So be IAET
So be IAET
by Theodore D Chan
With the recent signing of the Revised Corporation Code (“RCC”) or Republic Act (“RA”) 112321, the decades old Corporation Code has now been amended with the primary goal of simplifying corporate governance and to entice new investors to do business in the Philippines. Among the numerous amendments made in the enacted law, one of the notable changes made is the introduction of the One Person Corporation (“OPC”).
An OPC is a corporation composed of an individual, trust or an estate as a single stockholder, without a minimum authorized capital stock requirement except as a special law would otherwise provide. The establishment of an OPC allows individuals to function as a one-man team; harnessing the different powers that a corporation would enjoy without the need of five or more incorporators. Like a corporation, the single stockholder in an OPC will enjoy limited liability and has the power of designating a nominee and/or an alternate nominee to succeed the single stockholder in managing the corporation’s affairs. The potential impact of the OPC in the Philippine business arena is promising and while this remains to be seen, its possible use by new and existing business owners as a mode of tax avoidance cannot be left unchecked, especially on the imposition of improperly accumulated earnings tax (“IAET”).
Section 2 of Revenue Regulations (“RR”) No. 02-01 defines IAET as a form of penalty tax equal to ten percent (10%) imposed on corporations on their improperly accumulated taxable income. The IAET serves as a deterrent to the avoidance of tax upon shareholders who are supposed to be taxed on their dividends distributed from the company’s profits. Basically, if a company’s earnings are distributed to its shareholders, then these shareholders will be subsequently liable for income tax thereon, whereas if the company retains its earnings, shareholders would not be liable for income tax on these undistributed profits. The idea of penalizing the act of inappropriately accumulating earnings beyond the reasonable needs of a business is to encourage dividing and distributing dividends to shareholders and appropriate excess earnings for the improvement of business operations. The liability is not as much as the consequence of the accumulation, but the purpose behind the accumulation of income.
This is where the “immediacy test” comes into play. Section 3 of RR No. 02-01 provides that businesses must be able to reasonably justify its accumulation of income for an immediate need, whether the company is in anticipation of a future capital expenditure or retaining earnings as required by law or applicable regulation. In the case of Cyanamid Philippines, Inc. vs. the Court of Appeals, et al., the Supreme Court explained that in order to determine the accumulation of profits to be reasonable and avoid the payment of IAET, the controlling intention of the taxpayer must be manifested at the time of accumulation, not subsequent to accumulation which the Supreme Court considers an afterthought. Furthermore, the accumulated profits must also be used within a reasonable time after the close of the taxable year, to establish a clear and convincing intention by the business to accumulate for an immediate need. Court of Tax Appeals (“CTA”) Case No. 8295 (Greenhills Properties, Inc. vs CIR) further emphasized the need to couple the definiteness of plans to appropriate its earnings or profits with clear actions. Not only should an OPC explicitly provide an indefinite purpose of its reason for accumulation, proper action must also be taken to consummate these plans.
However, this does not mean that OPCs will be automatically subject to scrutiny on their existence. There are forms of organizations that may be construed as created for the sole purpose of accumulating profits beyond the reasonable needs of a business thus indicative of avoiding income tax. A company formed having practically no activities except holding property, and collecting the same income therefrom or investing therein, shall be considered as a holding company within the definition of Section 29(C)(1) of the Tax Code, as amended, and thus is prima facie evidence to the avoidance of income tax under Section 7 of RR No. 02-01. The same holds true for the operations of investment companies. Companies created for the purpose of performing activities that include or consist substantially of buying and selling stocks, securities, real estate, or other investment property (whether upon an outright or a marginal basis) so that the income derived is not only from investment yield but also from profits upon market fluctuations are also considered clear evidence of the purpose of avoiding income taxes. In both instances however, the RR explains that the corporation, with clear evidence to support its true purpose of its operations, may prove the contrary.
The introduction of the OPC in the Philippines does not necessarily translate to it being a vehicle for avoiding payment of income taxes. It may in fact be what new and existing business owners need to be able to contend in a fast-paced Philippine economy. The Bureau of Internal Revenue (BIR) has yet to issue a tax regulation to shed some light on the taxation of OPCs. Notwithstanding this fact, business owners who wish to establish OPCs must also take into consideration the consequences of holding or retaining its accumulated profit beyond the reasonable needs of the business. As another form of corporation, it is important for an OPC to always express its true intention in retaining earnings or profits, earmarking the same in the company’s notes to financial statements and supporting them with proper documentation. A defined purpose acted upon within a reasonable timeframe is what corporations, including OPCs, are encouraged to do. “IAET” cannot be denied.
Theodore D. Chan is an Associate from the Tax Group of KPMG R.G. Manabat & Co. (KPMG RGM&Co.), the Philippine member firm of KPMG International. KPMG RGM&Co. has been recognized as a Tier 1 tax practice and Tier 1 transfer pricing practice by the International Tax Review.
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