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9/29/2016

G.R.No.172231

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RepublicofthePhilippines
SUPREMECOURT
Manila
THIRDDIVISION
G.R.No.172231February12,2007
COMMISSIONEROFINTERNALREVENUE,Petitioner,
vs.
ISABELACULTURALCORPORATION,Respondent.
DECISION
YNARESSANTIAGO,J.:
Petitioner Commissioner of Internal Revenue (CIR) assails the September 30, 2005 Decision1 of the Court of
AppealsinCAG.R.SPNo.78426affirmingtheFebruary26,2003Decision2oftheCourtofTaxAppeals(CTA)in
CTA Case No. 5211, which cancelled and set aside the Assessment Notices for deficiency income tax and
expanded withholding tax issued by the Bureau of Internal Revenue (BIR) against respondent Isabela Cultural
Corporation(ICC).
The facts show that on February 23, 1990, ICC, a domestic corporation, received from the BIR Assessment
NoticeNo.FAS18690000680fordeficiencyincometaxintheamountofP333,196.86,andAssessmentNotice
No. FAS18690000681 for deficiency expanded withholding tax in the amount of P4,897.79, inclusive of
surchargesandinterest,bothforthetaxableyear1986.
ThedeficiencyincometaxofP333,196.86,arosefrom:
(1) The BIRs disallowance of ICCs claimed expense deductions for professional and security services
billedtoandpaidbyICCin1986,towit:
(a)ExpensesfortheauditingservicesofSGV&Co.,3fortheyearendingDecember31,19854
(b) Expenses for the legal services [inclusive of retainer fees] of the law firm Bengzon Zarraga
NarcisoCudalaPecsonAzcuna&Bengsonfortheyears1984and1985.5
(c)ExpenseforsecurityservicesofElTigreSecurity&InvestigationAgencyforthemonthsofApril
andMay1986.6
(2) The alleged understatement of ICCs interest income on the three promissory notes due from Realty
Investment,Inc.
ThedeficiencyexpandedwithholdingtaxofP4,897.79(inclusiveofinterestandsurcharge)wasallegedlydueto
the failure of ICC to withhold 1% expanded withholding tax on its claimed P244,890.00 deduction for security
services.7
OnMarch23,1990,ICCsoughtareconsiderationofthesubjectassessments.OnFebruary9,1995,however,it
received a final notice before seizure demanding payment of the amounts stated in the said notices. Hence, it
brought the case to the CTA which held that the petition is premature because the final notice of assessment
cannotbeconsideredasafinaldecisionappealabletothetaxcourt.ThiswasreversedbytheCourtofAppeals
holdingthatademandletteroftheBIRreiteratingthepaymentofdeficiencytax,amountstoafinaldecisionon
the protested assessment and may therefore be questioned before the CTA. This conclusion was sustained by
thisCourtonJuly1,2001,inG.R.No.135210.8ThecasewasthusremandedtotheCTAforfurtherproceedings.
OnFebruary26,2003,theCTArenderedadecisioncancelingandsettingasidetheassessmentnoticesissued
againstICC.Itheldthattheclaimeddeductionsforprofessionalandsecurityserviceswereproperlyclaimedby
ICC in 1986 because it was only in the said year when the bills demanding payment were sent to ICC. Hence,
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evenifsomeoftheseprofessionalserviceswererenderedtoICCin1984or1985,itcouldnotdeclarethesame
asdeductionforthesaidyearsastheamountthereofcouldnotbedeterminedatthattime.
TheCTAalsoheldthatICCdidnotunderstateitsinterestincomeonthesubjectpromissorynotes.Itfoundthatit
wastheBIRwhichmadeanoverstatementofsaidincomewhenitcompoundedtheinterestincomereceivableby
ICC from the promissory notes of Realty Investment, Inc., despite the absence of a stipulation in the contract
providing for a compounded interest nor of a circumstance, like delay in payment or breach of contract, that
wouldjustifytheapplicationofcompoundedinterest.
Likewise, the CTA found that ICC in fact withheld 1% expanded withholding tax on its claimed deduction for
security services as shown by the various payment orders and confirmation receipts it presented as evidence.
ThedispositiveportionoftheCTAsDecision,reads:
WHEREFORE,inviewofalltheforegoing,AssessmentNoticeNo.FAS18690000680fordeficiencyincometax
in the amount of P333,196.86, and Assessment Notice No. FAS18690000681 for deficiency expanded
withholdingtaxintheamountofP4,897.79,inclusiveofsurchargesandinterest,bothforthetaxableyear1986,
areherebyCANCELLEDandSETASIDE.
SOORDERED.9
Petitioner filed a petition for review with the Court of Appeals, which affirmed the CTA decision,10 holding that
althoughtheprofessionalservices(legalandauditingservices)wererenderedtoICCin1984and1985,thecost
oftheserviceswasnotyetdeterminableatthattime,hence,itcouldbeconsideredasdeductibleexpensesonly
in1986whenICCreceivedthebillingstatementsforsaidservices.ItfurtherruledthatICCdidnotunderstateits
interestincomefromthepromissorynotesofRealtyInvestment,Inc.,andthatICCproperlywithheldandremitted
