1. COMMISSIONER OF INTERNAL REVENUE V. LANCASTER PHILIPPINES, INC.

Facts:
Lancaster Philippines, Inc. is a domestic corporation established in 1963 and is engaged in the
production, processing, and marketing of tobacco.

In 1999, the Bureau of Internal Revenue issued Letter of Authority authorizing its revenue
officers to examine Lancaster's books of accounts and other accounting records for all internal
revenue taxes due from taxable year 1998 to an unspecified date.

The BIR issued a Preliminary Assessment Notice (PAN) which cited Lancaster for: 1)
overstatement of its purchases for the fiscal year April 1998 to March 1999 ; and 2)
noncompliance with the generally accepted accounting principle of proper matching of cost
and revenue. More concretely, the BIR disallowed the purchases of tobacco from farmers
covered by Purchase Invoice Vouchers for the months of February and March 1998 as
deductions against income for the fiscal year April 1998 to March 1999.

Lancaster argued that the February and March 1998 purchases should not have been
disallowed. It maintained that the situation of farmers engaged in producing tobacco, like
Lancaster, is unique in that the costs, i.e., purchases, are taken as of a different period and
posted in the year in which the gross income from the crop is realized. Lancaster concluded
that it correctly posted the subject purchases in the fiscal year ending March 1999 as it was
only in this year that the gross income from the crop was realized.

Lancaster received from the BIR a final assessment notice which assessed Lancaster's
deficiency income tax amounting to P11,496,770.18, as a consequence of the disallowance of
purchases claimed for the taxable year ending 31 March 1999.

BIR insists that the purchases in question should have been reported in FY 1998 in order to
conform to the generally accepted accounting principle of proper matching of cost and
revenue. Thus, when Lancaster reported the said purchases in FY 1999, this resulted in
overstatement of expenses warranting their disallowance and, by consequence, resulting in
the deficiency in the payment of its income tax for FY 1999.
Issue:
Was Lancaster wrong in applying for deductions for the taxable year in which the gross income
on tobacco crops was realized and not in the FY in which they were incurred?

Ruling:
No.

A reading of RAM No. 2-95, however, clearly evinces that it conforms with the concept that the
expenses paid or incurred be deducted in the year in which gross income from the sale of the
crops is realized. Put in another way, the expenses are matched with the related incomes
which are eventually earned. Nothing from the provision is it strictly required that for the
expense to be deductible, the income to which such expense is related to be realized in the
same year that it is paid or incurred. As noted by the CTA, the crop method is an unusual
method of accounting, unlike other recognized accounting methods that, by mandate of Sec.
45 of the NIRC, strictly require expenses be taken in the same taxable year when the income
is 'paid or incurred, ' or 'paid or accrued, ' depending upon the method of accounting employed
by the taxpayer.

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. An example of such method not
expressly mentioned in the NIRC, but duly approved by the CIR, is the 'crop method of
accounting' authorized under RAM No. 2-95.

Crop Year Basis is a method applicable only to farmers engaged in the production of crops
which take more than a year from the time of planting to the process of gathering and disposal.
Expenses paid or incurred are deductible in the year the gross income from the sale of the
crops are realized.

The crop method recognizes that the harvesting and selling of crops do not fall within the same
year that they are planted or grown. This method is especially relevant to farmers, or those
engaged in the business of producing crops who, pursuant to RAM No. 2-95, would then be
able to compute their taxable income on the basis of their crop year.

The rule enjoins the recognition of the expense (or the deduction of the cost) of crop
production in the year that the crops are sold (when income is realized).

In the present case, we find it wholly justifiable for Lancaster, as a business engaged in the
production and marketing of tobacco, to adopt the crop method of accounting. A taxpayer is
authorized to employ what it finds suitable for its purpose so long as it consistently does so ,
and in this case, Lancaster does appear to have utilized the method regularly for many
decades already.

Considering that [Lancaster's] fiscal period is from April 1, 1998 to March 31, 1999. On the
other hand, its crop year is from October 1, 1997 to September 1, 1998. Accordingly, in
applying the crop year method, all the purchases made by the respondent for October 1, 1997
to September 1, 1998 should be deducted from the fiscal year ending March 31, 1999, since it
is the time when the gross income from the crops is realized.
2. COMMISSIONER OF INTERNAL REVENUE vs. GENERAL FOODS (PHILS.), INC.

