Tax-exempt entities

By Genevieve M. Limbo, 1 August 2013

The huge amount of P1.2 trillion for the national budget set by Congress for this year has placed a heavy burden on the Bureau of Internal Revenue (BIR) to further intensify its revenue collection efforts. In view of the present administration’s policy of not imposing new taxes, the BIR has to resort to other courses of actions to help meet this revenue target. One of the recent measures undertaken by the BIR is strengthening its regulatory and monitoring powers over tax-exempt entities, ensuring that the conditions for their tax-exempt status are properly complied with and that they are not simply used as instruments for tax avoidance. Specifically, these are the entities enumerated under Section 30 of the Tax Code, consisting of nonstock, nonprofit corporations and associations organized and operated exclusively for religious, charitable, scientific, athletic, or cultural purposes or for rehabilitation of veterans; and nonstock and nonprofit educational institutions, among others, which are generally exempt from income tax.

The exemption granted under Section 30 is not automatic since it is still incumbent upon the concerned nonprofit, nonstock entity to prove that it is qualified for such exemption. Thus, entities falling under this section are still required to secure a ruling from the BIR confirming their tax-exempt status. In a sense, such ruling offers them a certain level of protection in the event of a regular audit of their books by the BIR.

Generally, the tax exemption ruling, once issued, is considered valid and subsisting for the life of the nonstock, nonprofit entity covered by it. It becomes invalid only if the facts on which the tax exemption ruling was based are found to be inaccurate or no longer subsist. Thus, revalidation of the tax exemption ruling was not necessary as a matter of practice.

However, the continuing validity of tax exempt rulings was somehow changed in the case of proprietary nonprofit, nonstock hospitals, which are subject to a preferential income tax rate of 10% under Section 27 (B) of the Tax Code. These entities were able to secure tax exemption rulings under Section 30 of the Tax Code because they are also operated for charitable purposes or for promotion of social welfare and thus, exempt from corporate income tax under Section 30.

In the case of Commissioner of Internal Revenue vs. St. Luke’s Medical Center, G.R. No. 195909, Sept. 26, 2012, the Supreme Court held that a proprietary nonprofit hospital shall be exempt under Section 30 provided it is a nonstock corporation or association, it is organized and operated exclusively for charitable purposes, and no part of its net income or assets shall belong to or inure to the benefit of any member, organizer, officer or any specific person.

Organizational test requires that the constitutive documents of the corporation exclusively limit its purposes to activities exempted by law, while operational test mandates that the regular activities shall be exclusively devoted to the accomplishment of its purposes. The corporation is considered noncompliant with the operational test if a substantial part of its operations are considered “activities conducted for profit.”

As a consequence of this decision, the BIR issued Revenue Memorandum Circular (RMC) No. 4-2013 dated Jan. 11, 2013, which essentially revoked all tax exempt rulings issued to proprietary nonprofit hospitals prior to Nov. 1, 2012, and required them to secure a revalidated tax exemption ruling/certificate. Under this RMC, applications for tax exempt ruling or revalidation shall be filed with the Revenue District Office (RDO) where the entity is registered, supported by copies of their latest articles of incorporation and by-laws duly certified by the Securities and Exchange Commission, BIR Certificate of Registration, Tax Clearance issued by the RDO, Income Tax Return or Annual Information Return, financial statements for the last three years, and statement of modus operandi and sources of revenues.

Taking off from RMC 4-2013, the BIR recently released Revenue Memorandum Order (RMO) No. 20-2013 dated July 22, 2013, which effectively extends the application of RMC No. 4-2013 to all other nonprofit, nonstock corporations covered under Section 30. Under RMO 20-2013, nonprofit, nonstock corporations and associations are required to secure a tax exemption ruling before they can avail of the exemption benefit under Section 30. In the case of corporations and associations which were already issued a tax exemption ruling prior to June 30, 2013, they are required to secure a revalidation of their existing ruling which are given a validity period of only up to Dec. 31, 2013. The processing of the applications for new ruling or revalidation shall follow the same procedures and requirements prescribed under RMC 4-2013 as discussed above. In addition, any changes in the articles of incorporation and by-laws of the entity must be certified by an executive officer, while salaries and compensation of the board of trustees should be certified by the Treasurer.

For nonstock, nonprofit educational institutions, they must have the necessary permit/accreditation to operate as an educational institution issued by CHEd, DepEd or TESDA, which shall be accompanied by a certificate of operation/good standing issued by the appropriate government agency if the permit/accreditation was issued more than five years prior to the application. A certificate of utilization of annual revenues and assets issued by the Treasurer or his equivalent indicating the breakdown provided under Section 1.3 of Department of Finance Order No. 137-87 is also necessary.To qualify for exemption under the RMO, the applicant should also meet the organizational and operational tests as clarified in the St. Luke’s decision as discussed above, i.e, the purposes of the corporation as stated in its constitutive documents are exclusively limited to activities exempted by law, and that a substantial part of its regular activities are exclusively devoted to the accomplishment of its nonprofit purposes.Application for tax exempt ruling or revalidation will undergo a pre-evaluation process to be conducted by the RDO. If the corporation or association is found to be disqualified to avail of the exemption, it shall be properly notified by the RDO. The final decision of the RDO may be appealed to the Regional Director within 30 days from receipt of the notice. If denied at the regional level, the corporation or association shall be assessed accordingly for deficiency income tax, inclusive of penalties and interest.

Another important feature of RMC 20-2013 is the provision which fixes the period of validity of tax exempt rulings to only three years from the date of their issuance, unless sooner revoked or cancelled. The ruling may be renewed for another three years upon filing of a subsequent application for tax exemption/ revalidation.The RMC further imposes as a mandatory condition for exemption the filing by the corporation of its annual information return, such that non-filing of said document will result in the automatic forfeiture of the tax exemption benefit, reckoned from the start of the year of noncompliance.It is worthy to note that the tax ruling is a critical document that serves as basis by counterparties (e.g., banks, suppliers, etc.) to verify tax exemption.So while the concerned entities may find these requirements cumbersome, they are left with no choice but to comply in order to continue enjoying tax exemption.

For so long, nonprofit, nonstock corporations and associations have generally enjoyed a period of blissful and peaceful existence, not having been strictly under the watchful eyes of the BIR. However, with the recent changes in the BIR’s regulatory policies, they would have to face the reality that this would soon come to an end. Because tax-exempt corporations and associations will now be actively regulated and monitored similar to regular corporations, it would be necessary for them to review their operations to verify that the conditions for their exemption are not violated, and that they are fully compliant with their other tax and statutory reporting obligations.

The author is a director  at the Tax Services Department of Isla Lipana & Co., the Philippine member firm of the PwC network. 

Views or opinions presented in this article are solely those of the author and do not necessarily represent those of Isla Lipana & Co. The firm will not accept any liability arising from such article; the author will be personally liable for any consequent damages or other liabilities.