Business organisations in the Philippines are generally formed as incorporated entities or corporations, although business firms may also be organised as partnerships or sole proprietorships.
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, corporations may be organised with a sole shareholder (a "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 corporate income tax rate is 25% while the minimum corporate income tax (MCIT) is 2%. This was reduced to 1% until 30 June 2023, after which it will revert to 2%. A lower corporate income tax of 20% is also provided for domestic corporations with net taxable income not exceeding PHP5 million and with total assets not exceeding PHP100 million, excluding land on which the corporation’s office, plant and equipment are situated during the taxable year for which the tax is imposed.
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 a 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%.
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-sourced 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.
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 subject 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 subject to final tax, and to add back expenses that are not deductible under tax laws (eg, provisions for bad debts since, under the Tax Code, bad debts must be 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-sourced 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 2020 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, uncommercialised patents on products and services, and products of locally undertaken R&D activities, 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 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 Corporate Recovery and Tax Incentives for Enterprises Act (the "CREATE Law”) sets out the fiscal incentives for entities engaged in preferred activities and registered with the Board of Investments, and for business enterprises that are located within designated economic zones ("ecozones") or former military bases that were converted into ecozones or freeport zones.
Under the CREATE Law, a uniform set of incentives may be granted to qualified enterprises whose activities are listed in the strategic investment priority plan, among other conditions. The fiscal incentives that may be granted to qualified registered enterprises under the CREATE Law are:
There are other special laws that provide fiscal incentives to certain sectors or undertakings such as co-operatives and renewable energy developers in order to promote economic development.
Additionally, under the CREATE Law, the grant of a preferential tax rate to existing registered enterprises will have a sunset period of ten years from effectiveness of the law if the existing registered enterprise is availing of the 5% gross income tax incentives. Existing registered enterprises availing of the ITH may continue to enjoy such incentive for the period granted under the terms of their registration. Enterprises that, prior to the CREATE Law, were granted the ITH and the 5% gross income tax incentives after the expiry of the ITH are allowed use the ITH for the period specified in the terms of their registration and thereafter, to avail of the 5% preferential tax, subject to the ten-year limit for both incentives under the CREATE Law.
Furthermore, the Fiscal Incentives Review Board (FIRB) is tasked to grant appropriate tax incentives to registered projects or activities upon the recommendation of the relevant investment promotion agency. The grant of tax incentives to registered projects or activities with investment capital of PHP1 billion and below is delegated by the FIRB to the concerned investment promotion agencies to the extent of their approved registered project or activity under the strategic investment priority plan. The FIRB is authorised under the CREATE Law to adjust the threshold amount of PHP1 billion.
The President is also given the power to modify the period or manner of availing incentives in the interest of national economic development and upon recommendation of the FIRB, provided that the grant of an ITH shall not exceed eight years and, thereafter, a special corporate income tax rate of 5% may be granted. However, the cumulative period of incentive availment for incentives granted by the President shall not exceed 40 years.
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, 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.
Under the CREATE Law, registered enterprises granted tax incentives are entitled to an enhanced NOLCO, which means that the net operating loss of a registered project or activity during the first three years from the start of commercial operations that had not been offset as deduction from gross income may be carried over as deduction from gross income within the next five consecutive taxable years immediately following the year of such loss.
Interest paid or incurred by a taxpayer within a taxable year on indebtedness in connection with their business is generally allowed as a deduction from their gross income, but such allowable deduction for interest expense shall be reduced by 20% 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 and foreign corporations on the sale or exchange of shares in a domestic corporation not traded on the Philippine stock exchange are subject to a final tax of 15%.
The sale of shares listed and traded on 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 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. Under the Tax Reform for Acceleration and Inclusion (TRAIN) Law, beginning 1 January 2023, VAT-registered corporations are no longer required to file monthly VAT declarations. They are now required to file VAT returns and pay VAT within 25 days following the close of each taxable quarter.
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 that 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 that are held as capital assets is subject to a separate tax – CGT or stock transaction tax.
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:
The concept of a one-person corporation was 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 CREATE Law repealed the Philippine Tax Code provision imposing a 10% IAET on improperly accumulated taxable income.
The RCC 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 sold.
Net capital gains realised by individuals on the sale or exchange of shares in domestic corporations (including closely held corporations) not traded on the Philippine stock exchange are subject to a final tax of 15%. The sale of shares in domestic corporations outside the stock exchange is subject to DST at the rate of PHP1.50 for every PHP200 of the par value of the shares issued.
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.
The sale of shares listed and traded on 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 25%.
