Chapter 5
Chapter 5
Chapter 5
CHAPTER 5
FINAL INCOME TAXATION
This Chapter discusses the features of final income taxation, the items of £TOss
income, and the class of taxpayers subject to final income tax.
Final tax is one of the exceptions to the scope of the regular income tax. An
excellent understanding of the items of passive income and those taxpayers
subject to final tax including their final tax rates is extremely crucial to your
mastery of income taxation.
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Under the NIRC, final income tax is imposed on certain passive income and upon
non-resident persons not engaged in business in the Philippines.
Passive income
Items of passive income are earned, with very minimal involvement from the
taxpayer and are generally irregular in timing and amount. Unlike items of active
income, they are not usually specifically monitored by taxpayers. When not
recorded by the taxpayer, their existence can be difficult to predict while their
actual amount may be difficult to determine. Thus, the final withholding at source
is the most favored scheme in taxing items of passive income.
Thus, the law subjects them to final income tax wherein Philippine residents
paying them income, passive or active, are obligated to withhold the following
final tax:
General final
Non-resident person not engaged in trade or business tax rate
Non-resident alien not engaged in trade or business 25%
Non-resident foreign corporation 25%
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Required: Compute the total final income tax to be withheld by Banko Negro.
Solution:
Depositors Amount Rate _ Final Tax
Resident individuals P 600,000 x20% P. 120,000
Resident/domestic corporations 800,000 x 20% 160,000
NRA-NETB 200,000 x 25% 50,000
NRFCs 100,000 x 25% 25,000
Total accrued interest expense P_1,700,000 P__355,000
Savings or time deposits with cooperatives are not subject to final tax
The final tax is limited to banks and shall not be applied with time and savings
account deposit maintained by members with cooperatives and by primary
cooperatives with their federations. (Dumaguete Cathedral Credit Cooperative vs,
CIR, G.R. 182722)
Deposit substitutes
Deposit substitute means an alternative form of obtaining funds from the public
other than deposits through the issuance, endorsement, or acceptance of debt
instruments for the borrowers own account, for the purpose of relending or
purchasing of receivables and other obligations, or financing their own needs or
the needs of their agent or dealer. Public means 20 or more corporate lenders at
any one time.
Debt instrument issued for interbank call loans with maturity of not more than 5 days
to cover deficiency in reserves against deposit liabilities, including those betwee
n oF
among banks and quasi-banks, shall not be considered as deposit
substitutes.
Classification of debt instruments
Number of borrowers at origination
Issuer of debt instrument
19 or less 20 or more
Corporate issuer
Private borrowing Deposit substitute
Government including BSP
Deposit substitute Deposit substitute
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Note:
4. Origination means issuance.
2. Interest on deposit substitute (i.e. public borrowing) is subject to final tax. Interest on private
borrowing is subject to regular income tax.
Any person holding any interest, whether legal or beneficial, on a debt instrument or
holding thereof either by assignment or participation, with or without recourse, shall
be considered as lender and thus be counted in applying the 19-lender rule.
Thus, debt instruments may not be initially considered deposit substitute for failing
the 19-lender rule but may subsequently qualify as such when the number of lender
increase to at least 20 when any of the original lenders assigned, securitized or
participated out the debt instrument.
Illustration 1
John earns interest income from the following investment placements in various debt
instruments:
The interest income from the foregoing instruments shall be taxable as follows:
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If foh i a/an
Illustration 2
ABC Company wants to take advantage of the decreasing interest rates. It disposed of
its investment in various short-term deposit substitutes. It gained total of P300,000
from the disposal inclusive of P180,000 interest income.
Only the P180,000 interest income shall be subject to 20% final tax. The P120,000 (i.e.
P300,000 — P180,000) trading gain on the debt instruments shall be subject to regular
income tax. Also, forex gains on trading foreign currency denominated instruments, if
any, shall likewise be subject to regular tax.
