CTA Case No. 3604

DECISION

In this petition for review, petitioner Pfizer, Inc., assails the decision of respondent Commissioner of Internal Revenue dated September on 1962 denying petitioner's request for cancellation of the assessment in the amounts of P245,052.08 and FS5,137.65 as deficiency income tax for the fiscal year ended November 30, 1974, and withholding tax at source for the year 1974, respectively.

For the material facts, petitioner alleges and respondent eimits thats

1. Petitioner is a corporation duly organized and existing under and by virtue of the laws of the a a Loy eas Nv I we Fhilippines with principal affice address at 64th Floor, Araza Euilding, Faseo de Roxas, Makati, Metro Manilas Ze Respondent is the duly appointed Commissiener of Internal Revenue who holds office at the Rureatt of Internal Revenue Building, Diliman, Quezon City, where he may be served with

SLUMM CM SS &

ao In a letter dated May 270, 1979 which petitioner received an August 29, 1979, respondent assessed and demanded fram petitioner a total amount of F300,689,.75 as alleged deficiency income and withholding taxes for the year ending November 30, 1974 computed as follows:

Net income per return ~ FO,460,875,.2 Add: Unallowable deductians:

1. Research and dev. exps.

ee Other marketing exps. -~ F 82,926.42

3. Overpriced por- tion of purchases ~ F110,940.94 ~ FL 494,967.07 Net income per inves- fy 1 F300,199.71 tigation ~ £8,994 ,942. 31 Incame tax due thereon ~ FS,124,230,00 Income tax already paid -~ P2991 .296.90 Balance ~ Fo 472,924.00 wee kh

- 3 - GBdd: 14% int. p.a. fr. : S/AG/75 ~ B/16/78 , ~~ -F

TOTAL AMOUNT DUE AND

COLLECTIBLE ~ &F

72,628.08 Informal dividend - Corporatian Ffizer (Hongkong) 7 EF 29% withholding tax at source due theredn - F 38,829,353 Add: 14% int. p.a. fr. 1/26/75 - 1/26/78 ~ Fo 16,208.32 TOTAL. AMOUNT DUE AND COLLEC . IBLE ~ Pty LBZ OO

4. In a letter dated October 24, 1979 which respondent received an October 29, 1979, petitioner protested the assessment;

oe In a letter dated September 21, petitioner received on February 25, 198s denied petitioner's protest and demand for the payment of the deficiency in the amount of FS00,689.73 3 be In assessing petitioner for income tax for the year in question, disallowed the following:

EN Pa CD Wn bas reiterated 1982 which respondent his assessment deficiency respondent

4 - (a) Research and development e:-:penses ( b) ( c ) Marketing expenses Overpriced portion of purchases F'300,199.71 p 82,926.42 P110 , 940.94 Averring that the disallowance of the .i. terns described in paragraph 6 above has no factual and legal basis petitioner appealed to this Court. In its petit.ion review, petit.ioner assigned as errors, and issues, the following: 1.

Respondent .in assessing pe titioner for a 11 ege;•d def ic ienc:y incom~____te.li for the year in question erred in disallowing the following: (a) Research and development (b) ( c ) e:-:penses Marketing expenses Overpriced port.ion of t.etr·a c y c 1 ine P300,199.7l 82,926.42 110,940.94 2.

Res pondent i n assess.ing petitioner for deficiency \.'J.i thho 1 d i!J..Q...._j;_a:-: for the year in question in tr-ea ti.ng the overpriced portion of tetracycline as informal distribution of dividends to Pfize r Corporation, a corporation organized and ..

existing under the laws of the State of Ne w York, U.S.A. (Pfi zer New York).

DECI S ION

CTA CASE NO. 3 604 - 5 - Re§.~E. r c;J:~L~DJ.LJJ..eve 1 opmen t _ Ex pe.D se'-"s=--_ _,P-'3=0~0'-'''-'1 =-_,_9-'9'-'•:..7 "--= 1 In disallowing the claimed deduction of - ·.:.

research .:mc:l development eNpenses of F'300,199.7l, respondent explained in his decision appealed from (E:-:h. 7, pp. 190-.1.9.1., BIR records) that "It is the stand of this Office that since your client (petitioner herein) is manufacturing and selling dr-ugs under estab l ished patent, processes or fonnulas t hat have alr-eady been devE~loped by its p<:l.ren t company, Pfizer New York, U.S.A . , research and development costsj as well as othe r marketing expenses, can no longer be claimed by your- c lient as c:lec:luctiblf-~ e:·:penSf.·~s."

