CHAPTER 5

FINAL INCOME TAXATION

Chapter Objectives
a. Understanding and appreciation of the features and scope of final tax
b. Mastery of those certain passive income subject to final tax and the
corresponding final tax rates
c. Mastery of the general final tax rates on certain non-residents and
their exceptions
d. Knowledge of the other applications of the final income tax scheme
Features of Final Income Taxation
1. Final Tax

2. Tax withholding at source

3. Territorial Imposition

4. Imposed on certain passive income and persons not engaged in

business in the Philippines
Non-resident persons not engaged in business int
the Philippines
Such as NRA-NETB and NRFC, have high risk of non-compliance. These
taxpayers usually do not have principal offices or fixed places of
business in the Philippines. Their distance and absence from the
Philippines make it very unlikely for tax compliance to be expected.

Thus, the law subjects them to final income tax. Philippine residents
shall withhold the following final tax from their Gross Income, Active or
Passive, from all sources within the Philippines:
Non-resident person not engaged in trade or business General final tax rate
Non-resident alient non engaged in trade or business 25%
Non-resident foreign corporation 30%
General Principles
1. Applicable only to passive income from sources within the
Philippines
2. The taxpayer receives the income net of tax
3. The payee is not required to file an income tax return for the
particular income subjected to final withholding tax(FWT)
4. The Philippine Government cannot compel non-residents subjects to
foreign countries to withhold the tax as this would amount to
infringement of foreign sovereignty
5. All items of income earned from sources abroad, passive or active,
are subject to tax under the general scope of the Regular Income Tax
Rationale of Final Income Taxation
Final Withholding tax is built upon taxpayer and government
convenience:
1. It relieves the taxpayer of the obligation to file an income tax return.
2. For the government, it is the most convenient and effective system in
collecting taxes on income where there is high risk of non-compliance
or tax evasion.
Passive Income subject to Final Tax
1. Interest Income

2. Royalties

3. Dividends

4. Prizes

5. Other winnings
Interest Income - Currency Bank Deposits
Recipient
Sources of Interest Income Individuals Corporations
Short Term Deposits 20% 20%
Long Term Deposits/investment certificates Exempt* 20%

Note: *Exemption does not include NRA-NETB

Short Term Deposits are those made for a period of less than five years.
Long Term Deposits refer to certificate of time deposit or investment in the form of savings,
common or individual trust funds, deposit substitutes and other investments with a maturity of
not less than five years, the form of which shall be prescribed by the BSP and issued by the banks
only to individuals.
Tax on pre-termination of long term deposits of
individuals
If the deposit or investment placement of individual taxpayers is pre-
terminated before 5 years, any previously untaxed or exempted interest
income will be subjected to the following final taxes upon pre-
termination:
Holding Period Final Tax
Less than 3 years 20%
3 years to less than 4 years 12%
4 years to less than 5 years 5%
5 years or more 0%
Savings or Time Deposit with Cooperatives are not
subject to final tax
The final tax is limited to banks and shall not be applied with time and
savings account deposit maintained by members with cooperatives and
by primary cooperatives with their federations.
Yield or any other monetary benefit from:
Deposit Substitute - Means an alternative form of obtaining funds from
at least 20 persons at any one time other than deposits through the
issuance, endorsement, or acceptance of debt instruments for the
borrowers own account, for the purpose of relending or purchasing of
receivables and other obligations, or financing their own needs or the
needs of their agent or dealer.
Government Securities - including Treasury Bonds, Treasury Bills, and
Treasury Notes shall be considered as deposit substitute irrespective of
the number of lender at origination if such debt instruments and
securities are to be traded or exchanged in the secondary market.
Interest Income - Foreign Currency Deposit with
Foreign Currency Depository Banks
The interest income from foreign currency deposits under the foreign
currenct deposit system or expanded foreign currency deposit system
by residents is Subject to final tax of:
NIRC TRAIN Law
Taxpayer Individuals Corporations Both
Residents 7.5% 7.5% 15%
Non-Residents Exempt Exempt Exempt

Note:
1. Residents TP includes RC, RA, DC and RFC.
2. Non-Residents TP includes NRC, NRA and NRFC.
3. It should be emphasize that NRA-NETB and NRFC are also exempt.
4. There is no long term or short term classifications of foreign currency deposits.
Interest Income - Foreign Currency Deposit with
Foreign Currency Depository Banks
The reduced final tax rates on interest income on FCD and the
exemption of Non-resident depositors are intended to encourage the
deposit of foreign currencies in our banks which will be used in the
financing of our international trades. Our Philippine Peso is not a
globally accepted currency. Our foreign trade will be limited without
adequate foreign currency reserves in our banking sector.
Dividends
Means any distribution made by a corporation to its shareholders out of its
earnings or profits and payable to its shareholders, whether in money or in the
other property.