Illustration 1
Mr. Acebo appointed the trust department of RCBC Bank to manage his money
through a trust agreement. The RCBC Bank trust department invested Mr. Acebo’s
money in 5-year corporate bonds.
Even if Mr. Acebo does not withdraw his money from the trust agreement for at least 5
years, his interest income from the trust agreement will still be subject to 20% final tax
since the underling instrument (i.e. corporate bonds) is not issued by a bank.
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Illustration 2
Assume instead that the RCBC trust department invested Mr. Acebo’s money in a 10-
year time deposit under its own name without mentioning that it was in trust for him.
The investor in this case to the 10-year time deposit is the bank which is a corporate
taxpayer subject to regular tax. Mr. Acebo would not qualify for exemption to the 20%
final tax since the investment was not made “in trust for the name of specific and
qualified individual”.
Illustration 3
Assume instead that RCBC trust department invested the money under the name of
Mr. Acebo’s in a 10-year long-term deposit.
Mr. Acebo’s interest income derived from the trust agreement shall be exempt from
income tax provided both he will hold such deposit or investment in a continuous and
uninterrupted period for at least 5 years. The trust must also hold the underlying
instrument (10-year deposit) for at least 5 years.
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The net proceeds of the deposit and accrued interest to be released to the deposito,
upon pre-termination shall be:
Principal balance P 1,000,000
Accrued interest for 2023 50,000
Final tax to be withheld ( 42,000)
Net proceeds to be released to the depositor P_1,008,000
Pre-termination, transfer or negotiation of investment certificates
For purposes of applying the pre-termination rates for individual taxpayers op
long-term investment certificates, the remaining maturity of the instrument mus
still satisfy the 5-year requirement.
Illustration 1
A debt instrument with a maturity of 10 years was held by Mr. X (a resident citizen)
for 6 years then transferred it to Mr. Y (another resident citizen) who in turn held it
for 4 years until the instrument matured.
The final tax due on the interest income of each holder shall be as follows:
Illustration 2
A debt instrument with a maturity of 10 years was held by Mr. X (a non-resident
citizen) for 3 years and transferred it to Mr. Y (a resident alien). Mr. Y held it for two
years before subsequently transferring it to Mr. Z (a resident citizen) who held it until
maturity or 5 years.
The final tax due on the interest income of each holder shall be as follows:
Illustration 3
An instrument with a maturity of 10 years held by Mr. X (a NRA-NETB) for 3 years and
transferred it to Mr. Y (a NRA-ETB). Mr. Y held it for 2 years before subsequently
transferring it to Mr. Z (a resident alien), who pre-terminated it after 4 years.
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The final tax due on the interest income of each holder shall be as follows:
The reduced final tax rates on interest income on foreign currency deposit and the
exemption of non-resident depositors are intended to encourage the deposit of
foreign currencies in our banks which will be. used in the financing of our
international trades. Our Philippine peso is not a globally accepted currency. Our
foreign trade will be limited without adequate foreign currency reserves in our
banking sector.
Illustration
Mr. Seeman is an Overseas Filipino Worker. He deposits all his savings in a savings
account under the foreign currency deposit unit (FCDU) of a domestic bank. During
the month, the savings deposit account earned $1,000 interest equivalent to P41,500.
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Scenario 1: Mr. Seeman deposited his savings through the account of his resident wife
The final tax shall be computed as follows:
P 41,500.00 |
Interest income
Final tax rate 15%
Final tax P_6,225.00
Scenario 2: Mr. Seeman deposited his savings through a joint account with his
resident wife.
The final tax shall be computed as follows:
Interest income P 41,500.00
Portion taxable 50%
Taxable interest income P 20,750.00
Multiply by: final tax rate __15%
Final tax P__ 3,112.50
}
Scenario 3: Mr. Seeman deposited his savings account through his own account. |
In this case, the interest income shall be exempt from final tax.
