Contributed By SyCip Salazar Hernandez & Gatmaitan (Makati City - HQ)
Business in the Philippines is generally done through incorporated entities or corporations, although business may also be done through partnerships and sole proprietorships.
Corporations are either formed under the Corporation Code of the Philippines or created under special law.
Corporations formed or organised under the Corporation Code may be stock or non-stock corporations. Stock corporations are those with capital stock divided into shares and authorised to distribute to the shareholders dividends on the basis of the shares held. All other corporations are non-stock corporations. These corporations have the powers provided under the Corporation Code, and may exercise such other powers as may be essential or necessary to carry out the business purposes stated in their articles of incorporation. They may exist for 50 years but this term may be extended for another period not exceeding 50 years in any single instance.
Corporations are taxed as separate legal entities. For income tax purposes, joint-stock companies, joint accounts (cuentas en participacion), associations, insurance companies, or partnerships are treated as corporations. However, general professional partnerships ('GPPs'), and joint ventures or consortiums formed for the purpose of undertaking construction projects or engaging in petroleum, coal, geothermal and other energy operations pursuant to an operating or consortium agreement under a service contract with the Philippine government are not taxed as separate corporations and the income tax is imposed on the partners and/or consortium members.
The taxable income of corporations is generally subjected to a 30% corporate income tax (or their gross income is subject to a minimum corporate income tax of 2%). When corporations declare dividends to their shareholders, or profits to their partners, in the case of partnerships, these dividends and profits are again taxed at the shareholder- or partner-level. Individual shareholders and partners are generally subject to 10% final tax on dividends. Dividends declared by a domestic corporation to another domestic corporation or to a resident foreign corporation are not subject to income tax.
Sole proprietorships, on the other hand, have no separate juridical personality. Proprietors are taxed as individuals, and the income tax rates range from 0%-35%.
GPPs and certain unincorporated joint ventures or consortiums are the types of transparent entities commonly used in the Philippines. These GPPs and unincorporated joint ventures or consortiums are exempt from income tax. The income tax is imposed on the partners or the consortium members.
GPPs are formed by persons for the sole purpose of exercising their common profession, while non-taxable unincorporated joint ventures or consortiums are those formed for the purpose of undertaking construction projects or engaging in petroleum, coal, geothermal and other energy operations pursuant to an operating or consortium agreement under a service contract with the Philippine government.
The incorporation test is used in determining the residence of incorporated businesses for taxation purposes in the Philippines.
A corporation organised under the laws of the Philippines is a domestic corporation, while a corporation organised under the laws of a foreign country is a foreign corporation. A foreign corporation doing business in the Philippines (for example, through a branch) is considered a resident foreign corporation.
For purposes of income taxation, the residence of transparent entities is generally not material since they are exempt from income tax. It is, however, relevant to determine the residence of the individuals or corporations composing the transparent entity, as they will be subjected to income tax.
Corporations are generally subject to the following taxes:
Transparent entities (ie, GPPs and certain types of unincorporated joint ventures or consortiums) are exempt from income tax but they are generally subject to the following taxes:
Individuals engaged directly in business or through transparent entities are generally subject to the following taxes:
Taxable income is defined as gross income less deductions that are authorised for such types of income by the Philippine Tax Code or other special laws.
Taxable income may not be entirely based on accounting profits. There are certain incomes that are taxable for accounting purposes but are not taxable under the Philippine Tax Code and certain deductions that are allowable for accounting purposes but not allowed under the Philippine Tax Code, and vice versa.
For instance, accounting income should be adjusted so as to exclude from taxation the income that has been subjected to final tax, and to add back expenses, which under tax laws are not deductible (eg, provisions for bad debts since the Philippine Tax Code requires that bad debts be actually written off to be deductible).
Taxable income is generally computed in accordance with the method of accounting regularly employed in keeping the books of the taxpayer, but if no such method of accounting has been so employed, or if the method employed does not clearly reflect the income, the computation will have to be made in accordance with such method as in the opinion of the Commissioner of Internal Revenue ('CIR') clearly reflects the income. In the Philippines, the accounting method is generally based on the Philippine Financial Reporting Standards ('PFRS'), but in a case of conflict between the PFRS and tax law and regulations, tax law and regulations shall prevail for purposes of income taxation.
