CIR v.

GENERAL FOODS
Case: respondent corporation claimed as deduction, among other business expenses, the
amount of P9,461,246 for media advertising for "Tang."
Issue: Deductible?
Ruling: No.

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.

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.

The respondent corporation itself also admitted, in its letter protest 8 to the Commissioner of
Internal Revenue’s assessment, that the subject media expense was incurred in order to protect
respondent corporation’s brand franchise, a critical point during the period under review.

The protection of brand franchise is analogous to the maintenance of goodwill or title to one’s
property. This is a capital expenditure which should be spread out over a reasonable period of
time.9

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.
UST REVIEWER: The protection of taxpayer’s brand franchise is analogous to the maintenance of
goodwill or title to one’s property which is in the nature of a capital expenditure. An advertising
expense, of such nature does not qualify as an ordinary business expense, because the benefit to
be enjoyed by the taxpayer goes beyond one taxable year
NOTE:
Ordinary expenses are those which are common to incur in trade or business. On the other hand,
capital expenditures are those incurred to improve assets and benefits for more than 1 taxable
year. Ordinary expenses are usually incurred during a taxable year and benefits such taxable year.
CIR vs. BENEDICTO
FACTS: On July 16, 1990, a compromise agreement was executed between the PCGG,
represented by PCGG Chairman Mateo Caparas (Caparas) and Benedicto in Berne, Switzerland,
wherein they agreed that the Swiss cases involvi'rfg the latter's bank deposits would be
terminated with the withdrawal of his (Benedicto's) opposition to the appeals filed against the
grant of international legal cooperation. On the other hand, the Republic would request the Swiss
authorities to unfreeze all deposits with the Swiss Federal and Cantonal authorities in order to
comply with the agreement. It was also agreed upon that the PCGG shall grant Benedicto
immunity from civil, criminal and tax liabilities over his 49% share in the Swiss deposits amounting
to US$ l 5 ,633, 722.53 in consideration of his having ceded to the Republic 51 % of the total
amount of the said deposits.
Here, the CIR himself specifically declared that the amount being assessed for deficiency income
tax against the intestate estate arose from the "income" Benedicto got in taxable year 1990 by
virtue of the compromise agreement. In other words, without the said agreement, Benedicto
would not have received his 49% share in the Swiss deposits.
ISSUE: whether or not the Intestate estate of Roberto S. Benedicto can be held liable for
deficiency income tax
RULING:
Income means all the wealth which flows into the taxpayer other than a mere return on capital.
Capital is a fund or prope1iy existing at one distinct point in time while income denotes a flow of
wealth during a definite period of time. Income is gain derived and severed from capital. For
income to be taxable, the following requisites must exist:
(1) there must be gain;
(2) the gain must be realized or received; and
(3) the gain must not be excluded by law or treaty from taxation.
It has been clearly established that, although the deposits were subject of a freeze order by the
Swiss authorities, they remained, and were later confirmed, to be owned by Benedicto as early
as 1986 when they were frozen. The compromise agreement only led to the unfreezing of these
deposits and termination of the Swiss cases against Benedicto in exchange for the withdrawal of
his opposition and appeal against the grant of international legal cooperation requested by the
Republic. The 49% share in the deposits was in no way an income because Benedicto did not gain
any wealth or did not become any richer than he was before. In fact, his wealth was diminished
by virtue of the agreement for having ceded 51% to the Republic. The 49% share was, therefore,
a mere return of capital which was not subject to income tax. The CTA En Banc was correct in
affirming the CTA Division's disposition that "if there would be any amount of the Swiss deposits
that may be subjected to income tax, the same pertains only to the interest income component
of said deposits, for the interest income earned by said Swiss deposits is a gain derived and
severed from capital, or a flow of wealth."
Cyanide Philippines vs CA
Facts:

Petitioner, Cyanamid Philippines, Inc., a corporation organized under Philippine laws, is a wholly
owned subsidiary of American Cyanamid Co. based in Maine, USA. It is engaged in the
manufacture of pharmaceutical products and chemicals, a wholesaler of imported finished
goods, and an importer/indentor.

