Taxability of Partnerships

A partnership is an agreement between two or more persons who bind themselves to contribute money, property or
industry to a common fund with the intention of dividing the profits for themselves.

General commercial partnerships are taxable the same manner as regular corporation.
Section 2. Corporation defined. – A corporation is an artificial being created by operation of law, having
the rights of succession and the powers, attributes and properties expressly authorized by law or incident to
its existence. (Corporation Code of the Philippines)

The tax implication of this is that the partnership may avail of all the allowable corporate deductions under Section
34 of the Tax Code; it shall also be subject to the rule on Minimum Corporate Income Tax and Improperly
Accumulated Earnings Tax.

Tax Rate Tax Base

Normal Corporate Income Tax
(In General)
Minimum Corporate Income Tax
Improperly Accumulated Earnings
30% (paid when NCIT is higher than Taxable income from all sources
the MCIT)
2% (paid when the NCIT is lower Gross Income
than the MCIT) (Gross Income basis-RR12-2007:
include all income earned including
those derived outside of the main
activities of the taxpayer.)
10% Improperly accumulated earnings

The term “Corporation” in taxation (NIRC) includes joint stock companies, joint accounts, associations, insurance
companies or partnerships no matter how created or organized. Nationality of the incorporators has no bearing in
ascertaining the tax status of the corporation.

It excludes:
1. general professional partnership;
2. unincorporated joint venture or consortium engaged in construction, or petroleum operations under
contract with the government
3. joint consortium for the purpose of engaging in petroleum, geothermal and other energy operations
pursuant to a consortium agreement with the government

General Professional Partnerships

A general professional partnership is a partnership formed by persons for the SOLE purpose of exercising their
COMMON profession, no part of the income of which is derived from engaging any trade or business.

Joint venture

To be a joint venture:
1. Each party contributes money, property, service etc.
2. profits are shared among the parties
3. there is joint proprietary interest and mutual control
4. for a single business transaction

A joint venture is not taxable as a corporation if:

1. it is an UNICORPORATED entity
2. for the purpose of undertaking construction projects, or engaging in petroleum with an operating contract
with the government

An exempt joint venture may become a taxable partnership if AFTER the construction period, the joint venture
partners engage in the business of leasing the units of the building.
Co-ownership
 There is a co-ownership whenever the ownership of an undivided thing or right belongs to different
persons.
 Generally, a co-ownership is not considered as a separate taxable entity.
 It may be converted into a taxable partnership if after the partition of the properties, the common properties
are invested and used as a common fund with intent to produce profits.
 There must be clear intent to form a partnership. An isolated transaction cannot be interpreted as a
partnership, because the mere sharing of gross returns does not by itself establish the existence of a
partnership.

CASES

LORENZO T. ONA et.al

VS.

COMMISSIONER OF INTERNAL REVENUE

G.R. NO. L-19342 MAY 25, 1972

FACTS:
Julia Buñales died on March 23, 1944, leaving as heirs her surviving spouse, Lorenzo T.
Oña and her five children. In a Civil Case for settlement of her estate Lorenzo T. Oña the
surviving spouse was appointed administrator of the estate of said deceased. The administrator
submitted the project of partition, which was approved by the Court. Because three of the heirs,
namely Luz, Virginia and Lorenzo, Jr., all surnamed Oña, were still minors when the project of
partition was approved, Lorenzo T. Oña, their father and administrator of the estate, filed a
petition for appointment as guardian of said minors. the Court appointed him guardian of the
persons and property of the aforenamed minors

The project partition shows that the heirs have undivided ½ interest in 10 parcels of land,
6 houses and money from the War Damage Commission.

Although the project of partition was approved by the Court, no attempt was made to
divide the properties and they remained under the management of Oña who used said properties
in business by leasing or selling them and investing the income derived therefrom and the
proceeds from the sales thereof in real properties and securities. As a result, petitioners’
properties and investments gradually increased. Petitioners returned for income tax purposes
their shares in the net income but they did not actually receive their shares because this left with
Oña who invested them.
 Based on these facts, CIR decided that petitioners formed an unregistered partnership and
therefore, subject to the corporate income tax, particularly for years 1955 and 1956. Petitioners
asked for reconsideration, which was denied hence this petition for review from CTA’s decision.

