Consolidated Mines v. Court Of Tax Appeals

MAKALINTAL, J.:

These are appeals from the amended decision of the Court of Tax Appeals dated August 7, 1961, in CTA Cases No. 565 and 578, both entitled "Consolidated Mines, Inc. vs. Commissioner of Internal Revenue," ordering the Consolidated Mines, Inc., hereinafter referred to as the Company, to pay the Commissioner of Internal Revenue the amounts of P79,812.93, P51,528.24 and P71,392.82 as deficiency income taxes for the years 1953, 1954 and 1956, respectively, or the total sum of P202,733.99, plus 5% surcharge and 1% monthly interest from the date of finality of the decision. The Company, a domestic corporation engaged in mining, had filed its income tax returns for 1951, 1952, 1953 and 1956.

In 1957 examiners of the Bureau of Internal Revenue investigated the income tax returns filed by the Company because on August 10, 1954, its auditor, Felipe Ollada claimed the refund of the sum of P107,472.00 representing alleged overpayments of income taxes for the year 1951. After the investigation the examiners reported that (A) for the years 1951 to 1954 (1) the Company had not accrued as an expense the share in the company profits of Benguet Consolidated Mines as operator of the Company's mines, although for income tax purposes the Company had reported income and expenses on the accrual basis; (2) depletion and depreciation expenses had been overcharged; and (3) the claims for audit and legal fees and miscellaneous expenses for 1953 and 1954 had not been properly substantiated; and that (B) for the year 1956 (1) the Company had overstated its claim for depletion; and (2) certain claims for miscellaneous expenses were not duly supported by evidence.

In view of said reports the Commissioner of Internal Revenue sent the Company a letter of demand requiring it to pay certain deficiency income taxes for the years 1951 to 1954, inclusive, and for the year 1956. Deficiency income tax assessment notices for said years were also sent to the Company. The Company requested a reconsideration of the assessment, but the Commissioner refused to reconsider, hence the Company appealed to the Court of Tax Appeals.

The assessments for 1951 to 1954 were contested in CTA Case No. 565, while that for 1956 was contested in CTA Case No. 578. Upon agreement of the parties the two cases were heard and decided jointly. On May 6, 1961 the Tax Court rendered judgment ordering the Company to pay the amounts of P107,846.56, P134,033.01 and P71,392.82 as deficiency income taxes for the years 1953, 1954 and 1956, respectively.

The Tax Court nullified the assessments for the years 1951 and 1952 on the ground that they were issued beyond the five-year period prescribed by Section 331 of the National Internal Revenue Code. However, on August 7, 1961, upon motion of the Company, the Tax Court reconsidered its decision and further reduced the deficiency income tax liabilities of the Company to P79,812.93, P51,528.24 and P71,382.82 for the years 1953, 1954 and 1956, respectively. In this amended decision the Tax Court subscribed to the theory of the Company that Benguet Consolidated Mining Company, hereafter referred to as Benguet, had no right to share in "Accounts Receivable,"

hence one-half thereof may not be accrued as an expense of the Company for a given year. Both the Company and the Commissioner appealed to this Court. The Company questions the rate of mine depletion adopted by the Court of Tax Appeals and the disallowance of depreciation charges and certain miscellaneous expenses (G.R. Nos. L-18843 & L-18844).

The Commissioner, on the other hand, questions what he characterizes as the "hybrid" or "mixed" method of accounting utilized by the Company, and approved by the Tax Court, in treating the share of Benguet in the net profits from the operation of the mines in connection with its income tax returns (G.R. Nos. L-18853 & L-18854).

With respect to methods of accounting, the Tax Code states: Sec. 38. General Rules. The net income shall be computed upon the basis of the taxpayer's annual accounting period (fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer but if no such method of accounting has been so employed or if the method employed does not clearly reflect the income the computation shall be made in accordance with such methods as in the opinion of the Commissioner of Internal Revenue does clearly reflect the income ...

