CIR V. Isabela Cultural Corp.

(2007)
Lessons Applicable: Accrual method, burden of proof in accrual method, deductibility of ordinary and
necessary trade, business, or professional expenses, all events test

Laws Applicable:

FACTS:

 BIR disallowed Isabela Cultural Corp. deductible expenses for services which were rendered
in 1984 and 1985 but only billed, paid and claimed as a deduction on 1986.  
 After CA sent its demand letters, Isabela protested.
 CTA found it proper to be claimed in 1986 and affirmed by CA
ISSUE: W/N Isabela who uses accrual method can claim on 1986 only

HELD: case is remanded to the BIR for the computation of Isabela Cultural Corporation’s liability
under Assessment Notice No. FAS-1-86-90-000680.

NO

 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; - 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
 (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.
 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.
 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.
 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.
 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. 
 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.
 In the instant case, the expenses for professional fees consist of expenses for legal
and auditing services. The expenses for legal services pertain to the 1984 and 1985 legal and
retainer fees of the law firm Bengzon Zarraga Narciso Cudala Pecson Azcuna & Bengson, and
for reimbursement of the expenses of said firm in connection with ICC’s tax problems for the
year 1984. As testified by the Treasurer of ICC, the firm has been its counsel since the 1960’s. -
failed to prove the burden

Facts:
Isabela Cultural Corporation (ICC), a domestic corporation received an assessment notice for
deficiency income tax and expanded withholding tax from BIR. It arose from the disallowance of
ICC’s claimed expense for professional and security services paid by ICC; as well as the alleged
understatement of interest income on the three promissory notes due from Realty Investment Inc.
The deficiency expanded withholding tax was allegedly due to the failure of ICC to withhold 1% e-
withholding tax on its claimed deduction for security services. ICC sought a reconsideration of the
assessments. Having received a final notice of assessment, it brought the case to CTA, which held
that it is unappealable, since the final notice is not a decision. CTA’s ruling was reversed by CA,
which was sustained by SC, and case was remanded to CTA. CTA rendered a decision in favor of
ICC. It ruled that the deductions for professional and security services were properly claimed, it said
that even if services were rendered in 1984 or 1985, the amount is not yet determined at that time.
Hence it is a proper deduction in 1986. It likewise found that it is the BIR which overstate the interest
income, when it applied compounding absent any stipulation.
Petitioner appealed to CA, which affirmed CTA, hence the petition.

Issue:
Whether or not the expenses for professional and security services are deductible.

Held:
No. One of the requisites for the deductibility of ordinary and necessary expenses is that it must
have been paid or incurred during the taxable year. This requisite is dependent on the
method of accounting of the taxpayer. In the case at bar, ICC is using the accrual method of
accounting. Hence, under this method, an expense is recognized when it is incurred. Under a
Revenue Audit Memorandum, when the method of accounting is accrual, expenses not being
claimed as deductions by a taxpayer in the current year when they are incurred cannot be claimed in
the succeeding year. 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 test does not demand that the amount of income or liability be known absolutely, only that a
taxpayer has at its disposal the information necessary to compute the amount with reasonable
accuracy. From the nature of the claimed deductions and the span of time during which the firm was
retained, ICC can be expected to have reasonably known the retainer fees charged by the firm. They
cannot give as an excuse the delayed billing, since it could have inquired into the amount of their
obligation and reasonably determine the amount.

CIR V GENERAL FOODS
Test of Reasonableness
 

Facts:
Respondent corporation General Foods (Phils), which is engaged in the manufacture of “Tang”,
“Calumet” and “Kool-Aid”, filed its income tax return for the fiscal year ending February 1985 and
claimed as deduction, among other business expenses, P9,461,246 for media advertising for “Tang”.

The Commissioner disallowed 50% of the deduction claimed and assessed deficiency income taxes of
P2,635,141.42 against General Foods, prompting the latter to file an MR which was denied.

General Foods later on filed a petition for review at CA, which reversed and set aside an earlier
decision by CTA dismissing the company’s appeal.

Issue:
W/N the subject media advertising expense for “Tang” was ordinary and necessary expense fully
deductible under the NIRC

Held:
No. Tax exemptions must be construed in stricissimi juris against the taxpayer and liberally in favor
of the taxing authority, and he who claims an exemption must be able to justify his claim by the
clearest grant of organic or statute law. Deductions for income taxes partake of the nature of tax
exemptions; hence, if tax exemptions are strictly construed, then deductions must also be strictly
construed.
To be deductible from gross income, the subject advertising expense must comply with the following
requisites: (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.

While the subject advertising expense was paid or incurred within the corresponding taxable year
and was incurred in carrying on a trade or business, hence necessary, the parties’  views conflict as to
whether or not it was ordinary. To be deductible, an advertising expense should not only be
necessary but also ordinary.

