IT Module No.

FINAL INCOME TAXATION

Module Specific Learning Outcomes

After this module, students are expected to demonstrate:

a. Understanding and appreciation of the features and scope of final tax;
b. Mastery of those certain passive income subject to final tax and their 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 schemes.

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

The Final Withholding Tax

1. Income payor serves as the withholding tax agent of the BIR; the taxpayer receives the
income net of tax; the taxpayer need not file an income tax return to report the same.

2. The final withholding tax system is inherently territorial. It applies only to certain passive
income earned from sources within the Philippines.

Rationale of Final Income Taxation

Convenience and effective system in collecting taxes on income where there is high-risk of non-
compliance or tax evasion. Example: Non-resident aliens not engaged in trade or business
(NRA-NETBs) and non-resident foreign corporations (NRFCs), have high risk of non-
compliance. These taxpayers do not have offices or fixed place of business in the Philippines
making tax compliance very unlikely due to their absence or distance in the Philippines. Thus,
the law subjects them to final income tax, as follows:
General Final
Non-resident person not engaged in trade or business
Tax Rate
Non-resident alien not engaged in trade or business 25%
Non-resident foreign corporation 30%

PASSIVE INCOME SUBJECT TO FINAL TAX

1. Interest or yield from bank deposits or deposit substitutes
2. Domestic dividends, in general
3. Dividend income from a Real Estate Investment Trust
4. Share in the net income of a business partnership, taxable associations, joint ventures, joint
accounts, or co-ownership
5. Royalties, in general
6. Prizes exceeding P10,000
7. Winnings
8. Informer’s tax reward
9. Interest income on tax-free corporate covenant bonds

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INTEREST INCOME OR YIELD - Interest income or yield from local currency bank deposits
or deposit substitutes are subject to final tax as follows:

Recipient
Source of interest income Individuals Corporations
Short-term deposits 20% 20%
Long-term deposits/investment certificates Exempt 20%

Short-term deposits – those made for a period of less than 5 years.

Long-term deposits or investment certificates – refer to certificate of time deposit or
investment in the form of savings, common or individual trust funds, deposit substitutes,
investment management accounts, 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 banks only (not by non-
bank financial intermediaries or finance companies) to individuals in denominations of P10,000
and other denominations as may be prescribed by the BSP.

Illustration 1:
A taxpayer earned the following interest income from various time deposits.
6-month time deposit P 8,000
2-year time deposit 12,000
5-year time deposit 40,000
Total interest income P 60,000
Required: Compute the final tax if the taxpayer is an individual and if a corporation.

Solution:
Individual Taxpayer Corporate Taxpayer
6-month time deposit P 8,000 x 20% P 1,600 P 1,600
2-year time deposit 12,000 x 20% 2,400 2,400
5-year time deposit 40,000 x 0%/20% 0 8,000
Final withholding tax P 4,000 P12,000

Illustration 2:
Banco de Oro incurs the following interest in its savings and time deposit accounts from the
following depositors.
Depositors Amount
Resident individuals P 600,000
Resident and domestic corporations 800,000
NRA-NETBs 200,000
NRFCs 100,000
Total accrued interest expense P 1,700,000
Required: Compute the total final income tax to be withheld by Banco de Oro.

Solution:

Depositors Amount Rate Final Tax

Resident individuals P 600,000 x 20% P 120,000
Resident and domestic corporations 800,000 x 20% 160,000
NRA-NETBs 200,000 x 25% 50,000
NRFCs 100,000 x 30% 30,000
Total accrued interest expense P 1,700,000 P 360,000

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Tax on pre-termination of long-term deposits of individuals
If the deposit or investment 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 deposits with cooperatives are not subject to final tax – The final tax is
limited to banks and shall not be applied with time and savings deposit maintained by members
with cooperatives and by primary cooperatives with their federations. (Dumaguete Cathedral
Credit Cooperative vs. CIR, G.R. 182722)

Other applications of the final tax on interest

1. Deposit substitute
2. Government securities
3. Money market placements
4. Trust funds
5. Other investments evidenced by certificates prescribed by the BSP

Deposit substitute – an alternative form of obtaining funds from at least 20 persons at any 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 debt instruments and securities including treasury bonds, treasury bills, and
treasury notes shall be considered as deposit substitute irrespective of the number of lenders at
origination if such debt instruments and securities are to be traded or exchanged in the
secondary market.

