EN BANC

[C.T.A. EB CASE NO. 287. January 14, 2008.]

(CTA Case No. 6520)

CS GARMENTS, INC., petitioner, vs. COMMISSIONER OF INTERNAL REVENUE, respondent.

DECISION

CASANOVA, J p:

This is an appeal to the Court of Tax Appeals (CTA) En Banc by way of a verified Petition for Review, filed
by herein petitioner, CS Garments, Inc., under Section 18 of R.A. 9282. The petition is praying that the
Decision 1 (Assailed Decision) dated January 4, 2007 rendered by the Second Division of this Court
(Second Division) in CTA Case No. 6520 entitled, "CS Garments, Inc. vs. Commissioner of Internal
Revenue" as well as the Resolution 2 (Assailed Resolution) dated May 25, 2007 promulgated also by the
Second Division be reversed and set aside in part. In both the assailed Decision and Resolution, the
Second Division cancelled the respondent-Commissioner of Internal Revenue's assessment for
deficiency expanded withholding taxes for calendar year (CY) 1998 amounting to P47,880.00, and
partially cancelled the deficiency documentary stamp tax (DST) assessment amounting to P1,963.00.
However, the Second Division upheld the validity of the other tax assessments against petitioner
amounting to a total of P2,029,570.12, plus 20% delinquency interest pursuant to Section 249(C)(3) of
the Tax Code, computed as follows: TAHIED

INCOME TAX

DEFICIENCY TAX VAT DST at 5% at 34% Total

Basic Tax Due P314,194.00 P145.00 P817,573.94 P1,789.44

25% Surcharge 78,548.50 36.25 204,393.49 447.36

20% Interest 188,516.00 P102.02 422,898.52 925.6

––––––––––– –––––––– –––––––––––– –––––––––

P581,258.50 283.27 P1,444,865.95 P3,162.40 P2,029,570.12

========== ======= =========== ======== ===========

THE FACTS

The facts of the case, as culled from the records, are as follows:

"Petitioner is a domestic corporation duly organized and existing under and by virtue of the laws of the
Philippines with principal office at Road A, Cavite Ecozone, Rosario, Cavite. 3 On the other hand,
respondent is the duly appointed Commissioner of Internal Revenue of the Philippines authorized under
law to perform the duties of said office, including, inter alia, the power to assess taxpayers for allegedly
deficiency internal revenue tax liabilities and to act upon administrative protests or requests for
reconsideration/reinvestigation of such assessments. 4
Petitioner is registered with the Philippine Economic Zone Authority (PEZA) under Certificate of
Registration No. 89-064, duly approved on December 18, 1989. As such, it is engaged in the business of
manufacturing garments for sale abroad. 5 cHCSDa

On November 24, 1999, petitioner received from respondent Letter of Authority No. 00012641 dated
November 10, 1999, authorizing the examination of petitioner's books of accounts and other accounting
records for all internal revenue taxes covering the period January 1, 1998 to December 31, 1998. 6

On October 23, 2001, petitioner received five (5) formal demand letters with accompanying Assessment
Notices from respondent, through the Office of the Revenue Director of Revenue Region No. 9, San
Pablo City, requiring it to pay the alleged deficiency VAT [Value Added Tax], Income, DST and
withholding tax assessments for taxable year 1998 in the aggregate amount of P2,046,580.10, 7 broken
down as follows:

Deficiency VAT

Basic tax due P314,194.00

Add: Surcharge 157,097.00

Interest 188,516.00

–––––––––––––

Total Amount Payable P659,807.00

–––––––––––––

Deficiency Income Tax (at Normal Rate of 34%)

Basic tax due P78,639.00

Add: Surcharge 39,320.00

Interest 43,251.00

–––––––––––––

Total Amount Payable P161,210.00

–––––––––––––

Deficiency Income Tax (at Special Rate of 5%)

Basic tax due P742,574.10

Add: Surcharge -

Interest 408,416.00

Compromise Penalty 25,000.00

–––––––––––––

Total Amount Payable P1,175,990.10

 –––––––––––––

Deficiency DST

Basic tax due P806.00

Add: Surcharge 403.00

Interest 484.00

–––––––––––––

Total Amount Payable P1,693.00

–––––––––––––

Deficiency EWT

Basic tax due 22,800.00

Add: Surcharge 11,400.00

Interest 13,680.00

–––––––––––––

Total Amount Payable P47,880.00

–––––––––––––

GRAND TOTAL P2,046,580.10

============

On November 20, 2001, or within the 30-day period prescribed under Section 228 of the Tax Code, as
amended, petitioner filed a formal written protest with the respondent assailing the above assessments.
8 IAcDET

On January 11, 2002, or within the sixty-day period after the filing of the protest, petitioner submitted to
the Assessment Division of Revenue Region No. 9, San Pablo City, additional documents in support of its
protest. 9

Respondent failed to act with finality on the protest filed by petitioner within the period of one hundred
eighty (180) days from January 11, 2002 or until July 10, 2002. Hence, petitioner appealed before this
Court via a Petition for Review filed on August 6, 2002 or within thirty (30) days from the last day of the
aforesaid 180-day period." 10

The case was raffled to the Second Division of this court for decision. After trial on the merits, the
Second Division rendered the Assailed Decision on January 4, 2007 upon which the Second Division
cancelled respondent's assessment against CS Garments for deficiency expanded withholding taxes for
CY 1998 amounting to P47,880.00, and partially cancelled the deficiency DST assessment amounting to
P1,963.00. However, the Second Division upheld the validity of the deficiency income tax assessments
by subjecting the disallowed expenses in the amount of P14,851,478.83 and a portion of the undeclared
local sales P1,541,936.60 (amounting to P1,500,000.00) to income tax at the special rate of 5%. The
remainder of undeclared local sales of P1,541,936.06 (amounting to P41,936.60) was subjected to
income tax at the rate of 34%. The Second Division found that total tax liability of CS Garments
amounted to P2,029,570.12, plus 20% delinquency interest pursuant to Section 249(C)(3), and
computed the same as follows: DTAaCE

INCOME TAX

DEFICIENCY TAX VAT DST at 5% at 34% Total

Basic Tax Due P314,194.00 P145.00 P817,573.94 P1,789.44

25% Surcharge 78,548.50 36.25 204,393.49 447.36

20% Interest 188,516.00 P102.02 422,898.52 925.6

––––––––––– ––––––– –––––––––––– ––––––––– –––––––––––

P581,258.50 283.27 P1,444,865.95 P3,162.40 P2,029,570.12

========== ====== =========== ======== ===========

On January 29, 2007, CS Garments filed its "Motion for Partial Reconsideration" 11 of the said decision.
On May 25, 2007, in a resolution, 12 the Second Division denied CS Garments' motion for lack of merit.

On June 20, 2007, CS Garments filed before the Court En Banc a "Motion for Extension of Time to File
Petition for Review" which was granted by the Court En Banc in a Resolution dated June 20, 2007. On
July 5, 2007, CS Garments filed the instant Petition for Review 13 before the Court En Banc.

THE ASSIGNED ERRORS

On the instant petition, CS Garments submits that the Second Division erred in its conclusion that:

I. Respondent's Formal Assessment Notices ("FAN") comply with the requirements of law.
cCAIaD

II. The sales generated by petitioner from its participation in the trade fairs conducted by the
Cavite Export Processing Zone, and its sales to employees, are subject to 10% VAT.

III. The isolated sale of petitioner's company vehicle to its General Manager is subject to 10% VAT.

IV. Petitioner had undeclared local sales in the amount of P1,541,936.60 which is subject to normal
income tax at the rate of 34%.

V. The expenses incurred by petitioner in connection with advertising, clinic and office supplies,
representation, commissions, transportation, freight and handling, professional fees, export fees, taxes
and licenses and fringe benefit taxes are unallowable under Rule XX, Section 2 of the PEZA Rules and
Regulations.

THE COURT EN BANC'S RULING

After a careful and thorough evaluation and consideration of the records of the case, including CS
Garments' arguments and allegations, the Court En Banc found that the Second Division did not commit
any error in their appreciation of facts and evidence as well as their application of laws and
jurisprudence in the Assailed Decision. The conclusion laid down by the Second Division, finding CS
Garments liable to the aforementioned deficiency taxes including penalties and interest, was correct.
CIAHaT

Regarding the first assignment of error, CS Garments alleged that respondent's Formal Assessment
Notices failed to comply with the requirements laid down in Section 228 of the Tax Code and Section
3.1.4 of Revenue Regulations No. 12-99. CS Garments claimed that the notices do not state the law nor
the facts which gave rise to the deficiency tax assessments and that the same merely gave a brief
rundown of figures which CS Garments allegedly failed to pay as well as the total amount for each
assessment.