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 25%. 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 10%, which represents the difference between the RCIT rate of 25% and the 15% tax rate on dividends. This is referred to as tax sparing credit.
The Philippine Bureau of Internal Revenue’s (BIR) 2022 priority programme included an intensified audit and investigation on, among others, withholding tax on compensation income, which was intended to be one of the sources for the collection of at least 3% of the BIR’s total collection goal.
The Philippines is a party to tax treaties with 43 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 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.
Before the payment of the income, the non-resident deriving income from Philippine sources (eg, interest, dividends, royalties) must submit a prescribed application form for treaty purposes, a tax residency certificate duly issued by the foreign tax authority, and the relevant provision of the applicable tax treaty to the payor of the income or the withholding agent in order to avail of the preferential treaty rates for these incomes. The withholding agent may apply the preferential tax treaty rates upon submission of the required documents by the non-resident, subject to the filing of a request for confirmation with the BIR on the propriety of the withholding tax rate applied on the income. Failure to provide the required documents may result in the imposition of withholding tax using the regular rates prescribed under the Tax Code. If the regular rate under the Tax Code was applied on the income instead of the preferential treaty rates, the non-resident income recipient may file a tax treaty relief application and a claim for refund with the BIR to prove its entitlement to the treaty benefit.
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.
To provide a framework and guide for transfer pricing examinations by the BIR, the BIR issued transfer pricing audit guidelines, which are applicable to controlled transactions between related/associated parties where at least one party is subject to tax in the Philippines and to transactions between a permanent establishment and its head office or other related branches.
The BIR also issued regulations to ensure that proper disclosures of a related-party transaction are made and that these transactions are conducted at arm’s length. The BIR amended these regulations to streamline the procedure for submission of the disclosure form, transfer pricing documentation and other supporting documents by providing safe harbours and materiality thresholds.
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 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 as 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 is 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 "OECD Guidelines").
International transfer pricing disputes are not prevalent in the Philippines. However, the BIR has recognised transfer pricing issues in prior issuances, and it has recently issued guidelines and procedures for requesting mutual agreement procedure (MAP) assistance in the Philippines. While the typical recourse of a taxpayer affected by double taxation or inaccurate application of treaty provisions is to file an administrative or judicial appeal, with the MAP guidelines, the taxpayer is given the option to resolve disputes through the MAP process. Resolution of a MAP case may take an average of 24 months. The time to complete the MAP case will depend on the complexity of the issue and the co-operation of the taxpayer and competent authorities.
While specific guidelines have not yet been released, the BIR has signified that taxpayers may avail of advance pricing arrangements (APAs) to reduce the risk of transfer pricing examination and double taxation. An APA may be unilateral, which is an agreement between the taxpayer and the BIR, or bilateral or multilateral, which is an agreement involving the Philippines and one or more of its treaty partners. If a taxpayer does not choose to enter into an APA, it may still invoke the article on MAPs in Philippine tax treaties to resolve double taxation issues. Given that the MAP regulations are fairly new, there is no data yet on MAP cases.
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 its findings with the taxpayer and the latter may contest the facts and issues identified. 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 APA and the MAP relief. However, difficulties in the actual implementation have yet to be seen since the BIR has not yet issued APA guidelines, and while MAP assistance guidelines have been issued, the regulations are fairly new.
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-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:
Regional operating headquarters (ROHQs) of non-local corporations are now subject to the RCIT.
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 25% subject to the tax sparing credit and tax treaty.
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 and non-resident foreign corporations arising from the sale of stock in local corporations not traded on the local stock exchange are subject to CGT of 15%.
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 the 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 that is 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.
Additionally, no interest expense deduction is allowed if both the taxpayer and the person to whom the interest is paid or payable are related parties as specified under the Philippine Tax Code.
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-sourced income and foreign-sourced income together constitute the local corporation’s gross income. The local corporation pays the higher of RCIT of 25% (or 20%) based on gross income less the allowable deductions provided under the Tax Code, or MCIT of 2% (reduced to 1% until 30 June 2023) based on gross income.
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 generally 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 25% (or 20%), or MCIT of 2% (reduced to 1% until 30 June 2023). However, under the CREATE Law, dividends from foreign subsidiaries may be exempt from tax provided the following conditions are met:
If any of the above conditions is not satisfied, the dividends shall be considered as taxable income of the local corporation in the year of actual receipt or remittance, subject to surcharges, interest and penalties, as may be applicable.
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 25% (or 20%).
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 a 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 subject to RCIT of 25% (or 20%) after taking into account the allowable deductions provided under the Philippine Tax Code, or to MCIT of 2% (reduced to 1% until 30 June 2023).
