Commissioner of Internal Revenue v. Enron Subic Power Corp.

NINTH DIVISION [CA-G.R. SP No. 67843. November 24, 2004.] COMMISSIONER OF INTERNAL REVENUE , petitioner , vs . ENRON SUBIC POWER CORPORATION , respondent . D E C I S I O N DE LEON , M . M ., J p : Petitioner prays for the reversal of the Decision 1 of the Court of Tax Appeals (CTA) promulgated on September 12, 2001 ordering the cancellation and withdrawal of the deficiency income tax assessment for the year 1996 against respondent and of the Resolution 2 dated November 12, 2001 denying the motion for reconsideration 3 of said Decision . The following antecedent facts are not disputed. Respondent Enron Subic Power Corporation is a domestic corporation and duly registered with the Subic Bay Metropolitan Authority as a freeport enterprise. On April 15, 1997, respondent filed its Annual Income Tax Return (ITR) for the taxable year 1996 showing a net loss of P7,684,948.00. On May 26, 1999, respondent received a Formal Assessment Notice ("FAN") No. 019-44-96-0000371 4 from petitioner alleging that respondent had deficiency taxes due to the government for taxable year 1996 in the total amount of P2,880,817.25. Details of the assessment reveal an unpaid tax in the amount of P1,852,422.00, a surcharge of P463,105.50, an interest of P540,289.75, and a compromise penalty of P25,000.00. Respondent protested the deficiency tax assessment to the Commissioner of Internal Revenue ("Commissioner") through the Regional Director of Revenue Region No. 4. Said protest remained pending after the 180-day period provided for by Section 228 of the NIRC. Thus, respondent raised its protest to the CTA via a Petition for Review 5 filed on January 10, 2000. Respondent raised therein the alleged procedural lapse committed by the Commissioner when the latter failed to cite the legal and factual grounds on which the assessment was made. Respondent also questioned the following computations of the Commissioner in arriving at the amount of deficiency tax: (a) the inclusion of supervision fees received by respondent from Subic Power Corporation and Batangas Power Corporation to gross income earned; (b) the disallowance as deductible expense of cost of sales coming from restoration costs of the Subic power stations; (c) the disallowance as deductible expense of insurance expense; and (d) the disallowance of tax credits. The Commissioner countered the aforementioned allegations of respondent in his Answer 6 and raised the following Special and Affirmative Defenses: "3. Prior to the issuance of the assessment, petitioner was informed of the proposed assessment and the basis thereof which it protested. . . . 4. The amount of P30,011,118.00 paid by Subic Power Corporation (SPC) and Batangas Power Corporation (BPC) as reimbursements for the alleged actual costs incurred by petitioner in the performance of its obligations under the Operation & Maintenance Supervision Agreement (O&M) is not deductible, as it is a fact that SPC, BPC and petitioner are all operated and/or controlled by Enron Development Corporation, a U.S. based company, which fact makes these companies interrelated. It is no secret that `reimbursement' of so-called actual costs is a common practice applied by companies for the purpose of reducing, avoiding, or altogether escaping the payment of taxes. EHSTDA 5. Contrary to allegation of petitioner that the restoration costs of the power plants were charged in full against income as costs of sale, since there is no discernible future benefits which it may derive, the fact is that petitioner agreed to the restoration in order to corner a much bigger contract for the construction of another power plant now operated by Subic Power Corporation. Obviously, petitioner derived the benefit of a bigger contract when it agreed to do the restoration. Hence, the costs should be capitalized. 6. While insurance may be a necessary expense, it does not necessarily mean a direct cost that may be deductible from gross income. As a matter of fact, Revenue Regulation No. 1-95, as amended, explicitly excluded as allowable deduction from gross income `insurance expense' other than those incurred in the importation of goods. 7. With respect to the tax credit claimed by petitioner, suffice it to say that it is totally unsupported by documents or other evidence. . . ." 7 The CTA rendered the appealed Decision on September 12, 2001. The CTA deemed it unnecessary to pass upon the substantive arguments raised by the parties and granted respondent's Petition for Review on the sole ground that the Commissioner did not observe the procedural requirements at the assessment stage. The dispositive portion of said Decision is quoted below: "IN THE LIGHT OF ALL THE FOREGOING, the instant Petition for Review is hereby GRANTED. Accordingly, the assessment issued by the Respondent against the Petitioner for the year 1996, particularly Formal Assessment Notice No. 019-44-96-0000371 dated May 12, 1999 for deficiency income tax amounting to P2,880,817.25 is hereby ORDERED CANCELLED and WITHDRAWN. SO ORDERED." 8 The Commissioner's Motion for Reconsideration 9 of the CTA Decision was denied in a Resolution issued on November 12, 2001. Hence, the instant Petition for Review . 