Foreign currency deposits with foreign currency depositary banks – The interest income
from foreign currency deposits under the foreign currency deposit system by residents is
subject to a final tax of 15%

Taxpayer Individuals Corporations

Residents 15% 15%
Non-residents Exempt Exempt
Note:

1. Resident taxpayers include resident citizens, resident aliens, domestic corporations and resident
foreign corporations.
2. Non-resident taxpayers include non-resident citizens, non-resident aliens and non-resident foreign
corporations.
3. NRA-NETBs and NRFCs are also exempt.
4. There is no long-term or short-term classification of foreign currency deposits.

Joint accounts on forex deposits – If the bank account is jointly in the name of a non-resident
and a resident taxpayer, 50% of the interest shall be exempt while the other 50% shall be
subject to the 15% final tax.

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Illustration:
Mr. Siman is an OFW. He deposits all his savings in a savings account under the foreign
currency deposit unit (FCDU) of a domestic bank. During the month, the savings deposit
account earned $1,000 interest equivalent to P41,500.

Scenario 1: Mr. Siman deposited his savings through the account of his resident wife. The final
tax shall be computed as follows:

Interest income P 41,500.00

Final tax rate 15%
Final tax P 6,225.00

Scenario 2: Mr. Siman deposited his savings through a joint account with his resident wife. The
final tax shall be computed as follows:

Interest income P 41,500.00

Portion taxable 50%
Taxable interest income P 20,750.00
Final tax rate 15%
Final tax P 3,112.50

Scenario 3: Mr. Siman deposited his savings through his own savings account. In this case, the
interest income shall be exempt from the final tax.

Interest income subject to regular tax – Taxation schemes are mutually exclusive to one another.
Any form of income not subject to either final tax or 6% capital gains tax shall be subject to the
regular income tax. Interest income from the following sources is subject to regular income tax,
not to final tax:

1. Lending activities, whether or not in the course of business

2. Investments in bonds
3. Promissory notes
4. Foreign sources, whether bank or non-bank
5. Interest due to penalty for legal delay or default

DIVIDENDS

Dividends – 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 form of 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 own stocks of the corporation.
5. Liquidating dividends – distribution of corporate net assets as a return of capital.

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As a rule, dividends are income subject to tax. However, the following are not income for
taxation purposes:

1. Stock dividends – are transfer of retained earnings to capital account. It increases the
shareholder’s equity without the corresponding increase in assets. It should be properly
taxable when realized or through its sale.

2. Liquidating dividends – the receipt of liquidating dividends is not viewed as income but as an
exchange of properties. When the 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 the extent of capital gain.

When are stock dividends taxable?

Normally, stock dividends are exempt from income tax. Exceptionally, stock dividends are
subject to tax at the fair value of the stocks received under the following conditions:
a. Subsequent cancellation and redemption – For instance, a corporation declared stock
dividends and immediately called the stock dividends for redemption and cancellation. This
event is equivalent to a declaration of cash dividend.

b. If it leads to substantial alteration in ownership in the corporation. Substantial alteration in

ownership in a corporation may occur when stock dividends are given in lieu of cash
dividends or when the corporation declared an optional stock or cash dividend.

Stock dividend vs. Stock split – A stock split results in reduction in the par value of stock and
an increase in the number of shares of shareholders without any change in the shareholders
interest. While stock dividend may be taxable under certain conditions, stock split will never be
subject to income tax.

