Republic of the PHILEPP.IUNES Court of Tax Appeals Quezon Ciry General Foods, Inc. vs. Commissioner of Internal Revenue, et al.

DECISION -

-~ 3 - compensation for personal services actually rendered; travelling expenses while away from home in the pursuit of trade, profession or business, rentals or other payments required to he made as a condition to the continued use or possession, for the purposes of the trade or business, of property which the taxpayer has not taken or is not taking title or in which he has no equity.

Under the above provision, before an expense is allowed as deduction from gross income, it must satisfy the following requirements:

1) The expense must be both ordinary and necessary;

2) The expense must be paid or ineurred within the taxable year; and 3) The expenses must be incurred in carrying on a trade or business.

The term “advertising” is here used in its generally understood meaning, namely, use of the spoken or written word in printed matter, movies, radio and television to acquaint the public with the taxpayer’s merchandise or services.

Evidence showed that the questioned advertising expenses were indeed "paid or incurred within the taxable year" and that they were "incurred in carrying on a trade or business”. There is no dispute about that. But what is not clear, (and this is where the bone of contention lies), is whether the questioned advertising expenses are indeed "ordinary and necessary".

10u IH:C lSJ 0 C . 't' .l\ .

C<1SP

N 0. 4JH6 'J'li is Co urt in tt1 t:

C c'l ~>e of Visayan Cebu 'l'erminal Co . , Inc., vs.

Co l. of Int. Rev.,(C'l'l\ Case No .

1 28 , .Jun e 2 9, 1 95"7) ron~3j rte re d an expense as necessary "Hher e exp,.:.udit ur r~ is ap propriate or helpful in the devel< pm ent of tlle ta x p ;=tyer' s business or that the same is proper for t.IH' pllrpos P of reali zi ng a pr nt it or minimizing a l osE:".

J.L j~~: also r.::o nsid ••re cl necess ary "if it is appropriate and h e lptul t·o th e ta.xpayer's business Ot' occupation.

\'/h en ,""Ill is called necess ary , it merely (l j s t j n qu-i f ; l 1"' d t rom p ~ L. so 11 a 1 expend i t u r e or t rom one n ot pert i n eut to the bu si 110ss ot the taxpayer".

( 1955 ,

CCH

1:' •" cl .

'l' ax Co u r ~; e , par.

4 0 3 ) 1/e cl o n o t, theref rJre , ;:tc-gue aga in s t the necessity ot advertising expenses as part of mo dern bu f;i n ess for indeed , they are necessary for its survival .

'l' h e que s t i o n , h o \v e v e r , rem a i n s :

1'/e re those ;:1 rl v e r t ·i s i n g e x p e n s e s o r d i n a r y 'l Henc e , tor an adverti s ing expe n se to be deductible, it shou ld not only be n ncesf::Jry, but also ordinary.

One

cannot be separAted from th e other.

This

Court

h as long recog ni zed that subject , ll o 1·1 eve 1 , to tHo 1 i mit at ions , exp end iture s for a r1 v e r tis in g are clecluctible in th e year Hhen paid or incurred.

The first limit a. tion relates to the extent to

Hhich

the expenc!i.t ur es are actually capit a l o u tl ays , thus 10.1 necessitating an inquiry into the nature or purpose of such expenditures, (Mertens, Vol. 4A 25.38 p. 190, citing HLH. Sheldon & Co., 19 TC 481 (1952); Ralph E. Duncan, 30 Tc 386 (1958); and Funkhouser Industries, Ince., TC Memo 1957-197). The second limitation, not necessarily entirely exclusive of the first, relates to whether the expenditures are ordinary and necessary, giving rise to the reasonableness of the amount of such expenditures. (see Mertens, intra; emphasis supplied).

Advertising is generally of two kinds, namely: 1) advertising to stimulate the current sale of merchandise or use of services; and 2) advertising designed to stimulate the future sale ot merechandize or use of services. The latter type involves expenditures incurred, in whole or in part, to create or maintain some form of good will 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 advertising of the first kind, then, except as to questions of reasonableness of amount, there is no doubt such expenditures are deductible as business expenses. Dit, s however, the expenditures are for advertising of the second kind, then normally they are to be spread over the reasonable perio of time, irrespective of whether the 102

DECISTON -

CGLPLA, Case No. 4386 taxpayer is on the cash er accrual basis. The underlying theor,;y is that a capital asset which has a determinable life has been acquired and, therefore, the expenditure should be spread over the life of that. asset. (Mertens, supra, citing several American jurisprudence; emphases supplied).

In the case at bar, the Petitioner failed in the two limitations set by American jurisprudence. The first is the test on the “reasonableness” of the amount incurred, and hence, not ordinary. The second is the test on whether or not the questioned advertising expenses are actually capital outlays to create "“goodyvill" to the product and/or Petitioner's business, and hence, considered as capital expenditure to be spread over the life of the asset.

