Asia Pacific Tax and Business Fundamentals 2011 Sample excerpt Philippines * Introduction The significant national taxes levied in the Republic of the Philippines are income tax, estate tax, donor s tax, value added tax, percentage tax, excise tax on certain goods, and documentary stamp tax. Individuals who are self-employed are also subject to a business tax in the form of value added tax or a percentage tax. Real property tax, real property transfer tax and business tax are imposed by local governments. National internal revenue taxes, including income tax, are imposed under the National Internal Revenue Code (NIRC), as amended, and administered by the Bureau of Internal Revenue (BIR). The Bureau of Customs is responsible for the administration of taxes, tariffs and duties from imports, as well as the collection of national internal revenue taxes on imported goods as the agent of the BIR. Local tax laws are embodied in ordinances promulgated by local governments in accordance with the Local Government Code, and are administered by the offices of the treasurer and assessor of each local government. Employers are mandated to make contributions to the social security system on behalf of their employees. Social security contributions are compulsory for all employees, including self-employed persons. A. Corporate Taxation A.1. A.1.1. Corporate income tax Taxable persons Corporate income tax is levied on domestic and foreign companies. Partnerships, joint-stock companies, joint accounts (cuentas en participacion) and associations are taxed as companies separately from the individual partners. The following are not taxed as companies: general professional partnerships formed by persons for the sole purpose of exercising their common profession and no part of the income of which is derived from engaging in any trade or business. Each partner is required to report as gross income his distributive share actually or constructively received, in the net income of the partnership, the net income of the partnership being computed in the same manner as that of a company; 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 consortium agreement under a service contract with the government. Certain government-owned or government-controlled companies are exempt, such as the Government Service Insurance System, the Social Security System, the Philippine Health Insurance Corporation, the Philippine Charity Sweepstakes Office and the Philippine Amusement and Gaming Corporation. * This chapter is based on information available up to 1 January 2011.
The following private companies, among others, are exempt to the extent that their activities are not conducted for profit: non-stock corporations or associations organized and operated exclusively for religious, charitable, scientific, athletic or cultural purposes, or for the rehabilitation of veterans, no part of the net income or asset of which belongs or inures to the benefit of any member, organizer, officer or any specific person; a business league chamber of commerce, or board of trade, not organized for profit and no part of the net income of which inures to the benefit of any private stockholder or individual; a civic league or organization not organized for profit but operated exclusively for the promotion of social welfare; and non-stock and non-profit educational institutions. This chapter is restricted to Philippine-incorporated (domestic) public and private companies as well as foreignincorporated entities of a similar description, whether resident or non-resident. These entities are referred to as companies. A.1.2. Residence The residence of a company is determined by the place of its registration. Companies created or organized in the Philippines or under its laws are domestic companies. Other companies not so organized are foreign companies. In this survey, foreign companies that are engaged in trade or business in the Philippines, such as branches, are referred to as resident foreign companies. Foreign companies that are not engaged in trade or business in the Philippines are referred to as non-resident foreign companies. A.1.3. Taxable income Domestic companies are subject to corporate income tax on their worldwide income, while resident foreign companies are taxed only on income from Philippine sources. Non-resident foreign companies are also subject to corporate income tax on income from Philippine sources only (see A.3.2.). Domestic companies and resident foreign companies are subject to the higher of the ordinary corporate income tax and the minimum corporate income tax (see A.1.6.). The discussion in this section on taxable income and deductions applies to the ordinary corporate income tax. A.1.3.1. General Taxable income means the pertinent items of gross income specified in the NIRC, less any deductions authorized for such types of income by the NIRC or other special laws. Generally, gross income means all income derived from whatever source, including (but not limited to) the following items: compensation for services, including fees, commissions and similar items; gross income derived from the conduct of trade or business; gains derived from dealings in property; interest; rent; royalties; and dividends. A.1.3.2. Exempt income The following are exempt: domestic dividends; gifts, bequests and devises;
