An eye on accounts: Details of the tax code

Taxes in the Philippines are imposed at the national and local levels. At the national level, taxes are levied and collected pursuant to the National Internal Revenue Code, the Tariff and Customs Code, and several special laws. There are four main types of national internal revenue taxes: income, indirect (value-added and percentage taxes), excise and document stamp taxes, all of which are administered by the Bureau of Internal Revenue (BIR). At the local level, governments have some autonomy to impose separate taxes on business and ownership of property.

There is a territorial system of taxation for foreign corporations and individuals, and non-resident citizens. Only Philippine-sourced income is subject to Philippine taxes for the latter group.

Businesses incorporated under Philippine laws and resident citizens are subject to income tax on their worldwide income.

CORPORATE INCOME TAX: The general rate is set at 30% on net taxable income. There is a minimum corporate income tax (MCIT) equivalent to 2% of gross income, which applies beginning on the fourth year of commercial operation.

Allowable expenses in computing the gross income subject to MCIT for certain business activities have been enumerated. The excess MCIT paid over the regular corporate income tax is allowed as a tax credit against the regular corporate income tax payable in the succeeding three years.

The 30% rate also applies to non-resident foreign corporations. The tax is, however, calculated on gross income instead of net income. Exemptions apply pursuant to tax treaty provisions.

Certain types of income and corporations are subject to special tax rates, which are as follows:

• International carriers doing business in the Philippines are required to pay 2.5% of gross billings from carriage originating from the Philippines. Lower rates are available under tax treaties. Exemption applies on condition of reciprocity;

• Expanded foreign-currency deposit units of banks are required to pay 10% on onshore interest income;

• Offshore banking pays 10% on onshore interest income;

• Regional operating headquarters of multinational companies are required to pay 10% of taxable income;

• Regional or area headquarters of multinational companies are exempt. These entities are not allowed to generate income from Philippine sources nor solicit or market goods and services on behalf of their parent company or affiliates. They are authorised to act as supervisory, communications and coordinating centres for their subsidiaries and branches;

• Contractors and subcontractors engaged in petroleum exploration are required to pay 8% of gross income in lieu of all other taxes;

• Non-resident foreign owners, lessors or distributors of motion pictures pay 25% on gross income;

• Non-resident owners of vessels pay 4.5% of gross rental, lease or charter fees from citizens;

• Non-resident foreign lessors of aircraft, machinery and other equipment pay 7.5% on rentals, charter fees, and other fees from Philippine sources. These taxes are withheld by the payer.

TAX BASE: Taxable income is computed in accordance with the accounting method employed by the company. Where there are differences in financial and tax reporting on the recognition of income and expenses, the differences are recognised as reconciling items on the income tax return.

DEDUCTIBLE EXPENSES: In general, all expenses incurred in connection with the conduct of business are allowed to be claimed as deductions when calculating net income subject to tax.

The tax code lists the following major classifications of allowable deductions:

• Ordinary and necessary expenses;

• Interest;

• Taxes;

• Losses;

• Bad debts;

• Depreciation;

• Depletion of oil and gas wells and mines;

• Charitable and other contributions;

• Research and development; and

• Contributions to employee pension trust. Deductibility of certain expenses is subject to limitations. The interest expense allowed shall be reduced by an amount equivalent to 33% of the company’s interest income that is subject to final tax. Interest paid by corporations to a majority individual owner or shareholder is non-deductible. Interest expenses are not allowed as a tax expense if paid to a personal holding company that is more than 50% owned by a majority shareholder of the corporation. Entertainment and recreation expenses are subject to a limit of 0.5% and 1% of net revenue for taxpayers engaged in selling goods and services, respectively.

Income tax paid in a foreign country by a domestic corporation on foreign-sourced income may be claimed as a deductible expense. Alternatively, the company may opt to claim the foreign tax as a tax credit against Philippine income tax proportionate to the Philippine income tax due on such income.

Property losses sustained in relation to the business and not indemnified by insurance or other means are deductible from gross income. The net operating loss incurred in any taxable year can be carried forward to the three succeeding taxable years. Capital losses can be offset only against capital gains. Losses from wash sales of stock or securities are not deductible.

Research and development expenses may be claimed as a deduction during the year they are incurred. The taxpayer has an option to amortise the expense over a period of not less than 60 months, beginning with the month when the benefits from such expenditure were realised.

