Chapter 5

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Chapter 5 - Final Income Taxation

CHAPTER 5
FINAL INCOME TAXATION

Chapter Overview and Objectives

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.

After finishing this Chapter, readers are expected to demonstrate:


a. Understanding and appreciation of the features and scope of final tax
b. Mastery of those certain passive income subject to final tax and their
corresponding final tax rates |
c. Mastery of the general final tax rates on certain non-residents and their
exceptions
d. Knowledge of the other applications of the final income tax scheme

FEATURES OF FINAL INCOME TAXATION


1. Final tax
2. Tax withholding at source
3. Territorial imposition
4. Imposed on certain passive income and persons not engaged in business in
the Philippines

The Final Withholding System


The final withholding system imposes upon the person making income payments
the responsibility to withhold the tax. The tax which will be deducted at source is
final. The taxpayer receives the income net of tax and there would be no need for
him to file an income tax return to report the same.

The final withholding system is inherently territorial. It applies only to certain


passive income earned from sources within the Philippines. Note that taxation is
territorial and we cannot impose tax obligation (filing or withholding) against
non-resident subjects of foreign sovereignty. Hence, all items of income earne
from sources abroad, passive or active, are subject to tax under the general scop®
of the regular income tax.

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Rationale of Final Income Taxation


The final withholding tax is built upon taxpayer and government convenience. It
relieves the taxpayer of the obligation to file an income tax return. This is very
convenient for taxpayers who are limited by distance, time and cost to comply. For
the government, the final withholding system is the most convenient and effective
system in collecting taxes on income where there is high risk of non-compliance or
tax evasion.

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.

Non-resident persons not engaged in business in the Philippines


Non-resident persons not engaged in trade or business in the Philippines, such as
non-resident aliens not engaged in trade or business (NRA-NETBs) and non-resident
foreign corporations (NRFCs), have high risk of non-compliance. These taxpayers
do not have offices or fixed places of business in the Philippines making tax
compliance very unlikely due to their absence and distance in the Philippines.
Also, the Philippine government cannot impose upon them the obligation to file
return due to territorial consideration.

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%

PASSIVE INCOME SUBJECT TO FINAL TAX


1. Interest or yield from bank deposits or deposit substitutes
2. Domestic dividends, in general |
3. Dividend income from a Real Estate Investment Trust

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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.

The 19-lender rule


The mere flotation of a debt instrument is not considered to be a public borrowing and
is not deemed a deposit substitute if there are only 19 or less individual or corporate
lenders at any one time.

The 19-lender rule does not apply to government securities


Government debt instruments and securities including Treasury bonds, Treasury bills,
and Treasury notes shall be considered as deposit substitute irrespective of the
number of lender at origination if such debt instruments and securities are to be
traded or exchanged in the secondary market,

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.

Timing of withholding of final tax


1. Zero coupon instruments or securities - upon origination
2. Interest-bearing instruments or securities - upon payment of interest

Summary of tax rules on interest on debt instruments

Deposit substitutes __- Recipient


Issued by banks: Individuals Corporations
- Short term 20% 20%
- __Longterm Exempt RIT
Issued by non-banks
- Short term 20% 20%
- Long-term 20%" _ RIT
*Per Section 3 of RR14-2012, exemption on long-term certificates or investments is limited to those
issued by banks only

Illustration 1
John earns interest income from the following investment placements in various debt
instruments:

Instrument Remarks Term


DI1 BSP treasury notes 5 years
DI2 BSP treasury bills 1 year
DI3 Itogon Bank deposit certificates 5 years
DI 4 Ayala corporate bonds issued to the public 10 years
DI5 Securitized SB corporate bonds (100 lender) 3 years
DI 6 Promissory note negotiated by ABC Bank 2 years
DI7 KT Bank bonds participated out to 30 lenders 8 years

The interest income from the foregoing instruments shall be taxable as follows:
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If foh i a/an

DINo. | Debt instrument classification Individual Corporation


DI1_| Long-term deposit substitute (BSP) Exempt RIT
DI2_ | Short-term deposit substitute (BSP) 20% FIT 20% FIT
D13__| Long-term bank deposit Exempt RIT
DI4 | Long-term deposit substitute by a non-bank 20% FIT RIT
DIS __| Short-term deposit substitute by a non-bank 20% FIT 20% FIT
DI6__| Private borrowing by a bank RIT RIT
DI7__| Long-term deposit substitute by a bank Exempt RIT |
Note: The final tax exemption on interest income derived from long-term certificates or debt
instruments refers only to those issued by banks and applies only to individual taxpayers.

