LEGAL BASES

1. Re: Accrual Basis

G.R. No. 172231             February 12, 2007

COMMISSIONER OF INTERNAL REVENUE, Petitioner,
vs.
ISABELA CULTURAL CORPORATION, Respondent.

Hence, petitioner, through the Office of the Solicitor General, filed the instant
petition contending that since ICC is using the accrual method of accounting, the
expenses for the professional services that accrued in 1984 and 1985, should have
been declared as deductions from income during the said years and the failure of
ICC to do so bars it from claiming said expenses as deduction for the taxable year
1986. As to the alleged deficiency interest income and failure to withhold expanded
withholding tax assessment, petitioner invoked the presumption that the
assessment notices issued by the BIR are valid.

The issue for resolution is whether the Court of Appeals correctly: (1) sustained the
deduction of the expenses for professional and security services from ICC’s gross
income; and (2) held that ICC did not understate its interest income from the
promissory notes of Realty Investment, Inc; and that ICC withheld the required 1%
withholding tax from the deductions for security services.

The requisites for the deductibility of ordinary and necessary trade, business, or
professional expenses, like expenses paid for legal and 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.11

The requisite that it must have been paid or incurred during the taxable year is
further qualified by Section 45 of 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
accounting upon the basis of which the net income is computed x x x".

Accounting methods for tax purposes comprise a set of rules for determining when
and how to report income and deductions.12 In the instant case, the accounting
method used by ICC is the accrual method.

Revenue Audit Memorandum Order No. 1-2000, provides that under the accrual
method of accounting, expenses not being claimed as deductions by a taxpayer in
the current year when they are incurred cannot be claimed as deduction from
income for the succeeding year. Thus, a taxpayer who is authorized to deduct
certain expenses and other allowable deductions for the current year but failed to do
so cannot deduct the same for the next year.13

The accrual method relies upon the taxpayer’s right to receive amounts or its
obligation to pay them, in opposition to actual receipt or payment, which
characterizes the cash method of accounting. Amounts of income accrue where the
right to receive them become fixed, where there is created an enforceable liability.
Similarly, liabilities are accrued when fixed and determinable in amount, without
regard to indeterminacy merely of time of payment.14

For a taxpayer using the accrual method, the determinative question is, when do the
facts present themselves in such a manner that the taxpayer must recognize income
or expense? The accrual of income and expense is permitted when the all-events
test has been met. This test requires: (1) fixing of a right to income or liability to
pay; and (2) the availability of the reasonable accurate determination of such
income or liability.
The all-events test requires the right to income or liability be fixed, and the amount
of such income or liability be determined with reasonable accuracy. However, the
test does not demand that the amount of income or liability be known absolutely,
only that a taxpayer has at his disposal the information necessary to compute the
amount with reasonable accuracy. The all-events 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 determined with "reasonable accuracy." Accordingly, the term
"reasonable accuracy" implies something less than an exact or completely
accurate amount.[15]

The propriety of an accrual must be judged by the facts that a taxpayer

knew, or could reasonably be expected to have known, at the closing of its
books for the taxable year.[16] Accrual method of accounting presents largely a
question of fact; such that the taxpayer bears the burden of proof of establishing the
accrual of an item of income or deduction.17

Corollarily, it is a governing principle in taxation that tax exemptions must be

construed in  strictissimi juris against the taxpayer and liberally in favor of the taxing
authority; and one who claims an exemption must be able to justify the same by the
clearest grant of organic or statute law. An exemption from the common burden
cannot be permitted to exist upon vague implications. And since a deduction for
income tax purposes partakes of the nature of a tax exemption, then it must also be
strictly construed.18

July 12, 2017

G.R. No. 183408
COMMISSIONER OF INTERNAL REVENUE, Petitioner
vs.
LANCASTER PHILIPPINES, INC., Respondent

The issue essentially boils down to the proper timing when Lancaster should
recognize its purchases in computing its taxable income. Such issue directly
correlates to the fact that Lancaster's 'crop year ' does not exactly coincide with its
fiscal year for tax purposes.

