Prior to the effectivity of the Corporate Recovery and Tax Incentives for Enterprises (CREATE) Law, Philippine tax rules imposed a 10% tax on improperly accumulated taxable income of corporations. This improperly accumulated earnings tax (IAET) is imposed as a penalty on corporations which allow accumulation of earnings for the purpose of avoiding tax liability for their shareholders if they decide to distribute profits in the form of dividends.

Not all corporations, though, are subject to IAET. Revenue Regulation (RR) No. 2-2001 identifies corporate taxpayers who are exempt from IAET. These include:

a) banks and other non-bank financial intermediaries;

b) insurance companies;

c) publicly held corporations;

d) taxable partnerships;

e) general professional partnerships;

f) non-taxable joint ventures; and

g) enterprises duly registered with the Philippine Economic Zone Authority (PEZA) under R.A. 7916, and enterprises registered pursuant to the Bases Conversion and Development Act (BCDA) of 1992 under R.A. 7227, as well as other enterprises duly registered under special economic zones declared by law which enjoy payment of special tax rates on their registered operations or activities in lieu of other taxes, national or local.

There have been several instances during tax assessments or audits when PEZA-registered entities, especially those that are under income tax holiday (ITH), find themselves being assessed for IAET. Based on some examiners’ interpretations of the exception (g) cited above, PEZA-registered enterprises may enjoy exemption from IAET if they are under the 5% preferential tax regime. 

But just recently, the Supreme Court (SC) decided on a tax case where one of the issues involved is whether the respondent, a PEZA-registered entity, is subject to IAET on its accumulated income from registered activities enjoying the ITH incentive.

In that case, the Bureau of Internal Revenue (BIR) made a distinction between the respondent’s income from certain registered activities which have been granted ITH extension and its income from the rest of its registered activities which were subject to the preferential five percent (5%) tax rate. The tax authority argued that only the latter is exempt from IAET since the registered enterprises exempt under Sec. 4(g) of RR No. 2-2001 pertain only to those enjoying the special tax rate.

The SC concurred with the CTA en banc’s interpretation that the phrase “which enjoy payment of special tax rate on their registered operations or activities in lieu of other taxes, national or local” applies only to corporations belonging to the third group, that is, the other enterprises duly registered under special economic zones declared by law. The CTA explained that the use of comma in Section 4(g) of RR No. 2-2001 signifies independence of one thing from the others included in the enumeration, such that the particular portion contemplates three different groups excluded from the coverage of the imposition of the IAET.

In addition, the CTA en banc also noted that qualifying words restrict or modify only the words or phrases to which they are immediately associated, and not those distantly or remotely located. In this case, the court ruled that PEZA-registered enterprises and those registered pursuant to the BCDA are exempted from the imposition of the IAET without further qualification. Therefore, regardless of whether a corporation duly registered with the PEZA or registered pursuant to the BCDA enjoys an ITH or the special tax regime at a rate of 5% on its registered activities, it shall be exempt from IAET.

This interpretation now opens some concerns for taxpayers falling under the third group and are enjoying ITH incentive. With the repeal of the imposition of the IAET under the CREATE Law, the tax authority is left with only a few open taxable years to pursue assessments related to IAET. Thus, the BIR may be on the lookout for possible improperly accumulated earnings in its tax audits covering taxable years prior to the effectivity of the CREATE Law.

Nevertheless, taxpayers need not fret that much considering that IAET will only be imposed in case of failure to prove that the accumulation of profits is for reasonable business needs and not for the purpose of avoiding dividend tax liability upon corporate shareholders. Now that IAET is no longer imposed, companies are not compelled any longer to distribute profits to investors. This provides more potential for reinvestment for business expansion in the Philippines which would, in turn, generate more employment for our countrymen.

Let’s Talk Tax is a weekly newspaper column of P&A Grant Thornton that aims to keep the public informed of various developments in taxation. This article is not intended to be a substitute for competent professional advice.


As published in BusinessWorld, dated 07 September 2021