DIVIDENDS
“Dividends” means any distribution made by a corporation to its shareholders
out of its earnings or profits and payable to its shareholders, whether in money or
in other property. (Sec. 73, NIRC)
Types of dividends: |
1. Cash dividends - paid in cash |
2. Property dividends - paid in non-cash properties including stocks or securities |
of another corporation . |
3. Scrip dividends - those paid in notes or evidence of indebtedness of the |
corporation |
Stock dividends - paid in the stocks of the corporation
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Chapter 5 - Final Income Taxation
As a rule, dividends are income subject to tax. However, the following are not
income for taxation purposes:
1. Stock dividends
Stock dividends representing transfer of surplus to capital account shall not
be subject to tax. Stock dividends are in the form of increase in corporate
value (i.e. capital gain) which should be properly taxable when realized
through disposal or sale of the stocks investment.
The distribution of stocks of another corporation as dividends is a taxable
property dividend and nota stock dividend.
2. Liquidating dividends
Under the NIRC, the receipt of liquidating dividends is not viewed as income
but as exchange of properties. When the liquidating dividends exceed the cost
of the investments, the excess is a taxable capital gain, subject to regular
income tax. Any loss is deductible only to the extent of capital gain.
Taxability of Stock Dividends
Normally, stock dividends are exempt from income tax. Exceptionally, stock
dividends are subject to tax at the fair value of the stocks received under the
following conditions:
a. Subsequent cancellation and redemption
If a corporation cancels or redeems stock issued as a dividend at such time
and in such manner as to make the distribution and cancellation or
redemption, in whole or in part, equivalent to the distribution of a taxable
dividend, the amount so distributed shall be taxable to the extent it represents
a distribution of earnings or profit.
For instance, a corporation declared stock dividends and immediately called the
stock dividends for redemption and cancellation. This act is equivalent to
declaration of cash dividends.
b. If it leads to substantial alteration in ownership in the corporation
Substantial alteration in ownership in a corporation may occur when stock
dividends are given in lieu of cash dividends or when the corporation declared
an optional stock or cash dividend.
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, Recipient of dividends
Source of dividends Individuals Corporations
“Domestic corporation 10% final tax! Exempt
Foreign corporation Regular tax Regular tax3
Note:
1. A NRA-ETB is subject to a 20% final tax on dividend, not to the usual 10%; but an NRa.
NETB is subject to a 25% final tax.
2. A NRFC is not exempt but is subject to the 25% general final tax rate. However, the
imposable dividend tax shall be 15% when the tax sparing rule applies. This will be
discussed later.
3. With conditional exemption for reinvestment to be discussed in detail in Chapter 9
Illustrative 1
Mati Company declared a total of P2,000,000 dividends. P800,000 is due to corporate
shareholders while P1,200,000 is due to individual shareholders.
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A Corp. B, Inc.
Dividends declared P —- 100,000 90,000
Less: 10% dividends tax 10,000 ~ | 9,000
Net dividends P. 90,000 P__81,000
This is a form of direct duplicate taxation. To eliminate the impact of double taxation,
inter-corporate dividends such as those declared by A Corp. to B, Inc. is exempted
from final tax. When the dividend finally falls to an individual shareholder, the 10%
final tax applies.
On the other hand, the exemption of inter-corporate dividends does not apply to
the share of a corporation from the net income of a business partnership due to
absence of express legal exemption. Exemption is restricted to dividend
declaration only.
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The following recipients of REIT dividends are exempt from the final tax:
a. Non-resident alien individuals or non-resident foreign corporations entitled
to claim preferential tax rate pursuant to applicable tax treaty.
