Dear Atty. Gab

Musta Atty!

I am writing to you today because I am quite confused about the tax obligations of our small organization, the Lingap Komunidad Clinic. We established it a few years ago in Bacolod City as a non-stock, non-profit corporation with the primary goal of providing accessible healthcare to underserved communities. A significant portion of our services, especially consultations and basic medicines, are provided completely free of charge to indigent patients. We rely heavily on donations and a few grants to make this possible.

However, to ensure the clinic’s sustainability and cover our operational costs like rent, utilities, and staff salaries (who are not highly paid, by the way), we also charge minimal fees to patients who have some capacity to pay. These fees are still much lower than private hospitals. Additionally, we operate a small pharmacy within the clinic premises, selling medicines at a small markup, and a tiny canteen offering affordable meals and snacks. All income generated from these paying patients, the pharmacy, and the canteen is meticulously accounted for and plowed right back into the clinic’s operations – to buy more medical supplies, maintain equipment, and expand our free services. No individual member or officer benefits personally from these earnings.

Recently, I’ve heard conflicting opinions. Some say that because we are non-profit and use all our income for our mission, we are completely exempt from income tax. Others suggest that our income-generating activities, even if the profit is used for charity, might be taxable. I am now very worried about potential tax liabilities. Could you please shed some light on this, Atty. Gab? Are we at risk of being assessed for taxes despite our charitable nature?

Thank you for your guidance,
Regina Gatchalian

Dear Regina,

Thank you for reaching out and for the commendable work Lingap Komunidad Clinic is doing in Bacolod City. It’s understandable to feel confused about the tax implications for non-profit organizations, especially when they engage in some income-generating activities to support their mission.

The core principle here is that while your clinic is organized as a non-stock, non-profit entity, this status does not automatically grant a blanket exemption from all income taxes. Philippine tax laws distinguish between income derived from purely charitable activities and income from activities conducted for profit, even if those profits are ultimately used to fund charitable endeavors. Income from profit-generating activities, such as charging paying patients or running a pharmacy and canteen, is generally subject to income tax. However, for certain types of non-profit entities like hospitals, there might be a preferential tax rate applicable to this income, provided specific conditions are met.

When ‘Non-Profit’ Meets ‘For-Profit’: Understanding Your Clinic’s Tax Obligations

Your concern highlights a common area of confusion for many non-profit organizations. The heart of the matter lies in how Philippine tax law defines and treats charitable institutions and their income. While your clinic’s primary purpose is undoubtedly charitable, the way it generates some of its funds has specific tax implications.

A charitable institution, in the eyes of the law, typically provides services that lessen the burden of the government. As one Supreme Court decision clarified the essence 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.

This principle underscores why tax exemptions are granted – it’s a form of state subsidy recognizing the public good these institutions provide. However, to qualify for a full income tax exemption under Section 30(E) of the National Internal Revenue Code (NIRC), an institution must meet stringent requirements. The NIRC specifies that such an 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 crucial element here for your clinic is the requirement that it be “operated exclusively” for charitable purposes. While your free services to indigent patients clearly fall under this, the income derived from paying patients, your pharmacy, and canteen, even if minimal and reinvested, are generally considered income from “activities conducted for profit.” These activities, by their nature, involve a purpose to generate revenue over and above the direct cost of those specific services or goods, distinguishing them from purely donative or subsidized charitable acts.

This leads us to a very important provision, the last paragraph of Section 30 of the NIRC, which states:

Notwithstanding the provisions in the preceding paragraphs, the income of whatever kind and character of the foregoing organizations from any of their properties, real or personal, or from any of their activities conducted for profit regardless of the disposition made of such income, shall be subject to tax imposed under this Code. (Emphasis supplied)

This means that even if an organization like yours is generally tax-exempt for its charitable work, any income it earns from profit-oriented activities is taxable. The phrase “regardless of the disposition made of such income” is key – it clarifies that plowing the profits back into the clinic’s charitable operations does not, by itself, make that income exempt from tax at the point it is earned.

However, there’s a specific provision that may apply to your clinic. Section 27(B) of the NIRC provides for a preferential tax rate for certain entities. It states:

Proprietary educational institutions and hospitals which are non-profit shall pay a tax of ten percent (10%) on their taxable income x x x. For purposes of this Subsection, the term ‘unrelated trade, business or other activity’ means any trade, business or other activity, the conduct of which is not substantially related to the exercise or performance by such educational institution or hospital of its primary purpose or function. (Emphasis supplied)

If Lingap Komunidad Clinic is considered a “proprietary non-profit hospital,” then the income derived from your paying patients, pharmacy, and canteen would be subject to this 10% income tax rate instead of the regular corporate income tax rate. “Proprietary” in this context generally means private (not government-owned or operated). “Non-profit” means that no part of its net income or assets accrues to the benefit of any member or specific person, and all net income is devoted to the institution’s purposes. Your clinic seems to meet the non-profit aspect. The determination of whether it’s a “hospital” under this provision would depend on its specific services and licensing.

It’s also important to remember that tax exemptions are strictly construed against the taxpayer. This means the law is interpreted narrowly, and the burden is on the taxpayer (your clinic) to prove it meets all the requirements for exemption or for a preferential rate. Being organized as a non-stock, non-profit corporation is a starting point, but the operational test – particularly the “operated exclusively” for charitable purposes rule for full exemption – is critical.

Practical Advice for Your Situation

• Review Your Clinic’s Structure and Operations: Confirm that your Articles of Incorporation and actual daily operations clearly reflect your status as a non-stock, non-profit entity primarily dedicated to charitable purposes, ensuring no private inurement.
• Meticulously Segregate Financial Records: It is crucial to maintain separate and detailed accounting for income and expenses related to your purely charitable activities (free services funded by donations) versus those from your income-generating activities (paying patients, pharmacy, canteen). This segregation is vital for accurate tax computation.
• Assess Qualification for Preferential Tax Rate: Determine if Lingap Komunidad Clinic qualifies as a “proprietary non-profit hospital” under Section 27(B) of the NIRC. If it does, the net income from your paying patients and other for-profit services would be subject to the 10% tax rate.
• Understand the “Operated Exclusively” Test: Recognize that while your clinic has a significant and commendable charitable component, the activities generating income from paying patients and sales are legally considered “conducted for profit.” This means that portion of your income is taxable.
• Reinvested Profits Are Taxable at Source: The fact that profits from paying services, the pharmacy, or canteen are reinvested into the clinic’s operations does not exempt that income from being taxed when earned. The tax applies to the net income derived from these specific for-profit activities.
• Ensure No Private Inurement: Continue to strictly adhere to the principle that no part of the clinic’s net income or assets benefits any private member, organizer, officer, or specific person. This is fundamental to maintaining non-profit status and eligibility for any tax considerations.
• Seek Professional Tax Guidance: I strongly recommend consulting with a qualified accountant or tax lawyer. They can help accurately assess your clinic’s specific situation, compute any potential tax liability, ensure compliance with Bureau of Internal Revenue (BIR) filings, and provide tailored advice.

Navigating tax laws can indeed be complex, especially for organizations with mixed charitable and income-generating activities. By understanding these principles and taking proactive steps, you can ensure Lingap Komunidad Clinic fulfills its mission while complying with its legal obligations.

Hope this helps!

Sincerely,
Atty. Gabriel Ablola

For more specific legal assistance related to your situation, please contact me through gaboogle.com or via email at connect@gaboogle.com.

Disclaimer: This correspondence is provided for informational purposes only and does not constitute legal advice. For specific legal guidance tailored to your situation, please schedule a formal consultation.