New guidelines for tax exemption of non-stock non-profits

It is the activities of a non-stock, nonprofit corporation that entitle it to a tax exemption.

In a move to clarify the nature, character, and tax treatment of corporations under Section 30 of the Tax Code, the Commissioner of Internal Revenue (CIR) issued Revenue Memorandum Order (RMO) No. 38-2019 containing the new guidelines for the processing and issuance of Certificates of Exemption (CTE).

The RMO is a reiteration of Revenue Memorandum Circular (RMC) No. 64-2016, which provides parameters on which entities fall within the ambit of the so-called “Section 30 corporations,” i.e., tax-exempt corporations.

Section 30 corporations include (1) labor, agriculture or horticultural organizations not organized principally for profit; (2) mutual savings banks not having capital stock represented by shares, and cooperative banks without capital stock organized and operated for mutual purposes and without profit; (3) beneficiary society orders or associations, operating for the exclusive benefit of the members; (4) cemetery company, owned and operated exclusively for the benefit of its members; (5) non-stock corporations or associations operated exclusively for religious, charitable, scientific, athletic, or cultural purposes, or for the rehabilitation of veterans; (6) business leagues, chambers of commerce, boards of trade not organized for profit; (7) civic leagues or those organized exclusively for the promotion of social welfare; (8) non-stock and nonprofit educational institutions; (9) government educational institutions; (10) farmers’ or other mutual typhoon or fire insurance companies, mutual ditch or irrigation companies, mutual or cooperative telephone companies, or like organizations of a purely local character; (11) as well as farmers’, fruit growers’ associations operated as a sales agent for the purpose of marketing the products of its members.

The RMO shall apply to all tax-exempt corporations listed above except for non-stock and nonprofit educational institutions which are covered separately by RMC 44-2016.

Mere registration with the Securities and Exchange Commission (SEC) as a non-stock, nonprofit corporation does not automatically entitle an entity to the tax exemption. It is a corporation’s activities that determine the true nature of the organization and its taxability or exemption from taxes.

Thus, to determine whether a corporation qualifies for income tax exemption under Section 30 of the Tax Code, the BIR provided two determinative tests: (1) organizational test; and (2) operational test.

The organizational test requires that the corporation’s constitutive documents (i.e., SEC registration, Articles of Incorporation (AOI), and By-Laws) show that its primary purpose(s) falls under Section 30 of the Tax Code. The operational test, on the other hand, requires that the regular activities of the corporation be exclusively devoted to the furtherance of such primary purpose.

Further, the earnings of a Section 30 corporation that chiefly come from donations, grants, or contributions should not inure to the benefit of its trustees, organizers, officers, members, or any specific person. As such, the RMO listed certain payments to individuals that would be considered as inurement prohibitions.

However, realistically, Section 30 corporations need other sources of income to survive and continue serving their purpose. Thus, in concurrence with the law, the RMO recognizes that these corporations are allowed to engage in activities conducted for profit without losing their tax exemption.

Thus, interest income from bank deposits, gains from investments, rental income from real or personal properties shall be subject to income tax. Consequently, Section 30 corporations are required to file quarterly and annual income tax returns to report such other income.

Furthermore, the exemption shall only be limited to income tax. It therefore excludes withholding tax, value-added tax, or percentage tax. Thus, Section 30 corporations have the responsibility to withhold taxes on the compensation income of their employees, and on the payments to individuals or corporations subject to tax. Likewise, their purchases of goods, properties, or services, and importations shall be subject to the 12% VAT. As an indirect tax, it can be passed on to the purchaser.

Section 30 corporations who availing of the tax exemption are required to secure a Certificate of Tax Exemption (CTE) or a tax exemption ruling. A CTE shall be valid for three years from the date of its effectivity, unless sooner revoked or canceled. However, it may be renewed or revalidated for another three years.

Nonetheless, to ease the process, the securing of CTEs has now been simplified under the RMO. The request is filed with the Revenue District Office (RDO) where the corporation is registered, and the CTE is subsequently issued by the Revenue Region.

However, the RMO remains silent on how the CTE requirements apply to new Section 30 corporations. Specifically, since two of the mandatory requirements are the Income Tax Returns or Annual Information Returns and Financial Statements of the corporation for the last three years, a new company will not be able to provide such documentary requirements. In that case, would the AoI and By-Laws be sufficient documents for them to secure a CTE and consequently, be qualified for tax exemption for the next three years? At the end of the day, a Section 30 Corporation does not lose its character as such, and its consequent exemption from taxation merely because it cannot submit certain documentary requirements.

While the BIR merely seeks to ensure that only qualified taxpayers are rightfully availing of the exemption, and safeguard against tax evasion and abuse of exemptions, it may be worthwhile to consider that the tax exemption granted to corporations under Section 30 of the Tax Code is to compensate them for the services they render to benefit the public. Thus, one would hope that more leniency and flexibility is afforded to them as long as they comply substantially with the requirements of the law.