RMC No. 89-2024 — Clarifying the taxability of income derived by Local Government Units engaged in proprietary functions

BUREAY OF INTERNAL REVENUE RECORDS MANAGEMENT DIVISION REPUBLIC OF THE PHILIPPINES AE

BUREAU OF INTERNAL REVENUE DEPARTMENT OF FINANCE Nationaf Office Building Quezon City BY: AdMIN unIT .2 AUG 1 3 2024 TiMe: 4:40

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REVENUE MEMORANDUM CIRCULAR NO.0 8 9 - 2 0 2 4

SUBJECT: Clarifying the Taxability of Income Derived by Local Government Units (LGUs) engaged in Proprietary Functions

TO: All Internal Revenue Officials, Employees and Others Concerned

BACKGROUND

22 (d) of Republic Act ("RA") No. 71602 provides that Local Government Units ("LGUs") being political subdivisions, shall enjoy local autonomy, including full autonomy in the exercise of their proprietary functions and in the management of their economic enterprises. Section 2, Article X of the 1987 Philippine Constitution' ("Constitution") and Section

use and disposition and which shall be retained by them; and (2) acquire, develop, lease. participants in the attainment of national goals. have the power to: (1) create its own sources of revenues and to levy taxes, fees and charges basic policy of local autonomy. Such taxes, fees and charges shall accrue exclusively for their and functions and thereby ensure their development into self-reliant communities and active subject to such guidelines and limitations as the Congress may provide, consistent with the encumber, alienate, or otherwise dispose of real or personal property held by them in their proprietary capacity and to apply their resources and assets for productive, developmental, or welfare purposes, in the exercise or furtherance of their governmental or proprietary powers Section 5 of the Constitution and Section 18 of RA No. 7160 provide that LGUs shall

liable to pay tax imposed upon their taxable income, to wit: Code"), expressly provides that LGUs (which are considered as a government agency3) are Section 27 (C) of the National Internal Revenue Code of 1997, as amended ("Tax

"SEC. 27 Rates of income tax on domestic corporations. -

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' February 2, 1987. 2 An Act Providing for a Local Government Code of 1991, October 10, 1991. 1987; Revenue Regulations No. 2-2023 dated March 29, 2023; Boy Scouts of the Philippines vs. National Labor Relations Commission, G.R. No. 80767, April 22, 1991, BIR Ruling No. OT-0659-2020, December 9, 2020; BIR 3 Section 2 of Executive Order No. 292, otherwise known as the "Revised Administrative Code of 1987." July 25 Ruling No. 1353-18, November 15, 2018. FEUrEAU OF TNtERNAL REVENUE ITERNAL COMMUNICATIONS DIVISION MNGTTG

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C) Government-owned or Controlled Corporations, Agencies

notwithstanding, all corporations, agencies, or instrumentalities owned or controlled by the Government, except the Government Service Insurance System (GSIS), the business, industry or activity. Instrumentalities. -- The provisions of existing special or general laws to the contrary Social Security System (SSS), the Philippine Health Insurance Corporation (PHIC), the local water districts (LWD), shall pay such rate of tax upon their taxable income as are imposed by this Section upon corporations or associations engaged in a similar

exercise of essential government function accruing to LGUs are exempt from tax, to wit: However, Section 32 (B) (7) (b) of the Tax Code clarified that income derived from the

"SEC. 32. Gross Income. -

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income and shall be exempt from taxation under this Title: (B) Exclusions from gross income. -- The following items shall not be included in gross

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(7) Miscellaneous Items.

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from any public utility or from the exercise of essential governmental function accruing to the Government of the Philippines or to any political subdivision thereof. ' (b) Income Derived by the Government or its Political Subdivisions. -- Income derived

its proprietary functions shall be subject to Philippine taxes as are imposed upon corporations or associations engaged in similar business, industry or activity. Hence, it is clear that only the income derived by the LGUs from the performance of

imposition of taxes on the proprietary activities of LGUs based on the current laws and recent This Circular is, therefore, issued to provide clarification and guidance relating to the

jurisprudence.