We hold that expenses, although highly necessary, cannot be deducted unless they are also ordinary. An expense to be considered ordinary must be reasonable in amount (1988 CCH Fed. Tax Course, par. 403). There is, however, no criterion as to what is ordinary expense because there is no hard and fast rule as to what is reasonable amount for it to be considered ordinary. We do not attempt to draw the dividing line. We only say it depends in each case on the particular facts and the 105

DECLSTON -

nature of the expenditure itself, which in turn depends on the extent and permanency ot the word accomplished hy the expenditure (see Atlas Consolidated Mining and Development Corporation, vs. Commissioner of Internal Revenue, No. L-26911, Jan. 27, 1981, 102 SCRA 246).

Tn thea present case, Petitioner claimed as deductihte media Advertising expense in the amount of P9,461,246 which is almost one-half ({(%) of Petitioner’s 5 claim for "Harketing Expenses". Such amount does not include the amount of P2,678,328 which is claimed under "Other advertising and promotions" expense. “The amount ot PY,461,216 tor Media Advertising expense is almost twice over General and Administrative Expenses. For clearer understanding, Petitioner’s Sechedule I- General Beupenses ffor the Fiscal Year ended February 28, 1985 is hereby quoted thus:

GENERAL FOODS PHILIFPINES, INC.

SCHEDULE I - GENERAL EXPENSES

FOR THE FISCAL YEAR ENDED FEBRUARY 28, 1985

GENERAL AND ADNITSTRATIVE BEPENSES

Salaries and vages Po£,796 706 Employes henefits and allowances 704,285 Stationery and general operating supplies 157,726 Pepairs and maintenance 418,138 Freight, storage and cartags . 41,523 Pent. 15,689 Fostaqe, telephone and telegraph 234,297 Hngloyee provuremsnt expenses . 10t,{75

— 8 ~ Travelling expenses 173,432 Netor vehicle operating expenses 113,519 Representation and entertaingent 125,230 Professicnal and legal fees 446 646 Publisations and association membership dues 61,633 Rank charges 135,999 HigealLaneags 117,624 4,640,636 Media advertising 9,461,246 Consumer promotion 1,548,014 Other advertising and promotions 2,678,228 Sales field ovpenca 1,998,055 Transportation 656,694 Market research 939,326 administrative and production management. 1,289,080 Royalty expense _ 1,294,831 18,965,614 TOTAL P27 696, 250 (BLR Records, p. 143) Witb sueh a gargantuan erypense for the advertisement ot a singular product, Which even excludes “other advertising and promotions" expenses, We are net prepared to aceepk that such amount is reasonable "to stimulate the current sale of merchandise" regardless of Petitioner s explanation that such expense "does not connote unreasonableness considering the grave economic Situation taking place after the Aquino assassination characterized by capital flight, strong deterioration of the purchasing power of “the Philippine peso and the slackening demand for consumer products" (Petitioner's Hemorandum, CTA Records p. 2/73) We are not convinced

C:

10U

DECISION - ;

with such an aybiaantion, The staggering expense led us to believe that such expenditure was incurred “to create or maintain some form of good will for the taxpayer’s trade or business or for the industry or prakees ion of which the taxpayer is a wember.? The term “good will". can hardly be said to have any precise signification; it is generally used to denote the benefit arising from connection and reputation. (Words and Phrases, Vol. 18

p. 556 citing Douhart vs. Laogan, 8&6 I1il. App. 294). As held in the case of Welch vs. Helvering, efforts to establish reputation are akin to acquisition of capital assets and, therefore, expenses related thereto are not business expense but capital expenditures. (Atlas Mining and Development Corp., vs. Commissioner of Internal Revenue, supra). For sure such expenditure was meant not only to generate present sales but more for future and prospective benefits. Hence, "abnormally large expenditures for advertising are usually to he spread over the period of years during which the benefits of the expenditures are received" (Mertens, —e citing Colonial Ice Cream Co., 7 BTA 154).

WHEREFORE, in all the foregoing, and finding no error in the case appealed from, We hereby RESOLVE to DISMISS the instant petition for lack of merit and ORDER

1LUb

- 10 - \ the Petitioner to pay the respondent Commissioner the assessed amount of P2,635,141.42 representing its deficiency income tax Liability for the fiscal year ended February 28, 1985.

MANUE

Associat@®“Judge

WE CONCUR:

) ERYESTO D. acbsttA

Yresiding Judge

je < RAMON O. DE Mi

Associate Judge

/ CHRTILE TCA TT TON

I hereby certify that the’ decision was reached after due consultation among the members of the Court of Tax Appeals in accordance with Section 13, Article VIII of the Constitution.

Que. Quan ERNESTO D. ACOSTA

Presiding Judge

Court of Tax Appeals