The Supreme Court ruled that Avon was not liable for excise tax on denatured alcohol that evaporated during transit, clarifying the scope of excise tax exemptions under the National Internal Revenue Code (NIRC). The Court emphasized that excise tax applies to distilled spirits, not denatured alcohol that has not undergone processing, rectification, or distillation. This decision protects businesses using denatured alcohol as raw material from excise taxes on unavoidable losses during transportation, as long as the alcohol remains unfit for oral intake and hasn’t been reprocessed.

When Evaporation Meets Taxation: Who Absorbs the Loss?

Avon Products Manufacturing, Inc. contested a deficiency excise tax assessment on 21,163.48 liters of denatured ethyl alcohol that evaporated during transit from its supplier to its warehouse. The Bureau of Internal Revenue (BIR) argued that any difference between the purchased and received volumes of denatured alcohol should be subject to excise tax, based on a condition in Avon’s permit. Avon, however, maintained that the evaporated denatured alcohol was exempt from excise tax under Section 134 of the NIRC, as it was not reprocessed into a distilled spirit.

The central legal question before the Supreme Court was whether Avon should be assessed deficiency excise tax on the shortages of denatured alcohol that evaporated during transit, before its processing, rectification, or distillation. This hinged on interpreting Section 134 of the NIRC and its application to losses incurred during transportation. The resolution of this issue has significant implications for manufacturers who rely on denatured alcohol as a raw material and the extent of their tax liabilities.

The Supreme Court began its analysis by examining the nature of excise taxes. Section 129 of the NIRC states that excise taxes apply to goods manufactured or produced in the Philippines for domestic sales or consumption, or for any other disposition, and to things imported. In Commissioner of Internal Revenue v. Pilipinas Shell Petroleum Corporation, the Court clarified that excise tax attaches upon goods manufactured or produced in the Philippines as soon as they come into existence.

The transformation undergone by the term “excise tax” from its traditional concept up to its current definition in our Tax Code was explained in the case of Petron Corporation v. Tiangco… beginning with the National Internal Revenue Code of 1986, as amended, the term “excise taxes” was used and defined as applicable “to goods manufactured or produced in the Philippines… and to things imported.” (Underscoring ours) This definition was carried over into the present NIRC of 1997.

Building on this foundation, the Court emphasized that, under the current definition, the liability for excise tax on distilled spirits attaches upon its existence. Section 141 of the NIRC, as amended by Republic Act (R.A.) No. 9334, specifically provides that “the tax shall attach to this substance as soon as it is in existence as such, whether it be subsequently separated as pure or impure spirits, or transformed into any other substance either in the process of original production or by any subsequent process.” Therefore, the crucial point is the transformation of the substance into ethyl alcohol or ethanol through processing, rectification, or distillation.

To clarify the scope, the Court defined rectification as the process of refining, purifying, or enhancing the quality of ethyl alcohol only by distillation. Distillation, in turn, involves separating components or substances from a liquid mixture through selective boiling and condensation. These definitions are essential for understanding when excise tax liability arises concerning distilled spirits.

Section 134 of the NIRC provides a key exemption for denatured alcohol. It states that denatured alcohol of not less than 180° degrees proof or ninety percent (90%) absolute alcohol shall, when suitably denatured and rendered unfit for oral intake, be exempt from the excise tax prescribed in Section 141. The Court highlighted the specific conditions under which this exemption applies:

SEC. 134. Domestic Denatured Alcohol. – Domestic alcohol of not less than one hundred eighty degrees (180°) proof (ninety percent (90%) absolute alcohol) shall, when suitably denatured and rendered unfit for oral intake, be exempt from the excise tax prescribed in Section 141… Provided, finally, That any alcohol, previously rendered unfit for oral intake after denaturing but subsequently rendered fit for oral intake after undergoing fermentation, dilution, purification, mixture or any other similar process shall be taxed under Section 141 of this Code and such tax shall be paid by the person in possession of such reprocessed spirits.

The Court then addressed the CIR’s claim that Avon failed to sufficiently show that the evaporated denatured alcohol was more than 180° proof or 90% absolute alcohol. After examining the Formal Letter of Demand issued by the BIR, the Court noted that it specifically indicated that the denatured alcohol purchased by Avon, which evaporated during transit, had 189° proof or 94.5% absolute alcohol. As such, the denatured alcohol was rendered unfit for oral intake, thus exempt from excise tax.

The Court also noted that if the CIR believed that the denatured alcohol purchased by Avon was not suitably denatured, then it could have rendered a deficiency assessment on the whole 1,309,000 liters of denatured alcohol purchased from January to December 2008. Instead, it only assessed excise tax on the 21,163.48 liters of denatured alcohol that evaporated during transit, based on the belief that losses of distilled spirits under Section 22 of RR No. 3-2006 could be equally applied to losses of denatured alcohol.

