Tax #48 (Income from Sources within the Philippines) CIR, petitoner, vs. CTA an Smith !

line an (1984)

"rench #$erseas Co% (Philippine &ranch), respondents.

Doctrine: Where an expense is clearly related to the production of Philippine-derived income or to Philippine operations (e.g. salaries of Philippine personnel, rental of office building in the Philippines , that expense can be deducted from the gross income ac!uired in the Philippines." #he overhead expenses incurred by the parent company in connection $ith finance, administration, and research and development $hich direct benefit its branches all over the $orld are items $hich cannot be definitely allocated or identified $ith the operations of the Philippine branch, and thus, under %ec. &'(b of ()*+ and %ec. ,-. of Do/ **-0, the company can claim as its deductible share a ratable part of such expenses, $hich is based uponthe ration of the local branch1s gross income to the total gross income of the multinational corp. $orld$ide." "acts'Proce ure( This case is about the refund of a 1971 income tax amounting to P324 2!!. "mith #$ine and %rench &verseas 'om(an) a mu$tinationa$ firm domici$ed in Phi$ade$(hia Penns)$vania is $icensed to do business in the Phi$i((ines. *t is engaged in the im(ortation manufacture and sa$e of (harmaceutica$s drugs and chemica$s. *n its 1971 origina$ income tax return "mith #$ine dec$ared a net taxab$e income of P1 489 277 and (aid P!11 247 as tax due. The e uctions claime from )ross income +as P!,1 ,4, (-77 ,.,) from its share of its hea office o$erhea expenses. 1n 1973 it fi$ed an amended return and c$aimed it over(aid b) P324 2!! because of /underdeduction of home office overhead0. *t based this c$aim of under(a)ment from an authenticated certification from "mith #$ine1s inde(endent internationa$ auditors. *n that certification it said that /Phi$i((ine share in the una$$ocated overhead ex(enses of the main office for the )ear ended 2ecember 31 1971 +as actua$$) -219 !47 (P1 427 484).0 3) reason of the ne+ ad4ustment "mith #$ine5s tax $iabi$it) +as great$) reduced from P!11 247 to P18. 992 resu$ting in an over(a)ment of P324 2!!. 6ence it made a forma$ c$aim for refund +ith '*7. *t neverthe$ess fi$ed a (etition +ith the 'T8. The 'T8 ru$ed in favor of the refund and it ordered the '*7 to do so. Issue's( 1. *'+ 'T8 +as correct in finding in favor of "mith #$ine in its c$aim for refund9 ,el 'Ratio( 1. :es. Sec% -. of #l +IRC (C%A% 4..), repro uce in +IRC /011 (P%2% //38) "ec. 37. *ncome from sources +ithin the Phi$i((ines. ; xxx xxx xxx (b) <et income from sources in the Phi$i((ines. ; %rom the items of gross income

s(ecified in subsection (a) of this section there sha$$ be deducted the ex(enses $osses and other deductions (ro(er$) a((ortioned or a$$ocated thereto and a ratab$e (art of an) ex(enses $osses or other deductions +hich cannot definite$) be a$$ocated to some item or c$ass of gross income. The remainder if an) sha$$ be inc$uded in fu$$ as net income from sources +ithin the Phi$i((ines. 2ept% of "inance RR45 ( etermines the e uctions to 6e ma e to etermine the net income from Phil% Sources) "ec. 1.,. 8((ortionment of deductions. ; %rom the items s(ecified in section 37(a) as being derived s(ecifica$$) from sources +ithin the Phi$i((ines there sha$$ be deducted the ex(enses $osses and other deductions (ro(er$) a((ortioned or a$$ocated thereto and a ratab$e (art of an) other ex(enses $osses or deductions +hich can not definite$) be a$$ocated to some item or c$ass of gross income. The remainder sha$$ be inc$uded in fu$$ as net income from sources +ithin the Phi$i((ines. The rata6le part is 6ase upon the ratio of )ross income from sources within the Philippines to the total )ross income% Example= 8 non>resident a$ien individua$ +hose taxab$e )ear is the ca$endar )ear derived gross income from a$$ sources for 1939 of P18, ,,, inc$uding therein= *nterest on bonds of a domestic cor(oration P9 ,,, 2ividends on stoc? of a domestic cor(oration 4 ,,, 7o)a$t) for the use of (atents +ithin the Phi$i((ines 12 ,,, @ain from sa$e of rea$ (ro(ert) $ocated +ithin the Phi$i((ines 11 ,,, Tota$ P3. ,,, that is one>fifth of the tota$ gross income +as from sources within the Philippines. The remainder of the gross income +as from sources +ithout the Phi$i((ines determined under section 37(c). The expenses of the taxpa7er for the 7ear amounte to P18,888 . &f these ex(enses the amount of P8 ,,, is (ro(er$) a$$ocated to income from sources +ithin the Phi$i((ines and the amount of P4, ,,, is (ro(er$) a$$ocated to income from sources +ithout the Phi$i((ines. The remain er of the expense, P-8,888, cannot 6e efinitel7 allocate to an7 class of income. 8 ratab$e (art thereof based u(on the re$ation of gross income from sources +ithin the Phi$i((ines to the tota$ gross income sha$$ be deducted in com(uting net income from sources +ithin the Phi$i((ines. Thus these are deducted from the P3. ,,, of gross income from sources +ithin the Phi$i((ines ex(enses amounting to P14 ,,, Are(resenting P8 ,,, (ro(er$) a((ortioned to the income from sources +ithin the Phi$i((ines and P. ,,, a ratab$e (art (one>fifth) of the ex(enses +hich cou$d not be a$$ocated to an) item or c$ass of gross income.B The remainder P22 ,,, is the net income from sources +ithin the Phi$i((ines. %rom these 7u$es su(ra /it is manifest that +here an ex(ense is c$ear$) re$ated to the (roduction of Phi$i((ine>derived income or to Phi$i((ine o(erations (e.g. sa$aries of Phi$i((ine (ersonne$ renta$ of office bui$ding in the Phi$i((ines) that ex(ense can be deducted from the gross income acCuired in the Phi$i((ines +ithout resorting to a((ortionment.

The overhead ex(enses incurred b) the (arent com(an) in connection +ith finance administration and research and deve$o(ment a$$ of +hich direct benefit its branches a$$ over the +or$d inc$uding the Phi$i((ines fa$$ under a different categor) ho+ever. These are items +hich cannot be definite$) a$$ocated or *dentified +ith the o(erations of the Phi$i((ine branch. 3ased on the above>mentoned ru$es /Smith !line can claim as its e ucti6le share a rata6le part of such expenses based upon the ratio of the local 6ranch9s )ross income to the total )ross income, worl wi e of the mu$tinationa$ cor(oration. The +eight of evidence bo$sters the (osition of "mith #$ine that the amount of P1 427 484 re(resents the ratab$e share. 'T8 decision affirmed. 2igested b)= Da) @arcia (82,1!)