Income from the use of intellectual property in the Philippines is included in the taxpayer’s gross income for income tax purposes. If the taxpayer is a resident citizen or a domestic corporation, income from the use of intellectual property within or without the Philippines will be subject to income tax.
Businesses conducting research and development ('R&D') activities, however, may be granted fiscal incentives such as the income tax holiday for a certain period. Under the 2017 Investment Priorities Plan ('IPP') of the Philippine government, “innovation drivers” such as R&D activities have been identified as preferred activities for investment subject to incentives. The IPP also provides that innovation drivers also cover the commercialisation of new and emerging technologies and products of the Department of Science and Technology or government-funded R&D, such as agricultural biotechnology tools, photonics and nanotechnology, and natural health products.
With respect to R&D expenses, a taxpayer may treat research or development expenditures, which are paid or incurred during the taxable year in connection with the taxpayer’s business as ordinary and necessary expenses, as deductible expenses during the taxable year when the expenses were paid or incurred.
However, subject to the relevant rules and regulations, the taxpayer may opt to treat as deferred expenses the research and development expenditures that are:
Such deferred expenses shall be amortised over a period of not less than 60 months, as may be elected by the taxpayer beginning with the month in which the taxpayer first realises benefits from such expenditures.
The general investment incentives laws are the Special Economic Zone Act of 1995, the Omnibus Investments Code of 1987 and the Bases Conversion and Development Act of 1992.
Under the Special Economic Zone Act of 1995, businesses located in designated economic zones ('ecozones') and registered with the relevant ecozone authority are entitled to fiscal incentives such as, but not limited to, income tax holiday for a certain period, a preferential tax rate of 5% on gross income earned in lieu of national and local taxes except real property tax on land owned by developers, and exemption from taxes and duties on imported equipment, raw materials and supplies directly needed for the enterprise’s operations.
Under the Omnibus Investments Code of 1987, entities engaged in preferred activities and registered with the Board of Investments are likewise entitled to fiscal incentives such as income tax holiday for a certain period, exemption from taxes and duties on imported spare parts, and exemption from wharfage dues and export tax, duty, impost and fees, among others.
The Bases Conversion and Development Act of 1992 provides fiscal incentives to business enterprises that are located within certain economic and freeport zones. These zones were formerly military bases that were converted into economic zones. These incentives include tax and duty-free importation of raw materials and capital equipment, and a preferential tax rate of 5% on gross income earned in lieu of national and local taxes.
There are also a number of special laws that provide fiscal incentives to certain sectors or undertakings in order to promote economic development. Fiscal incentives are granted to co-operatives, renewable energy developers, exporters, tourism enterprises, among others.
The Philippine Tax Code provides that the net operating loss of an enterprise (ie, the excess of allowable deductions over the gross income of the business) for any taxable year immediately preceding the current taxable year, which had not been previously offset as deduction from gross income, may be carried over as a deduction from gross income for the next three consecutive taxable years immediately following the year of such loss. However, any net loss incurred in a taxable year during which the taxpayer was exempt from income tax is not allowed as a deduction. Additionally, a net operating loss carry-over shall be allowed only if there has been no substantial change in the ownership of the business or enterprise in that:
Ordinary loss is deductible against ordinary gain and capital gain. Capital loss, on the other hand, is deductible only against capital gain.
Individual taxpayers sustaining a net capital loss in any taxable year are also allowed to deduct such loss against capital gain in the succeeding taxable year but only in an amount not exceeding net income in the said taxable year.
The amount of interest paid or incurred by a taxpayer within a taxable year on indebtedness in connection with his business is generally allowed as a deduction from his gross income, but such allowable deduction for interest expense shall be reduced by 33% of the interest income of the taxpayer subject to final tax. An example of interest income subject to final tax is interest income from peso bank accounts which is subject to twenty percent (20%) final tax.
However, no deduction is allowed in respect of interest under the following circumstances:
At the option of the taxpayer, interest incurred to acquire property used in business may be allowed as a deduction or treated as a capital expenditure.
Consolidated tax grouping is not permitted under Philippine law. Losses incurred by one company in a group may not be utilised by another company.
