Local Business Tax on Dividends and Interest Earned by Holding Companies

The Supreme Court has clarified when a holding company's dividend and interest income may be subject to local business tax (LBT). In City of Davao v. ARC Investors, Inc. (G.R. No. 249668, July 13, 2022), the Court ruled that a holding company that merely receives dividends from shares it owns and earns incidental interest from money market placements is not "doing business" as a non-bank financial intermediary (NBFI). The decision protects passive investment income of holding companies from local taxation, a question that affects many corporate groups operating in Philippine cities.

Facts of the Case

ARC Investors, Inc. (ARCII) is a domestic holding company whose primary purpose is to own shares of stock in other corporations. Its Articles of Incorporation expressly prohibited it from acting as an investment company or securities broker. In 2010, ARCII earned P801.6 million from dividends on its preferred shares in San Miguel Corporation and interest on money market placements.

The City of Davao assessed ARCII for LBT equivalent to 0.55% of these amounts, claiming ARCII was a financial institution subject to tax under the Local Government Code (LGC). ARCII protested, and the case eventually reached the Court of Tax Appeals, which cancelled the assessment. The city appealed to the Supreme Court.

The Legal Question

The sole issue was whether ARCII qualified as a non-bank financial intermediary subject to LBT under the LGC. Under the relevant provisions, cities may tax banks and other financial institutions on gross receipts derived from interest, dividends, and similar income.

The Court's Ruling

The Supreme Court denied the city's petition and affirmed the cancellation of the assessment. The Court held that to be considered an NBFI under the LGC, three requisites must concur: (1) the entity is authorized by the Bangko Sentral ng Pilipinas to perform quasi-banking functions; (2) its principal functions include lending, investing, or placing funds for its own account or for others; and (3) it performs these functions on a regular and recurring basis, not in isolated transactions.

ARCII met none of these requirements. It was not BSP-authorized, its primary purpose was merely to hold shares for policy-controlling purposes, and its money market placements were incidental to managing its dividend income.

The Court distinguished a holding company from a financial intermediary. A holding company invests in equity securities to control another company's policies, while a financial intermediary actively deals in public funds and is regulated by the BSP. Investment activities of a holding company are merely incidental operations.

The Court also cited the Bureau of Local Government Finance's opinion that interest, dividends, and gains from sale of shares of non-bank and non-financial institutions are merely passive investment income, not part of gross sales or receipts under the LGC's definition. Such passive income is not subject to LBT.

Practical Takeaways

• Passive income is generally not taxable as LBT. Dividends and interest earned by a non-financial corporation from its investments are passive income, not business receipts subject to local business tax.
• Holding companies are not automatically financial intermediaries. A company whose main purpose is to hold shares in other corporations will not be treated as an NBFI merely because it earns dividends or places funds in interest-bearing instruments.
• Regularity matters. To be subject to LBT as a financial institution, the entity must perform lending or investment functions on a regular and recurring basis, not in isolated transactions.
• Check the BSP authorization. An entity not authorized by the Bangko Sentral to perform quasi-banking functions cannot be taxed as a non-bank financial intermediary.
• Review local assessments carefully. Local governments may attempt to tax passive income of holding companies. Taxpayers should verify whether the local assessment is based on a proper classification of the business.

This article is general information and not legal advice. For your specific situation, consult a lawyer or ask ASG Legal AI.