Noticeably, the records of this case are rife with terms and concepts in accounting.
As a science, accounting 40 pervades many aspects of financial planning,
forecasting, and decision making in business. Its reach, however, has also
permeated tax practice.
To put it into perspective, although the foundations of accounting were built
principally to analyze finances and assist businesses, many of its principles have
since been adopted for purposes of taxation.41 In our jurisdiction, the concepts in
business accounting, including certain generally accepted accounting principles
(GAAP), embedded in the NIRC comprise the rules on tax accounting.

To be clear, the principles under financial or business accounting, in theory and

application, are not necessarily interchangeable with those in tax accounting. Thus,
although closely related, tax and business accounting had invariably produced
concepts that at some point diverge in understanding or usage. For instance, two of
such important concepts are taxable income and business income (or accounting
income). Much of the difference can be attributed to the distinct purposes or
objectives that the concepts of tax and business accounting are aimed at. Chief
Justice Querube Makalintal made an apt observation on the nature of such
difference. In Consolidated Mines, Inc. v. CTA,42he noted:

While taxable income is based on the method of accounting used by the taxpayer, it
will almost always differ from accounting income. This is so because of a
fundamental difference in the ends the two concepts serve. Accounting attempts
to match cost against revenue. Tax law is aimed at collecting revenue. It is quick to
treat an item as income, slow to recognize deductions or losses. Thus, the tax law
will not recognize deductions for contingent future losses except in very limited
situations. Good accounting, on the other hand, requires their recognition. Once this
fundamental difference in approach is accepted, income tax accounting methods
can be understood more easily.43 (emphasis supplied)

While there may be differences between tax and accounting,44 it cannot be said
that the two mutually exclude each other. As already made clear, tax laws borrowed
concepts that had origins from accounting. In truth, tax cannot do away with
accounting. It relies upon approved accounting methods and practices to effectively
carry out its objective of collecting the proper amount of taxes from the taxpayers.
Thus, an important mechanism established in many tax systems is the requirement
for taxpayers to make a return of their true income.45 Maintaining accounting books
and records, among other important considerations, would in turn assist the
taxpayers in complying with their obligation to file their income tax returns. At the
same time, such books and records provide vital information and possible bases for
the government, after appropriate audit, to make an assessment for deficiency tax
whenever so warranted under the circumstances.
The NIRC, just like the tax laws in other jurisdictions, recognizes the important
facility provided by generally accepted accounting principles and methods to the
primary aim of tax laws to collect the correct amount of taxes. The NIRC even
devoted a whole chapter on accounting periods and methods of accounting, some
relevant provisions of which we cite here for more emphasis:

CHAPTER VIII
ACCOUNTING PERIODS AND METHODS OF ACCOUNTING

Sec. 43. General Rule. - The taxable income shall be computed upon the basis of the
taxpayer's annual accounting period (fiscal year or calendar year, as the case may
be) in accordance with the method of accounting regularly employed in keeping the
books of such taxpayer; but if no such method of accounting has been so employed,
or if the method employed does not clearly reflect the income, the computation shall
be made in accordance with such method as in the opinion of the Commissioner
clearly reflects the income.
If the taxpayer's annual accounting period is other than a fiscal year, as defined in
Section 22(Q), or if the taxpayer has no annual accounting period, or does not keep
books, or if the taxpayer is an individual, the taxable income shall be computed on
the basis of the calendar year.

Sec. 44. Period in which Items of Gross Income Included. - The amount of all items of
gross income shall be included in the gross income for the taxable year in which
received by the taxpayer, unless, under methods of accounting permitted under
Section 43, any such amounts are to be properly accounted for as of a different
period.

In the case of the death of a taxpayer, there shall be included in computing taxable
income for the taxable period in which falls the date of his death, amounts accrued
up to the date of his death if not otherwise properly includible in respect of such
period or a prior period.