Nonetheless, when a taxpayer merges, consolidates or combines with another person, that taxpayer’s net operating losses may be transferred or assigned to the surviving or new corporation or entity if the shareholders of the transferor/assignor, or the transferor (in case of other business combinations) gains control of at least 75% or more in nominal value of the outstanding issued shares or paid up capital of the transferee/assignee (in case the surviving entity is a corporation) or 75% or more interest in the business of the transferee/assignee (in case the transferee/assignee is other than a corporation).
Additionally, in the case of a merger, the net operating loss carryover shall be allowed as a deduction from gross income of the surviving entity if the taxpayer who sustained and accumulated the net operating losses is the surviving entity.
Net capital gains realised by domestic corporations on the sale or exchange of shares in a domestic corporation not traded in the Philippine stock exchange are subject to a final tax of 15%. Net capital gains realised by foreign corporations not exceeding PhP100,000 are taxed at 5%, while net capital gains in excess of PhP100,000 are subject to 10% final tax.
The sale of shares listed and traded in the Philippine stock exchange is subject to a stock transaction tax of 6/10 of 1% based on the gross selling price or gross value in money of the shares of stock sold.
If the corporation is a non-resident foreign corporation, it may avail itself of tax treaty relief on capital gains derived from the alienation of property in the Philippines.
A corporation who, in the course of trade or business, sells, barters, exchanges, leases goods or properties, or renders services, is subject to value-added tax at the rate of 12% on the sale of goods or service, barter or exchange. The importation of goods is likewise subject to value-added tax.
Depending on the transaction, corporations may be subject to documentary stamp tax, which is a tax on documents, instruments, loan agreements and papers, and upon acceptances, assignments, sales and transfers of obligations, rights or properties.
Certain goods manufactured or produced (eg, distilled spirits, tobacco products, mineral products, petroleum products, sweetened beverages) in the Philippines for domestic sales or consumption or for any other disposition, or which are imported, are subject to excise tax. Cosmetic surgery services performed in the Philippines are also subject to excise tax. Excise taxes are imposed in addition to value-added tax.
Certain income payments are subject to final or creditable withholding taxes. Thus, incorporated businesses (ie, domestic corporations) may be constituted as withholding agents when they make payments that are subject to final or creditable withholding tax.
Passive income that is subject to final withholding tax are no longer included in the computation of the taxable income. The following types of passive income earned by incorporated businesses are subject to the following final withholding tax:
The sale of shares of stock in a domestic corporation is also subject to a separate tax – capital gains tax or stock transaction tax.
In addition to the above taxes, incorporated businesses may also be subject to improperly accumulated earnings tax ('IAET') equal to 10% of improperly accumulated taxable income.
Incorporated businesses (ie, employers) are also required to pay a 35% fringe benefits tax on the grossed-up monetary value of fringe benefits furnished or granted to their employees, except rank and file employees, unless the fringe benefit is required by the nature of, or necessary to, the trade or business of the employer, or when the fringe benefit is for the convenience or advantage of the employer.
Following the general way in which business is done in the Philippines, closely held businesses would usually operate in corporate form. The Philippine Corporation Code has its own definition of what is considered a 'close' corporation.
As a rule, corporate practice of a profession is not sanctioned under Philippine law. According to the Philippine Supreme Court, this rule is hinged on the idea that “the ethics of any profession is based on individual responsibility, personal accountability and independence, which are all lost where one verily acts as a mere agent, or alter ego, of unlicensed persons or corporations.”
The Philippine Tax Code imposes an IAET at the rate of 10% based on improperly accumulated taxable income. The IAET is imposed to deter corporations from accumulating profits for the purpose of avoiding income tax at the shareholder level. The IAET does not apply to publicly held corporations, among others.
Publicly held corporations are domestic corporations not falling under the definition of closely held corporations, which refer to corporations at least 50% in value of the outstanding capital stock or at least 50% of the total combined voting power of all classes of stock entitled to vote is owned directly or indirectly by or for not more than 20 individuals.
Cash and property dividends received by individuals who are citizens or resident aliens from their shares in domestic corporations (including closely held corporations) are subject to a final tax of 10%. Cash and property dividends received by non-resident aliens engaged in trade or business in the Philippines and by non-resident aliens not engaged in trade or business in the Philippines, from their shares in domestic corporations, are subject to a final tax of 20% and 25%, respectively.
