For the last few months, proprietary educational institutions (PEIs) have been in the ropes due to the controversial Revenue Regulation (RR) issued by the Bureau of Internal Revenue (BIR) last April 8, 2021 – RR No. 5-2021. This tax regulation gives a stricter definition of being a non-profit of PEIs. To avail of the new income tax rate of 1% under the Corporate Recovery and Tax Incentives for Enterprises (CREATE) Act, PEIs must ensure that no net income or asset accrues to or benefits any member or specific person, with all net income or assets devoted to the institution’s purposes and all its activities conducted not for profit. This definition makes it difficult for PEIs to qualify for the lower income tax rate, considering that most of these private educational institutions are stock corporations owned by private individuals who receive their share of profit.

Private schools led by the Coordinating Council of Private Educational Associations of the Philippines (COCOPEA) have been appealing to rectify this “erroneous insertion” in RR 5-2021, stating that this definition does not exist in Section 27(B) of the National Internal Revenue Code (NIRC) of 1997, as amended.

In July 2021, the BIR answered the call of private schools by issuing RR 14-2021 which suspends the implementation of certain provisions of RR 5-2021 by removing the phrase “which are non-profit” as part of the definition of Proprietary Educational Institutions. With the suspension of RR 5-2021, PEIs are pushing to avail of the preferential income tax rate of 1% starting July 1, 2020 to June 30, 2023. It is prudent to say that necessary adjustments must be made in the recorded deferred tax assets/liabilities.

PAS 12, Income taxes states that deferred tax assets and liabilities shall be measured at the tax rates that are expected to apply to the period when the asset is realized or the liability is settled, based on tax rates (and tax laws) that have been enacted or substantively enacted by the end of the reporting period. As PEIs’ deferred tax assets/deferred tax liabilities are measured using the 10% income tax rate prior to considering the effects of the CREATE Act, PEIs must remeasure, taking into consideration the realization/settlement of these assets/liabilities within the next two years.

Deferred tax assets are the amounts of income taxes recoverable in future periods in respect of: (a) deductible temporary differences; (b) the carryforward of unused tax losses; and (c) the carryforward of unused tax credits. The most common deductible temporary difference is the allowance for expected credit losses (ECL). When a PEI provides an allowance for ECL, a corresponding expense will be recognized in its financial statements. However, this will not be immediately deductible in computing tax profit. Under Section 3 of RR No. 5-99, the general requirements for a valid bad debts deduction are that: (a) there must be an existing indebtedness which must be valid and legally demandable; (b) it must be connected with the taxpayer's business; (c) it must be actually charged off in the books as of the end of the taxable year; and (d) it must be actually ascertained to be worthless and uncollectable as of the end of the taxable year. PEIs must make a reasonable estimate as to when the allowance for ECL will be expected to be tax deductible and any amount which might be deductible until June 2023 must be measured using the 1% income tax rate to come up with the remeasured deferred tax asset.

Deferred tax liabilities are the amounts of income taxes payable in future periods in respect of taxable temporary differences. A good example of taxable temporary difference for PEIs arises from their option to elect either: (a) to deduct expenditures otherwise considered as capital outlays of depreciable assets incurred during the taxable year for the expansion of school facilities or (b) to deduct allowance for depreciation under the NIRC of 1997, as amended. If the latter is selected, there will be no difference between the deductible amount of the allowance for depreciation for the taxable and accounting profit. However, a temporary difference will arise if a PEI elects to deduct the capital asset additions in the income tax declaration instead of the usual allowance for depreciation. Given that the carrying amount of the asset is higher as compared to the tax base, this will result to a deferred tax liability. As the carrying amount of the asset declines because of yearly depreciation, it is expected that the corresponding deferred tax liability decreases. With the income tax rate for PEIs pegged at 1% until June 30, 2023, it is reasonable that portions of deferred tax liabilities will be remeasured using the 1% rate pertaining to the depreciation until the income tax rate reverts to 10%.

With the passage of the CREATE Act, it is important that changes in tax rates must be taken into account in measuring the deferred tax assets/liabilities. To be able to remeasure them accurately, one key factor is that the management must be able to make reasonable assumptions and estimates as to the timing of their realizability or settlement.


As published in Mindanao Times, dated 06 September 2021