Types of Dividends
1. Cash Dividends - paid in cash
2. Property Dividends - paid in non-cash properties including stocks or securities of
another corporation
3. Scrip Dividends - those paid in notes or evidence of indebtedness of the
corporation
4. Stock Dividends - paid in the stocks of the corporation
5. Liquidating Dividends - distribution of corporate net asset
Dividends
As a rule, dividends are income subject to tax. However, the following
are not income for taxation purposes:
1. Stock Dividends - representing transfer of surplus to capital account
shall not be subject to tax. Stock dividends are in the form of increase
in corporate value which should be properly taxable when realized
through disposal or sale of the stocks investment. The distribution of
stocks of another corporation as dividends is a taxable property
dividend and not a stock dividend.
2. Liquidating Dividends - Under the NIRC, the receipt of liquidating
dividends is not viewed as income but as exchange of properties. When
liquidating dividends exceed the cost of the investments, the excess is a
taxable capital gain, subject to regular income tax. Any loss is
deductible only to extend of capital gain.
Dividends
Stock Dividend vs. Stock Split
Stock dividend is a capitalization of earnings while stock split results in
reduction in the par value of stock and an increase in the number of
shares of shareholders. Assuming a 2 for 1 split, a shareholder holding
one P50 par value stock will be given two P25 par value stocks. While
stock dividend may be taxable under certain conditions, stock split will
never be subject to income tax.
Dividends
Dividend Tax Rules
Recipients of Dividends Source of Dividends
Individuals Domestic Corporation Foreign Corporation
RC and NRC 10% Regular Tax
NRA-ETB 20% Regular Tax
NRA-NETB 25% Regular Tax
Corporations
Domestic Corporation Exempt Regular Tax
Resident Foreign Corporation Pre Dominance Test Regular Tax
Non-Resident Foreign Corporation 30% Regular Tax
Exempt Dividends
1. Inter-corporate Dividends
Inter-corporate Dividends received by a domestic corporation and
resident foreign corporation from a domestic are exempted under the
NIRC to minimize double taxation.
2. Dividends from cooperatives
Under RA 9520, the distribution of dividends by an exempt cooperative
to its members either representing interest on capital or as patronage
refunds shall not be subject to tax.
Business Partnership, taxable associations, joint
venture, joint accounts or co-ownerships
Under Sec. 73 of the NIRC, the net income of these entities is deemed
constructively received by the partners, members or venturers, respectively, in
the same year the net income is reported. Hence, the 10% final tax applies at
the point of determination of the income, not at the point of actual distribution.

Share in business partnership net income

The “share in net income” includes the share in the residual profit and
provisions for salary, interest and bonus to a partner. However, if the provisions
for salaries, interests and bonuses are expensesd as such in the book of the
partnership, they are subject to regular tax to the receiving partner, not to final
tax. In this case, only the share in the residual income after such provisions is
subject to final tax.
Royalties
Passive royalty income received from sources within the Philippines is
subject to the following final tax rates:
Recipient
Sources of passive royalties Individuals Corporations
Books, literary works and 10% Final Tax Rate 20% Final Tax Rate
musical compositions
Other Sources 20% Final Tax* 20% Final Tax*

Note: Royalties on Cinematographic films and similar works paid to NRA-ETB, NRA-NETB or NRFCs is subect to a
final tax of 25%*
Illustration
E-Soft Inc. develops application programs for establishments. These programs were
individually tailored to meet specific requirements of the establishments and required
upgrades, occasional troubleshooting, and adjustments for problems. The developer
receives 1% of the sales of the establishment as royalty.

E-Soft also developed a utility program and assigned it to an e-marketer which sells the
utility program through the internet. E-soft receives 30% royalty on each copy of the
program sold.

The royalties from application programs are active income subject to RIT. The royalty from
the utility programs is passive income subject to FWT, but if the e-marketer is not a
resident in the Philippines, the passive income from abroad shall be subject to RIT.
Prizes
The taxation of prizes varies. It may be exempt from income tax or subject to
either final tax or regular income tax.
Exempt Prizes
1. Prizes received by a recipient without any effort on his part to join a contest.
2. Prizes from sports competition that are sactioned by their respective national
sports organizations
Requisites of Exemption
1. The Recipient was selected without any action on his part to enter the
contest.
2. The recipient is not required to render substantial future services as a
condition to receiving the price or reward.
Taxable Prizes
Recipient
Amount of Taxable Prizes Individuals Corporations
Prizes exceeding P10,000 20% Final Tax Regular Tax
Prizes not exceeding P10,000 Regular Tax Regular Tax

There is no final tax imposition on corporate prizes under the NIRC

Winnings
Recipient Types of Winnings - NIRC
Individuals PCSO or Lotto Winnings Other Winnings, in general

RC, NRC, RA, NRA-ETB, NRA-NETB Exempt 20% Final Tax

Corporations
DC, RFC and NRFC Exempt Regular Tax

Recipient Types of Winnings - TRAIN Law

Individuals PCSO or Lotto Winnings - PCSO or Lotto Winnings Other Winnings
Not more than P10,000 - more than P10,000
RC, NRC, RA, NRA-ETB, Exempt 20% Final Tax 20% Final Tax
NRA-NETB
Corporations
DC, RFC and NRFC Exempt 20% Final Tax Regular Tax