Facts:
Respondent corporation, which is engaged in the manufacture of beverages such as "Tang,"
"Calumet" and "Kool-Aid," filed its income tax return for the fiscal year ending February 28,
1985. In said tax return, respondent corporation claimed as deduction, among other business
expenses, the amount of P9,461,246 for media advertising for "Tang."

The Commissioner disallowed 50% or P4,730,623 of the deduction claimed by respondent

corporation. Consequently, respondent corporation was assessed deficiency income taxes in
the amount of P2,635, 141.42.

CTA: With such a gargantuan expense for the advertisement of a singular product, which even
excludes "other advertising and promotions" expenses, we are not prepared to accept that
such amount is reasonable "to stimulate the current sale of merchandise" regardless of
Petitioner's explanation. The staggering expense led us to believe that such expenditure was
incurred "to create or maintain some form of good will for the taxpayer's trade or business or
for the industry or profession of which the taxpayer is a member." The term "good will" is
generally used to denote the benefit arising from connection and reputation. As held in the
case of Welch vs. Helvering, efforts to establish reputation are akin to acquisition of capital
assets and, therefore, expenses related thereto are not business expenses but capital
expenditures. For sure such expenditure was meant not only to generate present sales but
more for future and prospective benefits. Hence, "abnormally large expenditures for advertising
are usually to be spread over the period of years during which the benefits of the expenditures
are received.

Issue:
Whether or not the subject media advertising expense for "Tang" incurred by respondent
corporation was an ordinary and necessary expense fully deductible under the National
Internal Revenue Code? Or was it a capital expenditure, paid in order to create "goodwill and
reputation" for respondent corporation and/or its products, which should have been amortized
over a reasonable period?

Ruling:
A capital expenditure.

Deductions for income tax purposes partake of the nature of tax exemptions; hence, if tax
exemptions are strictly construed, then deductions must also be strictly construed.

Section 34 (A) (1): 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.
We find 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.

Respondent corporation's venture to protect its brand franchise was tantamount to efforts to
establish a reputation. This was akin to the acquisition of capital assets and therefore
expenses related thereto were not to be considered as business expenses but as capital
expenditures.

True, it is the taxpayer's prerogative to determine the amount of advertising expenses it will
incur and where to apply them. Said prerogative, however, is subject to certain considerations.
The first relates to the extent to which the expenditures are actually capital outlays; this
necessitates an inquiry into the nature or purpose of such expenditures. The second, which
must be applied in harmony with the first, relates to whether the expenditures are ordinary and
necessary. Concomitantly, for an expense to be considered ordinary, it must be reasonable in
amount.

The Court of Tax Appeals ruled that respondent corporation failed to meet the two foregoing
limitations.

Respondent corporation incurred the subject advertising expense in order to protect its brand
franchise. We consider this as a capital outlay since it created goodwill for its business and/or
product. The P9,461,246 media advertising expense for the promotion of a single product,
almost one-half of petitioner corporation's entire claim for marketing expenses for that year
under review, inclusive of other advertising and promotion expenses of P2,678,328 and
P1,548,614 for consumer promotion, is doubtlessly unreasonable.
3. COMMISSIONER OF INTERNAL REVENUE, Petitioner, versus ISABELA CULTURAL
CORPORATION

Facts:
ICC received from the BIR Assessment Notice for deficiency income tax in the amount of
P333,196.86, and Assessment Notice for deficiency expanded withholding tax in the amount of
P4,897.79, inclusive of surcharges and interest, both for the taxable year 1986.

The deficiency income tax of P333,196.86, arose from BIR's disallowance of ICC's claimed
expense deductions for professional and security services billed to and paid by ICC in 1986, to
wit: auditing services, retainer’s fees, security services.

CTA: It held that the claimed deductions for professional and security services were properly
claimed by ICC in 1986 because it was only in the said year when the bills demanding
payment were sent to ICC. Hence, even if some of these professional services were rendered
to ICC in 1984 or 1985, it could not declare the same as deduction for the said years as the
amount thereof could not be determined at that time.

