Back to school: A refresher on the taxation of educational institutions

Yesterday marked the end of beach days for students as they officially start a new academic year. While summer 2022 might seem brief, the young may very well be looking forward to face-to-face classes. Zoom classes can be set aside for the meantime while students flock back to schools for their first-ever in-person classes since the pandemic.

At the onset of the pandemic, a plunge was seen in the number of enrollees especially in academic year 2020-2021, mainly due to pandemic-driven economic and social factors and a reluctance to transition to alternative modes of learning. Private schools took a hit as students transferred to the public-school system or dropped school altogether. It is hoped that academic year 2022-2023 will see an increase in enrollees; initial numbers from the Department of Education (DepEd) appear to be positive.

This optimism for increased enrolment, however, does come with tax implications. Along with the increase in enrollees and subsequently, tuition, educational institutions are still subject to some form of tax. So, to all educators and school administrators, grab your pen and paper (or your tablet, as the kids might say), it’s time to take a refresher course on the taxation of educational institutions.

LESSON 1: WHAT’S THE INCOME TAX RATE FOR EDUCATIONAL INSTITUTIONS AGAIN?Before we discuss taxing school income, it is important to determine the corporate structure of the school, which will be used to classify it either as a proprietary education institution (PEI), a non-stock, non-profit educational institution (NSNP-EI), or a government educational institution (GEI).

PEIs, commonly known as “private schools,” are managed and administered by private individuals, groups, or stockholders. PEIs may be registered as domestic corporations, partnerships, or other recognized entities under the law, provided that they are registered and adhere to the rules and regulations of either the DepEd, Commission on Higher Education (CHED), or the Technical Educations and Skills Development Authority (TESDA).

PEIs registered as domestic corporations are subject to a preferential income tax rate of 10% based on net taxable income. The Corporate Recovery and Tax Incentives for Enterprises (CREATE) Act, however, granted a reprieve to PEIs by lowering the tax rate to 1% of net taxable income between July 1, 2020 and June 30, 2023. The preferential tax rate is given to PEIs, provided that incomes received from unrelated business or other activities do not exceed 50% of the total revenue for the taxable year; otherwise, PEIs may be subject to the regular corporate income tax on the entire amount of taxable income. PEIs other than domestic corporations are still subject to the regular income tax rates depending on their structure. As such, a PEI owned by a sole proprietorship may still be subject to the regular income tax.

NSNP-EIs are also considered private schools, as these are managed by private groups of individuals, better known under corporate law as “trustees” or “members.” NSNP-EIs do not issue shares of stock or dividends. Further, no income shall inure to the benefit of any trustee, member, director, or officer of NSNP-EIs. These institutions are required to register and adhere to the rules of DepEd, CHED, and TESDA as well.

As expressly provided in the Constitution, and further reiterated under Section 30(H) of the Tax Code, NSNP-EIs are exempt from income tax on their revenue and assets, provided that the revenue and assets are actually, directly, and exclusively for educational purposes. Unrelated income, however, may still be subject to the appropriate income taxes.

To ensure that the income from NSNP-EIs is actually, directly and exclusively used for education purposes, NSNP-EIs are required to secure a one-time tax exemption certification from the Bureau of Internal Revenue (BIR) through the submission of applicable documents as required under Revenue Memorandum Order No. 44-2016. Such certification may be revoked by the BIR for any violation of any existing tax rule, or if there are material changes in the character, purpose or method of operation by the NSNP-EI.

GEIs are schools that are supported, either fully or partially, by the government. These institutions are commonly formed by express provision of law and their tax exemptions are usually stated in their charter. Generally, GEIs are exempt from income tax under Section 29(I) of the Tax Code.

LESSON 2: IS MY SCHOOL SUBJECT TO VAT ON INCOME OR REVENUE RECEIVED?Section 109(H) of the Tax Code states that educational services rendered by private educational institutions and GEIs duly accredited with either the DepEd, CHED, or TESDA are exempt from VAT. However, the exemption does not extend to the input VAT on purchases made by the schools. In connection with this, input VAT on purchases made by private schools may be claimed as a cost or expense.

It must be noted, however, that the VAT exemption of private schools only extends to receipts from educational services such as tuition. In several BIR VAT rulings and tax appeals cases, gross receipts from other activities such as the disposal of school vehicles and equipment for operational use and rentals received by PEIs or NSNP-EIs from canteen concessionaires may still be subject to VAT. Thus, while the private school may be exempt from VAT on its tuition, it may still be subject to VAT on other areas.

Revenue received from non-educational activities has been the subject of various administrative and judicial cases involving educational institutions — this is one to watch.

LESSON 3: DOES MY SCHOOL NEED TO WITHHOLD TAXES FROM PURCHASES? Taxpayers such as NSNP-EIs or GEIs, who are exempt from payment of income tax, are generally exempt from withholding tax on income receipts as well. However, this does not absolve the school from withholding taxes on its purchases.

Common expenses such as rent, payments to professionals, management, and technical consultants are all subject to certain withholding taxes under Revenue Regulation (RR) No. 02-1998, as amended by RR No. 11-2018. This means that on every payment made to suppliers, the school must withhold a certain percentage therefrom net of VAT.

Last, schools that are considered as top withholding agents are required to withhold 1% on every purchase of goods or 2% on every purchase of service from regular suppliers.

Blessed with preferential tax rates and exceptions, schools must also invest in a robust regulatory compliance team aside from having a strong roster of faculty members. Of equal importance is regulatory compliance of educational institutions as part of our collective aim of enriching the country’s youth and improving our educational and tax system.

Any questions? There being none, class dismissed!

Let’s Talk Tax is a weekly newspaper column of P&A Grant Thornton that aims to keep the public informed of various developments in taxation. This article is not intended to be a substitute for competent professional advice.

Joen Jacob G. Ramas is a senior in charge of Tax Advisory & Compliance division at the Cebu office of P&A Grant Thornton, the Philippine member firm of Grant Thornton International Ltd.