Commissioner of Internal Revenue v. Sony Philippines

G.R. No. 178697 (November 17, 2010)

Facts:

On November 24, 1998, the Commissioner of Internal Revenue (CIR) issued Letter of Authority No. 000019734 (LOA 19734) to examine the books of accounts and other records of Sony Philippines, Inc. (Sony) for revenue taxes pertaining to the year 1997 and unverified prior years. Following this, on December 6, 1999, the CIR issued a preliminary assessment for deficiency taxes and penalties for the year 1997, which Sony protested. The CIR subsequently issued final assessment notices detailing discrepancies in Sony's tax obligations.

The assessments included a deficiency Value Added Tax (VAT) amounting to P11,141,014.41, a deficiency Expanded Withholding Tax (EWT) of P1,992,462.72, and various penalties for late remittance of internal revenue taxes totaling P2,288,473.78. Sony filed a protest against these assessments on February 2, 2000, and submitted supporting documents on February 16, 2000. After the lapse of 180 days without a decision from the CIR, Sony filed a petition for review with the Court of Tax Appeals (CTA) on October 24, 2000.

The CTA-First Division ruled in favor of Sony, canceling the deficiency VAT assessment but upholding the deficiency EWT assessment and the penalties for late remittance. The CIR sought reconsideration, which was denied, prompting the CIR to appeal to the CTA-En Banc. The CTA-En Banc affirmed the decision of the CTA-First Division, leading the CIR to file a petition for review with the Supreme Court.

Legal Issues:

1. Whether the CIR's deficiency VAT assessment against Sony was valid given the scope of the LOA.
2. Whether the commission expense incurred by Sony should be subject to a 10% withholding tax instead of the 5% rate.
3. Whether the assessment of withholding tax on rental deposits was proper.
4. Whether the remittance of final withholding tax on royalties was filed on time.

Arguments:

• CIR's Arguments:

  • The CIR contended that the LOA, despite its wording, should be interpreted to include the fiscal year ending March 31, 1998.
  • The CIR argued that Sony's advertising expense, reimbursed by Sony International Singapore (SIS), should not qualify for input VAT credits.
  • The CIR maintained that the commission expense should be subject to a 10% withholding tax as per Revenue Regulation No. 2-98.
  • The CIR asserted that the withholding tax on rental deposits was valid and that the final withholding tax on royalties was filed late.

• Sony's Arguments:

  • Sony argued that the LOA did not cover the fiscal year ending March 31, 1998, and thus the VAT assessment was invalid.
  • Sony contended that the advertising expense was legitimate and entitled to input VAT credits, regardless of reimbursement.
  • Sony maintained that the commission expense was correctly assessed at a 5% withholding tax rate under Revenue Regulations No. 6-85.
  • Sony claimed that the remittance of final withholding tax on royalties was timely filed according to the terms of the Manufacturing License Agreement (MLA).

Court's Decision and Legal Reasoning:

The Supreme Court upheld the decisions of the CTA-First Division and the CTA-En Banc, finding no merit in the CIR's arguments. The Court emphasized that the LOA's scope was limited to the year 1997 and did not extend to the fiscal year ending March 31, 1998. The Court noted that the CIR's revenue officers exceeded their authority by assessing taxes for a period not covered by the LOA.

Regarding the input VAT credit, the Court ruled that Sony was entitled to the credit for the advertising expense, as it was a legitimate business expense supported by VAT invoices. The reimbursement from SIS did not negate Sony's entitlement to the input VAT credit.

On the issue of the commission expense, the Court agreed with the CTA's application of the 5% withholding tax rate, clarifying that the applicable regulations during the assessment period were those in effect prior to the adoption of Revenue Regulation No. 2-98.

Finally, the Court affirmed the CTA's ruling on the timeliness of the final withholding tax remittance on royalties, concluding that Sony complied with the required deadlines as per the MLA.

Significant Legal Principles Established:

1. The necessity of a clearly defined scope in a Letter of Authority for tax assessments.
2. The entitlement to input VAT credits for legitimate business expenses, regardless of reimbursement arrangements.
3. The importance of applying the correct withholding tax rates based on the applicable regulations during the relevant assessment period.
4. The adherence to contractual terms in determining the timing of tax remittances.