Contributions to a qualified employee pension trust are deductible to the extent of the excess of the contribution needed to cover the pension liability accrued during the taxable year. The amount shall be apportioned equally over a period of 10 years. The plan should be pre-qualified by the tax authorities.

REQUIREMENT FOR DEDUCTIBILITY: Expenses must be substantiated with sufficient evidence, such as official receipts and other records. Expenses may be disallowed as a deduction if the prescribed withholding tax on payments made for such expenses is not withheld and paid to the tax authorities.

OPTIONAL STANDARD DEDUCTION: Corporations may claim an optional standard deduction (OSD) at 40% of gross income in lieu of the itemised deductible expenses. The option to claim the OSD may be changed every year but the choice, once made in the first quarter, is irrevocable for the taxable year.

TAX YEAR: A corporation may choose either the calendar or fiscal year for its taxable year, depending on which schedule more accurately reflects its taxable income. Prior approval from the Commissioner of Internal Revenue is required in order for a company to change its accounting period.

GROUP OF COMPANIES: For tax purposes, each company is an independent entity and as such, it must file its own tax return and pay its own taxes. The filing of consolidated tax returns or the relieving of losses within a group of companies is not allowed.

Related companies must interact on an arm’s-length basis. The commissioner is authorised to allocate revenues and expenses between related companies to prevent tax evasion or to correctly reflect each individual entity’s income.

In 2013 the Philippines issued the transfer-pricing regulations, which specify the methodologies to be used in determining the arm’s-length price and the documentation required to show compliance with the arm’s-length standard in related-party transactions. This documentation shall be submitted to the tax authorities upon notification.

CORPORATE TAX RETURNS & PAYMENT: Domestic and resident foreign corporations must file their quarterly income tax returns within 60 days of the end of each taxable quarter. They must also file a final adjusted return on or before the 15th of the fourth month following the end of the tax year – April 15 for taxpayers on calendar year. The quarterly and annual returns cover the regular income tax and the MCIT, as well as income subject to special tax regimes.

Non-resident foreign corporations are not required to file income tax returns. Taxes due on their Philippine-sourced income are withheld at the source by the Philippine-based company making the payment.

Excess income taxes paid during the year may be applied for refund or the amount may be carried over to the next quarter. The latter option shall be irrevocable for that taxable year and no application for cash refund is allowed. Tax credit certificates (TCCs) may only be used to pay for certain direct internal revenue tax liabilities of the holder and are prohibited from being transferred or assigned to any person.

In 2012 a monetisation programme that allows all value-added tax (VAT)-TCCs to be converted to cash was implemented. The VAT-TCC monetisation programme runs for five years from 2012 to 2016.

IAET: The improperly accumulated earnings tax (IAET) is a penalty that is levied against closely held corporations for the unreasonable accumulation of earnings resulting in the non-distribution of dividends to shareholders and, consequently, to deferred payment of the dividends tax. The IAET is imposed at 10% of the improperly accumulated taxable income in excess of the amount necessary to cover the reasonable needs of the business, which, under existing regulations, is limited to 100% of the paid-up capital of the corporation inclusive of accumulations taken from other years. Paid-up capital refers to the par value, excluding any premium paid. The IAET is due one year and 15 days following the close of the tax year and is covered by a separate tax return.

Banks, insurance companies, publicly held corporations and companies registered with and enjoying preferential tax treatment in special economic and freeport zones are not covered by the IAET.

DIVIDENDS & PROFIT REMITTANCES: Dividends from a domestic corporation are tax-exempt in the hands of other domestic corporations. The tax is 10% if these are paid to citizens and residents, and 25% if paid to non-resident foreign nationals.

Dividends received by domestic corporations from foreign corporations form part of the income subject to the regular corporate tax. Dividends received by non-resident foreign corporations from domestic corporations are taxed at 30% or the treaty rate.

A lower rate of 15% applies if the recipient’s home country does not impose a tax on foreign-sourced dividends or when there are tax-sparing provisions.

A 15% tax rate also applies on the remittance of profits of Philippine branches to their foreign parent companies. The tax is based on total profits that are applied to remittance without any deduction for the tax component. The tax is generally not waived even if the profits for remittance are reinvested in the Philippines. Branches which are registered in the special economic zones are exempt from this tax.