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 has 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 subject 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 the 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 the APA process 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.
This firm is not aware of any specific plans of the government to revise the tax laws in order to give effect to Pillars One and Two of BEPS.
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, the CREATE Law, was signed into law on 26 March 2021. Among the amendments under the CREATE Law is the provision of a sunset period for the preferential tax rate enjoyed by ROHQs of non-resident foreign corporations, which, according to the Department of Finance, will “address the potentially harmful tax features flagged by the OECD”. Under the CREATE Law, starting 1 January 2022, ROHQs will be subject to the RCIT rate.
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 APAs 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. In 2020, the BIR issued regulations setting out the guidelines, procedure and the required forms for the proper disclosure of related-party transactions that were intended to improve the BIR’s transfer pricing risk assessment and audit functions.
Currently, the Philippines has a competitive tax policy and grants generous fiscal and non-fiscal incentives to inward investments. It has reduced its corporate income tax rates in order to boost the country’s competitiveness and attract foreign investments. The CREATE Law reduced the corporate income tax rate and rationalises tax incentives to make the incentive system performance-based, targeted, time-bound and transparent.
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. Tax reforms were also introduced to help businesses recover from the effects of the pandemic.
Tax leakages under the Philippine tax system may be attributed to transfer pricing and tax avoidance cases. In this regard, 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 Philippine government has issued transfer pricing guidelines, although it appears that the BIR has not strictly implemented the rules. Furthermore, the CREATE Law limited the period of availment of tax incentives granted prior to the CREATE Law to existing registered enterprises (which are mostly located in ecozones or freeport zones) to a fixed period of ten years from effectivity of the law. The incentives under the CREATE Law were designed to be performance-based and enterprises intending to avail of the incentives under the CREATE Law must register new activities that are listed under the government’s strategic investment priorities plan.
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 20% of the interest income subject to final tax. This is intended to bridge the gap between the ordinary corporate income tax rate of 25% 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.
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.
The Philippines’ tax treaties with certain countries have taken into account double taxation convention (DTC) limitation of benefits.
The transfer pricing changes may entail adjustments to 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 that currently required under the transfer pricing regulations.
The taxation of profits from intellectual property is not currently 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 – including payment gateways, delivery channels and internet service providers – to register their business, issue receipts, file returns and pay the taxes due on their income.
The BIR also issued a circular clarifying that Philippine Offshore Gaming Operations (POGO) licensees, whether foreign-based or Philippine-based, conducting offshore gaming operations are required to register with the BIR before they commence business. Recent legislation also imposed a 5% tax on the gaming revenues of POGOs and 25% tax on non-gaming revenues.
POGOs are required to submit to the BIR periodic reports on POGO operations certified by independent third-party auditors to ensure that the proper taxes are being levied. 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.
Legislation on the taxation of digital businesses has been filed and approved by the House of Representatives (HOR).
The HOR approved House Bill No 4122, which does not impose new taxes but seeks to clarify that electronic or digital services such as digital advertising, subscription-based services and other services using information communication technology (ICT)-enabled infrastructure, are subject to VAT. Educational services, even if provided online, remain exempt from VAT.
Revenues earned by offshore companies from licensing IP in the Philippines are subject to FWT of 25% (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 of a preferential tax rate on royalties derived from the licensing of IP in the Philippines.
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Significant Developments in Corporate Tax
The taxation landscape in the Philippines is dynamic. A number of tax laws and regulations were passed in 2022, and along with the election of a new president in the same year, tax reforms are expected to continue in the foreseeable future.
Below are some of the significant developments in the Philippines.
Mutual Agreement Procedure Guidelines
The Philippine Bureau of Internal Revenue (BIR) has issued a set of guidelines and procedures for requesting mutual agreement procedure (MAP) assistance in the Philippines, a process which is considered an alternative mode of resolving disputes arising from differences or the inaccurate interpretation or application of treaty provisions. The MAP guidelines provide for the process of initiating a MAP request, the supporting documents and information that the taxpayer needs to submit to the Philippine competent authority, and guidance in the implementation of a MAP agreement.
Generally, before accepting a MAP request, the responsible officer performs a preliminary assessment of the case to determine whether the requisites for a valid MAP request are present. Once the MAP request is accepted, the MAP office will commence a detailed analysis of the MAP request to determine if the taxpayer’s objection is justified and whether the Philippine competent authority can resolve the case unilaterally or will require the involvement of the competent authority of the other jurisdiction to reach an agreement or a solution to the issue. Assuming a bilateral process was followed, the taxpayer will be notified of any agreement reached between the competent authorities, and a period of time will be given to the taxpayer to express their acceptance or disapproval of the mutual agreement. If the taxpayer accepts the mutual agreement reached, the Philippine competent authority is mandated to give effect to such mutual agreement and ensure its timely implementation.
