In 2012, the Bureau of Internal Revenue (BIR) issued Revenue Memorandum Circular (RMC) No. 35-2012, which clarified the taxability of clubs organized and operated exclusively for pleasure, recreation, and other nonprofit purposes.
The RMC emphasized the clear intention of legislators to omit from the Tax Code of 1997, as amended, recreational clubs from the list of income tax-exempt corporations. Consequently, the club’s income derived from whatever source, such as membership fees, assessment dues, rental income, service fees, and the like are subject to income tax. The RMC further stated that gross receipts including, but not limited to the preceding club income, are also subject to VAT.
To dispel confusion due to rulings that exempt recreational clubs from income tax and VAT, RMC 35-2012 repealed all rulings and policies that are inconsistent with its directives.
In reaction, recreational clubs challenged the validity of the RMC through an appeal to the Regional Trial Court (RTC), arguing that the policy was unjust, oppressive, and confiscatory for subjecting membership fees, assessment dues, and service fees to income tax and VAT.
In a 2016 decision, the RTC declared RMC 35-2012 valid and constitutional.
However, the Supreme Court, in a case docketed as G.R. No. 228539, recently set aside the ruling of the RTC on the basis that RMC 35-2012 erroneously interpreted the phrase “income from whatever source.”
While the RMC was correct to say that the exemption from income tax previously granted to recreational clubs had been deleted in the Tax Code of 1997, the interpretation that membership fees and assessment dues are sources of income from which tax liabilities may accrue is misplaced. The Court distinguished between the term “capital,” which means the fund, and the term “income,” which refers to the flow of services rendered by capital and further defined as profit or gain.
Applying this distinction, membership fees, assessment dues, and other fees of a similar nature only constitute contributions for the maintenance and operations of the facilities and services offered by recreational clubs to their members. They are not paid as consideration for services or goods purchased but instead, are utilized as funds for the upkeep of the club facilities and for retention of membership in the club. These payments are held in trust and are to be used to cover operating and general costs. As funds intended for the preservation and maintenance of the clubs’ general operations, nothing is to be gained upon their collection.
Funds in the form of capital are to be distinguished from fees as consideration for the clubs’ services and other income-generating facilities like bars, restaurants, and accommodations that constitute income or profit. Recreational clubs are generally free to use these fees for whatever purpose they desire, and thus, these are considered “fruits” from business transactions.
The Supreme Court emphasized that as long as the membership fees, assessment dues, and other items of similar nature are treated by recreational clubs as collections from their members solely for their membership and for the maintenance and preservation of their operations and facilities, the funds should not be classified as income from whatever source subject to income tax. They only form part of the capital from which no income tax may be collected or imposed. Moreover, imposing income tax on these membership fees and assessment dues is arbitrary and confiscatory because these are capital and not income.
As for VAT, the membership fees and assessment dues do not involve the sale of goods or services. Since there is no economic activity involved in the collection in the absence of a sale, VAT is not imposable.
Because RMC 35-2012 interpreted the phrase income from whatever source to include membership fees, assessment dues, and other items of similar nature, the BIR exceeded its authority by issuing an erroneous construction of the law. As a rule, administrative regulations should always be in accord with the provisions of the statute they seek to carry into effect. Any resulting inconsistency shall be resolved in favor of the fundamental law or the Tax Code in this case.
While the Supreme Court ruled specifically in the case of recreational clubs, condominium corporations and homeowners’ associations may be left wondering if the same logic can be applied to exempt from income tax the dues and fees they collect from their members. After all, the fees are intended for the same purpose. Well, that discussion may be a separate article entirely.
Anyhow, while it took nearly five years for the Court to resolve the validity of RMC 35-2012, recreational clubs can now put the issue to rest and focus on the business of providing better facilities and services to their members. Besides, why tax the funds needed by clubs to preserve recreational facilities for the maintenance of the members’ wellbeing? As the saying goes, bread is the first necessity of life, and recreation is a close second.
The views or opinions expressed in this article are solely those of the author and do not necessarily represent those of Isla Lipana & Co. The content is for general information purposes only, and should not be used as a substitute for specific advice.
Maria Jonas Yap
Tax Senior Manager, PwC Philippines
Tel: +63 (2) 8452728 loc. 2024