Preferential rates of branch profits remittance tax are also available under treaties.

INTEREST & ROYALTIES: Royalties payable to nonresident foreign corporations are subject to the 30% final withholding tax. A lower rate of 25% is imposed on non-resident foreign nationals.

Interest on foreign loans paid to non-resident foreign corporations is taxed at 20%. Preferential rates are available under tax treaties.

OTHER PASSIVE INCOME: Scheduled rates apply on most passive income, including the following:

• Interest from bank deposits and yields from deposit substitutes and similar arrangements, royalties, prizes and other winnings from Philippine sources – 20%;

• Interest from foreign currency deposits in a local bank – 7.5% (non-residents are exempt);

• Interest income from long-term deposits – individuals are exempt;

• Gains from the sale of shares listed and traded through the local exchange – exempt from income tax but subject to a transaction tax at 0.5% of selling price;

• Capital gains from the sale of land and buildings classified as capital assets – 6% of the gross selling price or market value, whichever is higher (not applicable to non-resident foreign individuals and corporations); and

• Capital gains from the sale of shares in a domestic corporation, not traded through the local stock exchange – 5% on the first P100,000 ($2410) of net gain and 10% on the excess. This tax is imposed on the cumulative net gain from the sale of shares during the taxable year. Gains from the surrender of shares upon dissolution of the issuing company are taxed at the regular corporate/individual tax rates.

OTHER CAPITAL ASSETS: Gains from the sale or disposition of capital assets other than land or buildings and shares in domestic corporations are taxed as business income. For individuals, only 50% of the gain is taxed if the asset is held for more than 12 months. Capital losses are deductible only to the extent of gains made.

PERSONAL INCOME TAX: Foreign nationals and nonresidents are subject to income tax only on income from Philippine sources; only residents are taxed on worldwide income. Graduated rates from 5% to 32% apply to citizens, resident aliens and non-resident aliens staying in the country for more than 180 days in a year. If engaged in business or the practice of a profession, the net taxable income is calculated in the same manner as that for corporations. The 40% OSD for individuals is, however, based on gross revenues.

Non-resident foreign nationals not doing business in the Philippines are taxed at a rate of 25% on their Philippine-sourced income, including wages, rents, gains, interest, dividends and royalties. Foreign nationals who are employed by offshore banking units, regional or area headquarters and operating headquarters of multinational companies, and petroleum service contractors and subcontractors enjoy a preferential tax rate of 15%.

INDIVIDUAL TAX RETURNS & PAYMENT: For individuals, the tax year is always the calendar year and the income tax is due on or before April 15 of the following year. The tax liabilities of spouses are calculated separately, although spouses are required to file their tax returns jointly.

Starting with the tax year ending December 31, 2013, individuals filing income tax returns are required to disclose in their annual income tax returns the amounts and sources of other income that is exempt from tax or already subjected to final taxes.

For employees receiving only compensation, employers are relied upon to ensure that the correct tax for the year is fully withheld. Employees qualifying under the substituted filing scheme are exempt from filing annual income tax returns.

Employees receiving only the statutory minimum wage are exempt from the payment of income tax if they do not earn other taxable income, whether from the conduct of business or from other employment. Employers are not required to withhold tax from them. Non-resident aliens not engaged in business are not required to file an annual income tax return.

WITHHOLDING TAXES: Most income is subject to withholding of taxes. If the payor of tax is classified as a top-20,000 corporation or a top-5000 individual engaged in business, it is required to withhold on all payments for the purchase of goods (1%) and services (2%). Withholding taxes on income subject to the regular corporate rate are creditable against the calculated liability. Most categories of passive income are subject to withholding taxes.

For corporate taxpayers, this is disclosed as income that is no longer subject to regular income tax. Income payments to non-resident foreign corporations are likewise withheld at the source as final taxes. Hence, nonresident foreign corporations are not required to file annual income tax returns.

INDIRECT TAXES: VAT of 12% is imposed on the gross selling price on the sale, barter or exchange of goods and properties, as well as on the gross receipts from the sale of services within the Philippines, including the lease of properties.

The 12% VAT paid on the company’s purchases relative to its business subject to VAT is credited against the 12% VAT due on gross sales or receipts. The net amount is the VAT payable by the company.

