Zooming in on per diem, prohibited inurements

Non-profit organizations play a vital role in building healthy communities by providing critical services that contribute to economic stability and mobility. They serve as additional help aside from the programs and funds from the government. They may be considered the heart of the community. They work across multiple sectors to meet the vital needs and enhance the quality of life of the community. They have the unique ability to serve as a bridge in the community by leveraging resources and expertise to build collaborations between private and public entities, professionals, and volunteers to work together towards the common good.

The government recognizes the importance of non-profit organizations. Hence, they are given income tax exemptions under Section 30 of the 1997 Tax Code, as amended. To avail the tax exemption, however, certain requirements should be complied with. Among these requirements is the inurement prohibition.

Revenue Memorandum Circular No. 051-14 provides that for an entity to qualify as a non-stock and/or non-profit institution exempt from income tax under Section 30 of the 1997 Tax Code, as amended, its earnings or assets must not inure to the benefit of any of its trustees, organizers, officers, members or any specific person. The following are considered "inurements" of such nature:

• The payment of compensation, salaries, or honorarium to its trustees or organizers;
• The payment of exorbitant or unreasonable compensation to its employees;
• The provision of welfare aid and financial assistance to its Members;
• Donation to any person or entity (except donations made to other entities formed for the purpose/purposes similar to its own);
• The purchase of goods or services for amounts in excess of the fair market value of such goods or value of such services from an entity in which one or more of its trustees, officers or fiduciaries has an interest; and
• When upon dissolution and satisfaction of all liabilities, its remaining assets are distributed to its trustees, organizers, officers, or members. Its assets must be dedicated to its exempt purpose.

The purpose of inurement prohibitions is to prevent those in control of the organization from siphoning off the assets of the exempt institutions.

Accordingly, in various rulings, the Bureau of Internal Revenue (BIR) denied the request for tax exemption of non-stock non-profit organizations as it deemed that such institutions’ earnings or assets inure to the benefit of their trustees, officers, or members. It was noted, however, that a significant number of requests for tax exemption were denied because the non-stock non-profit organizations’ Board of Trustees are entitled to receive per diem or honorarium. The BIR deemed that giving such per diem or honorarium is considered distribution of equity (including net income) and is a form of private inurement.

In connection with the foregoing, I encountered questions from companies and organizations on whether the mere act of giving per diem to BoT, regardless of the amount, is considered private inurement to warrant the disqualification for tax exemption.  Should it be considered an inurement prohibited under Section 30 of the Tax Code, as amended, only if the amount is exorbitant or unreasonable? Note that per diem is normally given to somehow compensate the BoT in performing his duties and responsibilities, which will redound to the benefit and welfare of the organization. 

These questions have finally been addressed by the Department of Finance (DOF) in DOF Opinion No. 011.2022. In the said opinion, the DOF clarified that the inurement prohibition under Section 30 of the NIRC, as amended, was specifically incorporated as a tool to ascertain that non-stock non-profit organizations are not used as tax shelter through tax exemptions granted thereto or for their officers or organizers to gain or benefit from the income or assets of such organizations, which should appropriately be devoted to the furtherance of the purpose for which they were organized. 

Accordingly, the giving of reasonable per diem is not automatically an inurement in violation of the provisions provided for by law. All relevant facts and surrounding circumstances should be taken into account before the same could be considered inurement prohibition. Moreover, the DOF opines that the exigencies of the operations of non-profit organizations also require them to incur reasonable expenses. However, such per diem to be granted must be a legitimate expense arising from the performance of duties that will lead to the organization achieving its purposes.

Hence, in the said opinion, the DOF reversed the decision of the BIR in BIR Ruling No. 466-2014 (S3OF-0181-2020) that the provision for reasonable per diems in the Articles of Incorporation of the organization is an outright violation of the inurement prohibitions.

We are hoping that the foregoing DOF opinion would provide some clarity that the giving of per diem to BoT should not result in outright denial of tax exemptions to non-stock non-profit organizations, especially if such organizations would be able to prove that such amount is reasonable and a legitimate expense that arises from the performance of duties that will lead to the achievement of its purposes. It would be much appreciated by these organizations if the BIR would further provide guidelines in determining whether the per diem given or to be given to the BoT be considered inurement prohibitions so these organizations could focus on what is most important to them, i.e., promoting the welfare of the communities they are serving.

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 06 September 2022