This is suppor-ted by the findings o ·f the revenue e:·:aminer assigned to inves tigate thi s case in his first indor-sement dated November .1.3, 1978 (E :·: h.

pp.

102- 105, BIR r·ec:or·ds) to the effE?c:t that the drug s e:·:por1 r:>d by petitioner have already been so chemically composed and perfected for outright consumption without the necessi t:y of ·further· tr·ials, e:·: perimenting and testing. Against this bac kdrop, it would seem unusual therefore for pE~ti tioner· to have provided for- and development expenses as its business operations do

- 6 - not apparent 1 y req1~Ti re res ea rch~ e:·:per imen t and development of a product~ formula or improvement of an already existing drug. However~ a perusal of the detailed expense account of this item (Exh. E, p. 45~ BIR records) shows that of the total expenditure of P300,199.71 only the amount of P.t.t.t,459.00 repr·esen ting clinical and investigati6nal expense~ as pointed out by petitioner itself~ would fall under research and development cost. (p. 146, CTA record s .) The ethel'- e:·:penses consisting basically of ad min .i. s tr·;:.~ tion and s uper·vision;

scientific and technical;

accounting, clerical and secretarial;

other ..

payroll;

sp~cial compensation;

social securi t.y ta:·:es;

compensation insurance;

group n::~ pai r ..

<:\ncl maintenance supplies;

manufacturing supplies; electricity; accounting and other professional services;

posta~le;

telephone, telegr-aph and cable;

traveling, moving and ent.er·taining expense;

memberships, dues and subscriptions;

building, off ice and sani tary services; stationery and office supplies; equipment purchased, rented or serviced;

company meetings;

corporate expense and mi scellaneous items; general

DECIS I ON

CTA CASE NO. 3 60 4 - 7 - insurance;

taxes;

rent of premises; depreciation amortization;

admittedly allowable deductions.

Since these items are clearly and unequivocally ordinary and nec:essar·y e:-:penses in carrying on petitioner's business the amount of P188,740.71 is therefore a deductible expense under Section 30(a) of the Tax Code. On the clinical and inves tigational expense of P111~459.00~ testimonial evidence to this effect presented by petitioner reveals that: / Tes timony of Dioscorro Tatad, financ .i al ma nager of pe~itioner: H .· ·.

N Q.

In line 41., you have ~~ere "Clinical and Investigation E::pens~2", and opposite to that you have the figure "P.t.t.t,459.00".

Can you e:-:pl.3in?

A.

Well, the ~e clinical and investig- ation ~x penses, these are expenses incur r·ed by the pharmaceutical ~ .i ivisir.m in conducting tests of the products in the market, and this inc 1 udes cost of the pr-oduc t i t s e 1 ·f that. ar-e being ·given to the doctors, hos pitals and other c l inician for them to test the product to their patients.

And thes e doctors are r·equi reel to submit a report to the medical director on their findings on the pr-oduct as to its efficacy and the result of their tests whether 3So

DEC I SI ON

CTA CASE NO. 3 6 0 4 - 8 - t.h~:-?se ar-e good or- \I'Jha tever reac: t.ions are being encoun t.ered by the doc tors in conducting the test.." (TSN~ December 14~ 1984~ pp. 8 - 9~ 11) Dr. Antonio Perla s ~ vice president for me dical af ·fair s~ likewise described the petitioner-'s activities as follows: Q.

Please e:-:plain what activities does this clinical trial consist of? A.

l>-Je have differ-ent kinds of clinical tr-ials.

- ....

The first one is the registration trial.

The purpose of the regis- tration trial is to test the me dicine among Filipinos for safety and efficacy as r·equir··ed by the Ministry of Health.

After- th.:1t we also have some clinical tr-ials. We conduct to he 1 p pr··omote the product of the company.

WP u s ua 11 y ask physicians to conduct c linical trials to d emonstrate to Filipinos the drugs we have to market are effecti ve and s.:~fe.

Because o ·f d .i. f fen:?nces of 1 i ving cnnd .i tions, c limate~ physique, diet s ~ habits~ r·eact.ions, bac kground and others~ it cannot be sai d with certainty that drugs and medicines manufactured in the United States for- Amer ic<:~.ns are just as safe and effective for Filipinos living in the Philippines.

These dr-ugs and medicines had to be 3J'?