Petitioner, through its external accountant, Sycip, Gorres, Velayo & Co., claimed, among others,
that the surtax for the undue accumulation of earnings was not proper because the said profits
were retained to increase petitioner's working capital and it would be used for reasonable
business needs of the company.

Relying on decisions of the American Federal Courts, petitioner stresses that the accumulated
earnings tax does not apply to Cyanamid, a wholly owned subsidiary of a publicly owned
company.10 Specifically, petitioner cites Golconda Mining Corp. vs. Commissioner, 507 F.2d 594,
whereby the U.S. Ninth Circuit Court of Appeals had taken the position that the accumulated
earnings tax could only apply to a closely held corporation.

Issue: WHETHER THE RESPONDENT COURT ERRED IN HOLDING THAT THE PETITIONER IS LIABLE
FOR THE ACCUMULATED EARNINGS TAX FOR THE YEAR 1981
Ruling:
Sec. 29- Imposition of Improperly Accumulated Earnings
The provision discouraged tax avoidance through corporate surplus accumulation. When
corporations do not declare dividends, income taxes are not paid on the undeclared dividends
received by the shareholders. The tax on improper accumulation of surplus is essentially a
penalty tax designed to compel corporations to distribute earnings so that the said earnings by
shareholders could, in turn, be taxed.

Petitioner does not fall among those exempt classes in Sec 29 B (2).

As of 1981 the working capital of Cyanamid was P25,776,991.00, or more than twice its current
liabilities. That current ratio of Cyanamid, therefore, projects adequacy in working capital. Said
working capital was expected to increase further when more funds were generated from the
succeeding year's sales. Available income covered expenses or indebtedness for that year, and
there appeared no reason to expect an impending "working capital deficit" which could have
necessitated an increase in working capital, as rationalized by petitioner.

In order to determine whether profits are accumulated for the reasonable needs to avoid the
surtax upon shareholders, it must be shown that the controlling intention of the taxpayer is
manifest at the time of accumulation, not intentions declared subsequently, which are mere
afterthoughts. Furthermore, the accumulated profits must be used within a reasonable time
after the close of the taxable year. In the instant case, petitioner did not establish, by clear and
convincing evidence, that such accumulation of profit was for the immediate needs of the
business.
CHAMBER OF REAL ESTATE v. ROMULO
FACTS:

Petitioner assails the validity of the imposition of minimum corporate income tax (MCIT) on
corporations and creditable withholding tax (CWT) on sales of real properties classified as
ordinary assets.

Section 27(E) of RA 8424 provides for MCIT on domestic corporations and is implemented by RR
9-98. Petitioner argues that the MCIT violates the due process clause because it levies income
tax even if there is no realized gain.

Petitioner also seeks to nullify Sections 2.57.2(J) (as amended by RR 6-2001) and 2.58.2 of RR 2-
98, and Section 4(a)(ii) and (c)(ii) of RR 7-2003, all of which prescribe the rules and procedures
for the collection of CWT on the sale of real properties categorized as ordinary assets. Petitioner
contends that these revenue regulations are contrary to law for two reasons: first, they ignore
the different treatment by RA 8424 of ordinary assets and capital assets and second, respondent
Secretary of Finance has no authority to collect CWT, much less, to base the CWT on the gross
selling price or fair market value of the real properties classified as ordinary assets.

ISSUE: whether or not the imposition of the MCIT on domestic corporations is unconstitutional
and

whether or not the imposition of CWT on income from sales of real properties classified
as ordinary assets under RRs 2-98, 6-2001 and 7-2003, is unconstitutional.

RULING:

Domestic corporations owe their corporate existence and their privilege to do business to the
government. They also benefit from the efforts of the government to improve the financial
market and to ensure a favorable business climate. It is therefore fair for the government to
require them to make a reasonable contribution to the public expenses.

Congress intended to put a stop to the practice of corporations which, while having large turn-
overs, report minimal or negative net income resulting in minimal or zero income taxes year in
and year out, through under-declaration of income or over-deduction of expenses otherwise
called tax shelters.

