INDUSTRIAL TEXTILES MANUFACTURING COMPANY OF THE PHILIPPINES, INC. (ITEMCOP), PETITIONER, VS. COMMISSIONER OF INTERNAL REVENUE AND THE COURT OF TAX APPEALS, RESPONDENTS.

Industrial Textiles Manufacturing Company of the Philippines versus Commissioner of Internal Revenue

The Case

This is a petition for review brought by Industrial Textiles Manufacturing Company of the Philippines, known as ITEMCOP, against the Commissioner of Internal Revenue and the Court of Tax Appeals. ITEMCOP is a new and necessary industry that manufactures jute bags. The dispute concerns the sales tax it owed for the year 1959, and specifically which costs of raw materials it was allowed to deduct from its gross sales in computing that tax. The case matters because it settles the reach of the deduction granted by Section 186-A of the Tax Code: whether the tax-free raw materials used in manufacture must have been locally bought from a tax-exempt industry, or whether imported tax-free materials also qualify. It also illustrates the deference the Supreme Court gives to the factual findings of the Court of Tax Appeals.

Procedural History

ITEMCOP filed its sales tax returns for 1959 and claimed certain deductions for the cost of raw materials. The Bureau of Internal Revenue disallowed part of the claim and recomputed another part. ITEMCOP appealed to the Court of Tax Appeals. The Court of Tax Appeals sustained the Bureau on the disallowed deduction of raw materials imported tax-free in 1958, but upheld the taxpayer on the question of the actual cost of the raw materials purchased and used in 1959. ITEMCOP then brought the matter to the Supreme Court by petition for review.

Facts

As a new and necessary industry, ITEMCOP enjoyed full tax exemption in 1957 and 1958. In 1959, its exemption was reduced to ninety percent, so it became partially subject to the sales tax on the jute bags it manufactured and sold.

In 1959, a local manufacturer of an essential item such as jute bags was subject to a seven percent sales tax on gross sales, but could deduct the cost of raw materials from gross sales, whether those raw materials were tax-paid or tax-free. In its 1959 returns, ITEMCOP reported gross sales of 10,395,208 pesos and 25 centavos, and deducted 4,764,391 pesos and 44 centavos as the cost of raw materials. That figure had two components: raw materials imported in 1958 tax-free amounting to 939,687 pesos and 31 centavos, and raw materials imported or bought locally in 1959 amounting to 3,824,704 pesos and 13 centavos.

The Bureau of Internal Revenue disallowed the deduction of the 1958 tax-free imported materials, reasoning that under Section 186-A only the cost of tax-free raw materials locally bought from a new and necessary industry could be deducted. As to the 1959 materials, the Bureau ruled that their actual cost was 3,524,240 pesos and 18 centavos rather than the higher figure the taxpayer computed. The Court of Tax Appeals agreed with the Bureau on the first point but agreed with the taxpayer on the second.

Issues

• Whether or not the cost of raw materials imported tax-free in 1958 and used in the manufacture of jute bags sold in 1959 is deductible from 1959 gross sales in determining the sales tax liability.
• Whether or not the finding of the Court of Tax Appeals on the actual cost of the raw materials imported in 1959 and used in the manufacture of jute bags sold that same year may be disturbed on appeal.

Applicable Provisions

Section 186-A of the Tax Code provides:

Section 186-A. Whenever a tax-free product is utilized in the manufacture or production of any article, in the determination of the value of such finished article, the value of such tax-free product shall be deducted.

This provision is the basis of the deduction ITEMCOP claimed, and the Court reads it to cover tax-free raw materials regardless of whether they were imported or locally bought.

Ruling

On the first issue, the Court ruled in favor of ITEMCOP. Following its earlier ruling in Republic Flour Mills versus Commissioner of Internal Revenue, the Court held that the cost of raw materials imported tax-free in 1958 and used in manufacturing jute bags sold in 1959 is deductible from 1959 gross sales. The Court reasoned that under the text of Section 186-A, it does not matter that the raw materials are imported rather than locally bought from a tax-exempt industry. The provision speaks simply of a tax-free product utilized in manufacture, and directs that its value be deducted in determining the value of the finished article.

On the second issue, the Court ruled against ITEMCOP. The question of the actual cost of the raw materials imported in 1959 and used that year is a question of fact. The finding of the Court of Tax Appeals on that factual matter was not shown to be unsupported by substantial evidence, and so it must be left undisturbed.

Doctrine

Under Section 186-A of the Tax Code, whenever a tax-free product is utilized in the manufacture or production of any article, the value of that tax-free product is deducted in determining the value of the finished article for sales tax purposes. The deduction does not depend on whether the tax-free raw material was locally bought from a tax-exempt industry or imported; the statute draws no such distinction, and the Court will not read one into it. Separately, the factual findings of the Court of Tax Appeals, when supported by substantial evidence, are binding on the Supreme Court and will not be disturbed on appeal.

Disposition

The Court modified the decision of the Court of Tax Appeals by allowing the deduction from ITEMCOP's 1959 gross sales of the cost of raw materials imported tax-free in 1958 and used in manufacturing jute bags sold in 1959, while leaving undisturbed the finding on the actual cost of the 1959 raw materials.

Remember This

The one line to memorize: a tax-free product used in manufacture is deducted in full under Section 186-A, whether imported or locally bought. Examiners use this case to test the scope of the tax-free raw materials deduction and the finality of the Court of Tax Appeals' factual findings.