Tax Treatment of Educational Institutions

Income Tax Treatment of Educational Institutions

Commissioner of Internal Revenue  vs. De La Salle University, Inc. (G.R. No. 196596)

In Commissioner of Internal Revenue  vs. De La Salle University, Inc. (CIR v. De La Salle), the Supreme Court classified educational institutions based on tax treatment into 2 kinds. Referring to Article XIV, Section 4 (3) of the 1987 Constitution, the Supreme Court said:

X x x x the constitutional provision refers to two kinds of educational institutions: (1) non-stock, non-profit educational institutions and (2) proprietary educational institutions.

X x x x x

X x x x x there is a marked distinction between the treatment of non-stock, non-profit educational institutions and proprietary educational institutions. The tax exemption granted to non-stock, non-profit educational institutions is conditioned only on the actual, direct and exclusive use of their revenues and assets for educational purposes. While tax exemptions may also be granted to proprietary educational institutions, these exemptions may be subject to limitations imposed by Congress.

Expounding on the tax treatment of the these different classes of educational institutions, the Supreme Court stated:

While a non-stock, non-profit educational institution is classified as a tax-exempt entity under Section 30 (Exemptions from Tax on Corporations) of the Tax Code, a proprietary educational institution is covered by Section 27 (Rates of Income Tax on Domestic Corporations).

The Supreme Court then declared:

By the Tax Code’s clear terms, a proprietary educational institution is entitled only to the reduced rate of 10% corporate income tax. The reduced rate is applicable only if: (1) the proprietary educational institution is nonprofit and (2) its gross income from unrelated trade, business or activity does not exceed 50% of its total gross income.

In effect, the Supreme Court applied the modifiers “proprietary” and “non-profit” in the phrase “Proprietary educational institutions and hospitals which are non-profit” , found in the beginning of Section 27(B),  to both educational institutions and hospitals. This interpretation was laid down in Commissioner v. St. Luke’s Medical Center, Inc.  where the Supreme Court stressed that “Section 27(B) of the NIRC imposes a 10% preferential tax rate on the income of (1) proprietary non-profit educational institutions and (2) proprietary non-profit hospitals.”

Republic Act No. 11534 –  Corporate Recovery and Tax Incentives for Enterprises (CREATE) Act

For a while, Republic Act No. 11534 (CREATE) seemed to confirm and adopt  the pronouncement of the Supreme Court when it amended Section 27(B) of the NIRC.

Prior to the amendment,  the pertinent portion of Section 27(B) provided:

A ‘proprietary educational institution’ is any private school maintained and administered by private individuals or groups with issued with an issued permit to operate from the Department of Education, Culture and Sports (DECS) or the Commission on Higher Education (CHED)m or the Technical Education and Skills Development Authority (TESDA) x x x x x.

Notably, Section 27(B) only defined ‘proprietary educational institution’ . The term ‘hospital’ was not included in the definition.

As amended by CREATE, the quoted portion was reworded to read as follows:

‘Proprietary’ means a private hospital, or any private school maintained and administered by private individuals or groups with an issued permit to operate from the Department of Education (DepEd), 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.

Revenue Regulations No. 5-2021

Implementing the amendment, Revenue Regulations No. 5-2021 (RR 5-2021) further amplified that the term ‘proprietary educational institutions’  refers  to “any private school, which is non-profit for purposes of these Regulations, maintained and administered by private individuals or groups with an issued permit to operate from the Department of Education (DepEd), or the Commission on Higher Education (CHED), or the Technical Education and Skills Development Authority (TESDA), in accordance with existing laws and regulations”.

Effect of CREATE, as implemented by RR 5-2021, on Section 27(B)

Clearly, based on the provisions of CREATE and RR 5-2021, the entitlement to the  reduced 10% rate was conditioned on the status of the private school as ‘non-profit’. Thus, a private school formed for profit was not entitled to the reduced rate.

Such changes would have  adversely affected private schools which are organized for profit. These schools used to enjoy the preferential tax rate of 10%. Under the amended provisions of the Section 27(B), as implemented by RR 5-2021, these schools would be subjected to the regular rate of either 25% or 20%, as the case may be. Moreover, these schools would not be entitled to the temporary reduction of the rate to 1% from July 1, 2020 until June 30, 2023, as a relief from the impact of the Covid-19 pandemic. In other words, not only that these private schools would not be able to enjoy the reduced rate of 1%, they would even be taxed at a higher rate of either 20% or 25%.

