Unnumbered BIR Ruling

January 29, 1998 Sugarsteel Industries, Inc. Legaspi Towers 200 Paseo de Roxas Makati, Metro Manila Attention: Robert C . Chiang VP-Comptroller Gentlemen : This refers to your administrative protest against the assessment of this Bureau particularly involving the following deficiency tax assessments, to wit: casia ASSESSMENT NO. NATURE OF ASSESSMENT AMOUNT C-1-92-IT-261-96 Deficiency Income Tax P19,125,962.75 C-1-92-VAT-262-96 Deficiency VAT 5,589,599.17 Deficiency EWT: C-1-92-EWT-263-96 Freight/Shipping line 5,875.73 C-1-92-EWT-264-96 Handling 23,924.66 C-1-92-EWT-265-96 Trucking 878.51 TOTAL P24,746,240.82 =========== After a careful review of the facts of the case as well as the law and jurisprudence involved, this Office finds merit in your contention that you are not liable to the following deficiency assessments, viz: A. 1992 Deficiency Income Tax P19,125,962.75 B. 1992 Deficiency Value-Added Tax P5,589,599.17 It was ascertained, however, that you are still liable to pay the following deficiency expanded withholding tax assessments: Freight/ Shipping Line Handling Trucking P4,208,257.93 P1,068,415.12 P703,661.41 Rate of Tax 1% 1% 1% EWT due thereon P42,082.58 P10,684.15 P7,036.61 Less: Tax already paid 40,119.09 2,689.28 6,743.04 Deficiency EWT P1,963.49 P7,994.87 P293.57 Add: 25% Surcharge 490.87 1,998.72 73.39 20% Interest up to 1/31/98 1,861.22 7,578.47 278.28 Total Amount due & Collectible P4,315.58 P17,572.06 P645.24 ============ ============ ========= In view thereof, you are requested that you immediately pay the aggregate amount of P22,532.88 as deficiency expanded withholding tax for taxable year 1992, exclusive of increments that may still accrue thereon, to the BIR District Office in Makati which has jurisdiction over your Office within five (5) days from receipt hereof, otherwise, this Bureau will enforce collection through the summary remedies provided by law. cdtech This constitutes the final decision of this Bureau on the matter. Very truly yours, (SGD.) LIWAYWAY VINZONS-CHATO Commissioner of Internal Revenue ATTACHMENT MEMORANDUM FOR: The Commissioner SUBJECT : SUGARSTEEL INDUSTRIES, INC . We refer to the protested internal revenue tax case of SUGARSTEEL INDUSTRIES, INC. (the "taxpayer") involving its 1992 deficiency tax assessments, viz: aisadc ASSESSMENT NO. NATURE OF ASSESSMENT AMOUNT C-1-92-IT-261-96 Deficiency Income Tax P19,125,962.75 C-1-92-VAT-262-96 Deficiency VAT 5,589,599.17 Deficiency EWT: C-1-92-EWT-263-96 Freight/Shipping line 5,875.73 C-1-92-EWT-264-96 Handling 23,924.66 C-1-92-EWT-265-96 Trucking 878.51 TOTAL P24,746,240.82 =========== I. THE TAX ASSESSMENT It appears from the records that on July 12, 1996, a demand was made on subject taxpayer by the Bureau for the payment of the following tax assessments: A. 1992 DEFICIENCY INCOME TAX Net Income per return P1,635,500.35 Add: Underdeclaration of Sales Total Purchases per F/S P372,382,044.88 Total Purchases per Investigation 390,074,112.08 Difference P17,692,067.20 Divided by the ratio of Cost of Sales to Sales .947179 18,678,694.52 Amount subject to tax P20,314,194.85 Rate of Tax 35% Income Tax Due thereon P7,109,968.18 Less: Tax already paid 526,160.01 Deficiency Income Tax P6,583,808.17 Add: 25% Surcharge 1,645,952.04 50% Surcharge 3,291,904.09 20% Interest p.a. from 4/15/93 to 8/15/96 7,604,298.44 Total Amount Due & Collectible P19,125,962.75 =========== B. 1992 DEFICIENCY VALUE-ADDED TAX Underdeclaration of Sales P18,678,694.52 Rate of Tax 10% VAT due thereon P1,867,869.40 Less: Tax already paid - Deficiency VAT P1,867,869.40 Add: 25% Surcharge 466,967.35 50% Surcharge 933,934.70 20% Interest p.a. from 1/20/93 to 8/20/96 2,320,827.72 Total Amount Due & Collectible P5,589,599.17 =========== C. 1992 DEFICIENCY EXPANDED WITHHOLDING TAX Freight/ Shipping Line Handling Trucking P4,208,257.93 P1,068,415.12 P703,661.41 Rate of Tax 1% 1% 1% EWT due thereon P42,082.58 P10,684.15 P7,036.61 Less: Tax already 40,119.09 2,689.28 6,743.04 paid Deficiency EWT P1,963.49 P7,994.87 P293.57 Add: 25% Surcharge 490.87 1,998.72 73.39 50% Surcharge 981.75 3,997.44 146.79 20% Interest up to 8/15/96 2,439.62 9,933.63 364.76 Total Amount due & Collectible P5,875.73 P23,924.66 P878.51 ======== ======== ====== II. THE PROTEST LETTER The taxpayer filed its protest letter dated August 13, 1996 on the above tax assessments. It stated that the Investigating Examiner has counter checked personally with the National Steel Corporation (its sole supplier of Cold Rolled Coils [CRC]) the whole year purchases. Its explanation and justification are presented below: Total Purchases per Financial Statement P372,382,044.88 Total Purchases per investigation (the Total Debt only appearing in the Ledger of Raw Materials 390,074,112.88 Difference P17,692,067.20 =========== The taxpayer contends that the Investigating Examiner's computation of the Total Purchases was based solely on the total debit in the Raw Materials ledger without considering the adjusting entries therein. It maintains that the cited difference consist of entries which should have been properly excluded as purchases. It illustrates the adjusting entries as follows: 1. January 22, 1992 (DR) Deposit Receivable NSC P17,518.91 (CR) Raw Materials P15,850.43 (CR) Input Tax 1,668.48 To correct the CRC price based on NSC Invoice as seconds instead of Prime. 2. March 27, 1992 (DR) Deposit Receivable NSC P314,341.40 (CR) Raw Materials P284,404.12 (CR) Input Tax 29,937.28 To reverse part of the entry made on CRC receipts per MBR 1873 for this is a replacement of collapsed coils, with original entry: (DR) Raw Materials . . . (CR) Deposit Receivable NSC . . . 3. April 24, 1992 Original Entry (DR) Raw Materials P5,420,064.74 (DR) Input Tax 563,826.00 (CR) Marginal Deposit Zinc P5,983,890.74 To take up the cost of Zinc importation per LC#145858. April 30, 1992 Reversing Entry (DR) Marginal Deposit Zinc P5,983,890.74 (CR) Raw Materials P5,420,064.74 (CR) Input Tax 563,826.00 To reverse entry made on April 24 due to changes in exchange rate. April 30, 1992 Revised New Entry (DR) Raw Materials P5,575,071.40 (DR) Input Tax 563,826.00 (CR) Marginal Deposit Zinc P6,138,897.40 To take up the correct cost of Zinc importation per LC# 145858 as revised above. 4. August 31, 1992 Original Entry (DR) Raw Materials P9,586,611.57 (DR) Input Tax 978,225.71 (CR) Marginal Deposit Zinc P10,564,837.28 To take up the cost of CRC receipts per MRR 2053. cdll August 31, 1992 Reversing Entry (DR) Deposit Receivable NSC P10,564,837.28 (CR) Raw Materials P9,586,611.57 (CR) Input Tax 978,225.71 To reverse entry made on CRC receipts per MRR 2053 due to wrong pricing used. August 31, 1992 Revised New Entry (DR) Raw Materials P10,511,802.67 (CR) Input Tax 1,072,632.92 (CR) Deposit Receivable NSC P11,584,435.59 To take up the correct cost of CRC per MRR 2053. 5. September 23, 1992 (DR) Deposit Receivable NSC P320,857.28 (CR) Raw Materials P291,148.28 (CR) Input Tax 29,709.00 To adjust the cost of August deliveries due to change in price (MRR 2052). Over debited to Raw Materials. 6. September 23, 1992 DR) Deposit Receivable NSC P1,019,598.31 (CR) Raw Materials P925,191.06 (CR) Input Tax 94,407.25 To adjust the cost of CRC deliveries due to change in price (MRR 2053). Over debited to Raw Materials. 