By Mark Anthony Tamayo on June 3, 2021

A positive change brought about by Republic Act (RA) 11534 (Create Act) was the repeal of Section 29 of the National Internal Revenue Code of 1997 relating to the imposition of a 10 percent improperly accumulated earning tax (IAET) or surtax.

Based on the Revenue Regulations (RR) 5-2021, the IAET shall no longer be applied to the entire taxable year for all fiscal years/taxable years ending after April 11, 2021, the effectivity date of the Create Act. While the repeal is prospective in application, the inescapable implication is that any open fiscal/taxable years ending prior to the aforesaid date may technically still be the subject of an audit or investigation by the Bureau of Internal Revenue (BIR).

Nature of IAET

The very essence of IAET is to impel domestic corporations to distribute earnings so that the said earnings by shareholders could, in turn, be taxed. It is based on the improperly accumulated taxable income of a domestic corporation formed for the purpose of avoiding the income tax with respect to its shareholders (resident or foreign), by permitting the earnings and profits to accumulate beyond the reasonable needs of the business, instead of being divided or distributed to the shareholders.

Basically, what is being subjected to IAET is the improper accumulation beyond the “reasonable needs of the business.” The touchstone of the liability is the purpose behind the accumulation. If the accumulation of earnings vis-à-vis failure to pay dividends to shareholders was due to a justified purpose for the reasonable and immediate needs of the business, such purpose should be able to refute any allegation of improper accumulation.

Under RR 2-2001, the accumulation of earnings up to 100 percent of the paid-up capital of the corporation was considered within the reasonable needs of the business. The term “paid-up capital” includes any additional paid-in capital (APIC) or premiums paid over and above the par value of the shares (SEC Memorandum Circular 11-2008; BIR Ruling DA-C-084 266-08). APIC are not earnings or profits of a corporation generated from the normal and continuous operations of the business (Cebu Air vs CIR, CTA Case 9106 dated Jan. 11, 2018).

Consequently, the allowance for the increase in the accumulation of earnings up to 100 percent of the paid-up capital (including APIC) of the corporation is still within the reasonable needs of the business.

Earnings that are reserved and specially allocated for a justified purpose (e.g., definite corporate expansion projects; compliance with any loan covenants; earnings reserve subject to legal prohibition against its distribution), were likewise deemed as falling within the reasonable needs of the business.

Countering an IAET assessment

Section 29 was principally a specific anti-tax avoidance provision designed to provide a substitute alternative to the otherwise imposable tax on dividends. The IAET is the nature of a penalty that may be imposed, particularly during BIR audit.

The fact that a corporation is a mere holding company or investment company shall be prima facie evidence of a purpose to avoid the tax upon its shareholders. Likewise, the fact that the earnings or profits of a corporation are permitted to accumulate beyond the reasonable needs of the business shall be determinative of the purpose to avoid the tax upon its shareholders.

Note though that the accumulation or retention of profits per se should not ipso facto trigger an outright IAET exposure. If, however, the BIR raises the issue on improper accumulation and determines that an IAET assessment is proper, the burden shifts to the corporation to rebut the allegation and prove otherwise through the presentation of relevant evidence. This applies even if the corporation is not a mere holding or investment company and does not have an unreasonable accumulation of earnings or profits.

Thus, as a matter of approach, it is imperative for the corporation to sufficiently demonstrate that its accumulated earnings were intended for the immediate, including reasonably anticipated needs, of the business (Immediacy Test). The controlling intention and the determination of such reasonable needs must be manifested at the time of accumulation, and not merely the product of an afterthought (Basilan Estates Inc. vs. CIR, GR L-22492, Sept. 5, 1967; Cyanamid Philippines Inc. vs. CA, et al., GR 108067, Jan. 20, 2000; RR 2-2001).

The definiteness of the plans (coupled with clear actions to consummate these plans) must likewise be present. A mere Secretary’s Certificate without mentioning a definite planned expansion, as well as bare allegations and self-serving testimonies without a document or supporting evidence presented as to their link will not suffice. In the same manner, a speculative or a mere recognition of a future problem without a definite plan, purpose or solution will not suffice (Section 7, RR 2-2001).

In order to fully support non-applicability of the IAET imposition, relevant documents, such as, among others, a copy of minutes of the meeting of its board of directors, the board resolution itself, or a memorandum recommending the appropriation of such retained earnings for its definite planned expansion should be presented to substantiate the claim (see 1Maple Sales, Inc. v. CIR, CTA EB 1662 dated Feb. 21, 2019).

Summing up

The decision to determine the reasonable and immediate needs of the business should be at best left to the board of directors. The IAET, to a certain extent, hampered the economic growth of corporations in so far as it limited their creativeness to venture into certain investments and activities. Its repeal is certainly a welcome development.

Although the IAET has been repealed, it should be noted that open fiscal/taxable years prior to April 11, 2021 can still be the subject of an audit investigation by the BIR. Moreover, the retention of surplus profits in excess of 100 percent of a corporation’s paid-in capital is still prohibited under Section 42 of the Revised Corporation Code of the Philippines, save for certain instances.

Any issues raised on the matter, however, may be refuted through the presentation of clear and convincing evidence as discussed above.

#11534 #CREATELaw #IAET #Surtax #IAETRepeal #Section29TaxCode 

Mark Anthony P. Tamayo is a certified public accountant-lawyer and a partner of Mata-Perez, Tamayo & Francisco (MTF) Counsel. He is a recipient of the “2016 Asia Tax Practice Leader” award, and is a consistently voted as one of the recognized indirect tax leaders in the Philippines by the International Tax Review.

https://www.manilatimes.net/2021/06/03/business/top-business/one-last-look-at-surtax/1801762