The inurement predicament

“THUS, as a matter of efficiency, the government forgoes taxes which should have been spent to address public needs, because certain private entities already assume a part of the burden. This is the rationale for the tax exemption of charitable institutions. The loss of taxes by the government is compensated by its relief from doing public works which would have been funded by appropriations from the Treasury (The Rationale for Exempting Nonprofit Organizations from Corporate Income Taxation by H. Hansmann, as cited by the Supreme Court in the case of the Commissioner of Internal Revenue vs. St. Luke’s Medical Center, 2012).”

A similar income tax exemption is provided under Section 30 of our Tax Code to various nonstock and/or nonprofit (“NSNP”) organizations registered in the Philippines.

Such exemption, however, is again under fire with the issuance of Revenue Memorandum Circular (“RMC”) No. 51-2014 by the Bureau of Internal Revenue (“BIR”) last 6 June 2014.

Under the RMC, for such organizations to qualify for the benefit of exemption under Section 30, no part of their net income or asset must belong to or inure to the benefit of any member, organizer, officer or any specific person. This prohibition on inurement is what the Circular seeks to clarify.

Under the Circular, the BIR enumerates six scenarios which it deems to be in violation of the prohibition on inurement.

In effect, an NSNP entity stands to lose its tax exemption when it: 1) pays unreasonable amounts of compensation to its employees; 2) pays compensation, salaries, or honorarium to its trustees; 3) extends loans and financial assistance to its members; 4) donates to any person or entity other than to other entities formed for the same purpose as its own; 5) pays for goods or services in amounts more than what they are actually worth in the market from a supplier where any one of its trustees, officers or fiduciaries has interest; or 6) upon dissolution, distributes its remaining assets to its trustees, organizers, officers or members.

Upon scrutiny, however, it seems that -- contrary to the BIR’s objective of clarifying the prohibition on inurement -- the Circular also raised more questions.

For one, are all nonstock entities enumerated under Section 30 bound to comply with the prohibition on inurement to ensure continuous relief from income tax?

A closer look at Section 30 (entitled “Exemption from Tax on Corporations”) will reveal that, while there are 11 categories of organizations listed there, only nonstock entities under Section 30 (E) and (F) contain an express qualification on the prohibition on inurement.

A basic rule in statutory construction dictates that when there is a qualification of a rule, such qualification must be understood with reference to the immediately preceding part of the provision to which it is attached and not to the law in its entirety or to the other sections thereof (Agpalo).

The current wording of the RMC, however, concludes that all entities that derive exemption under any one of the 11 subparagraphs of Section 30 -- including labor organizations, business leagues, and civic organizations -- are duty-bound to observe the prohibition.

Another question that comes to mind is whether the NSNP entity making payments or distributions classified as a prohibited inurement under the RMC will still lose its income tax exemption even if such payments or distributions are otherwise sanctioned by the law?

One prohibited inurement under the Circular is the payment of compensation, salaries, or honorarium to trustees or organizers. Indeed, for philanthropic reasons, a person agreeing to occupy a seat in the board of an NSNP organization, such as a foundation or charitable institution, generally should not expect to be compensated. Under the law, however, all private corporations including NSNP corporations are allowed to fix the compensation of its trustees in its by-laws. In fact, the Corporation Code already limits the compensation of its directors, as well as a penalty for any violation of the said limitation. Hence, if the salaries paid to the trustees are reasonable and by reason of the services these trustees render for the furtherance of the specific purpose with which their respective entities were established, such payments are permitted by the law.

Another transaction considered as a prohibited inurement is the provision of welfare aid and financial assistance to an NSNP’s members. Given this, various organizations that regularly extend non-interest bearing loans and aid to its members may lose their income tax exemption.

Labor organizations, for example, grant financial aid in favor of their union members, in case a member is either suspended or terminated from employment without reasonable cause. Veterans foundations, on the other hand, extend aid and assistance to Filipino veterans and their dependents to complement the efforts of the Government, and to promote patriotism and love of country. Various civic livelihood organizations, likewise, give similar financial assistance to its members to address the primary needs of the less fortunate and assist them in starting a business or livelihood.

All these organizations are nonstock corporations supposedly exempt from income tax under Section 30. Under the Circular, however, financial assistance extended by these entities, even if done with mainly altruistic intentions, are considered prohibited inurements, which disqualifies them from exemption.

Another prohibition worth noting would be the one on donating to any person or entity other than to other entities formed for the same purpose. This seems to effectively prohibit charitable organizations from doling out charity to the less fortunate, unless of course, they want to suffer tax from simply carrying out their purpose.

There is now doubt as to the purpose of penalizing an NSNP by denying it tax exemption even if its acts are in accordance with law and with their purpose.

It is not difficult to comprehend the objective of the BIR in applying stricter rules to NSNP organizations, especially now that our country is in the midst of a scandal due to the abuse of bogus nongovernment organizations. When tax exemptions are taken advantage of to the detriment of the Filipino people, the government should take measures to ensure that only those qualified are availing of the proper exemptions.

However, it seems that a far greater number -- legitimate entities with actual magnanimous objectives -- is being punished for the sins of a select few.

While taxes are the lifeblood of the government and tax exemptions shall be strictly construed against taxpayers, we should still be mindful that qualified NSNP organizations are exempt from income tax, because, in the main, they are providing services and resources which the government should be delivering in the first place. Tax rules must not be so stringent so as to frustrate such rationale and discourage those who want to serve others from doing so.

Ma. eliza christine c. gomez is a senior consultant at the Tax Services Department of Isla Lipana & Co., the Philippine member firm of the PwC network. Readers may call (02) 845-2728 or e-mail the author for questions or feedback.

ma.eliza.christine.gomez@ph.pwc.com

source:  Businessworld

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