DECIS ION

CTA CASE NO . 3 6 0 4 - 9 - clinically tried and investigated. Thus as stated by Mr. Ramon Tan of petitioner company (Exh. 3~ pp.

54-·-60 ~ B I R records) ~ the resear-ch and development expense involved particularly: liaison with leading medical associat.ion.s gr-oup and pr <::\c titioners so that new products can be tried locally;

'H-e pare d Lerm.i.ne r··E!actions clinical investigation the local experience to the new products;

to and sec ure feedback information on the efficacy and safety of medic a l produc t s so that better treatment dosage of drugs can be established; maintain file on current deve lopments r~lating to the drug industry; Since these clinical and inves- ti<] <'l tion s ~ s hovJn abovf:~ ~ were aimed at.

di s c:over·· .i.n<] o ·f new knowlPdqe vJith th£"7?

hope that sue:: h know J. edqf.?

would be usefu 1 in deve J. oping or :i. rnpr··ovinq the safety and effi c acy of petitioner's products whir:. h invar· .i.ab l y brought be nefits whir:. h la stf.:~ d ·for·· mn r·e than nne y~:?ar or·· even year-·s, the amount F'.1.1.1,459.00 the F'300,.199.7.1., as petitioner' s

c. ouri st.? 1 admitted, should therefore be capitalized. 398

10 - These e:·:penses "consist o"f outlays paid to r·ec::;ear-c h age~nc .i.es "for· e:·: p 1 ora tory st ud y ~ r·esear-ch stud y, .in --depth interviews~ med ica l surveys, e:-:~?c:ution tE-)St a nd c:ommE?nts o ·f specia l groups of med .ic:a l per-scmne 1 on' spec .if .ic or par-t.icu 1. ar- drr·ugs s u ch as the n~::~w mini press, c:ombant.r- .i. n , con tn"'mine, v .i.s.ine ~ "fas.i.gyn, c:afiel and geopen conducted the basic pur· pose of furthe r- improving

t. ht'? quality and e f ficiency of ( E:-: h.

p.

104~ BIR r ecords .)

Whil e petitioner's witness te s t .i~ied :

Q.

How about the other mark eti ng e:-:pense which was di sa ll owed, can you e:-:plain the n ature of this e:-:pen se? A ..

We l J., these arr·e e:·:pe n sr:.~s being paid to adver·t.i s.i. ng c:ompa.n .i.es to con due: t tes ts al s o in the mad::f.~ t, espt>cia lly when there are new products to be mar ke ted by the marketing divi sion. B~?·fon·~ they dec .ide to 1 aunc h a r:wodu c: t, they havr:~ to conduct t e~s t s wh~:~t h er· thesE~ pr·oduc ts are adaptab l F.? here, so they engage the services of thes~ ~dver-tising companies to do the job.

(TSN, December 14, 1984~ pp . 12- 13) - ·.:..

the petitioner's E:·:hibit "F" (p .

42-43, BIR r·ecor-ds) s hows that such e:-:penses were paid to research organizations/companies primarily for in-depth 399

DECISION —-

interviews on certain drugs, intraduction of new drugs, research service for exploratory studies an arugs , meadical SUMV@YS « cancept ard package drug artwork, execution tests for bringing about significant improvements of the quality and efficacy of petitioner’ s products. Since these marketing expenses are in the mature af search ar critical investigatian in bringing about qnificankt improvement ta petitioner's products, the beneficial effects of which would extend toa future periads . the AMOumt af Pee F2G. 42 representing such expenses should therefore he capitalized.

Overpriced Portion of Purchases Tt appears that for the fiscal period af 1974, petitioner purchase from Ffizer, Hangkang, as noted hy respondent’s examiner, 741,685 kilograms af tetracycline at a total price af FRS3,811.74. Respandent’s examiner also discovered that for the same year, Ffizer, Hangkong alsa sold to Warner Chilcott 800 kilograms of tetracycline at a total price af FR29,490,80, Comparing these sales, respandent’s examiner surmised that the overpriced 40 ..