income exempt under a tax treaty; income derived by foreign governments; financing institutions owned, controlled or enjoying refinancing from such foreign governments; and international or regional financial institutions established by foreign governments, from their investments in loans, stocks, bonds or other domestic securities, or from interest on deposits; income derived by the government or its political subdivisions from any public utility or from the exercise of any essential governmental function; gains from the sale, exchange or retirement of bonds, debentures or other certificates of indebtedness with a maturity of more than 5 years; and gains from the redemption of shares of stock in a mutual fund. A.1.3.3. Deductions A.1.3.3.1. Deductible expenses The following are deductible from gross income: ordinary and necessary trade, business or professional expenses, such as salaries, wages, travel costs, rental and royalties; interest (however, interest incurred to acquire property used in a trade, business or profession may be treated as a capital expenditure); taxes, including foreign taxes not claimed as tax credit (see A.3.1.3.); ordinary and capital losses (see A.1.5.); bad debts; depreciation (see A.1.3.5.); exploration and development costs of companies engaged in petroleum or mining operations; charitable contributions to certain domestic companies and donations to the government, its agencies or political subdivisions for public purposes, up to 5% of the company s taxable income (under certain conditions, the donation is fully deductible); research and development expenses (the taxpayer may opt to treat such expenses as a deferred expense over a period of at least 60 months); contributions to an employee s pension trust; and contributions by the employer to an employee s Personal Equity and Retirement Account (PERA) to the extent of the amount allowable to the contributor beginning 1 January 2009 under RA 9505. In lieu of the deductions mentioned above, domestic corporations and resident foreign corporations may elect for a standard deduction in an amount not exceeding 40% of their gross income. The deduction for interest expenses is subject to a reduction by an amount equal to 33% (42% prior to 1 January 2009) of the company s interest income that has been subjected to final tax. The above items are allowed as a deduction only if it is shown that any tax required to be deducted and withheld therefrom has been paid to the BIR. A.1.3.3.2. Non-deductible expenses The following are not deductible: dividends; entertainment, amusement and recreation expenses in excess of 0.5% of net sales and 1% of net revenue, for companies engaged in the sale of goods and services, respectively; and any such expenses that are contrary to the law, morals, public policy or public order; bribes, kickbacks and similar payments; income tax, estate and donor s taxes, and taxes assessed against local benefits of a kind tending to increase the value of the property assessed; foreign taxes claimed as tax credit; interest incurred to finance petroleum exploration; and
premiums on life insurance policies on the life of an officer or employee, or of any person financially interested in the company s trade or business if the company is a direct or indirect beneficiary. A.1.3.4. Valuation of inventory The rules on the valuation of inventory are guided by the following tests: it must conform as nearly as possible to the best accounting practice in the trade or business; and it must clearly reflect income. The cost price and cost-or-market price methods are acceptable under the above-mentioned tests. Under the cost price method, inventory may be valued using the specific identification, FIFO, LIFO, weighted-average and moving-average methods. Greater weight is given to consistency in the use of a valuation method rather than to the actual method used as long as the method or basis used is substantially in accordance with existing regulations. However, the following methods are not allowed: deducting a reserve for price changes or an estimated depreciation in value; taking work-in-process or other parts of the inventory at a nominal price or at less than proper value; omitting portions of stock on hand; using a constant price or nominal value for a so-called normal quantity of materials or goods in stock; and including stock in transit (either to or from the taxpayer) where the title is not vested in the taxpayer. A.1.3.5. Depreciation and amortization A reasonable allowance for exhaustion, wear and tear (including a reasonable allowance for obsolescence) of property used in trade or business is allowed as depreciation. As a rule, depreciation is mandatory and cannot be postponed. The annual depreciation allowance is determined on the basis of the cost of the depreciable property, its estimated useful life and its salvage value, as may reasonably be claimed by the taxpayer in accordance with recognized trade practices. Companies usually adopt the estimated useful life as stated in Bulletin F issued by the US Treasury or as provided under Philippine generally accepted accounting principles. The use of a different or shorter estimated life is usually confirmed through a ruling from the BIR. The accepted depreciation methods include: straight-line method; declining-balance method, using a rate not exceeding twice the rate which would have been used had the annual allowance been computed under the straight-line method; sum-of-the-years-digit method; and any other method which may be prescribed by the Secretary of Finance upon recommendation of the Commissioner of Internal Revenue. Inventories and stock-in-trade, land, goodwill, and generally assets that do not have an estimated useful life cannot be depreciated for tax purposes. A.1.3.6. Reserves and provisions Reserves for which no loss was actually sustained during the year are not deductible. Provisions for bad debts are also not deductible. A.1.4. Capital gains
