Producers Bank of the Philippines v. Commissioner of Internal Revenue

ELEVENTH DIVISION [CA-G.R. SP No. 48937. August 28, 2003.] PRODUCERS BANK OF THE PHILIPPINES , petitioner , vs . COMMISSIONER OF INTERNAL REVENUE , respondent . D E C I S I O N VALDEZ , JR. , J p : Appealed in this petition for review is the decision 1 promulgated on June 24, 1998 by the Court of Tax Appeals in C.T.A. Case Nos. 4436 and 4811, the dispositive portion of which reads: "WHEREFORE, in view of all the foregoing, petitioner is hereby ORDERED to PAY the respondent Commissioner of Internal Revenue the amounts of P507,595.14, inclusive of the 25% surcharge (CTA Case No. 4436) and P343,438.20, inclusive of the 25% surcharge (CTA Case No. 4811), plus 10% interest per annum from the date prescribed for payment until fully paid, pursuant to Section 249(b) of the Tax Code, as amended. "SO ORDERED." 2 The following facts, as found in the proceedings a quo , are undisputed: "Petitioner is a commercial banking corporation organized and existing under Philippine laws. On various dates, it opened Letters of Credit (LC) in favor of Samsung Co., Ltd. (Samsung) for the account of Fertilizer Marketing Co. of the Philippines, Inc. (FERMAP), to recover the importation of complete fertilizer from Korea to the Philippines, as follows: "LC No. Date Amount Due Date Bill of Opened Lading Date "15151 12/18/82 $943,624.00 360 days 12/17/82 after B/L date "15924 08/01/83 580,866.00 90 days 08/11/83 after B/L date "15922 08/01/83 365,860.00 90 days 09/13/83 after B/L date "Sometime in August, 1983, the Government of the Philippines suffered a foreign exchange crisis which resulted in the default in the payment of its foreign debts. On October 24, 1983, the Central Bank of the Philippines (CB) was forced to issue Circular No. 966, effective October 25, 1983 (Exh. AA), compelling all banks to sell to the CB 80% of all their foreign exchange receipts. This Circular was later on amended by Circular No. 970, dated November 4, 1983 (Exh. BB) requiring all banks to sell to the CB all of their foreign exchange receipts. "As a consequence, petitioner was not able to pay the drafts drawn on the abovementioned letters of credit when they fell due. These drafts remained unpaid until the CB issued Circular No. 1010, dated June 6, 1984 (Exh. CC), reducing the 100% foreign exchange receipts surrender to 80% followed by Circular No. 1023, dated September 6, 1984 (Exh. DD) further reducing the percentage of surrender to 79.5%. "With the minimal allowable foreign exchange retention, the petitioner negotiated for a payment on installment of its unpaid draft. During the negotiations, Samsung, through its correspondent bank, allegedly refused to pay any tax on the interest that will be imposed principally due to the delay in the payment of the drafts. Thus, the petitioner paid Samsung the sums assessed as interest on foreign loans but which petitioner alleges to be damages for breach of contract. "On February 7, 1989, petitioner received from respondent Letter of Assessment No. FAS-1-85-89-000163 (subject of CTA Case No. 4436), dated January 27, 1989, demanding payment of the total amount of P751,540.79 representing petitioner's 1985 deficiency withholding tax on interest paid to a foreign corporation in the sum of P406,076.11 as interest and P300.00 as compromise penalty. Said assessment was protested by petitioner through a letter, dated February 24, 1989, which protest was denied by respondent in her letter, dated February 22, 1990, and which was received by petitioner on March 15, 1990, this time assessing the latter the total amount of P940,589.54, consisting of P406,076.11 as basic tax; P203,038.06 as surcharge; P331,175.37 as interest and P300.00 as compromise penalty. According to respondent, the 25% surcharge was adjusted to 50% in view of petitioner's failure to file the withholding tax returns as required by Section 319 of the Tax Code. "On January 18, 1990, petitioner again received from respondent Letter of Assessment No. FAS-1-86-89-00074 (subject of CTA Case No. 4811), dated January 7, 1990, demanding payment of the sum of P660,532.54, representing petitioner's 1986 deficiency withholding tax on interest paid to foreign loan in the sum of P274,750.56 as basic tax; P137,375.28 as surcharge; P240,406.70 as interest and P8,000.00 as compromise. The petitioner protested said assessment in a letter, dated February 11, 1990 which was received by respondent on February 13, 1990. "On several occasions beginning May up to July 1990, petitioner's counsel conferred with the examiners of the banks, Insurance and Financing Division of the BIR and explained why the aforesaid assessment should be withdrawn. Thereafter, the matter was no longer raised until April 27, 1992 when petitioner was served with a warrant of Distraint and/or Levy on its properties while the resolution of the protest is pending." 