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CIR vs. CTA and Smith Kline & French Overseas Co.

(Philippine branch)
FACTS Smith Kline and French Overseas Company, a multinational firm domiciled in Pennsylvania, is licensed to do
business in the Phils. It is engaged in the importation, manufacture, and sale of pharmaceutical drugs and chemicals.
In its original incomes tax return in !", Smith Kline declared a net taxable income of P,#$!,%"" and paid
P&,%#" as tax due. 'mong the deductions claimed from gross income (as P&),)#) as its share of the head office
overhead expenses.
*o(ever, in its amended return in !"+, there (as an overpayment of P+%#,%&& ,arising from underdeduction of
home office overhead.- It made a formal claim for refund of the alleged overpayment because it appears that sometime in
October !"%, Smith Kline received from its international independent auditors an authenticated certification to the effect
that the Philippine share in the unallocated overhead expenses of the main office for the year ended .ecember !" (as
actually P,#%",#$#, and that the allocation (as made on the basis of the percentage of gross income in the Philippines to
gross income of the corporation as a (hole. /y reason of the ne( ad0ustment, Smith Kline1s tax liability (as greatly reduced
from P&,%#" to P$2,!!%, resulting in an overpa!ment o" P#$%&$''.
3he C3' rendered a decision in !$) ordering the Commissioner to refund the overpayment or grant a tax credit to
Smith Kline. 3he Commissioner appealed.
ISS() Is Smith Kline1s share of the head office overhead expenses incurred outside the Philippines deductible4
*)+, 56S. Smith Kline1s share of the head officer overhead expenses incurred outside the Philippines is deductible.
Section #- o" the old .IRC. Net Income from sources in the Philippines.
,From the items of gross income specified in subsection 7a8 of this section, there shall be deducted the expenses,
losses, and other deductions properly apportioned or allocated thereto and a ratable part of any expenses, losses, or other
deductions (hich cannot definitely be allocated to some item or class of gross income. 3he remained, if any, shall be included
in full as net income from sources (ithin the Philippines.-
Section /01. Apportionment of deductions.
,93he ratable part is based upon the ration of gross income from sources (ithin the Philippines to the total gross
6:';P<6= ' non>resident alien individual (hose taxable year is the calendar year, derived gross income from all
sources for !+! of P/21&111, including therein=
Interest on bonds of a domestic corporation P!,)))
.ividends on stoc? of a domestic corporation #,)))
@oyalty for the use of patents (ithin the Phils %,)))
Aain from sale of real property located in the Phils ,)))
3O3'< +2,)))
3hat is, B& of the total gross income (as from sources (ithin the Philippines. 3he remainder of the gross income (as from
sources (ithout the Philippines. 3he expenses of the taxpayer for the year amount to P"$,))). Of these expenses, P$,))) is
properly allocated to income from sources (ithin the Phils and P#),))) is from sources (ithout the Phils. 3he remainder of
the expense, P+),))), cannot be definitely allocated to any class of income. ' ratable part thereof, based upon the relation
of gross income from sources (ithin the Phils to the total gross income shall be deducted in computing net income from
sources (ithin the Phils. 3hus, these are deducted from the P+2,))) of gross income from sources (ithin the Phils expenses
amounting to P#,))) 7representing P$,))) properly apportioned to the income from sources (ithin the Philippines and
P2,))), a ratable part 7B&8 of the expenses (hich could not be allocated to any item or class of gross income8. 3he
remainder of P%%,))) is the net income from sources (ithin the Phils.
From the foregoing provisions, it is manifest that (here an expense is clearly related to the production of Philippine>
derived income or to Phil operations 7e.g., salaries of Phil personnel, rental of office building in the Phils8, that expense can
be deducted from the gross income acCuired in the Phils (ithout resorting to apportionment.
3he overhead expenses incurred by the parent company in connection (ith finance, administration, and research and
development, all of (hich direct benefit its branches all over the (orld, including the Phils, fall under a different category
ho(ever. 3here are items (hich cannot be definitely allocated or identified (ith the operations of the Phil branch. For !",
the parent company of Smith Kline spent D,)"","+!. Ender Sec. +", Smith Kline can claim as its deductible share a ratable
part of such expenses based upon the ration of the local branch1s gross income to the total gross income, (orld(ide, of the
multinational corporation. Smith Kline also presented ample evidence to support its claim for refund. Fe hold that Smith
Kline1s amended !" return is in conformity (ith the la( and regulations. 3he 3ax Court correctly held that the refund or
credit of the resulting overpayment is in order.