Issue:
Whether the Court of Appeals correctly: (1) sustained the deduction of the expenses for
professional and security services from ICC's gross income.

Ruling:
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.

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.

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 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. 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 as well as the
compensation for its legal services. The failure to determine the exact amount of the expense
during the taxable year when they could have been claimed as deductions cannot thus be
attributed solely to the delayed billing of these liabilities by the firm. For one, ICC, in the
exercise of due diligence could have inquired into the amount of their obligation to the firm,
especially so that it is using the accrual method of accounting. For another, it could have
reasonably determined the amount of legal and retainer fees owing to its familiarity with the
rates charged by their long time legal consultant.

The professional fees of SGV & Co. for auditing the financial statements of ICC for the year
1985 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 year 1985, it cannot determine the professional fees
which said company would charge for its services.

As to the expenses for security services, the records show that these expenses were incurred
by ICC in 1986[20] and could therefore be properly claimed as deductions for the said year.

In sum, Assessment Notice 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 BIR's disallowance of ICC's expenses for professional
services.
4. ING BANK N.V., ENGAGED IN BANKING OPERATIONS IN THE PHILIPPINES AS ING
BANK N.V. MANILA BRANCH, PETITIONER, VS. COMMISSIONER OF INTERNAL
REVENUE, RESPONDENT

Facts:
ING Bank received a Final Assessment Notice covering deficiency tax assessments for taxable
years 1996 and 1997. ING Bank "paid the deficiency assessments for [the] 1996 compromise
penalty, 1997 deficiency documentary stamp tax and 1997 deficiency final tax in the respective
amounts of P1,000.00, P1,000.00 and P75,013.25 [the original amount of P73,752.47 plus
additional interest]. ING Bank, however, "protested [on the same day] the remaining ten (10)
deficiency tax assessments in the total amount of P672,576,939.18.

ING Bank argued that it is not liable for deficiency withholding tax on compensation for the
accrued bonuses in the taxable years 1996 and 1997 considering that these were not
distributed to petitioner's officers and employees during those taxable years, hence, were not
yet subject to withholding tax.

Consequently, petitioner is still liable for the amounts of P167,384.97 and P397,157.70
representing deficiency withholding taxes on compensation for the respective years of 1996
and 1997

Issue:
Whether petitioner is liable for deficiency withholding tax on compensation for the accrued
bonuses in the taxable years 1996 and 1997 considering that these were not distributed to
petitioner's officers and employees during those taxable years, hence, were not yet subject to
withholding tax.

Ruling:
YES. Petitioner ING Bank is liable for the withholding tax on the bonuses since it claimed the
same as expenses in the year they were accrued.

The tax on compensation income is withheld at source under the creditable withholding tax
system wherein the tax withheld is intended to equal or at least approximate the tax due of the
payee on the said income. It was designed to enable (a) the individual taxpayer to meet his or
her income tax liability on compensation earned; and (b) the government to collect at source
the appropriate taxes on compensation. Taxes withheld are creditable in nature. Thus, the
employee is still required to file an income tax return to report the income and/or pay the
difference between the tax withheld and the tax due on the income. For over withholding, the
employee is refunded. Therefore, absolute or exact accuracy in the determination of the
amount of the compensation income is not a prerequisite for the employer's withholding
obligation to arise.
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.

An expense is accrued and deducted for tax purposes when (1) the obligation to pay is already
fixed; (2) the amount can be determined with reasonable accuracy; and, (3) it is already
knowable or the taxpayer can reasonably be expected to have known at the closing of its
books for the taxable year.

The obligation of the payor/employer to deduct and withhold the related withholding tax arises
at the time the income was paid or accrued or recorded as an expense in the
payor's/employer's books, whichever comes first.

Petitioner ING Bank accrued or recorded the bonuses as deductible expense in its books.
Therefore, its obligation to withhold the related withholding tax due from the deductions for
accrued bonuses arose at the time of accrual and not at the time of actual payment.

