G.R. No. 172231 - Commissioner of Internal Revenue vs. Isabela Cultural Corp.

On February 23, 1990, Isabela Cultural Corporation (ICC) received 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, both for the taxable year 1986.
The assessments arose from the BIR’s disallowance of ICC’s claimed deductions for professional services (auditing and legal fees) and security services, an alleged understatement of interest income on promissory notes from Realty Investment, Inc., and ICC’s alleged failure to withhold 1% expanded withholding tax on its payment for security services.

ICC filed a request for reconsideration on March 23, 1990. After receiving a final notice before seizure on February 9, 1995, ICC elevated the case to the Court of Tax Appeals (CTA), which dismissed the petition as premature for lack of a final decision.
The Court of Appeals (COA) reversed, holding that the BIR’s demand letter constituted a final decision appealable to the CTA. The Supreme Court, in G.R. No. 135210 (July 1, 2001), upheld the COA and remanded the case to the CTA.

On February 26, 2003, the CTA cancelled and set aside both assessment notices, ruling that ICC properly claimed the disputed deductions in 1986, did not understate interest income, and withheld the required 1% tax.
On September 30, 2005, the COA affirmed the CTA decision. The Commissioner of Internal Revenue (CIR) then filed the present petition for review before the Supreme Court.

Whether the COA correctly sustained ICC’s deduction of professional and security service expenses for taxable year 1986 under the accrual method.
Whether the COA correctly held that ICC did not understate its interest income from promissory notes and that it properly withheld the 1% expanded withholding tax on security services.