We do not agree.

After scrutinizing the five (5) assessment notices, 14 the Court En Banc found that the Second Division
was correct when it ruled the following, to wit:

"This Court is convinced that respondent duly apprised petitioner of the factual and legal bases in
finding the latter liable to the deficiency income tax on disallowed expenses pursuant to Section 228 of
the National Internal Revenue Code (NIRC) of 1997, as amended. As can be seen in the letter of demand
dated October 15, 2001 and the attached Schedule of Discrepancies, respondent provided a detailed
breakdown of the disallowed expenses which resulted to the said assessment. Likewise, respondent
cited Rule XX, Section 2 of the Rules and Regulations of Republic Act No. 7916 as legal basis for the
disallowances.

At a glance, respondent likewise complied with Section 228 of the 1997 NIRC, as amended, in arriving at
the assessments for deficiency EWT, DST and VAT for taxable year 1998. Although in the letters of
demand respondent may not have specified the legal provisions supporting his conclusion, it is sufficient
that the nature of taxes allegedly unpaid by petitioner is indicated therein. One would know with
certainty the applicable provisions of law pertaining to DST on lease agreements, 10% VAT on local sales,
5% EWT on rental expenses with reference to the figures in the form of numerical representations
stated in the letters of demand. CcaASE

The phrase "in writing" under Section 228 is not exclusively confined to written words but includes
figures. "Writings" consist of letters, words, or numbers, or their equivalent, set down by handwriting,
typewriting, printing, photostating, photographing, magnetic impulse, mechanical or electronic
recording, or other form of data compilation. 15 In whatever form and manner, as long as the taxpayer
is informed how the assessment was made, then, there is no violation of Section 228 of the 1997 NIRC,
as amended.

It bears stressing that in the protest, petitioner did not question the infirmity of the assessment notice
and letter of demand involving the 10% VAT on local sales. Well-settled is the rule that the Court cannot
take cognizance of matters raised for the first time on appeal. 16

Further, the Court cannot give credence to petitioner's assertion that the deficiency income tax
assessment on the alleged undeclared local sales is devoid of factual and legal bases.
It must be pointed out that it was petitioner who offered the Schedule of Other Income 17
demonstrating the breakdown thereof giving rise to the assessment for deficiency income tax on local
sales of P1,541,936.60 at the rate of 34%. Without the supporting documents proffered by petitioner,
respondent would not have ascertained its liabilities pertaining to income tax on local sales and the
other tax deficiencies. EICDSA

Considering that in its protest, petitioner did not question the validity of the assessment for deficiency
VAT under Section 228 of the 1997 NIRC, as amended, the Court sees no reason why it is raising the
same infirmity concerning the assessment for deficiency income tax on local sales as both taxes refer to
the same tax base.

Thus, the mere fact that petitioner intelligently rebutted respondent's assessments for deficiency 5%
income tax on disallowed expenses, 34% income tax on local sales, EWT, DST and VAT, demonstrates
respondent's compliance with Section 228 of the 1997 NIRC, as amended."

Anent the second assignment of error, CS Garments claimed that the deficiency VAT assessment arising
from the sales generated by it in trade fairs as well as its sales to employees are devoid of legal basis. CS
Garments argued that since it is a PEZA-registered enterprise, its local sales to buyers from Customs
Territory are considered technical importations made by buyers who are the ones liable for the
corresponding taxes on such sales.

We do not agree.

To reiterate, in CS Garments' protest-letter 18 dated November 19, 2001, petitioner stated that "[t]he
alleged local sales being subject to VAT were generated by the company for the year 1998 from its
participation in the trade fairs conducted by the Cavite Export Processing Zone Authority as well as its
sales to its employees". Furthermore, petitioner admitted that "[t]hese sales were made to buyers
located in the Customs Territory". Although a Zone Export Enterprise, like the petitioner, is generally
engaged in exporting its finished product, it is not prohibited from making domestic sales pursuant to
Section 26 of Republic Act No. 7916 entitled "An Act Providing For The Legal Framework And
Mechanisms For The Creation, Operation, Administration, And Coordination Of Special Economic Zones
In The Philippines, Creating For This Purpose, The Philippine Economic Zone Authority (PEZA), And For
Other Purposes"; which provides as follows: TCDcSE

"SEC. 26. Domestic Sales. — Goods manufactured by an ECOZONE enterprise shall be made
available for immediate retail sales in the domestic market, subject to payment of corresponding taxes
on the raw materials and other regulations that may be adopted by the Board of the PEZA.

However, in order to protect the domestic industry, there shall be a negative list of industries that will
be drawn up by the PEZA. Enterprises engaged in the industries included in the negative list shall not be
allowed to sell their products locally. Said negative list shall be regularly updated by the PEZA.

The PEZA, in coordination with the Department of Trade and Industry and the Bureau of Customs, shall
jointly issue the necessary implementing rules and guidelines for the effective implementation of this
section." (Emphasis supplied)

Pursuant to the above-quoted provision of Republic Act No. 7916, the Board of Directors of the
Philippine Economic Zone Authority (PEZA) promulgated the "Rules and Regulations to Implement
Republic Act No. 7916, otherwise known as the Special Economic Zone Act of 1995". Section 5 of Rule
VIII thereof provides that domestic sales shall be subject to all applicable rules and regulations including
the payment of customs duties and internal revenue taxes, thus: cSEaDA

"SEC. 5. Domestic Sale. — Finished products of registered Export or Free Trade Enterprises not included
in the negative list shall be made available for domestic sale in the customs territory or retail
stores/shopping malls within the commercial/tourist or other authorized areas of the ECOZONES,
subject to all applicable rules and regulations including the payment of customs duties and internal
revenue taxes, to the applicable provisions of the Retail Trade Nationalization Law, as amended, and to
such other regulations or limitations as may be adopted by the Board." (Emphasis supplied)

Moreover, the aforementioned rules and regulations further provides, in Section 3 of Rule X thereof that
"[m]erchandise or goods may be taken into or brought out of the restricted areas of the ECOZONES only
upon prior approval or permit by the PEZA in accordance with its documentation and security
procedures".

Indeed, domestic sales are allowed subject to certain conditions to be complied with by the Zone Export
Enterprise particularly regarding the payment of internal revenue taxes and customs duties and the
documents required for the entry and exit of goods to and from the "restricted areas" of the ECOZONES.
More particularly, Section 4 of Rule X requires the accomplishment of PEZA prescribed forms and the
submission of the documents relative to the importation, exportation or entry of the goods into the
customs territory: DaACIH

"SEC. 4. Prescribed Forms. — The application for the entry or exit permit of goods shall be filed by the
ECOZONE Export or Free Trade Enterprise or entity concerned in the form prescribed by the PEZA. The
PEZA shall require the submission of shipping, commercial and other pertinent documents relative to
the importation, exportation, or entry into the customs territory of said goods." (Emphasis supplied)

Finished products of a Zone Export Enterprise, such as herein petitioner, may therefore be introduced
into the customs territory in three (3) different ways, these are: (1) importation, (2) exportation, or (3)
entry.

The finished goods locally sold by petitioner in the Cavite Export Processing Zone Trade Fair and its
finished goods sold to its employees were introduced into the customs territory by "entry" It is not
disputed that the finished goods were sold at the trade fair to the public at large. Consequently, such
sales are "domestic sales".