Here, petitioner ING Bank already recognized a definite liability on its part considering that it
had deducted as business expense from its gross income the accrued bonuses due to its
employees. Underlying its accrual of the bonus expense was a reasonable expectation or
probability that the bonus would be achieved. In this sense, there was already a constructive
payment for income tax purposes as these accrued bonuses were already allotted or made
available to its officers and employees.

The Petition is PARTLY GRANTED. The assessments with respect to petitioner ING Bank's
liabilities for deficiency documentary stamp taxes on its special savings accounts for the
taxable years 1996 and 1997 and deficiency tax on onshore interest income under the foreign
currency deposit system for taxable year 1996 are hereby SET ASIDE solely in view of
petitioner ING Bank's availment of the tax amnesty program under Republic Act No. 9480. The
April 5, 2005 Decision of the Court of Tax Appeals En Banc, which affirmed the August 9, 2004
Decision and November 12, 2004 Resolution of the Court of Tax Appeals Second Division
holding petitioner ING Bank liable for deficiency withholding tax on compensation for the
taxable years 1996 and 1997 in the total amount of P564,542.67 inclusive of interest, is
AFFIRMED.
5. H. TAMBUNTING PAWNSHOP, INC. VS. COMMISSIONER OF INTERNAL REVENUE

Facts:
H. Tambunting Pawnshop, Inc. is a domestic corporation duly licensed and authorized to
engage in the pawnshop business.

The Bureau of Internal Revenue issued assessment notices and demand letters assessing
Tambunting for deficiency percentage tax, income tax and compromise penalties for taxable
year 1997.

Tambunting instituted an administrative protest against the assessment notices and demand
letters with the Commissioner of Internal Revenue. However, it was ordered to pay
P4,536,687.15 representing deficiency income tax for the year 1997, plus 20% delinquency
interest.

Tambunting argues that the CTA should have allowed its deductions because it had been able
to point out the provisions of law authorizing the deductions; that it proved its entitlement to the
deductions through all the documentary and testimonial evidence presented in court- he CTA
had allowed deductions for ordinary and necessary expenses on the basis of cash vouchers
issued by the taxpayer or certifications issued by the payees evidencing receipt of interest on
loans as well as agreements relating to the imposition of interest.

Issue:
Ruling:
This case involved assessments relating to transactions incurred by Tambunting prior to the
effectivity of Republic Act No. 8424 (National Internal Revenue Code of 1997, or NIRC of
1997), the provisions governing the propriety of the deductions was Presidential Decree 1158
(NIRC of 1977)

The proper substantiation requirement for an expense to be allowed is the official receipt or
invoice. While the rental payments were subjected to the applicable expanded withholding
taxes, such returns are not the documents required by law to substantiate the rental expense.
Petitioner should have submitted official receipts to support its claim.

In order that the cash vouchers may be given probative value, these must be validated with
official receipts.

Deductions for income tax purposes partake of the nature of tax exemptions and are strictly
construed against the taxpayer, who must prove by convincing evidence that he is entitled to
the deduction claimed.27 Tambunting did not discharge its burden of substantiating its claim
for deductions due to the inadequacy of its documentary support of its claim. Its reliance on
 withholding tax returns, cash vouchers, lessor’s certifications, and the contracts of lease was
futile because such documents had scant probative value. As the CTA En Banc succinctly put
it, the law required Tambunting to support its claim for deductions with the corresponding
official receipts issued by the service providers concerned.

6. CM HOSKINS VS. CIR L-24059

FACTS: CM HOSKINS is a domestic corporation engaged in the real estate business as

brokers, managing agents and administrators. It filed its income tax return for its fiscal year
ending September 30, 1957 showing a net income of P92,540.25 and a tax liability due
thereon of P18,508.00, which it paid in due course. Upon verification of its return,
respondent Commissioner of Internal Revenue, disallowed four items of deduction in
petitioner's tax returns and assessed against it an income tax deficiency in the amount of
P28,054.00 plus interests. Among those disallowed is the item paid to Mr. C. M. Hoskins, its
founder and controlling stockholder the amount of P99,977.91 representing 50% of supervision
fees earned by it.

ISSUE: Is the payment by the taxpayer to its controlling stockholder of 50% of its supervision
fees or the amount of P99,977.91 a deductible ordinary and necessary expense? NO

RULING: Considering that in addition to being Chairman of the board of directors of petitioner
corporation, which bears his name, Hoskins, who owned 99.6% of its total authorized capital
stock while the four other officers-stockholders of the firm owned a total of four-tenths of 1%,
or one-tenth of 1% each, with their respective nominal shareholdings of one share each was
also salesman-broker for his company, receiving a 50% share of the sales commissions
earned by petitioner, besides his monthly salary of P3,750.00 amounting to an annual
compensation of P45,000.00 and an annual salary bonus of P40,000.00, plus free use of the
company car and receipt of other similar allowances and benefits, the Tax Court correctly ruled
that the payment by petitioner to Hoskins of the additional sum of P99,977.91 as his equal or
50% share of the 8% supervision fees received by petitioner as managing agents of the real
estate, subdivision projects of Paradise Farms, Inc. and Realty Investments, Inc. was
inordinately large and could not be accorded the treatment of ordinary and necessary
expenses allowed as deductible items within the purview of Section 30 (a) (i) of the Tax Code.

If such payment of P99,977.91 were to be allowed as a deductible item, then Hoskins would
receive on these three items alone (salary, bonus and supervision fee) a total of P184,977.91,
which would be double the petitioner's reported net income for the year of P92,540.25. As
correctly observed by respondent. If independently, a one-time P100,000.00-fee to plan and
lay down the rules for supervision of a subdivision project were to be paid to an experienced
realtor such as Hoskins, its fairness and deductibility by the taxpayer could be conceded; but
here 50% of the supervision fee of petitioner was being paid by it to Hoskins every year since
1955 up to 1963 and for as long as its contract with the subdivision owner subsisted,
regardless of whether services were actually rendered by Hoskins, since his services to
petitioner included such planning and supervision and were already handsomely paid for by
petitioner.
The Court reaffirmed the test of reasonableness, enunciated in the earlier 1967 case
involving the same parties, that: "It is a general rule that 'Bonuses to employees made in
good faith and as additional compensation for the services actually rendered by the employees
are deductible, provided such payments, when added to the stipulated salaries, do not exceed
a reasonable compensation for the services rendered'. The conditions precedent to the
deduction of bonuses to employees are: (1) the payment of the bonuses is in fact
compensation; (2) it must be for personal services actually rendered; and (3) the bonuses,
when added to the salaries, are 'reasonable . . . when measured by the amount and quality of
the services performed with relation to the business of the particular taxpayer'.
"There is no fixed test for determining the reasonableness of a given bonus as compensation.
This depends upon many factors, one of them being 'the amount and quality of the services
performed with relation to the business.' Other tests suggested are: payment must be 'made in
good faith'; 'the character of the taxpayer's business, the volume and amount of its net
earnings, its locality, the type and extent of the services rendered, the salary policy of the
corporation'; 'the size of the particular business'; 'the employees' qualifications and
contributions to the business venture'; and 'general economic conditions. However, 'in
determining whether the particular salary or compensation payment is reasonable, the
situation must be considered as whole. Ordinarily, no single factor is decisive it is important to
keep in mind that it seldom happens that the application of one test can give satisfactory
answer, and that ordinarily it is the interplay of several factors, properly weighted for the
particular case, which must furnish the final answer."

Petitioner's case fails to pass the test. On the right of the employer as against respondent
Commissioner to fix the compensation of its officers and employees, we there held further that
while the employer's right may be conceded, the question of the allowance or disallowance
thereof as deductible expenses for income tax purposes is subject to determination by
respondent Commissioner of Internal Revenue. Thus: "As far as petitioner's contention that as
employer it has the right to fix the compensation of its officers and employees and that it was in
the exercise of such right that it deemed proper to pay the bonuses in question, all that We
need say is this: that right may be conceded, but for income tax purposes the employer cannot
legally claim such bonuses as deductible expenses unless they are shown to be reasonable.
To hold otherwise would open the gate of rampant tax evasion.

As such, the same should be considered as as a distribution of earnings and profits of the
taxpayer.