The primary purpose of any legitimate business is to earn a profit. Continued and repeated losses
after operations of a corporation or consistent reports of minimal net income render its financial
statements and its tax payments suspect. For sure, certain tax avoidance schemes resorted to by
corporations are allowed in our jurisdiction. The MCIT serves to put a cap on such tax shelters.
As a tax on gross income, it prevents tax evasion and minimizes tax avoidance schemes achieved
through sophisticated and artful manipulations of deductions and other stratagems. Since the
tax base was broader, the tax rate was lowered.

For income to be taxable, the following requisites must exist:

(1) there must be gain;

(2) the gain must be realized or received and

(3) the gain must not be excluded by law or treaty from taxation.

Certainly, an income tax is arbitrary and confiscatory if it taxes capital because capital is not
income. In other words, it is income, not capital, which is subject to income tax. However, the
MCIT is not a tax on capital.

The MCIT is imposed on gross income which is arrived at by deducting the capital spent by a
corporation in the sale of its goods, i.e., the cost of goods and other direct expenses from gross
sales. Clearly, the capital is not being taxed.

Furthermore, the MCIT is not an additional tax imposition. It is imposed in lieu of the normal
net income tax, and only if the normal income tax is suspiciously low. The MCIT merely
approximates the amount of net income tax due from a corporation, pegging the rate at a very
much reduced 2% and uses as the base the corporation’s gross income.

Besides, there is no legal objection to a broader tax base or taxable income by eliminating all
deductible items and at the same time reducing the applicable tax rate.49

Statutes taxing the gross "receipts," "earnings," or "income" of particular corporations are
found in many jurisdictions. Tax thereon is generally held to be within the power of a state to
impose; or constitutional, unless it interferes with interstate commerce or violates the
requirement as to uniformity of taxation.50

We thus join a number of other courts in upholding the constitutionality of the [AMT]. xxx [It] is
a rational means of obtaining a broad-based tax, and therefore is constitutional.

NOTE: Sec. 27 E- Minimum Income Tax: 2% of the gross income…when the minimum income tax
is greater than the tax computed
Petitioner alleges that RR 9-98 is a deprivation of property without due process of law because
the MCIT is being imposed and collected even when there is actually a loss, or a zero or negative
taxable income:

Sec. 2.27(E) [MCIT] on Domestic Corporations. —

(1) Imposition of the Tax. — xxx The MCIT shall be imposed whenever such corporation has zero
or negative taxable income or whenever the amount of [MCIT] is greater than the normal income
tax due from such corporation. (Emphasis supplied)

RR 9-98, in declaring that MCIT should be imposed whenever such corporation has zero or
negative taxable income, merely defines the coverage of Section 27(E). This means that even if a
corporation incurs a net loss in its business operations or reports zero income after deducting its
expenses, it is still subject to an MCIT of 2% of its gross income. This is consistent with the law
which imposes the MCIT on gross income notwithstanding the amount of the net income. But
the law also states that the MCIT is to be paid only if it is greater than the normal net income.
Obviously, it may well be the case that the MCIT would be less than the net income of the
corporation which posts a zero or negative taxable income.

We now proceed to the issues involving the CWT.

The withholding tax system is a procedure through which taxes (including income taxes) are
collected. Under Section 57 of RA 8424, the types of income subject to withholding tax are
divided into three categories: (a) withholding of final tax on certain incomes; (b) withholding of
creditable tax at source and (c) tax-free covenant bonds. Petitioner is concerned with the second
category (CWT) and maintains that the revenue regulations on the collection of CWT on sale of
real estate categorized as ordinary assets are unconstitutional.

Petitioner, after enumerating the distinctions between capital and ordinary assets under RA
8424, contends that Sections 2.57.2(J) and 2.58.2 of RR 2-98 and Sections 4(a)(ii) and (c)(ii) of RR
7-2003 were promulgated "with grave abuse of discretion amounting to lack of jurisdiction" and
"patently in contravention of law" because they ignore such distinctions. Petitioner’s conclusion
is based on the following premises: (a) the revenue regulations use gross selling price (GSP) or
fair market value (FMV) of the real estate as basis for determining the income tax for the sale of
real estate classified as ordinary assets and (b) they mandate the collection of income tax on a
per transaction basis, i.e., upon consummation of the sale via the CWT, contrary to RA 8424 which
calls for the payment of the net income at the end of the taxable period.

