Tuesday, October 30, 2012

Commissioner of Internal Revenue vs. St. Luke's Medical Center, Inc., G.R. No. 195909, September 26, 2012


Commissioner of Internal Revenue vs. St. Luke's Medical Center, Inc.

G.R. No. 195909 September 26, 2012

In a nutshell:

St. Luke’s Medical Center, Inc. (St. Luke’s) is a hospital organized as a non-stock and non-profit corporation. St. Luke’s accepts both paying and non-paying patients. With respect to its non-paying patients, St. Luke’s is exempted from income tax pursuant to Sec. 30 (E) and (G) of the NIRC for being a non-stock corporation or organization operated exclusively for charitable or social welfare purposes. Accepting paying patients does not destroy the exemption of St. Luke’s under Sec. 30 of the NIRC. Instead, the last paragraph of Sec. 30 of the NIRC provides that St. Luke’s activities conducted for profit, regardless of the disposition of such income, shall be subject to tax imposed under this Code.

What is the income tax rate to be applied to St. Luke’s activities conducted for profit? With respect to its paying patients, St. Luke’s is subject to the 10% preferential tax rate of proprietary non-profit hospitals under Section 27(B).



Relevant Sections:

Before discussing the case, let us take a look at the relevant sections of the law in question.

Section 27(B) of the National Internal Revenue Code (NIRC) states:

(B)  Proprietary Educational Institutions and Hospitals.   ̶ Proprietary educational institutions and hospitals which are non-profit shall pay a tax of ten percent (10%) on their taxable income except those covered by Subsection (D) hereof:  Provided, That if  the  gross  income  from unrelated trade, business or other activity exceeds fifty percent (50%) of the total gross income derived by such educational institutions or hospitals from all sources, the tax prescribed in Subsection (A) hereof shall be imposed on the entire taxable income. For purposes of this Subsection, the term ‘unrelated trade, business or other activity’ means any trade, business or other activity, the conduct of which is not substantially related to the exercise or performance by such educational institution or hospital of its primary purpose or function. A ‘proprietary educational institution’ is any private  school  maintained  and  administered  by  private  individuals  or groups  with  an  issued  permit  to  operate  from  the  Department  of Education, Culture and Sports (DECS), or the Commission on Higher Education (CHED), or the Technical Education and Skills Development Authority (TESDA), as the case may be, in accordance with existing laws and regulations. (Emphasis supplied)

In comparison, Section 30(E) and Section 30(G) state:

            Sec. 30. Exemptions from Tax on Corporations. – The following organizations shall not be taxed under this Title in respect to income received by them as such:

      x x x x

            (E) Nonstock corporation or association organized and operated exclusively for religious, charitable, scientific, athletic, or cultural purposes, or for the rehabilitation of veterans, no part of its net income or asset shall belong to or inure to the benefit of any member, organizer, officer or any specific person;

      x x x x

            (G) Civic League or organization not organized for profit but operated exclusively for the promotion of social welfare

      x x x x

            Notwithstanding the provisions in the preceding paragraphs, the income of whatever kind and character of the foregoing organizations from any of their properties, real or personal, or from any of their activities conducted for profit regardless of the disposition of such income, shall be subject to tax imposed under this Code.
      (Emphasis supplied)

CASE DIGEST
Facts:

St. Luke’s Medical Center, Inc. (St. Luke’s) is a hospital organized as a non-stock and non-profit corporation.

The BIR assessed St. Luke’s deficiency taxes for 1998 comprised of deficiency income tax, value-added tax, and withholding tax. The BIR claimed that St. Luke’s should be liable for income tax at a preferential rate of 10% as provided for by Section 27(B). Further, the BIR claimed that St. Luke’s was actually operating for profit in 1998 because only 13% of its  revenues  came from  charitable purposes. Moreover, the hospital’s board of trustees, officers and employees directly benefit  from  its  profits  and  assets.

On the other hand, St. Luke’s maintained that it is a non-stock and non-profit institution for charitable and social welfare purposes exempt from income tax under Section 30(E) and (G) of the NIRC. It argued that the making of profit per se does not destroy its income tax exemption.

Issue:

            The sole issue is whether St. Luke’s is liable for deficiency income tax in 1998 under Section 27(B) of the NIRC, which imposes a preferential tax rate of 10^ on the income of proprietary non-profit hospitals.

Ruling:

            Section 27(B) of the NIRC does not remove the income tax exemption of proprietary non-profit hospitals under Section 30(E) and (G). Section 27(B) on one hand, and Section 30(E) and (G) on  the other  hand,  can  be  construed  together without  the  removal  of  such  tax exemption.

Section 27(B) of the NIRC imposes a 10% preferential tax rate on the income  of  (1)  proprietary  non-profit  educational  institutions and (2) proprietary non-profit hospitals. The only qualifications for hospitals are that they must be proprietary and non-profit. “Proprietary” means private, following the definition of a “proprietary educational institution” as “any private school  maintained  and  administered  by  private individuals  or groups” with a government permit. “Non-profit” means no net income or asset accrues to or benefits any member or specific person, with all the net income or asset devoted to the institution’s purposes and all its activities conducted not for profit.

“Non-profit” does not necessarily mean “charitable.” In Collector of Internal Revenue v. Club Filipino Inc. de Cebu, this Court considered as non-profit a sports club organized for recreation and entertainment of its stockholders and members. The club was primarily funded by membership fees and dues. If it had profits, they were used for overhead expenses and improving its golf course. The club was non-profit because of its purpose and  there  was  no  evidence  that  it was  engaged  in  a  profit-making enterprise.

