BIR Ruling [UN-176-A-94]

June 8, 1994 BIR RULING [UN-176-A-94] MEMORANDUM FOR : The Commissioner This refers to the internal revenue tax case of the Maricalum Mining Corporation (MMC), 2283 Pasong Tamo Extension, Makati, Metro Manila, involving the amount of P11,283,491.00 representing deficiency final withholding tax for the period January to September 1988 under Assessment Notice and Letter of Demand both Numbered FAS-2-88-93-005107 and both dated December 1, 1993. Records of the case disclosed that MMC was incorporated on October 19, 1984 to own and operate a copper mine and mill complex at Dipolog, Negros Occidental; that MMC was formerly a wholly-owned subsidiary of the Development Bank of the Philippines (DBP) and the Philippine National Bank (PNB) which was acquired by them through the assignment and transfer to MMC of the property which was foreclosed from the Marinduque Mining and Industrial Corporation; that on February 27, 1987, a deed of transfer was executed by and between the PNB and the DBP on the one hand and the National Government on the other wherein the total assets of MMC was transferred to the National Government including DBP and PNB's exposure in the company pursuant to Proclamation No. 50 creating the Asset Privatization Trust (APT); that in 1992, MMC was acquired from the APT by the Phimco Group; that on May 10, 1985, MMC and Marubeni Corporation of Japan executed a Basic Marketing Agreement providing among others as follows: cdi "1. MMC hereby agrees to grant to Marubeni an exclusive right to purchase from MMC ninety percent (90%) of the copper concentrates to be produced from Dipolog, which has an existing rated capacity of 40,000 dry metric tons of ore per day and Marubeni agrees to purchase the same upon terms and conditions to be separately agreed upon; "2. MMC hereby appoints Marubeni as its exclusive marketing agent for the distribution and sale of all molybdenum concentrates to be produced from Sipalay. Terms and conditions of sales molybdenum concentrates shall be determined by MMC; "3. To implement the foregoing paragraphs 1 and 2, MMC and Marubeni agree to enter into Sale and Purchase Contracts for copper concentrates from time to time and Exclusive Agency Agreement for Molybdenum concentrates for the entire period during which this agreement is in force; "4. Marubeni shall be entitled to a discount at the rate of three-fourths of one percent (0.75%) of the price agreed between MMC and Marubeni on the basis of FOB value of the copper concentrates to be purchased by Marubeni; xxx xxx xxx "For all copper concentrates sold to Philippine Smelting and Refining Corporation (PASAR), Marubeni shall be entitled to a commission at the same rate as set above. For all molybdenum concentrates sold by MMC; Marubeni shall be entitled to a commission at the rate of three-fourths of one percent (0.75%) on the basis of FOB values. Likewise, on May 10, 1985 MMC and Marubeni executed an Advance Payment Agreement whereby advances to MMC shall be used as an operation fund, liquidation fund and contingency fund for the purpose of covering start-up costs and working capital requirement such as operating costs and capital expenditures for the resumption of the Sipalay operations; and that the advances shall be repaid together with interest thereon to accrue by way of deduction upon the purchase amount (which may also be constructively inwardly remitted utilizing an escrow account of PNB in trust for MMC for each shipment of the concentrates payable by Marubeni pursuant to the contract). In a Memo-Report dated November 10, 1993, the Examiner reported as follows: "xxx xxx xxx "Advances per se do not give rise to a taxable item. But in this particular case when advances from a non-resident foreign corporation should be repaid with interest (Art. 6.1 Advance Payment Agreement), it was unquestionably foreign loans. The interest therefrom is subject to final tax under Section 24 of the Tax Code. However, at the treaty rate of 15% (Art. 11, RP-Japan Tax Treaty). Based on COA audited figures, the total interest expense for the months of January to September amounts to P17,985,357.85 . xxx xxx xxx (Emphasis supplied) "The idea of the word "commission" involves the meaning that a sum of money is paid to an agent for effecting a sale to a third person. . . . is percentage or allowance to a factor or agent for transacting business for another (Words and Phrases, Permanent ed. 7A). Apparently for a commission to be due, there must be a service rendered. Within this context therefore, the commission due to Marubeni on MMC's sale to Pasar as stipulated in the Basic Marketing Agreement cannot, in substance, be considered as commission since no service was rendered by Marubeni to deserve a remuneration. "Discounts are generally classified as either cash or trade. Cash discounts on one hand are given to induce purchases by volume and trade discounts on the other hand are offered to induce prompt payment. Volume and time are therefore the factors considered to enjoy discounts. In the case at hand, MMC is extending an even discount rate conditioned upon nothing. We believe the discounts set forth in the Basic Marketing Agreement are not within the parameter of a discount usual in trade practice that is recognized in both accounting and taxation. To our minds therefore, both the commission and discounts due to Marubeni on the sale of copper concentrates by MMC are nothing but interest . After all, it was Marubeni which provided the rehabilitation and extended advances to start the mining operation. If it were reasonable for Marubeni which provided the rehabilitation and extended advances to start the mining operation. If it were reasonable for Marubeni to derive gains from its huge advances, then it could be reasonably expected to desire receiving such gains undiminished. Taxes for sure was a consideration factor. xxx xxx xxx "We therefore believe that the total amount of P5,884,363.84 claimed as marketing expense commission for the months of January to September being in substance an interest expense, should be subjected to the 15% final tax. This general ledger account was the combined total of discounts and commission incurred on sale of copper concentrates. No molybdenum concentrates