BIR Ruling [UN-248-A-95]

July 6, 1995 BIR RULING [UN-248-A-95] MEMORANDUM FOR The Commissioner This refers to the protest filed by Counsel, Atty. Ruben B. Ancheta, for and in behalf of his client, COLLEGE ASSURANCE PLAN PHILS. INC. (CAP), 126 Amorsolo St., Legaspi Village, Makati, Metro Manila, against the assessments of this Office involving the respective amounts of P45,661,987.89 and P532,798.45 or a total of P46,194,786.34 as deficiency business taxes for the year 1990, covered by Assessment Notice Nos. FAS-4-90-93-00-1861 and FAS4-90-93-00-1862, both dated April 13, 1993. cdlex The records show that CAP is a domestic corporation primarily engaged in the business of selling pre-need/educational assistance plans which is duly registered with the Securities and Exchange Commission (SEC) on February 14, 1980. For the year 1990, it filed the quarterly and annual percentage tax returns as dealer in securities and paid the 6% tax due thereon. On the basis of Letter of Authority No. 0007461, an investigation was conducted by Revenue Officer Edmond Caluag, who recommended the issuance of the deficiency assessments in the total amount of P46,194,786.34, against CAP arising from the disallowance of the following deductions from gross sales of pre-need plans issued in 1990 for purposes of the percentage tax of 6% on gross income as a dealer in securities, to wit: Amount credited to trust fund P190,969,065.00 Advisors' Commission 76,422,995.18 Collection Bonus and Bank Charges 85,872,278.38 Prizes and Awards 29,135,927.39 Licensing Fees/Royalties 9,637,686.96 Direct Marketing Expenses 7,815,046.74 Total Disallowances 399,852,999.65 6% tax due thereon P23,991,179.98 Add: Surcharge 5,997,795.00 Interest 15,648,012.91 Compromise penalty 25,000.00 TOTAL AMOUNT DUE AND COLLECTIBLE P45,661,987.89 Discrepancy on payment of tax per book and per return: Basic P293,957.77 Add: Surcharge 73,489.44 Interest 20% per annum 165,351.24 TOTAL AMOUNT DUE AND COLLECTIBLE P532,798.45 GRAND TOTAL P46,194,786.34 =========== It is the contention of the investigating examiner that the percentage tax of 6% under Section 116 of the Tax Code is based on gross income or gross receipts less actual cost or purchase price; that the amount credited to trust fund should not be deducted from the gross receipts, for the simple reason that it is not an expense but an investment that earns interest. (BIR Ruling No. 72-007-038-91) It also appears that the reason for the disallowance of the other items claimed as deductions is that they are not direct costs, but selling expenses. The principal issue in this case is what constitutes acquisition cost of a dealer in securities in relation to the 6% tax on "gross income". In his protest letter dated September 17, 1993, Atty. Ancheta contended that CAP does not buy securities for subsequent sale. It is a pre-need company issuing primary instruments. But these instruments have costs. The protest was anchored on the 1987 ruling issued in CAP's favor by former Commissioner Bienvenido A. Tan, Jr. which states as follows: "Anent your second query, the items appearing in the above computation in the total amounts of P31,214,738 and P54,350,258 constitute the cost of the securities which were deducted from the gross collection to arrive at your gross income subject to 5% tax as dealer in securities. These computations will serve as your guide in determining gross income to be declared in your future returns for percentage tax purposes." It appears that since 1987, CAP has relied religiously on the said ruling in determining its percentage tax liability. Thus, in its 1990 returns, it considered as part of direct costs trust fund reserve, advisors commission, collection bonus and bank charges, prizes and awards, licensing fees and direct marketing expenses. Pursuant to the provisions of the Revised Securities Act, (Batas Pambansa Blg. 178 approved on February 16, 1982), new rules on the registration and sale of pre-need plans and similar contracts and investments were promulgated for the information and observance of all concerned. These rules apply to Pre-need plans like life plan, pension plan, educational plan, and interment contracts which provide for the payment and/or performance of future service/s for monetary consideration at the time of actual need, payable in cash or installment by planholders at stated prices, with or without interest, and/or insurance coverage. As defined in the New Rules for Registration of Pre-need Plans and Similar Contracts, "trust fund" means a fund initially set up, separate and distinct from the paid-up capital of the corporation registered and licensed by the SEC to engage in the business of selling pre-need plans and contracts, and subsequently from planholders payments, separately established with a trustee bank under a trust agreement approved by the SEC to pay for annuities, services or property as provided for in the contracts. To guarantee the delivery of property or performance of services in the future, a deposit shall be made by the issuer with a trust company, bank or investment house in an amount equivalent to 40% of the gross pre-need price of the plan if sold for cash, within sixty (60) days upon receipt of payment; for plans sold on installment basis, the graduated amount equivalent to 5%, 60% or 65% of quarterly gross collections shall be deposited to the trust fund within 60 days following the end of each quarter of the fiscal year of the issuer. Under the rules the trust fund (inclusive of earnings) shall be administered and managed by a trust company, bank, or investment house authorized to perform trust functions in the Philippines. No withdrawal shall be made from the trust fund except for: (1) paying the cost of services rendered or property delivered; (2) bank charges and investment expenses in the operation of the trust fund; (3) cash surrender/termination value payable to the planholders; (4) annuities; (5) contributions to the fund of cancelled plans; and (6) taxes on trust funds. It is clear from the above rules of the SEC that a deposit must be made by the issuer of pre-need plans to the trust fund, computed on the basis of 40% of the gross pre-need price of the plan, for cash sales and on a graduated rate of 5% 60% for installment sales. It appears however, that it has been the company's policy to contribute to the trust fund of the educational plan as follows: For cash sales 61% For installments sales 1st 20% of the