Exports are subject to 0% VAT and entitle the exporter to claim a refund for VAT that has been paid on its purchases of goods, properties and services relating to the product.

Exempt status is granted to certain transactions and entities. In such cases, VAT paid on the inputs is not allowed to be claimed as creditable input VAT. Instead, the VAT paid forms part of the deductible costs of the business in question.

A VAT taxpayer files monthly declarations and quarterly returns that serve as the final adjusted return for the period. The VAT on services performed in the Philippines by non-resident foreign corporations, as well as the VAT on royalties and rentals payable to such non-resident foreign corporations, is withheld by the paying local company.

Imports are subject to VAT unless specified. VAT is paid whether or not the importer conducts business. Percentage taxes on gross receipts apply to most services and transactions not subject to VAT, such as:

• Carriers of passenger on land – 3%;

• International carriers on carriage of cargoes – 3%;

• Franchisees of gas and water utilities – 2%;

• Banks and non-bank financial firms – 1%, 5% or 7%;

• Life insurance companies and agents of foreign insurance firms – 5% of the premiums; and

• Sale of shares through initial public offerings – one half of 1% the selling price.

EXCISE TAXES: In addition to VAT, excise taxes are also imposed on the following: alcohol, tobacco, petroleum products, automobiles, mineral products and non-essential goods such as jewellery and precious stones, perfumes, yachts and other sport vessels.

DOCUMENTARY STAMP TAX: A documentary stamp tax (DST) is required for certain documents, transactions or instruments specified in the tax code when the obligation or right arises from Philippine sources or when the property is situated in the Philippines. These include:

• Bills of exchange – 0.15%;

• Bills of lading – 1%;

• Sale of real property – 1.5%;

• Original issuance of shares – 0.5% of par value;

• Sale of shares (except those listed and traded in the local stock exchange) – 0.38%;

• Debt instruments – 0.5%; and

• Lease agreements – 0.1% of the yearly lease.

TAX AUDIT: The period allowed for tax authorities to audit companies and assess deficiency taxes is three years from the date of filing of the final return. If fraud is alleged, this period may extend to 10 years from the date of discovery of the possible fraud.

The deficiency tax may be collected within five years from the date when the assessment becomes final. Assessments may be contested in courts.

RECOVERY OF TAXES: In the case of taxes that have been excessively or erroneously paid, a taxpayer may apply for refund or the issuance of TCCs within two years from the date of payment. For purposes of the creditable taxes withheld, the option to carry forward the excess credits generated shall be irrevocable once chosen. A VAT-registered taxpayer may apply for refund of any excess VAT when the taxpayer shifts to a non-VAT activity or ceases to be in business.

BOOKKEEPING REQUIREMENTS: All business entities subject to internal revenue taxes are required to maintain books of account. These consist of a journal, a ledger and subsidiary records required for the business. Entities subject to VAT are also required to keep subsidiary sales and purchase journals.

Books of accounts and other accounting records may be kept in either English or Spanish. The books and records must be preserved for a period of at least three years. Companies with gross quarterly sales or receipts exceeding P150,000 ($3615) shall have their books audited and examined yearly by independent certified public accountants who should be accredited as tax agents by the tax bureau.

For public companies, banks and insurance companies, the independent certified public accountants should further be accredited by regulatory agencies, such as the Securities and Exchange Commission (SEC), the Bangko Sentral ng Pilipinas (the central bank) or the Insurance Commission.

Financial statements are required to be filed together with annual income tax returns. In addition to maintaining books of accounts, the Corporation Code requires businesses to keep the following items: records of all the business transactions, minutes of meetings of shareholders and directors, and a stock and transfer book. Sales should be evidenced by official receipts and invoices based on the prescribed format. The books may be in manual or digital form. These are required to be registered with the tax authorities prior to their use. Large taxpayers, however, are mandated to adopt a digitised accounting system.

