Contributed By SyCip Salazar Hernandez & Gatmaitan
Businesses in the Philippines generally adopt a corporate form, although some businesses operate through partnerships. Individuals may also operate as sole proprietors or in partnerships.
Corporations are either formed under the Revised Corporation Code of the Philippines (RCC) or created under special law.
Corporations formed or organised under the RCC 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. Under the RCC, which took effect on 23 February 2019, corporations may be organised with a sole shareholder ("one-person corporation").
Corporations have the powers provided under the RCC, and may exercise such other powers as may be essential or necessary to carry out the business purposes stated in their articles of incorporation. Corporations may exist perpetually.
Corporations are taxed as separate legal entities. For income tax purposes, entities that are not corporations as defined under the RCC – such as joint-stock companies, joint accounts, 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 (MCIT) of 2%). When corporations declare dividends to their shareholders, or profits to their partners, in the case of partnerships that are considered corporations, 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%.
Among the transparent entities commonly used in the Philippines, GPPs and unincorporated joint ventures or consortiums are exempt from income tax. The income tax is imposed on their partners or 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 Philippine taxation purposes.
A corporation organised under Philippine laws 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. A non-resident foreign corporation refers to a foreign corporation not engaged in trade or business within the Philippines.
For income tax purposes, domestic corporations are taxed on their worldwide income; foreign corporations are taxed only on their Philippine-source income.
Income tax of domestic and resident foreign corporations is based on their taxable income, or gross income less allowable deductions, while non-resident foreign corporations are taxed on their gross income, without deductions.
For purposes of income taxation, the residence of transparent entities is generally not material since they are exempt from income tax. However, the determination of the residence of the individuals or corporations composing the transparent entity is relevant, as they are the ones directly 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 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 allowed under the Philippine Tax Code or other special laws.
Taxable income is not entirely based on accounting profits. Certain items are income for accounting purposes but are not taxable under the Tax Code. Certain deductions are allowable for accounting purposes but not under the Tax Code, and vice versa.
For instance, accounting income should be adjusted to exclude from taxable income any income that has been subjected to final tax, and to add back expenses that under tax laws are not deductible (eg, provisions for bad debts since under the Tax Code bad debts must 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 such method does not clearly reflect the income, the computation will be made in accordance with such method as in the opinion of the 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, the latter shall prevail for purposes of income taxation.
Income earned by an alien or a foreign corporation from the use of intellectual property in the Philippines is considered as Philippine-source income and is subject to Philippine income tax. Income earned by a resident citizen or a domestic corporation from the use of intellectual property within or outside the Philippines will be subject to Philippine income tax.
Businesses conducting research and development (R&D) activities may be granted fiscal incentives such as the income tax holiday (ITH) for a certain period. Under the 2017 Investment Priorities Plan of the Philippine government, “innovation drivers” such as R&D activities have been identified as preferred activities for investment subject to incentives. 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.
A taxpayer may treat R&D 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 they were paid or incurred.
However, subject to the relevant rules and regulations, the taxpayer may opt to treat as deferred expenses the R&D 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 ("PEZA Law"), the Omnibus Investments Code of 1987 (OIC) and the Bases Conversion and Development Act of 1992 ("BCDA Law").
Under the PEZA Law, businesses located in designated economic zones ("ecozones") and registered with the relevant ecozone authority are entitled to fiscal incentives such as ITH 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 OIC, entities engaged in preferred activities and registered with the Board of Investments are likewise entitled to fiscal incentives such as ITH 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.
The BCDA Law provides fiscal incentives to business enterprises that are located within former military bases that were converted into ecozones or freeport 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 other special laws that provide fiscal incentives to certain sectors or undertakings such as co-operatives, renewable energy developers, exporters and tourism enterprises in order to promote economic development.
The Philippine Tax Code provides that the net operating loss (NOL) of an enterprise (ie, the excess of allowable deductions over the gross income) 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 when the taxpayer was exempt from income tax is not allowed as a deduction. Additionally, a net operating loss carry-over (NOLCO) shall be allowed only if there has been no substantial change in the ownership of the business in that:
where such substantial change resulted from the said taxpayer’s merger or consolidation or business combination with another person, and not through a sale by a shareholder.
Ordinary loss is deductible against ordinary gain and capital gain, while capital loss 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.
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 20% final tax.
No deduction is allowed in respect of interest:
The taxpayer may opt to treat interest incurred to acquire property used in business as a deduction or 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 NOL may be transferred or assigned to the surviving or new corporation or entity if the shareholders of the transferor/assignor gain control of at least 75% or more in nominal value of the outstanding issued shares or paid-up capital of the transferee/assignee (if the surviving entity is a corporation) or 75% or more interest in the business of the transferee/assignee (if the transferee/assignee is not a corporation).