Petitioner theorizes that since RA 8424 treats capital assets and ordinary assets differently,
respondents cannot disregard the distinctions set by the legislators as regards the tax base,
modes of collection and payment of taxes on income from the sale of capital and ordinary assets.

Petitioner’s arguments have no merit.

Authority of the Secretary of Finance to Order the Collection of CWT on Sales of Real Property
Considered as Ordinary Assets

The Secretary of Finance is granted, under Section 244 of RA 8424, the authority to promulgate
the necessary rules and regulations for the effective enforcement of the provisions of the law.
Such authority is subject to the limitation that the rules and regulations must not override, but
must remain consistent and in harmony with, the law they seek to apply and implement. 64 It is
well-settled that an administrative agency cannot amend an act of Congress.65

We have long recognized that the method of withholding tax at source is a procedure of collecting
income tax which is sanctioned by our tax laws.66 The withholding tax system was devised for
three primary reasons: first, to provide the taxpayer a convenient manner to meet his probable
income tax liability; second, to ensure the collection of income tax which can otherwise be lost
or substantially reduced through failure to file the corresponding returns and third, to improve
the government’s cash flow.67 This results in administrative savings, prompt and efficient
collection of taxes, prevention of delinquencies and reduction of governmental effort to collect
taxes through more complicated means and remedies.68

Respondent Secretary has the authority to require the withholding of a tax on items of income
payable to any person, national or juridical, residing in the Philippines. Such authority is derived
from Section 57(B) of RA 8424 which provides:

SEC. 57. Withholding of Tax at Source. –

xxx xxx xxx

(B) Withholding of Creditable Tax at Source. The [Secretary] may, upon the recommendation of
the [CIR], require the withholding of a tax on the items of income payable to natural or juridical
persons, residing in the Philippines, by payor-corporation/persons as provided for by law, at the
rate of not less than one percent (1%) but not more than thirty-two percent (32%) thereof, which
shall be credited against the income tax liability of the taxpayer for the taxable year.

The questioned provisions of RR 2-98, as amended, are well within the authority given by Section
57(B) to the Secretary, i.e., the graduated rate of 1.5%-5% is between the 1%-32% range; the
withholding tax is imposed on the income payable and the tax is creditable against the income
tax liability of the taxpayer for the taxable year.

Effect of RRs on the Tax Base for the Income Tax of Individuals or Corporations Engaged in the
Real Estate Business

Petitioner maintains that RR 2-98, as amended, arbitrarily shifted the tax base of a real estate
business’ income tax from net income to GSP or FMV of the property sold.

Petitioner is wrong.
The taxes withheld are in the nature of advance tax payments by a taxpayer in order to extinguish
its possible tax obligation. 69 They are installments on the annual tax which may be due at the
end of the taxable year.70

Under RR 2-98, the tax base of the income tax from the sale of real property classified as ordinary
assets remains to be the entity’s net income imposed under Section 24 (resident individuals) or
Section 27 (domestic corporations) in relation to Section 31 of RA 8424, i.e. gross income less
allowable deductions. The CWT is to be deducted from the net income tax payable by the
taxpayer at the end of the taxable year.71 Precisely, Section 4(a)(ii) and (c)(ii) of RR 7-2003
reiterate that the tax base for the sale of real property classified as ordinary assets remains to be
the net taxable income:

Section 4. – Applicable taxes on sale, exchange or other disposition of real property. -

Gains/Income derived from sale, exchange, or other disposition of real properties shall unless
otherwise exempt, be subject to applicable taxes imposed under the Code, depending on
whether the subject properties are classified as capital assets or ordinary assets;

xxx xxx xxx

a. In the case of individual citizens (including estates and trusts), resident aliens, and non-resident
aliens engaged in trade or business in the Philippines;

xxx xxx xxx

(ii) The sale of real property located in the Philippines, classified as ordinary assets, shall
be subject to the [CWT] (expanded) under Sec. 2.57.2(j) of [RR 2-98], as amended, based on the
[GSP] or current [FMV] as determined in accordance with Section 6(E) of the Code, whichever is
higher, and consequently, to the ordinary income tax imposed under Sec. 24(A)(1)(c) or 25(A)(1)
of the Code, as the case may be, based on net taxable income.

xxx xxx xxx

c. In the case of domestic corporations.

