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[G.R. No. 143672.

April 24, 2003]


COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. GENERAL FOODS (PHILS.),
INC., respondent.
DECISION
CORONA, J.:
Petitioner Commissioner of Internal Revenue (Commissioner) assails the
resolution[1] of the Court of Appeals reversing the decision[2] of the Court of Tax
Appeals which in turn denied the protest filed by respondent General Foods (Phils.),
Inc., regarding the assessment made against the latter for deficiency taxes.
The records reveal that, on June 14, 1985, respondent corporation, which is
engaged in the manufacture of beverages such as Tang, Calumet and KoolAid, 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.
On May 31, 1988, 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. The latter filed
a motion for reconsideration but the same was denied.
On September 29, 1989, respondent corporation appealed to the Court of Tax
Appeals but the appeal was dismissed:
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 Petitioners explanation that such expense does not
connote unreasonableness considering the grave economic situation taking place
after the Aquino assassination characterized by capital fight, strong deterioration of
the purchasing power of the Philippine peso and the slacking demand for consumer
products (Petitioners Memorandum, CTA Records, p. 273). We are not convinced
with such an explanation. The staggering expense led us to believe that such
expenditure was incurred to create or maintain some form of good will for the
taxpayers trade or business or for the industry or profession of which the taxpayer
is a member. The term good will can hardly be said to have any precise
signification; it is generally used to denote the benefit arising from connection and
reputation (Words and Phrases, Vol. 18, p. 556 citing Douhart vs. Loagan, 86 III.
App. 294). 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. (Atlas Mining and Development
Corp. vs. Commissioner of Internal Revenue, supra). 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 (Mertens, supra, citing Colonial Ice Cream Co., 7 BTA 154).

WHEREFORE, in all the foregoing, and finding no error in the case appealed from, we
hereby RESOLVE to DISMISS the instant petition for lack of merit and ORDER the
Petitioner to pay the respondent Commissioner the assessed amount of
P2,635,141.42 representing its deficiency income tax liability for the fiscal year
ended February 28, 1985.[3]
Aggrieved, respondent corporation filed a petition for review at the Court of Appeals
which rendered a decision reversing and setting aside the decision of the Court of
Tax Appeals:
Since it has not been sufficiently established that the item it claimed as a deduction
is excessive, the same should be allowed.
WHEREFORE, the petition of petitioner General Foods (Philippines), Inc. is hereby
GRANTED. Accordingly, the Decision, dated 8 February 1994 of respondent Court of
Tax Appeals is REVERSED and SET ASIDE and the letter, dated 31 May 1988 of
respondent Commissioner of Internal Revenue is CANCELLED.
SO ORDERED.[4]
Thus, the instant petition, wherein the Commissioner presents for the Courts
consideration a lone 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 (NIRC).
It is a governing principle in taxation that tax exemptions must be construed in
strictissimi juris against the taxpayer and liberally in favor of the taxing authority;[5]
and he who claims an exemption must be able to justify his claim by the clearest
grant of organic or statute law. An exemption from the common burden cannot be
permitted to exist upon vague implications.[6]
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.
We then proceed to resolve the singular issue in the case at bar. Was the media
advertising expense for Tang paid or incurred by respondent corporation for the
fiscal year ending February 28, 1985 necessary and ordinary, hence, fully
deductible under the NIRC? 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?
Section 34 (A) (1), formerly Section 29 (a) (1) (A), of the NIRC provides:
(A) Expenses.(1)

Ordinary and necessary trade, business or professional expenses.-

(a)
In general.- There shall be allowed as deduction from gross income all
ordinary and necessary expenses paid or incurred during the taxable year in

carrying on, or which are directly attributable to, the development, management,
operation and/or conduct of the trade, business or exercise of a profession.
Simply put, 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.[7]
The parties are in agreement that the subject advertising expense was paid or
incurred within the corresponding taxable year and was incurred in carrying on a
trade or business. Hence, it was necessary. However, their views conflict as to
whether or not it was ordinary. To be deductible, an advertising expense should not
only be necessary but also ordinary. These two requirements must be met.
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 respondents
business. Otherwise, the expense must be considered a capital expenditure to be
spread out over a reasonable time.
We agree.
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.
In the case at bar, the P9,461,246 claimed as media advertising expense for Tang
alone was almost one-half of its total claim for marketing expenses. Aside from
that, respondent-corporation also claimed P2,678,328 as other advertising and
promotions expense and another P1,548,614, for consumer promotion.
Furthermore, the subject P9,461,246 media advertising expense for Tang was
almost double the amount of respondent corporations P4,640,636 general and
administrative expenses.
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
taxpayers 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.
We agree with the Court of Tax Appeals that the subject advertising expense was of
the second kind. Not only was the amount staggering; the respondent corporation
itself also admitted, in its letter protest[8] to the Commissioner of Internal
Revenues assessment, that the subject media expense was incurred in order to
protect respondent corporations 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 ones property. This is a capital expenditure which should be spread out over
a reasonable period of time.[9]
Respondent corporations 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.[10]
True, it is the taxpayers prerogative to determine the amount of advertising
expenses it will incur and where to apply them.[11] 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.[12] 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.
We find said ruling to be well founded. 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 corporations 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.
It has been a long standing policy and practice of the Court to respect the
conclusions of quasi-judicial agencies such as the Court of Tax Appeals, a highly
specialized body specifically created for the purpose of reviewing tax cases. The
CTA, by the nature of its functions, is dedicated exclusively to the study and
consideration of tax problems. It has necessarily developed an expertise on the
subject. We extend due consideration to its opinion unless there is an abuse or
improvident exercise of authority.[13] Since there is none in the case at bar, the
Court adheres to the findings of the CTA.