Additionally, in a merger, the NOLCO shall be allowed as a deduction from gross income of the surviving entity if the taxpayer who sustained and accumulated the NOL 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 that, in the course of trade or business, sells, barters, exchanges, leases goods or properties, or renders services, is subject to VAT at the rate of 12% on the sale of goods or service, barter or exchange. The importation of goods is likewise subject to VAT.
Depending on the transaction, corporations may be subject to documentary stamp tax (DST), 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 VAT, and VAT is computed on the gross selling price or gross receipt plus the excise tax.
Certain income payments are subject to final or creditable withholding taxes. 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 (FWT) is 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 FWT:
The sale, exchange or disposition of lands and/or buildings that are not actually used in the business of a corporation and are treated as capital assets is subject to 6% capital gains tax (CGT) based on the gross selling price or fair market value of the property, whichever is higher.
The sale of shares of stock in a domestic corporation is subject to a separate tax – CGT or stock transaction tax.
Additionally, 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 business is done in the Philippines, closely held businesses would usually operate in corporate form.
The RCC has its own definition of a "close" corporation. A close corporation is one whose articles of incorporation provides that (i) all the corporation’s issued stock of all classes, exclusive of treasury shares, are held of record by not more than 20 persons; (ii) all the issued stock of all classes are subject to specified restrictions on transfer; and (iii) the corporation is not listed in any stock exchange or has not made any public offering of its stocks of any class.
The concept of a one-person corporation was recently introduced in the RCC.
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 fact that the earnings or profits of a corporation are permitted to accumulate beyond the reasonable needs of the business is determinative of the purpose to avoid the tax upon its shareholders, unless contrary evidence is shown. The IAET does not apply to publicly held corporations, among others.
The RCC also prohibits stock corporations from retaining surplus profits in excess of 100% of their paid-in capital stock subject to certain exceptions.
Cash and property dividends received by citizens or resident aliens from their shares in domestic corporations (including closely held corporations) are subject to a final tax of 10%, while those received by non-resident aliens engaged in trade or business in the Philippines and non-resident aliens not engaged in trade or business in the Philippines are subject to a final tax of 20% and 25%, respectively.
Stock dividends are not subject to income tax if the number of shares received is in proportion to the existing shareholding of the stockholder. However, the issuance of shares through the declaration of a stock dividend is subject to DST 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 subject to a final tax of 10%, while those received by non-resident aliens engaged in trade or business in the Philippines and non-resident aliens not engaged in trade or business in the Philippines 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 if the number of shares received is in proportion to the existing shareholding of the stockholder. However, the issuance of shares through the declaration of a stock dividend is subject to DST 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 6/10 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 FWT of 25%.
Interests and royalties earned by non-resident foreign corporations are subject to FWT of 30%.
However, interest on foreign loans received by non-resident foreign corporations is subject to FWT of 20%.
Dividends earned by non-resident foreign corporations are generally subject to FWT of 30%. This rate is reduced to 15% if the country of domicile of the non-resident foreign corporation 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 RCIT 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 showing which 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 an applicable tax treaty.
For interest, dividends and royalties, no tax treaty relief application (TTRA) is required but the non-resident must submit a certificate of residence for tax treaty relief (CORTT) form to the payor of the income or the withholding agent in order to avail of the preferential treaty rates for these incomes. Such preferential tax treaty rates or exemptions shall be applied and used outright by the withholding agents upon submission of CORTT forms by the non-resident, subject to a compliance check and post-reporting validation during the regular tax audit by the BIR on the payor or withholding agent. Non-compliance with the regulations prescribing the procedures to avail of the tax treaty benefits on dividends, interests and royalties is a ground for denial of the non-resident’s claim for preferential tax treatment, as well as the disallowance of the relevant expense on the part of the payor or withholding agent.
For other types of income, the availment of tax treaty relief must be preceded by a TTRA filed with the BIR. If the BIR finds that the entity is not qualified, then the TTRA will be denied.
Based on the BIR’s transfer pricing guidelines, 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 continues 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 transfer pricing regulations prescribed 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 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.
The BIR recently issued the transfer pricing audit guidelines applicable to controlled transactions including sale, purchase, transfer and use of tangible and intangible assets, intra-group services, interest payments and capitalisation, among others, between related/associated parties, where at least one party is subject to tax in the Philippines. For purposes of the guidelines, the permanent establishment is treated separately from its head office or other related branches or subsidiaries for tax purposes.
The transfer pricing regulations recognise 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.