Stock dividends are not subject to income tax so long as the number of shares received is in proportion to the existing shareholding of the individual stockholder. However, the issuance of shares through the declaration of a stock dividend is subject to documentary stamp tax at the rate of PhP2 for every PhP200 of the par value of the shares issued.
Net capital gains realised by individuals on the sale or exchange of shares in domestic corporations (including closely held corporations) not traded in the Philippine stock exchange are subject to a final tax of 15%.
Cash and property dividends received by individuals (citizens and resident aliens) from their shares in publicly traded corporations are also subject to a final tax of 10%.
Cash and property dividends received by non-resident aliens engaged in trade or business in the Philippines and by non-resident aliens not engaged in trade or business in the Philippines, from their shares in domestic corporations that are publicly traded, are subject to a final tax of 20% and 25%, respectively.
Stock dividends declared by publicly traded corporations are likewise not subject to income tax so long as the number of shares received is in proportion to the existing shareholding of the individual stockholder. However, the issuance of shares through the declaration of a stock dividend is subject to documentary stamp tax at the rate of PhP2 for every PhP200 of the par value of the shares issued.
Sale of shares listed and traded in the Philippine stock exchange is subject to a stock transaction tax of six tenths of 1% based on the gross selling price or gross value in money of the shares of stock sold.
Interests, dividends and royalties earned by non-resident aliens not doing business in the Philippines are subject to a 25% final withholding tax.
Interests and royalties earned by non-resident foreign corporations are subject to a 30% final withholding tax.
However, interest on foreign loans received by non-resident foreign corporations is subject to a final withholding tax of20%.
Dividends earned by non-resident foreign corporations are generally subject to a final withholding tax of 30%. However, this rate is reduced to 15% if the country in which the non-resident foreign corporation is domiciled allows a credit against the tax due from the non-resident foreign corporation taxes deemed to have been paid in the Philippines equivalent to 15%, which represents the difference between the regular income tax rate of 30% and the 15% tax rate on dividends. This is referred to as tax sparing credit.
The Philippines is a party to tax treaties with 45 countries. There is no public data available that would show which of these tax treaty countries are primarily used by investors to make investments in Philippine corporate stock or debt.
The Philippine Bureau of Internal Revenue ('BIR') requires the submission of documents to ascertain whether an entity applying for a tax treaty relief is entitled to the preferential tax rates under the tax treaty being used.
For interest, dividends and royalties, no tax treaty relief application is required but the non-resident must submit a certificate of residence for tax treaty relief form to the payor of the income or the withholding agent in order to avail of the preferential treaty rates for these incomes.
For other types of income, the availment of tax treaty relief must be preceded by a tax treaty relief application filed with the BIR. If the BIR finds that the entity is not qualified, then the tax treaty application will be denied.
Based on the transfer pricing guidelines issued by the BIR, intra-firm or inter-related transactions account for a substantial portion of the transfer of goods and services in the Philippines, but the revenue collection from related-party groups continue to decrease. The BIR has attributed this to the fact that related companies are more interested in their net income as a whole rather than as separate entities. Accordingly, the BIR issued transfer pricing regulations to prescribe the guidelines in determining the appropriate revenues and taxable income of the parties in controlled transactions by providing the methods for establishing an arm’s length price. The regulations also require taxpayers to maintain or keep the documents necessary for the taxpayer to prove that efforts were exerted to determine the arm’s length price or standard in measuring transactions among associated enterprises.
Under the transfer pricing guidelines, the BIR recognises that an appraisal of the risk is important in determining arm’s length prices or margins. Only those risks that are economically significant in determining the value of transactions or margins of entities will be identified and used in the comparability analysis to be conducted in applying the arm’s length principle. However, we have not seen any case where the BIR specifically challenged the use of related party limited risk distribution arrangements.
While the Philippines is not a member of the OECD, the transfer pricing regulations issued by the BIR were based on the OECD Transfer Pricing Guidelines.