Sec. 39. Period in which items of gross income included. - The amount of all items of gross income shall be included in the gross income for the taxable year in which received by the taxpayer, unless, under the methods of accounting permitted under section 38, any such amounts are to be properly accounted for as of a different period ...

Sec. 40. Period for which deductions and credits taken. - The deductions provided for in this Title shall be taken for the taxable year in which "paid or accrued"

or "paid or incurred" dependent upon the method of accounting upon the basis of which the net income is computed, unless in order to clearly reflect the income the deductions should be taken as of a different period ... It is said that accounting methods for tax purposes1 comprise a set of rules for determining when and how to report income and deductions.

The U.S. Internal Revenue Code2 allows each taxpayer to adopt the accounting method most suitable to his business, and requires only that taxable income generally be based on the method of accounting regularly employed in keeping the taxpayer's books, provided that the method clearly reflects income.3 The Company used the accrual method of accounting in computing its income. One of its expenses is the amount-paid to Benguet as mine operator, which amount is computed as 50% of "net income." The Company deducts as an expense 50% of cash receipts minus disbursements, but does not deduct at the end of each calendar year what the Commissioner alleges is "50% of the share of Benguet"

in the "accounts receivable." However, it deducts Benguet's 50% if and when the "accounts receivable" are actually paid.

It would seem, therefore, that the Company has been deducting a portion of this expense (Benguet's share as mine operator) on the "cash & carry" basis. The question is whether or not the accounting system used by the Company justifies such a treatment of this item; and if not, whether said method used by the Company, and characterized by the Commissioner as a "hybrid method,"

may be allowed under the aforequoted provisions of our tax code.4 For a proper understanding of the situation the following facts are stated: The Company has certain mining claims located in Masinloc, Zambales. Because it wanted to relieve itself of the work and expense necessary for developing the claims, the Company, on July 9, 1934, entered into an agreement (Exhibit L) with Benguet, a domestic anonymous partnership engaged in the production and marketing of chromite, whereby the latter undertook to "explore, develop, mine, concentrate and market" the pay ore in said mining claims.

The pertinent provisions of their agreement, as amended by the supplemental agreements of September 14, 1939 (Exhibit L-1) and October 2, 1941 (Exhibit L-2), are as follows: IV.

Benguet further agrees to provide such funds from its own resources as are in its judgment necessary for the exploration and development of said claims and properties, for the purchase and construction of said concentrator plant and for the installation of the proper transportation facilities as provided in paragraphs I, II and III hereof until such time as the said properties are on a profit producing basis and agrees thereafter to expand additional funds from its own resources, if the income from the said claims is insufficient therefor, in the exploration and development of said properties or in the enlargement or extension of said concentration and transportation facilities if in its judgment good mining practice requires such additional expenditures. Such expenditures from its own resources prior to the time the said properties are put on a profit producing basis shall be reimbursed as provided in paragraph VIII hereof.

Expenditures from its own resources thereafter shall be charged against the subsequent gross income of the properties as provided in paragraph X hereof. VII. As soon as practicable after the close of each month Benguet shall furnish Consolidated with a statement showing its expenditures made and ore settlements received under this agreement for the preceding month which statement shall betaken as accepted by Consolidated unless exception is taken thereto or to any item thereof within ten days in writing in which case the dispute shall be settled by agreement or by arbitration as provided in paragraph XXII hereof.

VIII. While Benguet is being reimbursed for all its expenditures, advances and disbursements hereunder as evidenced by said statements of accounts, the net profits resulting from the operation of the aforesaid claims or properties shall be divided ninety per cent (90%) to Benguet and ten per cent (10%) to Consolidated. Such division of net profits shall be based on the receipts, and expenditures during each calendar year, and shall continue until such time as the ninety per cent (90%) of the net profits pertaining to Benguet hereunder shall equal the amount of such expenditures, advances and disbursements.