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.

Trust funds or investment management accounts


Investments in trust funds of banks (except qualified exempt employee trust funds), or
investment management accounts are subject to the same final tax rules. However, in
order to claim final tax exemption on long-term investment, it is also mandatory that:
a. The investment of the individual investor in the common or individual trust fund
or investment management account must be held/managed by the bank for at least
5 years.
b. The underlying investments of the individual trust account or investment
management account must qualify as a deposit substitute issued by a bank.
c. The individual trust account or investment management account must hold on to
such underlying investment for at least 5 years.

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.

Pre-termination of long-term deposits or investment of individuals


If the deposit or investment placement of individual taxpayers is pre-terminated
before 5 years, any previously untaxed or exempted interest income will be
subjected to the following final taxes upon pre-termination:
Holding period Pre-termination tax
Less than 3 years 20%
3 years to less than 4 years 12%
4 years to less than 5 years 5%
5 years or more 0%

Illustration - long-term deposits


On January 1, 2020, Patricia invested P1,000,000 in Baguio Bank's 5-year time deposit.
The deposit pays 10% interest annually. Alice pre-terminated the deposit on July 1,
2023.
The final tax on pre-termination will be computed as follows:
2020 interest income (P1,000,000 x 10%) P 100,000
2021 interest income (P1,000,000 x 10%) 100,000
2022 interest income (P1,000,000x10%) . 100,000
2023 accrued interest income
(P1,000,000 x 10% x 6 months/12 months) 50,000
Total interest income P 350,000
Final tax rate applicable to less than 4-year pre-termination 12%
Final tax P___ 42,000

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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:

Holder | Classification Remaining maturity |’ Holding period Finaltax |


Mr. X RC 10 years - long-term 6 years _. Exempt
Mr. Y RC 4 years - short-term 4 years 20% FWT
Note: Mr. Y's remaining maturity upon acquisition of the instrument is already less than 5S years so he
is now subject to 20% final tax. (See Q&A Nos, 2 and 3 of RMC 81-2012 dated December 10, 2012)

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:

Holder | Classification | Remaining maturity Holding period Final tax


Mr. X NRC 10 years - long-term 3 years 12% FWT
Mr. Y NRA 7 years — long-term 2 years 20% FWT
Mr. Z RC 5 years - long-term 5 years Exempt

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:

Holder| Classification | Remaining maturity | Holding period


| Finaltax _|
Mr. X NRA-NETB_| 10 years-long-term | __3 years 25% FWT
Mr. Y NRA-ETB 7 years — long-term 2 years 20% FWT
Mr. Z RA 5 years - long-term 4 years 5%
Note: NRA-NETBs are not subject to the reduced pre-termination tax rate on long-term deposits or
investment certificates.

Foreign currency deposit with foreign currency depositary banks


The interest income from foreign currency deposits under the foreign currency
deposit system or expanded foreign currency deposit system by residents is
subject to a final tax of 15%.

Taxpayer Individuals Corporations


Residents 15% 15%
Non-residents Exempt Exempt
Note:
1. Resident taxpayers include resident citizens, resident aliens, domestic corporations and resident
foreign corporations. .
2. Non-residents taxpayers include non-resident citizens, non-resident aliens and non-resident
foreign corporations. a
3. It should be emphasized that NRA-NETBs and NRFCs are also exempt.
4, There is no long-term or short-term classification of foreign currency deposits.

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.

Joint accounts on forex deposits


If the bank account is jointly in the name of a non-resident and a resident
taxpayer, 50% of the interest shall be exempt while the other 50% shall be subject
to the 15% final tax.

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.

Interest income subject to regular tax


Interest income from the following sources is subject to regular income tax, not to
final tax:
1. Lending activities, whether or not in the course of business
2. Investments in corporate bonds
3. Promissory notes
4. Foreign sources, whether bank or non-bank _
5. Penalty for legal delay or default

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
ui

Liquidating dividends - distribution of corporate net asset

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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.