plan value 5% 2nd 20% of the plan value 30% 3rd 20% of the plan value 72% 4th 20% of the plan value 98% 5th 20% of the plan value 98% Management believes that the above funding schedule would more approximate the future liability of the corporation for fully paid and active plans, and still provide a reasonable allowance for possible reinstatement of lapsed plans. Actuarial valuation report shows that the CAP Trust fund is at an adequate level. It is observed that the above schedule of contributions of CAP to the trust fund reserve is more favorable to planholders. It is apparent that the amount set aside is even more than the required percentage set by the SEC, to guarantee the delivery of property or performance of services in the future, like payment of the obligations to educational planholders as they mature. While such contributions to the trust fund are not in the nature of expenses/alleged by the examiner, yet, it cannot be denied that they represent a certain percentage of the amounts collected from the planholders and required by the SEC to be deposited with a trust company to guarantee the faithful compliance of the obligation under the Plan. To disallow such amount credited to the trust fund would be tantamount to taxing that percentage of contributions of planholders which actually are held in trust by CAP, and earmarked as reserved fund to guarantee the payment of services and/or delivery of the property or cash surrender/termination value to planholders. As aforementioned, the deficiency assessment arose also from the disallowance of items claimed as direct cost or acquisition cost and other expenses that give value to the securities issued by CAP. Under Section 116 of the Tax Code, dealers in securities shall pay a tax equivalent to six (6%) per centum of their gross income. Gross income is the difference between gross receipts and acquisition cost. In the case of pre-need plan, like the educational plan issued by CAP, acquisition cost or direct cost is the sum total of the cost to comply with the obligations under the contract with planholders, plus expenses that give value to the securities. The obligations under the pre-need/educational plan of CAP consist of the following: 1) Tuition and other school fees; 2) The gross selling price of the plan which is supposed to be paid back to the subscriber after a certain period; 3) Insurance on the life of the subscribers; and 4) Trust fund reserve required by SEC to be put up by the issuer. A pre-need plan is not a security in itself until it is sold, for it is only after sales that an obligee is born. A security necessarily must have an obligor and an obligee. When the pre-need plan becomes a security, it is only then that it acquires value. Those expenses incurred to create the security out of the pre-need plan that give it value consist of: commissions, bonus and awards which are promotional expenses, SEC license fees, expenses for processing and issuance of the plan, documentation expenses, collection and bank charges and direct marketing expenses. In this kind of business, those expenses are treated as capital investment. When recovered as part of the selling price of the pre-need plan, they merely constitute a return on investments. Return of capital is not income. Hence, although part of gross sales/receipts, they should be deducted as actual cost of acquisition to arrive at the tax base (gross income) for purposes of the six (6) percent tax. It is, therefore, our opinion that there is no legal basis for the disallowance of the aforementioned expenses which gave rise to the deficiency assessment of P46,194,786.34. In this connection, since the year involved in this case is 1990, the ruling issued by former Commissioner Tan in 1987 is applicable in the audit of CAP's percentage tax returns. On the other hand, the subsequent ruling issued by former Commissioner Ong in 1991 which in effect disallows the contribution to the trust fund reserve should not be made to apply retroactively to cover the 1990 percentage tax case of CAP, pursuant to Section 246 of the Tax Code, as amended, which provides as follows: "SEC. 246. Non-retroactivity of Rulings . Any revocation, modification or reversal of any of the rules and regulations promulgated in accordance with the preceding section or any of the rulings or circulars promulgated by the Commissioner shall not be given the retroactive application if the revocation, modification, or reversal will be prejudicial to the taxpayers except in the following cases: (a) where the taxpayer deliberately misstates or omits material fact from his return or in any document required of him by the Bureau of Internal Revenue; (b) where the facts subsequently gathered by the Bureau of Internal Revenue are materially different from the facts on which the ruling is based; or (c) where the taxpayer acted in bad faith." In the reinvestigation conducted by the examiner, a report was made that CAP has issued 405,972 pre-need plans subject to documentary stamp tax of P3.00 per plan. Consequently, he proposed that the amount of P1,217,916.00 as documentary stamp tax plus surcharge of P304,479.00 or a total of P1,522,395 should be assessed and collected from CAP. It may be stated in this connection that prior to the amendments introduced by Republic Act No. 7660 (Documentary Stamp Tax Law), pre-need plans are not subject to documentary stamp tax. However, beginning January 14, 1994, date of effectivity of RA 7660, pre-need plans are subject to the documentary stamp tax of fifty centavos (P0.50) on each Five Hundred Pesos (P500.00), or fractional part thereof, of the value or amount of the plan, pursuant to Section 186 of the Tax Code, as amended. Such being the case, the proposal to assess and collect the documentary stamp tax on pre-need plans issued by CAP in 1990 has no legal basis. In view of the foregoing, it is respectfully recommended that the deficiency assessment in the total amount of P46,194,786.34 as deficiency percentage tax for the year 1990 issued against the College Assurance Plan Phils. Inc. (CAP) be cancelled for lack of legal basis and that the proposed assessment of P1,522,395.00 as deficiency documentary stamp tax for the same period should not be given due course. Respectfully submitted: MILAGROS V. REGALADO Chief, Law Division I CONCUR: ALICIA P. CLEMENO Assistant Commissioner Legal Service RECOMMENDATION APPROVED: LIWAYWAY VINZONS-CHATO Commissioner of Internal Revenue