On April 7, 2022, the Department of Finance (DOF) issued Tax Regulation (RR) No. 3-2022 to implement Republic Act (RA) No. 11635. RA No. 11635 provides for tax on the income of educational institutions and private hospitals, which are non-profit organizations. RR No. 3-2022 expressly provides that owner-educational establishments may benefit from the preferential income tax rates of 1% (available from July 1, 2020 to June 30, 2023) and 10% (from July 1, 2023). July 2023), provided that their gross income from trade, business or any other activity that is not related to education, does not exceed 50% of their total gross income from all sources. The 1% rate is based on the Business Recovery and Tax Incentives Act (CREATE), which amended the National Tax Code (Tax Code). RR No. 3-2022 and RA No. 11635 specify that a private educational institution does not have to be “non-profit” to benefit from the preferential tax rates.
Prior to April 11, 2021 (the effective date of CREATE), Section 27(B) of the Internal Revenue Code provided the following:
ARTICLE 27. Rates of tax on the income of national companies.
. . . .
(B) Educational institutions and private hospitals. – Educational institutions and private non-profit hospitals shall pay a tax of ten percent (10%) on their taxable income, except those covered by subsection (D) hereof: to provided that, if the gross income derived from a trade, business or other unrelated 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 all taxable income.
Amended Section 27(B) of the Internal Revenue Code provided a rate of 1% from July 1, 2020 to June 30, 2023 as a form of relief for those affected by the covid-19 pandemic, based on his declaration of Politics. Section 27(B) of the Internal Revenue Code, as amended by the CREATE Act, reads as follows:
(B) Educational institutions and private hospitals. — Educational institutions and private hospitals that are not-for-profit will pay a tax of ten percent (10%) on their taxable income, except those covered by subsection (D) herein: provided, that from July 1, 2020 and until the rate here imposed will be one percent (1%).
This reduced preferential tax rate of 1% from 1%, which is similar to the preferential rate of 10%, is still subject to the requirement that the beneficiary institution’s gross income from a trade, business or any other non-educational activity does not exceed 50% of the entity’s total gross income from all sources. If the 50% threshold is exceeded, the applicable tax rate is the normal corporate tax rate of 25%.
Implementation of CREATE
On April 8, 2021, the DOF issued RR No. 5-2021 to implement the provisions of the CREATE Act. RR 3-2022 defined “private educational institutions” as follows:
all private schools, that are not-for-profit for the purposes of these Rulesmaintained and operated by individuals or groups, with an operating license issued by the Department of Education (DepEd) or the Commission for Higher Education (CHED) or the Technical Education and Development Authority of skills (TESDA), as the case may be, under the laws and regulations in force. (Emphasis added.)
However, the effectiveness of certain provisions of RR No. 5-2021, including the above provision, was suspended effective July 26, 2021, when the DOF issued RR No. 14-2021 to:
easing the tax burden on private educational institutions, particularly during this time of the COVID-19 pandemic, and taking into account bills pending in Congress to amend Section 27(B) of the National Internal Revenue Code (NIRC) of 1997, as amended, to finally clarify the taxation of school income.
The explanatory note to one of these bills stated that:
Section 27(B) of the [Tax Code, as amended by CREATE]creates ambiguity as to who the preferential tax rates apply to. It further states that “being owner and non-profit is a legal impossibility, because in its general sense, owner means privately owned and operated and run as a for-profit organization while non-profit organization profit is 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 “not-for-profit” in Section 27(B) of the Internal Revenue Code as amended by CREATE applies to both hospitals and nursing homes. private education. It entered into force on January 25, 2022. RA No. 11635 amends Section 27(B) of the Internal Revenue Code so that the provision reads as follows:
(B) Hospitals that are not-for-profit, proprietary educational institutions shall pay ten percent (10%) tax on their taxable income, except those covered by subsection (D) hereof; provided, that on and after July 1, 2020 and until June 30, 2023, the tax rate imposed hereby is one percent (1%). (Emphasis added.)
On April 7, 2022, the DOF issued RR No. 3-2022 to implement RA No. 11635. The definition of “private educational institutions” in RR No. 3-2022 does not contain the word ” not-for-profit”, but now also expressly refers to entities organized for profit. The definition in RR No. 3-2022 is as follows:
A. Private Educational Institutions – means all private schools maintained and operated by private individuals or groups, with a license issued to operate by the Department of Education (DepEd) or the Higher Education Commission (CHED) ) or Technical Education and Skills Development (TESDA), as applicable, in accordance with applicable laws and regulations. The most common organizational structure for educational institutions registered with the Securities and Exchange Commission (SEC) under Section 27(B) of the NIRC, as amended, is as follows:
a) Joint-stock companies are those which have a share capital divided into shares and are authorized to distribute to the holders of these shares, dividends or allocations of excess profits on the basis of the shares held; characterized as organized for profit that benefits shareholders; profits are declared and distributed to shareholders; composed of shareholders (also called stockholders or stockholders); and governed by a Board of Directors (CA).
b) Non-stock companies are those which are not incorporated as stock companies; generally characterized as organized for purposes other than profit; the income earned is not so distributed but used to pursue its own objectives; composed of members; and governed by what is commonly referred to as a Board of Directors (BOT).
Following the publication of RA No. 11635 and RR No. 3-2022, it is now clear that an educational institution owner has access to preferential tax rates of 1% since July 1, 2020, which will end on June 30, 2023 These will then change to 10% preferential income tax rates from July 1, 2023.
The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.