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Page 46 | UST 2017

METHODS OF ACCOUNTING

Accounting methods for tax


purposes comprise a set of
rules for determining how
to report income and
deductions.

General Rule: the law does not


provide for a specific method of
accounting to be employed by the
taxpayer.

The law only authorizes the CIR to


employ particular method of CIR v Isabela Cultural
accounting of income where: Corporation
2007
a. The taxpayer does not Ponente: YNARES-SANTIAGO, J.:
employ a method for
computing income, or
DOCTRINE: The requisites for
b. The taxpayer’s method for the deductibility of ordinary and
accounting does not clearly necessary trade, business, or
refect the income professional expenses, like
(Domondon, 205, citing Sec. expenses paid for legal and
43 of NIRC) auditing services, are:

(a) the expense must be ordinary


and necessary;

(b) it must have been paid or


incurred during the taxable year;

(c) it must have been paid or


incurred in carrying on the trade
or business of the taxpayer; and

(d) it must be supported by


receipts, records or other
pertinent papers.
The requisite that it must have P333,196.86, and Assessment
been paid or incurred during the Notice No. FAS-1-86-90-000681
taxable year is further qualified by for deficiency expanded
Section 45 of the NIRC which withholding tax in the amount of
states that: P4,897.79, inclusive of surcharges
and interest, both for the taxable
"[t]he deduction provided for
year 1986.
in this Title shall be taken for
the taxable year in which
‘paid or accrued’ or ‘paid or
The deficiency income tax of
incurred’, dependent upon the
P333,196.86, arose from:
method of accounting upon
the basis of which the net (1) BIR disallowance of ICC’s
income is computed x x x". claimed expense deductions
for professional and security
services billed to and paid by
QUICK FACTS: BIR disallowed the ICC in 1986, to wit:
following ICC expenses for years
(a) Expenses for auditing
1984-1986 to be included in ICC’s
services of SGV & Co., for
1986 tax expense deductions:
the year ending Dec 31, 1985
(1) Expenses for auditing services
(b) Expenses for legal
for year ending 31 December 1985;
services [incl of retainer fees]
(2) Expenses for legal services for of law firm Bengzon for 1984
years 1984 and 1985; and and 1985

(3) Expense for security services (c) Expense for security


for months of April and May 1986. services of El Tigre Security
BIR thus charged ICC for for months of April and May
deficiency income taxes. ICC 1986
contested the assessment.
(2) Understatement of ICC
interest income on 3
promissory notes due from
FACTS:
Realty Investment
On Feb 23, 1990, ICC received
from BIR Assessment Notice No.
FAS-1-86-90-000680 for deficiency The deficiency expanded
income tax in the amount of withholding tax of P4,897.79
(inclusive of interest and professional and security services
surcharge) was allegedly due to the were properly claimed by ICC in
failure of ICC to withhold 1% 1986 because it was only in the
expanded withholding tax on its said year when the bills
claimed P244,890.00 deduction for demanding payment were sent to
security services. ICC. Hence, even if some of these
professional services were
rendered to ICC in 1984 or 1985, it
On March 23, 1990, ICC sought could not declare the same as
for a reconsideration, but on Feb deduction for the said years as the
9, 1995, it received a final notice amount could not be determined at
before seizure demanding payment that time. ICC did not understate
of amounts stated in the said its interest income on the subject
notices. promissory notes. It was the BIR
which made an overstatement of
said income when it compounded
CTA held that petition is the interest income receivable by
ICC from the promissory notes of
premature because final notice of
assessment cannot be considered Realty Investment, Inc., despite the
as a final decision appealable to absence of a stipulation in the
contract. CTA also found that ICC
the tax court. CA reversed the
holding that a demand letter of the in fact withheld 1% expanded
BIR reiterating the payment of withholding tax on its claimed
deduction for security services as
deficiency tax, amounts to a final
decision on the protested shown by the various confirmation
assessment and may therefore be receipts it presented as evidence.
questioned before the CTA. This
conclusion was sustained by this
Court on July 1, 2001, G.R. No. CA affirmed CTA decision, holding
135210. Case was remanded to that although the professional
CTA for further proceedings. services (legal and auditing) were
rendered to ICC in 1984 and 1985,
the cost of the services was not yet
CTA rendered a decision canceling determinable at that time, hence, it
and setting aside the assessment could be considered as deductible
notices issued against ICC. It held expenses only in 1986 when ICC
that the claimed deductions for received the billing statements for
said services. It further ruled that
ICC did not understate its interest The requisites for the deductibility
income from the promissory notes of ordinary and necessary trade,
of Realty Investment, Inc., and that business, or professional expenses,
ICC properly withheld and like expenses paid for legal and
remitted taxes on the payments for auditing services, are: (a) the
security services for the taxable expense must be ordinary and
year 1986. necessary; (b) it must have been
paid or incurred during the taxable
year; (c) it must have been paid
BIR contention: Since ICC is or incurred in carrying on the
using the accrual method of trade or business of the
accounting, the expenses for the taxpayer; and (d) it must be
professional services that accrued supported by receipts, records or
in 1984 and 1985, should have other pertinent papers.
been declared as deductions from
income during the said years and
the failure of ICC to do so bars it The requisite that it must have
from claiming said expenses as been paid or incurred during the
deduction for the taxable year taxable year is further qualified by
1986. Sec 45 of the NIRC which states
that: "[t]he deduction provided for
in this Title shall be taken for the
Issue: Whether the deduction of the taxable year in which ‘paid or
expenses for professional and accrued’ or ‘paid or incurred’,
security services of 1984-1986 are dependent upon the method of
valid deductions from ICC’s gross accounting upon the basis of
income for 1986 which the net income is
computed x x x".