The Philippine Tax Code authorises the CIR to distribute, apportion or allocate gross income or deductions between or among two or more organisations, trades or businesses, whether or not incorporated and organised in the Philippines, owned or controlled directly or indirectly by the same interests, if he determines that such distribution, apportionment or allocation is necessary in order to prevent evasion of taxes or clearly reflect the income of any such organisation, trade or business.
The purpose, therefore, of transfer pricing adjustments made by the BIR is to ensure that taxpayers clearly reflect income attributable to controlled transactions and to prevent the evasion of taxes with respect to such transactions.
The difficulty in operating MAPs remains to be seen as the BIR has yet to issue separate guidelines on the application of MAP processes.
For purposes of the discussion below, the term 'non-local corporation' refers to a foreign corporation, which is defined under the Philippine Tax Code as a corporation not created or organised in the Philippines or under its laws.
Local branches of non-local corporations are taxed differently from local subsidiaries of such non-local corporations in that local branches of non-local corporations are subject to income tax only on their Philippine-sourced income while local subsidiaries of non-local corporations are considered domestic corporations and subject to income tax on their worldwide income.
With respect to their taxable income (Philippine-sourced or worldwide as applicable), local branches and local subsidiaries of non-local corporations are subject to the same tax rates:
However, the remittance of branch profits by the local branch to the foreign head office is subject to branch profit remittance tax of 15%, while remittance of dividends by the local subsidiary to the foreign head office is subject to a final withholding tax of 30% subject to the tax sparing credit.
Net capital gains from the sale of stock in local corporations are always subject to Philippine income tax, except if there is an applicable tax treaty that grants capital gains tax exemption.
Net capital gains of non-resident individuals arising from the sale of stock in local corporations not traded in the local stock exchange are subject to 15% capital gains tax. Net capital gains of non-resident foreign corporations not exceeding PhP100,000 are subject to 5% capital gains tax, while any gain in excess of PhP100,000 is subject to 10% capital gains tax.
The gain from the sale of shares of a non-local holding company that directly owns the stock of a local corporation will be considered income from sources outside the Philippines and will not be subject to Philippine income tax unless the seller is a resident Philippine citizen or a domestic corporation.
Treaties eliminate capital gains tax under certain conditions. For instance, there are tax treaties that exempt the net capital gains arising from the sale of shares in a local corporation from capital gains tax if the assets of the local corporation do not consist principally of real property.
In general, there is no change of control provision that by itself would trigger tax and duty charges unless the change in control arises from the disposition of shares of stock in a domestic corporation. However, change of control may affect deductibility of certain expenses such as the net operating loss carryover, which is deductible from gross income only if there has been no substantial change in the ownership of a business or enterprise.
The BIR prescribed a formula under Revenue Audit Memorandum Order No. 1-95. This issuance provides the audit guidelines and procedures for the proper determination of the income tax liability of Philippine branches and liaison offices of multinational enterprises selling goods or providing services. Using the formula, a portion of the income derived from Philippine sources by the foreign entity is attributed and taxed to the branch or the liaison office.
There is no specific standard applied in allowing a deduction for payments by local affiliates for management and administrative expenses incurred by a non-local affiliate. As a rule, an expense may be allowed as a deduction from the gross income of the local affiliate if the same is an ordinary and necessary expense paid or incurred during the taxable year in carrying on, or which are directly attributable to, the development, management, operation and/or conduct of the trade or business of the local affiliate. The transfer pricing guidelines issued by the BIR also require that the payment should be consistent with the arm’s length principle. In case of payment to a non-local affiliate, an additional requirement is the withholding of any applicable withholding taxes by the local affiliate and remittance of the tax to the BIR.
In addition to the usual requirements of the deductibility of interest expense, the interest agreed upon by and between affiliates should be in accordance with the arm’s length principle adopted by the BIR, and the necessary withholding taxes withheld and paid to the BIR.
For purposes of the discussion below, the term 'local corporation' refers to a domestic corporation, which is defined under the Philippine Tax Code as a corporation created or organised in the Philippines or under its laws.
Foreign income of local corporations is not exempt from corporate tax as local corporations are taxed on income sourced within and without the Philippines.