Based on the guidelines, the average timeframe to resolve MAP cases is 24 months from receipt of a complete MAP request. However, the actual timeframe depends on the complexity of the case, and co-operation of the taxpayer and competent authorities.
Spontaneous Exchange of Taxpayer-Specific Rulings
The exchange of information (EOI) provision of the Philippines’ double taxation agreements requires the competent authorities of the contracting states to exchange information necessary for carrying out the provisions of the tax treaties or the domestic laws of the contracting state in relation to the taxes covered by the tax treaties. The EOI may be upon request, automatic or spontaneous.
The BIR has issued the guidelines and procedures for the spontaneous exchange of taxpayer-specific rulings, the scope of which covers:
The EOI section of the International Tax Affairs Division (ITAD) of the BIR has been designated as the office responsible for exchanging the specific rulings to the foreign tax authority of the potential exchange jurisdictions on or before the prescribed deadline. Rulings may be exchanged either through registered mail or encrypted electronic mail.
Work-from-Home Arrangements for Entities Registered Under the Philippine Economic Zone Authority
Generally, an entity registered with the Philippine Economic Zone Authority (PEZA) must physically locate within an economic zone, otherwise, the entity will not be entitled to incentives. This finds basis in the Corporate Recovery and Tax Incentives for Enterprises Act (the "CREATE Law"), which provides that any activity conducted outside the geographical boundaries of a PEZA economic zone is not entitled to incentives unless such project or activity is registered with another Investment Promotion Agency (IPA).
In contrast, incentives enjoyed by entities registered with the Board of Investments (BOI), which is another IPA, are not subject to geographical boundaries because the BOI does not administer any economic zone. Therefore, there is no legal impediment for entities registered with the BOI to adopt a 100% work-from-home arrangement.
Considering that registered business enterprises (RBEs) in the Information Technology and Business Process Management (IT-BPM) sector have adopted work-from-home as their business model as a result of the COVID-19 pandemic, and following the clamour for IPAs to allow up to 100% work-from-home arrangements, the Fiscal Incentives Review Board (FIRB) released a resolution allowing RBEs in the IT-BPM sector to transfer their registration to BOI from the IPA administering an economic zone or freeport zone where their project is located until 31 December 2022 and adopt a 100% work-from-home arrangement while keeping their tax incentives. Since only about 40% of the affected RBEs have timely submitted the requirements for the transfer of registration, the FIRB has extended the deadline for the transfer until 31 January 2023.
The House of Representatives, during the 18th Congress, approved House Bill No 7425, which seeks to impose value added tax (VAT) on the sale of goods and services conducted via electronic and digital platforms, make non-resident digital service providers liable for collecting and remitting the VAT on their transactions and require covered non-resident digital service providers to register with the BIR. However, the Bill was not approved by the Philippine Senate.
In the current Congress (ie, 19th Congress), the House of Representatives filed and approved a similar bill, House Bill No 4122. The Bill does not impose new taxes but seeks to clarify that electronic or digital services such as digital advertising, subscription-based services, and other services using information communication technology (ICT)-enabled infrastructure are subject to VAT. Digital educational services such as online courses and webinars rendered by accredited private educational institutions, however, are exempt from VAT. House Bill No 4122 also introduced another section to the Philippine Tax Code, whereby non-resident digital service providers will be liable for assessing, collecting and remitting the VAT on transactions that go through their platforms. Under that Bill, the term digital service provider refers to a service provider of a digital service or good to a buyer, through operating an online platform for the purposes of buying and selling goods or services or by making transactions for the provision of digital services on behalf of any person. House Bill No 4122 was transmitted to the Senate in November 2022 and is currently pending with the Senate.
Lower Income Tax Rates for Individual Taxpayers
The Tax Reform for Acceleration and Inclusion (TRAIN) Law, which took effect on 1 January 2018, updated the income tax brackets and tax rates of individual taxpayers – particularly, Filipino citizens and foreign nationals residing in the Philippines. Under the TRAIN Law, individuals with taxable income of more than PHP250,0000 are taxed at graduated rates of 20% to 35% from 1 January 2018 until 31 December 2022. Starting 1 January 2023, the income tax rates for these individuals earning taxable income of more than PHP250,000 but not exceeding PHP8 million are taxed at reduced graduated rates of between 15% and 30%. The income tax rate applicable to income exceeding PHP8 million remains at 35%.
