CASE DIGEST: CIR vs. Lancaster (G.R. No. 183408; July 12, 2017)


The CIR issued letters of authority (LOA) to revenue officers to examine Lancaster's books for FY 1997-1998. Later, the CIR issued deficiency income tax assessment (DITA) against Lancaster for FY 1998-1999. Moreover, the CIR flagged Lancaster's alleged deviation from generally accepted accounting principles in using a "cropping year" not in line with its FY. Finally, Lancaster applied for deductions for the taxable year in which the tobaccos crops were realized not in the FY in which the expenses were incurred. The CIR disallowed these deductions.

On appeal, the CTA resolved that there was excess of authority on the part of the CIR and its revenue officers, citing the disparity in coverage between the LOA and the DITA. However, this issue was never raised by Lancaster.

[1] Does the CTA have power to rule upon the CIR's or revenue officers' scope of authority?
[2] Did the CTA err in resolving the issue on the revenue officers' acts in excess of authority although never raised by Lancaster?
[3] Did the revenue officers exceed their authority in examining Lancaster's books for FY 1 April 1997 to 31 March 1998 but issuing DITA for FY 1 April 1998 to 31 March 1999?
[4] Did Lancaster deviate from GAAP by adopting a method by which its incomes and deductions within a "cropping year" are included in its return for the following year, considering that these years do not coincide?
[5] Was Lancaster wrong in applying for deductions for the taxable year in which the gross income on tobacco crops was realized and not in the FY in which they were incurred?
[1] Yes, the CTA has jurisdiction to rule upon other matters arising under the National Internal Revenue Code or other law or part of law administered by the BIR.

Since it is the power of the CIR to examine and assess taxpayers, and it is pursuant to such power that the CIR authorized its revenue officers to conduct an examination of the books of account and accounting records of Lancaster, and eventually issue a deficiency assessment against it, such power being one granted by the Tax Code, the CTA has power to judge this issue.

[2] No the CTA did not err. Under the Revised Rules of the Court of Tax Appeals, "In deciding the case, the Court may not limit itself to the issues stipulated by the parties but may also rule upon related issues necessary to achieve an orderly disposition of the case."

[3] Yes, the revenue officers exceeded their authority in doing so.

The audit process normally commences with the issuance by the CIR of a Letter of Authority. The LOA gives notice to the taxpayer that it is under investigation for possible deficiency tax assessment; at the same time it authorizes or empowers a designated revenue officer to examine, verify, and scrutinize a taxpayer's books and records, in relation to internal revenue tax liabilities for a particular period. The DITA should be based on the FY covered by the LOA.

Under Revenue Memorandum Order (RMO) No. 43-90, the LOA shall cover a taxable period not exceeding one taxable year. Therefore, although in this case the LOA states, "taxable year 1998 to [blank]," it is presumed that the authority is for one taxable year only. Hence, when the DITA for the following year was issued, there was excess of authority.

[4] No, Lancaster did not. In the present case, we find it wholly justifiable for Lancaster, as a business engaged in the production and marketing of tobacco, to adopt the crop method of accounting.

An accounting method is a "set of rules for determining when and how to report income and deductions."The Tax Code recognizes the following methods: (1) Cash basis method; (2) Accrual method; (3) Installment method; (4) Percentage of completion method; and (5) Other accounting methods.

Any of the foregoing methods may be employed by any taxpayer so long as it reflects its income properly and such method is used regularly. The peculiarities of the business or occupation engaged in by a taxpayer would largely determine how it would report incomes and expenses in its accounting books or records. The NIRC does not prescribe a uniform, or even specific, method of accounting.

An example of such method not expressly mentioned in the NIRC, but duly approved by the CIR, is the 'crop method of accounting' authorized under RAM No. 2-95. The pertinent provision reads: Crop Year Basis is a method applicable only to farmers engaged in the production of crops which take more than a year from the time of planting to the process of gathering and disposal. Expenses paid or incurred are deductible in the year the gross income from the sale of the crops are realized.

The crop method recognizes that the harvesting and selling of crops do not fall within the same year that they are planted or grown. This method is especially relevant to farmers, or those engaged in the business of producing crops who, pursuant to RAM No. 2-95, would then be able to compute their taxable income on the basis of their crop year. On when to recognize expenses as deductions against income, the governing rule is found in the second sentence of Subsection F cited above. The rule enjoins the recognition of the expense (or the deduction of the cost) of crop production in the year that the crops are sold (when income is realized).

[5] No, there was no error in Lancaster doing so.

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