The sports club in Club Filipino Inc. de Cebu may be non-profit, but it was not charitable. The  Court  defined  “charity”  in  Lung  Center  of  the Philippines  v. Quezon  City as  “a  gift,  to  be  applied  consistently  with existing laws, for the benefit of an indefinite number of persons, either by bringing their minds and hearts under the influence of education or religion, by assisting them to establish themselves in life or [by] otherwise lessening the  burden  of  government.” However, despite its being a tax exempt institution, any income such institution earns from activities conducted for profit is taxable, as expressly provided in the last paragraph of Sec. 30.

To be a charitable institution, however, an organization must meet the substantive  test  of  charity  in  Lung  Center.  The   issue  in  Lung  Center concerns exemption from real property tax and not income tax. However, it provides for the test of charity in our jurisdiction. Charity is essentially a gift to an indefinite number of persons which lessens the burden of government. In  other  words,  charitable  institutions  provide  for  free  goods  and services to the public which would otherwise fall on the shoulders of government. Thus, as a matter of efficiency, the government forgoes taxes which  should  have  been  spent  to  address  public  needs,  because  certain private entities already assume a part of the burden. This is the rationale for the  tax  exemption  of  charitable  institutions.  The  loss  of  taxes  by  the government is compensated by its relief from doing public works which would have been funded by appropriations from the Treasury

The Constitution exempts charitable institutions only from real property taxes. In the NIRC, Congress decided to extend the exemption to income taxes. However, the way Congress crafted Section 30(E) of the NIRC is materially different from Section 28(3), Article VI of the Constitution(Emphasis supplied)

Section 30(E) of the NIRC defines the corporation or association that is exempt from income tax. On the other hand, Section 28(3), Article VI of the Constitution does not define a charitable institution, but requires that the institution “actually, directly and exclusively” use the property for a charitable purpose. (Emphasis supplied)

To be exempt from real property taxes, Section 28(3), Article VI of the Constitution requires that a charitable institution use the property “actually, directly and exclusively” for charitable purposes. (Emphasis supplied)

To be exempt from income taxes, Section 30(E) of the NIRC requires  that  a  charitable  institution  must  be  “organized  and  operated exclusively” for charitable purposes.  Likewise, to be exempt from income taxes, Section 30(G) of the NIRC requires that the institution be “operated exclusively” for social welfare. (Emphasis supplied)

However, the last paragraph of Section 30 of the NIRC qualifies the words “organized and operated exclusively” by providing that:

Notwithstanding the provisions in the preceding paragraphs, the income of whatever kind and character of the foregoing organizations from any of their  properties,  real  or  personal,  or  from  any  of  their  activities conducted  for  profit  regardless  of  the  disposition  made  of  such income, shall be subject to tax imposed under this Code. (Emphasis supplied)

In short, the last paragraph of Section 30 provides that if a tax exempt charitable institution conducts “any” activity for profit, such activity is not tax  exempt  even  as  its  not-for-profit activities  remain  tax  exempt.

Thus, even if the charitable institution must be “organized and operated exclusively” for charitable purposes, it is nevertheless allowed to engage in “activities conducted for profit” without losing its tax exempt status for its not-for-profit activities. The only consequence is that the “income  of  whatever  kind  and  character” of  a  charitable  institution “from  any  of  its  activities  conducted  for  profit,  regardless  of  the disposition made of such income, shall be subject to tax.”  Prior to the introduction of Section 27(B), the tax rate on such income from for-profit activities was the ordinary corporate rate under Section 27(A).  With the introduction of Section 27(B), the tax rate is now 10%. (Emphasis supplied)

The Court finds that St. Luke’s is a corporation that is not “operated exclusively” for charitable or social welfare purposes insofar as its revenues from paying patients are concerned. This ruling is based not only on a strict interpretation of a provision granting tax exemption, but also on the clear and plain text of Section 30(E) and (G). Section 30(E) and (G) of the NIRC requires that an institution be “operated exclusively” for charitable or social welfare purposes to be completely exempt from income tax. An institution under Section 30(E) or (G) does not lose its tax exemption if it earns income from its for-profit activities. Such income from for-profit activities, under the last paragraph of Section 30, is merely subject to income tax, previously at the ordinary corporate rate but now at the preferential 10% rate pursuant to Section 27(B). (Emphasis supplied)

St. Luke’s fails to meet the requirements under Section 30(E) and (G) of the NIRC to be completely tax exempt from all its income. However, it remains a proprietary non-profit hospital under Section 27(B) of the NIRC as long as it does not distribute any of its profits to its members and such profits are reinvested pursuant to its corporate purposes. St. Luke’s, as a proprietary non-profit hospital, is entitled to the preferential tax rate of 10% on its net income from its for-profit activities.

St. Luke’s is therefore liable for deficiency income tax in 1998 under Section 27(B) of the NIRC. However, St. Luke’s has good reasons to rely on the letter dated 6 June 1990 by the BIR, which opined that St. Luke’s is “a corporation for purely charitable and social welfare purposes” and thus exempt from income tax.

In Michael J. Lhuillier, Inc. v. Commissioner of Internal Revenue, the Court said that “good faith and honest belief that one is not subject to tax on the basis of previous interpretation of government agencies tasked to implement the tax law, are sufficient justification to delete the imposition of surcharges and interest.”

WHEREFORE,  St. Luke’s Medical Center,  Inc.  is ORDERED TO  PAY  the  deficiency  income  tax  in 1998  based  on the  10%  preferential  income tax rate  under Section 27(8) of the National  Internal Revenue Code.  However, it  is  not liable for surcharges and  interest  on  such  deficiency  income  tax  under  Sections  248  and  249  of the  National  Internal  Revenue  Code.  All  other  parts  of the  Decision  and Resolution of the Court of Tax Appeals are AFFIRMED.