ISSUE:
Does the property constitutes unregistered partnership subject to corporate income tax?
RULING:
Yes. For tax purposes, the co-ownership of inherited properties is automatically
converted into an unregistered partnership the moment the said common properties and/or the
incomes derived therefrom are used as a common fund with intent to produce profits for the heirs
in proportion to their respective shares in the inheritance as determined in a project partition
either duly executed in an extrajudicial settlement or approved by the court in the corresponding
testate or intestate proceeding. The reason is simple. From the moment of such partition, the
heirs are entitled already to their respective definite shares of the estate and the incomes thereof,
for each of them to manage and dispose of as exclusively his own without the intervention of the
other heirs, and, accordingly, he becomes liable individually for all taxes in connection
therewith. If after such partition, he allows his share to be held in common with his co-heirs
under a single management to be used with the intent of making profit thereby in proportion to
his share, there can be no doubt that, even if no document or instrument were executed, for the
purpose, for tax purposes, at least, an unregistered partnership is formed.

It is but logical that in cases of inheritance, there should be a period when the heirs can be
considered as co-owners rather than unregistered co-partners within the contemplation of our
corporate tax laws aforementioned. Before the partition and distribution of the estate of the
deceased, all the income thereof does belong commonly to all the heirs, obviously, without them
becoming thereby unregistered co-partners, but it does not necessarily follow that such status as
co-owners continues until the inheritance is actually and physically distributed among the heirs,
for it is easily conceivable that after knowing their respective shares in the partition, they might
decide to continue holding said shares under the common management of the administrator or
executor or of anyone chosen by them and engage in business on that basis. Withal, if this were
to be allowed, it would be the easiest thing for heirs in any inheritance to circumvent and render
meaningless Sections 24 and 84(b) of the National Internal Revenue Code.

It is true that in Evangelista vs. Collector, 102 Phil. 140, it was stated, among the reasons
for holding the appellants therein to be unregistered co-partners for tax purposes, that their
common fund "was not something they found already in existence" and that "it was not a
property inherited by them pro indiviso," but it is certainly far fetched to argue therefrom, as
petitioners are doing here, that ergo, in all instances where an inheritance is not actually divided,
there can be no unregistered co-partnership. As already indicated, for tax purposes, the co-
ownership of inherited properties is automatically converted into an unregistered partnership the
moment the said common properties and/or the incomes derived therefrom are used as a common
fund with intent to produce profits for the heirs in proportion to their respective shares in the
inheritance as determined in a project partition either duly executed in an extrajudicial settlement
or approved by the court in the corresponding testate or intestate proceeding. The reason for this
is simple. From the moment of such partition, the heirs are entitled already to their respective
definite shares of the estate and the incomes thereof, for each of them to manage and dispose of
as exclusively his own without the intervention of the other heirs, and, accordingly he becomes
liable individually for all taxes in connection therewith. If after such partition, he allows his
share to be held in common with his co-heirs under a single management to be used with the
intent of making profit thereby in proportion to his share, there can be no doubt that, even if no
document or instrument were executed for the purpose, for tax purposes, at least, an unregistered
partnership is formed. This is exactly what happened to petitioners in this case.

G.R. No. 78133 October 18, 1988

MARIANO P. PASCUAL and RENATO P. DRAGON, petitioners, 

vs.
THE COMMISSIONER OF INTERNAL REVENUE and COURT OF TAX
APPEALS, respondents.
GANCAYCO, J.:

The distinction between co-ownership and an unregistered partnership or joint venture for
income tax purposes is the issue in this petition.

