Clarity on the taxation of educational institutions

Education is one of the most important pillars of any developing country. No less than the 1987 Philippine Constitution itself requires the state to 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 more or less severe mobility restrictions due to the COVID-19 pandemic. In response to this situation, our education systems have had to adapt, although pilot testing for face-to-face classes in some localities has had to be abandoned due to the sudden increase in COVID cases.

In recognition of their role in providing a public good, educational institutions enjoy certain tax privileges under the Constitution and the Revenue Code.

NON-PROFIT EDUCATIONAL INSTITUTIONS WITHOUT STOCK
Under Article XIV, Section 4(3) of the Constitution, all income and assets of non-profit educational institutions without share capital used genuinely, directly and exclusively for educational purposes are exempt from tax and of rights. As clearly established in case law (GR n° 196596, 198841 and 198941), the tax exemption of the income and assets of non-profit educational establishments depends on their use. Actually, directly and exclusively for educational purposes.

In a decision (GR n° 202792), the Supreme Court upheld this constitutional exemption by canceling the compensatory tax contributions of an educational institution, even if the latter late paid the filing fees to the Court of Justice. tax appeal when filing his legal appeal. According to the High Court, while procedural rules are important tools designed to facilitate the dispensation of justice, legal niceties can be excused where strict compliance will hinder the achievement of the justice it seeks to deliver.

OWNER EDUCATIONAL INSTITUTIONS
Educational institutions can also be organized as joint-stock companies, classified as proprietary educational institutions. Unlike non-profit, non-equity educational institutions, proprietary educational institutions are not covered by the aforementioned broad tax exemptions on their income and assets as provided for in the Constitution. Nevertheless, the Constitution provides that tax privileges may be conferred on them subject to limitations provided by law, including restrictions on dividends and reinvestment provisions.

These tax privileges are granted under Section 27(B) of the Internal Revenue Code, which provides a special lower corporate tax rate for private educational institutions and hospitals. The lower rate is usually 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 through June 30, 2023 to relieve schools and hospitals that have been severely impacted by the COVID pandemic.

However, during the implementation of the CREATE Act temporary tax relief, there was confusion as to what is considered a private educational institution subject to the special tax rate under the Revenue Code. . In Tax Regulation No. 5-2021, private educational institutions were defined and qualified as referring to private non-profit schools. This confusion apparently stems from the original wording of the Tax Code:

(B) Educational institutions and private hospitals. — Educational institutions and proprietary hospitals that are non-profit will pay a ten percent (10%) tax on their taxable income. . .” (Underscore provided.)

It appears that the nonprofit requirement for the special tax rate has been interpreted to cover both private educational institutions and hospitals. Such an interpretation in the regulations has created a seemingly absurd situation in which the lower tax is conferred on an essentially non-existent class of schools. As mentioned earlier, private educational institutions include corporations that are by their nature organized as for-profit corporations. A non-profit private educational institution could be seen as an oxymoron or a contradiction of terms. Naturally, there was a clamor from the education sector to rectify the misinterpretation. Thus, tax regulation No. 14-2021 was promulgated to suspend the implementation of the provisions on the “non-profit” qualification of owner educational establishments.

MODIFICATION OF THE TAX CODE
Aware of the above controversy, our legislators recently passed Republic Act No. 11635, which sought to address the issue by clarifying the wording of the Tax Code itself. As amended by this law, Section 27(B) of the Internal Revenue Code now reads as follows:

(B) Educational institutions and private hospitals.Non-profit hospitals and private educational institutions must pay a ten percent (10%) tax on their taxable income. . .” (Underscore provided.)

Thus, it is now clear that the not-for-profit 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 operating license issued by the relevant government agencies (eg DepEd, CHED, TESDA). It should be noted that under the same provision of the Tax Code, to benefit from the lower rate, their gross income from a trade, business or other unrelated activity must not exceed 50% their total gross income; otherwise, the standard corporate income tax rate (currently 25%) applies to all of their taxable income.

More than ever, the COVID pandemic has caused us – as individuals, as a community and as a nation – to think about our priorities. While public health remains the highest priority, access to affordable education deserves equal attention. Thanks to brilliant minds from education, many medical and technological breakthroughs in the fight against the COVID pandemic have been achieved and countless lives have been saved. This author personally hopes that the state will continue to prioritize education in accordance with its constitutional mandate and enable the education sector to contribute to nation building through the development of future generations.

Any 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 informational purposes only and should not be used as a substitute for advice. specific.

Marion D. Castañeda is a senior executive in the tax services department of Isla Lipana & Co., the Philippine member firm of the PwC network.

marion.castañ[email protected]

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