10 The instant appeal is grounded on the lone error attributed to the CTA, to wit: "THE TAX COURT ERRED IN HOLDING THAT RESPONDENT WAS NOT INFORMED IN WRITING OF THE LEGAL AND FACTUAL BASIS OF THE ASSESSMENT." The CTA did not commit any error warranting the reversal of the appealed Decision . The applicable law governing the protest of assessment of tax deficiency is laid down in Section 228 of the National Internal Revenue Code of 1997, which states: "Sec. 228. Protesting of Assessment . When the Commissioner or his duly authorized representative finds that proper taxes should be assessed, he shall first notify the taxpayer of his findings: Provided , however , that a pre-assessment notice shall not be required in the following cases: . . . The taxpayer shall be informed in writing of the laws and the facts on which the assessment is made; otherwise, the assessment shall be void. . . ." 11 The above provision is further detailed in Revenue Regulation 12-99 made to apply retroactively to all deficiency tax assessments issued beginning January 1, 1998. "SEC. 3. Due Process Requirement in the Issuance of a Deficiency Tax Assessment . 3.1 Mode of procedures in the issuance of a deficiency tax assessment: 3.1.1 Notice for informal conference. . . . 3.1.2 Preliminary Assessment Notice (PAN). If after review and evaluation by the Assessment Division or by the Commissioner or his duly authorized representative, as the case may be, it is determined that there exists sufficient basis to assess the taxpayer for any deficiency tax or taxes, the said Office shall issue to the taxpayer, at least by registered mail, a Preliminary Assessment Notice (PAN) for the proposed assessment, showing in detail, the facts and the law, rules and regulations, or jurisprudence on which the proposed assessment is based (see illustration in ANNEX A hereof). If the taxpayer fails to respond within fifteen (15) days from date of receipt of the PAN, he shall be considered in default, in which case, a formal letter of demand and assessment notice shall be caused to be issued by the said Office, calling for payment of the taxpayer's deficiency tax liability, inclusive of the applicable penalties. . . ." 12 From the aforequoted provisions, before the taxpayer may be formally assessed of and required to pay deficiency tax, the government must first give the taxpayer an opportunity to present his side by informing him how and why the deficiency tax assessment was calculated. DacTEH The CTA correctly ruled that the Commissioner merely issued a formal assessment and indicated therein the supposed tax, surcharge and compromise penalty due thereon, which does not contain the factual and legal grounds on which the subject assessment is based. The Formal Assessment Notice, it observed, only itemized the deductions disallowed and included the same in the gross income and imposed the preferential tax rate of 5% on certain cost items, nothing more. In support of this petition, the Commissioner relies on the strength of Annex "G", which is a copy of the working papers showing the details of assessment furnished to ESPC's representative. Annex "G" contains "notes to adjustments" explaining why certain incomes are subject to the 5% final tax and why certain deductions are not allowable. We hold that Annex "G" does not observe the requirements of Section 228 of the NIRC and Revenue Regulation 12-99. The proposed assessment of the Commissioner made at least four adjustments in the computation of ESPC's taxable income for the year 1996 by including as income the supervision fees earned from Batangas Power Corporation and Subic Power Corporation, by reducing the deductible amount for restoration costs, by disallowing insurance expense as deduction from income, and by disallowing tax credits. The "notes to adjustments" in Annex "G" which purport to have sufficiently informed the taxpayer of the basis of the assessment only cites Revenue Regulation 1-95 as legal basis for all the adjustments but does not lay down the factual basis for its applicability. Under the rules, the pre-assessment notice must not only refer to the supporting revenue laws or regulations for the assessment but must also justify their applicability to the factual milieu of the assessment. It is interesting to note that in his Answer 13 to respondent's Petition for Review filed before the CTA, the Commissioner lengthily made factual allegations in support of the assessment which were nowhere to be found in Annex "G." Had the Commissioner timely and properly laid down those allegations in Annex "G", We might have ruled that the same constituted sufficient compliance with the procedural requirement of pre-assessment notice. In sum, there was no compliance with the requirement of Section 228 of the NIRC. Hence, the assessment is void. WHEREFORE, the instant petition for review is DENIED and the Decision of the Court of Tax Appeals dated September 12, 2001 is hereby AFFIRMED in toto . SO ORDERED. Footnotes 1. Annex "A," Rollo , p. 19. 2. Annex "B," Rollo , p. 30. 3. Annex "E," Rollo , p. 64. 4. Rollo , p. 98. 5. Annex "C," Rollo , p. 31. 6. Annex "D," Rollo , p. 59. 7. Ibid ., at 60-61. 8. CTA Decision, p. 11; Rollo , pp. 28-29. 9. Supra note 3. 10. Rollo , p. 5. 11. Emphasis supplied. 12. Emphasis supplied. 13. Supra note 6.