3 Petitioners, thus, filed CTA Case Nos. 4436 and 4811 with the Court of Tax Appeals. In CTA Case No. 4436, respondent Commissioner of Internal Revenue, in its answer averred that the petitioner's books of accounts classified the payment to suppliers or beneficiaries of the letters of credit as interest payment which, by its nature is subject to withholding tax; that its right to assess petitioner's deficiency withholding tax has not yet prescribed because the case involves tax evasion arising from petitioners' willful refusal to file a return; hence subject to ten-year prescriptive period. Respondent in its answer filed in CTA Case No. 4811, on the other hand, asserted lack of jurisdiction of the Court of Tax Appeals on the ground that the protest filed by the petitioner is still pending with the bureau. It further alleged that in 1986, petitioner paid interest on its foreign loans in the total amount of P1,331,670.40; that upon investigation, it was ascertained that petitioner bank failed to withhold the corresponding tax on the said interest payment in the amount of P660,532.54, inclusive of 50% fraud penalty and interest incident to delinquency; that the deficiency withholding tax assessment no. FAS-1-86-89-000074 was issued pursuant to law and well within the ten (10) year prescriptive period provided for under the Tax Code. On July 3, 1993, the two (2) cases were consolidated upon motion of the petitioner, which was granted by the Court of Tax Appeals. An order to consolidate these cases were issued on September 24, 1992. On June 24, 1998, the Court of Tax Appeals promulgated the assailed decision in favor of the CIR and against the petitioner. Hence, this petition, faulting the Court of Tax Appeals for the following errors: "THE COURT A QUO ERRED IN CONSIDERING AS "INTEREST" PAID TO NON-RESIDENT FOREIGN CORPORATIONS AMOUNTS PAID AS DAMAGES FOR BREACH OF CONTRACT UNDER THE LETTERS OF CREDIT. "THE COURT A QUO ERRED IN NOT FINDING THAT ASSESSMENTS MADE ON RESPONDENT HAD, IN FACT, ALREADY PRESCRIBED. "THE COURT A QUO ERRED IN HOLDING THAT THE WARRANT OF DISTRAINT AND LEVY CONSTITUTES CIR'S FINAL DECISION ON THE APPELLANT'S PROTEST." 4 Payments to sellers/exporters or their correspondent banks by the local bank which issued the letters of credit, petitioner argues, form part of the purchase price and are not interest payment added on the cost of the imported goods. According to petitioner-bank, these are integral part of the services offered by a bank to facilitate export/import transactions. The payment made to Samsung and Ssangyong were in fact payments of drafts drawn on the letters of credit. It failed, however, to make good its obligation under the letters of credit due to the prevailing legal restrictions on the foreign exchange receipts. Thus, Korean bank demanded payment of liquidated damages for the delay. The item, however, was entered in petitioner's book of accounts as "interest" for lack of legal term. The additional payments on top of the principal obligation, it claims, were not subject to withholding tax, as interest payments subject to 15% withholding tax, it contends, only refer to interest on foreign loans but do no include payment of drafts drawn on the letters of credit. The assessments made by the CIR, therefore, petitioner claims, haven no basis in law and should be withdrawn. We are not persuaded. There is no dispute that petitioner failed to pay the drafts drawn under the letters of credit when they fell due. It, thus, negotiated with the correspondent banks the installment payment of the unpaid drafts, which resulted in the restructuring of the loan. The amount paid by petitioner to Samsung and Ssangyong can, thus, be considered foreign loan under Section 2 of Revenue Regulation No. 4-75, which reads: "For purposes of these regulations, the term 'foreign loan' refers to loan contracts including all debt items, whether in kind or in cash, which are payable in foreign currency or in kind entered into by a Philippine resident, corporate or otherwise, with a non-resident. These consist of loans of the Central Bank, the National Government and its instrumentalities, government corporations and financial institution; loans of the private sector including trade credits (D/A and O/A), which are normally renewable and other revolving credit arrangements. Therefore, foreign loans shall include the purchase of goods and services on credit by the Philippine resident from a non-resident either under deferred payment terms or on installment . . ." 5 As aptly explained by the CTA in its assailed decision: "It is clear from the aforequoted definition provided by Revenue Regulations No. 4-75 that what was obtained by FERMAP from Samsung is a foreign loan since a foreign loan covers purchase of goods on credit by a Philippine resident from a non-resident foreign corporation either under deferred payment terms or on installment. If paid on time, FERMAP pays no interest, but because of the delay in payment brought about by the CB Circular and which resulted in the restructuring of the loan, FERMAP was charged with a corresponding interest. The letters of credit upon which the petitioner issued the drafts in favor of Samsung where merely the means to obtain the loan." 6 The amount paid by petitioner on top of its principal obligation is, therefore, an interest on foreign loan. Thus, subject to fifteen percent (15%) withholding tax, pursuant to Section 51 7 of Presidential Decree No. 1994 otherwise known as the National Internal Revenue Code of 1985. Petitioner's argument that even assuming arguendo that the amount paid to Korean bank were interest, still the same cannot be the subject of assessment here in the Philippines, for the provision of the