CHAPTER XII

Taxation

Taxes are levied in the Philippines by the Federal, Provincial, and municipal governments. Municipal and Provincial taxes are relatively insignificant and consist chiefly of property and fixed or graduated license taxes on businesses and occupations. Details should be obtained from authoritative local sources. Principal Federal taxes, such as income and excise taxes, are discussed below, as well as certain other levies of lesser importance but which may be of interest to prospective investors.

In general, the trend in Federal taxation since Philippine independence has been toward more and higher taxes and efforts to curtail tax evasion. An important new levy, the excise tax on foreign exchange, has been established, many tax rates have been increased substantially, and the base for calculating excise taxes on most imports has been inflated. Efforts have been made to improve the tax collection system.

In the aggregate these steps, most of which were suggested by the U. S. Economic Survey Mission to the Philippines in 1950 and some of which were a prerequisite to United States aid, have served to boost much-needed revenues, a primary objective. Moreover, the international balance-of-payments position has been improved to the extent that the heavy tax burden on nonessential imports has discouraged purchases in such categories.

A major move to lessen tax burdens has been the exemption of "new and necessary" industries from all taxes payable in connection with the industry until December 31, 1958, with graduated diminishing exemptions from January 1, 1959, to December 31, 1962. Details on this measure, designed to encourage industrial development and thereby diversify the country's economy, are provided on page 86. An explanation of what constitutes "transacting business" in the Philippines for taxation and other purposes is given in chapter XIII.

INCOME TAX

Taxable Income Defined 1

Taxable income, using the general definition for gross income, is defined to include "gains, profits,

1 Special provisions are made by the National Internal Revenue Code, as amended, regarding income and deductions of domestic and foreign insurance companies.

and income derived from salaries, wages, or compensation for personal service of whatever kind and in whatever form paid, or from professions, vocations, trades, businesses, commerce, sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; also from interests, rents, dividends, securities, or the transactions of any business carried on for gains or profits, and income derived from any source whatever," unless exempt from the income tax by law.

Receipts not subject to income tax.-The following are among the types of receipts which are not subject to the income tax:

Proceeds of life insurance.

Amounts received by insured as a return of premiums.

The value of property acquired by gift, bequest, devise, or descent, although income from such property is subject to income tax.

Interest on Government securities to the extent provided in the act authorizing their issue.

Compensation for injuries or sickness under accident or health insurance or workmen's compensation acts.

Income of any kind exempt from taxation under terms of a treaty obligation binding on the Philippines.

Income of foreign governments received from investments in the Philippines or from interest on deposits in banks in the Philippines.

Income received by certain organizations, as such, is also not subject to the income tax. Included are entities not organized for profit and the net incomes of which do not inure to the benefit of private stockholders or individuals. Labor unions; fraternal beneficiary societies; corporations or associations established and operated for religious, charitable, scientific, and educational purposes; chambers of commerce; social clubs; and marketing associations are among the organizations the incomes of which may qualify as tax exempt. (Note: In the case of religious, charitable, scientific, and educational entities, income from their properties or activities conducted for profit is subject to the income tax.)

Deductions in general.-Net income is determined by subtracting from gross taxable income certain deductions allowed by law. Deductible, in general, are business expenses, interest on in

debtedness, certain direct taxes, losses not compensated for by insurance or otherwise, bad debts, depreciation of property used in trade or business, certain charitable contributions and gifts, and payments to employees' pension trusts.2

(Note: In computing net taxable income, no deduction is allowed for personal, living, or family expenses; amounts expended to improve the value of any property or estate; amounts expended for restoration or making good the exhaustion of property, if allowance for depreciation or depletion is or has been made; or premiums on life insurance of employees. No deduction is allowed, moreover, in connection with losses from sales or exchanges of property in transactions involving certain persons and/or entities, such as members of a family.)

In lieu of specified deductions, individuals, other than nonresident aliens, may elect a standard deduction of 1,000 pesos or 10 percent of gross taxable income, whichever is the smaller amount (see also section on individual income tax).

