BIR Ruling [DA-244-04]

May 7, 2004 BIR RULING [DA-244-04] 27 (B); 30 (H); BIR Ruling No. 40, s. 1969 The Regional Director Revenue Region No. 1 Calasiao, Pangasinan S i r : This refers to your letter dated September 10, 2002 requesting for a clarification if Montessori schools are exempt under Section 30(H) of the Tax Code of 1997 or are they considered as proprietary educational institutions whose income is subject to a ten (10%) tax pursuant to Section 27(B) of the same Tax Code. It is represented that the request for clarification has been prompted by the deluge of applications for tax exemptions of Montessori-type schools which operate locally and cater to children who belong to high-income groups, declaring that they are non-stock, non-profit and invoking exemption under Section 30(H) of the Tax Code of 1997. In reply, please be informed that Section 4(3) of Article XIV of the New Constitution provides, viz : "ARTICLE XIV Education, Science and Technology Arts, Culture and Sports Sec. 4(3) All revenues and assets of non-stock, non-profit educational institutions used actually, directly, and exclusively for educational purposes shall be exempt from taxes and duties. Upon the dissolution or cessation of the corporate existence of such institutions, their assets shall be disposed of in the manner provided by law. Proprietary educational institutions, including those cooperatively owned, may likewise be entitled to such exemptions subject to the limitations provided by law including restrictions on dividends and provisions for reinvestment." Likewise, Section 30(H) of the Tax Code of 1997 provides, viz : Sec. 30. Exemptions from Tax on Corporations . The following organizations shall not be taxed under this Title in respect to income received by them as such: xxx xxx xxx (H) A non-stock and non-profit educational institution xxx xxx xxx Moreover, Section 27(B) of the Tax Code of 1997 provides, viz : "Sec. 27. Rates of Income Tax on Domestic Corporation . xxx xxx xxx (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. For purposes of this Subsection, the term "unrelated trade, business or other activity" means any trade, business or other activity, the conduct of which is not substantially related to the exercise or performance by such educational institution or hospital of its primary purpose or function. A proprietary educational institution is any private school maintained and administered by private individuals or groups with an issued permit to operate from the Department of Education, Culture and Sports (DECS), 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." Furthermore, Section 3 of Department Order No. 92-88, amending Department Order No. 137-87 dated December 16, 1987 provides, viz : "SEC. 3. Section 2 of the said Department Order is likewise amended to read as follows: "SEC. 2. Coverage of Exemption under Section 4(3), Article XIV or the New Constitution The exemption herein contemplated refers to internal revenue taxes and duties, in appropriate cases, imposed by the national government and in CERTAIN CASES TO LOCAL TAXES IMPOSED BY LOCAL GOVERNMENT UNITS UNDER THE LOCAL TAX CODE on all revenues and assets of non-stock, non-profit educational institutions used actually, directly and exclusively for educational purposes." Thus, both under the Constitution and Sec. 30(H) of the Tax Code of 1997 educational institutions to be exempt from tax must be non-stock and non-profit and that all revenues and assets must be used actually, directly and exclusively for educational purposes. Nevertheless, under Sec. 4(3), Art. XIV of the Constitution, proprietary education institution, including those cooperatively owned, may likewise be entitled to such exemptions subject to the limitations provided by law including restrictions on dividends and provisions for reinstatement. While under Sec. 27(B) of the Tax code of 1997 proprietary educational institutions which are non-profit shall pay a tax of ten percent (10%) on their taxable income. In addition, to qualify for exemption, non-stock, non-profit and proprietary educational institutions must be registered with the Securities and Exchange Commission as a non-stock, non-profit or proprietary educational institutions whose articles of incorporation must contain the following: 1) that no part of the net income shall inure to the benefit of any of its officers and members; 2) that the trustees do not receive any compensation 3) that in case of dissolution, assets of the corporation shall belong to similar institution or to the government; must be able to prove viability of its operation, and must submit government permit from the Department of Education Culture and Sports or from the Commission on Higher Education pursuant to Revenue Memorandum 10-2001 dated February 10, 2001. Moreover, the mere fact that no cash or stock dividend is being declared by an educational institution organized as a stock corporation will not sustain the claim that the net income of the educational institution does not inure to the benefit of its stockholders. . . . (T)he net profits of a corporation inure to the benefit of the stockholders not only by way of cash dividends but also thru the accumulation of profits as surplus or additional capital, or the investment thereof in additional assets. And it is for this reason that under the amendment to then Section 27(e) (now Section 31) of the Tax Code, effected by Republic Act No. 82, a private educational institution organized as a stock corporation is subject to income tax on its net income for the year, although no dividends are declared for said year. ( CIR vs. University of the Visayas , L-13554, Oct. 30, 1964). Therefore, a private educational institution organized as stock corporation is subject to the corporate income tax imposed by then Section 24(now Section 27) of the Tax Code. ( BIR Ruling No. 40, s. 1969 ). A non-stock private educational corporation organized and operated for educational purposes is subject to the 10% special rate of income tax provided for under then Section 24 (now Sec. 27) of the Tax Code, as amended by Section 1 of Republic Act No. 600 and section 1 of Republic Act No. 5423, June 27, 1968, on its income from sources other than from tuition, matriculation, laboratory; library, athletic, graduation fees of similar nature essential to, or necessarily connected with the educational purposes of an institution of learning. ( Jesus Sacred Heart College vs. CIR , 95 Phil. 16) A private educational institution which deviates from its purely educational purposes and activities shall be treated like any private domestic corporation engaged in business for profit with respect to income derived therefrom. The protective mantle of income tax benefit or exemption cannot be extended to a private educational institution which chooses to descend from its high pedestal of tax preference or immunity to the level of an ordinary private corporation engaged in profitable undertaking or business. ( Xavier School, Inc. vs. CIR , CTA Case No. 1682, Oct. 8, 1969; p. 79, Jose Aranas, Updated National Internal Revenue Code, 1988 edition). Thus, to be exempt from taxes, an educational institution must be non-stock, non-profit. Proprietary educational institutions, including those cooperatively owned, may likewise be entitled to such exemptions subject to the limitations provided by law including restrictions on dividends and provisions for reinvestment. In view thereof, Montessori Schools, which are not non-stock, non-profit educational institutions, shall pay a tax of ten percent (10%) on their taxable income except those covered by Subsection (D) of Section 27 of the Tax Code. 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 from all sources, the tax prescribed in Subsection (A) of Section 27 shall be imposed on the entire taxable income. (SGD.) JOSE MARIO C. BUAG Deputy Commissioner Legal and Inspection Group