taxesonthepaymentsforsecurityservicesforthetaxableyear1986.
Hence,petitioner,throughtheOfficeoftheSolicitorGeneral,filedtheinstantpetitioncontendingthatsinceICCis
using the accrual method of accounting, the expenses for the professional services that accrued in 1984 and
1985,shouldhavebeendeclaredasdeductionsfromincomeduringthesaidyearsandthefailureofICCtodoso
barsitfromclaimingsaidexpensesasdeductionforthetaxableyear1986.Astotheallegeddeficiencyinterest
incomeandfailuretowithholdexpandedwithholdingtaxassessment,petitionerinvokedthepresumptionthatthe
assessmentnoticesissuedbytheBIRarevalid.
TheissueforresolutioniswhethertheCourtofAppealscorrectly:(1)sustainedthedeductionoftheexpensesfor
professionalandsecurityservicesfromICCsgrossincomeand(2)heldthatICCdidnotunderstateitsinterest
incomefromthepromissorynotesofRealtyInvestment,IncandthatICCwithheldtherequired1%withholding
taxfromthedeductionsforsecurityservices.
The requisites for the deductibility of ordinary and necessary trade, business, or professional expenses, like
expensespaidforlegalandauditingservices,are:(a)theexpensemustbeordinaryandnecessary(b)itmust
havebeenpaidorincurredduringthetaxableyear(c)itmusthavebeenpaidorincurredincarryingonthetrade
orbusinessofthetaxpayerand(d)itmustbesupportedbyreceipts,recordsorotherpertinentpapers.11
TherequisitethatitmusthavebeenpaidorincurredduringthetaxableyearisfurtherqualifiedbySection45of
the National Internal Revenue Code (NIRC) which states that: "[t]he deduction provided for in this Title shall be
taken for the taxable year in which paid or accrued or paid or incurred, dependent upon the method of
accountinguponthebasisofwhichthenetincomeiscomputedxxx".
Accountingmethodsfortaxpurposescompriseasetofrulesfordeterminingwhenandhowtoreportincomeand
deductions.12Intheinstantcase,theaccountingmethodusedbyICCistheaccrualmethod.
RevenueAuditMemorandumOrderNo.12000,providesthatundertheaccrualmethodofaccounting,expenses
notbeingclaimedasdeductionsbyataxpayerinthecurrentyearwhentheyareincurredcannotbeclaimedas
deductionfromincomeforthesucceedingyear.Thus,ataxpayerwhoisauthorizedtodeductcertainexpenses
and other allowable deductions for the current year but failed to do so cannot deduct the same for the next
year.13
Theaccrualmethodreliesuponthetaxpayersrighttoreceiveamountsoritsobligationtopaythem,inopposition
to actual receipt or payment, which characterizes the cash method of accounting. Amounts of income accrue
wheretherighttoreceivethembecomefixed,wherethereiscreatedanenforceableliability.Similarly,liabilities
are accrued when fixed and determinable in amount, without regard to indeterminacy merely of time of
payment.14
Forataxpayerusingtheaccrualmethod,thedeterminativequestionis,whendothefactspresentthemselvesin
such a manner that the taxpayer must recognize income or expense? The accrual of income and expense is
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permitted when the allevents test has been met. This test requires: (1) fixing of a right to income or liability to
payand(2)theavailabilityofthereasonableaccuratedeterminationofsuchincomeorliability.
Thealleventstestrequirestherighttoincomeorliabilitybefixed,andtheamountofsuchincomeorliabilitybe
determinedwithreasonableaccuracy.However,thetestdoesnotdemandthattheamountofincomeorliability
beknownabsolutely,onlythatataxpayerhasathisdisposaltheinformationnecessarytocomputetheamount
with reasonable accuracy. The allevents test is satisfied where computation remains uncertain, if its basis is
unchangeable the test is satisfied where a computation may be unknown, but is not as much as unknowable,
within the taxable year. The amount of liability does not have to be determined exactly it must be
determinedwith"reasonableaccuracy."Accordingly,theterm"reasonableaccuracy"impliessomething
lessthananexactorcompletelyaccurateamount.[15]
The propriety of an accrual must be judged by the facts that a taxpayer knew, or could reasonably be
expectedtohaveknown,attheclosingofitsbooksforthetaxableyear.[16]Accrualmethodofaccounting
presentslargelyaquestionoffactsuchthatthetaxpayerbearstheburdenofproofofestablishingtheaccrualof
anitemofincomeordeduction.17
Corollarily,itisagoverningprincipleintaxationthattaxexemptionsmustbeconstruedinstrictissimijurisagainst
thetaxpayerandliberallyinfavorofthetaxingauthorityandonewhoclaimsanexemptionmustbeabletojustify
the same by the clearest grant of organic or statute law. An exemption from the common burden cannot be
permittedtoexistuponvagueimplications.Andsinceadeductionforincometaxpurposespartakesofthenature
ofataxexemption,thenitmustalsobestrictlyconstrued.18
In the instant case, the expenses for professional fees consist of expenses for legal and auditing services. The