I FUNCTIONS OF LOCAL GOVERNMENT UNIT

governmental, legislative, public, or political; and (ii) proprietary, corporate or private: Under Section 15 of RA No. 7160, LGUs' powers are two-fold in character: (i)

A. Governmental Functions

judicial, public and political aspects. In its public capacity, a responsibility exists in the performance of acts for the public benefit, and in this respect, it is merely a part of the administer the powers of the State and promoting public welfare which includes the legislative. An LGU is exercising its governmental powers when it is performing acts which

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machinery of government of the sovereignty creating them, and the authority of the state is supreme.

government unit which are conferred or imposed upon it as a local agency that are essential to advancement of the public health, safety, morals, general welfare, security, prosperity and its existence in the sense of serving the public and which has for its objective the promotion or Government function is defined as functions of a municipal corporation or a local

contentment of the inhabitant or in the performance of a duty imposed by sovereign power.s

operation, intended recipients of its services or customers and the disposition of its revenues.1 has the burden of proving that the objective of its economic endeavor is purely governmental. It must present through evidentiary documents, the purpose of its creation, the manner of its In order to establish as to whether an LGU performs a governmental function or not, it

B. Proprietary Functions

general interest of society, and merely optional on the government.7 Proprietary powers are exercised for the special benefit and advantage of the community which include those: (1) that are ministerial, private, and corporate in nature, and not necessary to its existence; and (2) which inure to the advantage of its inhabitants. Proprietary function refers to those that are undertaken only by way of advancing the

considered performance of proprietary functions of the LGUs: Section 2 (5) of Revenue Regulations ("RR") No. 18-2012, qualified the acts that are

"SECTION 2. Definition of Terms.

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business taxes in the same manner as other private corporations similarly situated. function; and (2) it must be engaged in similar business, industry, or activity as public corporation or a local government unit acts in its proprietary character, it is regarded as having the rights and obligations of a private corporation. For performed by other ordinary taxable corporations. All income realized from or 5. Government Proprietary Function - for purposes of these Regulations, when a government entities to be taxable, the following requisites must concur: (1) the government entity concerned must not be performing an essential governmental received in the exercise of its proprietary functions shall be subject to income tax and

specific act of LGU to be considered as proprietary in nature: Based on the foregoing, the following requisites must all be present in order for a

1. the LGU concerned must not be performing an essential governmental function; and

5 BIR Ruling No. 369-2011, October 5, 2011. 6 Imposition of Income Tax and VAT by the BIR to Local Economic Enterprises, Bureau of Local Government Finance Opinion, April 20, 2017. 7 BIR Ruling No. 471-2018, March 13, 2018. 4 Angat River Irrigation System, et al. v. Angat River Workers' Union et al., G.R. Nos. L-10943 & L-10944, December 28, 1957. S tECORIS MANAGEMENt OIViSION EAU OF INTERNAL REVENUE

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2. the LGU must be engaged in similar business, industry, or activity as performed by other ordinary taxable corporations.

private or proprietary in character.: be considered and would be decisive. The basic element, no matter how beneficial to the public the undertaking may be, is that it is governmental in essence, otherwise the function becomes undertaking or function of an LGU. The surrounding circumstances of a particular case are to There is no hard and fast rule for purposes of determining the true nature of an

I. TAX TREATMENT OF INCOME DERIVED FROM THE PERFORMANCE OF PROPRIETARY FUNCTIONS OF LGUs

just like an income of any other private or government corporation. purpose of economic gain and profit ("Proprietary Income") shall be subject to tax and treated To reiterate, any income derived by an LGU acting in its corporate capacity and for the

obligations of a private corporation. Based on Section 30 of the Tax Code, the income of income, shall be subject to tax imposed under the Tax Code.9 whatever kind and character of corporations from any of their properties, real or personal, or from any of their activities conducted for profit regardless of the disposition made of such When LGUs act in its proprietary character, it is regarded as having the rights and

Presidential Decree No. 1931 (1984) and Executive Order No. 93 (1987).10 of all government units, including, for the avoidance of doubt, LGUs, were withdrawn by It bears stressing that the tax exemption privileges, including preferential tax treatment

As such, the Proprietary Income derived by LGUs shall be subject to the following internal revenue taxes:

A. Income Tax

performance of proprietary activities are subject to income tax. Section 27 (C) of the Tax Code provides that income derived by LGUs from the

It must be noted that this includes income taxes imposed on passive income under Section 27(D) of the Tax Code such as, but not limited to, royalties, interests, dividends. system, and capital gain realized from sale, exchange, or other disposition of lands and/or buildings which are not actually used in the performance of such LGU's sale of shares of stocks, income derived under the expanded foreign currency deposit governmental functions.

io BIR Ruling No. 055-1991, April 3, 1991; BIR Ruling No. 369-2011, October 5, 2011. 8 Torio vs. Fontanilla, 85 SCRA 602 (1978) 9 Imposition of Income Tax and VAT by the BIR to Local Economic Enterprises, Bureau of Local Government Finance Opinion, April 20, 2017.

