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RATIONALE OF TAX EXEMPTION OF NON-PROFIT ORGANIZATION

A Synthesis

Presented To the Faculty of

Department of Accountancy

School of Accountancy, Management, Computing and Information Studies

In Partial Fulfillment

Of The Requirement of the Course

Accounting 505 (Synthesis)

Submitted by

Hazel Joy E. Benigno

May 2019
INTRODUCTION

Taxation is the exercise of the State’s inherent power to impose a charge or burden
upon persons, properties, rights, privileges, income and receipts from employment or business
transactions within its jurisdiction for the purpose of raising revenue to defray the legitimate
expenses of the government (Untian, 2002). The primary purpose of taxation on the part of the
government is to accumulate funds in order to provide infrastructures that will promote the
general welfare and the protection of its citizens and to enable it to finance its activities.
Taxation is said to be the lifeblood of the government, without taxation the government would be
paralyzed and may not be able to give the citizen a civilized society, hence, tax payment is
necessary in order to maintain the sovereignty of the State (Pagaspas, 2016). Taxation is based
on the principle that the citizen supports the State by making portion from his property that is
demanded by the State in order that he may enjoy the benefit of an organized society.

Tax is imposed upon all persons, properties, or the exercise of a right or privilege by the
State with the exception that Government Entities and International Comity are exempted from
paying tax (Banggawan, 2017). The reason for exempting Government entities is that it will only
cause additional cost for the government and that immunity is necessary in order that
governmental functions will not be interfered. On the other hand, International Comity is
exempted from paying tax mainly because it is out of friendly agreement between nations.
Taxation is imposed by the State which has jurisdiction over the subject or object of taxation,
therefore tax cannot operate beyond a state’s territorial limit because such territories do not
receive any benefit from the State.

Taxation is labeled as a burden on the part of the taxpayers. These burdens may be
avoided or minimized by means of shifting, capitalization, tax evasion, transformation, tax
avoidance, and tax exemption (Banggawan, 2017). Shifting is done by transferring the burden of
tax by original payer to another payer. Capitalization refers to how asset value is changed when
the cash flow is changed by an increase or decrease in the tax liability for that asset. Tax
evasion is the use by the taxpayer of illegal or fraudulent means to defeat or lessen the payment
of a tax. It is also known as “tax dodging.” It is punishable by law. Tax transformation may be
defined as the effective application of organizational design, process improvement, and
enabling technology to improve data integrity, tax function efficiency, and performance. Tax
avoidance is the exploitation by the taxpayer of legally permissible alternative tax rates or
methods of assessing taxable property or income in order to avoid or reduce tax liability. It is
politely called “tax minimization” and is not punishable by law. Tax exemption it is the grant of
immunity to particular persons or corporations or to persons or corporations of a particular class
from a tax which persons and corporations generally within the same state or taxing district are
obliged to pay.

Some entities which are exempted from paying tax include but not limited to non-stock or
non-profit organization which is formed for religious, charitable, scientific, athletic, cultural, or
social welfare. Tax exemptions are also applicable to non-government organizations that are
formed for the aforementioned purposes. Also, entities that are exempt under special laws in
which Philippines are a signatory are also exempted and enjoying the relief from such tax
burdens. These entities are enjoying exemptions from any tax burden provided that they comply
with the rules and regulations of the authority for such grant of benefit.

Non-profit organization is an entity that enjoys the freedom from taxation. Non-profit
organization, by definition, is an organization that is formed for the purpose of serving the public
by providing the needs of the community. Non-profit organization is, in essence, charitable in
nature. They raise money but they spend it to further their mission and not to benefit the donors,
founders, member, or directors. Non-profit organizations allow people to come together and join
resources in order to achieve goals that benefit the purpose for that organization’s being
(Machuca, July 2017). The main function of a non-profit organization is to raise revenue for the
furtherance of its purpose which is the main reason of its formation. The purposes may be for
charity or social welfare, it could be religious in function, it could be for trade research and
education, and it could also be for scientific, athletic or cultural in function. All these functions
must be achieved in order for an organization to be called a non-profit. The activities of a non-
profit organization must be conducted for the benefit of the organization and not the owners. In
order to qualify for tax exempt status, the organization must benefit the public.
BODY

Non-profit organization is a type of business that is prohibited from distributing its profit
to its members or directors, who in nature exercise control over the organization. In simple
words, such earnings of a non-profit organization must be plowed back into financing the goods
or services of which the organization was formed to provide. Not all non-profit organizations are
exempt from income taxation. Rather, only non-profit organizations that are solely dedicated to
particular purpose are exempt. The purposes that qualify a non-profit organization from tax
exemption include; religious, charitable, scientific, athletic, cultural or social welfare. Any non-
profit organizations which are not formed for the aforementioned purposes shall be subject to
income taxation. Non-profit organizations are exempt from federal income tax, state and local
property taxes and sales taxes. But they are not exempt from withholding payroll taxes from
their employees. They are also taxable to income they earned which would not be used for the
furtherance of their mission. But what merely are the reasons for such exemption?