Stock dividend vs. Stock split


Stock dividend is a capitalization of earnings while stock split results in reduction in
the par value of stock and an increase in the number of shares of shareholders.
Assuming a 2-for-1 split, a shareholder holding one P50-par value stock will be given
two P25-par value stocks, While stock dividend may be taxable under certain
conditions, stock split will never be subject to income tax.
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Dividend Tax Rules

, 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.

The final tax to be withheld by Mati Company shall be:

Shareholders _Amount Rate __Amount_


Individual shareholders P 1,200,000 x 10% P 120,000
Corporate shareholders 800,000 x 0% 0
Final tax P__120,000
Illustrative 2
Bayog Company declared a total of P1,000,000 dividends in March 2021. An analysis
of the recipient shareholders is as follows:
Shareholders —Amount_
Resident aliens and citizens P 500,000
NRAs engaged in trade or business
100,000
NRAs not engaged in trade/business
50,000
Non-resident corporations —__100,000
Total dividends
P__750,000
The total final tax to be withheld by Bayog Company shall be:
Shareholders Dividends _Rate_ _ Final Tax _
Resident aliens and citizens P 500,000 x10% P —_ 50,000
NRAs engaged in trade or business 100,000 x 20% 20,000
NRAs-NE TBs
50,000 x25% 12,500
NRFCs
100,000 x 25% 25,000
Total P__750,000 P__ 107,500
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presumptive source of dividend distribution


Any distribution made to the shareholders or members of a corporation shall be
deemed to have been made from the most recently accumulated profits or surplus,
and shall constitute a part of the annual income of the distributee for the year in
which received. (Sec. 73(C), NIRC)
Exempt Dividends
1. Inter-corporate dividends from domestic corporations - exempt from final tax
2. Dividends from cooperatives - exempt from final tax
3. Qualified foreign-sourced dividends - exempt from regular tax

Inter-corporate dividends from domestic corporations


Inter-corporate dividends received by a domestic corporation and resident
foreign corporation from a domestic corporation are exempted under the NIRC to
minimize double taxation.
Illustration
B, Inc. owns 100% of A Corp. During the year, A Corp. declared P100,000 dividends to
B, Inc. B, Inc., in turn, declared the same dividends to its shareholders. The following
table illustrates the double taxation:

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.

This exemption extends to dividends received by business partnerships from


domestic corporations since business partnerships are considered corporations
under the NIRC. However, the exemption does not extend to dividends received by
general professional partnership, exempt joint ventures and exempt co-ownership
because they are not considered corporations under the NIRC.

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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Dividends from cooperatives


Under RA 9520, the distribution of dividends by an exempt cooperative to its
members either representing interest on capital or as patronage refunds shall not
be subject to tax.

Inter-corporate dividends from foreign corporations


Dividends received by corporations from foreign corporations are generally
subject to regular income tax. However, domestic corporate recipients of such
dividends may be exempted under certain conditions which will be discussed in
detail in Chapter 9,

ENTITIES TAXABLE AS CORPORATIONS ARE SUBJECT TO 10% FINAL TAX


The 10% final withholding tax also applies to dividends or share in the net income
of entities considered corporations under the NIRC and special laws, such as:
1. Real Estate Investment Trusts
2. Business partnerships
3. Taxable associations
4. Taxable joint ventures, joint accounts or consortia
5. Taxable co-ownerships

Real Estate Investment Trust or REIT


A REIT is a publicly listed corporation established principally for the purpose of
owning income-generating real estate assets.

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)

Business partnership, taxable associations, joint venture, joint accounts or |


co-ownerships
Under Sec. 73 of the NIRC, the net income of these entities is deemed
constructively received by the partners, members or venturers, respectively, in
the same year the net income is reported. Hence, the 10% final tax applies at the
point of determination of the income, not at the point of actual distribution.
ae

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Share in business partnership net income


The “share in net income” includes the share in the residual profit and provisions
for salary, interest and bonus to a partner. However, if the provisions for salaries,
interests, and bonuses are expensed as such in the book of the partnership, they
are subject to regular tax to the receiving partner, not to final tax. In this case, only
the share in the residual income after such provisions is subject to final tax.
Illustration
The partnership profit distribution of partners Andy and Mar based on their agreed
profit distribution scheme is as follows:
Andy Mar
Salaries to industrial partner P 40,000 P 0
Interest to capitalist partner - 12,000
Bonus to industrial partner 25,000
Residual profit sharing 8.000 24.000
Profit sharing Pp 73,000 P 36,000

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%,"

Passive vs. Active royalties


Royalties of a passive nature such as royalties of claim owners or land owners of
mining properties, royalties of inventors from companies that manufacture and
sell their invention, and royalty from licensing agreements that transfers the use
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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.