The net profits shall be computed as provided in Paragraph X hereof. X. After Benguet has been fully reimbursed for its expenditures, advances and disbursements as aforesaid the net profits from the operation shall be divided between Benguet and Consolidated share and share alike, it being understood however, that the net profits as the term is used in this agreement shall be computed by deducting from gross income all operating expenses and all disbursements of any nature whatsoever as may be made in order to carry out the terms of this agreement. XIII.

It is understood that Benguet shall receive no compensation for services rendered as manager or technical consultants in connection with the carrying out of this agreement.ℒαwρhi৷ It may, however, charge against the operation actual additional expenses incurred in its Manila Office in connection with the carrying out of the terms of this agreement including traveling expenses of consulting staff to the mines. Such expenses, however, shall not exceed the sum of One Thousand Pesos (P1,000.00) per month. Otherwise, the sole compensation of Benguet shall be its proportion of the net profits of the operation as herein above set forth.

XIV. All payments due Consolidated by Benguet under the terms of this agreement with respect to expenditures made and ore settlements received during the preceding calendar month, shall be payable on or before the twentieth day of each month. There is no question with respect to the 90%-10% sharing of profits while Benguet was being reimbursed the expenses disbursed during the period it was trying to put the mines on a profit-producing basis.5 It appears that by 1953 Benguet had completely recouped said advances, because they were then dividing the profits share and share alike.

. As heretofore stated the question is: Under the arrangement between the Company and Benguet, when did Benguet's 50% share in the "Accounts Receivable accrue?6 The following table (summary, Exhibit A, of examiner's report of January 28, 1967, Exh. 8) prepared for the Commissioner graphically illustrates the effect of the inclusion of one-half of "Accounts Receivable"

as expense in the computation of the net income of the Company: SUMMARY: 1951 1952 1953 1954 Original share of Benguet 1,313,640.26 3,521,751,94 2,340,624.59 2,622,968.58 Additional share of Rec'bles 383,829.87 677,504.76 577,394.66 282,724.76 Total share of Benguet 1,697,470.13 4,199,256.70 2,918,009.25 2,905,693.34 Less: Receipts due from prior year operation 269,619.00 383,829.87 677,504.76 577,384.66 Share of Benguet as adjusted (Acc'rd) 1,427,851.13 3,815,426.83 2,240,504.49 2,328,308.68 Less: Participation of Benguet already deducted 1,313,640.26 3,521,751.94 2,340,624.59 2,622,968.58 Additional Expense (Income) 114,210.87 293,674.89 (100,120.10) (294,659.90) In the aforesaid table "Additional share on Rec'bles" is one-half of "Total Rec'bles minus "Total Payables." It indicates, from the Commissioner's viewpoint, that there were years when the Company had been overstating its income (1951 and 1952) and there were years when it had been understating its income (1953 and 1954).7 The Commissioner is not interested in the taxes for 1951 and 1952 (which had prescribed anyway) when the Company had overstated its income, but in those for 1953 and 1954, in each of which years the amount of the "Accounts Receivable"

was less than that of the previous year, and the Company, therefore, appears to have deducted, as expense, compensation to Benguet bigger (than what the Commissioner claims is due) by one-half of the difference between the year's "Accounts Receivable" and the previous year's "Accounts Receivable," thus apparently understating its income to that extent.

According to the agreement between the Company and Benguet the net profits "shall be computed by deducting from gross income all operating expenses and all expenses of any nature whatsoever." Periodically, Benguet was to furnish the Company with the statement of accounts for a given month "as soon as practicable after the close" of that month.

The Company had ten days from receipt of the statement to register its objections thereto. Thereafter, the statement was considered binding on the Company. And all payments due the Company "with respect to the expenditures made and ore settlements received during the calendar month shall be payable on or before the twentieth of each month."

The agreement does not say that Benguet was to share in "Accounts Receivable." But may this be implied from the terms of the agreement? The statement of accounts (par.

