As the debate on adopting federalism in the Philippines heats up, the powers and limitations of local government units (LGUs) to tax is coming to the fore.
The local business tax (LBT) imposed by LGUs is based on gross sales or receipts of the particular taxpayer.
Section 131 (n) of the Local Government Code of 1991 defines “Gross Sales or Receipts” as including “the total amount of money or its equivalent representing the contract price, compensation or service fee, including the amount charged or materials supplied with the services and the deposits or advance payments actually or constructively received during the taxable quarter for the services performed or to be performed excluding discounts if determinable at the time of sales, sales return, excise tax, and value-added tax (VAT).”
In the 2007 case of Ericsson Telecommunications, Inc. vs. City of Pasig, the Supreme Court interpreted the above provision as follows: “[T]he law is clear. Gross receipts include money or its equivalent actually or constructively received in consideration of services rendered or articles sold, exchanged or leased, whether actual or constructive.”
The Local Revenue Codes of most local government units adopts the above definition of gross receipts. However, the issue on whether income of holding companies consisting of dividends, interest and other passive income fall within the purview of gross receipts so as to be subject to LBT, frequently arises as several LGUs try to subject said income to LBT.
In a 2016 the Court of Tax Appeals (CTA) case involving a holding company that derives its revenue from dividend income, interest income, rental, management fees and other income, the CTA expressly explained that “no interpretation is needed on what items are included in gross receipts. Simply put, gross receipts are the amount or fee for the services rendered. Nowhere does the provision state that it includes dividend income, interest income, rental income or gain from the sale of fixed assets.” In this case, the CTA noted that while the holding company should be taxed only on its earnings from services rendered, and considering that it did not report any management fees earned, said holding company should not have been imposed with LBT on its other income, since these items are not taxable under the applicable local revenue code.
The CTA went on to explain that under the National Internal Revenue Code (NIRC), the general definition of a gross income enumerates the various kinds of income, including compensation, income from the conduct of trade, business or profession, gains derived from dealings in property, interest, rents, and dividends, among others. The disputed income in this case, that is, interest, rents, dividends and income from the sale of properties are under a category of their own, and not included in the income from the conduct of business. Also, separate provisions were provided for certain passive income that includes interest, capital gains tax for the sale of real property, and dividends. From the general definition of the term, these kinds of income are excluded in the computation of the gross income, or gross sales or receipts, of a taxpayer.
In effect, the above definition in the NIRC should be applied to the income of said holding company in this case, and should be excluded in the computation of its gross receipts. The holding company should be taxed only on its earnings from management fees, or the fees for services it performed for its subsidiaries.
Section 133 (a) of the LGC as implemented in Article 221 (a) of the IRR of the LGC expressly provides that “the taxing powers of provinces, cities, municipalities, and barangays shall not extend to the levy of income tax, except when levied on banks and other financial institutions.”
Section 143 (f) of the LGC provides that the “municipality may impose taxes on banks and other financial institutions, at a rate not exceeding fifty percent (50%) of one percent (1%) on the gross receipts of the preceding calendar year derived from interest, commissions and discounts from lending activities, income from financial leasing, dividends, rentals on property and profit from exchange or sale of property, insurance premium.”
In a 2011 opinion, the Bureau of Local Government Finance (BLGF) explained that “unless imposed on banks and other financial institutions, any tax imposed on interest, dividends, and gains from sale of shares of non-bank and non-financial institutions assume the nature of income tax. The reason for this is evident, that is, while banks and other financial institutions derive gross receipts in the ordinary course of their business as financial institutions, the same cannot be said for non-bank and non-financial institutions. As to the latter, interest, dividends, and gains from sale of shares are merely passive investment income.”
The BLGF Opinion further explained that “[T]he above definition of the phrase ‘gross sales or receipts’ does not include nor make mention of passive income such as dividend income received from another domestic corporation, as one of those that are considered part or form part of the “gross sales or receipts” and therefore such income is not subject to LBT. Thus, income arising from interest, dividends, royalties do not form part of the taxpayer’s gross receipts as these are merely incidental, having been earned outside of its primary scope of business operations and therefore not subject to LBT under Section 143 of the LGC.
In the May 2018 case of Te Deum Resources, Inc. vs. City of Davao, the CTA En Banc once again had occasion to rule on the same issue involving a holding company that received dividends from its investment in preferred shares of an affiliate which were then deposited in a trust account which earned interest from money market placements.
Citing the above provisions and using the same rationale above, the CTA ruled that “dividends and interest income on money market placements are not subject to local business tax, unless levied on banks and other financial institutions.”
The LGU based its imposition of LBT on the argument that the taxpayer may be considered a non-bank financial intermediary, falling under the category of a bank and other financial institutions so as to be subject to LBT as provided under the above-cited Section 143 (f) of the LGC. The LGU was upheld by the Regional Trial Court (RTC) and the CTA in Division agreed with the RTC’s conclusion that the taxpayer falls within the category of financial intermediary whose business is subject to LBT.
The LGU argued that under Section 131 (e) of the LGC, the term “banks and other financial institutions” include non-bank financial intermediaries, xxx investment companies xxx.”
In effect, the CTA En Banc reversed the decision of the CTA in Division and explained that while “non-bank financial intermediaries” are included in the term “banks and other financial institutions,” the term “non-bank financial intermediaries” are those that are “defined under applicable laws, or rules and regulations.” The CTA cited the definition of “non-bank financial intermediaries” under Section 22(W) of the NIRC; BIR Revenue Regulation No. 9-2004; and the Manual of Regulations for Non-Bank Financial Institutions issued by the BSP. The CTA expressly held that “[T]aken together, these laws and regulations reveal the following basic requirements for a person or entity to be considered as a “non-bank financial intermediary:”
1) The person or entity is “authorized by the BSP to perform quasi-banking activities”;
2) The principal functions of the said person or entity “include the lending, investing or placement of funds or evidences of indebtedness or equity deposited to them, acquired by them, or otherwise coursed through them, either for their own account or for the account of others”;
3) The person or entity must perform any of the following functions on a regular and recurring, not on an isolated basis, to wit:
a. Receive funds from one (1) group of persons, irrespective of number, through traditional deposits, or issuance of debt or equity securities; and make available/lend these funds to another person or entity, and in the process acquire debt or equity securities;
b. Use principally the funds received for acquiring various types of debt or equity securities; and
c. Borrow against, or lend on, or buy or sell debt or equity securities;
d. Hold assets consisting principally of debt or equity securities such as promissory notes, bills of exchange, mortgages, stocks, bonds, and commercial papers;
e. Realize regular income in the nature of, but need not be limited to, interest, discounts, capital gains, underwriting fees, guarantees, fees, commissions, and service fees, principally from transactions in debt or equity securities or by being an intermediary between suppliers and users of funds.
A non-bank financial intermediary may not be considered as such unless it possesses all the requirements that qualify it to fall within its legal definition. Consequently, the holding company is not a non-bank financial intermediary or an investment company subject to LBT.
The CTA has been consistent in its rulings and rationale such that LGUs should do well to issue assessments for deficiency LBT that are consistent with the provisions of the LGC.
Cristina D. Panlilio-Ong is a Director of the Tax Advisory and Compliance of P&A Grant Thornton. P&A Grant Thornton is one of the leading audit, tax, advisory, and outsourcing services firms in the Philippines.
As published in BusinessWorld, dated 19 June 2018