Filing of Value-Added Tax Returns
Under the Philippine Tax Code and the related VAT regulations, every person liable to pay VAT is required to pay the tax on a monthly basis and file a monthly VAT declaration, referred to as BIR Form 2550M, not later than the 20th day following the close of the month if the taxpayer is filing manually, or not later than the 21st to 25th day following the end of the month depending on the grouping of the taxpayer filing through the Electronic Payment and Filing System of the BIR. For the third month, VAT taxpayers are required to file a quarterly return, referred to as BIR Form 2550Q, covering the three months of the taxable quarter within 25 days following the close of each quarter. The TRAIN Law has amended this to provide that, beginning 1 January 2023, the filing and payment required under the Philippine Tax Code and VAT regulations shall be done within 25 days following the close of each taxable quarter. Thus, starting 2023, filing of the monthly VAT declaration or BIR Form 2550M has been discontinued and VAT taxpayers are no longer required to pay the tax on a monthly basis.
Minimum Corporate Income Tax
Prior to the CREATE Law, a minimum corporate income tax (MCIT) of 2% based on the gross income as of the end of the taxable year was imposed on a domestic corporation or resident foreign corporation, when MCIT is greater than the regular corporate income tax of the corporation. The MCIT applies as of the fourth taxable year immediately following the year in which a domestic corporation or resident foreign corporation commenced its business operations.
In response to the COVID-19 pandemic, the CREATE Law reduced the MCIT from 2% to 1% beginning 1 July 2020 until 30 June 2023. From1 July 2023, the MCIT will revert to the old rate of 2%.
Other Percentage Tax
The Philippine Tax Code provides that any person whose sales or receipts do not exceed the amount of PHP3 million and who is not a VAT-registered person is exempt from VAT, but the taxpayer shall be required to pay a percentage tax of 3% based on the taxpayer’s gross quarterly sales or receipts.
In response to the COVID-19 pandemic, the CREATE Law lowered this percentage tax to 1% effective 1 July 2020 until 30 June 2023. From 1 July 2023, the rate of the percentage tax will revert to 3%.
Income Tax on Proprietary Educational Institutions and Non-Profit Hospitals
Prior to its amendment, Section 27(B) of the Philippine Tax Code provides that proprietary educational institutions and hospitals which are non-profit are subject to a preferential tax of 10% based on their taxable income. However, if the gross income from unrelated trade, business or other activity exceeds 50% of the total gross income derived by such educational institution or hospital from all sources, the latter will be subject to the regular corporate income tax of 25% (or 20% if the corporation has a net taxable income of not more than PHP5 million and total assets of not more than PHP100 million, excluding land on which the corporation’s office, plant and equipment are situated during the taxable year for which the tax is imposed).
The term unrelated trade, business or other activity means any trade, business or other activity, the conduct of which is not substantially related to the exercise or performance by such educational institution or hospital of its primary purpose or function, while the term proprietary means a private hospital or any private school maintained and administered by private individuals or groups with an issued permit to operate from the Department of Education (DepEd), or the Commission on Higher Education (CHED), or the Technical Education and Skills Development Authority (TESDA), as the case may be, in accordance with existing laws and regulations.
In response to the COVID-19 pandemic, the preferential tax of 10% was reduced to 1% beginning 1 July 2020 until 30 June 2023 under the CREATE Law. The rate will revert to 10% as of 1 July 2023.
When the revenue regulations implementing the new tax rates under the CREATE Law were issued by the BIR, the regulations defined the term proprietary educational institution as any private school which is non-profit and the term non-profit (as used in the definition of proprietary educational institutions) as “no net income or asset of the institution accrues to or benefits any member or specific person, with all the net income or assets devoted to the institution’s purposes and all its activities conducted not for profit”.
This definition caused confusion because a proprietary educational institution, which is a privately run, profit-making organisation, cannot be considered as non-profit. To address this issue, the Secretary of Finance released another issuance suspending the implementation of the regulations with respect to the taxation on proprietary educational institutions.
Republic Act (RA) No 11635, an act amending Section 27(B) of the Philippine Tax Code, was subsequently enacted. RA 11635 rephrased Section 27(B) to state that hospitals which are non-profit and proprietary educational institutions shall pay a tax of 10% on their taxable income. It was clarified that the term non-profit applies only to hospitals and does not qualify proprietary educational institutions.
The reduction of the income tax rate from 10% to 1% for the period 1 July 2020 to 30 June 2023 was retained under that Law.
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