Under the audit guidelines, the BIR must conduct a functional, asset and risk analysis in order to determine the nature of the taxpayer’s business. Functional analysis is performed to obtain accurate identification on the characteristics of the taxpayer’s business as well of its counterparts, and consequently, the level of the risks borne and the remuneration or profit (which must be proportional with the risks borne) can be predicted.
However, this firm has not yet seen and are not aware whether the BIR has already applied these audit guidelines and 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 are largely 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 necessary, in order to prevent evasion of taxes or clearly reflect the income of any such organisation, trade or business.
Thus, transfer pricing adjustments made by the BIR are to ensure that taxpayers clearly reflect income attributable to controlled transactions and to prevent tax evasion in such transactions.
Under the transfer pricing audit guidelines, upon finding that the price or rate is not at arm’s length, the BIR will propose adjustments by imputing the arm’s-length margin (eg, the discrepancy between the price or profit of the affiliated transactions and the arm’s-length price or profit). The primary adjustments may also lead to secondary adjustments.
The BIR will discuss their findings with the taxpayer and the latter may contest the facts and issues identified, similar to the notice of informal conference stage in a regular tax audit. Thereafter, the regular tax audit process and remedies (eg, protest, administrative and judicial appeal) will be applicable.
The transfer pricing regulations granted the taxpayers the option to avail of the advance pricing agreements (APA) and the mutual agreement procedure (MAP) relief. However, difficulties in the actual implementation have yet to be seen since, to date, the BIR has not yet issued APA or MAP guidelines.
The term "non-local corporation" used here shall refer to a foreign corporation, 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. Local branches of non-local corporations are subject to income tax only on their Philippine-source 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 local branch’s remittance of branch profits 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 FWT 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 CGT 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 CGT of 15%. Net capital gains of non-resident foreign corporations not exceeding PHP100,000 are subject to CGT of 5%, while any gain in excess of PHP100,000 is subject to CGT of 10%.
The gain from the sale of shares of a non-local holding company 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 CGT 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 CGT 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 in a domestic corporation. However, change of control may affect deductibility of certain expenses such as the NOLCO, which is deductible from gross income only if there has been no substantial change in the ownership of a business or enterprise.
The BIR’s Revenue Audit Memorandum Order No 1-95, which contains 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, prescribes a formula whereby 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 the case of payment to a non-local affiliate, the payor must withhold any applicable withholding taxes and remit the same 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.
In determining whether the interest payment transactions are at arm’s length, the BIR, under the transfer pricing audit guidelines, will look into various factors such as the nature and purpose of the debt, market conditions at the time the loan is extended, amount of principal and period of the loan, security offered and guarantees, and the amount of debt already held by the borrower.
The term "local corporation" used here shall refer to a domestic corporation, 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 they are taxed on worldwide income.
Philippine-source income and foreign-source income together constitute the local corporation’s gross income. The local corporation pays the higher of RCIT of 30% based on gross income less the allowable deductions provided under the Tax Code, or MCIT of 2% based on gross income.
Foreign-source 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 an RCIT rate of 30%, or subject to MCIT of 2%.
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 its gross income, and after subtracting the allowable deductions, the taxable income shall be subject to RCIT of 30%.
If local corporations do not recognise income for the use of their intangibles by non-local subsidiaries, transfer pricing issues may arise.
There are no controlled foreign corporation (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 RCIT of 30% after taking into account the allowable deductions provided under the Philippine Tax Code or subject to MCIT of 2%.
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, but certain transactions or taxpayers are considered mandatory or priority audit cases by the BIR. 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 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.
In August 2019, the BIR issued the transfer pricing audit guidelines, which provide standardised audit procedures and techniques applicable to taxpayers with related-party or intra-company transactions. The audit guidelines specify the audit procedures to be applied to common transfer pricing issues relating to intra-group services, intangible assets and interest payments.
The transfer pricing regulations implement the authority of 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 APA and MAP processes will be issued, but these have yet to be released.
The Philippines is not a member of the 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 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. It is anticipated that the bill will also be approved by the Senate considering the support it obtained from various business groups and from the head of one of the investment promotion agencies. The government is pushing for the tax reform proposal to be passed and signed into law by early 2020.
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, which allow taxpayers to enter into APA with the BIR, but the separate guidelines on APAs are not yet in place.
In August 2019, the BIR issued transfer pricing audit guidelines prescribing standardised audit procedures and techniques in auditing taxpayers with related-party or intra-group transactions. While these guidelines serve as an internal manual for BIR examiners in the conduct of their tax audit, the guidelines contain the application of arm’s-length principles in specific common transfer pricing issues (eg, intra-group services, intangible assets), transfer pricing methods and various factors to consider that the taxpayer may find valuable in its preparation of transfer pricing documentation.