Philippine-sourced income and foreign-sourced income together constitute the local corporation’s gross income, which, after taking into account the allowable deductions provided under the Philippine Tax Code, is subject to the regular corporate income tax of 30%. However, a minimum corporate income tax of 2% based on gross income is imposed on a local corporation, beginning on the fourth taxable year immediately following the year in which such corporation commenced its business operations, when the minimum corporate income tax is greater than the regular corporate tax.
Foreign-sourced income is not exempt from Philippine income tax. Hence, local expenses attributable to such foreign-sourced income are deductible, subject to the rules on allowable deductions provided in the Philippine Tax Code.
Dividends received by local corporations from foreign subsidiaries are included in the local corporations’ gross income, which, after taking into account the allowable deductions provided under the Philippine Tax Code, is subject to the regular corporate income tax rate of 30%.
Intangibles developed by local corporations may not be used by their non-local subsidiaries in their business without the former incurring local corporate tax. Local corporations should enter into a sale or licensing agreement with non-local subsidiaries pursuant to which the local corporations should receive compensation in accordance with the arm’s length principle. Any income derived by the local corporation should be included in the local corporations’ gross income, and after subtracting the allowable deductions, the taxable income shall be subject to the regular corporate income tax of 30%.
If local corporations do not recognise income for the use of their intangibles by non-local subsidiaries, a transfer pricing issue may arise.
There are no CFC rules in the Philippines. As a rule, Philippine tax law does not tax a local parent company on the CFC’s taxable income unless the CFC distributes dividends to the parent company.
Following the concept of separate legal personality and piercing the veil of corporate entity, a non-local affiliate will be considered a resident of the Philippines if circumstances show that the affiliate is just an extension of the juridical personality of the local corporation. However, this is largely a fact-driven exercise.
The gain realised by local corporations on the sale of shares in non-local affiliates is included in the local corporations’ gross income, which is subjected to the regular corporate tax of 30% after taking into account the allowable deductions provided under the Philippine Tax Code.
The Philippines’ anti-avoidance rules are based on jurisprudence. The Supreme Court makes a distinction between tax avoidance and tax evasion. Tax avoidance is recognised as a tax saving device using means sanctioned by law. Nonetheless, the Supreme Court ruled that a transaction that is prompted more by the mitigation of tax liabilities than for legitimate business purposes constitutes tax evasion, which is subject to both criminal and civil penalties.
In general, all taxpayers are considered possible candidates for audit. However, the BIR has identified certain transactions or taxpayers that are considered mandatory or priority audit cases. The mandatory audit cases include claims for tax refund/credit on erroneous/double payment of taxes, regardless of amount or requests for tax clearance of taxpayers undergoing merger/consolidation/split-up/spin-off and other types of corporate reorganisations.
Priority audit cases include issue-oriented audits (eg, transfer pricing, BEPs, industry issues), taxpayers deriving their revenue/income exclusively or substantially from their parent company/subsidiaries/affiliates, taxpayers with shared expenses and other interrelated charges being imputed by a parent company to its affiliates and likewise an affiliate to other affiliates in a conglomerate, and controlled corporations.
If a taxpayer is subjected to an audit, the BIR will issue a letter of authority to examine the taxpayer’s books, accounts and other records for a specific taxable year. The taxpayer has the opportunity to contest the BIR’s findings through administrative or judicial process. The BIR has three years from the prescribed date for filing or actual filing of the taxpayer’s income tax return, whichever is later, to assess deficiency taxes, except in cases of non-filing, false returns or fraudulent returns with intent to evade tax where the BIR has a right to assess within ten years from discovery.
The recommended changes under the BEPS action plan have not yet been incorporated in local tax laws and regulations. In January 2013, the Philippines put in place transfer pricing regulations based on OECD guidelines to provide guidance in applying the arm’s length principle for cross-border and domestic transactions between related enterprises. The transfer pricing regulations implement the authority given under the Philippine Tax Code to the CIR to allocate income or deductions between two or more organisations owned or controlled directly or indirectly by the same interests, and also include the requirement for taxpayers to keep adequate documentation that will demonstrate the taxpayer’s compliance with the 'arm’s length' principle. The transfer pricing regulations further state that additional regulations relating to the application of advance pricing arrangement and mutual agreement procedure processes will be issued, but these have yet to be released.
