Taxwise Or Otherwise

If there’s any good this pandemic has brought to our country, and to the business community in particular, I think one of them would be the passage of the Corporate Recovery and Tax Incentives  for Enterprises (CREATE) Act.  Among others, CREATE lowered the corporate income tax rates from 30% to 25% (or 20% for small and medium enterprises), rationalized fiscal incentives, and repealed certain provisions of the National Internal Revenue Code (NIRC) or Tax Code of the Philippines.  One of those repealed is the imposition of the 10% Improperly Accumulated Earnings Tax (IAET).

Prior to CREATE, the 10% IAET was imposed on the improperly accumulated taxable income of a corporation formed for the purpose of avoiding the income tax on its shareholders, by permitting the earnings and profits of the corporation to accumulate, instead of distributing them to the shareholders as dividends.  Its imposition aimed to deter or penalize corporations for the improper accumulation of earnings to avoid the payment of dividends tax that would have been due had the earnings been distributed as dividends to the shareholders. 

If retention of the profits is justifiable, such as the use of undistributed profits for the reasonable needs of the business, such purpose would not generally make the retention improper and subject to the penalty tax.

The Bureau of Internal Revenue (BIR) considered the accumulation of earnings up to 100% of the paid-up capital of a corporation as falling within the “reasonable needs of the business.” Moreover, earnings that are reserved for a justified purpose (e.g., definite corporate expansion, compliance with any loan covenants, earnings reserve subject to the legal prohibition against its distribution) were also considered within the purview of “reasonable needs of the business.” 

The Tax Code also exempted from the imposition of the 10% IAET, certain companies, including publicly-held corporations. Publicly-held companies refer to those, where the top 20 ultimate individual shareholders hold less than 50% of the value of the outstanding capital stock or the voting power of the corporation pursuant to Revenue Regulations (RR) No. 2-2001.

In determining stock ownership, the BIR regulations allowed tracing the ownership up to the level of the individual owners. Hence, the stock owned directly or indirectly by or for a corporation, partnership, estate, or trust shall be considered as being proportionately owned by its shareholders, partners, or beneficiaries. An individual shall also be considered as owning the stock owned, directly or indirectly, by or for his family, or by his partner in a partnership.

A publicly-listed corporation or a corporation owned directly or indirectly by a publicly-listed corporation is not automatically exempt from IAET. As mentioned, the individual ownership of a corporation shall be considered in determining whether a corporation is publicly-held for IAET purposes.

Thus, in one ruling, the BIR did not consider a corporate taxpayer as publicly-held even though more than 50% of its shareholdings are indirectly owned by a publicly-listed company. The ownership of the taxpayer was traced past the corporate shareholders and up to the level of the individual shareholders. The BIR observed that although publicly listed, the ultimate parent of the taxpayer was effectively controlled by only a few individuals (i.e., less than 10), and thus cannot be considered publicly held for purposes of exemption from IAET.

Domestic corporations and subsidiaries of foreign companies, which are held by publicly-listed corporations, face these challenges or questions around their excess accumulated earnings during BIR tax audits or investigations.  Oftentimes, they end up being assessed deficiency 10% IAET for allegedly having excess undistributed earnings and/or for failure to provide adequate supporting documents to prove that they are publicly-held companies, as the case may be.

The repeal of IAET under the CREATE Act is truly a welcome development for these corporations as they will no longer have to deal with this issue when they are audited by the BIR in the future.  Moreover, domestic corporations, in general, will not have to think about declaring dividends every so often, which in some cases would be remitted out to an offshore parent company, thereby taking money out of the Philippines.  With the funds still in the country, these could be re-invested and used by these domestic companies to grow their business in the Philippines and benefit the economy, which is sorely needed especially after the pandemic.

In Revenue Regulations No. 5-2021, the BIR provides that the repeal of IAET applies to the entire taxable year for all fiscal years/taxable years ending after the effectivity of CREATE. Note that the repeal under the Act did not specifically provide any retroactivity clause.  Therefore, the general rule on effectivity date applies, which is officially April 11, or 15 days after CREATE’s publication on 27 March 2021.

Technically speaking, any excess retained earnings in 2020 and prior years may still be at risk of being questioned or assessed for IAET if the accumulation of earnings is found to be beyond the reasonable needs of the business.

That said, will the BIR find less interest in pursuing assessments related to IAET for 2020 and prior years given the repeal under the CREATE Act?  We’ll have to see and find out in the coming tax audits.

The 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 information purposes only, and should not be used as a substitute for specific advice.


Nelson V. Soriano is a Tax Director at the Tax Services Department of Isla Lipana & Co., the Philippine member firm of the PwC network.

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