Having established that the denatured alcohol was more than 180° proof or 90% absolute alcohol, the Court then considered whether the denatured alcohol purchased by Avon underwent rectification, distillation, or other similar processes to render it fit for oral intake. Upon reviewing the records, the Court concluded that the denatured alcohol which evaporated during transit did not go through any of these processes. Therefore, the liability for excise tax was not triggered.

The CTA, therefore, erred when it applied Section 22 of RR No. 3-2006 on the denatured alcohol that evaporated during transit. Section 22 deals with losses on distilled spirits, not denatured alcohol that has not undergone further processing. The Court found it inconsistent to treat the denatured alcohol Avon received as free of excise tax while subjecting the evaporated shortages to excise tax, especially since the latter did not undergo any rectification or distillation process.

It is well-settled that tax statutes are construed strictissimi juris against the government. “Tax laws may not be extended by implication beyond the clear import of their language, nor their operation enlarged so as to embrace matters not specifically provided.” The Court found that the CIR failed to present any proof that the denatured alcohol which evaporated was reprocessed to a distilled spirit, nor did it show any legal justification in applying Section 22 of RR No. 3-2006 to a completely different article. As such, the 21,163.48 liters of denatured alcohol which evaporated during transit remained exempt from excise tax.

FAQs

What was the key issue in this case?	The key issue was whether Avon should be assessed deficiency excise tax on denatured alcohol that evaporated during transit before it could be processed. The court needed to determine if this evaporation triggered excise tax liability under the NIRC.
What is denatured alcohol, and why is it important in this case?	Denatured alcohol is alcohol rendered unfit for drinking, often used in manufacturing. In this case, its tax-exempt status under certain conditions played a crucial role in determining whether Avon owed excise taxes on the evaporated amount.
What is the significance of Section 134 of the NIRC?	Section 134 of the NIRC provides an exemption from excise tax for denatured alcohol that meets specific criteria, including being at least 180° proof and rendered unfit for oral intake. This section was central to Avon’s argument that the evaporated alcohol should not be taxed.
What was the BIR’s argument for assessing excise tax?	The BIR argued that a condition in Avon’s permit stipulated that any difference between the purchased and received volumes of denatured alcohol would be subject to excise tax. The BIR also tried to apply regulations regarding distilled spirits to the evaporated denatured alcohol.
How did the Court interpret the relevant tax regulations?	The Court interpreted the tax regulations strictly against the government, emphasizing that tax laws cannot be extended by implication. It found that the regulations regarding distilled spirits did not apply to denatured alcohol that had not been reprocessed.
What evidence did the Court rely on in making its decision?	The Court relied on the BIR’s Formal Letter of Demand, which indicated that the denatured alcohol was 189° proof, thus meeting the criteria for exemption. The Court also considered the fact that the alcohol did not undergo any rectification, distillation, or similar processes.
What is the practical implication of this ruling for manufacturers?	The ruling clarifies that manufacturers using denatured alcohol as a raw material are not liable for excise tax on losses due to evaporation during transit, as long as the alcohol remains unfit for oral intake and hasn’t been reprocessed. This provides a more predictable tax environment for these businesses.
Can the BIR impose excise tax if the denatured alcohol is reprocessed into something drinkable?	Yes, Section 134 of the NIRC stipulates that if denatured alcohol, previously unfit for oral intake, undergoes processing to become fit for consumption, it becomes subject to excise tax. The person in possession of the reprocessed spirits is responsible for paying the tax.
What was the outcome of the case?	The Supreme Court granted Avon’s petition, reversing the CTA’s decision and declaring the deficiency assessment void. This means Avon did not have to pay the excise tax on the evaporated denatured alcohol.

In conclusion, the Supreme Court’s decision in this case provides clarity on the excise tax treatment of denatured alcohol, particularly regarding losses incurred during transit. By emphasizing the importance of processing, rectification, or distillation in triggering excise tax liability, the Court has provided a clearer framework for businesses using denatured alcohol as a raw material.

For inquiries regarding the application of this ruling to specific circumstances, please contact ASG Law through contact or via email at frontdesk@asglawpartners.com.

Disclaimer: This analysis is provided for informational purposes only and does not constitute legal advice. For specific legal guidance tailored to your situation, please consult with a qualified attorney.
Source: AVON PRODUCTS MANUFACTURING, INC. vs. COMMISSIONER OF INTERNAL REVENUE, G.R. No. 222480, November 07, 2018