The Philippines is not a member of OECD but the Philippine government supports OECD initiatives against BEPS. The Philippines participated in meetings of the OECD Committee on Fiscal Affairs and its former CIR served as one of the Vice-Chairs of the ad hoc group that worked on the development of the multilateral instrument to implement the tax treaty-related BEPS action plan.
One of the government’s principal objectives in tax administration is to attain its collection targets. The government’s first tax reform package already took effect in January 2018. The second tax reform package proposed by the administration of President Rodrigo Duterte includes an amendment to tighten tax avoidance rules. The proposed amendment expanded the powers of the CIR to include the power to impute income in order to counteract tax avoidance arrangements and to disregard and consider tax avoidance transactions or arrangements as void for income tax purposes. The tax bill has been approved by the House of Representatives and will have to undergo approval by the Senate before it can be signed into law by the President. The second tax reform package is expected to be approved in the last quarter of 2018 so that it can take effect in January 2019. It is not known if the amendment on tax avoidance will make it into the final version of the law.
The BIR also identified as one of its priority programmes for the year 2018 the conduct of intensified audit investigations involving BEPS and transfer pricing to ensure taxpayer compliance and to collect the right taxes.
Traditionally, international tax does not have a very high public profile in the Philippines, although there is now more consciousness about it due to the number of foreign investors in the Philippines and increasing outward investments of Philippine companies. Transfer pricing concerns arising from related party transactions of local subsidiaries with their foreign parent companies or affiliates continue to drive the discourse on developing more comprehensive guidelines for the implementation and enforcement of regulations on transfer pricing. The transfer pricing guidelines were released by the BIR in 2013, but no additional regulations have been issued since then. For example, the 2013 transfer pricing guidelines allow taxpayers to enter into advance pricing arrangements ('APA') with the BIR but the separate guidelines on APAs are not yet in place. As the tax authority directs the conduct of intensified audit investigations involving BEPS and transfer pricing and as taxpayers seek clarity on how to comply with the 'arm’s length' principle, the government may turn to the BEPS recommendations in order to develop a more robust implementation and enforcement mechanism to address taxpayers’ transfer pricing concerns.
So far, the BEPs action plan has had limited impact on Philippine tax laws and regulations. The government is currently pursuing a tax reform package aimed at reducing the corporate income tax rate and simplified tax filing procedures, although the principal objectives of the current administration’s tax reform policy is to promote inclusive growth and to raise revenues to support the administration’s ten-point socioeconomic agenda, which includes a massive infrastructure programme.
The actions recommended by BEPS may have a more significant impact on transfer pricing provisions and tax avoidance rules, especially if applied to transactions between related parties where the local affiliate enjoys income tax incentives (eg, enterprises located at economic zones and freeport zones). The administration’s second proposed tax reform package expands the power of the CIR to expressly include the power to impute income among related companies, if necessary to prevent avoidance of taxes or to clearly reflect the income of such companies and the power to disregard as void a transaction that has tax avoidance as its purpose or effect. However, until the second tax reform package is signed into law, it is not yet clear what mechanisms will be put in place to implement the amendments.
The Philippines has not adopted hybrid mismatch rules in response to BEPS. There are no hybrid mismatch rules in the second proposed tax reform package.
The Philippines has primarily a territorial tax regime, although resident citizens and domestic corporations are taxed on worldwide income. Consistent with territoriality, non-residents are taxed only on income derived from the Philippines.
The Philippines applies a tax arbitrage rule on deductible interest which reduces the allowable deduction for interest expenses by 33% of the interest income subject to final tax. This is intended to bridge the gap between the ordinary corporate income tax rate of 30% and the final tax rate on interest income which is generally 20%.
Also, interest expense deduction will not be allowed if the interest payment is between two corporations, more than 50% of the stock of which is owned directly or indirectly by or for the same individual, if either one of the corporations is a personal holding company. A personal holding company is one which meets the stock ownership and gross income requirements under the tax regulations. Under the stock ownership requirement, it is necessary that more than 50% in value of the personal holding company’s outstanding stock is owned, directly or indirectly, by not more than five individuals. Under the gross income requirement, it is necessary that 70% or more of the gross income of the corporation must be classified as personal holding company income.
