BIR Ruling [UN-207-95]

June 9, 1995 BIR RULING [UN-207-95] Joaquin Cunanan & Co. 8th Floor BA-Lepanto Building 8747 Paseo de Roxas Makati, Metro Manila Attention: Mr . Jose S . Tayag, Jr . Partner Gentlemen : This refers to your letter dated May 11, 1995 requesting for confirmation of your opinion, viz: 1. That the purchase of certain trademarks, formulas may be depreciated or amortized over the remaining useful lives of said assets; cd 2. That the payment of royalties as determined between buyer and seller is a deductible expense on the part of the buyer at the time of payment and such payments will be subject to a final withholding tax of 20% and that the technical fees would be considered as royalties and will also be subject to the final withholding tax of 20%; 3. That the non-competition contract paid for by the buyer will be allowed as a deductible expense at the time of payment; and 4. That the payment for goodwill is not subject to depreciation or amortization but can only be deducted for tax purposes if the asset or business related to the goodwill is sold. It is represented that your client, San Miguel Corporation (SMC), purchased the shares of stock of a wholly-owned subsidiary of Procter and Gamble, which owns the tangible properties of the spreads business like machinery and equipment, inventories and supplies; that in addition to this, SMC will also purchase certain trademarks, formulas, and agreed to pay royalties for the exclusive use of certain brand names, technical fees during the initial and transition stage of the acquisition, non-competition contract and goodwill, all related to the spreads business. In reply, please be informed that intangibles, the use of which in the trade or business is definitely limited in duration, may be the subject of depreciation allowance but intangibles, the use of which in the business or trade is not so limited, will not usually be a proper subject of such an allowance. If, however, an intangible asset acquired through capital outlay is known from experience to be of value in the business for only a limited period, the length of which can be estimated from experience with reasonable certainty, such intangible asset may be the subject of a depreciation allowance provided the facts are fully shown in the return or prior thereto to the satisfaction of the Commissioner of Internal Revenue. (Sec. 107, Revenue Regulations No. 2, otherwise known as Income Tax Regulations) In view thereof, we are answering your request for opinion as follows: 1. We reiterate our opinion in BIR Ruling No. 211-88 that the purchase of certain trademarks may be depreciated or amortized over the average remaining useful lives of the trademarks purchased. However, the cost of the different formulae can be amortized over the (a) remaining useful lives of the trademarks purchased, or (b) the expected period within which your client proposes to continue manufacturing the products using the said formulae. 2. The payment of royalties as determined between the buyer and the seller is a deductible expense on the part of the buyer at the time of payment but only to the extent of the amortized value over the agreed period when royalties will have to be paid and such payments will be subject to final withholding tax of 20%. In this connection, this Office in BIR Ruling No. 206-88 opined that the royalties to be paid on the basis of future sales may be discounted to determine the present values and may be paid at said discounted or present value at the time of acquisition and that it is acceptable for tax purposes to amortize the said present values (i.e., the cash price as discounted) over the agreed period (say 5 to 8 years) when royalties will have to be paid and that the said royalties payment is subject to the final withholding tax of 20%. Based on your representations, however, it is not clear on whether the technical fees to be paid by SMC during the initial and transition stage of the acquisition could be considered as royalty or not. Please submit to us the "Technical Services Agreement" of your said client so that we could properly determine as to whether the subject technical fees can be considered as royalties. 3. In BIR Ruling No. 206-88, we have ruled that the amount paid for an agreement not to compete in a trade or business, where your client can prove the existence of such an agreement, is considered as capital expenditures and is subject to allowances for depreciation ratably spread over the period mentioned in the said agreement but only where the elimination of competition is for a definite and limited term. (par. 23.68, Vol. 4 Mertens Law of Federal Income Taxation) Accordingly, contrary to your opinion that the amount paid for by your client under the non-competition contract will be allowed as a deductible expense at the time of payment, the same can only be amortized ratably spread over the agreed period wherein the seller may not compete in the same line of business that was sold to your client. 4. Goodwill is not such property as is subject to exhaustion. (par. 22, 085 CCH-Standard Federal Tax Reports) Accordingly, your opinion that any amount of goodwill paid for by your client may not be deducted for tax purposes unless the same business or the assets related to the said goodwill is sold by your client is hereby confirmed. (BIR Ruling No. 206-88 dated May 12, 1988) cdtech Very truly yours, ALICIA P. CLEMENO Assistant Commissioner Legal Service