Accordingly, we find that the Court of Appeals committed reversible error when it
declared the subject media advertising expense to be deductible as an ordinary and
necessary expense on the ground that it has not been established that the item
being claimed as deduction is excessive. It is not incumbent upon the taxing
authority to prove that the amount of items being claimed is unreasonable. The
burden of proof to establish the validity of claimed deductions is on the taxpayer.
[14] In the present case, that burden was not discharged satisfactorily.
WHEREFORE, premises considered, the instant petition is GRANTED. The assailed
decision of the Court of Appeals is hereby REVERSED and SET ASIDE. Pursuant to
Sections 248 and 249 of the Tax Code, respondent General Foods (Phils.), Inc. is
hereby ordered to pay its deficiency income tax in the amount of P2,635,141.42,
plus 25% surcharge for late payment and 20% annual interest computed from
August 25, 1989, the date of the denial of its protest, until the same is fully paid.
SO ORDERED.
PHILEX MINING
CORPORATION,
Petitioner,
- versus Nachura, and,
Reyes, JJ.
COMMISSIONER OF
INTERNAL REVENUE,
Respondent.

G.R. No. 148187


Present:
Ynares-Santiago, J. (Chairperson),
Carpio Morales, *
Chico-Nazario,

Promulgated:

April 16, 2008


x ---------------------------------------------------------------------------------------- x
DECISION
YNARES-SANTIAGO, J.:
This is a petition for review on certiorari of the June 30, 2000 Decision[1] of
the Court of Appeals in CA-G.R. SP No. 49385, which affirmed the Decision[2] of the
Court of Tax Appeals in C.T.A. Case No. 5200. Also assailed is the April 3, 2001
Resolution[3] denying the motion for reconsideration.
The facts of the case are as follows:
On April 16, 1971, petitioner Philex Mining Corporation (Philex Mining), entered into
an agreement[4] with Baguio Gold Mining Company (Baguio Gold) for the former
to manage and operate the latters mining claim, known as the Sto. Nino mine,
located in Atok and Tublay, Benguet Province. The parties agreement was
denominated as Power of Attorney and provided for the following terms:

4.
Within three (3) years from date thereof, the PRINCIPAL (Baguio Gold) shall
make available to the MANAGERS (Philex Mining) up to ELEVEN MILLION PESOS
(P11,000,000.00), in such amounts as from time to time may be required by the
MANAGERS within the said 3-year period, for use in the MANAGEMENT of the STO.
NINO MINE. The said ELEVEN MILLION PESOS (P11,000,000.00) shall be deemed, for
internal audit purposes, as the owners account in the Sto. Nino PROJECT. Any part
of any income of the PRINCIPAL from the STO. NINO MINE, which is left with the Sto.
Nino PROJECT, shall be added to such owners account.
5.
Whenever the MANAGERS shall deem it necessary and convenient in
connection with the MANAGEMENT of the STO. NINO MINE, they may transfer their
own funds or property to the Sto. Nino PROJECT, in accordance with the following
arrangements:
(a)
The properties shall be appraised and, together with the cash, shall
be carried by the Sto. Nino PROJECT as a special fund to be known as the
MANAGERS account.
(b)
The total of the MANAGERS account shall not exceed
P11,000,000.00, except with prior approval of the PRINCIPAL; provided, however,
that if the compensation of the MANAGERS as herein provided cannot be paid in
cash from the Sto. Nino PROJECT, the amount not so paid in cash shall be added to
the MANAGERS account.
(c)
The cash and property shall not thereafter be withdrawn from the
Sto. Nino PROJECT until termination of this Agency.
(d)
The MANAGERS account shall not accrue interest. Since it is the
desire of the PRINCIPAL to extend to the MANAGERS the benefit of subsequent
appreciation of property, upon a projected termination of this Agency, the ratio
which the MANAGERS account has to the owners account will be determined, and
the corresponding proportion of the entire assets of the STO. NINO MINE, excluding
the claims, shall be transferred to the MANAGERS, except that such transferred
assets shall not include mine development, roads, buildings, and similar property
which will be valueless, or of slight value, to the MANAGERS. The MANAGERS can,
on the other hand, require at their option that property originally transferred by
them to the Sto. Nino PROJECT be re-transferred to them. Until such assets are
transferred to the MANAGERS, this Agency shall remain subsisting.
xxxx
12.
The compensation of the MANAGER shall be fifty per cent (50%) of the net
profit of the Sto. Nino PROJECT before income tax. It is understood that the
MANAGERS shall pay income tax on their compensation, while the PRINCIPAL shall
pay income tax on the net profit of the Sto. Nino PROJECT after deduction therefrom
of the MANAGERS compensation.
xxxx