TAX INFORMER’S REWARD


A cash reward may be given to any person instrumental in the discovery of
violations of the National Internal Revenue Code or discovery and seizure of
smuggled goods. The tax informer’s reward is subject to 10% final tax.
Requisites of Tax Informer’s Reward:
1. Definite sworn information which is not yet in the possession of the BIR
2. The information furnished lead to the discovery of fraud upon interna}
revenue laws or provisions thereof. .
3. Enforcement results in recovery of revenues, surcharges, and fees and/or
conviction of the guilty party or imposition of any fine or penalty.
4. The informer must not be a: .
a. BIR official or employee
b. Other public official or employee
c. relative within the 6th degree of consanguinity of those officials or
employee in a. and b.

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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Chapter 5 - Final Income Taxation

TAX-FREE CORPORATE COVENANT BONDS


Interest income of non-resident aliens, citizens or residents of the Philippines on
obligations of domestic or
bonds, mortgages, deeds of trust, or other similar the
resident foreign corporations with tax-free or tax-reduction provision where
be subject to a
in whole or in part any tax on the interest shall
obligor shoulders tax
final withholding of 30%.
| Bond investor
Individuals Corporations
Tax on interest income on tax-free 30% final tax Regular income
corporate covenant bonds tax

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.

EXCEPTIONS TO THE GENERAL FINAL TAX ON NON-RESIDENT PERSONS NOT


ENGAGED IN TRADE OR BUSINESS IN THE PHILIPPINES
NRA-NETB NRFC
General Final Tax Rate 25% 25% ©
Exceptions:
1. Capital gain on sale of domestic 15% Capital 15% Capital
stocks directly to buyer gains tax _ gains tax
2. Rentals on cinematographic films
and similar works 25% of rentals 25% of rentals
3. Rentals of vessels 25% of rentals | 4.5% of rentals
4.. Rentals of aircrafts, machineries,
and other equipments 25% of rentals. | _ 7.5% of rentals
‘|S, Interest income under the foreign ict
currency deposit system Exempt . Exempt
6. Interest on foreign loans N/A 20%
15% if tax
7. Dividend income 25% sparing rule is
applicable
8. Tax on corporate bonds 30% 30%

Capital gains tax


Asarule, NRA-ETBs and NRFCs do not file income tax returns. Exceptionally, NRA-
NETBs and NRFCs are required to file income tax returns to report their gain from
dealings in domestic stocks directly to buyers. Ownership of the stocks shall not
be transferred to the assignee without the required return and tax clearance

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Chapter 5 - Final Income Taxation

(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

RHC shall withhold the following final taxes:


Royalties from invention P 300,000
Professional fees ; _1,000,000
Total gross income P1,300,000
Multiply by: final tax on NRA-NETB 25%
Total final withholding tax P__325,000 .

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.

The Tax Sparing Rule


NRFCs shall be subject to a 15% final tax on dividend income instead of the 25%
general final tax if the country of domicile of the NRFC credits against the tax due
of such NRFC taxes presumed to have been paid by such: NRFC from. the
Philippines equivalent to 10% of the dividends.
In applying the tax sparing rule, the Supreme Court ruled that the NIRC
does not
require that the foreign law of the non-resident corporation must give a deemed
paid tax credit for dividend equivalent to the percentage points waived
by the
Philippines pointing that the NIRC merely require the country of the NRFC to
a
deemed paid tax equivalent to that waived by the Philippines. (CIR vs.
Procter &
Gamble Philippines Manufacturing Corporation and the CTA (G.R.
66836))
Thus, the requirement of the tax Sparing rule is deemed satisfied if the country
to |
which the NRFC is domiciled imposes no tax on dividends from foreign sources.
(BIR Ruling Nos, 104-2012, March 22, 2012)
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Chapter 5 - Final Income Taxation

Illustration: The Tax Sparing Rule with NRFCs


An NRFC is due to receive a dividend of P1,000,000 from a domestic corporation. The
final tax to be imposed by the Philippines which shall be withheld by the domestic
corporation shall be 15%, not 25%, if the country of domicile of the NRFC also reduces
its income tax upon the P1,000,000 dividend by at least 10%, the dividend tax
percentage waived by the Philippines from the 25% general final tax rate. If the
country of the NRFC does not reduce its tax on the dividend by at least 10%, the
Philippines shall impose the 25% final tax.

