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February 12, 2001

REVENUE REGULATIONS NO. 02-01

SUBJECT : Implementing the Provision on Improperly Accumulated

Earnings Tax Under Section 29 of the Tax Code of 1997

TO : All Internal Revenue Officers and Others Concerned

SECTION 1. Scope. — Pursuant to Section 244 of the Tax Code

of 1997, in relation to Section 99 of the same Code, these Regulations are
being issued to prescribe the rules governing the imposition of Improperly
Accumulated Earnings Tax.

SECTION 2. Concept of Improperly Accumulated Earnings Tax

(IAET). — Pursuant to Section 29 of the Code, there is imposed for each taxable
year, in addition to other taxes imposed under Title II of the Tax Code of 1997, a
tax equal to 10% of the improperly accumulated taxable income of corporations
formed or availed of for the purpose of avoiding the income tax with respect to its
shareholders or the shareholders of any other corporation, by permitting the
earnings and profits of the corporation to accumulate instead of dividing them
among or distributing them to the shareholders. The rationale is that if the earnings
and profits were distributed, the shareholders would then be liable to income tax
thereon, whereas if the distribution were not made to them, they would incur no
tax in respect to the undistributed earnings and profits of the corporation. Thus, a
tax is being imposed in the nature of a penalty to the corporation for the improper
accumulation of its earnings, and as a form of deterrent to the avoidance of tax
upon shareholders who are supposed to pay dividends tax on the earnings
distributed to them by the corporation.

The touchstone of the liability is the purpose behind the accumulation of the
income and not the consequences of the accumulation. Thus, if the failure to pay
dividends is due to some other causes, such as the use of undistributed earnings
and profits for the reasonable needs of the business, such purpose would not
generally make the accumulated or undistributed earnings subject to the tax.
However, if there is a determination that a corporation has accumulated income
beyond the reasonable needs of the business, the 10% improperly accumulated
earnings tax shall be imposed.
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 SECTION 3. Determination of Reasonable Needs of the Business. —
An accumulation of earnings or profits (including undistributed earnings or profits
of prior years) is unreasonable if it is not necessary for the purpose of the business,
considering all the circumstances of the case. To determine the "reasonable needs"
of the business in order to justify an accumulation of earnings, these Regulations
hereby adhere to the so-called "Immediacy Test" under American jurisprudence as
adopted in this jurisdiction. Accordingly, the term "reasonable needs of the
business" are hereby construed to mean the immediate needs of the business,
including reasonably anticipated needs. In either case, the corporation should be
able to prove an immediate need for the accumulation of the earnings and profits,
or the direct correlation of anticipated needs to such accumulation of profits.
Otherwise, such accumulation would be deemed to be not for the reasonable needs
of the business, and the penalty tax would apply.

For purposes of these Regulations, the following constitute accumulation of

earnings for the reasonable needs of the business:

a) Allowance for the increase in the accumulation of earnings up

to 100% of the paid-up capital of the corporation as of Balance
Sheet date, inclusive of accumulations taken from other years;

b) Earnings reserved for definite corporate expansion projects or

programs requiring considerable capital expenditure as
approved by the Board of Directors or equivalent body;

c) Earnings reserved for building, plants or equipment acquisition

as approved by the Board of Directors or equivalent body;

d) Earnings reserved for compliance with any loan covenant or

pre-existing obligation established under a legitimate business
agreement;

e) Earnings required by law or applicable regulations to be

retained by the corporation or in respect of which there is legal
prohibition against its distribution;

f) In the case of subsidiaries of foreign corporations in the

Philippines, all undistributed earnings intended or reserved for
investments within the Philippines as can be proven by
corporate records and/or relevant documentary evidence.

SECTION 4. Coverage. — The 10% Improperly Accumulated

Earnings Tax (IAET) is imposed on improperly accumulated taxable income
earned starting January 1, 1998 by domestic corporations as defined under the Tax
Code and which are classified as closely-held corporations. Provided, however,
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 that Improperly Accumulated Earnings Tax shall not apply to the following
corporations:

a) Banks and other non-bank financial intermediaries;

b) Insurance companies;

c) Publicly-held corporations;

d) Taxable partnerships;

e) General professional partnerships;

f) Non- taxable joint ventures; and

g) Enterprises duly registered with the Philippine Economic Zone

Authority (PEZA) under R.A. 7916 , and enterprises
registered pursuant to the Bases Conversion and Development
Act of 1992 under R.A. 7227 , as well as other enterprises
duly registered under special economic zones declared by law
which enjoy payment of special tax rate on their registered
operations or activities in lieu of other taxes, national or local.
AScHCD

For purposes of these Regulations, closely-held corporations are those

corporations at least fifty percent (50%) in value of the outstanding capital stock or
at least fifty percent (50%) of the total combined voting power of all classes of
stock entitled to vote is owned directly or indirectly by or for not more than twenty
(20) individuals. Domestic corporations not falling under the aforesaid definition
are, therefore, publicly-held corporations.

For purposes of determining whether the corporation is closely held

corporation, insofar as such determination is based on stock ownership, the
following rules shall be applied:

(1) Stock Not Owned by Individuals. — Stock owned directly or

indirectly by or for a corporation, partnership, estate or trust
shall be considered as being owned proportionately by its
shareholders, partners or beneficiaries.

(2) Family and Partnership Ownership. — An individual shall be

considered as owning the stock owned, directly or indirectly, by
or for his family, or by for his partner. For purposes of this
paragraph, the family of an individual includes his brothers or
sisters (whether by whole or half-blood), spouse, ancestors and

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 lineal descendants.

