DE LA SALLE LIPA, INC., PETITIONER, VS. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

De La Salle Lipa versus Commissioner of Internal Revenue

The Case

This is a tax case between De La Salle Lipa, a non-stock, non-profit educational institution, and the Commissioner of Internal Revenue. De La Salle Lipa was assessed for deficiency income tax, value-added tax, and expanded withholding tax for taxable year 2005, arising from two sources of revenue: the consideration it received under a contract with Vintage Food Service for the exclusive operation of its school canteen, and the rental income it derived from the use of its facilities. The case matters because it is the occasion for the Court to restate, and to apply to a concrete taxpayer, the constitutional rule that the tax exemption of a non-stock, non-profit educational institution is anchored on the use of its revenues, not on their source, and to remind every examinee that the burden of proving that actual, direct, and exclusive use rests on the institution itself.

Procedural History

The Commissioner issued a Formal Letter of Demand for deficiency income tax, value-added tax, documentary stamp tax, and expanded withholding tax, inclusive of compromise penalty. De La SalLe Lipa protested, and after reinvestigation the Regional Director cancelled only its documentary stamp tax liability. De La Salle Lipa then filed a petition for review before the Third Division of the Court of Tax Appeals. The Third Division denied the petition, affirmed the Formal Letter of Demand with modification, cancelled the compromise penalty, and ordered De La Salle Lipa to pay the reduced amount inclusive of the twenty-five percent surcharge, with deficiency and delinquency interest. Both parties moved for reconsideration, and both were denied. Both parties then elevated the case to the Court of Tax Appeals En Banc, which consolidated the cases and affirmed the Third Division. The Commissioner moved for reconsideration, and the En Banc denied it. De La Salle Lipa filed a petition for review on certiorari with the Supreme Court, and the Commissioner likewise filed its own petition, which the Court consolidated.

Facts

De La Salle Lipa is a non-stock, non-profit domestic educational institution in Lipa City. On April 5, 2006, the Revenue Region issued a Letter of Authority authorizing revenue officers to examine its books and records for all internal revenue taxes for the period June 1, 2004 to May 31, 2005. A Preliminary Assessment Notice followed, based on three matters: a conditional donation of 14,660,000 pesos it received from Vintage Food Service under a contract dated November 11, 2004 and effective for ten years; rental income of 9,500,726.79 pesos; and its failure to withhold the two percent contractor's tax.

De La Salle Lipa protested and submitted documents, including its contract with Vintage Food Service and its Certificate of Registration as a donee institution. The Revenue District Office later informed it that the contract of donation was simulated and was in truth a contract of lease, the amount received being rental for the use of the facility. A second Preliminary Assessment Notice was issued, and De La Salle Lipa protested again, insisting that it manages and operates the canteen jointly with Vintage Food Service, and that in any event the amount was used for educational purposes.

A Formal Letter of Demand followed, which De La Salle Lipa protested on the ground that as a non-stock, non-profit educational institution using all its assets and revenues actually, directly, and exclusively for educational purposes, it is exempt from taxes. After reinvestigation, only the documentary stamp tax liability was cancelled. De La Salle Lipa then went to the Court of Tax Appeals, and while the case was pending before the En Banc it paid the judgment award of 32,737,917.66 pesos, with leave of court, subject to credit or refund depending on the final outcome.

Issues

• Whether or not the Letter of Authority validly covered the consideration received under the contract with Vintage Food Service, such that the assessment arising from it is valid.
• Whether or not the contract between De La Salle Lipa and Vintage Food Service is a contract of lease rather than a donation, and whether only one-tenth of the consideration is taxable for the year covered.
• Whether or not De La Salle Lipa, as a non-stock, non-profit educational institution, is exempt from the assessed deficiency income tax, value-added tax, and expanded withholding tax.
• Whether or not De La Salle Lipa is entitled to the ten percent preferential income tax rate or the forty percent standard deduction.

Applicable Provisions

Article 1643 of the Civil Code defines a contract of lease:

Article 1643. In the lease of things, one of the parties binds himself to give to another the enjoyment or use of a thing for a price certain, and for a period which may be definite or indefinite. However, no lease for more than ninety-nine years shall be valid.

This is the provision the Court used to characterize the contract with Vintage Food Service as a lease and not a donation.

