[WITH RESOLUTION OF OCT. 30, 1964]

University of the Visayas versus Collector of Internal Revenue

The Case

This is the case of the University of the Visayas, formerly the Visayan Institute, against the Collector of Internal Revenue. The school sued to recover income taxes it had paid, claiming that as a corporation organized and operated exclusively for educational purposes it was exempt from income tax. The Collector, on the other hand, insisted that the school was really a profit-making enterprise whose earnings benefited its president and stockholders. The case matters because it fixes the test for the educational exemption: the institution must be organized and operated exclusively for education, and no part of its income may inure to the benefit of any private stockholder or individual. It also teaches that earning a surplus, charging tuition, and even paying moderate salaries do not by themselves destroy the exemption.

Procedural History

The school first brought an action for refund in the Court of First Instance of Cebu. After Republic Act Number 1125 created the Court of Tax Appeals, the trial court certified the case to that court. The Court of Tax Appeals ruled for the school, holding it exempt under Section 27, paragraph e, of the National Internal Revenue Code, declaring the assessments for the years 1946 to 1950 null and void, and ordering the refund of the amount erroneously paid. The Collector then filed a petition for review in the Supreme Court under Section 18 of Republic Act Number 1125. The Supreme Court affirmed the Court of Tax Appeals.

Facts

In 1919 Vicente Gullas established a school in Cebu City called the Visayan Institute, and for a few years he was its sole owner. In 1921 he and four others formed a non-stock corporation to establish and maintain the school. The original plan to sell bonds to the public was abandoned, and Vicente Gullas and his wife put in their own money. In 1930 the institute amended its articles and became a stock corporation with an authorized capital of 50,000 pesos, fully subscribed and paid, with Vicente Gullas holding the largest block. In March 1948 the institute became the University of the Visayas.

The school did not file income tax returns for the years 1946 to 1950. After investigation, the Bureau of Internal Revenue examiner prepared returns from the profit and loss statements submitted by the school's accountant and assessed income tax, surcharges, and penalties. The school asked to pay by installment, and the Collector allowed this on condition of a surety bond. The school paid 1,000 pesos in December 1951 and three monthly installments in 1952 totaling 13,811.31 pesos. In March 1954 it asked for a refund of the total 14,811.31 pesos, claiming exemption as an educational corporation, and on the same day it sued in the Court of First Instance of Cebu.

At the hearing, Vicente Gullas testified that the school was engaged in a purely educational pursuit, that its income came from student fees, and that the receipts went to teachers' salaries, building repairs, library books, athletic equipment, scholarships, and charity. He admitted the school realized profit, but said the profit went back into improvements and scholarships. He received a salary of 1,000 pesos a month plus a 300 peso allowance. The accountant testified that no dividends had ever been distributed and that net income remained as surplus. Two revenue examiners testified that they found no declaration or payment of cash dividends from 1920 to 1941 and from 1946 to 1951.

Issues

• Whether or not the University of the Visayas is a corporation organized and operated exclusively for educational purposes within the meaning of Section 27, paragraph e, of the National Internal Revenue Code.
• Whether or not no part of its income inures to the benefit of any private stockholder or individual, notwithstanding that it earns profits, pays salaries to its president and other stockholders, and accumulates surplus.
• Whether or not the assessments for income tax for the years 1946 to 1950 are null and void and the taxes paid should be refunded.

Applicable Provisions

Section 27, paragraph e, of the National Internal Revenue Code, as amended, provides:

The following organizations shall not be taxed under this Title in respect to income received by them as such— Corporations or associations organized and operated exclusively for religious, charitable, scientific, athletic, cultural, or educational purposes, or for the rehabilitation of veterans no part of the income of which inures to the benefit of any private stockholder or individual; Provided, however, That the income of whatever kind and character from any of its properties, real or personal, or from any activity conducted for profit, regardless of the disposition made of such income, shall be liable to the tax imposed under this Code.

This is the provision under which the school claims exemption and against which the Collector's assessments must be measured.

Ruling

On the first issue, the Court held that the school is organized and operated exclusively for educational purposes. It applied its earlier ruling in the Cinco Educational Corporation case, where it held that a school does not become a profit-making enterprise merely because it charges tuition fees, which are its only source of income, and that every responsible organization must be run so as to insure its existence and, whenever possible, to have a surplus. The Court reasoned that limiting the exemption to schools on the verge of bankruptcy would discourage the establishment of colleges, which is the opposite of the objective of the law.

On the second issue, the Court held that no part of the income inures to the benefit of any private stockholder or individual. It noted that since incorporation no dividends had ever been declared or distributed, and that the income went to teachers' salaries, repairs, library books, equipment, scholarships, and charity. Following the Cinco ruling, the Court held that payment to those who work for a school as remuneration for their services is not a distribution of profit, and that the use of income to acquire additional buildings and equipment does not inure to stockholders because any benefit on dissolution is too remote and speculative. The Court quoted its earlier ruling:

The fact is that, as it has been established, the appellee is a non-profit institution and since its organization it has never distributed any dividend or profit to its stockholders.

On the third issue, since the school is exempt, the assessments were null and void and the taxes paid were erroneously collected and must be refunded.

Doctrine

To claim the educational exemption under Section 27, paragraph e, of the National Internal Revenue Code, a corporation must show two things: that it is organized and operated exclusively for educational purposes, and that no part of its income inures to the benefit of any private stockholder or individual. The mere fact that a school charges tuition fees and realizes a surplus does not make it a profit-making enterprise, for every responsible organization must be run so as to insure its existence and, whenever possible, to have a surplus. Payment of moderate salaries to those who work for the school, including its president, is remuneration for services and not a distribution of profit. The use of income to acquire additional buildings and equipment does not inure to stockholders, because any benefit upon dissolution is a contingency too remote to affect the exemption.

Disposition

The Supreme Court affirmed the judgment of the Court of Tax Appeals: the University of the Visayas is exempt from income tax, the assessments are null and void, and the Collector must refund the taxes erroneously paid.

Remember This

Memorize the twin test: organized and operated exclusively for educational purposes, and no part of the income inuring to any private stockholder or individual. Examiners use this case to test whether tuition fees, salaries to officer-stockholders, and accumulated surplus destroy the educational exemption, and the answer is that they do not.