RMC No. 89-2024: Clarifying the taxability of income derived by Local Government Units engaged in proprietary functions

Key points

1. What is proprietary. Only income from proprietary functions is taxed like that of corporations in similar business. An act is proprietary only if the LGU is not performing an essential governmental function and is engaged in a business, industry or activity like that of ordinary taxable corporations. PD No. 1931 (1984) and EO No. 93 (1987) withdrew tax exemptions of government units.
2. Income tax and withholding. Section 27(C) subjects proprietary income to Income Tax, including passive income under Section 27(D) such as royalties, interests, dividends, sale of shares and capital gains on land or buildings not used in government functions. Section 2.57.5(A) of RR No. 2-98 exempts from creditable withholding only payments received for government functions, so payments for proprietary functions are subject to withholding.
3. VAT, percentage tax, DST and invoices. Proprietary activity is liable to 12% VAT on total gross sales, or Percentage Tax under Title V, and to Documentary Stamp Tax on private contracts. LGUs issue invoices complying with Section 237 as amended by RA No. 11976 and RR No. 7-2024, and apply for an Authority to Print.
4. Property sales and exchanges. Sale of capital asset land or buildings carries 6% capital gains tax under Section 27(D)(5), on gross selling price or fair market value, whichever is higher. An exchange of properties in a voluntary commercial arrangement is subject to CGT and DST on fair market value. An individual dealing with the LGU may report under Section 24(D)(1) at 6% CGT, or under Section 24(A)(1) with DST under Section 196.
5. Leases, deposits and investments. Leasing property to a private party to build and run a commercial activity is proprietary. Keeping depository accounts and investments is also proprietary. Interest from deposits and yields from government securities, commercial papers and similar arrangements bear a 20% final tax under Section 27(D)(1).
6. Forfeited and auctioned property. For property forfeited or bought by the LGU at auction for real property tax delinquency, CGT is based on the bid price or zonal value, whichever is higher, and the Declaration of Forfeiture is subject to DST under Section 196. The CGT is paid upon consolidation of title after the one (1)-year redemption period, and if the property is redeemed there is no CGT.

Who is affected

• Local Government Units engaged in proprietary functions
• Persons dealing with LGUs in property exchanges

Deadlines and effectivity

• Redemption period of one (1) year before consolidation of title