The sale of land and/or building classified as ordinary asset and other real property (other than
land and/or building treated as capital asset), regardless of the classification thereof, all of which
are located in the Philippines, shall be subject to the [CWT] (expanded) under Sec. 2.57.2(J) of
[RR 2-98], as amended, and consequently, to the ordinary income tax under Sec. 27(A) of the
Code. In lieu of the ordinary income tax, however, domestic corporations may become subject
to the [MCIT] under Sec. 27(E) of the same Code, whichever is applicable. (Emphasis supplied)

Accordingly, at the end of the year, the taxpayer/seller shall file its income tax return and credit
the taxes withheld (by the withholding agent/buyer) against its tax due. If the tax due is greater
than the tax withheld, then the taxpayer shall pay the difference. If, on the other hand, the tax
due is less than the tax withheld, the taxpayer will be entitled to a refund or tax credit.
Undoubtedly, the taxpayer is taxed on its net income.

The use of the GSP/FMV as basis to determine the withholding taxes is evidently for purposes of
practicality and convenience. Obviously, the withholding agent/buyer who is obligated to
withhold the tax does not know, nor is he privy to, how much the taxpayer/seller will have as its
net income at the end of the taxable year. Instead, said withholding agent’s knowledge and
privity are limited only to the particular transaction in which he is a party. In such a case, his basis
can only be the GSP or FMV as these are the only factors reasonably known or knowable by him
in connection with the performance of his duties as a withholding agent.

No Blurring of Distinctions Between Ordinary Assets and Capital Assets

RR 2-98 imposes a graduated CWT on income based on the GSP or FMV of the real property
categorized as ordinary assets. On the other hand, Section 27(D)(5) of RA 8424 imposes a final
tax and flat rate of 6% on the gain presumed to be realized from the sale of a capital asset based
on its GSP or FMV. This final tax is also withheld at source.

The differences between the two forms of withholding tax, i.e., creditable and final, show that
ordinary assets are not treated in the same manner as capital assets. Final withholding tax
(FWT) and CWT are distinguished as follows:

FWT CWT

a) The amount of income tax withheld a) Taxes withheld on certain income

by the withholding agent is constituted payments are intended to equal or at
as a full and final payment of the income least approximate the tax due of the
tax due from the payee on the said payee on said income.
income.

b)The liability for payment of the tax
rests primarily on the payor as a
withholding agent.
b) Payee of income is required to report
the income and/or pay the difference
between the tax withheld and the tax
due on the income. The payee also has
the right to ask for a refund if the tax
withheld is more than the tax due.
 c) The payee is not required to file an c) The income recipient is still required
income tax return for the particular to file an income tax return, as
income. prescribed in Sec. 51 and Sec. 52 of the
NIRC, as amended.

As previously stated, FWT is imposed on the sale of capital assets. On the other hand, CWT is
imposed on the sale of ordinary assets. The inherent and substantial differences between FWT
and CWT disprove petitioner’s contention that ordinary assets are being lumped together with,
and treated similarly as, capital assets in contravention of the pertinent provisions of RA 8424.

NOTE:

1. Ordinary assets – refer to properties held by the taxpayer used in connection with his trade
or business which includes the following: [SOUR]

a) Stock in trade of the taxpayer or other 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

b) Property held by the taxpayer primarily for sale to customers in the Ordinary course of trade
or business

c) Property Used in the trade or business of a character which is subject to the allowance for
depreciation provided in the NIRC

d) Real property used in trade or business of the taxpayer

Examples of ordinary assets

a) The condominium building owned by a realty company, the units of which are for rent or for
sale

b) Machinery and equipment of a manufacturing concern subject to depreciation

c) The motor vehicles of a person engaged in transportation business

2. Capital assets - include property held by the taxpayer (whether or not connected with his
trade or business) other than SOUR above.