Parenthetically, petitioner attached photocopies of an Informal Import Entry Declaration (Bureau of

Customs Form 177), BOC official receipt for the duties and taxes paid on the importation, and
Application for permit to bring goods from the zone into the customs territory (PEZA Form 8106) to its
Supplemental Protest 19 dated January 9, 2002 to prove that the alleged local sales were in fact
importations made by the buyers from the Customs Territory. However, the Informal Import Declaration
and Entry is undated and in the name of PEZA TRADE FAIR, the BOC Official Receipt is in the name of the
petitioner and dated 3/5/01, and the Application for Permit to Bring Goods From the Zone Into the
Customs Territory dated 09 November 2000 shows petitioner as the Consignee/Importer. It is significant
to note that the documents submitted do not correspond to the taxable year in question which is 1998
only. aESIDH
Similarly, the sales made by the petitioner to its employees cannot be considered as an "importation"
because the PEZA Rules and Regulations has a particular provision regarding "sales to employees"
requiring prior written permission from the PEZA. However, petitioner failed to show proof that it was
authorized by the PEZA to sell its finished goods to its employees pursuant to Section 9 of Rule X of the
PEZA Rules and Regulations which provides:

"SEC. 9. Written Permission. — Products made in the restricted areas of the ECOZONES, samples thereof
and/or imported raw materials shall not be given nor sold by an Export or Free Trade Enterprise to its
visitors, workers, or employees without prior written permission from the PEZA." (Emphasis supplied)

Since petitioner violated the above-quoted provision requiring a written permission from the PEZA
before it can sell its finished product to its visitors, workers, or employees, its sales to its employees
shall likewise be considered as "'domestic sales" that is subject to the payment of internal revenue taxes
in the same way as petitioner's sales at the local trade fairs. It both cases, petitioner was not able to
show that it is exempt from the payment of the value-added tax. It is well-settled that exemptions from
taxation are not favored and tax statutes are to be construed in strictissimi juris against the taxpayer
and liberally in favor of the taxing authority. DCISAE

"Laws must receive sensible interpretation to promote the ends for which they are enacted. They should
be so given reasonable and practical construction as will give life to them, if it can be done without
doing violence to reason. Conversely, a law should not be so construed as to allow the doing of an act
which is prohibited by law nor so interpreted as to afford an opportunity to defeat compliance with its
terms, create an inconsistency, or contravene the plain words of the law. Interpretatio fienda est ut res
magis valeat quam pereat or that interpretation as will give the thing efficacy is to be adopted." 20 To
agree with the petitioner's argument that it is not liable because it is not the importer would result to an
absurdity. It could not be the intention of the law to run after all buyers of petitioner's finished goods at
a trade fair because it is impracticable.

As to the third assigned error, petitioner-CS Garments pointed out that the sale of its motor vehicle, a
Mercedes Benz, to its General Manager, Mr. Claus Sudhoff amounting to P1,600,000.00, is not subject to
VAT since its was not made in the ordinary course of its trade or business. Petitioner alleged that before
a particular transaction may be subject to VAT, it is important to determine the taxpayer's role or link in
the production chain of that particular product or service. Where the sale, barter or exchange of that
particular product or service is not made in the course of trade or business, such transaction may not be
made subject to VAT. It further alleged that since its primary business is to engage in the manufacture of
garments for sale abroad, the sale of its used company car does not have a direct relevance to
petitioner's primary business of manufacturing of garments. SDTaHc

The argument is without merit.

Section 105 of the NIRC of 1997, as amended, states that:

"SEC. 105. Persons Liable. — Any person who, in the course of trade or business, sells, barters,
exchanges, leases goods or properties, renders services, and any person who imports goods shall be
subject to value-added tax (VAT) imposed in Sections 106 to 108 of this Code.

xxx xxx xxx

"The phrase 'in the ordinary course of trade or business' means the regular conduct or pursuit of a
commercial or an economic activity, including transactions incidental thereto, by any person regardless
of whether or not the person engaged therein is a non-stock, non-profit private organization
(irrespective of the disposition of its net income and whether or not it sells exclusively to members or
their guests), or government entity. (Emphasis supplied)

Based on the foregoing, the VAT is imposed on a sale or transaction entered into by a person in the
course of any trade or business. A transaction will be characterized as having been entered into by a
person in the course of trade or business if it is: (1) regularly conducted; and (2) undertaken in pursuit of
a commercial or economic activity. Likewise, transactions that are made incidental to the pursuit of a
commercial or economic activity are considered as entered into in the course of trade or business.
"Incidental" means something else as primary; something necessary, appertaining to, or depending
upon another, which is termed the principal. 21 Hence, an isolated transaction is not necessarily
disqualified from being made incidentally in the course of trade or business. CHIScD

Here, petitioner's primary business is the manufacturing of garments for sale abroad. In carrying-out its
business, petitioner acquired and eventually sold a Mercedes Benz to its General Manager Mr. Sudhoff.
Prior to the sale, the motor vehicle formed part of petitioner's capital assets, specifically under the
account, "Property, Plant and Equipment". The Rules on International Accounting Standards (IAS)16
defines Property, Plant and Equipment as follows:

"6. Definitions

Property, plant and equipment are tangible assets that:

(a) are held by an enterprise for use in the production or supply of goods or services, for rental to
others, or for administrative purposes; and

(b) are expected to be used during more than one period." (Emphasis supplied)

Therefore, the sale of the motor vehicle is an incidental transaction because the said vehicle was
purchased and used in furtherance of petitioner's business. ECAaTS

Once an activity has been identified as a business, any supply[sale] made while carrying it on is likely to
be made in the course or furtherance of business. No distinction is made between capital and revenue
items. Thus, a supply[sale] in the course or furtherance of business includes: (1) the disposition of the
assets and liabilities of a business, (2) the disposition of a business as going concern; and (3) anything
done in connection with the termination or intended termination of a business. 22

Moreover, under Rule XV of the PEZA Rules and Regulations, petitioner is prohibited from selling or
otherwise disposing of capital equipment acquired under the incentives granted to an ECOZONE Export
and Free Trade Enterprise. Section 1 (A) (2) of Rule XV provides as follows:

"SEC. 1. Exemption from Duties and Taxes on Merchandise. — . . .

A. Importation of Capital Equipment

1. ...
2. Sale or Disposition of Capital Equipment — Any sale, transfer, assignment, donation or other
form of disposition of originally imported capital equipment/machinery including spare parts, brought
into the ECOZONE duty and tax-free, within five (5) years from date of acquisition shall require prior
approval of the Board. . . . SaCDTA

xxx xxx xxx

If the ECOZONE Export or Free Trade Enterprise sells, transfers or disposes of these machinery,
equipment and spare parts without prior approval of the Board within five (5) years from date of
acquisition, the ECOZONE Export or Free Trade Enterprise and the vendee, transferee, or assignee shall
be solidarily liable to pay twice the amount of the tax exemptions granted.

Any sale, transfer, assignment, donation or other form of disposition of capital equipment, brought into
the ECOZONE duty and tax-free, after five (5) years from date of acquisition shall require prior approval
of the PEZA Director-General." (Emphasis supplied)

The Deed of Absolute Sale 23 covering the subject vehicle shows that the vehicle is a 1996 model of
Mercedes Benz E-320 and that the Deed of Absolute Sale is dated 30 September 1998. Clearly, the
subject vehicle was sold by the petitioner within the five-year period from acquisition date without any
proof that said sale was with the approval of the Board. Petitioner should have been made liable for
twice the amount of tax exemptions granted pursuant to the aforequoted provision, in addition to the
deficiency value added tax. cDICaS

In other words, this Court En Banc agrees with the Second Division when it ruled the abovementioned
discussion.

The VAT liability of CS Garments amounted to P581,258.50, computed as follows:

Local Sales P1,541,936.60

Add: proceeds from sale of PPE 1,600,000.00 P3,141,936.60

–––––––––––––

Rate of VAT 10%

–––––––––––––

Basic Tax Due P314,194.00

Add: 25% Surcharge 78,548.50

20% Interest 188,516.00

–––––––––––––

Total deficiency tax due and payable P581,258.50

============

[Excluding interest pursuant to Section 249 C (3) of the 1997 Tax Code]
The deficiency DST in the amount of P283.27 was also correctly recomputed by the Second Division,
hence it still stands.