FACTS

On June 22, 1965, petitioners (Pascual and Dragon) bought 2 parcels of land from Santiago
Bernardino, et al. and on May 28, 1966, they bought another 3 parcels of land from Juan Roque.
The first two parcels of land were sold by petitioners in 1968 to Marenir Development
Corporation, while the three parcels of land were sold by petitioners to Erlinda Reyes and
Maria Samson on March 19,1970. Petitioners realized a net profit in the sale made in 1968 in
the amount of P165,224.70, while they realized a net profit of P60,000.00 in the sale made in
1970. The corresponding capital gains taxes were paid by petitioners in 1973 and 1974 by
availing of the tax amnesties granted in the said years.

However, then Acting BIR Commissioner Efren I. Plana, assessed and required petitioners to pay
a total amount of P107,101.70 as alleged deficiency corporate income taxes for the years 1968
and 1970.Petitioners protested the said assessment asserting that they had availed of tax
amnesties way back in 1974.

Respondent Commissioner informed petitioners that in the years 1968 and 1970, petitioners as
co-owners in the real estate transactions formed an unregistered partnership or joint venture
taxable as a corporation under Section 20(b) and its income was subject to the taxes prescribed
under Section 24, both of the NIRC that the unregistered partnership was subject to corporate
income tax as distinguished from profits derived from the partnership by them which is subject
to individual income tax; and that the availment of tax amnesty under P.D. No. 23, as amended,
by petitioners relieved petitioners of their individual income tax liabilities but did not relieve
them from the tax liability of the unregistered partnership. Hence, the petitioners were required
to pay the deficiency income tax assessed.

The CTA affirmed the decision and action taken by respondent commissioner with costs against
petitioners.

ISSUE

Should Pascual and Dragon be taxed as a corporation? (NO. There is co-ownership but there is
no evidence to show that they intended to enter into Partnership. There is no unregistered
partnership formed which can be taxed as a corporation.)
RULING

The issue in this case is whether petitioners are subject to the tax on corporations provided for in
section 24 of the NIRC, as well as to the residence tax for corporations and the real estate
dealers' fixed tax.

Sec. 24. Rate of the tax on corporations.—There shall be levied, assessed, collected, and
paid annually upon the total net income received in the preceding taxable year from all
sources by every corporation organized in, or existing under the laws of the Philippines, no
matter how created or organized but not including duly registered general co-partnerships
(companies collectives), a tax upon such income equal to the sum of the following: ...

Sec. 84(b). The term "corporation" includes partnerships, no matter how created or
organized, joint-stock companies, joint accounts (cuentas en participation), associations or
insurance companies, but does not include duly registered general co-partnerships (companies
colectivas).

Article 1767 of the Civil Code of the Philippines provides:

By the contract of partnership two or more persons bind themselves to contribute money,
property, or industry to a common fund, with the intention of dividing the profits among
themselves.

Pursuant to this article, the essential elements of a partnership are two, namely:

a. an agreement to contribute money, property or industry to a common fund; and

b. intent to divide the profits among the contracting parties.

The first element is undoubtedly present in the case at bar, for, admittedly, petitioners have
agreed to, and did, contribute money and property to a common fund.

However, there is no evidence that petitioners entered into an agreement to contribute money,
property or industry to a common fund, and that they intended to divide the profits among
themselves.

In Evangelists, there was a series of transactions where petitioners purchased twenty-four (24)

lots showing that the purpose was not limited to the conservation or preservation of the common
fund or even the properties acquired by them. The character of habituality peculiar to business
transactions engaged in for the purpose of gain was present. In the instant case, petitioners
bought 2 parcels of land in 1965. They did not sell the same nor make any improvements
thereon. In 1966, they bought another 3 parcels of land from one seller. It was only 1968 when
they sold the 2 parcels of land after which they did not make any additional or new purchase.
The remaining 3 parcels were sold by them in 1970. The transactions were isolated. The
character of habituality peculiar to business transactions for the purpose of gain was not present.