expensesforlegalservicespertaintothe1984and1985legalandretainerfeesofthelawfirmBengzonZarraga
Narciso Cudala Pecson Azcuna & Bengson, and for reimbursement of the expenses of said firm in connection
withICCstaxproblemsfortheyear1984.AstestifiedbytheTreasurerofICC,thefirmhasbeenitscounselsince
the1960s.19Fromthenatureoftheclaimeddeductionsandthespanoftimeduringwhichthefirmwasretained,
ICC can be expected to have reasonably known the retainer fees charged by the firm as well as the
compensationforitslegalservices.Thefailuretodeterminetheexactamountoftheexpenseduringthetaxable
yearwhentheycouldhavebeenclaimedasdeductionscannotthusbeattributedsolelytothedelayedbillingof
theseliabilitiesbythefirm.Forone,ICC,intheexerciseofduediligencecouldhaveinquiredintotheamountof
their obligation to the firm, especially so that it is using the accrual method of accounting. For another, it could
havereasonablydeterminedtheamountoflegalandretainerfeesowingtoitsfamiliaritywiththeratescharged
bytheirlongtimelegalconsultant.
As previously stated, the accrual method presents largely a question of fact and that the taxpayer bears the
burdenofestablishingtheaccrualofanexpenseorincome.However,ICCfailedtodischargethisburden.Asto
whenthefirmsperformanceofitsservicesinconnectionwiththe1984taxproblemswerecompleted,orwhether
ICC exercised reasonable diligence to inquire about the amount of its liability, or whether it does or does not
possess the information necessary to compute the amount of said liability with reasonable accuracy, are
questionsoffactwhichICCneverestablished.Itsimplyreliedonthedefenseofdelayedbillingbythefirmandthe
company,whichunderthecircumstances,isnotsufficienttoexemptitfrombeingchargedwithknowledgeofthe
reasonableamountoftheexpensesforlegalandauditingservices.
Inthesamevein,theprofessionalfeesofSGV&Co.forauditingthefinancialstatementsofICCfortheyear1985
cannot be validly claimed as expense deductions in 1986. This is so because ICC failed to present evidence
showing that even with only "reasonable accuracy," as the standard to ascertain its liability to SGV & Co. in the
year1985,itcannotdeterminetheprofessionalfeeswhichsaidcompanywouldchargeforitsservices.
ICC thus failed to discharge the burden of proving that the claimed expense deductions for the professional
services were allowable deductions for the taxable year 1986. Hence, per Revenue Audit Memorandum Order
No.12000,theycannotbevalidlydeductedfromitsgrossincomeforthesaidyearandwerethereforeproperly
disallowedbytheBIR.
Astotheexpensesforsecurityservices,therecordsshowthattheseexpenseswereincurredbyICCin198620
andcouldthereforebeproperlyclaimedasdeductionsforthesaidyear.
AnentthepurportedunderstatementofinterestincomefromthepromissorynotesofRealtyInvestment,Inc.,we
sustainthefindingsoftheCTAandtheCourtofAppealsthatnosuchunderstatementexistsandthatonlysimple
interest computation and not a compounded one should have been applied by the BIR. There is indeed no
stipulationbetweenthelatterandICContheapplicationofcompoundedinterest.21UnderArticle1959oftheCivil
Code,unlessthereisastipulationtothecontrary,interestdueshouldnotfurtherearninterest.
Likewise, the findings of the CTA and the Court of Appeals that ICC truly withheld the required withholding tax
fromitsclaimeddeductionsforsecurityservicesandremittedthesametotheBIRissupportedbypaymentorder
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andconfirmationreceipts.22Hence,theAssessmentNoticefordeficiencyexpandedwithholdingtaxwasproperly
cancelledandsetaside.
In sum, Assessment Notice No. FAS18690000680 in the amount of P333,196.86 for deficiency income tax
should be cancelled and set aside but only insofar as the claimed deductions of ICC for security services. Said
Assessment is valid as to the BIRs disallowance of ICCs expenses for professional services. The Court of
Appeals cancellation of Assessment Notice No. FAS18690000681 in the amount of P4,897.79 for deficiency
expandedwithholdingtax,issustained.
WHEREFORE,thepetitionisPARTIALLYGRANTED.TheSeptember30,2005DecisionoftheCourtofAppeals
in CAG.R. SP No. 78426, is AFFIRMED with the MODIFICATION that Assessment Notice No. FAS18690
000680, which disallowed the expense deduction of Isabela Cultural Corporation for professional and security
services,isdeclaredvalidonlyinsofarastheexpensesfortheprofessionalfeesofSGV&Co.andofthelawfirm,
BengzonZarragaNarcisoCudalaPecsonAzcuna&Bengson,areconcerned.Thedecisionisaffirmedinallother
respects.
ThecaseisremandedtotheBIRforthecomputationofIsabelaCulturalCorporationsliabilityunderAssessment
NoticeNo.FAS18690000680.
SOORDERED.
CONSUELOYNARESSANTIAGO
AssociateJustice
WECONCUR:
MA.ALICIAAUSTRIAMARTINEZ
AssociateJustice
ROMEOJ.CALLEJO,SR.
AssociateJustice

