CIR v GENERAL FOODS INC.

Test of Reasonableness | April 24, 2003 | J. Corona ISSUE/S & RATIO:

1. W/N the subject media advertising expense for “Tang” incurred by General
Nature of Case: Petition for review on certiorari Foods was an ordinary and necessary expense, fully deductible under the
Digest maker: IT National Internal Revenue Code – NO
SUMMARY: General Foods claimed its media advertising expenses in the amount of  Deductions for income tax purposes partake of the nature of tax exemptions;
P9.4M, as deduction in its income tax return. The CIR disallowed 50% of the hence, if tax exemptions are strictly construed, then deductions must also be
deduction, so General Foods was assessed deficiency taxes of P2.6M. On appeal, the strictly construed.
CTA ruled that the subject advertising expenses were not business expenses, but  It is a governing principle in taxation that tax exemptions must be construed
capital expenses. However, the CA reversed this ruling. The CIR filed a petition for in strictissimi juris against the taxpayer and liberally in favor of the taxing
review with the SC. The SC reversed the CA, ultimately ruling that the subject authority
advertising expenses are not ordinary expenses since they are unreasonable given  Section 34 (A) (1), formerly Section 29 (a) (1) (A), of the NIRC provides:
that: (a) said expenses are inordinately large; and (b) a capital expense/outlay which (A) Expenses. —

