REPUBLIC FLOUR MILLS, INC., PETITIONER, VS. THE COMMISSIONER OF IN­TERNAL REVENUE AND THE COURT OF TAX APPEALS, RESPONDENTS.

Republic Flour Mills versus Commissioner of Internal Revenue

The Case

This is an appeal by Republic Flour Mills, Incorporated against the Commissioner of Internal Revenue and the Court of Tax Appeals, decided in February 1970. The petitioner is a domestic corporation engaged in the manufacture of flour. It contests a deficiency assessment for manufacturer's sales tax for the year 1959. The single legal question is whether the cost of wheat grains imported tax-free in 1958, but actually milled and sold as flour in 1959, may be deducted from gross sales in computing the percentage tax due on the finished flour. The case matters because it fixes the meaning of the phrase tax-free product in the Tax Code, and it teaches the bar candidate how a clear and unambiguous tax provision is read: as it is written, without judicial addition or subtraction.

Procedural History

The Commissioner of Internal Revenue assessed Republic Flour Mills for deficiency sales tax for 1959. The corporation asked for a reinvestigation, and when that was denied it filed a petition for review in the Court of Tax Appeals, contesting both the assessment of advance sales tax on the wheat grains imported tax-free in 1958 and the disallowance of the deduction of the cost of those grains from its gross sales of flour in 1959. The Court of Tax Appeals sustained the correctness of the disputed assessment and ordered the corporation to pay deficiency sales tax and surcharge. Republic Flour Mills then appealed to the Supreme Court on the same legal issue that the parties had litigated below.

Facts

In 1957, Republic Flour Mills was granted tax-exemption privileges as a new and necessary industry under Republic Act 901, running from January 1957 as a diminishing exemption until the end of December 1962. The exemption covered the fixed and privileged tax on business, the percentage tax on sales of the manufactured products, and the advance sales tax on raw materials and supplies to be used exclusively in the production of flour.

In 1958, the corporation imported a quantity of wheat grains. It was not able to mill and use all of them that year, so by the first of January 1959 it carried a surplus of wheat grains from the previous year's importation. Those surplus grains were finally milled into flour and sold in 1959. For that year the corporation paid manufacturer's sales tax on its produce, in the computation of which the cost of the wheat left over from the 1958 importation was treated as a deductible item from gross sales.

The Commissioner disallowed the deduction and assessed a deficiency. The parties entered into a partial stipulation of facts fixing two alternative computations: if the deduction were allowed, the liability would be a small deficiency; if disallowed, a much larger one. The Court of Tax Appeals upheld the Commissioner, and the corporation appealed.

Issues

• Whether or not the cost of wheat grains imported tax-free in 1958, and utilized in the manufacture of flour sold in 1959, is a deductible item from gross sales in computing the manufacturer's sales tax for 1959 under Section 186-A of the Internal Revenue Code.
• Whether or not the phrase tax-free product in that section covers tax-free imported raw materials, or is limited to raw materials purchased from a tax-exempt industry.

Applicable Provisions

Section 186-A of the Internal Revenue Code, inserted by Republic Act 2025, provides:

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 is the provision the Court construes, and its all-encompassing wording is the basis for allowing the deduction.

Section 186 of the Tax Code, the general percentage tax provision, provides in its proviso:

Provided, That where the articles subject to tax under this section are manufactured out of materials likewise subject to tax under this section and section one hundred and eighty-nine, the total cost of such materials, as duly established, shall be deductible from the gross selling price or gross value in money of such manufactured articles.

This earlier rule allowed deduction only where the raw materials had themselves been subjected to sales tax, to preclude a second assessment of the percentage tax on the same materials.

Ruling

On the first issue, the Court ruled for the petitioner. The point in controversy had nothing to do with the exercise of the tax-exemption privilege; it was only whether the cost of the tax-free wheat grains used in manufacturing the also tax-exempt flour is deductible in computing the percentage tax admittedly due on the manufactured product in 1959. The Court held that it is.

On the second issue, the Court refused to read into the provision a qualification that is not there. The phrase tax-free product must be given its ordinary and common meaning: a material or article exempted from payment of tax. The Commissioner's argument that wheat grains are not a product because they are not made out of another article runs contrary to the legal definition of product, which covers anything that is produced, whether as the result of generation, growth, labor or thought. If fish are an agricultural product, the Court reasoned, wheat grains are equally products of agriculture. Had the Commissioner's definition been correct, the legislature would have written products of a tax-exempt industry rather than a tax-free product.

The Court also stressed that the exemption granted to the petitioner covered not only the sales tax on the manufactured product but also the sales tax on raw materials and supplies used exclusively in the manufacture of the exempt products. To bar the deduction would be to tear away the tax exemption from the sales tax on those materials. If the wheat grains were allowed to enter in 1958 free of advance sales tax, no reason existed to subject their value to tax merely because they were milled in 1959.

Finally, the Court acknowledged that tax exemptions and deductions are construed strictly against the taxpayer, but held that where the provision of law is clear and unambiguous, the law must be taken as it is, devoid of judicial addition or subtraction. Section 186-A was all-encompassing enough to comprehend tax-free raw materials, even if imported. Where the law provided no qualification for the privilege, the Court was not at liberty to supply any.

Doctrine

The rule a bar candidate must retain is this: under Section 186-A of the Internal Revenue 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. The term tax-free product means any material or article exempted from payment of tax, and it includes tax-free imported raw materials, not only raw materials purchased from a tax-exempt industry.

A second rule accompanies it: while tax exemptions and deductions are construed strictly against the taxpayer, a clear and unambiguous provision must be applied as written, without judicial addition or subtraction. The Court will not read into a statute a qualification the legislature did not place there.

Disposition

The Court reversed and set aside the decision of the Court of Tax Appeals, and ordered Republic Flour Mills to pay the Commissioner the smaller stipulated deficiency tax of 3,288 pesos and 16 centavos, with legal interest from the date the tax became due, without costs.

Remember This

Memorize the line that a tax-free product utilized in manufacture is deducted from the value of the finished article, and that tax-free imported raw materials fall within that phrase. Examiners use this case to test the meaning of tax-free product under Section 186-A and the rule that a clear tax provision is applied as written, without judicial addition or subtraction.