Non

Taxes imposed by foreign governments in respect to income, war profits, and excess profits may be deducted from gross income subject to Philippine income tax, provided the taxpayer does not or may not take credit for such taxes. resident aliens and foreign corporations may deduct foreign taxes from gross income only if and to the extent the taxes are connected with income from Philippine sources. Alien residents whose incomes from sources within their respective countries are not subject to Philippine income tax may deduct only the foreign taxes corresponding to net income subject to Philippine income tax.

Credit against tax liability.-Credit against Philippine income tax liability for taxes proper imposed by foreign governments on income, war profits, and excess profits is allowed as follows for the designated taxpayers:

A citizen or a domestic corporation. The amount of such taxes paid or accrued in the taxable year.

An alien resident. The amount of such taxes paid or accrued in the taxable year, if the foreign country concerned allows similar credit to Philippine citizens residing in the country.

A member of a partnership who is a citizen or resident. His proportionate share of such taxes if his distributive share of income from the partnership is duly reported for taxation under Philippine law.

A nonresident alien or a foreign corporation. Credit against Philippine income tax liability is subject to two limitations:

1. The credit claimed for tax paid to any foreign government may not be greater in ratio to the Philippine income tax liability than the ratio between the net income from within the foreign country and the total net income of the taxpayer.

2 Details of deductions appear in the National Internal Revenue Code, as amended, section 30, and in Revenue Regulation No. 2, issued on February 10, 1940.

2. The total credit claimed for taxes paid to foreign governments may not be greater in ratio to the Philippine tax liability than the ratio between the net income from all non-Philippine sources and the total net income of the taxpayer.

Treatment of gains and losses.-In computing net capital gain, net capital loss, and net income, taxpayers other than corporations are to take into account the entire gain or loss from the sale or exchange of capital assets when such assets are held a year or less; and one-half the gain or loss when assets are held more than a year. Corporations are to take into account the entire gain or loss from the sale or exchange of capital assets regardless of the length of time the assets are held.

Losses from the sale or exchange of capital assets shall be allowed only to the extent of the gains from other such sales or exchanges. However, a taxpayer, other than a corporation, sustaining in any taxable year a net capital loss may treat such loss (in an amount not in excess of the net income for such year) in the succeeding taxable year as a loss from the sale or exchange of a capital asset held for not more than 12 months. No carryover of net capital losses is accorded corporations.

Allocation of tax according to income source.— As explained in section 37 of the National Internal Revenue Code, as amended, and in section 152 of Revenue Regulation No. 2, issued February 10, 1940, income of taxpayers is divided into income derived entirely from Philippine sources, entirely from sources outside the Philippines, or partly from sources in the Philippines and partly from sources outside the Philippines.

Foreign corporations and nonresident aliens are subject to Philippine income tax only in respect to income from sources within the Philippines. Domestic corporations and citizens and residents of the Philippines are subject to Philippine income tax in respect to income derived from sources both within and outside the Philippines.

Gross income from sources within the Philippines, according to the Code and Regulation No. 2, includes the following items of gross income:

Interest on bonds, notes, or other interest-bearing obligations of residents, corporate or otherwise;

Dividends from a domestic corporation, and from a foreign corporation provided 50 percent or more of the foreign corporation's gross income in a given period was derived from Philippine

sources;

Compensation for labor or personal services performed in the Philippines irrespective of the residence of the payer, the place where the contract was made, and the place of payment;

Rentals or royalties from property in the Philippines, or from interest in such properties (this covers income deriving from the use or right to use in the Philippines patents, copyrights, secret processes and formulas, goodwill, trade-marks,

trade brands, franchises, and similar property); and

Gains, profits, and income from sale or other disposition of real property in the Philippines. (treatment of capital gains and losses is mentioned above).

Gross income from sources outside the Philippines includes interest and dividends other than those derived from sources in the Philippines, compensation for labor and personal services performed outside the Philippines, rentals and royalties derived from use or the right to use property outside the Philippines, and gains from the sale or other distribution of real property located outside the Philippines.