Sweeper CFC rules may not necessarily achieve the purpose of preventing the shifting of income to lower tax jurisdictions since there may be other reasons for locating offshore subsidiaries in low-tax rate jurisdictions. However, if sweeper CFC rules are adopted, they need to be carefully crafted to ensure that they target only activities that were entered into for tax avoidance purposes and do not unnecessarily affect economic activity adversely.
The Philippines already has general anti-avoidance rules based on principles arising from Supreme Court decisions. The Supreme Court has made a distinction between tax avoidance and tax evasion. According to the Supreme Court, tax avoidance is “the tax-saving device within the means sanctioned by law. This method should be used by the taxpayer in good faith and at arm’s length.” What the law clearly prohibits is tax evasion, which is considered the wilful attempt, in any manner, to evade or defeat any tax imposed under the Philippine Tax Code. The Supreme Court nonetheless considers transactions that are prompted more by the mitigation of tax liabilities than for legitimate business purposes as entered into for tax evasion purposes. Currently, proposed amendments to the Tax Code expressly provide that transactions with a tax avoidance purpose or effect may be considered void transactions.
The Philippines’ tax treaties with certain countries have taken into account DTC limitation of benefits.
The transfer pricing changes proposed may cause changes in the reporting regime in the Philippines. While the current transfer pricing regulations already require taxpayers to keep adequate documentation to be able to show that transfer prices are consistent with the arm’s length principle, the regulations do not require the transfer pricing documents to be submitted with tax returns, unless the tax authority requires or requests the taxpayer to do so. Taxpayers may resist the recommended transfer pricing documentation and treat it as an unduly burdensome process given that the three-tiered documentation approach requires more comprehensive information than those currently required under the transfer pricing regulations.
The taxation of profits from intellectual property is not a particularly controversial issue in the Philippines. The Philippines’ transfer pricing regulations apply to intangible properties, although the regulations will benefit from having a broader and more clearly delineated definition of intangible properties given that more Philippine companies are investing and expanding outside the Philippines. The Philippines also imposes a final withholding tax on the gross income earned by non-resident foreign corporations from sources within the Philippines. Gross income means all income derived from whatever source, including (but not limited to) income derived from rents or royalties. Income from rents and royalties are considered to be Philippine-sourced if the income arises from property located in the Philippines or from any interest in such property, or the use of, or the right or privilege to use in the Philippines any intellectual property. On the other hand, if the intellectual property is owned by a domestic corporation, royalties earned on such intellectual property from sources outside the Philippines will form part of the domestic corporation’s gross income for purposes of computing its taxable income.
Transparency may be necessary to enable tax authorities to determine taxpayers’ compliance. However, taxpayers may be reluctant to share information on their transactions unless they can be assured that sufficient mechanisms are in place to ensure the confidentiality of the information made available under the reporting requirements. In 2009, Republic Act No. 10021, otherwise known as the Exchange of Information on Tax Matters Act, was enacted pursuant to the government’s policy to comply with or commit to the internationally agreed tax standards required for the exchange of tax information with its tax treaty partners to help combat international tax evasion and avoidance. Under the law, information received by the foreign tax authority from the BIR pursuant to an international convention or agreement on tax matters are considered absolutely confidential in nature, and disclosure of such information shall be limited to the assessment or collection, enforcement or prosecution, of the taxes covered under such international conventions or agreements.
There is much awareness about the taxation of profits generated by digital economy businesses. The BIR has issued regulations requiring persons engaged in online transactions and apps-based businesses to register their business, issue receipts, file returns and pay the taxes due on their income. The BIR also recently issued a circular clarifying that Philippine Offshore Gaming Operations licensees, whether foreign-based or Philippine-based, conducting off-shore gaming operations are required to register with the BIR before they commence business. The tax authority, however, has recognised that enforcement of the regulations remains difficult due to the nature of online businesses, especially those that do not have any local presence in the Philippines.
There is no publicly available study on whether BEPS has affected revenue generation in the Philippines and the magnitude of such effect. The current administration is focused on passing tax reforms aimed at raising revenue collection for its socio-economic programmes. It remains to be seen how the government intends to address BEPS issues that result in revenue loss and whether the recommended changes under the BEPS action plan will be significantly adopted in local laws and regulations as more Philippine entities get involved in cross-border transactions.