Are Non-profit Hospitals Exempt from Income Tax?
Some taxpayers organize a non-stock, non-profit corporation to avoid paying income tax. However, latest jurisprudence shows that the non-profit nature of a corporation is not a complete tax shield.
In Commissioner of Internal Revenue vs. St. Luke’s Medical Center, Inc. (St. Luke’s), G.R. No. 203514, Feb. 27, 2017, the Supreme Court reiterated its previous ruling in a case involving the same hospital that if an exempt institution under Section 30(E) or (G) of the National Internal Revenue Code (NIRC) earns income from its for-profit activities, it will not lose its tax exemption but its income from for-profit activities will be subject to income tax at the preferential 10% rate pursuant to Section 27(B) thereof.
In this case, St. Luke’s was assessed by the BIR a deficiency income tax of P41 million for taxable year 2006. St. Luke’s claimed that as a non-stock, non-profit charitable and social welfare organization under Section 30(E) and (G) of the 1997 NIRC, it is exempt from paying income tax. St. Luke’s protested the assessment but the same was denied by the BIR, prompting the hospital to elevate the matter to the Court of Tax Appeals (CTA). St. Luke’s scored a victory at the CTA as it cancelled and set aside the assessment of the BIR. The BIR appealed the case to the Supreme Court contending that the CTA erred in exempting St. Luke’s from the payment of income tax.
The Supreme Court ruled against St. Luke’s. While the court recognizes the income tax exemption of proprietary non-profit hospitals under Section 30(E) and (G) of the Tax Code, it pointed out that Section 27(B) has the effect of subjecting the taxable income of two specific institutions, namely, proprietary non-profit educational institutions and proprietary non-profit hospitals, to a 10% preferential income tax rate. The Court said that the word “proprietary” means private while the word “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.
The claim of St. Luke’s that it is exempted from income tax since it is a charitable institution was rejected by the Court. To be a charitable institution, an organization must meet the substantive test of charity. 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 foregoes taxes which should have been spent to address public needs, because certain entities already assume a part of the burden.
The Constitution exempts charitable institutions only from real property taxes. In the NIRC, Congress decided to extend the exemption to income taxes. Section 30(E) of the NIRC provides that a charitable institution must be: (1) a non-stock corporation or association; (2) organized exclusively for charitable purposes; (3) operated exclusively for charitable purposes; and (4) 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.
The Court pointed out that under Section 30 of the NIRC, there is a qualifying phrase which provides that if a tax exempt charitable institution conducts ‘any’ activity for profit, such activity is not tax exempt even as its non-profit activities remain exempt.
The Court noted that St. Luke’s had total revenues of P1.73 billion from services to paying patients in 2006, hence, it cannot be disputed that a hospital which receives such amount from paying patients is not an institution ‘operated exclusively’ for charitable purposes. Clearly, revenues from paying patients are income received from activities conducted for profit. St. Luke’s, therefore, cannot hide behind its corporate form as a non-stock, non-profit charitable institution.