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B. Withholding tax

governmental functions. withholding tax shall not apply to income payments made to the national government and its instrumentalities, including provincial, city or municipal governments, this rule only applies to income payments received by the LGU in the performance of its While it is true that under Section 2.57.5 (A) of RR No. 2-98, withholding of creditable

private or government corporation. Hence, income payments to LGUs by reason of As discussed above, Proprietary Income shall be taxed the same just like any other performance of proprietary functions shall be subject to withholding tax pursuant to RR No. 2-98.

C. VAT

Section 105 of the Tax Code provides for the persons liable to VAT, to wit:

SEC. 105. Persons Liable. -- Any person who, in the course of trade or business, sells, barters, exchanges, leases goods or properties renders services, and any person who imports goods shall be subject to the value-added tax (VAT) imposed in Sections 106 to 108 of this Code. "

Moreover, Section 108 of the Tax Code provides for the tax rate and tax base of VAT on sale of services:

Lease of Properties. "SEC. 108. Value-added Tax on Sale of Services and Use or

collected. a value-added tax equivalent to twelve percent (12%) of the gross sales derived from the sale or exchange of services, including the use or lease of properties: (A Rate and Base of Tax. -- There shall be levied, assessed and

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or consideration. x x x kinds of services in the Philippines, for others for a fee, remuneration The phrase 'sale or exchange or services' means the performance of all

be held liable to twelve percent (12%) VAT on the total gross sales it derived from such activity.I When LGUs perform corporate or private function that is proprietary in nature, it shall

D. Other Percentage Taxes

Income derived by LGUs from the performance of its proprietary function that falls under Title V of the Tax Code shall be subject to percentage tax based on the percentage tax rates provided therein.

11 BIR Ruling No. 471-2018. March 13, 2018. BUREAU OF INTERNAL REVENUE D RECORDS MANAGEMENT DIVISION

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E. DST

corporations, shall be held liable for DST under the Tax Code. corporate or private function that is proprietary in nature, similar with private LGUs entering into private contracts/agreements relating to its performance of

For transactions subject to the above internal revenue taxes, LGUs shall issue the appropriate invoice/s complying with the requirements under Section 237 of the Tax Code, as

apply for Authority to Print in the printing of their principal and supplementary invoices following the procedure under RR No. 7-2024 and other relevant revenue issuances. amended by RA No. 11976, otherwise known as the "Ease of Paying Taxes Act," and as implemented by RR No. 7-2024 and other existing rules and regulations. Hence, they shall

IV. APPLICATION OF TAXES

A. Sale of properties that are no longer intended for governmental use

therefrom. It must be noted that the said CGT is an income tax, the burden of is higher, is imposed upon capital gains presumed to have been realized which rests upon the seller which, in this case, is the LGU. exchange, or other disposition of lands and/or buildings which are not actually used in business and are treated as capital assets by domestic corporations, a final tax of six percent (6%) based on the gross selling price or current fair market Under Section 27 (D) (5) of the Tax Code, it is provided that in the case of sale. value as determined in accordance with Section 6 (E) of the Tax Code, whichever

the exercise of its essential governmental function shall be excluded from its It is noteworthy to mention that LGU is subject to the CGT of 6% imposed on its capital gains presumed to have been realized from the sale of properties despite of its being a government entity. This is in accordance with Section 32 (B) (7) (b) of the Tax Code which provides that only the income derived by the LGU from

gross income.12

B. Leasing of properties

since no governmental or public policy of the state is involved. 13 obtaining profit. The LGU in this case acts in its proprietary or private character operate a commercial activity is primarily an economic activity with a view to Leasing of property to a private person and/or entity for it to construct, develop and

C. Exchange of properties

It has been the consistent stance of this Office that an exchange of properties

Section 6 (E) of the Tax Code. If the exchange of properties between the LGU and between two (2) parties is subject to CGT and the corresponding DST based on the fair market value of their respective properties as determined in accordance with

12 BIR Ruling No. DA-419-98 dated September 14, 1998; BIR Ruling No. 396-11, October 25, 2011. 13 BIR Ruling No. 239-14, June 25. 2014.