OTHER FINAL INCOME TAXES


1. Fringe benefits of managerial or supervisory employees
2. Income payments of residents other than depositary banks under the
expanded foreign currency deposit system (EFCDS) and expanded foreign
currency deposit units (EFCDUs)
3, Income payments to oil exploration service contractors or sub-contractors
FRINGE BENEFITS TAX ides}
Fringe benefits include all remunerations ‘under an employer- -employee
relationship that do not form part of compensation income. The fringe benefits of
managerial and supervisory employees: are subject toa final fringe benefi ts tax.
This will be discussed in detail in Chapter 11.

INTEREST AND OTHER INCOME PAYMENTS :TO DEPOSITARY BANKS UNDER


THE EXPANDED FOREIGN CURRENCY DEPOSIT SYSTEM)! |.
Residents, other than depositary banks: under: the expanded foreign currency
deposit system, shall withhold 10% final taxon income payments such as interest
income on loans from expanded foreign currency deposit units (FCDUs). The final
taxation of FCDUs and EFCDUs will be discussed in chapter 15-A.

INCOME PAYMENTS TO SUB- CONTRACTORS OF PETROLEUM SERVICE


CONTRACTORS
Under PD 1354, every subcontractor, whether db inet or foreign, entering into
a contract with a service contractor engaged in petroleum operations in the
Philippines shall be liable to a final income tax equivalent to eight percent (8%) of
its gross income derived from such contract, such tax to bei in lieu of any and all
taxes, whether national or local.
Provided, however, that any income received from all other sources within and
without the Philippines in the case of domestic subcontractors and within the
Philippines in the case of foreign subcontractors shall be subject to the regular
income tax under the NIRC.

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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.

Persons or entities contracted by a petroleum service contractor to locally supply


goods and materials that are required by and in, or that are inherently necessary
or incidental to, its exploration and development of petroleum mineral resources
and are entitled to the preferential 8% final tax on their.gross income derived —
from such contracts. (BIR Ruling No. 024-2001, June 13, 2001)

Note on Special Aliens


Under the old law, employees of offshore banking units, regional operating or
regional administrative headquarters of multinational companies, referred to as
special aliens, are previously subject to 15% final tax on gross compensation
income. The special alien classification is now abolished by virtue of a presidential
veto to the TRAIN law. As such, these employees are now subject to regular
income tax if they are residents and 25% final tax if they are non-residents.

FINAL WITHOLDING TAX RETURN CAE


The final withholding tax return (BIR Form 0619-F), Monthly Remittance Return
of Final Income Taxes Withheld, shall be filed in triplicate by every withholding
agent or payor who is either an individual or corporation for the first two months
of the quarter.
Deadline and place for monthly manual filing
The return shall be filed and the tax shall be paid or before the 10tr day of the
month following the month in which withholding was made with:
a. The authorized agent bank of the revenue district. office having jurisdiction
over the withholding agent’s place of business
b. In places where there are no authorized agent banks, to the revenue collection
officer
c. The authorized city or municipality treasurer within the revenue district
where the withholding agent's place of business is located
Monthly deadline for eFPS filing
In accordance with the schedule set forth in RR No. 26-2002, the deadline for ¢
filing of returns is as follows:
Group A ~ Fifteen (15) days following the end of the month
Group B - Fourteen (14) days following the end of the month
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Chapter 5 - Final Income Taxation

Group C - Thirteen (13) days following the end of the month


Group D - Twelve (12) days following the end of the month
Group E - Eleven (11) days following the end of the month
Note: Please check the groupings of taxpayers under eFPS in Chapter 4.

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.

Penalties for Late Filing or Remittance of Final Income Taxes Withheld


The same penalties for late payment of income taxes as discussed in Chapter 4
apply for non-withholding or non-remittance of final taxes.

ENTITIES EXEMPT FROM FINAL INCOME TAX


1. Foreign governments and foreign government-owned and controlled
corporations
2. International missions or organizations with tax immunity
3. General professional partnership
4. Qualified employee trust fund

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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