16.
The PRINCIPAL has current pecuniary obligation in favor of the MANAGERS
and, in the future, may incur other obligations in favor of the MANAGERS. This
Power of Attorney has been executed as security for the payment and satisfaction of
all such obligations of the PRINCIPAL in favor of the MANAGERS and as a means to
fulfill the same. Therefore, this Agency shall be irrevocable while any obligation of
the PRINCIPAL in favor of the MANAGERS is outstanding, inclusive of the MANAGERS
account. After all obligations of the PRINCIPAL in favor of the MANAGERS have been
paid and satisfied in full, this Agency shall be revocable by the PRINCIPAL upon 36month notice to the MANAGERS.
17.
Notwithstanding any agreement or understanding between the PRINCIPAL
and the MANAGERS to the contrary, the MANAGERS may withdraw from this Agency
by giving 6-month notice to the PRINCIPAL. The MANAGERS shall not in any manner
be held liable to the PRINCIPAL by reason alone of such withdrawal. Paragraph 5(d)
hereof shall be operative in case of the MANAGERS withdrawal.
x x x x[5]
In the course of managing and operating the project, Philex Mining made
advances of cash and property in accordance with paragraph 5 of the agreement.
However, the mine suffered continuing losses over the years which resulted to
petitioners withdrawal as manager of the mine on January 28, 1982 and in the
eventual cessation of mine operations on February 20, 1982.[6]
Thereafter, on September 27, 1982, the parties executed a Compromise with
Dation in Payment[7] wherein Baguio Gold admitted an indebtedness to petitioner
in the amount of P179,394,000.00 and agreed to pay the same in three segments
by first assigning Baguio Golds tangible assets to petitioner, transferring to the
latter Baguio Golds equitable title in its Philodrill assets and finally settling the
remaining liability through properties that Baguio Gold may acquire in the future.
On December 31, 1982, the parties executed an Amendment to Compromise
with Dation in Payment[8] where the parties determined that Baguio Golds
indebtedness to petitioner actually amounted to P259,137,245.00, which sum
included liabilities of Baguio Gold to other creditors that petitioner had assumed as
guarantor. These liabilities pertained to long-term loans amounting to
US$11,000,000.00 contracted by Baguio Gold from the Bank of America NT & SA
and Citibank N.A. This time, Baguio Gold undertook to pay petitioner in two
segments by first assigning its tangible assets for P127,838,051.00 and then
transferring its equitable title in its Philodrill assets for P16,302,426.00. The parties
then ascertained that Baguio Gold had a remaining outstanding indebtedness to
petitioner in the amount of P114,996,768.00.
Subsequently, petitioner wrote off in its 1982 books of account the remaining
outstanding indebtedness of Baguio Gold by charging P112,136,000.00 to
allowances and reserves that were set up in 1981 and P2,860,768.00 to the 1982
operations.
In its 1982 annual income tax return, petitioner deducted from its gross
income the amount of P112,136,000.00 as loss on settlement of receivables from

Baguio Gold against reserves and allowances.[9] However, the Bureau of Internal
Revenue (BIR) disallowed the amount as deduction for bad debt and assessed
petitioner a deficiency income tax of P62,811,161.39.
Petitioner protested before the BIR arguing that the deduction must be
allowed since all requisites for a bad debt deduction were satisfied, to wit: (a) there
was a valid and existing debt; (b) the debt was ascertained to be worthless; and (c)
it was charged off within the taxable year when it was determined to be worthless.
Petitioner emphasized that the debt arose out of a valid management
contract it entered into with Baguio Gold. The bad debt deduction represented
advances made by petitioner which, pursuant to the management contract, formed
part of Baguio Golds pecuniary obligations to petitioner. It also included
payments made by petitioner as guarantor of Baguio Golds long-term loans which
legally entitled petitioner to be subrogated to the rights of the original creditor.
Petitioner also asserted that due to Baguio Golds irreversible losses, it became
evident that it would not be able to recover the advances and payments it had
made in behalf of Baguio Gold. For a debt to be considered worthless, petitioner
claimed that it was neither required to institute a judicial action for collection
against the debtor nor to sell or dispose of collateral assets in satisfaction of the
debt. It is enough that a taxpayer exerted diligent efforts to enforce collection and
exhausted all reasonable means to collect.
On October 28, 1994, the BIR denied petitioners protest for lack of legal and factual
basis. It held that the alleged debt was not ascertained to be worthless since
Baguio Gold remained existing and had not filed a petition for bankruptcy; and that
the deduction did not consist of a valid and subsisting debt considering that, under
the management contract, petitioner was to be paid fifty percent (50%) of the
projects net profit.[10]
Petitioner appealed before the Court of Tax Appeals (CTA) which rendered judgment,
as follows:
WHEREFORE, in view of the foregoing, the instant Petition for Review is hereby
DENIED for lack of merit. The assessment in question, viz: FAS-1-82-88-003067 for
deficiency income tax in the amount of P62,811,161.39 is hereby AFFIRMED.
ACCORDINGLY, petitioner Philex Mining Corporation is hereby ORDERED to PAY
respondent Commissioner of Internal Revenue the amount of P62,811,161.39, plus,
20% delinquency interest due computed from February 10, 1995, which is the date
after the 20-day grace period given by the respondent within which petitioner has to
pay the deficiency amount x x x up to actual date of payment.
SO ORDERED.[11]
The CTA rejected petitioners assertion that the advances it made for the Sto. Nino
mine were in the nature of a loan. It instead characterized the advances as
petitioners investment in a partnership with Baguio Gold for the development and
exploitation of the Sto. Nino mine. The CTA held that the Power of Attorney

executed by petitioner and Baguio Gold was actually a partnership agreement.


