Commissioner of Internal Revenue v. Makati Leasing and Finance Corp.

[CA-G.R. SP No. 23578. November 25, 1992.] (C.T.A. Case No. 3354) COMMISSIONER OF INTERNAL REVENUE , petitioner-appellant , vs . MAKATI LEASING AND FINANCE CORPORATION and THE COURT OF TAX APPEALS , respondents-appellees . D E C I S I O N * LOMBOS-DELA FUENTE , J p : This is an appeal from the judgment rendered by the Court of Tax Appeals in CTA Case No. 3354 "Makati Leasing and Finance corporation vs. Commissioner of Internal Revenue" which upheld the petitioner's protest against the respondent's assessment for deficiency income tax for the year 1975 and annulled the said assessment (except that portion relating to petitioner's liability in the amount of P2,505.34 for withholding taxes for 1985). It is noted that the Commissioner, appellant, seasonably filed a notice of appeal with aforementioned court and that this was followed by a petition fir review filed with this Court. It was given due course and the private respondent, appellee, was required to file its Answer (page 58, rollo ). The factual antecedents and circumstances may be briefly stated as follows: 1. Private respondent-appellee, the Makati Leasing and Finance Corporation (MLFC), is a domestic corporation duly licensed to do business under existing laws. It is engaged inter alia in the leasing of equipment, barges, motor vehicles, etc. 2. MLFC has been leasing such equipment to its clients for an agreed rental and a period of time (e.g., Exh. C., to Liwayway Marketing Corporation), one of the stipulations being the lessee's obligation to return the said equipment to MLFC upon the expiration of the agreed term. 3. On November 10, 1980, MLFC received a letter dated October 30, 1980, of the herein petitioner-appellant which contains am assessment against said firm in the sum of P1,3111,066.12 as its "deficiency income tax" and the amount of P2,505.34 as its "deficiency withholding taxes", for the "year 1975" (Exh. D). The alleged income tax deficiency was arrived at as follows: "Net income per return P2,318,605.48 Add: Additional Income (Per adoption of Financing Method Rather than Operating Method 2,637,961.90 Net Income per investigation P4,956,567.38 Tax due thereon P1,724,798.00 Less: Tax already assessed 801,512.00 B a l a n c e P923,286.00 Add: 14% int. fr. 4/16/75-4/16/78 387,780.12 AMOUNT STILL DUE AND COLLECTIBLE P1,311,066.12 =========== (Emphasis supplied) 4. This assessment was promptly protested on the ground the same was based on the erroneous assumption that the said leases were "installment sales", instead of "pure and simple leases". Reconsideration of that assessment was denied by respondent-appellee in a letter (Exh. E) received by movant on June 22, 1981, wherein MLFC was informed that it was a "final decision" of the appellant Commissioner. It was forthwith brought to the Court of Tax Appeals by a petition for review. The matter was in due time resolved by the said Court in favor of MLFC (Annex A of Petitioner; p. 29, rollo ). In this appeal interposed by the Commissioner of Internal Revenue (herein petitioner ), it is insisted that the agreements entered into by MLFC with the lessee (e.g., Exh. C.) were "in substance and purpose" installment sales although in the form of lease contracts. After due consideration and evaluation of the facts and the applicable statutory provisions, We have found no sufficiently valid and convincing reasons warranting reversal or modification of the appealed judgment. Firstly, the appellee was duly licensed to do business under R.A. No. 5980 and was inter alia engaged in the leasing of various types of equipments during the taxable year mentioned in the assessment. Conformably with the intent of the contracting parties, MLFC'c agreements were all prepared in the form of lease contracts which spelled out the appellee's equipment being leased, the lease period and the rentals to be paid by the lessees. The basic features of a lease are concededly present. Secondly, the additional income for year 1975 was arrived at simply by conducting that the leases were practically "sales on installments" from the adoption by appellee of the "financing method" of reporting/recording rental income instead of the so-called "operating method" generally used in the leasing business. Evidently, the revenue examiner gave decisive weight to the fact that under the "financing method" the "gross rentals receivable . . . are recorded at the time the lease contract is booked" (e.g.,in a lease for a term of 5 years, the rentals accruing and payable during that period are reported immediately upon execution of the contract as receivables similar, We take it, to the method used in installment sales). Such approach ignored the basic features of a lease of equipment that would distinguish it from an installment sale. Third. That assessment likewise overlooked that the change from the "operating method" to the "financing method" requested by MLFC was "granted" by the appellant Commissioner's office in its letter of January 19, 1976, with an effectivity dates" . . . shall take effect beginning with the taxable year 1976 " (Exh. B). The questioned assessment covers "year 1975 ". Fourth. MLFC's request for change in the method of presentation was not unqualified, in the sense that it was totally discarding its "operating method" which it had used since the first year of its leasing business. Its letter dated "4 March 1975" (Exh. B.) insofar as relevant plainly stated: "Makati Leasing & Finance Corporation has kept its books of accounts in accordance with the "operating" method of accounting for leases. . . . " For taxation purposes , percentage taxes are computed on the basis of the gross rentals due/earned during the taxable period. For income tax purposes , net income subject to tax is arrived at by deducting operating costs (e.g., payroll, interest, percentage taxes and other business expenses, and depreciation of leased equipment, etc.) from the gross rentals due/earned during the taxable period. . . . "The company desires to change the system of recording its lease transactions in its books of accounts. This new system is known as the "financing" method which we are using for internal reporting purposes . . . . "The implementation of the new system shall involve the application of accounting concepts widely used in the industry and facilitate the preparation of periodic reports and financial statement. The manner by which percentage taxes are computed shall, however, still be under the "operating" method as explained in the earlier portion of this letter-request. Taxwise, therefore, no change will be effected ." (Emphasis supplied) Fifth. Appellant has argued that the appellee's lease agreements included "extraordinary terms" such as; section 10, granting the lessee an "option" to acquire the leased equipment by paying the stipulated "loss value"; section 11, requiring the lessee to pay the insurance premiums due on the leased equipment; and section 12, with respect to the payment by the lessee of taxes incident to the lease, to support the conclusion that such leases were in substance installment sales. It would suffice to say that these, in Our view, are peripheral aspects that would not obliterate or destroy the essential nature of the lease agreements between appellee and its contracting parties. In the purchase of real property, for instance, it is now a practice for the owner-seller to ask the buyer to pay the capital gains tax due; but, it cannot be seriously contended that the transaction is no longer that of sale. The same is true with respect to the payment of insurance premiums by a lessee of real property, if he is willing to assume that burden as part of the agreement. Those items in effect are added costs incident to the sale/lease. As to section 10, as pointed out by the appellee in its answer, the "option" pertains to the owner-lessor and not the lessee. Such provisions, We may add, fall well within the contracting parties' freedom to agree on stipulations or terms as may be deemed convenient, so long as they are not contrary to law, morals, good customs, public order or policy (Article 1308, Civil Code). These can hardly affect the principal purpose and/or intent of the parties in the execution of the contract. WHEREFORE, the aforementioned judgment of the Court of Tax Appeals should be, as it is hereby, AFFIRMED in its entirety. IT IS SO ORDERED. Bengzon and Abad Santos, Jr ., JJ ., concur. Footnotes * Raffled originally to the former Twelfth Division; then transferred on August 1992 to the ponente , Sixth Division.