VIII) and the payment part (XIV) that Benguet8 must make are both with respect to "expenditures made and ore settlements received." "Expenditures" are payments of money.9 This is the meaning intended by the parties, considering the provision that Benguet agreed to "provide such funds from its own resources, etc."; and that "such expenditures from its own resources"

were to be reimbursed first as provided in par. VIII, and later as provided in par. X. "Settlement"

does not necessarily mean payment or satisfaction, though it may mean that; it frequently means adjustment or arrangement.10 The term "settlement" may be used in the sense of "payment," or it may be used in the sense of "adjustment"

or "ascertainment," or it may be used in the sense of "adjustment" or "ascertainment of a balance between contending parties,"

depending upon the circumstances under which, and the connection in which, use of the term is made.11 In the term "ore settlements received," the word "settlement" was not used in the concept of "adjustment,"

"arrangement" or "ascertainment of a balance between contending parties," since all these are "made,"

not "received." "Payment," then, is the more appropriate equivalent of, and interchangeable with, the term "Settlement."

Hence, "ore settlements received" means "ore payments received," which excludes "Accounts Receivable."

Thus, both par. VIII and par. XIV refer to "payment,"

either received or paid by Benguet. According to par. X, the 50-50 sharing should be on "net profits;"

and "net profits" shall be computed "by deducting from gross income all operating expenses and all disbursements of any nature whatsoever as may be made in order to carry out the terms of the agreement." The term "gross profit"

was not defined. In the accrual method of accounting "gross income" would include both "cash receipts"

and "Accounts Receivable." But the term "gross income" does not carry a definite and inflexible meaning under all circumstances, and should be defined in such a way as to ascertain the sense in which the parties have used it in contracting.12 According to par.

VIII13 the "division of net profits shall be based on the receipts and expenditures." The term "expenditures" we have already analyzed.

As used, receipts" means "money received."14 The same par. VIII uses the term "expenditures, advances and disbursements."

"Disbursements" means "payment,"15 while the word "advances" when used in a contract ordinarily means money furnished with an expectation that it shall be returned.16 It is thus clear from par.

VIII that in the computation of "net profits" (to be divided on the 90%-10% sharing arrangement) only "cash payments" received and "cash disbursements"

made by Benguet were to be considered. On the presumption that the parties were consistent in the use of the term, the same meaning must be given to "net profits" as used in par.

X, and "gross income," accordingly, must be equated with "cash receipts." The language used by the parties show their intention to compute Benguet's 50% share on the excess of actual receipts over disbursements, without considering "Accounts Receivable"

and "Accounts Payable" as factors in the computation. Benguet then did not have a right to share in "Accounts Receivable,"

and, correspondingly, the Company did not have the liability to pay Benguet any part of that item. And a deduction cannot be accrued until an actual liability is incurred, even if payment has not been made.17 Here we have to distinguish between (1) the method of accounting used by the Company in determining its net income for tax purposes ; and (2) the method of computation agreed upon between the Company and Benguet in determining the amount of compensation that was to be paid by the former to the latter. The parties, being free to do so, had contracted that in the method of computing compensation the basis were "cash receipts"

and "cash payments." Once determined in accordance with the stipulated bases and procedure, then the amount due Benguet for each month accrued at the end of that month, whether the Company had made payment or not (see par. XIV of the agreement).

To make the Company deduct as an expense one-half of the "Accounts Receivable" would, in effect, be equivalent to giving Benguet a right which it did not have under the contract, and to substitute for the parties' choice a mode of computation of compensation not contemplated by them.18 Since Benguet had no right to one-half of the "Accounts Receivable," the Company was correct in not accruing said one-half as a deduction.

The Company was not using a hybrid method of accounting, but was consistent in its use of the accrual method of accounting. The first issue raised by the Company is with respect to the rate of mine depletion used by the Court of Tax Appeals. The Tax Code provides that in computing net income there shall be allowed as deduction, in the case of mines, a reasonable allowance for depletion thereof not to exceed the market value in the mine of the product thereof which has been mined and sold during the year for which the return is made [Sec. 30(g) (1) (B)].19 The formula20 for computing the rate of depletion is: Cost of Mine Property