FINANCIAL REPORTING FRAMEWORK: The amended Securities Regulation Code (SRC) Rule 68 (the Rule) issued by the Philippine SEC prescribed a financial reporting framework or set of accounting principles, standards, interpretations and pronouncements, that must be adopted in the preparation and submission of the annual financial statements of a particular group of entities. The following is an outline of the financial reporting framework prescribed by SRC Rule 68 for each group of entities covered by the Rule: Large and/or publicly accountable entities are those with total assets exceeding P350m ($8.4m) or total liabilities of more than P250m ($6m). Other entities covered by the Rule include those required to file financial statements under Part II of SRC Rule 68 (for example, an issuer that has sold a class of securities pursuant to registration under Section 12 of the SRC, an issuer with a class of securities listed for trading on an exchange, and an issuer with assets of at least P50m [$1.2m] that has 200 or more shareholders each holding at least 100 shares of a class of equity securities); entities in the process of issuing securities to the public market; or entities that are holders of secondary licences issued by regulatory agencies.

Entities qualifying in any of the criteria provided above shall use Philippine Financial Reporting Standards (PFRS) as their financial reporting framework. However, another set of reporting rules may be permitted by the SEC for certain regulated entities such as banks and insurance companies.

The PFRS are adopted by the Financial Reporting Standard Council (FRSC) from the International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board (IASB).

Small and medium-sized enterprises (SMEs) are defined as entities with total assets between P3m ($72,300) and P350m ($8.4m) or total liabilities between P3m ($72,300) and P250m ($6m). If the entity is a parent company, such amounts will be based on consolidated figures. Other entities classed as SMEs are those not required to file financial statements under Part II of SRC Rule 68; entities not in the process of issuing securities to the public market; and entities that are not holders of secondary licences.

Entities that qualify based on all above criteria shall use the PFRS for SMEs as their financial reporting framework. PFRS for SMEs are adopted by the FRSC from the IFRS for SMEs issued by the IASB. Outside of those exceptions allowed under the Rule, the SEC requires mandatory adoption of PFRS for SMEs for all entities that qualify as SMEs.

At the smallest end of the scale, micro entities are considered to be those with total assets and liabilities below P3m ($72,300); entities not required to file financial statements under Part II of SRC Rule 68; entities not in the process of offering securities to the public; and entities that do not hold secondary licences.

Micro entities may choose to use either the income tax basis or PFRS for SMEs, provided that the financial statements shall at least consist of the statement of management’s responsibility, auditor’s report, statement of financial position, statement of income and notes to financial statements, all of which cover the two-year comparative periods, if applicable.

RELIEF FROM DOUBLE TAXATION: Relief from double taxation is available for Philippine-sourced income received by non-resident foreign nationals under the tax treaties in effect with the following 37 countries: Australia, Austria, Bahrain, Bangladesh, Belgium, Brazil, Canada, China, the Czech Republic, Denmark, Finland, France, Germany, Hungary, India, Indonesia, Israel, Italy, Japan, Korean, Malaysia, Netherlands, New Zealand, Norway, Pakistan, Poland, Romania, the Russian Federation, Singapore, Spain, Sweden, Switzerland, Thailand, the UAE, the UK, the US and Vietnam. To avail themselves of the relief from double taxation pursuant to tax treaties, foreign nationals must file a tax treaty relief application (TTRA) before the occurrence of the first taxable event. Otherwise, the TTRA shall be denied or the transaction shall not be entitled to exemption or lower rate under the relevant tax treaty.

TAXES ON IMPORTS: Customs duties are generally imposed on articles imported into the Philippines at various rates. Certain imports may be exempt or conditionally exempt subject to certain situations. There are also some imports that are specifically prohibited. The basis for the calculation of the duties is the transaction value, which is subject to adjustments for certain costs. The VAT and excise taxes for imports are also collected by the Bureau of Customs.

LOCAL TAXES: Local governments impose taxes on businesses. The local government code provides for the maximum tax rates that these authorities may impose on business activities in their jurisdiction.

Property tax is levied at 1-2%, but the base differs depending on the actual use. For commercial and industrial properties, the tax base is 50% of the property’s market value. The base is lower, at 40%, for agricultural properties and 20% for residential properties.

SPECIAL TAX REGIMES: Entities registered in the country’s special economic zones are subject to a separate tax regime. They enjoy an income tax holiday of up to eight years. Thereafter, a preferential gross income tax rate of 5% is imposed, which is in lieu of national and local taxes, including the regular income tax, MCIT and the IAET, VAT and percentage taxes, excise taxes and DST.

The purchase of enterprises in economic zones are automatically zero-rated for VAT. Certain authorised imports are also free from other duties and taxes. OBG would like to thank Punongbayan & Araullo for their contribution to THE REPORT The Philippines 2014