MINITAV.CHICONAZARIO
AsscociateJustice

ANTONIOEDUARDOB.NACHURA
AssociateJustice
ATTESTATION
Iattestthattheconclusionsintheabovedecisionwerereachedinconsultationbeforethecasewasassignedto
thewriteroftheopinionoftheCourtsDivision.
CONSUELOYNARESSANTIAGO
AssociateJustice
Chairperson,ThirdDivision
CERTIFICATION
Pursuant to Section 13, Article VIII of the Constitution and the Division Chairpersons Attestation, it is hereby
certifiedthattheconclusionsintheaboveDecisionwerereachedinconsultationbeforethecasewasassignedto
thewriteroftheopinionoftheCourtsDivision.
REYNATOS.PUNO
ChiefJustice

Footnotes
1 Rollo, pp. 4859. Penned by Associate Justice Delilah VidallonMagtolis and concurred in by Associate

JusticesBienvenidoL.ReyesandJosefinaGuevaraSalonga.
2Id.at165181.
3Sycip,Gorres,Velayo&Co.
4Exhibits"O"to"T,"records,pp.128133.
5Exhibits"U"to"DD,"id.at134143.
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6Exhibits"EE"to"II,"id.at144148.
7Rollo,p.56.

ThefollowingisanitemizedscheduleofICCsdeficiencyassessment:
Taxableincome(loss)perreturn
Add:AdditionalTaxableIncome
(1)

Interestincome

(2)

Otherincome
Rentincome
Investmentserviceincome

(3)

P(114,345.00)
P429,187.47

9,169.64
23,725.36

Disallowanceofprioryearsexpenses
(a)Professionalfees(1985)

496,409.77

(b)Securityservices(1985)

41,814.00

NetTaxableIncomeperinvestigation

1,000,306.24
P885,961.24

Taxduethereon

P310,086.43

Less:TaxPaid

143,488.00

Balance

P166,598.43

Add:25%Surcharge

41,649.61

Subtotal

P208,248.04

Add:60%Interest
TotalAmountDueandCollectible

124,948.82
P333,196.86

ExpandedWithholdingTax
SecurityServices

P2,448.90

Add:25%Surcharge
Subtotal
Add:60%Interest
TotalAmountDueandCollectible

612.22
P3,061.12
1,836.67
P4,897.79

(CTADecision,Rollo,p.174)
8CommissionerofInternalRevenuev.IsabelaCulturalCorporation,413Phil.376.
9Rollo,p.181.
10ThedispositiveportionoftheCourtofAppealsDecision,states:

WHEREFORE,thepetitionisherebyDISMISSEDforlackofmeritandthedecisionappealedfromis
herebyAFFIRMED.
SOORDERED.(Id.at59)
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11CommissionerofInternalRevenuev.GeneralFoods(Phils.),Inc.,G.R.No.143672,April24,2003,401

SCRA545,551.
12DeLeon,TheNationalInternalRevenueCode,Annotated,vol.I,2003edition,p.443.
13ChapterIIB.
14 Mertens Law of Federal Income Taxation, Vol. 2 (1996), Cash and Accrual Methods, Chapter 12A,

12A:51,p.12A77.
15Id.at12A:58,p.12A87.
16Id.at12A:55,p.12A82.
17Id.at12A:51,p.12A77.
18CommissionerofInternalRevenuev.GeneralFoods(Phils.),Inc.,supranote11at550.
19TSN,July20,1995,p.86.
20Exhibits"EE"to"II,"records,pp.144148.
21Exhibits"E"to"J,"id.at119to123.
22Exhibits"QQ"to"WW,"id.at171191.
TheLawphilProjectArellanoLawFoundation

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