TAN CHIU, PETITIONER, VS. THE COLLECTOR OF INTERNAL REVENUE, RESPONDENT.

Tan Chiu versus the Collector of Internal Revenue

The Case

This is a tax case. Tan Chiu, a manufacturer of undershirts, sued the Collector of Internal Revenue to recover a percentage tax he had paid under Section 186 of the Internal Revenue Code, and the Collector resisted on the ground that the deduction Tan Chiu claimed was not available to him. The case matters to a reviewee because it fixes the meaning of the deduction for the cost of materials in the percentage tax on sales: the deduction exists to prevent double taxation, so it presupposes that the sales tax on the materials was actually paid. Where the materials came from a tax exempt new and necessary industry, no sales tax was paid, and no deduction may be claimed.

Procedural History

Tan Chiu paid the percentage tax on his sales of undershirts and then filed a claim for refund of the amount collected. When the claim was denied, the matter went to the Court of Tax Appeals, which sustained the assessment of the tax. The Court of Tax Appeals reasoned that the purpose of the deduction in Section 186 is to avoid double taxation, that is, to prevent a second assessment of the percentage tax on the material that went into the manufactured article, but that the knitting materials in this case had not previously been subjected to the sales tax because of the exemption granted to new and necessary industries under Republic Act Number 901, so their value should not be deducted from the selling price of the products manufactured. Tan Chiu then sought review of that decision in the Supreme Court, which affirmed the Court of Tax Appeals.

Facts

Tan Chiu purchased knitting materials amounting to 45,179 pesos and 64 centavos, and 6,939 pesos and 18 centavos, covering the first quarter up to the last quarter of 1956 and the period from January to May 1957. From those knitting materials he manufactured undershirts.

On the sales of the undershirts so manufactured, Tan Chiu was required to pay, and did pay, a percentage tax of 3,648 pesos and 32 centavos under Section 186 of the Internal Revenue Code. He then claimed a refund of that amount, arguing that the cost of the knitting materials should have been deducted from his gross selling price.

The difficulty was that the knitting materials had been produced by an industry that was new and necessary and therefore exempt under Republic Act Number 901. No sales tax had ever been paid on those materials. Tan Chiu argued that the exemption operated on the payor, the manufacturer, and not on the materials themselves, so that the deduction should still be allowed.

Issues

• Whether or not Tan Chiu may deduct from his gross selling price the cost of knitting materials that were never subjected to the sales tax because they came from a tax exempt new and necessary industry.
• Whether or not the exemption under Republic Act Number 901 attaches to the manufacturer as payor rather than to the materials, such that the deduction for the cost of materials may still be claimed.

Applicable Provisions

Section 186 of the Internal Revenue Code, as described in the decision, authorizes the deduction of the costs of materials from the gross selling price in computing the percentage tax on sales. It bears on the case because the entire controversy is whether that deduction is available where no sales tax was paid on the materials:

Section 186 of the Internal Revenue Code authorizing the deduction of the costs of materials manufactured from the gross selling price, is to avoid or prevent double taxation.

Republic Act Number 901 grants an exemption to new and necessary industries. It bears on the case because the knitting materials were produced by such an exempt industry, so no sales tax was paid on them:

Republic Act No. 901 exempts the payor or manufacturers, not the materials used in the manufacture.

Ruling

On the first issue, the Court held that the deduction may not be claimed. The purpose of allowing the cost of materials to be deducted from the gross selling price is to avoid or prevent double taxation, that is, to prevent a second assessment of the percentage tax on the material that already went into the production of the manufactured article. Since no sales tax had been paid on the knitting materials, there was no second tax to prevent, and the deduction had no basis.

On the second issue, the Court rejected the distinction between the payor and the product as merely a distinction in words. When the person engaged in a new and necessary industry is exempt from the tax, he does not pay the sales tax on the products that he manufactures in that industry. The cotton knitting materials were themselves the products of the tax exempt industry, so they were not subject to the sales tax. As no sales tax had been paid on the knitting materials, the deduction of their cost from the value of Tan Chiu's gross sales could not be claimed.

Doctrine

The deduction of the cost of materials from the gross selling price under Section 186 of the Internal Revenue Code rests on the purpose of avoiding double taxation. It is allowed only where the sales tax on those materials was actually paid, because only then would a second assessment of the percentage tax on the same material arise. Where the materials were produced by a new and necessary industry exempt under Republic Act Number 901, no sales tax was paid on them, and the deduction may not be claimed. The exemption in favor of a new and necessary industry operates so that the products of that industry are not subject to the sales tax; the distinction between exempting the payor and exempting the materials is merely verbal.

Disposition

The Supreme Court affirmed the decision of the Court of Tax Appeals, with costs against Tan Chiu, so the Collector of Internal Revenue prevailed and the refund was denied.

Remember This

The one line to memorize: the deduction for the cost of materials is a remedy against double taxation, so no prior sales tax on the materials means no deduction. Examiners use this case to test whether a candidate understands that a tax exemption for new and necessary industries removes the very tax that the deduction was designed to prevent.