Since the advanced amount partook of the nature of an investment, it could not be
deducted as a bad debt from petitioners gross income.
The CTA likewise held that the amount paid by petitioner for the long-term loan
obligations of Baguio Gold could not be allowed as a bad debt deduction. At the
time the payments were made, Baguio Gold was not in default since its loans were
not yet due and demandable. What petitioner did was to pre-pay the loans as
evidenced by the notice sent by Bank of America showing that it was merely
demanding payment of the installment and interests due. Moreover, Citibank
imposed and collected a pre-termination penalty for the pre-payment.
The Court of Appeals affirmed the decision of the CTA.[12] Hence, upon denial of its
motion for reconsideration,[13] petitioner took this recourse under Rule 45 of the
Rules of Court, alleging that:
I.
The Court of Appeals erred in construing that the advances made by Philex in the
management of the Sto. Nino Mine pursuant to the Power of Attorney partook of the
nature of an investment rather than a loan.
II.
The Court of Appeals erred in ruling that the 50%-50% sharing in the net profits of
the Sto. Nino Mine indicates that Philex is a partner of Baguio Gold in the
development of the Sto. Nino Mine notwithstanding the clear absence of any intent
on the part of Philex and Baguio Gold to form a partnership.
III.
The Court of Appeals erred in relying only on the Power of Attorney and in
completely disregarding the Compromise Agreement and the Amended Compromise
Agreement when it construed the nature of the advances made by Philex.
IV.
The Court of Appeals erred in refusing to delve upon the issue of the propriety of the
bad debts write-off.[14]
Petitioner insists that in determining the nature of its business relationship with
Baguio Gold, we should not only rely on the Power of Attorney, but also on the
subsequent Compromise with Dation in Payment and Amended Compromise with
Dation in Payment that the parties executed in 1982. These documents, allegedly
evinced the parties intent to treat the advances and payments as a loan and
establish a creditor-debtor relationship between them.
The petition lacks merit.
The lower courts correctly held that the Power of Attorney is the instrument that is
material in determining the true nature of the business relationship between
petitioner and Baguio Gold. Before resort may be had to the two compromise
agreements, the parties contractual intent must first be discovered from the

expressed language of the primary contract under which the parties business
relations were founded. It should be noted that the compromise agreements were
mere collateral documents executed by the parties pursuant to the termination of
their business relationship created under the Power of Attorney. On the other
hand, it is the latter which established the juridical relation of the parties and
defined the parameters of their dealings with one another.
The execution of the two compromise agreements can hardly be considered as a
subsequent or contemporaneous act that is reflective of the parties true intent.
The compromise agreements were executed eleven years after the Power of
Attorney and merely laid out a plan or procedure by which petitioner could recover
the advances and payments it made under the Power of Attorney. The parties
entered into the compromise agreements as a consequence of the dissolution of
their business relationship. It did not define that relationship or indicate its real
character.
An examination of the Power of Attorney reveals that a partnership or joint
venture was indeed intended by the parties. Under a contract of partnership, two or
more persons bind themselves to contribute money, property, or industry to a
common fund, with the intention of dividing the profits among themselves.[15]
While a corporation, like petitioner, cannot generally enter into a contract of
partnership unless authorized by law or its charter, it has been held that it may
enter into a joint venture which is akin to a particular partnership:
The legal concept of a joint venture is of common law origin. It has no precise legal
definition, but it has been generally understood to mean an organization formed for
some temporary purpose. x x x It is in fact hardly distinguishable from the
partnership, since their elements are similar community of interest in the
business, sharing of profits and losses, and a mutual right of control. x x x The main
distinction cited by most opinions in common law jurisdictions is that the
partnership contemplates a general business with some degree of continuity, while
the joint venture is formed for the execution of a single transaction, and is thus of a
temporary nature. x x x This observation is not entirely accurate in this jurisdiction,
since under the Civil Code, a partnership may be particular or universal, and a
particular partnership may have for its object a specific undertaking. x x x It would
seem therefore that under Philippine law, a joint venture is a form of partnership
and should be governed by the law of partnerships. The Supreme Court has
however recognized a distinction between these two business forms, and has held
that although a corporation cannot enter into a partnership contract, it may
however engage in a joint venture with others. x x x (Citations omitted) [16]
Perusal of the agreement denominated as the Power of Attorney indicates that the
parties had intended to create a partnership and establish a common fund for the
purpose. They also had a joint interest in the profits of the business as shown by a
50-50 sharing in the income of the mine.
Under the Power of Attorney, petitioner and Baguio Gold undertook to contribute
money, property and industry to the common fund known as the Sto. Nio mine.[17]
In this regard, we note that there is a substantive equivalence in the respective
contributions of the parties to the development and operation of the mine.