Generally, capital gains are subject to the ordinary income tax rates applicable to the taxpayer that realizes the gains. However, capital gains from the sale of certain shares and real property are subject to tax at specific rates. Net capital gains from the sale, exchange or other disposition of shares in a domestic company are subject to a tax of 5% on net capital gains not exceeding PHP 100,000 and 10% on the excess. The sale of shares listed and traded through the local stock exchange is exempt from income tax, but subject to a stock transaction tax (see C.1.1.). In case the fair market value of the shares sold, bartered or exchanged is greater than the amount of money and/or fair market value of the property received, the excess of the fair market value of the shares of stock sold, bartered or exchanged over the amount of money and the fair market value of the property received as consideration is deemed to be a gift subject to donor s tax (see D.2.7.). Presumed capital gains from the sale, exchange or disposition of land and/or buildings held as capital assets is subject to a 6% final tax based on the higher of the property s gross selling price or fair market value. A.1.5. Losses A.1.5.1. Ordinary losses Losses not compensated for by insurance or other forms of indemnity are deductible in the year they are sustained. Net operating losses may be carried forward and allowed as a deduction from gross income for the next 3 consecutive taxable years immediately following the year in which the net operating loss is incurred, and are referred to as net operating loss carryover (NOLCO). The NOLCO is not included in the computation of minimum corporate income tax (see A.1.6.). Net operating losses incurred in a taxable year where the taxpayer was exempt or availing of a preferential tax regime are not available as NOLCO. NOLCO is allowed subject to the condition that there has been no substantial change in ownership of the company, i.e. not less than 75% of the nominal value or paid-up capital of the company or business is owned by or on behalf of the same persons. A.1.5.2. Capital losses The following rules apply to capital losses: losses from the sale or exchange of capital assets are allowed only to the extent of the gains from such sales or exchanges; capital losses from the sale of shares in a domestic company not listed on a local stock exchange are deductible only from gains on the sale of such shares (see A.1.4.); and losses on the sale of land and/or buildings held as capital asset cannot be offset against gains from such sales (see A.1.4.). A.1.6. Rates A.1.6.1. Income and capital gains The ordinary corporate income tax rate for companies is 30% (35% prior to 1 January 2009). Domestic companies and resident foreign companies are subject to the higher of the ordinary corporate income tax and the minimum corporate income tax (MCIT). The MCIT applies from the fourth taxable year immediately following the year in which the company commenced its business operations. The MCIT rate is 2% of gross income. Gross income means:
gross sales less sales returns, discounts, allowances and cost of goods sold; or in the case of a taxpayer engaged in the sale of services, gross receipts less sales returns, discounts, allowances and cost of services. The MCIT is computed and paid at the time of filing the quarterly corporate income tax. However, the quarterly MCIT payment cannot be set off by the excess MCIT from the previous taxable year(s). Nonetheless, the expanded withholding tax, quarterly corporate income tax payments under the normal income tax, and the MCIT paid in the previous taxable quarter(s) can be applied against the quarterly MCIT. The BIR has issued guidelines on the determination of the cost of goods sold or cost of services for specific lines of business. MCIT in excess of the ordinary corporate income tax may be carried forward and credited against the ordinary corporate income tax for up to 3 years. See A.1.4. for the tax rates on certain capital gains. A.1.6.2. Withholding taxes The following are subject to a final withholding tax: Rate (%) interest on bank deposits and yield or any other monetary benefit from deposit substitutes and from trust funds and similar arrangements derived from sources within the Philippines interest from a depository bank under the Expanded Foreign Currency Deposit System or from an offshore banking unit 20 7.5 royalties 20 capital gains on the sale, exchange or other disposition of land and buildings in the Philippines held as capital assets 6