Examples of capital assets

a) Jewelry not used for trade or business

b) Residential houses and lands owned and used as such

c) Automobiles not used in trade or business

d) Stock and securities held by taxpayers other than dealers in securities

Petitioner insists that the levy, collection and payment of CWT at the time of transaction are
contrary to the provisions of RA 8424 on the manner and time of filing of the return, payment
and assessment of income tax involving ordinary assets.

The fact that the tax is withheld at source does not automatically mean that it is treated exactly
the same way as capital gains. As aforementioned, the mechanics of the FWT are distinct from
those of the CWT. The withholding agent/buyer’s act of collecting the tax at the time of the
transaction by withholding the tax due from the income payable is the essence of the withholding
tax method of tax collection.

No Rule that Only Passive

Incomes Can Be Subject to CWT

Petitioner submits that only passive income can be subjected to withholding tax, whether final
or creditable. According to petitioner, the whole of Section 57 governs the withholding of income
tax on passive income. The enumeration in Section 57(A) refers to passive income being
subjected to FWT. It follows that Section 57(B) on CWT should also be limited to passive income:

SEC. 57. Withholding of Tax at Source. —

(A) Withholding of Final Tax on Certain Incomes. — Subject to rules and regulations, the
[Secretary] may promulgate, upon the recommendation of the [CIR], requiring the filing
of income tax return by certain income payees, the tax imposed or prescribed by Sections
24(B)(1), 24(B)(2), 24(C), 24(D)(1); 25(A)(2), 25(A)(3), 25(B), 25(C), 25(D), 25(E); 27(D)(1),
27(D)(2), 27(D)(3), 27(D)(5); 28(A)(4), 28(A)(5), 28(A)(7)(a), 28(A)(7)(b), 28(A)(7)(c),
28(B)(1), 28(B)(2), 28(B)(3), 28(B)(4), 28(B)(5)(a), 28(B)(5)(b), 28(B)(5)(c); 33; and 282 of
this Code on specified items of income shall be withheld by payor-corporation and/or
person and paid in the same manner and subject to the same conditions as provided in
Section 58 of this Code.

(B) Withholding of Creditable Tax at Source. — The [Secretary] may, upon the
recommendation of the [CIR], require the withholding of a tax on the items of income
payable to natural or juridical persons, residing in the Philippines, by payor-
corporation/persons as provided for by law, at the rate of not less than one percent (1%)
 but not more than thirty-two percent (32%) thereof, which shall be credited against the
income tax liability of the taxpayer for the taxable year. (Emphasis supplied)

This line of reasoning is non sequitur.

Section 57(A) expressly states that final tax can be imposed on certain kinds of income and
enumerates these as passive income. The BIR defines passive income by stating what it is not:

…if the income is generated in the active pursuit and performance of the corporation’s primary
purposes, the same is not passive income…76

It is income generated by the taxpayer’s assets. These assets can be in the form of real properties
that return rental income, shares of stock in a corporation that earn dividends or interest income
received from savings.

On the other hand, Section 57(B) provides that the Secretary can require a CWT on "income
payable to natural or juridical persons, residing in the Philippines." There is no requirement that
this income be passive income. If that were the intent of Congress, it could have easily said so.

Indeed, Section 57(A) and (B) are distinct. Section 57(A) refers to FWT while Section 57(B)
pertains to CWT. The former covers the kinds of passive income enumerated therein and the
latter encompasses any income other than those listed in 57(A). Since the law itself makes
distinctions, it is wrong to regard 57(A) and 57(B) in the same way.

To repeat, the assailed provisions of RR 2-98, as amended, do not modify or deviate from the text
of Section 57(B). RR 2-98 merely implements the law by specifying what income is subject to
CWT. It has been held that, where a statute does not require any particular procedure to be
followed by an administrative agency, the agency may adopt any reasonable method to carry out
its functions.77 Similarly, considering that the law uses the general term "income," the Secretary
and CIR may specify the kinds of income the rules will apply to based on what is feasible. In
addition, administrative rules and regulations ordinarily deserve to be given weight and respect
by the courts78 in view of the rule-making authority given to those who formulate them and their
specific expertise in their respective fields.
CIR vs ISABELA CORPORATION