DEC ISI ON

CTA CASE NO . 3604 - 1 2 - por-tion pur-c hases in the s um of P110~940.94 fr-om Pfizer-~ Hongkong in 1974 (p. 98~ BIR r-ecords) is a built- in amount in petitioner's pr-icing system with Pfizer-~ Hongkong~ acting as the medium wher-eby infor-mal dividends wer-e r-emitted~ to the e xtent of the €~Nc:ess !' to the par·en t.

comp.:~ny ~ Pfizer- Cor-por-ation of New Yor-k. Ther-e is entirely no factual basis for· the a 11 ega tion that Pfizer-~ Hong kong~ is ac tinq as a medium thn.1ugh which dividend s wer·e channeled to pet .. i ticmer- · parent company~ Pfizer- Cor-por-ation of New Yor-k.

Honqkong~ was never· stoc kholder· of petitioner- dur-inq the period in que:~stion.

(t.s.n.~ December- 14~ 1984~ p. 16.)

AC ' _, a matter- of fact~ it was Pfi ze r- Cor-por-ation of New York~ a cor-poration organi zed under the laws of the St.<"' t:.e of U.S.A.~ which was the stockholder- of petitioner-.

(E :-:h. "J" ~ p.

68~ CT{)

r-E'!CCH"d S . )

An assessment fixes and determines the tax liability of a taxpayer-. Hence~ the assessment must be based on actu <:;~. l fact s . It should not be bc:\se cl on me r-e pF· ~~sumpt.i.on or- a ssumption no matter- how r-easonable or logical said pr-esumption may be • ..

401

DECISI ON

CTA CASE NO . 3604 - 1 3 - (Coll ec t o r of Internal Revenue v s .

Benipayo ~ 4 !3Cr\A 182. )

At any rate~ the records show that for the year .1974 involved in this case~ petitioner purchased from different suppliers tetracycline at unit costs ranging , from $32.80 to $ 3 5.43 per The r-ecor-·ded unit cost of tetr·acyc 1 ine pur-chased f· ··om Pfi z er-, Hongkong~ is $3:3.00 which is the r-·ange.

It seems evident, therefore~ that i s no question that petitioner purchased the product at arm's length or at its fair market value. (p . .179, BIR records.) Thi s a s sessment of P55, .t T l. 6 ~~ a s wi thho 1 ding t .;D: at. sour-ce fot·- .1974 was based on respondent's view that the over-·priced por .. t.i.on of t.etr-.:\cyc 1 ine const .H :.uted infor-m;.':\1 d.ist.r·.i.bution of dividends by petitioner to Pfizer, Hongkong. Having reached the conclusion that .ther .. e could be no such infor-mal dividend, this assessment cannot be sustained. 40~

- 14 - ~QD..!; .. l!:,!.?. .. ! .Q.D. .. In the light of the above~ petitioner ' s de ·f ic i ency .income ta :-:

for the f .i sc,::\ 1 year ended November 3 0~ 1974 is therefore computed a s follows: E: .. :L~c a !._Y_e a r:_..f-n ~j erl_~_g_y_!?. m .b~r 3_~~--;!. 9 7 4 .. J..m;. o 111-~---I!~~:!.. Net income per return - P8.460~875.24 Add: Unallowable deductions

1. Research and d~v~- lopment expenses P111~459.00 2 . Other marketing e ;.:pen s P <::~ Net income per inves- t .i. c:Ja t .i. on Income tax due thereon Income tax already paid Balance Add .14% int. p . a. from 3/16/75 to 3/16/78

TOTAL AMOUNT DUE AND

COLLECTIBLE Accordingly, petitioner EfL. .. {2 5 ~--:;s-~5~.~.1> 4. -- P3~0.19~34.1.00 -- __ -;;._ __ ,._c; ~..!. . ..s 3Q~ .. ..'! .. QO p 68~035.00 -- ==p= =9= .... ~ .... 609 • ?'_0 Pfizer, Inc.

is ordered to pay to respondent Commissioner of Internal Revenue the amount of P96,609.70 as deficiency income tax for the fiscal year ended November 30, 1974, plus surcharges and interest incident to delinquency pursuant to Section 51 (e) of the applicable National Internal Revenue Code, as amended.

403

- 15 -

WHEREFORE, the decision appealed from is modified as indicated in the above opinion of the Court.

With costs.

I CONCUR:

(on official leave ) CONSTANTE C. ROAQUIN Associate Judge 404 AMANTE Pres iding Judge DECISION CTA CASE NO . 3604 - 16 - C E R T I F I C A T I 0 N I hereby certify that th.i. s deci sion was reached after due consultation among the members of the Court of Tax Appeal s in accordance with Section 13~ Article VIII of the Constitution. 405 AMANTE ILLER Presiding ,Judge Court of Tax Appeals