Flexible tax treatment
HIDDEN AGENDA - Mary Ann LL. Reyes (The Philippine Star) - October 19, 2019 - 12:00am

As a corporate lawyer specializing in setting up business entities and as a commercial law professor, at least two questions are often asked of me following the recent revision of our Corporation Code.

The Revised Corporation Code of the Philippines, which took effect last February, allowed for the creation of a one-person corporation or OPC. Prior to the revision, a corporation must have at least five but not more than 15 incorporators. Now, a corporation can have at least two incorporators but not more than 15, except for OPCs which can have one and other cases provided for under the Code.

The first question is whether it is better to set up an OPC or a sole proprietorship while the second question deals with the similarities and differences between our OPC and the existing corporate structures available in the United States like the limited liability company and the S corporation.

To answer the first question, allow me to discuss the differences between an OPC and a sole proprietorship. An OPC, just like any corporation, is a juridical entity that has a legal personality that is separate and distinct from its shareholders. An OPC’s assets and liabilities are separate from the assets and liabilities of its single shareholder and incorporator, and is given the limited liability characteristic of a corporation.

A sole proprietorship, on the other hand, is in reality not a juridical entity. Its legal personality is the same as that of the proprietor or owner, which means that the assets and liabilities of the sole proprietorship are also those of the owner and vice versa. The creditor of the sole proprietorship can therefore go after the assets of the owner to satisfy his claim because the owner does not have limited liability. This is not the case for the stockholder in a corporation, or an OPC for that matter, whose liability is limited only to his shareholding in the corporation. A creditor cannot go after the stockholder for the liabilities of the corporation unless it is warranted to pierce the so-called veil of corporate fiction in cases when the corporation is used by the stockholder to perpetuate fraud, defeat public convenience, justify a wrong, or defend a crime. When the corporation’s separate legal entity is set aside, the law will regard the corporation and the persons composing it as one and the same.

How does one create an OPC and a sole proprietorship? Any natural person (except those engaged in the practice of a profession), trust, or estate must file the OPC’s articles of incorporation with the Securities and Exchange Commission and the OPC is created following the issuance by the SEC of a certificate of incorporation. A sole proprietorship in the Philippines, on the other hand, not being a business and legal entity, is not required to be registered to be created. But before the Bureau of Internal Revenue authorizes the printing of official receipts, then the proprietor must register a business name with the Department of Trade and Industry, get a business permit from the local government unit after submission of a copy of the certificate of business name registration, among other requirements,

Assuming that both the OPC and the sole proprietorship commence business operations, then the OPC is required by the SEC to submit periodic reportorial requirements such as the annual financial statements and other reports that the SEC may require. No such reports are required of the sole proprietorship. This makes it easier to maintain a sole proprietorship in the long run.

Then more importantly, an OPC is not subject to what is referred to as pass-through taxation and it is the OPC, not the single shareholder, who is subject to the corporate income tax rate of 30 percent. On the other hand, a sole proprietorship is a pass-through entity, which means that the owner is the one who pays the income tax on the business through his own personal tax return. Under the TRAIN Law, self-employed individuals with annual gross sales or income not exceeding the VAT threshold of P3 million have the option to choose between two tax rates: eight percent of gross sales or receipts and other income, in excess of P250,000; or graduated income tax rates of zero to 35 percent of net taxable income).

This brings us to the matter as to why OPCs have no choice but be subject to the corporate income tax (CIT) rate of 30 percent (or the minimum corporate income tax of two percent on gross income is applicable).

If the purpose of creating OPCs is to encourage the formation of micro, small and medium enterprises (MSMEs), then OPCs should have the benefit of limited liability but should not be treated like corporations for tax purposes, but should instead be subject to a graduated income tax rate based on the amount of taxable income just like the one applied to self-employed individuals or be given the flexibility to choose how they should be treated tax-wise.

Let us take the case of limited liability companies or LLCs.

An LLC is a type of corporate structure in the United States that combines the characteristics of a corporation with those of a sole proprietorship or partnership. In an LLC, the owners have limited liability which means that they are not personally liable for the company’s debts or liabilities which makes an LLC similar to a corporation. But unlike a corporation and like a partnership, pass-through taxation is available to an LLC which means that profits and losses are listed on the personal tax returns of the owners.

An LLC can choose to be taxed like a sole proprietorship, a partnership, a C or regular corporation, or an S or small business corporation if it qualifies as such (only corporations with 100 shareholders or less can be an S corporation but be taxed like a partnership and it must have only one class of stock; S corporation shareholders must be individuals, specific trusts and estates or certain tax-exempt organizations; but both C and S corporations may have only one shareholder).

By default, an LLC with one member is treated as a sole proprietorship and is disregarded as an entity. An LLC with more than one member is treated as a partnership which means that it is the individual partners who pay taxes based on their share of ownership in the partnership.

However, an LLC can elect to be treated as an association taxable as a corporation, whether as a regular one or as an S corporation. Unlike a C corporation, an S corporation is a pass-through entity for tax purposes. But while an S corporation has this pass-through feature just like a sole proprietorship and a partnership thereby avoiding double taxation, the three are not taxed the same way.

But unlike a corporation which may or may not exist in perpetuity or an OPC which has a perpetual existence, an LLC like a partnership may be dissolved upon the death or bankruptcy of a members.

Some of our legislators wanted to allow the formation of LLCs in the Philippines earlier but did not push through with filing a proposed legislation. If our legislators want OPCs to thrive, then they better take a look at how other countries give LLCs the flexibility to choose how they want to be treated for tax purposes.

For comments, e-mail at mareyes@philstarmedia.com

REVISED CORPORATION CODE OF THE PHILIPPINES
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