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By: Felson M. Dalaguete on October 18, 2018

A corporation that permits the accumulation of earnings and profits beyond the reasonable needs of the business is subject to the 10 percent Improperly Accumulated Earnings Tax (IAET).

If the accumulation is justified to be within the reasonable needs of the business, the IAET is not imposed.

The IAET thus effectively penalizes a corporation for the improper accumulation of its earnings instead of distributing it to its stockholders. If the earnings and profits were distributed, the shareholders would be liable to tax on dividends.

However, if no such distribution is made, because such undistributed profits or earnings are needed for the reasonable needs of business, no IAET would be due.

It should be noted that IAET is not imposed on publicly-held companies, banks and other non-bank financial intermediaries, and insurance companies.

The Tax Code defines “reasonable needs” to include the reasonably anticipated needs of the business. Revenue Regulations No. 2-2001 includes as among the items which constitutes “reasonable needs of the business” the “allowance for the increase in the accumulation of earnings up to 100 percent of the paid-up capital of the corporation.” Paid-up capital has always been construed to include both par value and additional paid-in capital (APIC).

However, in Revenue Memorandum Circular (RMC) 35-2011, the BIR held that in defining “paid-up” capital for purposes of fixing the amount that may be retained for the reasonable needs of the business, any excess capital over and above the par value or APIC is excluded.

In effect, the BIR limited the definition of paid-up capital to capital stock or the aggregate par value of the shares.

The interpretation in RMC 35-2001, however, is inconsistent with interpretations made by the Securities and Exchange Commission (SEC) and previous BIR issuances on what constitutes “paid-up capital.”

In SEC Memorandum Circular (MC) No. 11-2008, the SEC categorically defined paid-in capital as the amount of outstanding capital stock plus additional paid-in capital or premium paid over the value over the par value of shares. This circular was issued in relation to Section 43 of the Corporation Code which prohibits corporations from retaining surplus profits in excess of 100 percent of their paid-in capital stock, subject to certain exceptions.

Likewise, in a previous ruling, the BIR itself confirmed that the paid-up capital of the corporation is the sum of both the par value of shares issued and other capital investments classified under the “additional paid-in capital” account of the corporation (BIR Ruling DA-C-084 266-08). Thus, in said ruling, it was held that retained earnings not in excess of such sum amount shall not be constituted as improperly accumulated earnings subject to IAET.

In its recent decision in Cebu Air vs. Commissioner of Internal Revenue (CIR) (CTA Case No. 9106, September 27, 2018),the Court of Tax Appeals (CTA) clarified and held that for purposes of calculating the IAET, APIC should be included in the computation of “paid-up” capital. This interpretation is consistent with the definition of “paid-in capital” in SEC MC No. 11-2008 and the BIR’s old position.

The CTA further explained that APIC is the amount of capital in excess of the par value of the company’s shares. It held that if APIC is to be excluded from the amount that may be retained, “it would necessarily form part of the improperly accumulated earnings, which would then be subject to IAET.”

The interpretation of the CTA in Cebu Air should settle the issue on what constitutes “paid-in” capital of a company in calculating IAET on improperly accumulated earnings. APIC or surplus paid for by the stockholders, which is indeed part of the capital of a corporation, should be added to the aggregate par value of the shares for this purpose.

Clearly, RMC 35-2011 did not just clarify the provisions of Section 29 of the Tax Code and RR 2-2001, but it has also expanded the definition of “paid-up capital” that is not in line with the intention of the law.

In CIR vs. Philippine-Aluminum Wheels, Inc. (GR No. 216161, August 9, 2017), the Supreme Court held that the taxing authorities cannot extend the law or expand its coverage, as the power to amend or repeal a statute is vested in the legislature.

In case there is a discrepancy between the law and a regulation issued to implement the law, the law prevails because the rule or regulation cannot go beyond the terms and provisions of law.

Felson M. Dalaguete is a CPA-Lawyer and a Junior Associate of Mata-Perez, Tamayo, and Francisco (MTF Counsel). He is an active member of MTF Counsel’s corporate and tax practice. The contents of the above article are intended for general information only and do not constitute legal advice. If you have any question or comment regarding this article, you may email the author at or visit MTF Counsel’s website at

From The Manila Times website on October 18, 2018


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