 Co-ownership or co-possession does not itself establish a partnership, whether such co-
owners or co-possessors do or do not share any profits made by the use of the property;

 The sharing of gross returns does not of itself establish a partnership, whether or not the
persons sharing them have a joint or common right or interest in any property from which
the returns are derived;

This only means that, aside from the circumstance of profit, the presence of other elements
constituting partnership is necessary, such as the clear intent to form a partnership, the
existence of a juridical personality different from that of the individual partners, and the
freedom to transfer or assign any interest in the property by one with the consent of the
others (Padilla, Civil Code of the Philippines Annotated, Vol. I, 1953 ed., pp. 635-636)

The common ownership of property does not itself create a partnership between the owners,
though they may use it for the purpose of making gains; and they may, without becoming
partners, agree among themselves as to the management, and use of such property and the
application of the proceeds therefrom. (Spurlock vs. Wilson, 142 S.W. 363,160 No. App. 14.) 

The sharing of returns does not in itself establish a partnership whether or not the persons sharing
therein have a joint or common right or interest in the property. There must be a clear intent to
form a partnership, the existence of a juridical personality different from the individual partners,
and the freedom of each party to transfer or assign the whole property.

In the present case, there is clear evidence of co-ownership between the petitioners. There is no
adequate basis to support the proposition that they thereby formed an unregistered partnership.
The two isolated transactions whereby they purchased properties and sold the same a few years
thereafter did not thereby make them partners. They shared in the gross profits as co- owners and
paid their capital gains taxes on their net profits and availed of the tax amnesty thereby. Under
the circumstances, they cannot be considered to have formed an unregistered partnership which
is thereby liable for corporate income tax, as the respondent commissioner proposes.

And even assuming for the sake of argument that such unregistered partnership appears to have
been formed, since there is no such existing unregistered partnership with a distinct personality
nor with assets that can be held liable for said deficiency corporate income tax, then petitioners
can be held individually liable as partners for this unpaid obligation of the partnership.
However, as petitioners have availed of the benefits of tax amnesty as individual taxpayers in
these transactions, they are thereby relieved of any further tax liability arising therefrom.

SO ORDERED.

Problem
In 2010, Mang Joe Liby, after thirty (30) years experience as a mechanic for Mercedes Benz, decided to
establish his own auto repair shop with two of his former supervisors as his partners. For the year 2012, the
auto repair shop incurred the following:
a. Advertising expenses;
b. Donations to the Samahang Rizalista, a non-profit, non-stock religious corporation which
venerates as its God, the hero Jose Rizal;
c. Taxes paid on the importation of auto repair equipment;
d. Losses when the auto repair shop was burned;
e. Insurance premiums on the life of Mang Joe Liby payable to the partnership;
f. Salaries of mechanics.

Mang Joe and his partners now ask you how their partnership income shall be taxed in the light of the
provisions of the NIRC of 1997. What advise shall you give?

SUGGESTED ANSWER:
Mang Joe and his partners shall be taxed like a corporation. As defined under Sec. 22 (B), of the NIRC of
1997, a corporation includes partnerships no matter how created or organized, but does not include general
professional partnership. Since what was formed by Mang Joe and his partners was a business partnership,
they should be considered as having formed a corporation for tax purposes.

Since the partnership was organized and existing under Philippine law, its taxable income shall be subject
to 30% on taxable income. To arrive at its taxable income, the partnership is allowed to use the allowed
itemized deduction under Sec. 34 also of the NIRC of 1997. All of the above expenses, except the
insurance premium are all deductible.

The partnership shall not be subject to the minimum corporate income tax on domestic corporations,
because it is only on its second taxable year immediately following the commencement of its business
operations. The minimum corporate income tax is computed only beginning the fourth taxable year
immediately following the year the taxpayer corporation commenced business. (Sec. 27 [E] {1}, NIRC of
1997)

Should the partnership distribute its net income after tax to Mang Joe and his partnerships, their individual
shares in the distribution shall be subject to tax on dividends. (Sec. 24 [B] {2}, NIRC of 1997)