CIR vs. Isabela Cultural Corp

G.R. No.
172231 February 12, 2007

COMMISSIONER OF INTERNAL REVENUE, Petitioner,
vs.
ISABELA CULTURAL CORPORATION, Respondent.
The facts show that on February 23, 1990, ICC, a domestic corporation, 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:
(1) The BIRs disallowance of ICCs 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.,
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for the year ending
December 31, 1985;
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(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.
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(2) The alleged understatement of ICCs interest income on the three promissory notes
due from Realty Investment, Inc.
The deficiency expanded withholding tax of P4,897.79 (inclusive of interest and surcharge) was
allegedly due to the failure of ICC to withhold 1% expanded withholding tax on its claimed
P244,890.00 deduction for security services.
7

On March 23, 1990, ICC sought a reconsideration of the subject assessments. On February 9,
1995, however, it received a final notice before seizure demanding payment of the amounts
stated in the said notices. Hence, it brought the case to the CTA which held that the petition is
premature because the final notice of assessment cannot be considered as a final decision
appealable to the tax court. This was reversed by the Court of Appeals holding that a demand
letter of the BIR reiterating the payment of deficiency tax, amounts to a final decision on the
protested assessment and may therefore be questioned before the CTA. This conclusion was
sustained by this Court on July 1, 2001, in G.R. No. 135210.
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The case was thus remanded to
the CTA for further proceedings.
On February 26, 2003, the CTA rendered a decision canceling and setting aside the assessment
notices issued against ICC. 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.
The CTA also held that ICC did not understate its interest income on the subject promissory
notes. It found that it was the BIR which made an overstatement of said income when it
compounded the interest income receivable by ICC from the promissory notes of Realty
Investment, Inc., despite the absence of a stipulation in the contract providing for a compounded
interest; nor of a circumstance, like delay in payment or breach of contract, that would justify the
application of compounded interest.
Likewise, the CTA found that ICC in fact withheld 1% expanded withholding tax on its claimed
deduction for security services as shown by the various payment orders and confirmation
receipts it presented as evidence.
Petitioner filed a petition for review with the Court of Appeals, which affirmed the CTA
decision,
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holding that although the professional services (legal and auditing services) were
rendered to ICC in 1984 and 1985, the cost of the services was not yet determinable at that time,
hence, it could be considered as deductible expenses only in 1986 when ICC received the billing
statements for said services. It further ruled that ICC did not understate its interest income from
the promissory notes of Realty Investment, Inc., and that ICC properly withheld and remitted
taxes on the payments for security services for the taxable year 1986.
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 ICCs 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.
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G.R. No.

172231 February 12, 2007

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