Local Business Tax on “other income”

A company that is licensed to engage in the construction or operation of power plants is not subject to local business tax (LBT) on its other income comprising of dividend income, foreign exchange gain and interest income from bank deposits.

In the instant case, the company never conducted any business or engaged in commercial operation as evidenced by the affidavit of non-operation, which it submitted to the local government unit (LGU) with its application for business permit. However, in the notice of assessment issued by the LGU, it classified the company as a “Holding Company-Management Service,” and correspondingly, assessed it on its dividend income (from its shareholdings), foreign exchange gains and interest income (from its bank deposit of the remainder of its branch capital).

The Regional Trial Court (RTC) sustained the findings of the LGU when it held that the primary purpose indicated in the company’s certification reveals that services embodied under the definition of contractor includes persons whose activity consists essentially of the sale of all kinds of services for a fee. The Court of Tax Appeals (CTA) reversed the decision of the RTC and held that the LGU erred in classifying the company as a “Holding Company-Management Service.”

According to the CTA, in determining whether the company is a “holding company-management service,” the actual operations must be determined on the basis of evidence relating to its operations, rather than inferring from a reading of the primary purpose clause stated in the company’s Articles of Incorporation. An enterprise’s Articles of Incorporation only show what a corporation is empowered or authorized to do, but do not prove what the business of a corporation actually is.

The CTA further held that Section 143 in relation to Section 131(n) of the Local Government Code (LGC) is clear that the company is only subject to LBT on its gross sales or receipts. Under Section 131(n) of the LGC, the term “gross sales or receipts” is defined as the total amount of money or its equivalent, representing the contract price, compensation or service fee, including the amount charged for material supplied with the services and deposits or advance payments actually or constructively received during the taxable quarter for the services performed or to be performed for another person. Hence, only income arising from the company’s services performed or to be performed to its customers should be subject to LBT.

Since the company had no income arising from services performed or to be performed for its customers, the CTA held that the foreign exchange gain, dividend income and interest income should not form part of the company’s gross receipts that should be subject to LBT.

(Orleyte Company v. City of Makati, CTA AC No. 80 November 14, 2012)

Tax Brief – December 2012

Punongbayan and Araullo