Decision:
Accounting methods for tax
NO for audit services from purposes comprise a set of rules
SGV and legal services from for determining when and how to
Bengzon; report income and deductions. The
YES for security services. accounting method used by ICC is
the Accrual Method.
Held:
Revenue Audit Memorandum Order the taxpayer must recognize an
No. 1-2000, provides that under income or expense?
the accrual method of accounting,
The accrual of income and expense
expenses not being claimed as
is permitted when the all-events
deductions by a taxpayer in the
test has been met. It requires:
current year when they are
incurred cannot be claimed as (1) The fixing of a right to
deduction from income for the income or liability to pay;
succeeding year. Thus, a and
taxpayer who is authorized to
deduct certain expenses and other (2) The availability of the
allowable deductions for the reasonable accurate
current year but failed to do so determination of such
cannot deduct the same for the income or liability.
next year.

The ALL-EVENTS TEST requires


The accrual method relies upon the right to income or liability be
the taxpayer’s right to receive fixed, and the amount of such
amounts or its obligation to pay income or liability be determined
them, in opposition to actual with reasonable accuracy.
receipt or payment, which
characterizes the cash method of
accounting. Amounts of income However, the test does not demand
accrue where the right to receive that the amount of income or
them become fixed, where there is liability be known absolutely, only
created an enforceable liability. that a taxpayer has at his disposal
Similarly, liabilities are accrued the information necessary to
when fixed and determinable in compute the amount with
amount, without regard to reasonable accuracy. The ALL-
indeterminacy merely of time of EVENTS TEST is satisfied where
payment. computation remains uncertain, if
its basis is unchangeable; the test
is satisfied where a computation
For a taxpayer using the Accrual may be unknown, but is not as
Method, the determinative much as unknowable, within the
question is, when do facts present taxable year. The amount of
themselves in such a manner that liability does not have to be
determined exactly; it must be attributed solely to the delayed
determined with "reasonable billing of these liabilities by the
accuracy." firm. ICC could have inquired into
the amount of their obligation to
Accordingly, the term
the firm, especially since it is using
"reasonable accuracy"
the accrual method of accounting.
implies something less than
It could also have reasonably
an exact or completely
determined the amount of legal
accurate amount.
and retainer fees owing to its
familiarity with the rates charged
by their long time legal consultant.
The propriety of an accrual must
be judged by the facts that a SGV & Co. professional fees for
taxpayer knew, or could auditing financial statements of
reasonably be expected to have ICC for 1985 cannot be validly
known, at the closing of its books claimed as expense deductions in
for the taxable year. Accrual 1986. ICC failed to present
method of accounting presents evidence showing that even with
largely a question of fact; such that only "reasonable accuracy" as the
the taxpayer bears the burden of standard to ascertain its liability to
proof of establishing the accrual of SGV & Co. in year 1985, it cannot
an item of income or deduction. determine the professional fees
which said company would charge
The expenses for professional fees for its services.
for legal and auditing services
pertain to 1984 and 1985 legal and
retainer fees of the law firm
ICC thus failed to discharge the
Bengzon. As testified by the ICC
burden of proving that the claimed
Treasurer, the firm has been its
expense deductions for the
counsel since the 1960’s. From the
professional services were
nature of the claimed deductions
allowable deductions for the
and the span of time during which
taxable year 1986. Hence, per
the firm was retained, ICC can be
Revenue Audit Memorandum
expected to have reasonably
Order No. 1-2000, they cannot be
known the retainer fees charged by
validly deducted from its gross
the firm as well as the
income for the said year and were
compensation for its legal services.
therefore properly disallowed by
The failure to determine the exact
the BIR.
amount of the expense cannot be
As to the expenses for security
services, the records show that
these expenses were incurred by
ICC in 1986 and could therefore be
properly claimed as deductions for
1986.

TESTS IN DETERMINING
WHETHER INCOME IS EARNED
FOR TAX PURPOSES

Page 47 | UST 2017