Expenses, losses, and other allowable deductions are subtracted from the enumerated items of gross income and the remainder, if any, is included in full as net income from sources within or outside the Philippines, as the case may be.

Items of gross income other than those enumerated and corresponding expenses, losses, and other allowable deductions are allocated or apportioned to sources within or outside the Philippines in accordance with rulings of the Department of Finance.

When items of gross income are separately allocated to sources within the Philippines, for purposes of computing net income there should be deducted expenses, losses, and other deductions apportioned or allocated thereto, plus a ratable portion of deductions which cannot be allocated. The remainder, if any, is included in full as net income from sources within the Philippines.

When items of gross income are derived partly from within and partly from outside the Philippines, net income is computed by making the deductions as mentioned above. The portion of the net income to be attributed to sources within the Philippines may then be calculated on the basis of formulas prescribed by the Department of Finance.

Gains, profits, and income from transportation, telegraph, cable, or other services rendered partly within and partly outside the Philippines, or from the sale of personal property produced by the taxpayer in whole or in part in the Philippines and sold outside the Philippines or produced in whole or in part without and sold within the Philippines, are treated as income partly within and partly outside the Philippines. Gains, profits, and income derived from the purchase of personal property in the Philippines and its sale outside the Philippines, or vice versa, are treated as derived entirely from within the country where sold.

Double taxation of income.-The Philippines at present has no agreement with any country for the avoidance of double taxation. There have been no negotiations with the United States for a tax treaty which would cover double taxation. As matters stand, American citizens and firms may have a tax liability in both the Philippines and the

United States in respect to the same items of income. Because of the high rates of United States taxes, this has the effect of placing American entities operating in the Philippines at a competitive disadvantage taxwise with those foreign firms in the country which pay little in taxes to their home governments. It should be noted, however, that from the standpoint of United States tax liabilities the position of American firms doing business in the Philippines is no different from that of American entities operating in most other foreign countries.

Tax relief in the form of deductions and credits for foreign taxes as provided by the Philippine Internal Revenue Code has already been described. The United States Internal Revenue Code of 1954 provides certain relief for income received from foreign sources under certain conditions. Among the pertinent provisions of the U. S. code are the following:

1. Sections 164 and 901, which permit, within certain limits, either a deduction or a credit for foreign income taxes (or a tax in lieu of an income tax) paid by the United States taxpayer.

2. Section 911, which provides that an individual citizen may exclude from his gross income amounts received for personal services performed outside the United States if he has been a bona fide resident in a foreign country for an uninterrupted period which includes the tax year. As an alternative, earned income (limited to $20,000 per taxable year) may be excluded for the entire period if the taxpayer is merely present in a foreign country for at least 510 full days in any period of 18 consecutive months.

Individual Income Tax

The entire net income received in the preceding taxable year from all sources by a Philippine citizen or a resident of the Philippines is subject to an annual graduated tax. Rates range from 3 percent on net incomes not exceeding 2,000 pesos to 60 percent on net income in excess of 2 million pesos (see table 23). The entire net income received from Philippine sources by a nonresident alien who is engaged in trade or business in the Philippines or who has an office or place of busi

3 Taxable year is calendar year. In no instance may an individual establish a fiscal year as a basis for computing income. Resident of the Philippines for tax purposes is an alien actually present in the Philippines who is not a mere transient or sojourner. Whether he is transient or not is determined by his intentions with regard to the length and nature of his stay. One who comes to the Philippines for a definite purpose which in its nature may be promptly accomplished is a transient. floating intention, indefinite as to time, to return to another country is not sufficient to constitute an alien as a transient. alien who has acquired residence retains this status until he actually departs from the Philippines.

A mere

An

5 For the years 1950 through 1952 and 1954 higher rates were in effect, which ranged from 5 percent on net income not exceeding 2,000 pesos to 60 percent on net income in excess of 500,000 pesos. Rates in 1953 were the same as the present

(1955) rates.

Engaged in trade or business includes maintaining a resident agent or representative in the Philippines; or an agent or traveling salesman who makes sales or obtains orders.