(3) Option to Acquire Stocks. — If any person has an option to

acquire stock, such stock shall be considered as owned by such
person. For purposes of this paragraph, an option to acquire
such an option and each one of a series of option shall be
considered as an option to acquire such stock.

(4) Constructive Ownership as Actual Ownership. — Stock

constructively owned by reason of the application of paragraph
(1) or (3) hereof shall, for purposes of applying paragraph (1) or
(2), be treated as actually owned by such person; but stock
constructively owned by the individual by reason of the
application of paragraph (2) hereof shall not be treated as
owned by him for purposes of again applying such paragraph in
order to make another the constructive owner of such stock.

Provided, however, that a branch of a foreign corporation is not covered by

these Regulations, the same being a resident foreign corporation.

SECTION 5. Tax Base of Improperly Accumulated Earnings Tax. —

For corporations found subject to the tax, the "Improperly Accumulated Taxable
Income" for a particular year is first determined by adding to that year's taxable
income the following:

(a) income exempt from tax;

(b) income excluded from gross income;

(c) income subject to final tax; and

(d) the amount of net operating loss carry-over (NOLCO)

deducted.

The taxable income as thus determined shall be reduced by the sum of:

(a) income tax paid/payable for the taxable year;

(b) dividends actually or constructively paid/issued from the

applicable year's taxable income;

(c) amount reserved for the reasonable needs of the business as

defined in these Regulations emanating from the covered year's
taxable income.

The resulting "Improperly Accumulated Taxable Income" is thereby

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 multiplied by 10% to get the Improperly Accumulated Earnings Tax (IAET).

Once the profit has been subjected to IAET, the same shall no longer be
subjected to IAET in later years even if not declared as dividend. Notwithstanding
the imposition of the IAET, profits which have been subjected to IAET, when
finally declared as dividends, shall nevertheless be subject to tax on dividends
imposed under the Tax Code of 1997 except in those instances where the recipient
is not subject thereto.

For purposes of determining the source of earnings or profits declared or

distributed from accumulated income for each taxable year, the dividends shall be
deemed to have been paid out of the most recently accumulated profits or surplus
and shall constitute a part of the annual income of the distributee for the year in
which received pursuant to Section 73(C) of the Code. Provided, however,
that where the dividends or portion of the said dividends declared forms part of the
accumulated earnings as of December 31, 1997, or emanates from the accumulated
income of a particular year and, therefore, is an exception to the proceeding
statement, such fact must be supported by a duly executed Board Resolution to
that effect.

SECTION 6. Period for Payment of Dividend/Payment of IAET. —

The dividends must be declared and paid or issued not later than one year
following the close of the taxable year, otherwise, the IAET, if any, should be paid
within fifteen (15) days thereafter.

SECTION 7. Determination of Purpose to Avoid Income Tax. — The

fact that a corporation is a mere holding company or investment company shall be
prima facie evidence of a purpose to avoid the tax upon its shareholders or
members. Likewise, the fact that the earnings or profits of a corporation are
permitted to accumulate beyond the reasonable needs of the business shall be
determinative of the purpose to avoid the tax upon its shareholders or members. In
both instances, the corporation may, by clear preponderance of evidence in its
favor, prove the contrary.

For purposes of these Regulations, the term "holding or investment

company" shall refer to a corporation having practically no activities except
holding property, and collecting the income therefrom or investing the same.

The following are prima facie instances of accumulation of profits beyond

the reasonable needs of a business and indicative of purpose to avoid income tax
upon shareholders:

(a) Investment of substantial earnings and profits of the corporation

in unrelated business or in stock or securities of unrelated

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 business;

(b) Investment in bonds and other long-term securities;

(c) Accumulation of earnings in excess of 100% of paid-up capital,

not otherwise intended for the reasonable needs of the business
as defined in these Regulations.

In order to determine whether profits are accumulated for the reasonable

needs of the business as to avoid the imposition of the improperly accumulated
earnings tax, the controlling intention of the taxpayer is that which is manifested at
the time of accumulation, not subsequently declared intentions which are merely
the product of afterthought. A speculative and indefinite purpose will not suffice.
The mere recognition of a future problem or the discussion of possible and
alternative solutions is not sufficient. Definiteness of plan/s coupled with action/s
taken towards its consummation are essential.

SECTION 8. Transitory Provision. — The IAET shall not apply on

improperly accumulated income as of December 31, 1997 in the case of
corporations using the calendar year basis. In the case of corporations adopting the
fiscal year accounting period, the IAET shall not apply on improperly accumulated
taxable income as of the end of the month comprising the twelve-month period of
fiscal year 1997-1998.

Taxable income improperly accumulated, as heretofore discussed, prior to

the effectivity of these regulations if declared as dividend and paid/issued within
one month from the effectivity hereof will not be subjected to the 10% Improperly
Accumulated Earnings Tax.

SECTION 9. Effectivity. — These Regulations shall take effect fifteen

(15) days after publication in any newspaper of general circulation and shall cover
Improperly Accumulated Taxable Income earned starting January 1, 1998.

(SGD.) ALBERTO G. ROMULO

Secretary
Department of Finance
Recommending Approval:

(SGD.) RENE G. BAÑEZ

Commissioner
Bureau of Internal Revenue

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Copyright 2018 CD Technologies Asia, Inc. and Accesslaw, Inc. Philippine Taxation Encyclopedia Third Release 2018 7
 Endnotes

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RA 8424

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