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voluntary exchange, it is subject to the aforesaid taxes.14 the private person/entity relating to a commercial activity partakes the nature of

Accordingly, the private person/entity may opt to report the gain realized in the exchange in the manner provided for under Section 24 (A) (1) of the Tax Code

report his tax liabilities, if any, on gains realized on dispositions of real property to subject to CGT of 6% under Section 24 (D) (1) of the Tax Code, or under Sec. 24 (A) (1) thereof and the corresponding DST prescribed in Section 196 of the same Code. the government or any of its political subdivisions or agencies either as a transaction Under Section 24 (D) (1) of the Tax Code, an individual taxpayer has the option to

On the other hand, the LGU shall be subject to the CGT of 6% imposed under

realized from the said exchange transaction of real property considered as capital assets. This is because only the income derived by the LGU from the exercise of its essential governmental function shall be excluded from its gross income pursuant to Sec. 32 (B) (7) (b) of the Tax Code.1s Section 27 (D) (5) of the Tax Code on the capital gains presumed to have been

D. Interest from deposits and yield or any other monetary benefit from deposit substitutes and from trust funds and similar arrangements and royalties

municipality" and, hence, proprietary in character.16 It is in the nature of a function "for the special benefit and advantage of the city or The obligation of LGU to maintain depository accounts for its funds may not be construed as part of its essential governmental functions since this is not exercised in "administering the powers of the state and promoting the public welfare" nor is it included among the "legislative, judicial, public or political" powers of the LGU.

policy of the state is involved.17 With regard to investments, it appears that an LGU engages primarily in an economic activity with a view to obtaining profit when it maintains investments. The City acts in its proprietary or private character since no governmental or public

under Section 27(D)(1) of the Tax Code. derived from its deposit accounts and yield and other monetary benefit from its investments in government securities, commercial papers and similar arrangements The LGU is subject to the twenty percent (20%) final tax on its interest income

E. The forfeiture of or purchase by the LGU in the public auction of properties due to delinquency in real property taxes

or the zonal value of the foreclosed property, whichever is higher. The transaction shall be subject to CGT based on the bid price in the auction sale

14 BIR Ruling No. DA-(I-047) 571-08 dated December 23, 2008. 15 BIR Ruling No. 009-10 dated June 3, 2010; BIR Ruling No. 436-11, November 9. 2011. 17 BIR Ruling No. 013-04, September 13. 2004. 16 City of Manila vs. Intermediate Appellate Court, 179 SCRA 428, 434-435 (1989); BIR Ruling No. 013-04. September 13, 2004 S BUREAU OF INTERNAL REVENU CORDS MANAGEMENT DIVISION

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the LGU pursuant to Section 263 of RA No. 7160.18 The Declaration of Forfeiture is subject to DST under Section 196 of the Tax Code, since upon registration of this document with the Office of the Registry of Deeds, the Registrar of Deeds is duty bound to transfer the title of the forfeited property to

conditional sales of real property.19 of foreclosure sale. The Tax Code requires payment of CGT/DST even on Code, the CGT is required to be paid upon consolidation of title over the property by the highest bidder which shall be made after the lapse of one (1)-year redemption the CGT and DST, in order that a property may be registered under its name upon The statutory seller in this particular situation is the concerned LGU. Under the Tax period. If redeemed, there is no CGT due. But, if the owner fails to redeem the property, the highest bidder who, in most cases is the statutory seller (LGU), pays the registration of the certificate of sale. There is no exemption from taxes in case

Y REPEALING CLAUSE

repealed, modified or amended accordingly. All other Circulars and/or portions thereof that are inconsistent herewith are hereby

as wide publicity as possible. All concerned are hereby enjoined to be guided accordingly and to give this Circular

This Circular shall take effect immediately.

ROMEE f TvA JR. Con Mssioner of Internal Revenue

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18 BIR Ruling No. 224-11, July 12, 2011. 19 BIR Ruling No. 009-10, June 3, 2010. 3 ADMIN UNIT - 2 w TiMe: 4:4 0