Section 4, Article XIV of the Constitution provides:

Section 4. (3) All revenues and assets of non-stock, non-profit educational institutions used actually, directly, and exclusively for educational purposes shall be exempt from taxes and duties. Upon the dissolution or cessation of the corporate existence of such institutions, their assets shall be disposed of in the manner provided by law.

This is the constitutional anchor of the exemption, and it keys the exemption to the use of the revenues.

Section 30 of the National Internal Revenue Code of 1997 provides:

Section 30. Exemptions from Tax on Corporations. — The following organizations shall not be taxed under this Title in respect to income received by them as such: (H) A non-stock and non-profit educational institution; 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.

This is the statutory exemption, which the Court reads as keyed to the source of the income, and which it reconciles with the Constitution in favor of the usage test.

Section 3, Rule 13 of the Revised Rules of the Court of Tax Appeals provides:

Section 3. Findings of independent CPA. – The submission by the independent CPA of pre-marked documentary exhibits shall be subject to verification and comparison with the original documents, the availability of which shall be the primary responsibility of the party possessing such documents and, secondarily, by the independent CPA. The findings and conclusions of the independent CPA may be challenged by the parties and shall not be conclusive upon the Court, which may, in whole or in part, adopt such findings and conclusions subject to verification.

This governs the weight of the independent accountant's findings, which the tax court may adopt or reject.

Ruling

On the first issue, the Court held that the assessment was within the coverage of the Letter of Authority. The contract was executed on November 11, 2004, and although the entire consideration was received in advance, the contract itself allocated the amount as yearly consideration for the ten-year duration. The transaction and its tax liability therefore fell within the period covered by the audit.

On the second issue, the Court agreed that the contract was one of lease. De La Salle Lipa bound itself to grant Vintage Food Service possession and exclusive use of the canteen premises and the exclusive right to sell food, for a period of ten school year terms, in exchange for a sum paid in advance as yearly consideration. These are the elements of a lease under Article 1643. Because the amount was allocated as yearly consideration, only one-tenth was earned or realized in taxable year 2005, and only that portion was properly assessed. The Commissioner's claim that the entire amount should be taxed failed.

On the third issue, the Court held that De La Salle Lipa remained liable. Its exemption is anchored on usage, not source, so it had to prove two things: that it is a non-stock, non-profit educational institution, and that the income sought to be exempted was used actually, directly, and exclusively for educational purposes. The first was undisputed. The second was not proven. Its financial statements mentioned donations and rental income without any breakdown, no reconciliation showed how those amounts were pooled into the so-called General Fund, and its statements showed expenses unrelated to education, such as retirement contribution, entertainment, amusement, and recreation. The findings of the independent accountant were not binding on the tax court, which was bound to make its own independent assessment.

On the fourth issue, the Court held that De La Salle Lipa could not avail of the ten percent preferential rate or the forty percent standard deduction, because those privileges belong to proprietary educational institutions, and it is a non-stock, non-profit institution.

Doctrine

First, the tax exemption of a non-stock, non-profit educational institution under the Constitution is determined by the use of its revenues, not by their source. So long as the revenues are used actually, directly, and exclusively for educational purposes, they are exempt from taxes and duties, regardless of where they came from. Second, the last paragraph of Section 30 of the Tax Code, which taxes income from properties and profit-making activities regardless of disposition, is without force and effect insofar as it would tax revenues so used, because it is contrary to the Constitution. Third, the burden is on the institution to factually prove actual, direct, and exclusive use; a general claim that revenues were commingled in a general fund, without a breakdown or reconciliation, does not discharge that burden. Fourth, the findings of an independent certified public accountant are merely recommendatory and are never conclusive on the Court of Tax Appeals. Fifth, a contract granting another the enjoyment or use of a thing for a price certain and for a given period is a lease under Article 1643, whatever name the parties give it, and where the consideration is allocated as yearly payment, only the portion earned within the taxable period is taxable.

Disposition

The consolidated petitions were denied for lack of merit, and the decision of the Court of Tax Appeals En Banc was affirmed.

Remember This

Memorize this line: for a non-stock, non-profit educational institution, exemption follows the use of the revenue, not its source, but the institution must prove that use with evidence, not with labels. Examiners like to use this case to test the reconciliation of the constitutional usage test with Section 30 of the Tax Code, and to test whether you know that the findings of an independent accountant do not bind the tax court.