7. December 29, 1992 (DR) Accounts Receivable NSC P83,047.53 (CR) Raw Materials P83,047.53 To take up the claim from NSC re: mid-portion exceeds the specified thickness. LexLib 8. March 31, 1992 Original Entry: (DR) Cost of Production xxx (CR) Raw Materials xxx To take up adjustment on costing for February 1992 Zinc usages. Subsequently: (DR) Raw Material P477,180.52 (CR) Cost of Production P477,180.52 [Hence] this is not an actual purchase, just a reversing entry. 9. September 23, 1992 Original Entry Format: (DR) Cost of Production xxx (CR) Raw Materials xxx Same as above for August 1992 CRC usages due to change in CRC pricing. Subsequently: (DR) Raw Materials P478,047.89 (CR) Cost of Production P478,047.89 This is not a purchase. 10. September 30, 1992 Original Entry Format: (DR) Raw Materials xxx (CR) Marginal Deposit Zinc xxx (DR) Cost of Production xxx (CR) Raw Materials xxx Subsequently: (DR) Raw Materials P84,694.65 (CR) Cost of Production P84,694.65 To take up the refund of short shipment on Zinc importation per #148217. 11. December 23, 1992 (DR) Raw Materials P45,339.00 (CR) Cost of Production P45,339.00 To adjust the costing of 0.500 x 1220 on November usages. 12. Various adjusting entries in the sum of P487.41. During the hearing of October 10, 1997, the taxpayer (thru representative Mr. Robert C. Chiang, its VP-Comptroller) presented and marked as its supporting evidence the Journal Vouchers showing the individual adjusting entries illustrated above. The taxpayer further manifested its willingness to pay the other final assessment on the deficiency Expanded Withholding Taxes. III. THE ISSUE The main issue presented for resolution before this Office is whether or not the Investigating Examiner erred in computing the total purchases based solely on the sum of the debit side of the Raw Materials ledger. IV. RESOLUTION We find the approach employed by our Revenue Officers in computing/determining the income tax liability of herein protestant-taxpayer for taxable year 1992 not only too simplistic but outright erroneous. V. DISCUSSION The Basic Accounting Concept In resolving this case, it is necessary to discuss some basic accounting concepts. In accounting, the device called an account is used in recording accounting entries and in calculating the net change. Deposit Receivable , Input Tax , Raw Materials , and Cost of Production are example of accounts. An account has two sides for recording entry. Entry in the left-hand side is called debit (abbreviated DR) while the right-hand side is called credit (abbreviated CR). Every accounting transaction is expressed by a debit amount in one account and an equal and offsetting credit amount in another account ( double-entry bookkeeping). The balances of assets and expense accounts increase with an entry in the debit side and inversely decrease in the credit side. The balances of the liabilities , owner's equity , and revenue accounts increase with an entry in the credit side and correspondingly decrease in the debit side. Raw materials, Deposit Receivable, and Marginal Deposit are asset accounts while Cost of Production is an expense account. At the end of accounting period, the debit and credit sides are summed and the net amount is reflected as the end balance of the account. (Accounting Text and Cases, by Robert N. Anthony, pp. 92-95) A manufacturing company (like the subject taxpayer) has as a major function of converting its raw materials and purchased parts into ultimately salable goods. In determining the cost of production, (1) the materials' beginning balance and the period's net purchases of material are summed to arrive at materials available , then (2) the material's ending inventory is subtracted from the materials available to get the cost of materials used , and finally (3) other manufacturing costs are added to the materials used to get the cost of production. (Ibid. at pp. 170-173) The Taxpayer's Bookkeeping Procedure