RP-Korea Tax Treaty provides the tax situs of said interest in Korea, is likewise untenable. The pertinent provisions of the RP-Korea Tax Treaty 8 read: "Article 11 "INTEREST "1. Interest arising in a contracting State and paid to a resident of the other Contracting State may be taxed in that other State. "2. However, such interest may also be taxed in the Contracting State in which it arises, and according to the laws of that State, . . . xxx xxx xxx "4. Notwithstanding the provisions of paragraph 2 hereof, interest arising in a Contracting State and paid to a resident of the other Contracting State shall be taxable only in that other State if the interest is paid in respect of xxx xxx xxx "ii) "aa) in the case of the Philippines, the Central Bank of the Philippines. "(bb) in the case of Korea, the Bank of Korea, the Export-Import Bank of Korea, the Korea E xchange Bank and xxx xxx xxx" The use of word "may," in the afore-quoted provision of the RP-Korea Tax Treaty, signifies that the subject interest may be taxed either under Philippines law, where the interest arises, or in Korea. Moreover, the petition filed before us, is bereft of any allegation that the subject interest was paid in respect of a loan made, guaranteed or insured, or a credit extended, guaranteed or insured by the Bank of Korea, the Export-Import Bank of Korea, the Korea Exchange Bank, as provided in Article 11(4)(bb). Hence, its claim must fail. We quote with approval the following pronouncement of the CTA in its resolution denying petitioner's motion for reconsideration, which was quoted by the Commissioner of Internal Revenue in its comment: 'It is to be observed that the bank of Samsung Co., Ltd. In Korea First Bank and that of Ssangyong, the Bank of Seoul and trust Company, are not one of those enumerated under the treaty. Furthermore, the subject interest was not paid in respect of a loan extended, guaranteed or insured or of a credit extended, guaranteed or insured by the Korea First Bank or the Bank of Soul and Trust Company. These banks are mere agents or correspondent banks of the beneficiaries of the letters of credit. We cannot, therefore, apply the provisions of the RP-Korea Tax Treaty in the instant case.' 9 Anent petitioner's claim that the amount paid are liquidated damages but was entered in its book of accounts as "interest" for lack of legal term, suffice it to state that the same is devoid of merit. As aptly said by the CTA in its assailed decision: ". . . it is not correct to state that what was paid to Samsung are liquidated damages because as defined in Article 2226 of the Civil Code, liquidated damages are those agreed upon by the parties to a contract, to be paid in case of breach thereof. It is to be noted that when Samsung and FERMAP/petitioner agreed to pay interest it was because of the breach that had already taken place." 10 Petitioner, in the instant case, failed to present any proof that the said amount paid as interest was agreed upon in the contract. Neither, was there any allegation that payment of liquidated damages in case of breach was provided for in their contract. The interest, thus paid cannot be treated as liquidated damages. Moreover, damages for breach of contract constitute taxable income to the recipient in the year received to the extent that such damages constituted a loss of anticipated profits and non-taxable to the extent that the same represent a return of capital or investment. 11 In the case at bar, the liquidated damages paid by herein petitioner do not represent return of capital but constitute loss of anticipated profits. Hence, even assuming that they are liquidated damages, the same are still subject to tax. As further held by the CTA in its assailed decision: "What was paid is in the nature of compensatory interest which is defined as interest given by way of damages (Civil Code, Paras, 1985 Ed., Vol. IV, p. 148). However, while what was paid is not liquidated damages, it is of the same token as compensatory interest since both compensate for damages caused. And since they represent compensation for lost profits (BIR Rulings dated September 8, 1954 and September 21, 1990, Bar Reviewer is Taxation, Nolledo, 1987 Ed., p. 187), it follows then that the interest that was paid in the instant case was likewise to be treated as taxable income and, therefore, subject to 15% withholding tax." 12 Neither did we find any merit in petitioner's claim of liberal construction of tax laws in its favor. Petitioner, in the case at bar, is disclaiming its liability for tax on "interest" it paid on its foreign loan, arguing that the same were not taxable interests under the Tax Code. Its claim, therefore, is in the nature of tax exemption, which should be strictly construed against it and liberally in favor of the state. 