Sec. 45. Period/or which Deductions and Credits Taken. - The deductions 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 accounting upon the basis of which the
net income is computed, unless in order to clearly reflect the income, the deductions
should be taken as of a different period. In the case of the death of a taxpayer, there
shall be allowed as deductions for the taxable period in which falls the date of his
death, amounts accrued up to the date of his death if not otherwise properly
allowable in respect of such period or a prior period.

Sec. 46. Change of Accounting Period. - If a taxpayer, other than an individual,

changes his accounting period from fiscal year to calendar year, from calendar year
to fiscal year, or from one fiscal year to another, the net income shall, with the
approval of the Commissioner, be computed on the basis of such new accounting
period, subject to the provisions of Section 47.

xxxx

Sec. 48. Accounting for Long-term Contracts. - Income from long-term contracts shall
be repo1ied for tax purposes in the manner as provided in this Section.

As used herein, the term 'long-term contracts' means building, installation or

construction contracts covering a period in excess of one (1) year.

Persons whose gross income is derived in whole or in part from such contracts shall
report such income upon the basis of percentage of completion.1âwphi1

The return should be accompanied by a return certificate of architects or engineers

showing the percentage of completion during the taxable year of the entire work
performed under contract.

There should be deducted from such gross income all expenditures made during the
taxable year on account of the contract, account being taken of the material and
supplies on hand at the beginning and end of the taxable period for use in
connection with the work under the contract but not yet so applied.
If upon completion of a contract, it is found that the taxable net income arising
thereunder has not been clearly reflected for any year or years, the Commissioner
may permit or require an amended return.

Sec. 49. Installment Basis. -

(A) Sales of Dealers in Personal Property. - Under rules and regulations prescribed by
the Secretary of Finance, upon recommendation of the Commissioner, a person who
regularly sells or otherwise disposes of personal property on the installment plan
may return as income therefrom in any taxable year that proportion of the
installment payments actually received in that year, which the gross profit realized
or to be realized when payment is completed, bears to the total contract price.

(B) Sales of Realty and Casual Sales of Personality. - In the case (1) of a casual sale
or other casual disposition of personal property (other than property of a kind which
would properly be included in the inventory of the taxpayer if on hand at the close of
the taxable year), for a price exceeding One thousand pesos (₱1,000), or (2) of a
sale or other disposition of real prope1iy, if in either case the initial payments do not
exceed twenty-five percent (25%) of the selling price, the income may, under the
rules and regulations prescribed by the Secretary of Finance, upon recommendation
of the Commissioner, be returned on the basis and in the manner above prescribed
in this Section.

As used in this Section, the term 'initial payments' means the payments received in

cash or property other than evidences of indebtedness of the purchaser during the
taxable period in which the sale or other disposition is made.

(C) Sales of Real Property Considered as Capital Asset by Individuals. - An individual

who sells or disposes of real property, considered as capital asset, and is otherwise
qualified to report the gain therefrom under Subsection (B) may pay the capital
gains tax in installments under rules and regulations to be promulgated by the
Secretary of Finance, upon recommendation of the Commissioner.

(D) Change from Accrual to Installment Basis. - If a taxpayer entitled to the benefits

of Subsection (A) elects for any taxable year to report his taxable income on the
installment basis, then in computing his income for the year of change or any
subsequent year, amounts actually received during any such year on account of
sales or other dispositions of property made in any prior year shall not be excluded."
(emphasis in the original)

We now proceed to the matter respecting the accounting method employed by

Lancaster.

An accounting method is a "set of rules for determining when and how to report
income and deductions."46 The provisions under Chapter VIII, Title II of the NIRC
cited above enumerate the methods of accounting that the law expressly
recognizes, to wit:

(1) Cash basis method;47

(2) Accrual method;48
(3) Installment method;49
(4) Percentage of completion method;50 and
(5) Other accounting methods.

Any of the foregoing methods may be employed by any taxpayer so long as it

reflects its income properly and such method is used regularly. The peculiarities of
the business or occupation engaged in by a taxpayer would largely determine how it
would report incomes and expenses in its accounting books or records. The NIRC
does not prescribe a uniform, or even specific, method of accounting.