With regard to petitioner's undeclared sales, which is the fourth issue in this case, in the amount of
P1,541,936.60, We rule that the no error was committed by the Second Division when it decided the
following and We reiterate, viz.: HTAEIS

"Relevant provisions of Section 5(1) of RMC 74-99 read as follows:

SEC. 5. Tax Treatment Of Sales Made By A PEZA Registered Enterprise. —

(1) Sale of goods (i.e., merchandise), by a PEZA-registered enterprise, to a buyer from the Customs
Territory (i.e., domestic sales). — . . . The registered enterprise's "gross income earned" therefrom shall
be subject to the 5% special tax pursuant to Sec. 24 of R.A. No. 7916: Provided, however, that its sales in
the Customs Territory do not exceed the threshold allowed or permitted for such sales, pursuant to the
pertinent provisions of the PEZA rules and regulations: Provided, further, that for income tax purposes,
if such sales should exceed the aforesaid threshold, its income derived from such excess sales shall be
imposed with the normal income tax pursuant to the provisions of Title II, NIRC: Provided, further, that
in computing for the income tax due on such excess sales, its net income from such excess sales shall be
determined in accordance with the method of general apportionment pursuant to the provisions of Sec.
50, NIRC, (i.e., compute its total net income from total sales, then, compute its net income from such
excess sales by general apportionment, as follows: Excess sales divided by total sales times total net
income from total sales equals net income from excess sales). IaDcTC

Per Letter of Authority No. 98-0531 issued by PEZA on August 24, 1998, petitioner's authority to sell in
the local market was limited to the sale of export seconds and overruns of men's and boys' shirts, the
quantity of which should not exceed one percent (1%) of its actual export volume in 1997, or 6,423
pieces or a total value of P1.5 million, whichever is lower. 24

Since no data was available as regards petitioner's actual export volume in 1997, this Court shall
consider the volume of 6,423 pieces with a total value of P1.5 million as the prescribed threshold
amount for petitioner's 1998 local sales.

Following the provisions of Section 5(1) of RMC 74-99, out of the sales amount of P1,541,936.60 subject
of the deficiency 34% income tax assessment, only the excess local sales amount of P41,936.60 shall be
charged with a 34% income tax. The amount of P1,500,000.00 shall be imputed with the preferential
income tax rate of 5%. Hence, in the absence of documentary evidence establishing it properly declared
the total sales of P1,541,936.60 in its 1998 income tax return, petitioner shall be held liable to pay the
corresponding income taxes due." 25

With regard to the fifth issue, petitioner claimed that the Second Division committed an error when it
ruled that the expenses incurred by petitioner in connection with advertising, clinic and office supplies,
representation, commissions, transportations, freight and handling, professional fees, export fees, taxes
and licenses and fringe benefit taxes are unallowable under Rule XX, Section 2 of the PEZA Rules and
Regulations because there is no hard and fast rule on the right to a deduction which depends in each
case on the particular facts and the relation of the payment to the type of business in which the
taxpayer is engaged. It further argued that the intention of the taxpayer often may be the controlling
fact in making the determination. It concluded that each of the disallowed items of expenses of
petitioner was direct cost in the manufacture of its finished products. DHIaTS

We are not persuaded.

Again, We reiterate that pursuant to Section 24 of Republic Act No. 7916, the preferential tax rate of 5%
is imposed on Gross Income earned by an ECOZONE enterprise. Gross Income is in turn defined in
Section 2(nn), Rule I of the "Rules and Regulations to Implement Republic Act No. 7916, otherwise
known as The Special Economic Zone Act of 1995" [PEZA Rules], as follows:

"Gross Income" for purposes of computing the special tax due under Section 24 of the Act refers to
gross sales or gross revenues derived from business activity within the ECOZONE, net of sales discounts,
sales returns and allowances and minus costs of sales or direct costs but before any deduction is made
for administrative expenses or incidental losses during a given taxable period. The allowable deductions
from "gross income" are specifically enumerated under Section 2, Rule XX of these Rules.

Section 2, Rule XX of the PEZA Rules enumerates the specific deductions for ECOZONE Export
Enterprises as follows:

SEC. 2. Gross Income Earned; Allowable Deductions. — For purposes of these Rules, Gross Income
earned shall be as defined in Section 2(nn), Rule I of these Rules subject to the following allowable
deductions for specific types of enterprises: acEHSI

1. ECOZONE Export Enterprises, Free Trade Enterprises and Domestic Market Enterprises — Direct
salaries, wages or labor expenses

— Production supervision salaries

— Raw materials used in the manufacture of products

— Goods in process (intermediate goods)

— Finished goods

— Supplies and fuels used in production

— Depreciation of machinery and equipment used in production, and buildings owned or

constructed by an ECOZONE Enterprise

— Rent and utility charges associated with building, equipment and warehouses, or handling of
goods

— Financing charges associated with fixed assets

Based on the foregoing, for purposes of computing the 5% preferential tax, gross sales/revenues may be
reduced only by sales discounts, sales returns and allowances, costs of sales or direct costs or any of the
enumerated allowable deductions under Section 2, Rule XX of the PEZA Rules. aHcACT

Apparently, petitioner's claimed deductions for advertising, representation and entertainment,

transportation and travel, professional fee, export fees, taxes and licenses should be disallowed because
these expenses do not qualify as direct costs nor are they among the specified allowable deductions
under the PEZA Rules.

The same holds true with respect to petitioner's claimed deductions for clinic and office supplies.
Contrary to petitioner's assertion, the supplies referred to under the PEZA Rules relate to those utilized
in the production of goods.

Regarding the claimed deduction for commissions in the amount of P6,852,410.60, the same shall
likewise be denied. Commissions are entirely different from sales discounts. The word "commission"
involves the meaning that a sum of money is paid to an agent for effecting a sale to a third person or
defined as a percentage or allowance to a factor or agent for transacting business for another. 26
Clearly, for a commission to be due, there must be a service rendered. On the other hand, discounts are
generally classified as either cash or trade. Trade discounts are given to induce purchases by volume and
cash discounts are offered to induce prompt payment. Volume and time are therefore the factors
considered to enjoy discounts.

Under our VAT law, particularly, Section 106(D)(2) of the NIRC of 1997, sales discounts granted and
indicated in the invoice at the time of sale and the grant of which does not depend upon the happening
of a future event do not form part of the taxable base. Clearly, what the law contemplates as deductions
from the gross sales are trade discounts. The same rule applies for purposes of computing the tax base
for income tax either at the regular rate of 34% or special rate of 5%. 27 As earlier stated, commissions
cannot be treated as trade discounts deductible from gross sales to arrive at the gross income earned by
a PEZA entity. EDSAac

As regards the claimed deduction for freight and handling, based on the PEZA Rules, the allowable
deductions from gross sales/revenues may either be directly or indirectly related to the manufacturing
of a product and form part of inventory costs. Thus, the allowable deduction for the handling of goods
referred to under "rent and utility charges associated with building, equipment and warehouses, or
handling of goods" applies only to costs attributed to the production of goods. Any handling expenses
incurred in the sale of finished products are disallowed under the law. In the instant case, petitioner
failed to offer any documentary evidence for this Court to ascertain that indeed the amount of
P4,471,804.09 can be attributed to production costs and not to selling expenses.

As to the fringe benefit tax, the same shall be considered valid deduction for purposes of computing the
5% preferential tax if it has been paid/incurred in relation to direct labor or production employees. For
petitioner's failure to establish that the fringe benefit tax of P306,140.70 was paid in relation to its direct
labor cost, the same shall be denied.

Again, to recapitulate, petitioner is liable to pay deficiency 5% income taxes on its undeclared local sales
of P1,500,000.00 and on the disallowed expenses of P14,851,478.83 and deficiency 34% income tax on
its remaining undeclared local sales of P41,936.60, in the aggregate amount of P1,448,028.35, computed
as follows: TIcEDC

Deficiency Income Tax (at Special Rate of 5%)

Net income per return P29,080,558.00

Add: Undeclared local sales 1,500,000.00

 Disallowances per examiner's

recommendation

Advertising P201,900.00

Clinic Supplies 13,998.30

Office Supplies 597,562.03

Representation and Entertainment 550,265.03

Commission 6,852,410.60

Transportation & travel 1,176,994.72

Freight & Handling 4,471,804.09

Professional Fee 61,177.00

Export Fees 126,103.66

Taxes & Licenses 493,122.70

Fringe Benefit Tax 306,140.70

–––––––––––––

14,851,478.83

–––––––––––––

Net taxable income per audit P45,432,036.83

============

Income Tax Due (5%) P2,271,601.84

Less: Tax payment 1,454,027.90

–––––––––––––

Deficiency Basic Tax P817,573.94

Add: 25% Surcharge 204,393.49

20% Interest 422,898.52

–––––––––––––

Total Amount Due and Payable P1,444,865.95

Deficiency Income Tax (at Regular Rate of 34%)

Undeclared Local Sales P1,541,936.60

Less: Undeclared Local Sales subjected to 5% tax 1,500,000.00

 –––––––––––––

Undeclared Excess Local Sales P41,936.60

============

Taxable Net Income

Undeclared Excess Local Sales P41,936.60

Divided by Total Sales 190,404,800.60

Multiplied by Net Income P5,263.05

23,895,832.60

–––––––––––––

Tax Rate 34%

–––––––––––––

Deficiency Basic Tax P1,789.44

Add: 25% Surcharge 447.36

20% Interest 925.60

–––––––––––––

Total Amount Due and Payable P3,162.40

–––––––––––––

TOTAL DEFICIENCY INCOME TAX DUE AND PAYABLE P1,448,028.35

============

In sum, the Court En Banc finds no cogent justification to disturb the findings and conclusion spelled out
in the assailed January 4, 2007 Decision and May 25, 2007 Resolution of the CTA Second Division. What
the instant petition seeks is for the Court En Banc to view and appreciate the evidence in their own
perspective of things, which unfortunately had already been considered and passed upon. TADaCH

WHEREFORE, the instant Petition for Review is hereby DISMISSED for lack of merit. Accordingly, the
January 4, 2007 Decision and May 25, 2007 Resolution of the CTA Second Division are hereby AFFIRMED
in toto.