Pursuant to paragraphs 4 and 5 of the agreement, petitioner and Baguio Gold were
to contribute equally to the joint venture assets under their respective accounts.
Baguio Gold would contribute P11M under its owners account plus any of its income
that is left in the project, in addition to its actual mining claim. Meanwhile,
petitioners contribution would consist of its expertise in the management and
operation of mines, as well as the managers account which is comprised of P11M in
funds and property and petitioners compensation as manager that cannot be
paid in cash.
However, petitioner asserts that it could not have entered into a partnership
agreement with Baguio Gold because it did not bind itself to contribute money or
property to the project; that under paragraph 5 of the agreement, it was only
optional for petitioner to transfer funds or property to the Sto. Nio project
(w)henever the MANAGERS shall deem it necessary and convenient in connection
with the MANAGEMENT of the STO. NIO MINE.[18]
The wording of the parties agreement as to petitioners contribution to the common
fund does not detract from the fact that petitioner transferred its funds and property
to the project as specified in paragraph 5, thus rendering effective the other
stipulations of the contract, particularly paragraph 5(c) which prohibits petitioner
from withdrawing the advances until termination of the parties business relations.
As can be seen, petitioner became bound by its contributions once the transfers
were made. The contributions acquired an obligatory nature as soon as petitioner
had chosen to exercise its option under paragraph 5.
There is no merit to petitioners claim that the prohibition in paragraph 5(c) against
withdrawal of advances should not be taken as an indication that it had entered into
a partnership with Baguio Gold; that the stipulation only showed that what the
parties entered into was actually a contract of agency coupled with an interest
which is not revocable at will and not a partnership.
In an agency coupled with interest, it is the agency that cannot be revoked or
withdrawn by the principal due to an interest of a third party that depends upon it,
or the mutual interest of both principal and agent.[19] In this case, the nonrevocation or non-withdrawal under paragraph 5(c) applies to the advances made
by petitioner who is supposedly the agent and not the principal under the contract.
Thus, it cannot be inferred from the stipulation that the parties relation under the
agreement is one of agency coupled with an interest and not a partnership.
Neither can paragraph 16 of the agreement be taken as an indication that the
relationship of the parties was one of agency and not a partnership. Although the
said provision states that this Agency shall be irrevocable while any obligation of
the PRINCIPAL in favor of the MANAGERS is outstanding, inclusive of the MANAGERS
account, it does not necessarily follow that the parties entered into an agency
contract coupled with an interest that cannot be withdrawn by Baguio Gold.
It should be stressed that the main object of the Power of Attorney was not to
confer a power in favor of petitioner to contract with third persons on behalf of
Baguio Gold but to create a business relationship between petitioner and Baguio
Gold, in which the former was to manage and operate the latters mine through the

parties mutual contribution of material resources and industry. The essence of an


agency, even one that is coupled with interest, is the agents ability to represent
his principal and bring about business relations between the latter and third
persons.[20] Where representation for and in behalf of the principal is merely
incidental or necessary for the proper discharge of ones paramount undertaking
under a contract, the latter may not necessarily be a contract of agency, but some
other agreement depending on the ultimate undertaking of the parties.[21]
In this case, the totality of the circumstances and the stipulations in the parties
agreement indubitably lead to the conclusion that a partnership was formed
between petitioner and Baguio Gold.
First, it does not appear that Baguio Gold was unconditionally obligated to return
the advances made by petitioner under the agreement. Paragraph 5 (d) thereof
provides that upon termination of the parties business relations, the ratio which
the MANAGERS account has to the owners account will be determined, and the
corresponding proportion of the entire assets of the STO. NINO MINE, excluding the
claims shall be transferred to petitioner.[22] As pointed out by the Court of Tax
Appeals, petitioner was merely entitled to a proportionate return of the mines
assets upon dissolution of the parties business relations. There was nothing in the
agreement that would require Baguio Gold to make payments of the advances to
petitioner as would be recognized as an item of obligation or accounts payable for
Baguio Gold.
Thus, the tax court correctly concluded that the agreement provided for a
distribution of assets of the Sto. Nio mine upon termination, a provision that is
more consistent with a partnership than a creditor-debtor relationship. It should be
pointed out that in a contract of loan, a person who receives a loan or money or any
fungible thing acquires ownership thereof and is bound to pay the creditor an equal
amount of the same kind and quality.[23] In this case, however, there was no
stipulation for Baguio Gold to actually repay petitioner the cash and property that it
had advanced, but only the return of an amount pegged at a ratio which the
managers account had to the owners account.
In this connection, we find no contractual basis for the execution of the two
compromise agreements in which Baguio Gold recognized a debt in favor of
petitioner, which supposedly arose from the termination of their business relations
over the Sto. Nino mine. The Power of Attorney clearly provides that petitioner
would only be entitled to the return of a proportionate share of the mine assets to
be computed at a ratio that the managers account had to the owners account.
Except to provide a basis for claiming the advances as a bad debt deduction, there
is no reason for Baguio Gold to hold itself liable to petitioner under the compromise
agreements, for any amount over and above the proportion agreed upon in the
Power of Attorney.
Next, the tax court correctly observed that it was unlikely for a business corporation
to lend hundreds of millions of pesos to another corporation with neither security, or
collateral, nor a specific deed evidencing the terms and conditions of such loans.
The parties also did not provide a specific maturity date for the advances to become
due and demandable, and the manner of payment was unclear. All these point to