Dividend Tax Rules

Recipient of Dividends
Source of dividends Individuals Corporations

Domestic Corporation 10% FT Exempt

Foreign Corporation Regular tax Regular tax
Note:
1. A NRA-ETB is subject to a 20% final tax on dividend, not to the usual 10%, but an NRA-NETB is
subject to 25% final tax.

2. A NRFC is not exempt but is subject to the 30% general final tax rate. However, the imposable
dividend tax shall be 15% when the tax sparing rule applies. This will be discussed later.

Illustration 1:

Mindoro Company declared a total of P2M dividends. P800,000 is due to corporate

shareholders while P1.2M is due to individual shareholders. The final tax to be withheld by
Mindoro Company shall be:
Shareholders Amount Rate Final Tax
Individual shareholders P 1,200,000 x 10% P 120,000
Corporate shareholders 800,000 x 0% 0
Total P 2,000,000 P 120,000

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Illustration 2:

Apayao Company declared a total of P1.0M dividends in March 2020. An analysis of the
recipient shareholders is as follows:

Shareholders Amount
Resident aliens and citizens P 500,000
NRAs engaged in trade or business 100,000
NRAs not engaged in trade or business 50,000
Non-resident corporations 100,000
Total dividends P 750,000

The final tax to be withheld by Apayao Company shall be:

Shareholders Amount Rate Final Tax

Resident aliens and citizens P 500,000 x 10% P 50,000
NRAs engaged in trade or business 100,000 x 20% 20,000
NRAs not engaged in trade or 50,000 x 25% 12,500
business
Non-resident corporations 100,000 x 30% 30,000
Total dividends P 750,000 P 112,500

Exempt Dividends

1. Inter-corporate dividends
2. Dividends from cooperatives

Inter-corporate dividends – dividends received by a domestic corporation and resident foreign

corporation are exempted under the NIRC to minimize double taxation.

Illustration
B, Inc. owns 100% of A Corp. During the year, A Corp. declared P100,000 dividends to B, Inc.
B, Inc. in turn, declared the same dividends to its shareholders. The following table illustrated
the double taxation.
A Corp B, Inc.
Dividends declared P 100,000 P 90,000
Less: 10% dividends tax 10,000 9,000
Net dividends P 90,000 P 81,000

This exemption extends to dividends received by business partnerships from domestic

corporations since business partnerships are considered corporation under the NIRC. However,
the exemption does not extend to GPP, exempt joint ventures and exempt co-ownership
because they are not considered corporations under the NIRC.

On the other hand, the exemption of inter-corporate dividend does not apply to the share of a
corporation from the net income of a business partnership due to absence of express legal
exemption. Exemption is restricted to dividend declaration only.

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.

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ENTITIES TAXABLE AS CORPORATIONS ARE SUBJECT TO 10% FINAL TAX

The 10% final withholding tax also applies to dividends or share in the net income of entities
considered corporations under the NIRC and special laws, such as:
1. Real Estate Investment Trusts
2. Business partnerships
3. Taxable associations
4. Taxable joint ventures, joint accounts or consortia
5. Taxable co-ownerships

Real Estate Investment Trust or REIT – a publicly held corporation established principally for
the purpose of owning income-generating real estate assets.

The following recipients of REIT dividends are exempt from the final tax:
a. Non-resident alien individuals or non-resident foreign corporations entitled to claim
preferential tax rate pursuant to applicable tax treaty.
b. Domestic corporations or resident foreign corporations
c. Overseas Filipino workers – exempt from REIT dividend tax until August 12, 2018 (7 years
from the effectivity of RR13-2011 which took effect on August 12, 2011)

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,
interests and bonus to a partner. However, if the provisions for salary, interests and bonuses
are expenses as such in the books 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.