It appears from the records before us that the taxpayer uses herein described bookkeeping procedure in recording its purchases. Initially, upon placement of purchase order and payment of deposit, the taxpayer makes the following entries: (DR) Deposit Receivable NSC (for local materials) xxx - or - (DR) Marginal Deposit (for imported materials) xxx (CR) Cash xxx Then upon the arrival of the ordered materials, the deposit accounts are closed (credited) and transferred (debited) to the Raw Materials and Input Tax accounts. The following entries are prepared even without receiving the corresponding document yet: (DR) Raw Materials xxx (DR) Input Tax xxx (CR) Deposit Receivable-NSC (for local material) xxx -or- (CR) Marginal Deposit (for imported materials) xxx Finally, upon the arrival of the purchase documents, the original delivery entries are revised or adjusted to reflect the actual price of the materials. The following adjusting entries are made to reflect the decrease in the price of the materials. (DR) Deposit Receivable NSC (for local materials) xxx -or- (DR) Marginal Deposit (for imported materials) xxx (CR) Raw Materials xxx (CR) Input Tax xxx At the end of the reporting period, the amount of materials used (which is computed by adding the beginning balance and the total purchases for the period, less the ending inventory) is removed (credited) from the Raw Materials account and transferred to Cost of Production, as follows: (DR) Cost of Production xxx (CR) Raw Materials xxx The Computation of Total Purchases Our Examiner computed the amount of total purchases by simply summing the debit side of the Raw Materials account, less only the account's ending inventory. He did not exclude the adjusting entries which do not constitute purchases. He completely ignored the credit entries in the account. From the evidence before us, we found that the adjusting entries presented by the taxpayer legitimately explain the difference in the total purchases cited by our Examiner. These adjusting entries are individually evaluated below. Explanation of the transaction Increase/ (Decrease) THE CREDIT ENTRIES 1. On January 22, 1992, the account was credited to correct (P15,850.43) the CRC price based on NSC Invoice as seconds instead of Prime. This credit entry reduces the amount of purchases of materials. 2. On March 27, 1992, the account was credit to reverse part of the entry made on CRC receipts per MBR 1873 for this is a replacement of collapsed coils. (284,404.12) This credit entry reduces the amount of purchases also. 3. On April 24, 1992, the account was credited to reverse entry made on April 24, 1992 due to changes in exchange rate. (5,420,064.74) This credit entry corrects the double take-up of same purchases made on April 24, 1992 and on April 30, 1992. 4. On August 31, 1992, the account was credited to reverse entry made on CRC receipts per MRR 2053 due to wrong pricing used. (9,586,611.57) This credit entry corrects the double take-up of same purchases under MRR 2053 both made on August 31, 1992. 5. On September 23, 1992, the account was credited to adjust the cost of August deliveries due to change in price (MRR 2052). Over debited to Raw Materials. (291,148.28) This credit entry properly reduces the excess in the amount of purchases. 6. On September 23, 1992, the account was also credited to adjust the cost of CRC deliveries due to change in price (MRR 2053). Over debited to Raw Materials. (925,191.06) This credit entry also properly reduces the excess in the amount of purchases. 7. On December 29, 1992, the account was credited to take-up the claim from NSC re: mid-portion exceeds the specified (83,047.53) thickness. This credit entry reduces the price of the purchases of defective materials and also created a claim against NSC. THE DEBIT ENTRIES 8. On March 31, 1992, the account was debited to take up adjustment on costing of February Zinc usages. (477,180.52) This debit entry is not purchase of materials. Thus, it should be excluded from the amount of total purchases. 9. On September 23, 1992, the account was again debited to take up adjustment on costing of August CRC usages due to change in pricing. (478,047.89) This debit entry is not also a purchase of materials. 10. On September 30, 1992, the account was debited to take up the refund of short shipment of Zinc importation per LC#148217. (84,694.65) Again, this debit entry is not a purchase of materials. 11. On December 23, 1992, the account was debited to adjust the costing of 0.500 x 1220 on November usages. (45,339.00) This debit entry is not a purchase of materials. 12. Various adjusting entries with minimal amount. (487.41) TOTAL AMOUNT (P17,692,067.20) Considering the time gap between the delivery of materials and the arrival of the covering document, minor price adjustment is normally expected in the recording process. cda RECAPITULATION : Raw Materials Total DR Per General Ledger P390,074,112.08 Less: Adjustments xxx No. 1 P15,850.43 2 284,404.12 3 5,420,064.74 4 9,586,611.57 5 291,148.28 6 925,191.06 7 83,047.53 8 477,180.52 9 478,047.89 10 84,694.65 11 45,339.00 12 487.41 17,692,067.20 Total Raw Materials Purchased P372,382,044.88 Raw Materials Purchased Per Cost of Sales 372,382,044.88 NO DISCREPANCY P-0- ============= It is clear that there is no underdeclaration in the amount of taxpayer's total purchases for the whole year of 1992. Accordingly, we found that the taxpayer correctly filed its Income Tax for the taxable year 1992. B. 1992 Deficiency VAT This instant assessment was based on the premise that there was an underdeclaration of taxpayer's raw material's purchase during the taxable year 1992 resulting in the underdeclaration of sales. Having found this finding bereft of merit, the resolution of this instant assessment has, therefore, become moot and academic. C. 1992 Deficiency EWT Taxpayer, as previously mentioned, manifested its willingness to pay the same. Therefore, it has to be SUSTAINED. RECOMMENDATION In view of the foregoing discussions of facts and accounting procedures, the Legal Service, through its Appellate Division, respectfully submits its recommendations as follows: LibLex 1. For want of merit, the following assessments are hereby recommended to be withdrawn and cancelled, viz: A. 1992 Deficiency Income Tax P19,125,962.75 B. 1992 Deficiency Value-Added Tax P5,589,599.17 2. We recommend collection of the following 1992 Deficiency Expanded Withholding Taxes: Freight/ Shipping Line Handling Trucking P4,208,257.93 P1,068,415.12 P703,661.41 Rate of Tax 1% 1% 1% EWT due thereon P42,082.58 P10,684.15 P7,036.61 Less: Tax already 40,119.09 2,689.28 6,743.04 paid Deficiency EWT P1,963.49 P7,994.87 P293.57 Add: Surcharge 490.87 1,998.72 73.39 Interest up to 1/31/98 1,861.22 7,578.47 278.28 Total Amount due & Collectible P4,315.58 P17,572.06 P645.24 =========== ========== ========= 3. Finally, upon payment of the following amounts by SUGARSTEEL INDUSTRIES, INC., it is respectfully recommended that its 1992 internal revenue tax case be considered CLOSED AND TERMINATED, viz: cdt a. 1992 Deficiency EWT Freight/Shipping line P4,315.58 b. 1992 Deficiency EWT Handling P17,572.06 C. 1992 Deficiency EWT Trucking P645.24 TOTAL TAX TO BE PAID P22,532.88 ========= Respectfully submitted: (SGD.) RODULFO L. SALAZAR Chief, Appellate Division I CONCUR: (SGD.) SIXTO S. ESQUIVIAS IV Deputy Commissioner Legal & Enforcement Group Recommendation APPROVED: (SGD.) LIWAYWAY VINZONS-CHATO Commissioner of Internal Revenue