the inevitable conclusion that the advances were not loans but capital contributions
to a partnership.
The strongest indication that petitioner was a partner in the Sto Nio mine is the
fact that it would receive 50% of the net profits as compensation under paragraph
12 of the agreement. The entirety of the parties contractual stipulations simply
leads to no other conclusion than that petitioners compensation is actually its
share in the income of the joint venture.
Article 1769 (4) of the Civil Code explicitly provides that the receipt by a person of
a share in the profits of a business is prima facie evidence that he is a partner in the
business. Petitioner asserts, however, that no such inference can be drawn against
it since its share in the profits of the Sto Nio project was in the nature of
compensation or wages of an employee, under the exception provided in Article
1769 (4) (b).[24]
On this score, the tax court correctly noted that petitioner was not an employee of
Baguio Gold who will be paid wages pursuant to an employer-employee
relationship. To begin with, petitioner was the manager of the project and had put
substantial sums into the venture in order to ensure its viability and profitability. By
pegging its compensation to profits, petitioner also stood not to be remunerated in
case the mine had no income. It is hard to believe that petitioner would take the risk
of not being paid at all for its services, if it were truly just an ordinary employee.
Consequently, we find that petitioners compensation under paragraph 12 of the
agreement actually constitutes its share in the net profits of the partnership.
Indeed, petitioner would not be entitled to an equal share in the income of the mine
if it were just an employee of Baguio Gold.[25] It is not surprising that petitioner
was to receive a 50% share in the net profits, considering that the Power of
Attorney also provided for an almost equal contribution of the parties to the St.
Nino mine. The compensation agreed upon only serves to reinforce the notion
that the parties relations were indeed of partners and not employer-employee.
All told, the lower courts did not err in treating petitioners advances as investments
in a partnership known as the Sto. Nino mine. The advances were not debts of
Baguio Gold to petitioner inasmuch as the latter was under no unconditional
obligation to return the same to the former under the Power of Attorney. As for
the amounts that petitioner paid as guarantor to Baguio Golds creditors, we find no
reason to depart from the tax courts factual finding that Baguio Golds debts were
not yet due and demandable at the time that petitioner paid the same. Verily,
petitioner pre-paid Baguio Golds outstanding loans to its bank creditors and this
conclusion is supported by the evidence on record.[26]
In sum, petitioner cannot claim the advances as a bad debt deduction from its gross
income. 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] In this case,
petitioner failed to substantiate its assertion that the advances were subsisting
debts of Baguio Gold that could be deducted from its gross income. Consequently,
it could not claim the advances as a valid bad debt deduction.

WHEREFORE, the petition is DENIED. The decision of the Court of Appeals in


CA-G.R. SP No. 49385 dated June 30, 2000, which affirmed the decision of the Court
of Tax Appeals in C.T.A. Case No. 5200 is AFFIRMED. Petitioner Philex Mining
Corporation is ORDERED to PAY the deficiency tax on its 1982 income in the amount
of P62,811,161.31, with 20% delinquency interest computed from February 10,
1995, which is the due date given for the payment of the deficiency income tax, up
to the actual date of payment.
SO ORDERED.
G.R. No. L-68118 October 29, 1985
JOSE P. OBILLOS, JR., SARAH P. OBILLOS, ROMEO P. OBILLOS and REMEDIOS P.
OBILLOS, brothers and sisters, petitioners
vs.
COMMISSIONER OF INTERNAL REVENUE and COURT OF TAX APPEALS, respondents.
Demosthenes B. Gadioma for petitioners.

AQUINO, J.:
This case is about the income tax liability of four brothers and sisters who sold two
parcels of land which they had acquired from their father.
On March 2, 1973 Jose Obillos, Sr. completed payment to Ortigas & Co., Ltd. on two
lots with areas of 1,124 and 963 square meters located at Greenhills, San Juan,
Rizal. The next day he transferred his rights to his four children, the petitioners, to
enable them to build their residences. The company sold the two lots to petitioners
for P178,708.12 on March 13 (Exh. A and B, p. 44, Rollo). Presumably, the Torrens
titles issued to them would show that they were co-owners of the two lots.
In 1974, or after having held the two lots for more than a year, the petitioners
resold them to the Walled City Securities Corporation and Olga Cruz Canda for the
total sum of P313,050 (Exh. C and D). They derived from the sale a total profit of
P134,341.88 or P33,584 for each of them. They treated the profit as a capital gain
and paid an income tax on one-half thereof or of P16,792.
In April, 1980, or one day before the expiration of the five-year prescriptive period,
the Commissioner of Internal Revenue required the four petitioners to pay corporate
income tax on the total profit of P134,336 in addition to individual income tax on
their shares thereof He assessed P37,018 as corporate income tax, P18,509 as 50%
fraud surcharge and P15,547.56 as 42% accumulated interest, or a total of
P71,074.56.
Not only that. He considered the share of the profits of each petitioner in the sum of
P33,584 as a " taxable in full (not a mere capital gain of which is taxable) and
required them to pay deficiency income taxes aggregating P56,707.20 including the
50% fraud surcharge and the accumulated interest.