. Domestic corporations or resident foreign corporations
c. Overseas Filipino investors - exempt from REIT dividend tax until August 12,
2018 (7 years from the effectivity of RR13-2011 which took effect on August
12, 2011)
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Assuming the salaries, interest and bonus are not expense in the book, the 10% final
tax shall be:
Profit sharing P 73,000 P 36,000
Multiply by: Final tax rate 10% 10%
Final tax .?P 7300 P 3,600
Note: A partner, member or venture who is an NRA-ETB, NRA-NETB or NRFC shall be subject
respectively to 20%, 25% and 25% final tax rate.
ROYALTIES
Passive royalty income received from sourcess within the Philippines is subject to
the followingfinal tax rates:
Recipient
Source of passive royalties -' | Individuals Corporations
Books, literary works, and musical compositions | 10% final tax 20% final tax
Other sources 20% final tax” | 20% final tax*
Note:
1. Under the regulations, the 10% preferential royalty final tax on books and literary works
pertain to printed literatures. Royalties on books sold on e-copies or CDs such as e-books
are subject to the 20% final tax.
2. Royalties on cinematographic films and similar works paid to NRA-ETBs, NRA-NETBs or
NRFCs is subject to a final tax of 25%,"
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of trademark or technology are subject to 20% final tax. When royalties accry
from an undertaking where the taxpayer has active involvement, it is an active
income subject to the regular income tax.
Mlustration
E-Soft Inc. develops application programs for establishments. These programs were
individually tailored to meet specific requirements of the establishments and required
upgrades, occasional troubleshooting, and adjustments for problems. The developer
receives 1% of the sales of the establishment as royalty.
E-Soft also developed a utility program and assigned it to an e-marketer which sells
the utility program through the Internet. E-Soft receives 30% royalty on each copy of
the program sold.
The royalties from application programs are active income subject to regular income
tax. The royalty from the utility programs is passive income subject to final
withholding tax, but if the e-marketer is not a resident in the Philippines, the passive
income from abroad shall be subject to regular tax.
Royalties, active or passive, earned from sources abroad are subject to regular
income tax.
PRIZES
The taxation of prizes varies. Prizes may be exempt from income tax or subject to
either final tax or regular income tax.
Exempt prizes
1. Prizes received by a recipient without any effort on his part to join a contest.
Examples include prizes from such awards as Nobel Prize, Most Outstanding
Citizen, Most Benevolent Citizen of the Year, and similar awards.
2. Prizes from sports competitions that are sanctioned by their respective
national sport organizations
Requisite of exemption
1. The recipient was selected without any action on his part to enter the contest.
2. The recipient is not required to render substantial future services as 4
condition to receiving the price or reward.
Taxable prizes
For individual income taxpayers, taxable prizes are subject to either final tax oF
regular tax depending on the amount of the prize. There may be events 0
competitions where corporations earn prizes. However, there is no final t%
imposition on corporate prizes under the NIRC. Hence, the same must be subject
to regular income tax.
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Recipient
Amount of taxable prize Individuals Corporations
Prizes exceeding P10,000 20% final tax Regular tax
Prizes not exceeding P10,000 Regular tax Regular tax
Recall also that final taxation does not apply to foreign passive income; hence,
prizes from foreign sources are subject to the regular income tax.
WINNINGS
For individual income taxpayers, winnings received from sources within the
Philippines are generally subject to 20% final tax, except winnings from Philippine
Charity Sweepstakes Office (PCSO) games amounting to P10,000 or less.
Similar to prizes, there is no final tax imposed on corporate winnings under the
NIRC. Winnings that are not subjected to final tax by the payor should be reported
as part of the regular income. Also, winnings from foreign sources are subject to
regular income tax.
Recipient
Types of winnings Individuals Corporations
PCSO winnings not exceeding P10,000 Exempt Exempt
PCSO winnings exceeding P10,000 20% final tax 20% final tax
Other winnings, in general 20% final tax Regular tax
Note: PCSO winnings of NRA-NETBs and NRFCs, regardless of amount, are subject to 25% final
tax.
The tax rules on PCSO winnings shall be applied on a per ticket basis.