Too, other methods approved by the CIR, even when not expressly mentioned in the
NIRC, may be adopted if such method would enable the taxpayer to properly reflect
its income. Section 43 of the NIRC authorizes the CIR to allow the use of a method of
accounting that in its opinion would clearly reflect the income of the taxpayer.

G.R. Nos. L-18843 and L-18844 August 29, 1974

CONSOLIDATED MINES, INC., petitioner,

vs.
COURT OF TAX APPEALS and COMMISSIONER OF INTERNAL REVENUE,
respondents.

G.R. Nos. L-18853 & L-18854 August 29, 1974

COMMISSIONER OF INTERNAL REVENUE, petitioner,

vs.
CONSOLIDATED MINES, INC., respondent.

Office of the Solicitor General for Commissioner of Internal Revenue.

Tañada, Carreon & Tañada for Consolidated Mines, Inc.

17 Under the accrual system income is accruable in the year in which the
taxpayer's right thereto becomes fixed and definite, even though it may not be
actually received until a later year, while a deduction for a liability is to be
accrued and taken when the liability becomes fixed and certain, even though it
may not be paid until a later year. Commissioner of Internal Revenue v Blaine
141 F2d 201.
It has been held that the basis of the accrual system of accounting is that
obligations incurred in the normal course of business will be discharged in due
course; that the deductions have been "paid or accrued" or "paid and incurred;"
but in order to be accruable in the taxable year, a valid obligation upon which the
profit (or loss, in the case of a deduction) is to be determined must have existed
in the year in which the obligation became binding or enforceable. The date of
the accrued right to receive income, or the obligation to pay or expend money
constituting a deductible loss, is the date that fixes liability. Gain or loss may not
said to be fixed or accrued when the obligation is contingent upon the happening
of a future event. No duty or liability to pay an income tax upon a transaction
arises until the taxable year in which the event constituting the condition
precedent occurs under any system of accounting. Utah Idaho Sugar Co v Stage
Tax Commission, 73P 2d 974.

In the case of Republic v. De la Rama, L-21106, November 29, 1966, the

Supreme Court, in denying the imposition of the income tax, quoted with
 approval the finding of the lower court that there is no showing that income in
the form of said dividend had really been received which is the verb used in Sec.
21 of the National Internal Revenue Code, by The Estate, whether actually or
constructively.

18 The situation may thus be likened to that where a company and its sales
agent agreed that the latter's salary for each year was to be a given per cent of
his "cash collections," and because the company was keeping its books in
accordance with the accrual method, it is made to compute the agent's salary on
the accrual basis.

G.R. Nos. 118498 & 124377 October 12, 1999

FILIPINAS SYNTHETIC FIBER CORPORATION, petitioner,
vs.
COURT OF APPEALS, COURT OF TAX APPEALS and COMMISSIONER OF
INTERNAL REVENUE, respondents.

On the other hand, "under the accrual basis method of accounting, income is
reportable when all the events have occurred that fix the taxpayer's right to
receive the income, and the amount can be determined with reasonable
accuracy. Thus, it is the right to receive income, and not the actual receipt, that
determines when to include the amount in gross income." 5 Gleanable from this
notion are the following requisites of accrual method of accounting, to wit: "(1)
that the right to receive the amount must be valid, unconditional and
enforceable, i.e., not contingent upon future time; (2) the amount must be
reasonably susceptible of accurate estimate; and (3) there must be a reasonable
expectation that the amount will be paid in due course." 6

In the case at bar, after a careful examination of pertinent records, the Court
concurred in the finding by the Court of Appeals in CA GR. SP No. 32922 "that
there was a definite liability, a clear and imminent certainty that at the maturity
of the loan contracts, the foreign corporation was going to earn income in an
ascertained amount, so much so that petitioner already deducted as business
expense the said amount as interests due to the foreign corporation. This is
allowed under the law, petitioner having adopted the "accrual method" of
accounting in reporting its incomes."

2.