Philippines removes tax on improperly accumulated earnings

The passage of the Republic Act (RA) No. 11534 [otherwise known as the “Corporate Recovery and Tax Incentives for Enterprises (CREATE) Act”] is envisioned to attract more foreign investors to do business in the Philippines and increase its competitiveness in granting tax relief, transparency, and ease of doing trade and business of the country.

Prior to the enactment of the CREATE Act, an improperly accumulated earnings tax (IAET) equivalent to ten percent (10%) of the improperly accumulated taxable income is imposed to every corporation who avoids paying dividends tax with respect to its shareholders’ supposed dividends by permitting earnings and profits to accumulate instead of being divided or distributed.

Technically speaking, the imposition of IAET is a recovery mechanism of the Philippine government to compensate for the lost revenues it should have earned had the corporation declared and paid the necessary dividends. The said dividends, had it been declared and paid to shareholders of a corporation, should have been subjected to final tax and should have formed part of the revenues of the government.

Unfortunately, though, the imposition of IAET, being in the form of a penalty, may be construed to be burdensome to foreign investors as they must worry whether they are already mandated under the Philippine laws to declare and pay dividends annually. For instance, corporations may not accumulate and retain so much earnings in their respective books for purposes of future diversification, divestment, acquisitions, and usage for growth and boost of its business.

Thus, the passage of the CREATE Act repealed the specific provision for the imposition of the IAET under the Tax Code, as amended. Clearly, this penalty will no longer be an issue which will give much leeway for corporations on what they will do, and how they will manage the earnings that it will generate and retain over the years.

PEZA-Registered Enterprises are exempt from IAET

The Supreme Court, in the case of Commissioner of Internal Revenue v. Yumex Philippines Corporation (G.R. No. 222476, May 5, 2021), held that the IAET assessment in violation of the respondent’s right to due process is null and void.

Sec. 4 (g) of Revenue Regulations (RR) No. 2-2001 provides that enterprises duly registered with the Philippine Economic Zone Authorities (PEZA) under Republic Act (RA) No. 7916 are exempt from the 10% IAET.

The Supreme Court upheld the ruling of the Court of Tax Appeals (CTA) En Banc that the use of comma in Sec. 4 (g) of RR No. 2-2001 signifies independence of one thing from the others included in the enumeration, such that, the portion contemplates three different groups excluded from the coverage of the imposition of the improperly accumulated tax. Moreover, qualifying words restrict or modify only the words or phrases to which they are immediately associated, and not those distantly or remotely located. As such, 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 this third group (i.e., other enterprises duly registered under special economic zones described by law) and not to PEZA-registered companies (the respondent in this case).

To put it briefly, the fact of registration with the PEZA under RA No. 7916 (like in the case of the respondent) alone excludes a corporation or enterprise from the coverage of corporations upon which IAET may be imposed.

For more information contact Arnold Apdua, Managing Partner at AAA and Co., CPAs.

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