13 Clearly, the rule on liberal construction of tax laws finds no application in the case at bar. Petitioner likewise faults the Tax Court in not holding that respondent's right to assess the deficiency withholding tax on the subject interest already prescribed, being made beyond the three-year prescriptive period. Prescription as a defense in collection of deficiency taxes must be properly pleaded and proved. Thus: ". . . since prescription is one of the affirmative defenses set up by petitioner herein, it was incumbent upon the latter, if he wanted to avail itself of the benefits of section 331, to prove that it had submitted said returns, and that, having failed to do so, the conclusion must be that no such returns had been filed and that the Government had ten (10) years within which to make the corresponding assessment, as it did in this case." 14 Petitioner, in the instant case, however, failed to present any proof that corresponding return for the subject tax liabilities had been filed. As keenly observed by the CTA: "Nowhere in the records did we find any final withholding tax return supposedly filed by petitioner covering subject assessments." 15 The above finding was never assailed by the petitioner in this recourse. The petition, filed before us, is likewise bereft of any allegation that it filed the corresponding return for its subject tax liabilities. The applicable period, therefore, for assessment of petitioner's deficiency taxes, is ten years, pursuant to Section 269 16 of the National Internal Revenue Code of 1985: " Exceptions as to period of limitation of assessment and collection of taxes . (a) in the case of a false or fraudulent return with intent to evade tax or a failure to file a return, the tax may be assessed, or a proceeding in court for the collection of such tax may be begun without assessment, at any time within ten years after the discovery of the falsity, fraud, or omission: Provided, That in a fraud assessment which has become final and executory, the fact of fraud shall be judicially taken cognizance of in the civil or criminal action for the collection thereof." The subject assessments, therefore, were made well within the ten (10) year prescriptive period provided for by law. Finally, petitioner argues that the CTA erred in holding that warrant of distraint and levy constitutes the CIR's final decision on its protest in CTA Case No. 4811. The argument is bereft of merit. It is an accepted doctrine that warrant of distraint and levy is a proof of the finality of the assessment and renders hopeless a request for reconsideration. It is tantamount to an outright denial of the request for reconsideration or reinvestigation and makes the said request deemed rejected. 17 Hence, when the commissioner, in the instant case, proceeded with distraint and levy, without categorically deciding petitioner's protest, such action has been deemed an implied denial of the same. Petitioner instituted CTA Case No. 4811 only upon receipt of the warrant of distraint and levy. Such act clearly and indisputably manifests that petitioner itself treated the said act by the commissioner as an implied denial of its protest. The filing of CTA Case No. 4811 is antithetical with its present claim that there was no final decision yet on the disputed assessment. In fine, it is well settled that the court will not set aside lightly the conclusion reached by the Court of Tax Appeals which by the very nature of its function, is dedicated exclusively to the consideration of tax problems and has necessarily developed an expertise on the subject, unless there has been an abuse or improvident exercise of authority. 18 In the present case, we find no reversible error committed by the Court of Tax Appeals in rendering the assailed decision. WHEREFORE, the instant petition is DENIED. The assailed decision is AFFIRMED in toto . Costs against the petitioner. SO ORDERED. ETHCDS Tria-Tirona and Asuncion-Vicente, JJ . , concur. Footnotes 1. Rollo , pp. 50-62. 2. Id ., at p. 62. 3. Id ., at pp. 50-53. 4. Petition, Ibid., p. 42. 5. Footnote 1, supra ., at p. 51. 6. Id ., at p. 58. 7. "Section 51. Withholding of tax at source . xxx xxx xxx (e) Non residents aliens and foreign corporations. (1) Non-resident aliens . xxx xxx xxx (2) Non-resident foreign corporations . In the case of foreign corporations subject to tax under this Title, not engaged in trade or business within the Philippines, there shall be deducted and withheld at source in the same manner and upon the same items as provided in subsection (b)(1) of this section, as well as on remunerations for technical services or otherwise, a tax equal to thirty-five per centum (35%) thereof: Provided , That interest on foreign loans shall be subject to withholding tax of fifteen per centum (15%). This tax shall be returned and paid in the same manner and subject to the conditions as provided by Section 52. This tax shall not be required in the case of reinsurance premiums ceded to foreign insurance corporations not engaged in trade or business in the Philippines." 8. Convention Between the Republic of the Philippines and the Republic of Korea for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income. Emphasis ours. 9. Comment, Rollo , p. 98. 10. Footnote 1, supra ., at p. 59. 11. Eustaquio Ordoo, Digest of the 990 BIR Rulings, pp. 237-238. 12. Footnote 1, supra ., at p. 59. 13. Magsaysay Lines, Inc. vs. Court of Appeals, 260 SCRA 513, 525 (1996). 14. Taligaman Lumber Co. Inc. vs. Collector of Internal Revenue, 4 SCRA 842, 847 (1962). 15. Footnote 1, supra ., p. 59. 16. Formerly Section 319 of the National Internal Revenue Code of 1977, as amended by Batas Pambansa Blg. 700. 17. Commissioner of Internal Revenue vs. Algue, 158 SCRA 9, 12 (1988). 18. Sea-Land Service, Inc. vs. Court of Appeals, 357 SCRA 441, 445-446 (2001).