Illustration
The partnership profit distribution of partners Andy and Mar based on their agreed profit
distribution scheme is as follows:
Andy Mar
Salaries to industrial partner P 40,000 P 000000
Interest to capitalist partner - 12,000
Bonus to industrial partner 25,000
Residual profit sharing 8,000 24,000
Profit sharing P 73,000 P 36,000

Assuming the salaries, interest and bonus are not expense in the book, the 10% final tax shall
be:
Andy Mar
Profit sharing P 73,000 P 36,000
Final tax rate 10% 10%

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 Final tax P 7,300 P 3,600

Assuming the salaries, interest and bonus are expensed in the book, the 10% final tax shall be:
Andy Mar
Residual profit sharing P 8,000 P 24,000
Final tax rate 10% 10%
Final tax P 800 P 2,400

Andy Mar
Salaries to industrial partner P 40,000 P 0
Interest to capitalist partner 0 12,000
Bonus to industrial partner 25,000 0
Profit sharing to be reported as regular income P 65,000 P 12,000

The Improperly Accumulated Earnings Tax

Domestic corporations cannot avoid the dividends tax by simply not declaring dividends. IAET is
a 10% penalty tax imposed on the improper accumulation of corporate earnings beyond the
needs of business. This topic will be discussed in detail in the later modules.

ROYALTIES

Passive royalty income received from sources within the Philippines is subject to the following
tax rates:
Recipient
Source of passive royalties Individuals Corporations
Books. Literary works, and musical compositions 10% final tax 20% final tax
Other sources 20% final tax 20% final tax

Note:
1. Under the regulations, the 10% preferential royalty final tax on books and literary works pertain to
printed literatures. Royalties on books sold on e-copies or CDs such as e-books are subject to the
20% final tax.
2. Royalties on cinematographic films and similar works paid to NRA-ETBs, NRA-NETBs, or NRFCs is
subject to a final tax of 25%.

Passive vs Active royalties – passive royalties other than preferential royalties such as
royalties of claim owners or land owners of mining properties, royalties of inventors from
companies that manufacture and sell their inventions, and royalty from licensing agreements
that transfers the use of trademark or technology are subject to 20% final tax. When royalties
accrue from an undertaking where the taxpayer has active involvement, it is an active income
subject to the regular income tax.

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. E-Soft, Inc. receives 1% of the sales
as royalty.

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

The royalties from application programs are active income subject to regular income tax. The
royalty from the utility programs is passive income subject to final withholding tax, but if the e-
marketer is not a resident of the Philippines, the passive income from abroad shall be subject to
regular income tax. Royalties, active or passive, earned from sources abroad are subject to
regular tax.

PRIZES

The taxation of prizes varies. Prizes may be exempt from income tax or subject to either final
tax or regular income tax.

Exempt prizes
1. Prizes received by the recipient without any effort on his part to join a contest. Examples:
awards as Nobel prize, Most outstanding citizen, etc.,

2. Prizes from sports competition that are sanctioned by their respective national sports
organizations.

Requisite of exemption

a. The recipient was selected without any action on his part to join the contest.
b. The recipient is not required to render substantial future services as a condition to receiving
the reward.

Taxable prizes
Recipient
Amount of taxable prizes Individuals Corporation
Prizes exceeding P10,000 20% final tax Regular tax
Prizes not exceeding P10,000 Regular tax Regular tax
Prizes from foreign sources Regular tax Regular tax

WINNINGS

Recipients
Types of winnings Individuals NRA-NETBs Corporations NRFCs
PCSO/Lotto not exceeding Exempt Exempt
P10,000
25% final tax 30% final tax
PCSO/Lotto exceeding P10,000 20% final tax 20% final tax
Other winnings in general 20% final tax Regular tax

Note: The tax rules on PCSO or Lotto winnings shall be applied on a per ticket basis.

Illustration 1
Antonio won P10,000 first place in the singing contest sponsored by SID Company during their
company anniversary celebration. Since results of singing contest is based on effort rather than
chance, the P10,000 payment is a prize which is not subject to 20% final tax since it is below

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P10,000 threshold. Instead, Antonio shall report the prize in his regular income tax return. If the
amount exceeded P10,000, Syd Company shall withhold 20% final tax.