SO ORDERED.

(SGD.) CAESAR A. CASANOVA

Associate Justice

Ernesto D. Acosta, P.J., Juanito C. Castañeda, Jr., Lovell R. Bautista, Erlinda P. Uy and Olga Palanca-
Enriquez, JJ., concur.
Footnotes

1. Division Rollo, pp. 372-403.

2. Division Rollo, pp. 421-423.

3. par. 1, Facts Admitted, Division Rollo, p. 125.

4. par. 2, Facts Admitted, Division Rollo, p. 125.

5. par. 3, Facts Admitted, Division Rollo, p. 125.

6. BIR Rollo, p. 129.

7. par. 4, Facts Admitted, Division Rollo, pp. 125-126.

8. par. 5, Facts Admitted, Division Rollo, p. 126.

9. par. 6, Facts Admitted, Division Rollo, p. 126. CDcaSA

10. Pages 2-4 of January 4, 2007 Decision.

11. Division Rollo, pp. 405-418.

12. Ibid.

13. E.B. Rollo, pp. 9-30.

14. Exhibits X, Y, ZZ, AA and BB.

15. Black' Law Dictionary, Sixth Edition, page 1609 cited in Subic Power Corporation vs.
Commissioner of Internal Revenue, CTA Case No. 6059, May 8, 2003.

16. Victorias Milling Company, Inc. vs. Court of Appeals, 333 SCRA 663.

17. Exhibit 11.

18. Exhibit V.

19. Exhibit W.

20. AGPALO, Statutory Construction, Third Edition, 1995, p. 202.

21. DEOFERIO, JR. AND MAMALATEO, The Value Added Tax in the Philippines, First Edition, pp. 81-
82.

22. Ibid., p. 83.

23. Exhibit D.

24. BIR Records, page 2.

25. Pages 23-24 of January 4, 2007 Decision.

26. Words and Phrases, Permanent ed. 7A.

27. Commissioner of Internal Revenue vs. Central Luzon Drug Corporation, G.R. No. 159647, April
15, 2005. ACaTIc

Copyright 2008 CD Technologies Asia Inc.

C.T.A. Case No. 7086 January 10, 2008

ORION LAND, INCORPORATED vs. COMMISSIONER OF INTERNAL REVENUE

FIRST DIVISION

[C.T.A. CASE NO. 7086. January 10, 2008.]

ORION LAND, INCORPORATED, petitioner, vs. COMMISSIONER OF INTERNAL REVENUE, respondent.

DECISION

CASANOVA, J p:

This Petition for Review, filed on October 20, 2004, is seeking the cancellation of the deficiency
assessment by the Commissioner of Internal Revenue holding petitioner Orion Land, Inc. liable for
deficiency Income Tax for the Fiscal Year (FY) ending June 30, 2001 in the amount of P85,054,588.87,
including surcharges and interest, and alleged deficiency Value-Added Tax in the amount of
P27,133,312.84, including surcharges and interest. DScTaC

As culled from the records of the case, the facts are as follows:

Petitioner Orion Land, Inc. (OLI) is a domestic corporation duly organized and existing under the laws of
the Republic of the Philippines, with principal address at 20th Floor, LKG Tower, 6801 Ayala Avenue,
Salcedo Village, Makati City. 1

Respondent, on the other hand, is the Commissioner of the Bureau of Internal Revenue (Commissioner)
who was duly appointed and empowered to perform the duties of his office, including, among others,
the power to decide, cancel, and abate tax liabilities pursuant to Section 204 (B) of the 1997 National
Internal Revenue Code (Tax Code). 2

OLI is allegedly a part of a group of companies of which it is deemed as the parent company of Orion
Properties Development, Inc. (OPDI), and Tutuban Properties, Inc., (TPI) OLI's parent company, on the
other hand, is Prime Orion Philippines, Inc. (POPI), formerly Guoco Holdings Phils., Inc. (GHPI). 3 Shown
below is its corporate structure: 4

Part of its company policy is an inter-company lending program wherein the parent company sometimes
borrows money from banks or financial companies and extends the loaned amount to its subsidiaries. In
such instance, the parent company pays interest to banks and/or financial companies for the loan and at
the same time charges the subsidiary for interest on the financial support. In the transaction giving rise
to this petition, POPI/GHPI, lent money to OLI, and the latter extended assistance to its subsidiary Orion
Properties Development, Inc. (OPDI), which is deemed as the "final user" of the funds. 5 EHTISC

Hence, pursuant to the inter-company lending policy, on June 15, 1999, the Board Members of
petitioner, confirmed by unanimous vote the corporate advances given (and to be given) by OLI to its
subsidiary Guoco Property Development, Inc. Such advances were charged with interest based on the
actual cost of OLI's borrowing (i.e., passed-on interest) or at such rate as may be agreed upon by the
parties. 6

Almost six (6) months thereafter, or on January 25, 2000, OLI filed its Annual Income Tax Return showing
a taxable loss for the FY ending June 30, 1999. In the succeeding years, petitioner reflected taxable
losses in its annual tax return until fiscal year ending June 30, 2004. The losses are tabulated below: 7

EXHIBIT FISCAL YEAR TAXABLE INCOME LOSS

O June 30, 1999 (P11,492,532.00)

P June 30, 2000 (P11,651,491.00)

N June 30, 2001 (P11,708,290.00)

T June 30, 2002 (P282,576.00)

U June 30, 2003 (P62,239.00)

V-39 June 30, 2004 (P331,280.00)

Then, on September 8, 2003, OLI received from the Commissioner a Letter Notice dated September 1,
2003 stating that based on the records that the Bureau of Internal Revenue obtained from OPDI,
interest expense was paid by the latter to OLI as shown below: 8 AISHcD

MONTH FUND BORROWED-OLI INTEREST

July 31, 2001 839,347,358.73 10,900,822.84

August 31, 2001 850,248,181.57 11,481,872.60

September 30, 2001 861,730,054.17 10,680,950.13

October 31, 2001 585,037,757.34 8,034,548.36

November 30, 2001 593,072,305.70 7,751,544.00

December 31, 2001 600,823,849.70 7,935,555.90

January 31, 2002 608,759,405.60 7,656,341.68

February, 2002 616,415,747.28 7,002,380.15

March, 2002 623,418,127.43 7,840,703.81

April, 2002 116,665,955.60 2,285,712.55

May, 2002 — —
June, 2002 — —

———————

Total interest expense of OPDI 81,570,432.02

==========

The Bureau of Internal Revenue (BIR) added further that OPDI deducted from its income interest
expense paid to OLI in the amount of P138,108,836.00 9 from July 1, 2000 up to June 30, 2001 which OLI
did not declare in its income tax return. Hence, it assessed petitioner with the following deficiency taxes:
10 SECAHa

Fiscal Year Fiscal Year

UNDECLARED REVENUES June 30, 2001 June 30, 2002 Total

Interest Income — interest expense 138,108,836.00 81,570,432.02 219,679,268.02

by OPDI and payable to OLI ––––––––––––– –––––––––––– –––––––––––––

Delinquency Tax Due 44,194,827.52 26,102,538.24 70,297,365.76

Add: 20% interest from 9/2/01

to 10/2/03 (.4167) 18,415,984.00

––––––––––––

20% interest from 9/2/02

to 10/2/03 (.2167) 5,656,420.00 24,072,404.00

––––––––––– –––––––––––– ––––––––––––

Total Delinquency Income Tax 62,610,811.52 31,458,958.24 94,069,769.76

=========== =========== ===========

Petitioner was given a period of five (5) days from receipt of the letter to contest the deficiency
assessment and whether it will avail of the Voluntary Assessment and Abatement Program (VAAP), as
stated in Revenue Regulations 12-2002, as amended. 11

In response to the letter, OLI requested that it be given a period of thirty (30) days to contest the
assessment. 12 Commissioner denied this request on September 19, 2003 giving petitioner instead an
additional period of five (5) days to disprove the assessment. 13 cSDHEC

Then, on October 13, 2003, petitioner communicated to the Commissioner of its intent not to avail of
the VAAP. 14 On November 4, 2003, OLI received Letter of Authority No. 2000-00047145 authorizing
Revenue Officer Maria Lina M. Aficial to examine petitioner's books of accounts. 15 Come March 10,
2004, an Invitation for an Informal Conference was received by OLI giving it fifteen (15) days therefrom
to contest alleged deficiency tax assessments for the FY ending June 30, 2001 in the amount of
P56,502,895.30, including surcharge and interest, broken down as follows: 16
Income tax

Taxable Income (Loss) per ITR P(11,708,290.00)

Add: Interest Income undeclared per ITR 130,072,868.38

–––––––––––––

Adjusted Taxable Income P118,364,578.38

=============

Taxable (P118,364,578.38 x 32%) P37,876,665.08

Less: Tax Payment/Creditable Tax -

–––––––––––––

Deficiency Income Tax P37,876,65.08

Add: 25% Surcharge -

20% Interest (10-16-01 to 03-30-04) (49.11%) 18,601,230.22

Compromise Penalty 25,000.00

––––––––––––

TOTAL Deficiency Income Tax P56,502,895.30

============

Thereafter, a Preliminary Assessment Notice (PAN), 17 dated May 7, 2004 was received by petitioner on
May 12, 2004 showing the computation of deficiency income taxes of P84,223,252.77 and deficiency
Value Added taxes (VAT) of P26,873,768.27 that were computed as follows: CSDcTH

Date JV No. Amount

7/31/2000 00-07-214 P9,675,312.13

8/31/2000 00-08-223 9,808,616.43

9/30/2000 00-09-232 9,622,991.00

10/31/2000 00-10-243 10,076,340.80

11/30/2000 00-11-252 11,850,581.05

12/31/2000 00-12-261 12,885,542.98

1/31/2000 00-01-272 11,984,505.00

2/28/2001 01-02-282 10,496,613.55

3/31/2001 01-03-293 11,233,841.94

 4/30/2001 01-04-302 10,644,660.66

5/31/2001 01-05-312 11,127,338.65

6/30/2004 01-06-315 10,666,524.19

––––––––––––––

Interest Income P130,072,868.38

===========

Deficiency Income Tax

Taxable Income (Loss) per Return P(11,708,290.00)

Add: Adjustments

1. Undeclared interest Income P130,072,868.38

2. Undeclared Professional Fees 120,000.00 130,192,868.38

––––––––––––––– ––––––––––––––

Total P118,484,578.38

Add: NOLCO 11,708,290.00

––––––––––––––

Taxable Income (Loss) per Audit P130,192,868.38

Tax Due (32%) P41,661,717.88

Less: Tax payments/credits —

––––––––––––––

Deficiency Tax P41,661,717.88

Add: 50% Surcharge P20,830,858.94

20% Interest (10-16-01 to 5-25-04) 21,730,675.95 42,561,534.89

–––––––––––––– ––––––––––––––

P84,223,252.77

=============

Deficiency Value Added Tax

Taxable Sales per VAT Returns P-

Add: Undeclared Interest Income 130,072,868.38

–––––––––––––
 Total Taxable Sales per Audit P130,072,868.38

Output Tax P13,007,286.84

Less: Payment/Tax Credits

Carried forward from previous period 402.00

–––––––––––––

Deficiency VAT P13,006,884.84

Add: 50% Surcharge P6,503,442.42

20% Interest (7-26-01 to 5-25-04) 7,363,441.01 13,866,883.43

––––––––––––– –––––––––––––

P26,873,768.27

============

This time, the BIR included an amount of P120,000.00 as undeclared professional fees arising from
discrepancies in entries in OLI's financial statements and its filed returns (per FS — P50,000.00; per
returns — P170,000.00). The undeclared expense was treated by the BIR as undeclared source of
income based from the ruling of the High Court in Perez vs. CTA and CIR, L-10507 dated May 30, 1958.
18 ITaCEc

The BIR likewise included amounts for NOLCO claimed by OLI from its losses in FY 2001 and deficiency
VAT on its alleged undeclared interest income. 19

On May 31, 2004, OLI was served a Formal Assessment Notice (FAN) showing adjusted deficiency
income taxes totaling to P85,054,588.87 and deficiency VAT in the amount of P27,133,312.84 computed
as follows. 20

Deficiency Income Tax

Taxable Income (Loss) per Return P(11,708,290.00)

Add: Adjustments

1. Undeclared interest Income P130,072,868.38

2. Undeclared Professional Fees 120,000.00 130,192,868.38

––––––––––––– –––––––––––––

Total P118,484,578.38

Add: NOLCO 11,708,290.00

–––––––––––––

Taxable Income (Loss) per Audit P130,192,868.38

 Tax Due (32%) 41,661,717.88

Less: Tax payments/credits —

–––––––––––––

Deficiency Tax P41,661,717.88

Add: 50% Surcharge 20,830,858.94

20% Interest (10-16-01 to 6-30-04) 22,562,012.05

–––––––––––––

P85,054,588.87

=============

Deficiency Value Added Tax

Taxable Sales per VAT Returns P-

Add: Undeclared Interest Income 130,072,868.38

–––––––––––––

Total Taxable Sales per Audit P130,072,868.38

Output Tax 13,007,286.84

Less: Payment/Tax Credits

Carried forward from previous period 402.00

–––––––––––––

Deficiency VAT P13,006,884.84

Add: 50% Surcharge 6,503,442.42

20% Interest (7-26-01 to 6-30-04) 7,622,985.58

–––––––––––––

P27,133,312.84

=============

In response thereto, petitioner sent a protest letter to the Commissioner contesting the validity of the
FAN and sent various supporting documents to the BIR on August 10, 2004. 21 Despite petitioner's
defenses, a Preliminary Collection Letter dated September 7, 2004 was received by OLI on September
20, 2004 requiring the latter to settle its tax deficiencies in the amount of P112,187,901.71 within ten
(10) days from receipt of the letter. 22 aSTHDc
Petitioner wrote several clarificatory letters 23 but receiving no response from the Commissioner, OLI
thought it best to treat the collection letter as a denial of its protest letter. Hence, it filed its Petition for
Review before this Court on October 20, 2004 citing Section 228 of the Tax Code: 24

"SEC. 228. Protesting of Assessment. —

xxx xxx xxx

If the protest is denied in whole or in part, or is not acted upon within one hundred eighty (180) days
from submission of documents, the taxpayer adversely affected by the decision or inaction may appeal
to the Court of Tax Appeals within thirty (30) days from receipt of the said decision, or from the lapse of
one hundred eighty (180)-day period; otherwise, the decision shall become final, executory and
demandable."

In its petition, OLI alleged that the Commissioner erred in assessing it with deficiency income tax arising
from interest income it received from OPDI. It explained that the interest income received was mere
reimbursements of interest charges by the banks and financial institutions to POPI, who in turn passed it
on to OLI which further passed it on to OPDI. Hence, OLI derived no additional income from the interest
charges. 25 Since the interests were mere reimbursements and not income, the Commissioner likewise
erred in charging petitioner for deficiency VAT. aHcACT

Petitioner, further contested the finding of discrepancy in the professional fees amounting to
P170,000.00 as against those entries in its financial statements of P50,000.00, resulting to a difference
of P120,000.00. It alleged that the claim has no basis considering that the return it filed clearly declared
as a deduction P50,000.00 for "Outside Services." 26

With regard to the Net Operating Loss Carry Over (NOLCO), OLI counters respondent's claim that it is not
entitled thereto is erroneous. From the year 1999 up to June 30, 2000, petitioner incurred losses which
it did not offset against its gross income. Therefore, the same was properly utilized in the succeeding
year. 27

OLI also alleged in its petition that the surcharges imposed were baseless as there was no fraudulent
intent to conceal its income. 28

Respondent's Special and Affirmative Defenses, 29 contained in its Answer, are enumerated below:

"xxx xxx xxx

3. The assessments in question were made and issued in accordance with law, rules and
regulations. ASTcEa

4. It was disclosed that petitioner has transactions in the normal course of business with its
subsidiaries and affiliates principally consisting of interest and non-interest bearing advances payable on
demand. The subsidiary to whom advances were made and interests were charged was ORION
PROPERTY DEVELOPMENT, INC. (OPDI), of which petitioner did not declare such interest income, in
violation of Section 32 (A) of the 1997 Tax Code.

5. It was discovered from the petitioner's books of accounts that there has been discrepancy of
P120,000.00 on professional fees (per FS-P50,000.00; per Returns-P170,000.00), hence, adjustment was
made to taxable income. The undeclared expense is considered undeclared source of income as cited in
the case of Perez vs. CTA and CIR, L-10507 dated May 30, 1958, for it has been held that unreflected
sources of funds not accounted for in the taxpayers income tax returns led to the interference that part
of his income has not been reported, subject to income tax rate of 32% pursuant to Section 27 of the
1997 Tax Code.

6. The investigation of petitioner's books of accounts revealed that it had carried over the net
operating loss incurred during the year in the subsequent year, in conformity with the provision of
Section 34 (D)(3) of the 1997 Tax Code. It is appropriate that such loss should be taken into
consideration in computing the correct income tax liability for the current year in order to recapture the
income tax benefit realized in the following year because of such carry over. IADCES

7. The undeclared interest income of P130,072,868.38 which was subjected to deficiency income
tax is likewise subject to value-added tax (VAT) as imposed under Section 106 of the 1997 Tax Code.

8. All presumptions are in favor of the correctness of the tax assessment (Interprovincial Autobus
vs. Collector of Internal Revenue, 98 Phil. 290).

xxx xxx xxx"

Both parties presented various pieces of evidence both testamentary and documentary. However,
respondent was deemed to have waived his right to present documentary evidence when it failed to file
its formal offer on time. 30 With the admission of petitioner's memorandum, sans respondent's
memorandum, this case was submitted for decision on August 31, 2007.

From the parties' stipulation of facts and issues, the questions for decision are as follows: 31

1. whether or not it was proper for the respondent to impute interest income to petitioner arising
from its inter-company advances to OPDI; DIHETS

2. whether or not petitioner is liable for deficiency income tax on allegedly undeclared interest
income from advances to OPDI considering that petitioner did not actually earn interest income on such
advances;

3. whether or not the alleged undeclared interest income of the petitioner is subject to VAT;

4. whether or not there is a discrepancy in the amount of P120,000.00 in the professional fees
reflected in the petitioner's income tax return;

5. whether or not petitioner is entitled to claim the NOLCO in the amount of P11,708,290.00 as
allowable deductions; and

6. whether or not petitioner is liable to the imposition of 50% fraud surcharge penalty.

The first, second and third issues shall be decided concurrently.

Section 31 of the Tax Code defines "taxable income" as the "pertinent items of gross income specified in
this Code, less the deductions and/or personal and additional exemptions, if any, authorized for such
types of income by this Code or other special laws." However, taxable income does not include items
received which do not add to the taxpayer's net worth, or redound to his benefit such as amounts
merely deposited or entrusted to him. 32 DCTSEA
Section 32 of the same Code specifically includes "interests" 33 as a source for gross income. "Interests"
for use of money is defined as: 34

"the compensation allowed by law or fixed by the parties for the use or forbearance of borrowed
money; payments a borrower pays a lender for the use of money; cost of using credit or funds of
another"

A review of the records of the case prompted us to conclude that no benefit redounded to OLI from the
inter-company lending transactions between itself, POPI and OPDI.

It appears that respondent based this deficiency interest income assessment from its review of
petitioner's books of accounts. He presumed that the entries of interest charges against OPDI were
interest income which OLI did not declare in its income tax and VAT returns. 35

In its defense, petitioner presented to the Independent Certified Public Accountant (ICPA), Ms. Myra
Celeste Dabalos, journal vouchers issued to OPDI by OLI for evaluation. The ICPA summarized these
vouchers and compared them with the findings of the BIR. 36 Ms. Dabalos commented on the accuracy
of the BIR findings considering a negligible difference between vouchers and the BIR schedule of P1.28.
37 Thereafter, a comparison of the interest charges 38 by GHPI to OLI and interest charged by the latter
to OPDI were made and the findings show that the two sets of payments have no discrepancy. cHCIEA

Aside from these documents, the ICPA also summarized the accounting entries on interest charged by
GHPI and the interest charged to OPDI which showed that the entries on the journal vouchers were
described as interest expense in loans/advances obtained from OLI's parent company, GHPI. The
treatment of these interests by OLI as receivable from OPDI and as liability to GHPI were both
corroborated by OLI's Vice-President Treasurer, Mr. Ronald Sugapong in its court testimony on June 30,
2005 39 and by the ICPA in her report. 40 Mr. Sugapong's testimony further explained that the nature of
the transaction is merely a reimbursement of the interest paid by OLI to POPI/GHPI, viz.: 41

"ATTY ARANAS:

Q. Can you please explain to us the nature of this inter-company advances that allegedly, Orion
Land Inc., derived interest income from its subsidiary or affiliates? Can you please explain the nature of
this transaction?

MR. SUGAPONG:

A. Orion Land is part of our Group of Companies. So the, Group of Companies has an inter-
company lending policy . . . . HIaAED

And under this scenario, interest expense incurred by the parent company is being reimbursed
by the subsidiary company. Interest income allegedly received by the petitioner from its affiliates, OPDI,
is simply reimbursement of the interest charges by the bank and of the financial institutions to the
parent company. In this case, the interest charges now go to Prime Orion Philippines Incorporated. In
return, GSPI pass this interest to Orion Land, the parent company. And later on, Orion land reimbursed
this interest expense to OPDI, the final user of the funds.

xxx xxx xxx

ATTY ARANAS:
Q. And what is your recording of this charged interest expense to your affiliates?

MR. SUGAPONG:

A. Orion Land as the parent of OPDI, records this interest charges as liability to Prime Orion and a
receivable due from OPDI. aDTSHc

(emphasis supplied)

xxx xxx xxx"

Ms. Dabalos' findings, on the other hand, state that: 42

"We have verified that the interest the company charged OPDI is equal to the interest GHPI charges to
the company. Although the billing statements from GHPI to the Company and from the Company to
OPDI has an immaterial discrepancy of P1.27, the amount recorded in the Company's books as DUE
From OPDI is equal to the amount recorded as Due to GHPI on these transactions. Thus, the Company
did not incur income on these transactions." (emphasis supplied)

From the foregoing, no taxable income actually redounded to OLI, as the interest it received was merely
passed-on to it. It was merely deposited or entrusted to it for payment to POPI/GHPI. Furthermore, by
definition of "interest" the actual lender of the funds or creditor is not really OLI as it was a mere
conduit in the transaction.

Considering that the interest charged by OLI is not considered income, it cannot be thus subject to VAT.
IcHTED

As to the fourth issue, we likewise rule in petitioner's favor.

We cannot find any basis for respondent's assessment of the P120,000.00 discrepancy in professional
fees. Nor is there a basis for petitioner's claim that the actual cost of professional services was actually
P170,000.00. Documentary evidence 43 admitted show that the actual deduction for "outside services"
for fiscal year 2001 is in the amount of P50,000.00. No claiming of deduction of P170,000.00 took place
as consolidated by the ICPA with the company's ledger for professional fees. 44

Petitioner's argument that the discrepancy of P120,000.00 was based on the adjustment entries due to
the reversal of legal and secretarial fees to GHPI is well taken. It is substantiated by the inter-office
memorandum 45 issued on June 29, 2001 by GHPI's legal department to OLI, affirming that beginning
September 1, 2000, GHPI ceased issuing monthly billings to OLI and the finding of the ICPA of this fact.
46

On the issue of whether or not OLI is entitled to claim NOLCO, we also rule in the positive.

