Of NGOs, foundations and the blurred lines of the inurement prohibition

SUITS THE C-SUITE By Fidela T. Isip-Reyes

First Published in Business World (07/14/2014)

When news about fake non-government organizations (NGOs) related to the pork barrel scam hit the headlines, other non-stock, non-profit organizations (NSNPs) attracted the probing eyes of the Bureau of Internal Revenue (BIR). As a result, the BIR issued on June 6, 2014 Revenue Memorandum Circular (RMC) No. 51-2014, which is aimed at tightening the strict interpretation and implementation of tax-exempt NSNPs under Section 30 of the Tax Code.

Section 30 of the Tax Code enumerates the NSNP corporations, associations and organizations that are exempt from income tax with respect to income received by them as such. Tax-exempt status is accorded to these entities provided that (i) the entity is a non-stock and/or non-profit organization; (ii) the organization’s activities are directed exclusively toward its tax-exempt purpose; and (iii) no part of its net income and assets inures for the benefit of any private individual.

This third requirement – that no part of its net income and assets inures to the benefit of any private individual — is the “inurement” prohibition which RMC 51-2014 seeks to define. The circular also enumerates certain situations which it considers as an “inurement” which, if present, would prevent a NSNP from claiming the tax exemption. However, in laying down examples of prohibited inurements, RMC 51-2014 stirred up a cloud of confusion as the lines between permissible and forbidden acts became blurred.

For instance, RMC 51-2014 considers as an inurement the payment of compensation, salaries, or honorariums to the trustees or organizers of a NSNP. However, if the trustee or organizer is, at the same time, an employee of the NSNP, does this mean that he should not be reasonably remunerated for services rendered?

Also considered as an inurement is the payment of exorbitant or unreasonable compensation to employees of a NSNP. However, the terms “exorbitant” and “unreasonable” are not defined in RMC 51-2014, which leaves plenty of room for discussion and argumentation to justify the amount of compensation granted.

The provision of welfare aid and financial assistance to members of a NSNP is also prohibited under RMC 51-2014, with the exception only of a society, order, association, or non-stock corporation under Section 30(C) of the Tax Code providing for the payment of life, sickness, accident and other benefits exclusively to its members or their dependents. This places at a disadvantage members of other NSNPs under Section 30 of the Tax Code, such as a labor, agricultural or horticultural organization or a cemetery company, which are also organized and operated exclusively for the benefit and/or mutual aid of its members. Due to the inurement prohibition, the members of these otherwise qualified NSNPs are deprived of access to much-needed resources.

The RMC further provides that an organization whose principal activity is to receive and manage funds associated with savings or investment programs, including pension or retirement programs, is ineligible to claim income tax exemption. To this extent, the application of the inurement prohibition on pension or retirement programs should be further clarified, considering the income tax exemption of the income of an employee’s trust which forms part of a pension, stock bonus, or profit-sharing plan of an employer for the benefit of some or all of his employees.

Also, when it comes to donations, RMC 51-2014 includes as an inurement “donation to any person or entity (except donations made to other entities formed for the purpose/purposes similar to its own).” Does this mean then that only donations made to NSNPs with purpose/s similar to the purpose/s of the donor-NSNP are not inurements? The plain wording of this provision seems to imply that a donation by a charitable institution to its legitimate beneficiaries (e.g., street children) is automatically deemed an inurement, which defeats the very purpose for the establishment of the organization. This provision should also be further clarified.

The purchase of goods or services for amounts in excess of their fair market value from an entity, in which one or more of its trustees, officers or fiduciaries has an interest, is likewise viewed as an inurement. What is “fair market value” and when is a trustee, officer or fiduciary considered to have an interest in a corporation or association for the purpose of the inurement prohibition? Without a clear yardstick to measure what these concepts mean, NSNPs may unintentionally risk losing their tax-exempt status.

While clearly the objective of RMC 51-2014 is to clarify the inurement prohibition of Section 30 of the Tax Code, further clarification is required, so that both taxpayers and BIR examiners may be properly guided in interpreting the inurement prohibition. More significantly, it is hoped that this RMC will not be applied or interpreted as to unduly paralyze the activities of bona fide, legitimate NSNPs that contribute to and supplement significantly the government’s development and other activities.

Fidela T. Isip-Reyes is a Tax Partner of SGV & Co.

This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co.