Naturally, these changes ignited strong objections from the owners and administrators of private schools which are organized for profit. Fortunately, Congress favorably clarified the amended provisions of Section 27(B) through Republic Act No. 11635.

Republic Act No. 11635 and Revenue Regulations No. 3-2022

Under RA 11635, the modifier ‘nonprofit’ does not apply to proprietary educational institutions. The opening phrase of Section 27(B) stating:

Proprietary educational institutions and hospitals which are non-profit x x x x x

has been changed to:

Hospitals which are nonprofit and proprietary educational institutions x x x x x

Implementing RA 11635,  Revenue Regulations No. 3-2022 (RR 3-2022) specifies the entities covered by Section 27(B) as follows:

  1. Proprietary educational institutions;
  2. Hospitals which are non-profit; and
  3. Non-stock, non-profit educational institutions whose net income or asset accrue/inure to or benefit any member or specific person

Section 27(B) applies to non-stock, non-profit educational institutions

As laid down down by the Supreme Court, the requisites for availing the tax exemption under Article XIV, Section 4 (3) of the Constitution are as follows:

  1. the taxpayer falls under the classification non-stock, non-profit educational institution; and
  2. the income it seeks to be exempted from taxation is used actually, directly and exclusively for educational purposes

Once either requisite is not satisfied, the income of the non-stock, non-profit educational institution shall be taxable. In such a case, what is the applicable rate, the regular rate of 25% or 20% or the preferential rate of 10%?

Tax treatment of a non-stock, non-profit educational institution who deviates from its non-profit character

RR 3-2022 provides that the term ‘non-profit’, “as used in the definition of Proprietary Hospitals and Non-Stock, Non-Profit Educational Institutions, means that no net income or asset accrues to or benefits any member or specific person, with all the net income or assets devoted to the institution’s purposes and all its activities conducted not for profit.” Once any portion of its income or asset inures to the benefit of any person, a non-stock educational institution loses its non-profit character. Consequently, it cannot avail of the exemption provided under Article XIV, Section 4(3) of the Constitution. Its income will be taxable.

As previously mentioned, RR 3-2022 expressly places a non-stock, non-profit educational institution under the coverage of Section 27(B) should its net income or asset accrue or inure to  or benefit any member or specific person. Hence, the preferential or reduced rate of 10% will apply.

Tax treatment of a non-stock, non-profit educational institution who fails to prove the actual, direct and exclusive use of its income for educational purposes

The fact that a non-stock, non-profit educational institution fails to prove the actual, direct and exclusive use of its income for educational purposes does not necessarily disqualify the entity as nonprofit. As long as no part of its asset or revenue inures to the benefit of any specific person, the non-stock educational institution remains non-profit. The income, however, becomes taxable since the second requisite for the applicability of the tax exemption under Article XIV, Section 4 (3) of the 1987 Constitution is not met.

It is important to note that it is not the entire income of the school which is taxable, but only that part which is not used actually, directly and exclusively for educational purposes. Will the preferential or reduced rate of 10% apply?  

 De La Salle Lipa, Inc. vs. Commissioner of Internal Revenue (CTA EB No. 1430)

In De La Salle Lipa, Inc. vs. Commissioner of Internal Revenue, CTA EB No. 1430, the Court of Tax Appeals ruled that De La Salle Lipa, Inc., a non-stock, non-profit educational institution, was not entitled to avail of the preferential rate under Section 27(B). The CTA ratiocinated that, as explained by the Supreme Court in CIR v. De La Salle, non-stock, non-profit educational institutions are treated differently from proprietary educational institutions. While non-stock, non-profit educational institutions are granted tax exemption under the Constitution, and restated in Section 30 of the NIRC, proprietary educational institutions are granted  not exemption but only preferential treatment in the form of a reduced 10% income tax rate under Section 27(B). Hence, De La Salle Lipa, Inc., being  not a proprietary educational institution, was not entitled to the preferential 10% rate.

Applicability of Section 27(B) under RA 11635

RA 11635, as implemented by RR 3-2022, does not directly address this scenario. What is specifically covered under Section 27(B) is a non-stock, non-profit educational institution whose net income or asset accrues/inures to the benefit of any member or specific person.

There seems to be no material and justifiable reasons, however, that will warrant a different tax treatment of a non-stock, non-profit educational institution in cases where only the second condition is not met. Hence, it is submitted that Section 27(B) shall also apply.


Read: CIR v. DLSU