In order to "recapture" the actual income of OLI in FY 2001, the BIR added back the NOLCO of
P11,708,290.00 to its alleged deficiency income tax. Nonetheless, having ruled out the absence of
deficiency income tax of OLI, the BIR no longer has a reason to disallow the same. TSAHIa

Furthermore, Section 34 (D)(3) of the Tax Code states that:

"SEC. 34. Deductions from Gross Income. —

xxx xxx xxx

(3) Net Operating Loss Carry-Over. — The net operating loss of the business or enterprise for any
taxable year immediately preceding the current taxable year, which had not been previously offset as
deduction from gross income shall be carried over as a deduction from gross income for the next three
(3) consecutive taxable years immediately following the year of such loss: . . .

For purposes of this subsection, the term "net operating loss" shall mean the excess of allowable
deduction over gross income of the business in a taxable year. (emphasis supplied)

xxx xxx xxx"

The provisions of the law are clear; a loss that has not been previously offset from gross income may be
carried over to the three succeeding years. The law itself authorized petitioner such carry-over since OLI
had no gross income in the years 1999 and 2000 to offset the losses with. In other words, since OLI was
operating at a loss during these years, the carry-over to 2001 is proper. TEAaDC

Finally, on the imposition of surcharge: respondent, in his PAN 47 stated that the surcharge was
imposed pursuant to Section 248(B) of the 1997 Tax Code stating that petitioner failed to "report sales,
receipts or income in an amount exceeding thirty (30%) percent of that declared per return, which shall
render the taxpayer liable for substantial underdeclaration of sales receipts or income and shall
constitute a prima facie evidence of a false and fraudulent return."

Section 248 (B) of the 1997 Tax Code provides that:

"SEC. 248. Civil Penalties. —

xxx xxx xxx

(B) In case of willful neglect to file the return within the period prescribed by this Code or by rules
and regulations, or in case a false or fraudulent return is willfully made, the penalty to be imposed shall
be fifty percent (50%) of the tax or of the deficiency tax, in case, any payment has been made on the
basis of such return before the discovery of the falsity or fraud: Provided, That a substantial
underdeclaration of taxable sales, receipts or income, or a substantial overstatement of deductions, as
determined by the Commissioner pursuant to the rules and regulations to be promulgated by the
Secretary of Finance, shall constitute prima facie evidence of a false or fraudulent return: Provided,
further, That failure to report sales, receipts or income in an amount exceeding thirty percent (30%) of
that declared per return, and a claim of deductions in an amount exceeding (30%) of actual deductions,
shall render the taxpayer liable for substantial underdeclaration of sales, receipts or income or for
overstatement of deductions, as mentioned herein." (emphasis supplied) IcESaA

Since OLI was found not to have underdeclared its income, no surcharge can be imposed on it.
Furthermore, no fraudulent intent to defraud the government can be found in OLI. It is worthy to note
the ruling of the High Court in Aznar vs. CTA, 58 SCRA 519, G.R. No. L-20569. August 23, 1974, which is
stated thus:

"From the above exposition of facts, we cannot but emphatically reiterate the well established doctrine
that fraud cannot be presumed but must be proven. As a corollary thereto, we can also state that
fraudulent intent could not be deduced from mistakes however frequent they may be, especially if such
mistakes emanate from erroneous entries or erroneous classification of items in accounting methods
utilized for determination of tax liabilities. . . .

The lower court's conclusion regarding the existence of fraudulent intent to evade payment of taxes was
based merely on a presumption and not on evidence establishing a willful filing of false and fraudulent
returns so as to warrant the imposition of the fraud penalty. The fraud contemplated by law is actual
and not constructive. It must be intentional fraud, consisting of deception willfully and deliberately done
or resorted to in order to induce another to give up some legal right.

xxx xxx xxx

Respondent was correct in arguing that tax assessments are presumed correct, the taxpayer having the
duty to prove otherwise. Nonetheless, petitioner has sufficiently overturned this presumption with the
evidence it presented. Respondent should be reminded that "assessments should not be based on
presumptions no matter how logical the presumptions might be. In order to stand the test of judicial
scrutiny, the assessment must be based on actual facts." 48 Respondent failed to sufficiently support its
claims to substantiate his assessment. It is but proper that the deficiency tax assessment against
petitioner be withdrawn.

WHEREFORE, in view of the foregoing, the Petition for Review is hereby GRANTED. Accordingly, the
deficiency assessment by the Commissioner of Internal Revenue holding petitioner Orion Land, Inc.
liable for deficiency Income Tax for the Fiscal Year ending June 30, 2001 in the amount of
P85,054,588.87 and alleged deficiency Value-Added Tax in the amount of P27,133,312.84 are hereby
CANCELLED.

SO ORDERED.

(SGD.) CAESAR A. CASANOVA

Associate Justice

Ernesto D. Acosta, P.J. and Lovell R. Bautista, J., concur.

Footnotes

1. Joint Stipulation of Facts and Issues, par. 1, Rollo p. 108. DAcSIC

2. Ibid., par. 2.

3. TSN, June 30, 2005, p. 16; Petition for Review, pars. 20-21, Rollo p. 7.

4. Exhibit "J," Rollo p. 182.

5. TSN, June 30, 2005, Ibid., pp. 15-16.

6. Commissioner's Report, Exhibit "V-32".

7. Rollo pp. 191-192, 193-195, 188-190, 246-248, 249-251; Commissioner's Report. TESICD

8. Exhibit "B," Rollo pp. 152-153.

9. Ibid.
10. Joint Stipulation of Facts and Issues, par. 3, Rollo pp. 108-109; Exhibit "B-1," Rollo, p. 153.

11. Ibid. par. 4, Rollo p. 109.

12. Ibid., par. 5, Ibid.; Exhibit "C," Rollo p. 154.

13. Ibid., par. 6, Ibid.; Exhibit "D," Rollo pp. 155-157.

14. Ibid.; Exhibit "E," Rollo p. 158.

15. Ibid., par. 7, Rollo p. 109; Exhibit "F," Rollo p. 159.

16. Ibid. par. 8, Rollo pp. 109-110; Exhibit "G," Rollo pp. 160-161.

17. Ibid. par. 9; Exhibit "H" and "H-1," Rollo pp. 164, 166-167.

18. Exhibit "H-1," Rollo pp. 166-167; Answer, par. 5, Rollo p. 70.

19. Exhibit "I-1," Rollop p. 170-171.

20. Joint Stipulation of Facts and Issues, par. 10, Rollo p. 111; Exhibit "I," Rollo pp. 168-169.

21. Ibid., par. 12, Ibid., Exhibit "J", p. 174.

22. Ibid., par. 13, Ibid.; Exhibit "K," Rollo p. 183.

23. Ibid., par. 14-15, Ibid.; Exhibit "L," Rollo p. 184; Exhibit "M", p. 185.

24. Ibid. par. 16, Rollo pp. 111-112. IcDESA

25. Petition for Review, par. 21, Rollo p. 7.

26. Ibid., par. 26, Rollo pp. 8-9; Exhibit "N-1" Rollo p. 190.

27. Ibid., pars. 27-31, Rollo pp. 9-10.

28. Ibid., pars. 38-42, Rollo pp. 12-13.

29. Answer, pars. 3-8, Rollo pp. 70-71.

30. TSN, April 13, 2007, pp. 3-4.

31. Joint Stipulation of facts and issues, Rollo pp. 112-113.

32. Justice Jose C. Vitug and Pres. Justice Ernesto D. Acosta citing Commissioner vs. Tours Specialist,
183 SCRA 402, Tax Law and Jurisprudence, 2nd Edition, p. 95.

33. 1997 Tax Code, Sec. 32 (A)(4).

34. Black's Law Dictionary, 6th Edition, p. 812.

35. TSN, August 1, 2006 pp. 9-10.

36. Commissioner's Report, Exhibit "V," p. 3; TSN, January 26, 2006, pp. 13-15.

37. Ibid.
38. Exhibit "V-31."

39. TSN, June 30, 2005, pp. 16-17.

40. Exhibit "V," Commissioner's Report, p. 3 and p. 5.

41. Supra, note 29.

42. TSN, January 26, 2006, p. 13-14. cEaSHC

43. Exhibit "V-3-1," Commissioner's Report Exhibit "V."

44. Exhibits "V-33" and "V-34," Ibid.

45. Exhibit "V-35;" TSN, January 26, 2006, p. 15; Answer, par. 6, Rollo p. 71.

46. Commissioner's Report, Exhibit "V."

47. Exhibit "H," Rollo pp. 164-165.

48. Law of Basic Taxation in the Philippines by Benjamin B. Aban in citing CIR vs. Benipayo, G.R. No.
L-13656, January 31, 1962. IAETSC