FACTS: A domestic corporation, received from the BIR Assessment Notice No. FAS-1-86-90-
000680 for deficiency income tax in the amount of P333,196.86, and Assessment Notice No.
FAS-1-86-90-000681 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:

(1) The BIR’s disallowance of ICC’s claimed expense deductions for professional and
security services billed to and paid by ICC in 1986, to wit:

(a) Expenses for the auditing services of SGV & Co.,3 for the year ending
December 31, 1985;4

(b) Expenses for the legal services [inclusive of retainer fees] of the law firm
Bengzon Zarraga Narciso Cudala Pecson Azcuna & Bengson for the years 1984
and 1985.5

(c) Expense for security services of El Tigre Security & Investigation Agency for
the months of April and May 1986.6

ISSUE:

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

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. 19 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.

As previously stated, the accrual method presents largely a question of fact and that the taxpayer
bears the burden of establishing the accrual of an expense or income. However, ICC failed to
discharge this burden. As to when the firm’s performance of its services in connection with the
1984 tax problems were completed, or whether 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 questions of fact which ICC
never established. It simply relied on the defense of delayed billing by the firm and the company,
which under the circumstances, is not sufficient to exempt it from being charged with knowledge
of the reasonable amount of the expenses for legal and auditing services.

In the same vein, 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.

BIR v. CA

FACTS: Since respondent spouses failed to show the source of their cash purchases, the revenue
officers concluded that respondent Antonio’s Income Tax Returns (ITRs) for taxable years 2000,
2001,and 2003 were underdeclared.18 And since the under declaration exceeded 30% of the
reported or declared income, it was considered a prima facie evidence of fraud with intent to
evade the payment of proper taxes due to the government. The revenue officers, thus,
recommended the filing of criminal cases against respondent spouses for failing to supply correct
and accurate information in their ITRs.

RULING:

In Ungab v. Judge Cusi, Jr., we ruled that tax evasion is deemed complete when the violator has
knowingly and willfully filed a fraudulent return with intent to evade and defeat a part or all of
the tax.67 Corollarily, an assessment of the tax deficiency is not required in a criminal prosecution
for tax evasion.68 However, in Commissioner of Internal Revenue v. Court of Appeals, we clarified
that although a deficiency assessment is not necessary, the fact that a tax is due must first be
proved before one can be prosecuted for tax evasion.

In the case of income, for it to be taxable, there must be a gain realized or received by the
taxpayer, which is not excluded by law or treaty from taxation. The government is allowed to
resort to all evidence or resources available to determine a taxpayer’s income and to use
methods to reconstruct his income. A method commonly used by the government is the
expenditure method, which is a method of reconstructing a taxpayer’s income by deducting
the aggregate yearly expenditures from the declared yearly income. The theory of this method
is that when the amount of the money that a taxpayer spends during a given year exceeds his
reported or declared income and the source of such money is unexplained, it may be inferred
that such expenditures represent unreported or undeclared income.

In the case at bar, petitioner used this method to determine respondent spouses’ tax liability,

And since the underdeclaration is more than 30%of respondent spouses’ reported or declared
income, which under Section 248(B) of the NIRC constitutes as prima facie evidence of false or
fraudulent return, petitioner recommended the filing of criminal cases against respondent
spouses under Sections 254 and 255, in relation to Section 248(B) of the NIRC.

Respondent spouses’ defense that they had sufficient savings to purchase the properties remains
self-serving at this point since they have not yet presented any evidence to support this. And
since there is no evidence yet to suggest that the money they used to buy the properties was
from an existing fund, it is safe to assume that that money is income or a flow of wealth other
than a mere return on capital. It is a basic concept in taxation that income denotes a flow of
wealth during a definite period of time, while capital is a fund or property existing at one distinct
point in time.

Moreover, by just looking at the tables presented by petitioner, there is a manifest showing that
respondent spouses had under declared their income. The huge disparity between respondent
Antonio’s reported or declared annual income for the past several years and respondent spouses’
cash acquisitions for the years 2000, 2001, and 2003 cannot be ignored. Infact, it makes
uswonder how they were able to purchase the properties in cash given respondent Antonio’s
meager income.

