c. Situs of Income Taxation

Situs of Income Taxation

Factors that determine the situs of income tax (Sec. 23)¹

• Nationality
• Residence
• Source of income

Rules on source of income in determining whether income is from sources within or without the Philippines

Note:

Royalties (from property or use of property located in Philippines), include:

• Use of the right/privilege to use in the Philippines any copyright, patent, design or model, plan, secret formula or process, goodwill, trademark, trade brand or other like property or right
• Use of/the right to use in the Philippines any industrial, commercial or scientific equipment
• Supply of scientific, technical, industrial or commercial knowledge or information
• Supply of any assistance that is ancillary and subsidiary to, and is furnished as a means of enabling the application or enjoyment of, any such property/right in 1. above, such equipment in 2. above or knowledge/info in 3. above
• Supply of services by a nonresident person/his employees in connection with the use of property/rights belonging to, or the installation or operation of any brand, machinery or other apparatus purchased from such non-resident person
• Technical advice, assistance or services rendered in connection with technical mgmt./admin. of any scientific, industrial or commercial undertaking, venture or project
• The use of or the right to use:
• Motion picture films
• Films or video tapes for use in connection with TV
• Tapes for use in connection with radio broadcasting

Most-favored nation clause

Royalty income paid by a domestic corporation to a nonresident foreign corporation which is a resident of a Contracting State with which the Philippines has an effective tax treaty is generally subject to 15% final withholding tax, but the rate may be reduced to 10% for certain royalty payments or under the most-favored nation clause of the tax treaty, such as the Philippines-US Tax Treaty².

The purpose of the clause in a tax treaty is to grant to the other Contracting State a tax treatment that is no less favorable than that which is granted to the “most favored” among other countries.

It means each party to the treaty pledges that any tax concession given to any other treaty country will also be extended to the other party to the treaty; that is, it will not grant more favorable terms to other treaty countries without granting the same concession to the treaty partner involved.

When Income is Taxable

(1) Income from sources within the Philippines

General Formula:

“Attributable” means that the expense can be identified as the expense that generated the income.

Example: ABC Corp. manufactures clothes and sells them in the Philippines. It also sells shoes in the US. The cost of manufacturing the clothes is attributable to the income generated from selling the clothes. Since the income from the sale of clothes is income within, then the expense for manufacturing them must be deducted from gross income within. However, the cost of selling the shoes may not be deducted from income within since it is not attributable to income within. Rather, it is specifically attributable to income without.

Gross income from sources within the Philippines

• Interest derived from sources within the Philippines.
• Dividends from domestic corporations. Dividends from a foreign corporation meeting the 50% gross-income test are Philippine-source income only to the extent determined by the ratio of its Philippine-source gross income to its total gross income for the statutory period.
• Compensation for services performed within the Philippines.
• Rentals and royalties from properties located in the Philippines or any interest in such property including rentals or royalties for the use of or for the privilege of using within the Philippines, patents, copyrights and other like properties.
• Sale of real property located in the Philippines.
• Sale of personal property

General Rule: Gains, profit, and income derived from the purchase within and its sale without the Philippines, or from the purchase without and its sale within shall be treated as derived entirely from sources within the country in which the personal property is sold.

Exception: gains from the sale of shares of stock in a domestic corporation shall be treated as derived entirely from sources within the Philippines regardless where the said shares are sold.

Deductions:

Expenses, losses and other deductions properly allocated thereto and a ratable part of expenses, interests, losses and other deductions effectively connected with the business or trade conducted within the Philippines which cannot definitely be allocated to some items or class of gross income

Allowed only if fully substantiated by all information/documents necessary for their computation

Exceptions – No deduction for interest paid/incurred abroad shall be allowed unless:

• Indebtedness was actually incurred
• Indebtedness must be that of the taxpayer
• Interest must be legally due and stipulated in writing
• Interest must be paid or incurred during the taxable year
• Indebtedness must be in connection with the conduct or operation of trade/business in the Philippines

Gross income from sources without the Philippines

• Interests (other than those derived from sources within the Philippines)
• Dividends (other than those derived from sources within the Philippines)
• Compensation for labor or personal services performed without the Philippines
• Rentals or royalties from property located without the Philippines or from any interest in such property including rentals/royalties for the use of or for the privilege of using without the Philippines, patents, copyrights, secret processes & formulas, goodwill, trademarks, trade brands, franchises & other like properties
• Gains, profits & income from the sale of real property located without the Philippines

Note: The foregoing enumeration is merely the reverse of the enumeration of gross income from sources within the Philippines. Income not wholly from Philippine sources may be income from sources without the Philippines or income partly within and partly without; apply the applicable allocation or apportionment rules under Section 42(C) of the NIRC.

Deductions:

Expenses, losses and other deductions properly apportioned/allocated thereto and a ratable part of expenses, interests, losses and other deductions which cannot definitely be allocated to some items or class of gross income.

(3) Income partly within and partly without the Philippines

Items other than those specified above in (1) and (2) shall be allocated or apportioned to sources within or without the Philippines.

Covered are:

• Income from services rendered partly within and partly without;
• Income from sale of personal property produced (in whole or in part) within and sold without the Philippines; and
• Income from sale of personal property produced (in whole or in part) without and sold within the Philippines.

As for unallocated expenses, meaning those which are not entirely attributable to either income within or without, such expenses shall be allocated using the following formula: