1. Active vs. Passive Income

vi. Passive investment income

As a rule, passive income subjected to final tax is no longer included in the computation of the annual taxable income.

(a) Interest

Earned on currency bank deposits and yield or any other monetary benefit from deposit substitutes and from trust funds and similar arrangement

Rate of Final Tax

Interest income received by an individual (except a nonresident individual) from a depositary bank under the expanded foreign currency deposit system

Rate of Final Tax – 15% for a resident citizen or resident alien under NIRC, Sec. 24(B)(1), as amended by RA 10963.

Interest income received by a nonresident citizen from a depositary bank under the expanded foreign currency deposit system is exempt from income tax under NIRC, Sec. 24(B)(1).

Interest income received by an overseas contract worker from a depositary bank under the expanded foreign currency deposit system is exempt from income tax under NIRC, Sec. 24(B)(1).

Interest income from long term deposit or investment in the form of savings, common or individual trust fund, deposit substitutes, investment management accounts and other investments evidenced by certification in such form prescribed by the BSP.

Should the holder of the certificate pre-terminate the deposit or investment before the fifth (5th) year, a final tax shall be imposed on the entire income and shall be deducted and withheld by the depository bank from the proceeds of the long-term deposit or investment certificate based on the remaining maturity thereof.

For RC, NRC, RA, NRA-ETB

For RC and RA only: qualifying long-term deposits

For NRC – The long-term deposit exemption and preferential pre-termination rates do not apply to a nonresident individual. (NIRC, Sec. 24(B)(1), as amended by RA 10963)

For NRA-ETB – The long-term deposit exemption and preferential pre-termination rates do not apply to a nonresident individual. (NIRC, Sec. 24(B)(1), as amended by RA 10963)

For NRA-NETB – 25%

“Deposit substitutes” are defined as an alternative form of obtaining funds from the public (meaning borrowing from 20 or more lenders at any one time) other than deposits.

Tax treatment of interest income derived from government debt instruments and securities: Government debt instruments and securities to be considered as deposit substitutes must still follow the 20-lender rule as defined in Section 22(Y) of the NIRC³. (Rev. Regs. 14-12, Sec. 2)⁴

Interest income derived from deposit substitutes is subject to 20% FWT, while that derived from any other debt instruments not within the coverage of deposit substitutes is subject to 20% CWT. (Rev. Regs. 14-12, Secs. 2 and 7)

20-Lender Rule

The "20-lender rule" for deposit substitutes is a regulatory guideline in the Philippines that determines when a financial instrument is considered a deposit substitute. A deposit substitute involves borrowing funds from the public, typically through the issuance of debt instruments, without being classified as a traditional deposit.

According to Section 22(Y) of the National Internal Revenue Code⁵ (NIRC) of the Philippines, a deposit substitute is an alternative form of obtaining funds from the public, other than deposits, through the issuance, endorsement, or acceptance of debt instruments for the borrower's own account, for the purpose of relending or purchasing receivables and other obligations.

• The 20-lender rule specifies that if a borrower issues debt instruments to 20 or more lenders/investors at any one time, these instruments are classified as deposit substitutes.
• This classification triggers specific regulatory requirements and tax implications.
• Instruments classified as deposit substitutes are subject to a different regulatory and tax framework compared to traditional deposits.
• The interest income from deposit substitutes may be subject to a final withholding tax rate, which could differ from the tax treatment of interest on traditional deposits.
• Interest income earned from deposit substitutes is subject to a final withholding tax rate of 20%. This tax is withheld at the source, meaning the borrower issuing the debt instruments must withhold the tax and remit it to the Bureau of Internal Revenue (BIR).

(b) Dividend

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 other property.

Stock dividends represent the transfer of surplus to capital account and generally shall not be subject to tax, except when they result in a change in shareholders' proportionate interests in the corporation's net assets or paid-up capital (NIRC, Sec. 73(B)).

However, if a corporation cancels or redeems stock issued as dividend at such time and in such manner as to make the distribution and cancellation or redemption, in whole or in part, essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation shall be considered as taxable income to the extent that it represents a distribution of earnings or profits.

General Rule: Cash and property dividends are taxable. Stock dividends are generally not taxable, subject to the exceptions in NIRC, Sec. 73(B), including a resulting change in shareholders' proportionate interests.

Property dividends:

• These are considered income in the amount of the full market value as when received by the stockholder.
• If it was paid in stock of another corporation, it is not considered a stock dividend. It is still considered property dividend.

Liquidating dividends: taxable

• When a corporation distributes all its properties or assets in complete liquidation, the gain realized is taxable.
• Computation:
• When a corporation distributes all of its assets in complete dissolution and liquidation, there is no dividend income to the shareholder. Instead, there is a sale or exchange of property. (Rev. Regs. 02-40, Sec. 256)¹⁰
• When a corporation is dissolved and in process of complete liquidation and its shareholders surrendered their stock to it and paid the sums in question to them in exchange, a transaction took place, which was no different in its essence from a sale of the same stock to a third party. (Wise & Co., Inc. v. Meer, G.R. No. 48231, 30 June 1947)¹¹
• The gain is a capital gain, but subject to ordinary/regular income tax (Sec. 9, Rev. Regs. 6-2008)¹²

Individuals Rate of Final Tax:

Tax Treatment on Corporations of income derived from dividends:

• If the dividends are from a domestic corporation: Domestic and resident foreign corporations are tax exempt as they are treated as inter-corporate dividends.

For non-resident foreign corporations, the dividend is subject to:

• Tax treaty rate, if applicable
• 15% if no tax treaty but satisfies the tax-sparing provision
• 25% if no tax treaty and does not comply with the tax-sparing provision
• If the dividends are from a foreign corporation: The income generally forms part of the gross income of the corporation, but qualifying dividends received by a domestic corporation are exempt if the conditions in Sec. 27(D)(4) of the NIRC, as amended by RA 11534, are met. The situs of the income becomes material except for a domestic corporation which is taxed on worldwide income.

(c) Royalty income

A payment or a portion of proceeds paid to the owner of a right for the use of such right

From books, literary works and musical sources:

Other royalties:

viii. Prizes and awards

Amount in cash or in kind received by chance or through luck is generally taxable, unless otherwise provided by law.

If the prizes are derived from sources within:

If the prizes are derived from sources without – the said amount is included in the gross income for taxpayers who are taxable within and without the Philippines.

Prizes and awards made primarily in recognition of religious, charitable, scientific, educational, artistic, literary or civic achievement are excluded from the gross income, but only if:

• Recipient was selected without any action on his part; and
• Recipient not required to render substantial future services as a condition of receiving the prize/award.

Example: Nobel prize

Construed strictly; must be given in 1 of 7 given categories, which do not include athletic achievements

Contemplates a rational selection process; cannot just be randomly selected

Prizes/awards in a sports competition sanctioned by national sports associations whether held in the Philippines or abroad are also excluded from the gross income

Contemplates a particular competition, not a cumulative achievement (e.g. Sportsman of the year award does not qualify for exemption)

Passive income subject to final tax

Last Read 6/6

Tax on Certain Incomes Received by a NRFC

• Interest on Foreign Loans

A final tax at the rate of 20% is imposed on the amount of interest on foreign loans contracted on or after August 1, 1986. However, said income may be exempt from income tax or partially exempt pursuant to a treaty obligation to which the Philippine government is bound.

• Intercorporate Dividends

A final tax at the rate of 15% is imposed on the amount of cash and/or property dividends received from a domestic corporation, subject to the reciprocity rule.

Reciprocity Rule: The country in which the non-resident foreign corporation is domiciled shall allow a credit against the tax due from the nonresident foreign corporation for taxes deemed to have been paid in the Philippines equivalent to 10% of the dividends, or shall not impose tax on dividends received from a domestic corporation (National Internal Revenue Code, Sec. 28(B)(5)(b), as amended by RA 11534).

• Capital Gains from Sale of Shares of Stock not Traded in the Stock Exchange

A final tax at the rate of 15% is hereby imposed upon the net capital gains realized during the taxable year from the sale, barter, exchange or other disposition of shares of stock in a domestic corporation, except shares sold, or disposed of through the stock exchange (National Internal Revenue Code, Sec. 28(B)(5)(c), as amended by RA 10963).