Illustration 2
Rey’s raffle ticket was selected as the second winning ticket in the raffle draw of XYZ Mall for
P10,000 dubbed as “2nd prize”. Since raffle draw results is not based on effort but on chance,
the P10,000 payment is a winning subject to 20% final tax which shall be withhold by XYZ Mall.
Note that the P10,000 threshold applies only on prizes not on winnings.

Illustration 3

Mr. Dante Pay made three bets to the PCSO Lotto draws. All tickets won.. The details of the
winnings were:
EZ2 - P 4,000
6/42 - 10,000 (3-digit winning numbers)
6/45 - 20,000,000 Grand prize (sole winner)
The EZ2 and 6/42 winnings are exempt since they did not exceed P10,000 in amount. PCSO
shall withhold 20% final tax on the entire P20M amount of winnings.

TAX INFORMER’S REWARD

A cash reward may be given to any person instrumental in the discovery of violations of the
NIRC or discovery and seizure of smuggled goods. The tax informer’s reward is subject to 10%
final tax.

Requisites of tax Informer’s Reward:

1. Definite sworn information which is not yet in the possession of the BIR
2. The information furnished lead to the discovery of fraud upon internal revenue laws or
provision thereof
3. Enforcement results in recovery of revenues, surcharges, and fees and/or conviction of the
guilty party or imposition of any fine or penalty
4. The informer must not be a:
a. BIR official or employee
b. Other public official or employee
c. Relative within the 6th degree of consanguinity of those officials or employee in a and b

Amount of Cash Reward – whichever is lower of the following per case:

1. 10% of revenues, surcharges, or fees recovered and/or fine or penalty imposed and collected
or

2. P1,000,000. The amount of cash reward is subject to 10% final withholding tax which shall be
withheld by the government.

TAX-FREE CORPORATE COVENANT BONDS

Interest income of non-resident aliens, citizens or residents of the Philippines on bonds,

mortgages, deeds of trust, or other similar obligations of domestic or resident foreign

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corporations with tax-free or tax-reduction provision where the obligor shoulder in whole or in
part any tax on the interest shall be subject to a final withholding tax of 30%.
Bond Investor
Individuals Corporations
Tax on interest income on tax-free corporate Regular
30% final tax
covenant bonds income tax

EXCEPTIONS TO THE GENERAL FINAL TAX ON NON-RESIDENT PERSONS NOT IN THE

PHILIPPINES
NRA-NETB NRFC
General Final Tax Rate 25% 30%
Exceptions
1. Capital gain on sale of domestic stocks directly to buyer 15% CGT 15% CGT
2. Rentals on cinematographic films and similar works 25% of rentals 25% of rentals
3. Rentals of vessels 25% of rentals 4.5% of rentals
4. Rentals of aircrafts, machineries, and other equipment 25% of rentals 7.5% of rentals
5. Interest income under FCDS Exempt Exempt
6. Interest on foreign loans N/A 20%
7. Dividend income 25% 15% if w/ TSR
8. Tax on corporate bonds 30% 30%

Capital gains tax – NRA-NETBs and NRFCs are required to file income tax returns to report
their gain from dealings in domestic stocks directly to buyers. Ownership of the stocks shall not
be transferred to the assignee without the required return and tax clearance (Certificate
Authorizing Registration) from the BIR that the tax on the transfer has been paid.

INSERTION

ENTITIES EXEMPT FROM FINAL INCOME TAX

1. Foreign governments and foreign GOCCs
2. International missions or organizations with tax immunity
3. General professional partnership
4. Qualified employer trust fund

The first two categories are exempt on grounds of international comity. General professional
partnerships and qualified employee trust funds are expressly exempt from any income tax
imposed under the NIRC. These entities are exempt not only to final tax but also to capital gains
tax and regular income tax.

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