Illustration 1
Apolinario won P10,000 first place in the singing contest sponsored by Syd Company
during their company anniversary celebration.
Since results of singing contest is based on effort rather than chance, the P10,000
payment is a prize which is not subject to 20% final tax since it is below the P10,000
threshold. Apolinario shall report the prize in his regular income tax return. If the
amount exceeded P10,000, Syd Company shall withhold 20% final tax.
Illustration 2
Roy’s raffle ticket was selected as the second winning ticket in the raffle draw of ZFT
Mall for P10,000 dubbed as “2nd Prize”.
Since raffle draw results is not based on effort but on chance, the P10,000 payment is a
winning which is subject to 20% final tax. The same shall be withheld by ZFT Mall. Note
that the P10,000 threshold applies only on prizes, not on winnings.
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Mlustration 3
Mr. Dante Paya made three bets to the PCSO lotto draws. All tickets won. The details of
the winnings were:
- EZ2-P 4,000
- 6/42 -P10,000 (3-digit winning numbers)
- 6/45 -P20,000,000 Grand prize (sole winner)
The 6/42 and EZ2 winnings are exempt since they did not exceed P10,000 in amount
PCSO shall withhold 20% final tax on the entire P20M amount of the winnings.
Amount of Cash Reward - whichever is the lower of the following per case:
1. 10% of revenues, surcharges, or fees recovered and or fine or penalty
imposed and collected or
2. P1,000,000
The amount of cash reward is subject to 10% final withholding tax which shall be
withheld by the government. |
Illustration
Ms. Kirsten provided information to the BIR leading to the recovery of P12,000,000
unpaid taxes, The cash reward shall be computed as follows:
10% cash reward (P12,000,000 x10%) P 1,200,000
Cash reward limit
Cash reward (whichever is lower) . P 1,000,000
Less: 10% final withholding tax 100,000
Net amount to be released to the tax informer ' P__900,000
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Note:
1. The final tax applies to all individuals, regardless of classification.
2. There is no similar final tax provision for corporate recipients of “tax-free” interest; hence,
the regular income tax shall apply.
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(Certificate Authorizing Registration or CAR) from the BIR that the tax on the
transfer has been paid.
Illustration: NRA-NETBs
In 2021, Mr. Wang Lu, an NRA-NETB, was hired by Raha Humabon Company (RHC), a
domestic manufacturer, to install his invention in RHC’s factory. RHC pays him royalty
and the installation fees. Mr. Lu also agreed to design RHC’s website which he
designed and completed abroad. During Mr. Lu’s visit, he purchased shares of RHMC
and subsequently sold them directly to a buyer.
Royalties from invention P 300,000
Installation fees 1,000,000
Website development fees 500,000
Gain on sale of domestic stocks directly to a buyer 40,000
Note:
1. The final tax applies on gross income, whether active or passive. The same rule and final tax
rate apply with NRFC taxpayers.
2. The website development fee is not subject to final tax since the same is earned abroad.
Note that the service is rendered abroad, not in the Philippines.
3. Mr. Lu shall file a capital gains tax return for the gain on the sale of domestic stocks.
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The term "gross income" means all income earned or received as a result of the
contract entered into by the subcontractor with a service contractor engaged in
petroleum operations in the Philippines under Presidential Decree No. 87,
Note that the 8% final tax applies only to subcontractors, whether individuals o,
corporations, resident or non-resident. Petroleum service contractors are subject ty
the regular income tax.
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Quarterly filing
The withholding agent shall file (BIR Form 1601-FQ), Quarterly Remittance
Return of Final Income Taxes Withheld, on or before the last day of the month
after each quarter.
The first two categories are exempt on grounds of international comity. General
professional partnerships and qualified employee trust funds are expressly
exempt from any income tax imposed under the NIRC. pal
These entities are exempt not only to final. tax but also to capital gains tax and
regular income tax.
A comprehensive summary of final tax rates is presented in Appendix 1.
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