The Commissioner maintains that the subject advertising expense was not ordinary on the ground
that it failed the two conditions set by U.S. jurisprudence: first, “reasonableness” of the amount
incurred and second, the amount incurred must not be a capital outlay to create “goodwill” for the
product and/or private respondent’s business. Otherwise, the expense must be considered a capital
expenditure to be spread out over a reasonable time.

There is yet to be a clear-cut criteria or fixed test for determining the reasonableness of an
advertising expense. There being no hard and fast rule on the matter, the right to a deduction
depends on a number of factors such as but not limited to: the type and size of business in which the
taxpayer is engaged; the volume and amount of its net earnings; the nature of the expenditure itself;
the intention of the taxpayer and the general economic conditions. It is the interplay of these, among
other factors and properly weighed, that will yield a proper evaluation.

The Court finds the subject expense for the advertisement of a single product to be inordinately
large. Therefore, even if it is necessary, it cannot be considered an ordinary expense deductible under
then Section 29 (a) (1) (A) of the NIRC.

Advertising is generally of two kinds: (1) advertising to stimulate the current sale of merchandise or

use of services and (2) advertising designed to stimulate the future sale of merchandise or use of
services. The second type involves expenditures incurred, in whole or in part, to create or maintain
some form of goodwill for the taxpayer’s trade or business or for the industry or profession of which
the taxpayer is a member. If the expenditures are for the advertising of the first kind, then, except as
to the question of the reasonableness of amount, there is no doubt such expenditures are deductible
as business expenses. If, however, the expenditures are for advertising of the second kind, then
normally they should be spread out over a reasonable period of time.
The company’s media advertising expense for the promotion of a single product is doubtlessly
unreasonable considering it comprises almost one-half of the company’s entire claim for marketing
expenses for that year under review. Petition granted, judgment reversed and set aside.

AGUINALDO INDUSTRIES (FISHING

NETS) vs. COMMISSIONER OF
INTERNAL REVENUE G.R. No. L-
29790 February 25, 1982 Income Tax, Tax
Exemption, Necessary Expense
OCTOBER 23, 2017

FACTS:

Aguinaldo Industries Corp. is engaged in the manufacture of fishing nets, a tax-exempt industry,
and the manufacture of furniture. For accounting purposes, each division is provided with
separate books of accounts. Previously, Aguinaldo Industries acquired a parcel of land in
Muntinglupa,Rizal, as site of the fishing net factory. This transaction was entered in the books of
the Fish Nets Division of the Company.

Later, Aguinaldo Industries, it sold the said property, the profit from this sale which was entered
in the books of the Fish Nets Division as miscellaneous income to distinguish it from its tax-
exempt income. Petitioner filed two separate income tax returns and after investigation of these
returns, the examiners of the BIR found that the Fish Nets Division deducted from its gross
income P61,187.48 as additional remuneration paid to the officers of Aguinaldo Industries. The
examiner recommended the disallowance of the deduction. It appears from the books that such
deduction was claimed as part of the selling expenses of the land in Muntinglupa. Aguinaldo
Industries insists that said amount should be allowed as deduction because it was paid to its
officers as allowance or bonus pursuant to Section 3 of its by-laws.

ISSUE:
Whether the bonus given to the officers of Aguinaldo upon the sale of its Muntinglupa land is an
ordinary and necessary business expense deductible for income tax purposes?

RULING:

No. In general, only those ordinary and necessary expenses paid or incurred during the taxable
year in carrying on any trade or business, including a reasonable allowance for personal services
actually rendered can be claimed as a deductible. The bonus given to the officers of the
Aguinaldo Industries as their share of the profit realized from the sale of the land cannot be
deemed a deductible expense for tax purposes, even if the aforesaid sale could be considered as a
transact ion for Carrying on the trade or business of the Aguinaldo Industries and the grant of the
bonus to the corporate officers pursuant to Aguinaldo Industries’ by -laws could, as an intra-
corporate matter, be sustained.

Evidence show that the sale was effected through a broker who was paid by Aguinaldo Industries
a commission for his services. On the other hand, there is absolutely no evidence of any service
actually rendered by Aguinaldo Industries’ officers which could be the basis of a grant to them of
a bonus out of the profit derived from the sale. This being so, the payment of a bonus to them out
of the gain realized from the sale cannot be considered as a selling expense; nor can it be deemed
reasonable and necessary so as to make it deductible for tax purposes. Thus, the extraordinary
and unusual amounts paid by Aguinaldo to these directors in the guise and form of compensation
for their supposed services as such, without any relation to the measure of their actual services,
cannot be regarded as ordinary and necessary expenses within the meaning of the law.

Whenever a controversy arises on the deductibility, for purposes of income tax, of certain items
for alleged compensation of officers of the taxpayer, two (2) questions become material, namely:
(a)Have personal services been actually rendered by said officers? (b) In the affirmative case,
what is the reasonable allowance therefor