must be spread out over a reasonable period. Therefore, said expenses may not be
allowed as deductions under the NIRC. (1) Ordinary and necessary trade, business or professional expenses. —
(a) In general. — There shall be allowed as deduction from gross income all
DOCTRINE: There being no hard and fast rule in determining the reasonableness of a ordinary and necessary expenses paid or incurred during the taxable year in
deduction, the right to a deduction depends on a number of factors such as but not carrying on, or which are directly attributable to, the development,
limited to the type and size of business in which the taxpayer is engaged, the volume management, operation and/or conduct of the trade, business or exercise of
and amount of its net earnings, the nature of the expenditure itself, the intention of the a profession.
taxpayer, and the general economic conditions. GENERAL RULE: To be deductible from gross income, the subject advertising expense
must comply with the following requisites:
FACTS: a) the expense must be ordinary and necessary;
b) it must have been paid or incurred during the taxable year;
 June 14, 1985: General Foods Inc. filed its income tax return for the fiscal year
c) it must have been paid or incurred in carrying on the trade or business of the
ending Feb. 28, 1985
taxpayer; and
 Claimed as deduction, among other business expenses, P9,461,246 for media
d) it must be supported by receipts, records or other pertinent papers
advertising of one of the beverages it manufactures, “Tang”
APPLICATION IN THE CASE: The subject advertising expense was necessary, since it
 May 31, 1988: The Commissioner disallowed 50% or P4,730,623 of the deduction was incurred within the corresponding taxable year, and in carrying on a trade or
claimed by General Foods business. However, such expense was NOT ordinary.
 Consequently, General Foods was assessed deficiency taxes in the amount of  The subject advertising expense was not ordinary on the ground that it failed the
P2,635,141.42 two conditions set by US jurisprudence:
 General Foods filed a MR  (1) reasonableness of the amount incurred, and
 CIR denied the MR  (2) the amount incurred must not be a capital outlay to create goodwill for
 Sept. 29, 1989: General Foods appealed to the CTA the product/the business
 CTA dismissed the appeal  The interplay of the factors on which the right to deduction depends will yield a
 Ruled that it is not prepared to accept that the gargantuan expense, which proper evaluation of W/N a certain expense should be deducted
General Foods claimed was for the advertisement of a single product, was  Factors Affecting the Right to Deduction (not an exhaustive list)
reasonable to “stimulate the current sale of merchandise”  Type and size of business in which the taxpayer is engaged
 Regardless of the explanation that such expense “does not connote
 Volume and amount of its net earnings
unreasonableness, considering the grave economic situation taking
 Nature of the expenditure itself
place after the Aquino assassination…”
 Intention of the taxpayer and the general economic conditions
 Such expense for media advertising led the CTA to believe that such
expenditure was incurred “to create or maintain some form of good will for the  In the case at bar:
taxpayer's trade or business or for the industry or profession of which the  The P9,461,246 claimed as media advertising expense for "Tang" alone
taxpayer is a member." was almost one-half of its total claim for "marketing expenses."
 Efforts to establish reputation are akin to acquisition of capital assets,  General Foods also claimed P2,678,328 as "other advertising and
and therefore, expenses related thereto are not business expenses, but promotions expense" and another P1,548,614, for consumer promotion.
capital expenses (Welch v Helvering)  Furthermore, the subject P9,461,246 media advertising expense for "Tang"
 General Foods filed a petition for review in the CA was almost double the amount of respondent corporation's P4,640,636
 CA reversed the CTA Decision general and administrative expenses.
 It has not been sufficiently established that the item it claimed as a deduction is  SC: We find the subject expense for the advertisement of a single product
excessive, thus the same should be allowed as a deduction to be inordinately large
 The Commissioner filed a petition for review on certiorari before the SC
  Therefore, even if it is necessary, it cannot be considered as an ordinary CONCLUSION: The CA committed reversible error when it declared the subject
expense deductible under then Sec. 29(a)(1)(A) of the NIRC media advertising expense to be deductible as an ordinary and necessary expense
 Advertising is generally of two kinds: on the ground that "it has not been established that the item being claimed as
 (1) advertising to stimulate the current sale of merchandise or use of deduction is excessive."
services and  It is not incumbent upon the taxing authority to prove that the amount of
 (2) advertising designed to stimulate the future sale of merchandise or use items being claimed is unreasonable
of services.  The burden of proof to establish the validity of claimed deductions is on the
 Involves expenditures incurred, in whole or in part, to create or taxpayer
maintain some form of goodwill for the taxpayer's trade or business or  In the present case, that burden was not discharged satisfactorily.
for the industry or profession of which the taxpayer is a member.
 IMPORT OF THE TWO TYPES: DISPOSITIVE PORTION
 If the expenditures are for the advertising of the first kind, then, except as to WHEREFORE, premises considered, the instant petition is GRANTED. The assailed
the question of the reasonableness of amount, there is no doubt such decision of the Court of Appeals is hereby REVERSED and SET ASIDE. Pursuant to
expenditures are deductible as business expenses. Sections 248 and 249 of the Tax Code, respondent General Foods (Phils.), Inc. is hereby
 If, however, the expenditures are for advertising of the second kind, then ordered to pay its deficiency income tax in the amount of P2,635,141.42, plus 25%
normally they should be spread out over a reasonable period of time. surcharge for late payment and 20% annual interest computed from August 25, 1989, the
 SC: We agree with the CTA that the subject advertising expense was of the date of the denial of its protest, until the same is fully paid.
second kind, i.e. advertising designed to stimulate future sale
 The amount was staggering
 General Foods itself admitted in its letter of protest to the CIR assessment
that the subject media expense was incurred in order to protect General
Foods’ brand franchise, a critical point during the period under review
o The protection of brand franchise is analogous to the maintenance
of goodwill
o This is a capital expenditure, which should be spread out over a
reasonable period of time
 General Foods’ venture to protect its brand franchise was tantamount to efforts
to establish a reputation
 Akin to the acquisition of capital assets, and therefore, expenses related
thereto were NOT to be considered as business expenses, but as capital
expenditures
 While it is true that it is the taxpayer’s prerogative to determine the amount of
advertising expenses it will incur and where to apply them, such prerogative is
subject to the ff limitations:
i. Extent to which the expenditures are actually capital outlays
o Inquire into the nature or purpose of such expenditure
ii. W/N the expenditures are ordinary or necessary
o For an expense to be considered as ordinary, it must be
reasonable in amount
 SC: General Foods failed to meet the aforementioned limitations
i. General Foods incurred the subject advertising expense in order
to protect its brand franchise.
o We consider this as a capital outlay since it created goodwill for its
business and/or product.
ii. The P9,461,246 media advertising expense was not ordinary,
as it was unreasonable
o The gargantuan media advertising expense for the promotion of a
single product is doubtlessly unreasonable.
o The amount one-half of petitioner corporation's entire claim for
marketing expenses for that year under review
o The amount is inclusive of other advertising and promotion
expenses of P2,678,328 and P1,548,614 for consumer promotion,