Currently, the Philippines has a competitive tax policy and grants generous fiscal and non-fiscal incentives to inward investments, although it has the highest corporate income tax rate compared to other Association of Southeast Asian Nations (ASEAN) countries. The second tax reform package aims to rationalise tax incentives to make the incentive system performance-based, targeted, time-bound and transparent.
The government is also pursuing a tax reform package aimed at reducing the corporate income tax rate and simplified tax filing procedures, harmonisation of taxes on capital transactions and anti-avoidance rules.
The principal objective of the current administration’s tax reform policy is to promote inclusive growth and to raise revenues to support the administration’s ten-point socio-economic 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 ecozones and freeport zones).
The government’s second proposed tax reform package expands the power of the CIR to expressly include the power to disregard as void a transaction that has tax avoidance purposes or effects.
The Philippines has not adopted hybrid mismatch rules in response to BEPS. The fourth proposed tax reform package provides for a unified income tax rate for passive income such as interests, dividends and capital gains.
Generally, the current policy of the Philippine government is to develop a capital market by providing an efficient regulatory framework, and in terms of taxation, harmonising taxes on capital transactions to become simpler, fairer and more efficient.
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 Philippine-source income. Interest income is considered Philippine-sourced if it arises from loans extended to residents.
The Philippines applies a tax arbitrage rule on deductible interest that 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 that meets the stock ownership and gross income requirements under the tax regulations. Under the stock ownership requirement, more than 50% in value of the personal holding company’s outstanding stock must be owned, directly or indirectly, by not more than five individuals. Under the gross income requirement, 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’ general anti-avoidance rules are largely based on principles arising from Supreme Court decisions, which made a distinction between tax avoidance and tax evasion. 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 grant the CIR the power to impute income, which can be exercised where a transaction or arrangement is motivated by obtaining a tax benefit or advantage with no commercial reality or economic effect (eg, altering tax incidence, avoiding or deferring a tax liability). Consequently, the CIR may declare void any transaction where the motive is to obtain a tax benefit.
The Philippines’ tax treaties with certain countries have taken into account double taxation convention (DTC) limitation of benefits.
The proposed transfer pricing changes may cause changes in the reporting regime in the Philippines. The current transfer pricing regulations already require taxpayers to keep adequate documentation to show that transfer prices are consistent with the arm’s-length principle, but such documents are not required 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 two major categories of intangible properties or assets: manufacturing intangibles and marketing intangibles.
Manufacturing intangibles are generally created through R&D activities, which are risky and entail expenses.
Marketing intangibles include trade marks or trade names that help increase the marketing of goods and services and have important promotional value for the products.
To determine arm’s-length transactions, the existence of intangible assets must be considered as it necessarily entails a higher profitability level than the average for the industry. Thus, the owner will necessarily require and should be compensated with more than a mere return to recover the costs incurred for the development of such intangible assets.
The Philippines also imposes FWT on the gross income earned by non-resident foreign corporations from Philippine sources. Gross income includes income derived from rents or royalties, which 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. 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 its gross income for purposes of computing 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 sufficient mechanisms are in place to ensure the confidentiality of the information made available under the reporting requirements.
The Philippines enacted the Exchange of Information on Tax Matters Act of 2009 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 is considered absolutely confidential, 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.
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 offshore 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.
This firm is not aware of any specific plans to revise the tax laws in response to BEPS proposals for digital taxation, or introduce a new tax mechanism for offshore digital service providers. There is also no current proposal to amend the concept of "permanent establishment" for income tax purposes to cope with the digital economy. However, the BIR is still studying and exploring ways on how to properly tax online-based transactions and digital services.
Under the current rules on situs of taxation, income from services performed in the Philippines are considered Philippine-sourced income subject to income tax; thus, services performed offshore by non-residents should not be taxable under the current tax laws. This holds true until the current situs rules are amended, or unless there is a provision to the effect that digital services are considered performed within the Philippines, despite the service provider being located offshore.
Currently, the Philippine consumption tax (ie, VAT) on e-commerce transactions seems to apply to local players only. In a regular service transaction, the local taxpayer is constituted as a withholding agent who withholds the VAT from its income payments to non-residents who render services in the Philippines, and remits the VAT to the BIR. Thus, this mechanism should also be adopted in respect of digital services provided by non-residents to service recipients located in the Philippines.
Revenues earned by offshore companies from licensing IP in the Philippines are subject to FWT of 30% (royalty withholding tax regime). The FWT is withheld and remitted to the BIR by the local income payors.
IP owners who are residents in countries that have tax treaties with the Philippines may avail a preferential tax rate on royalties derived from the licensing of IP 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.