were sold during the year. " Summarily, the amount of P17,985,357.85 under interest and financing charges and P5,884,363.84 charged to marketing expense commission were altogether found subject to final tax of 15% . . ." (Emphasis supplied) The final withholding tax on interest and marketing expense commission per investigation is P3,580,458.25 plus surcharge of P1,790,229.14 and interest of P5,912,803.61 resulted in a deficiency final withholding tax of P11,283,491.00 for the period January to September 1988. In a letter dated November 10 and December 17, 1993 and February 10, 1994 counsel for MMC protested the assessment on the ground that the "commissions" which are also being subjected by the Examiners together with the interest on advances made by Marubeni Corporation of Japan to MMC to the 15% final withholding tax on interest under Art. 11(2) (b) of the RP-Japan Tax Treaty are actually sales discount to which Marubeni Corporation of Japan is entitled in accordance with paragraph 4 of their Basic Marketing Agreement; that the accounting clerks of MMC erroneously indicated in the invoices the account name "commissions" instead of "sales discount"; and that in the Statement of Income and Deficit for the years ended December 31, 1988 and 1987 said "commission charges" was deducted from the sales of mine products of MMC which clearly shows that such commission charges are actually sales discount; that there is no legal basis in subjecting the interest expense as well as the marketing expense commission which are actually "sales discount" to the 15% final withholding tax on interest under Article 11(2) (b) of the RP-Japan Tax Treaty; and that counsel for the taxpayer is offering to pay the amount of P2,697,803.68 representing the 15% basic withholding tax on the total interest paid of P17,985,357.85 without interest and surcharges by way of compromise under Section 204 of the Tax Code, as amended on the ground that MMC is in a financial distress. The question for resolution in this case is whether or not the "marketing expense commissions" which is actually a "sales discount" can be considered together with the interest on advances as interest income of Marubeni Corporation of Japan subject to the 15% withholding tax under Article 11 (2) (b) of the RP-Japan Tax Treaty. Ordinarily, discounts and rebates when properly determined and given are deductible from gross income. Rebates and discounts are legitimately given when made at the time of sale and in accordance with a pre-arranged agreement between the seller and the customer. The discounts or rebates are represented by a fixed percentage of deductible cost which shall appear on the face of the contract, document or invoice (See Valparaiso Grain and Lumber Co., 44 BTA 125; Messenger Publishing Co., 2 BTA 30; and Central Consumers Wine and Liquor; CL BTA 1190) Counsel for MMC has explained that the item marketing expense in the amount of P5,884,363.84 which was deducted from the gross sales of MMC's mine products appearing in the Statement of Income and Deficit of MMC for the year 1988 and which was audited by COA is actually the "sales discounts" agreed upon by MMC and Marubeni Corporation of Japan in accordance with their Basic Marketing Agreement executed on May 10, 1985 to the effect that "Marubeni shall be entitled to a discount at the rate of three fourths of one percent (0.75%) of the price agreed between MMC & Marubeni on the basis of FOB value of the copper concentrates to be purchased by Marubeni". The Exclusive Agency Agreement between MMC and Marubeni Corporation of Japan refers to the sale of molybdenum concentrates, however as reported by the Examiners no molybdenum concentrates was sold for the year 1988. Thus, the allegation of the counsel for MMC that the accounting clerks of MMC erroneously indicated in the invoices the account name as "commission" instead of "sales discount" is correct considering that no commissions was really paid to Marubeni Corporation Japan as no sale of molybdenum concentrates was made in 1988. Moreover, the account "marketing expense commissions" was never considered as an expense by MMC. The opinion of the Examiners and which was the basis of the aforementioned assessment to the effect that "both the commission and discounts due to Marubeni Corporation of Japan by MMC are nothing but interest" and that the "amount of P17,985,357.85 under interest and financing charges and P5,884,363.84 charged to marketing expense commission were all together subjected to final tax of 15%" has no legal and factual bases. There is no question that the interest payments of MMC to Marubeni Corporation of Japan in accordance with their Advance Payment Agreement executed on May 10, 1985 is subject to the 15% withholding tax pursuant to Art. 11 (b) (2) of the RP-Japan Tax Treaty. However, there is no legal and factual bases to disregard the Basic Marketing Agreement executed by MMC and Marubeni Corporation of Japan on May 10, 1985 and to consider the "commissions" which are actually the "sales discount" and the financing charges as interest subject to 15% withholding tax. Moreover, as reported by the Examiners in their Memo Report dated November 10, 1993, "all throughout its existence, MMC has been in dire financial difficulties. As a matter of fact, MMC ranked second among the biggest losers last year and the Statement of Income and Deficit for the year ended December 31, 1993 submitted by the counsel of MMC shows a deficit at end of December 1993 of P1,518,236,142. Accordingly, its offer of compromise to pay the amount of P2,697,803.68 representing 15% of the basic withholding tax on the total interest paid of P17,985,357.85 for the period covering January to September 1988 without interest and surcharges may be accepted under Section 204 of the Tax Code. In view of the foregoing consideration, it is respectfully recommended that MMC's offer of compromise to pay the amount of P2,697,803.68 in full and complete settlement of its aforementioned tax liabilities under Section 204 of the Tax Code, as amended be accepted. cdtech Respectfully submitted: ALICIA L. TOMACRUZ Chief, Law Division I CONCUR: JAIME M. MAZA Assistant Commissioner (Legal Service) APPROVED: LIWAYWAY VINZONS-CHATO Commissioner of Internal Revenue