The start of a new year (and in this case, the closing of a decade) is usually filled with hope and optimism. People generally scribble their resolutions, looking forward to another year of achieving more goals and milestones. For finance and accounting practitioners, the new year also marks the beginning of busier times ahead (especially those in companies that follow the calendar year as their accounting period), starting with the closing of accounting books and typically ending with the filing of the annual income tax return.
All businesses, regardless of accounting period, are required to secure business permits on or before the annual statutory deadline of Jan. 20. In general, part of the process of securing a business permit is the payment of local business tax (LBT) in the municipality or city where the business operates. The Local Government Code (LGC) empowers municipalities and cities to enact their respective local ordinances, imposing LBT within the bounds and limitations provided under the LGC. Depending on the type of business and the amount of gross sales/receipts during the preceding calendar year, an LBT can be:
a) fixed in amount, following the schedule of graduated LBT amounts per local ordinance;
b) computed by multiplying the gross sales/receipts during the preceding calendar year with the applicable LBT rate per local ordinance; or
c) a combination of both items (a) and (b) above.
In recent years, it has been the practice of some local government units (LGUs) to impose LBT on holding companies for their passive income (e.g., dividend and interest income). Such imposition of LBT can be considered questionable given judicial pronouncements to the contrary. Several cases decided by the Court of Tax Appeals (CTA) in previous years, involving various companies and LGUs, have consistently ruled that holding companies are not subject to LBT on their passive income.
Notwithstanding, some companies pay the LBT anyway for fear of not getting their business permit from the LGU. Strictly speaking, there is no legal basis to withhold the issuance of a business permit for the non-payment of LBT. In practice though, most, if not all, LGUs will refuse to issue the permit to those who do not pay (or more accurately, do not agree to pay the LBT being imposed). Constrained by this prevalent practice, some companies would initially opt to pay LBT on passive income being billed by an LGU to secure their business permit, and subsequently file a claim for refund to recover the erroneously paid tax.
Perhaps there is hope this new year. In a Supreme Court (SC) case, docketed G.R. No. 241697 dated July 29, 2019, the high court upheld previous CTA decisions, affirming the taxpayer’s claim for refund of erroneously paid LBT on its dividend income. As explained in the SC decision, the taxpayer is a holding company, and for LBT purposes, it was taxed by the LGU as a non-bank financial intermediary (NBFI). The LGU cites Section 143(f) of the LGC, which provides that banks and other financial intermediaries are subject to LBT on their gross receipts derived from dividends, and interests, among other sources of income. The definition of “banks and other financial intermediaries” specifically includes NBFIs.
According to the SC, LBT is imposed on the privilege of doing business within the LGU’s jurisdiction. The phrase “doing business” means some “trade or commercial activity regularly engaged in as a means of livelihood or with a view of profit.” Thus, the LBT imposed under Section 143(f) of the LGC is premised on the fact that the persons liable for such tax are banks or other financial intermediaries by virtue of their being engaged in the business as such.
Citing the Tax Code, banking laws, and pertinent regulations, among others, the SC ruled that the taxpayer is not an NBFI as it is not an entity authorized by the Bangko Sentral ng Pilipinas (BSP) to perform quasi-banking functions. Further, the high court made a distinction between a “holding company” and a “financial intermediary” as contemplated under the LGC, vis-a-vis other laws:
A “holding company’ is ‘organized’ and is basically conducting its business by investing substantially in the equity securities of another company for the purpose of controlling their policies (as opposed to directly engaging in operating activities) and ‘holding’ them in a conglomerate or umbrella structure along with other subsidiaries.” While holding companies may partake in investment activities, this does not per se qualify them as financial intermediaries that are actively dealing in the same. Financial intermediaries are regulated by the BSP because they deal with public funds when they offer quasi-banking functions. On the other hand, a holding company is not similarly regulated because any investment activities it conducts are mere incidental operations, since its main purpose is to hold shares for policy-controlling purposes.
Since the taxpayer is a holding company and not a bank or financial intermediary (i.e., an NBFI), the SC concluded that it could not be liable for LBT under Section 143(f) of the LGC.
Since SC decisions form part of jurisprudence and have the force and effect of law, hopefully, this case lays to rest the issue on the imposition of LBT on the passive income of holding companies. Nevertheless, it can be anticipated that LGUs might still insist on imposing LBT on holding companies, perhaps by arguing that the ruling does not apply to them because the party in the case involved only a specific LGU. Even the SC case itself concludes in the following manner: “this pronouncement is without prejudice to [the taxpayer’s] potential liability for other taxes, whether national or local, should it so engage in other profit-making activities aside from its management of the [investee’s] preferred shares, and the dividends resulting therefrom.” Though the case brings light to the controversy, companies should remain vigilant in ensuring they only pay taxes that are legally due from them.
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.
Marion D. Castañeda is a Manager at the Tax Services Department of Isla Lipana & Co., the Philippine member firm of the PwC network.
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