SyCip Salazar Hernandez & Gatmaitan
  May 7, 2022 - Philippines

Department of Finance issues new regulation to implement Republic Act No. 11635
  by SyCip Salazar Hernandez & Gatmaitan

Introduction

On 7 April 2022, the Department of Finance (DOF) issued Revenue Regulation (RR) No. 3-2022 to implement Republic Act (RA) No. 11635. RA No. 11635 provides for income tax on proprietary educational institutions and hospitals, which are non-profit organisations. RR No. 3-2022 expressly provides that proprietary educational institutions may benefit from the preferential income tax rates of 1% (available from 1 July 2020 to 30 June 2023) and 10% (from 1 July 2023), provided that their gross income from trade, business, or any other activity that is not related to education, is not more than 50% of their total gross income from all sources. The 1% rate is based on the Corporate Recovery and Tax Incentives for Enterprises Law (CREATE), which amended the National Internal Revenue Code (Tax Code). RR No. 3-2022 and RA No. 11635 clarify that a proprietary educational institution is not required to be "nonprofit" in order to benefit from the preferential income tax rates.

Background

Prior to 11 April 2021 (the date when the CREATE took effect), section 27 (B) of the Tax Code provided the following:

SECTION 27. Rates of Income Tax on Domestic Corporations.

. . . .

(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 except those covered by Subsection (D) hereof: Provided, That if the gross income from unrelated trade, business or other activity exceeds fifty percent (50%) of the total gross income derived by such educational institutions or hospitals from all sources, the tax prescribed in Subsection (A) hereof shall be imposed on the entire taxable income.

The amended section 27(B) of the Tax Code provided a 1% rate from 1 July 2020 to 30 June 2023 as a form of relief for those affected by the covid-19 pandemic, based on its declaration of policy. Section 27(B) of the Tax Code, as amended by the CREATE Law, reads:

(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 except those covered by Subsection (D) hereof: Provided, That beginning July 1, 2020 until June 30, 2023, the tax rate herein imposed shall be one percent (1%).

This reduced, 1% preferential tax rate of 1%, which is similar to the 10% preferential rate, is still subject to the requirement that the availing institution's gross income from non-education related trade, business or any other activity is no more than 50% of its total gross income of the entity from all sources. If the 50% threshold is breached, the applicable income tax rate is the 25% regular corporate income tax rate.

Implementation of CREATEOn 8 April 2021, the DOF issued RR No. 5-2021 to implement the provisions of the CREATE Law. RR No. 3-2022 defined "proprietary educational institutions" as:

any private schools, which are non-profit for the purpose of these Regulations, maintained and administered by private individuals or groups, with an issued permit to operate from the Department of Education (DepEd) or the Commission on Higher Education (CHED) or the Technical Education and Skills Development Authority (TESDA), as the case may be, under existing laws and regulations. (Emphasis added.)

However, the effectiveness of certain provisions of RR No. 5-2021, including the above provision, was suspended from 26 July 2021, when the DOF issued RR No. 14-2021 to:

ease the burden of taxation among proprietary educational institutions, especially during this time of COVID-19 pandemic, and taking into account the pending Bills in Congress seeking to amend Section 27 (B) of the National Internal Revenue Code (NIRC) of 1997, as amended, to finally clarify the income taxation of schools.

The explanatory note of one of such bills stated that:

Section 27(B) of the [Tax Code, as amended by CREATE] creates an ambiguity as to whom the preferential tax rates apply to." It further states that "being proprietary and nonprofit is a legal impossibility, as in its general sense, proprietary means privately owned and managed and run as a profit-making organization while nonprofit is one not conducted or maintained for the purpose of making a profit.

RA No. 11635 and RR No. 3-2022

RA No. 11635 was enacted to clarify whether the word "nonprofit" in section 27(B) of the Tax Code as amended by the CREATE applies to both hospitals and proprietary educational institutions. It took effect on 25 January 2022. RA No. 11635 amends section 27 (B) of the Tax Code so that the provision reads as follows:

(B) Hospitals which are nonprofit and proprietary educational institutions shall pay a tax of ten percent (10%) on their taxable income except those covered by Subsection (D) hereof: Provided, That beginning July 1, 2020 until June 30, 2023, the tax rate herein imposed shall be one percent (1%). (Emphasis added.)

On 7 April 2022, the DOF issued RR No. 3-2022 to implement RA No. 11635. The definition of "proprietary educational institutions" in RR No. 3-2022 does not contain the word "nonprofit", but now also expressly refers to entities organised for profit. The definition in RR No. 3-2022 is as follows:

A. Proprietary Educational Institutions — refer to any private schools maintained and administered by private individuals or groups, with an issued permit to operate from the Department of Education (DepEd) or the Commission on Higher Education (CHED) or the Technical Education and Skills Development Authority (TESDA), as the case may be, in accordance with existing laws and regulations. The most common organizational structure of educational institutions registered with Securities and Exchange Commission (SEC) under Section 27 (B) of the NIRC, as amended, are:

a. Stock Corporations are those which have capital stock divided into shares and are authorized to distribute to the holders of such shares, dividends, or allotments of the surplus profits on the basis of the shares held; characterized as organized for profit to be enjoyed by stockholders; profits are declared and they are distributed to stockholders; composed of stockholders (also called shareholders or share owners); and governed by a Board of Directors (BOD).

b. Non-stock Corporations are those organized not as a stock corporation; characterized generally, as organized for purposes other than profit; income earned are not so distributed but used to further its own purposes; composed of members; and governed by what is generally called a Board of Trustees (BOT).

Comment

Following the issuance of RA No. 11635 and RR No. 3-2022, it is now clear that a proprietary educational institution has had access to 1% preferential income tax rates since 1 July 2020, which will come to an end of 30 June 2023. These will then rise to 10% preferential income tax rates from 1 July 2023.

For further information on this topic please contact Hiyasmin H Lapitan at SyCip Salazar Hernandez & Gatmaitan (SyCipLaw) by telephone (+632 8982 3500, +632 8982 3600, +632 8982 3700) or email ([email protected]). The SyCipLaw website can be accessed at www.syciplaw.com.

Carina C Laforteza, partner and head of the tax department, and Giancarlo Kristoffer D Gabriel assisted in the preparation of this article.

Originally published on the Lexology site.