1 SCRA 980). Thus, the share of TCCEC in the cost of the electric coolers and ice coolers which are to be distributed to dealers-retailers of softdrinks as promotional items are considered ordinary and necessary expenses deductible in computing the net income of TCCEC subject to income tax. cdtech Very truly yours, (SGD.) JOSE U. ONG Commissioner