Non-profit organization relieve the burden of the government, hence, they are exempt
from income taxation. Non-profit organization reduces the financial burden of the government in
providing infrastructures projects such as toll roads, water and sewer systems, housing and
community development, construction of buildings, university and hospital systems, air ports
and sea ports and so on for the community (Bryce, 2017). The motive of non-profit
organizations is to lessen the burden of the government to finance, construct and deliver
specific product or service to the public to satisfy a recognizable public need of substantial
scale, and, thus reduce the impact of that function on government fiscally or operationally. Non-
profit organizations are directly entering into a contract to other entities in financing a project
therefore they also are directly incurring debts or liabilities which the government would
otherwise have had to incur if they enter a contract for themselves. The non-profit organization
takes out the debt, assumes all risks and liabilities thereby fully relieving the government of that
debt and expenses. By way of illustration, Consuelo Chito Madrigal Foundation or CCMF is a
non-profit organization that provides assistance to economically depressed community by
creating opportunities for advancement and productivity. CCMF recently engaged in housing
program to provide families a shelter and a home. The expenses incurred by CCMF are stated
directly in its financial statement and not on the government’s financial statement therefore
relieving the government of the expenses that CCMF incurs for the community.

Non-profit organizations benefit the society; consequently they are exempt from income
taxation. Non-profit organizations play a vital role in the social and economic wellbeing of the
nation. They provide goods and services to meet the needs of the community (Jonesboro,
January 2017). They provide a mechanism for promoting individual initiatives for the public
good. These organizations provide relief for people when it’s hard to find it elsewhere. Whether
it’s for health, education, or simple arts and humanities, they are by the people for the people
(Manifezt, 2018). They are formed to help the community overpass social issues such us
poverty, unemployment, health related issues and lack of education. These promote awareness
for specific issues and give incentive for change. For example, ERDA foundation is a non-profit
organization that helps socially and economically disadvantage children access to education.
ERDA foundation conducts educational programs that promote the benefit and importance of
education. Another example is the program that empowers youth and adults with factual
information about drugs so they can make informed decisions and live drug-free which Drug-
Free World conducts to certain communities.

Exemption for religious non-profit organizations preserves separation of church and

state. Keeping the churches tax exempt removes the temptation from the government to
interfere with the free exercise of religion. If the government would impose tax to religious non-
profit organization then they could not afford to stay open for the community, they are incapable
to provide influence on the society that helps reduce crimes and encourage good citizenship.
Losing tax exempt status for religious organization would spell the end for many churches
especially those small churches that finance their activities from donations. Therefore, tax
exempt status for churches and religious organizations serves as a continuing social benefit to
the society, and is consistent with the country’s commitment to keep the government from
unnecessary entanglement with religion.
 Taxing non-profit organization would cost more to the community rather than the taxes it
would generate. The purpose of a non-profit organization is to serve the public need without
turning a profit. It provides local economies with public goods that generate positive externalities
for the local community; a housing assistance program helps families in transition find affordable
housing, a conservation society provides open green space in the form of a downtown park, and
a non-profit hospital can provide emergency care to those without health insurance (Sobolewski,
2010). Tax is a financial burden imposed to the people or property benefiting from the state.
Taxing non-profit organization would result to an increase to its expenditure and would result to
a negative effect on the goods or services they would provide to the community. Meaning, if the
government imposes tax to non-profit organization, they would be forced to cut a portion of their
projects for the community, leaving the community purchasing their needs to a for-profit
organization. Thus, they are exempt from taxation.

Organizations, other than non-profit organizations, are taxed based on their taxable
income. Non-profit organizations do not have taxable income since all their funding came from
donations by their members, directors and other individuals other than those who control the
organization. They also get the funding from the government, general public and other private
foundations. It would be difficult to qualify a non-profit organization as taxable because their
income or profit is plowed back to their mission that is to serve the community by providing
goods or services to them unless some of its income or profit are being used to some purposes
other than those with which the organization is formed.

CONCLUSION

Non-profit organizations are organizations which are formed primarily to provide the
needs of the community. They are organizations which are charitable, religious, scientific,
athletic, cultural, or for social welfare in purpose. The government specifically granted the non-
profit organization immunity from paying tax provided that the income generated by the non-
profit organization must be used for the furtherance of its purpose or mission.

Non-profit organizations are exempt from income tax for several reasons. First, they are exempt
because they relieve the burden of the government by providing goods and services to the
community directly. They provide shelters, roads and other infrastructures to the community
who are in need. The government are relieve from the burden of providing these infrastructure
since the non-profit organizations had already done it, therefore it will yield additional savings for
the government. Second, non-profit organizations benefit the society. They provide the needs of
a community and help the community to overcome social issues namely drug addiction, lack of
education, housing issues and many more. The income that a non-profit organization generated
is being used to help the economically depressed community by providing them shelter, roads,
and other infrastructures. Therefore the government grants them the immunity in paying tax.
Third, the exempt status of churches and other religious organizations preserves the separation
of the state and the church. The reason for this is that to keep the state from interfering the state
and to keep the state from interfering the activities of the government. Fourth, taxing the non-
profit organization would impose additional cost to the organization. Tax is, in nature, a financial
burden. If the government would impose tax to a non-profit organization it would only increase
the non-profit organization’s expenses and would have a negative effect on the part of the
community. Lastly, income taxation is based on taxable income of business organizations. Non-
profit organizations do not have a taxable income therefore they are non taxable. They do not
have taxable income because the funds they are using to finance their projects are coming from
donations by its members or directors. Government and the general public also fund the
projects of the non-profit organizations.

Taxation is established for the betterment of both the government and the whole society.
The government uses tax to provide the people a sovereign society. The exemption of non-
profit organization is similarly for the benefit of the community. The non-profit organizations
must be retained at same exempt status because they help the economically depressed
community to grow and have a chance to rise up once more.
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