In view of the foregoing,we are convinced that there is probable cause to indict respondent
spouses for tax evasion as petitioner was able to show that a tax is due from them.
UP vs CIR

FACTS: When a corporation overpays its income tax liability as adjusted at the close of the taxable
year, it has two options: (1) to be refunded or issued a tax credit certificate, or (2) to carry over
such overpayment to the succeeding taxable quarters to be applied as tax credit against income
tax due.1 Once the carry-over option is taken, it becomes irrevocable such that the taxpayer
cannot later on change its mind in order to claim a cash refund or the issuance of a tax credit
certificate of the very same amount of overpayment or excess m. come tax credit.2

Does the irrevocability rule apply exclusively to the carry-over option? Such is the novel issue
presented in this case.

RULING: there are two options available to the corporation whenever it overpays its income tax
for the taxable year: (1) to carry over and apply the overpayment as tax credit against the
estimated quarterly income tax liabilities of the succeeding taxable years (also known as
automatic tax credit) until fully utilized (meaning, there is no prescriptive period); and (2) to apply
for a cash refund or issuance of a tax credit certificate within the prescribed period.11 Such
overpayment of income tax is usually occasioned by the over-withholding of taxes on the income
payments to the corporate taxpayer.

The irrevocability rule is provided in the last sentence of Section 76. A perfunctory reading of the
law unmistakably discloses that the irrevocable option referred to is the carry-over option only.
There appears nothing therein from which to infer that the other choice, i.e., cash refund or tax
credit certificate, is also irrevocable. If the intention of the lawmakers was to make such option
of cash refund or tax credit certificate also irrevocable, then they would have clearly provided so.

In other words, the law does not prevent a taxpayer who originally opted for a refund or tax
credit certificate from shifting to the carry-over of the excess creditable taxes to the taxable
quarters of the succeeding taxable years. However, in case the taxpayer decides to shift its option
to carryover, it may no longer revert to its original choice due to the irrevocability rule. As Section
76 unequivocally provides, once the option to carry over has been made, it shall be irrevocable.
Furthermore, the provision seems to suggest that there are no qualifications or conditions
attached to the rule on irrevocability.
Rhombus Energy vs CIR
The last sentence of Section 76 of the NIRC of 1997 reads: "Once the option to carry-over and
apply the excess quarterly income tax against income tax due for the taxable quarters of the
succeeding taxable years has been made, such option shall be considered irrevocable for that
taxable period and no application for tax refund or issuance of a tax credit certificate shall be
allowed therefor." The phrase "for that taxable period" merely identifies the excess income tax,
subject of the option, by referring to the taxable period when it was acquired by the taxpayer.
In the present case, the excess income tax credit, which BPI opted to carry over, was acquired by
the said bank during the taxable year 1998. The option of BPI to carry over its 1998 excess income
tax credit is irrevocable; it cannot later on opt to apply for a refund of the very same 1998 excess
income tax credit.
The Court of Appeals mistakenly understood the phrase "for that taxable period" as a
prescriptive period for the irrevocability rule. This would mean that since the tax credit in this
case was acquired in 1998, and BPI opted to carry it over to 1999, then the irrevocability of the
option to carry over expired by the end of 1999, leaving BPI free to again take another option as
regards its 1998 excess income tax credit. This construal effectively renders nugatory
the irrevocability rule. The evident intent of the legislature, in adding the last sentence to Section
76 of the NIRC of 1997, is to keep the taxpayer from flip-flopping on its options, and avoid
confusion and complication as regards said taxpayer's excess tax credit. The interpretation of the
Court of Appeals only delays the flip-flopping to the end of each succeeding taxable period.
CIR v. PNB
The instant petition presents no novel issue. In the more recent case of Winebrenner & Inigo Insurance
Brokers, Inc. v. Commissioner of Internal Revenue,26 consistent with the settled jurisprudence on the
matter, the Court specifically ruled that the presentation of the claimant's quarterly returns is not a
requirement to prove entitlement to the refund. Notably, said case applies squarely to the instant petition
and we find no good reason to deviate from its tenets as it remains to be a good law.