Clarity on the taxation of educational institutions

Education is one of the most important pillars of any developing nation. No less than the 1987 Philippine Constitution itself mandates that the State prioritize education to foster patriotism and nationalism, accelerate social progress, and promote total human liberation and development. For almost two years now, we have been experiencing mobility restrictions with varying degrees of severity due to the COVID-19 pandemic. In responding to this situation, our educational systems have had to adapt, even as pilot testing for face-to-face classes in some localities had to be scrapped due to the sudden surge in COVID cases.

NONSTOCK NONPROFIT EDUCATIONAL INSTITUTIONS
Under Article XIV, Section 4 (3) of the Constitution, all revenue and assets of nonstock nonprofit educational institutions used actually, directly and exclusively for educational purposes are exempt from taxes and duties. As established clearly by jurisprudence (G.R. Nos. 196596, 198841, and 198941), the tax exemption of revenue and assets of nonstock nonprofit educational institutions hinges on whether these are used actually, directly and exclusively for educational purposes.

In one decision (G.R. No. 202792), the Supreme Court upheld such constitutional exemption in canceling the deficiency tax assessments of an educational institution, even if the latter belatedly paid the docket fees with the Court of Tax Appeals upon filing its judicial appeal. According to the high court, while procedural rules are important tools designed to facilitate the dispensation of justice, legal technicalities may be excused when strict adherence will impede the achievement of justice it seeks to serve.

PROPRIETARY EDUCATIONAL INSTITUTIONS
Educational institutions can also be organized as stock corporations, classified as proprietary educational institutions. In contrast with nonstock nonprofit educational institutions, proprietary educational institutions are not covered by the aforementioned broad tax exemptions on their revenue and assets as mandated by the Constitution. Nonetheless, the Constitution provides that they can be conferred tax privileges subject to limitations provided by law, including restrictions on dividends and provisions for reinvestment.

Such tax privileges are granted under Section 27(B) of the Tax Code, which provides for a special lower corporate income tax rate for proprietary educational institutions and hospitals alike. The lower rate is generally 10%, but pursuant to Republic Act No. 11534 (more commonly known as the CREATE Act), the rate is temporarily reduced to 1% effective July 1, 2020 until June 30, 2023 to provide relief for schools and hospitals that have been severely affected by the COVID pandemic.

However, in implementing the CREATE Act’s temporary tax relief, there was confusion as to what qualifies as a proprietary educational institution subject to the special tax rate under the Tax Code. In Revenue Regulations No. 5-2021, proprietary educational institutions were defined and qualified as referring to nonprofit private schools. This confusion apparently arose from the original wording in the Tax Code:

“(B) Proprietary Educational Institutions and Hospitals. — Proprietary educational institutions and hospitals which are nonprofit shall pay a tax of ten percent (10%) on their taxable income . . .” (Underscore supplied.)

It seems that the nonprofit requirement for the special tax rate was interpreted to cover both proprietary educational institutions and hospitals. Such interpretation in the regulations created a seemingly absurd situation wherein the lower tax is conferred to an essentially non-existent category of schools. As previously mentioned, proprietary educational institutions include stock corporations that are, by their nature, organized as profit-oriented companies. A nonprofit proprietary educational institution could be considered an oxymoron or a contradiction of terms. Understandably, there was a clamor from the education sector to rectify the erroneous interpretation. Thus, Revenue Regulations No. 14-2021 were promulgated to suspend the implementation of the provisions on the “nonprofit” qualification of proprietary educational institutions.

TAX CODE AMENDMENT
Cognizant of the above controversy, our lawmakers recently passed Republic Act No. 11635, which sought to address the issue by clarifying the wording in the Tax Code itself. As amended by such law, Section 27(B) of the Tax Code now reads as follows:

“(B) Proprietary Educational Institutions and Hospitals. — Hospitals which are nonprofit and proprietary educational institutions shall pay a tax of ten percent (10%) on their taxable income . . .” (Underscore supplied.)

Thus, it is now clear that the nonprofit qualification only applies to hospitals and not to proprietary educational institutions. The latter refers to any private school maintained and administered by private individuals or groups with an issued permit to operate from the relevant government agencies (e.g., DepEd, CHED, TESDA). It is worth highlighting that, under the same Tax Code provision, to qualify for the lower rate, their gross income from unrelated trade, business, or other activity must not exceed 50% of their total gross income; otherwise, the regular corporate income tax rate (currently at 25%) applies to their entire taxable income.

More than ever, the COVID pandemic has pressed us — as individuals, as a community, and as a nation — to contemplate our priorities. While public health remains the highest priority, access to affordable education deserves equal attention. Through brilliant minds borne of education, many medical and technological breakthroughs in combating the COVID pandemic have been achieved, and countless lives are saved. This author personally hopes that the State continues to prioritize education following its constitutional mandate and enabling the education sector to contribute to nation-building through the development of future generations.