Thus, the petitioners are being held liable for deficiency income taxes and penalties
totalling P127,781.76 on their profit of P134,336, in addition to the tax on capital
gains already paid by them.
The Commissioner acted on the theory that the four petitioners had formed an
unregistered partnership or joint venture within the meaning of sections 24(a) and
84(b) of the Tax Code (Collector of Internal Revenue vs. Batangas Trans. Co., 102
Phil. 822).
The petitioners contested the assessments. Two Judges of the Tax Court sustained
the same. Judge Roaquin dissented. Hence, the instant appeal.
We hold that it is error to consider the petitioners as having formed a partnership
under article 1767 of the Civil Code simply because they allegedly contributed
P178,708.12 to buy the two lots, resold the same and divided the profit among
themselves.
To regard the petitioners as having formed a taxable unregistered partnership would
result in oppressive taxation and confirm the dictum that the power to tax involves
the power to destroy. That eventuality should be obviated.
As testified by Jose Obillos, Jr., they had no such intention. They were co-owners
pure and simple. To consider them as partners would obliterate the distinction
between a co-ownership and a partnership. The petitioners were not engaged in any
joint venture by reason of that isolated transaction.
Their original purpose was to divide the lots for residential purposes. If later on they
found it not feasible to build their residences on the lots because of the high cost of
construction, then they had no choice but to resell the same to dissolve the coownership. The division of the profit was merely incidental to the dissolution of the
co-ownership which was in the nature of things a temporary state. It had to be
terminated sooner or later. Castan Tobeas says:
Como establecer el deslinde entre la comunidad ordinaria o copropiedad y la
sociedad?
El criterio diferencial-segun la doctrina mas generalizada-esta: por razon del origen,
en que la sociedad presupone necesariamente la convencion, mentras que la
comunidad puede existir y existe ordinariamente sin ela; y por razon del fin objecto,
en que el objeto de la sociedad es obtener lucro, mientras que el de la indivision es
solo mantener en su integridad la cosa comun y favorecer su conservacion.
Reflejo de este criterio es la sentencia de 15 de Octubre de 1940, en la que se dice
que si en nuestro Derecho positive se ofrecen a veces dificultades al tratar de fijar
la linea divisoria entre comunidad de bienes y contrato de sociedad, la moderna
orientacion de la doctrina cientifica seala como nota fundamental de
diferenciacion aparte del origen de fuente de que surgen, no siempre uniforme, la
finalidad perseguida por los interesados: lucro comun partible en la sociedad, y

mera conservacion y aprovechamiento en la comunidad. (Derecho Civil Espanol,


Vol. 2, Part 1, 10 Ed., 1971, 328- 329).
Article 1769(3) of the Civil Code provides that "the sharing of gross returns does not
of itself establish a partnership, whether or not the persons sharing them have a
joint or common right or interest in any property from which the returns are
derived". There must be an unmistakable intention to form a partnership or joint
venture.*
Such intent was present in Gatchalian vs. Collector of Internal Revenue, 67 Phil.
666, where 15 persons contributed small amounts to purchase a two-peso
sweepstakes ticket with the agreement that they would divide the prize The ticket
won the third prize of P50,000. The 15 persons were held liable for income tax as an
unregistered partnership.
The instant case is distinguishable from the cases where the parties engaged in
joint ventures for profit. Thus, in Oa vs.
** This view is supported by the following rulings of respondent Commissioner:
Co-owership distinguished from partnership.We find that the case at bar is
fundamentally similar to the De Leon case. Thus, like the De Leon heirs, the Longa
heirs inherited the 'hacienda' in question pro-indiviso from their deceased parents;
they did not contribute or invest additional ' capital to increase or expand the
inherited properties; they merely continued dedicating the property to the use to
which it had been put by their forebears; they individually reported in their tax
returns their corresponding shares in the income and expenses of the 'hacienda',
and they continued for many years the status of co-ownership in order, as conceded
by respondent, 'to preserve its (the 'hacienda') value and to continue the existing
contractual relations with the Central Azucarera de Bais for milling purposes. Longa
vs. Aranas, CTA Case No. 653, July 31, 1963).
All co-ownerships are not deemed unregistered pratnership.Co-Ownership who
own properties which produce income should not automatically be considered
partners of an unregistered partnership, or a corporation, within the purview of the
income tax law. To hold otherwise, would be to subject the income of all
co-ownerships of inherited properties to the tax on corporations, inasmuch as if a
property does not produce an income at all, it is not subject to any kind of income
tax, whether the income tax on individuals or the income tax on corporation. (De
Leon vs. CI R, CTA Case No. 738, September 11, 1961, cited in Araas, 1977 Tax
Code Annotated, Vol. 1, 1979 Ed., pp. 77-78).
Commissioner of Internal Revenue, L-19342, May 25, 1972, 45 SCRA 74, where after
an extrajudicial settlement the co-heirs used the inheritance or the incomes derived
therefrom as a common fund to produce profits for themselves, it was held that they
were taxable as an unregistered partnership.
It is likewise different from Reyes vs. Commissioner of Internal Revenue, 24 SCRA
198, where father and son purchased a lot and building, entrusted the
administration of the building to an administrator and divided equally the net

income, and from Evangelista vs. Collector of Internal Revenue, 102 Phil. 140, where
the three Evangelista sisters bought four pieces of real property which they leased
to various tenants and derived rentals therefrom. Clearly, the petitioners in these
two cases had formed an unregistered partnership.
In the instant case, what the Commissioner should have investigated was whether
the father donated the two lots to the petitioners and whether he paid the donor's
tax (See Art. 1448, Civil Code). We are not prejudging this matter. It might have
already prescribed.
WHEREFORE, the judgment of the Tax Court is reversed and set aside. The
assessments are cancelled. No costs.
SO ORDERED
G.R. No. 172231

