CIR VS GENERAL FOODS, G.R. No. 143672 (April 24, 2003)

CIR VS GENERAL FOODS, G.R. No. 143672 April 24, 2003

FACTS:

On June 14, 1985, respondent corporation, General Foods (Phils.) Inc., which is engaged in the manufacture of beverages such as "Tang," "Calumet" and "Kool-Aid," filed its income tax return for the fiscal year ending February 28, 1985. In said tax return, respondent corporation claimed as deduction, among other business expenses, the amount of P9,461,246 for media advertising for "Tang."

The Commissioner disallowed 50% or P4,730,623 of the deduction claimed by respondent corporation. Consequently, respondent corporation was assessed deficiency income taxes in the amount of P2,635, 141.42. The latter filed a motion for reconsideration but the same was denied.

On September 29, 1989, respondent corporation appealed to the Court of Tax Appeals but the appeal was dismissed:

Aggrieved, respondent corporation filed a petition for review at the Court of Appeals which rendered a decision reversing and setting aside the decision of the Court of Tax Appeals. It ruled that since it has not been sufficiently established that the item it claimed as a deduction is excessive, the same should be allowed.

ISSUE: whether or not the subject media advertising expense for "Tang" incurred by respondent corporation was an ordinary and necessary expense fully deductible under the National Internal Revenue Code (NIRC). Or was it a capital expenditure, paid in order to create "goodwill and reputation" for respondent corporation and/or its products, which should have been amortized over a reasonable period?

ARGUMENT:

The Commissioner maintains that the subject advertising expense was not ordinary on the ground that it failed the two conditions set by U.S. jurisprudence: first, "reasonableness" of the amount incurred and second, the amount incurred must not be a capital outlay to create "goodwill" for the product and/or private respondent’s business. Otherwise, the expense must be considered a capital expenditure to be spread out over a reasonable time.

RULING:

No, it is not an ordinary (and necessary) expense fully deductible but a capital expenditure. The subject media expense was incurred in order to protect respondent corporation’s brand franchise which was tantamount to efforts to establish a reputation. This was akin to the acquisition of capital assets and therefore expenses related thereto were not to be considered as business expenses but as capital expenditures.

Deductions for income tax purposes partake of the nature of tax exemptions; hence, if tax exemptions are strictly construed, then deductions must also be strictly construed.

Section 34 (A) (1), formerly Section 29 (a) (1) (A), of the NIRC provides:

(A) Expenses.-

(1) Ordinary and necessary trade, business or professional expenses.-

(a) In general.- There shall be allowed as deduction from gross income all ordinary and necessary expenses paid or incurred during the taxable year in carrying on, or which are directly attributable to, the development, management, operation and/or conduct of the trade, business or exercise of a profession.

To be deductible from gross income, the subject advertising expense must comply with the following requisites:

(a) the expense must be ordinary and necessary;

(b) it must have been paid or incurred during the taxable year;

(c) it must have been paid or incurred in carrying on the trade or business of the taxpayer; and

(d) it must be supported by receipts, records or other pertinent papers.

The parties are in agreement that the subject advertising expense was paid or incurred within the corresponding taxable year and was incurred in carrying on a trade or business. Hence, it was necessary. However, their views conflict as to whether or not it was ordinary. To be deductible, an advertising expense should not only be necessary but also ordinary. These two requirements must be met.

IN THE CASE AT BAR, the P9,461,246 claimed as media advertising expense for "Tang" alone was almost one-half of its total claim for "marketing expenses." Aside from that, respondent-corporation also claimed P2,678,328 as "other advertising and promotions expense" and another P1,548,614, for consumer promotion.

Furthermore, the subject P9,461,246 media advertising expense for "Tang" was almost double the amount of respondent corporation’s P4,640,636 general and administrative expenses.

We find the subject expense for the advertisement of a single product to be inordinately large. Therefore, even if it is necessary, it cannot be considered an ordinary expense deductible under then Section 29 (a) (1) (A) of the NIRC.

KINDS OF ADVERTISING

Advertising is generally of two kinds: (1) advertising to stimulate the current sale of merchandise or use of services and (2) advertising designed to stimulate the future sale of merchandise or use of services. The second type involves expenditures incurred, in whole or in part, to create or maintain some form of goodwill for the taxpayer’s trade or business or for the industry or profession of which the taxpayer is a member. If the expenditures are for the advertising of the first kind, then, except as to the question of the reasonableness of amount, there is no doubt such expenditures are deductible as business expenses. If, however, the expenditures are for advertising of the second kind, then normally they should be spread out over a reasonable period of time.

IN THE CASE, the subject advertising expense was of the second kind, advertising to stimulate the FUTURE sale. It was incurred in order to protect respondent corporation’s brand franchise. The protection of brand franchise is analogous to the maintenance of goodwill or title to one’s property. This is a capital expenditure which should be spread out over a reasonable period of time.

Respondent corporation’s venture to protect its brand franchise was tantamount to efforts to establish a reputation. This was akin to the acquisition of capital assets and therefore expenses related thereto were not to be considered as business expenses but as capital expenditures.

IN A NUTSHELL

For an expense to be considered ordinary, it must be reasonable in amount. The Court of Tax Appeals ruled that respondent corporation failed to meet the two limitations. The first relates to the extent to which the expenditures are actually capital outlays; this necessitates an inquiry into the nature or purpose of such expenditures.The second, which must be applied in harmony with the first, relates to whether the expenditures are ordinary and necessary.

IN THE CASE, respondent corporation incurred the subject advertising expense in order to protect its brand franchise. We consider this as a capital outlay since it created goodwill for its business and/or product. The P9,461,246 media advertising expense for the promotion of a single product, almost one-half of petitioner corporation’s entire claim for marketing expenses for that year under review, inclusive of other advertising and promotion expenses of P2,678,328 and P1,548,614 for consumer promotion, is doubtlessly unreasonable.

Accordingly, we find that the Court of Appeals committed reversible error when it declared the subject media advertising expense to be deductible as an ordinary and necessary expense on the ground that "it has not been established that the item being claimed as deduction is excessive." It is not incumbent upon the taxing authority to prove that the amount of items being claimed is unreasonable. The burden of proof to establish the validity of claimed deductions is on the taxpayer.¹⁴ In the present case, that burden was not discharged satisfactorily.

 #TAXCASE

#DEDUCTIBLES