February 12, 2007

COMMISSIONER OF INTERNAL REVENUE, Petitioner,


vs.
ISABELA CULTURAL CORPORATION, Respondent.
DECISION
YNARES-SANTIAGO, J.:
Petitioner Commissioner of Internal Revenue (CIR) assails the September 30, 2005
Decision1 of the Court of Appeals in CA-G.R. SP No. 78426 affirming the February
26, 2003 Decision2 of the Court of Tax Appeals (CTA) in CTA Case No. 5211, which
cancelled and set aside the Assessment Notices for deficiency income tax and
expanded withholding tax issued by the Bureau of Internal Revenue (BIR) against
respondent Isabela Cultural Corporation (ICC).
The facts show that on February 23, 1990, ICC, 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 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.,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
(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. 135210.8 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. The dispositive portion of the
CTAs Decision, reads:
WHEREFORE, in view of all the foregoing, Assessment Notice No. FAS-1-86-90000680 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, are hereby CANCELLED and SET ASIDE.
SO ORDERED.9

Petitioner filed a petition for review with the Court of Appeals, which affirmed the
CTA decision,10 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.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 taxpayers 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 allevents test has been met. This test requires: (1) fixing of a right to income or
liability to pay; and (2) the availability of the reasonable accurate determination of
such income or liability.
The all-events test requires the right to income or liability be fixed, and the amount
of such income or liability be determined with reasonable accuracy. However, the
test does not demand that the amount of income or liability be known absolutely,
only that a taxpayer has at his disposal the information necessary to compute the
amount with reasonable accuracy. The all-events test is satisfied where computation
remains uncertain, if its basis is unchangeable; the test is satisfied where a
computation may be unknown, but is not as much as unknowable, within the
taxable year. The amount of liability does not have to be determined exactly; it
must be determined with "reasonable accuracy." Accordingly, the term "reasonable
accuracy" implies something less than an exact or completely accurate amount.[15]
The propriety of an accrual must be judged by the facts that a taxpayer knew, or
could reasonably be expected to have known, at the closing of its books for the
taxable year.[16] Accrual method of accounting presents largely a question of fact;
such that the taxpayer bears the burden of proof of establishing the accrual of an
item of income or deduction.17
Corollarily, it is a governing principle in taxation that tax exemptions must be
construed in strictissimi juris against the taxpayer and liberally in favor of the taxing
authority; and one who claims an exemption must be able to justify the same by the
clearest grant of organic or statute law. An exemption from the common burden
cannot be permitted to exist upon vague implications. And since a deduction for
income tax purposes partakes of the nature of a tax exemption, then it must also be
strictly construed.18
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 ICCs tax problems for the year 1984. As testified by the Treasurer
of ICC, the firm has been its counsel since the 1960s.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 firms
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.
ICC thus failed to discharge the burden of proving that the claimed expense
deductions for the professional services were allowable deductions for the taxable
year 1986. Hence, per Revenue Audit Memorandum Order No. 1-2000, they cannot
be validly deducted from its gross income for the said year and were therefore
properly disallowed by the BIR.
As to the expenses for security services, the records show that these expenses were
incurred by ICC in 198620 and could therefore be properly claimed as deductions for
the said year.
Anent the purported understatement of interest income from the promissory notes
of Realty Investment, Inc., we sustain the findings of the CTA and the Court of
Appeals that no such understatement exists and that only simple interest
computation and not a compounded one should have been applied by the BIR.
There is indeed no stipulation between the latter and ICC on the application of
compounded interest.21 Under Article 1959 of the Civil Code, unless there is a
stipulation to the contrary, interest due should not further earn interest.
Likewise, the findings of the CTA and the Court of Appeals that ICC truly withheld
the required withholding tax from its claimed deductions for security services and
remitted the same to the BIR is supported by payment order and confirmation
receipts.22 Hence, the Assessment Notice for deficiency expanded withholding tax
was properly cancelled and set aside.
In sum, Assessment Notice No. FAS-1-86-90-000680 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

BIRs disallowance of ICCs expenses for professional services. The Court of Appeals
cancellation of Assessment Notice No. FAS-1-86-90-000681 in the amount of
P4,897.79 for deficiency expanded withholding tax, is sustained.
WHEREFORE, the petition is PARTIALLY GRANTED. The September 30, 2005 Decision
of the Court of Appeals in CA-G.R. SP No. 78426, is AFFIRMED with the
MODIFICATION that Assessment Notice No. FAS-1-86-90-000680, which disallowed
the expense deduction of Isabela Cultural Corporation for professional and security
services, is declared valid only insofar as the expenses for the professional fees of
SGV & Co. and of the law firm, Bengzon Zarraga Narciso Cudala Pecson Azcuna &
Bengson, are concerned. The decision is affirmed in all other respects.
The case is remanded to the BIR for the computation of Isabela Cultural
Corporations liability under Assessment Notice No. FAS-1-86-90-000680.
SO ORDERED.

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