Republic of the Philippines

President Ramon Magsaysay State University

College of Accountancy and Business Administration
(Formerly Ramon Magsaysay Technological University)
Iba, Zambales, Philippines
Tel/Fax No.: (047) 811-1683

College/Department College of Accountancy and Business Administration

Course Code BA Core 3

Course Title Income Taxation

Place of the Course in the Program Major Subject

Semester & Academic Year First Semester AY 2020-2021

CHAPTER 4- FINAL TAX AND ITEMS OF GROSS INCOME

Introduction
This chapter provides an in-depth discussion of final income tax, the items of gross income, and the classes
of taxpayers subject to final income tax.

Intended Learning Outcomes

a. Appreciation of the features and scope of final tax
b. Knowledge 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 scheme

Discussion

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 system

 The final withholding system imposes upon the person making passive income payments the responsibility
to withhold the final tax due. The tax is withheld from source.
 The taxpayer receives the income net of tax and there would be no need for him to file an income tax return
to report the same.

 The final withholding system is inherently territorial. It applies to certain passive income earned from
source within the Philippines.

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  The Philippine government cannot compel non-resident subject of foreign countries to withhold the tax as
this would amount to encroachment of foreign sovereignty. Hence, all items of income earned from sources
abroad, passive or active, are subjects to tax under the general scope of the regular income tax.

Rationale
The final withholding tax is built upon taxpayer and government convenience. It relieves the taxpayer of the
obligation to file an income tax return. This is very convenient for taxpayers who are limited by distance, time and
cost to comply. For the government the final withholding system is the most convenient and effective system in
collecting taxes on income taxes where there is high risk of non-compliance or tax evasion.

Under the NIRC, final income tax is imposed on certain passive income and upon non-resident persons not engaged
in trade business in the Philippines.

Passive Income
Items of passive income are earned with very minimal involvement from the taxpayer and are generally irregular in
timing and amount. Unlike items of active income, they are not usually specifically monitored by taxpayers. When
not recorded by taxpayer, their existence can be difficult to predict while their actual amount may be difficult to
determine. Thus, the final withholding at source is the most favored scheme in taxing items of passive income.

Non-resident persons not engaged in business in the Philippines

Non-resident persons not engaged in trade or business in the Philippines, such as 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 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 source within the Philippines.

Non-resident person not engaged in trade or business General final 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 association, 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

FINAL TAX ON INDIVIDUALS AND CORPORATIONS

Unless otherwise indicated, the final tax rates to be discussed in the following sections apply to all taxpayers
(individuals and corporations) other than:
a. Non-resident alien not engaged in trade or business (NRA-NETB), and
b. Non-resident foreign corporation (NRFC).

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INTEREST INCOME OR YIELD FROM BANK DEPOSITS OR DEPOSIT SUBSTITUTES
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%

Note: *Exemption does not include NRA-NETB

Short term deposits are those for a period of less than five 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 investment 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 demonstrations of P10,000 and other demonstration as may be prescribed by
the BSP. (RMC 18-2011).

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 taxpayers

6-month time deposit P 8,000 x 20% P 1,600

2-year time deposit 12,000 x 20% P 2,400
5-year time deposit 40,000 x 0% 0
Final withholding tax P 4,000

Corporate taxpayers P 60,000 x 20% P 12,000

The exemption of individuals in interest income on long-term deposits is based on the fact that long-term
deposits are usually used to finance long-term projects such as infrastructures, property developments, and other
construction projects which are deemed essential to the development of the country.
Note that exemption is limited only to individuals to the exclusion of corporations.

Illustration 2
Allan, a resident taxpayer received a P16,000 interest income from a bank, determine the final tax withheld at
source.

Solution:

Gross interest income (P 16,000/80%) P 20,000

Multiply by: final tax rates 20%

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Final tax withheld P 4,000

Illustration 3
Banko Neg 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
Non-resident aliens not engaged in business 200,000
Non-resident corporations 100,000
Total accrued interest expense P 1,700,000

Required: Compute the total final income tax to be withheld by Banko Neg.

Solution:

Depositors Amount Rate Final Tax

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

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%

Illustration 1
On January 1, 2018, Alice invested P1,000,000 in Baguio Bank’s 5-year time deposit. The deposit pays 10% interest
annually. Alice pre-terminated the deposit on July 1, 2021.

The final tax on pre-termination will be computed as follow:

2018 interest income (P1,000,000 x 10%) P 100,000

2019 interest income (P1,000,000 x 10%) 100,000
2020 interest income (P1,000,000 x 10%) 100,000
2021 accrued interest income
(P1,000,000 x 10% x 6 months/12 months 50,000
Total interest income P 350,000
Final tax rate applicable to less than 4-year pre-termination 12%
Final tax P 42,000

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The net proceeds of the deposit and accrued interest to be released to the depositor upon pre-termination shall be:

Principal balance P 1,000,000

Accrued interest for 2021 50,000
Final tax to be withheld ( 42,000)
Net proceeds to be released to the depositor P 1,008,000

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 account 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 Bangko Sentral ng Pilipinas (BSP)

Deposit substitute means an alternative from 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 debt instruments and securities including Treasury bonds, treasury bills, and treasury notes shall be
considered as 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.

Foreign currency deposit with foreign currency depositary banks

The interest income from foreign currency deposits under the foreign currency deposit system or expanded 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:
1. Resident taxpayers include resident citizens, resident aliens, domestic corporations and resident foreign
corporations.
2. RFCs are still subject 7 ½ %
3. Non-residents taxpayers include non-resident citizens, non-resident aliens and non-resident foreign
corporations.
4. It should be emphasized that NRA-NETBs and NRFCs are also exempt.
5. There is no long-term or short term classification of foreign currency deposits.

Note 2:

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The reduced final tax rates on interest income on foreign currency deposit 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 Philippines peso is not a globally accepted currency. Our foreign trade will
be limited without adequate foreign currency reserve in our banking sector.

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. (RR10-98)

Illustration
Mr. Saruman is an Overseas Filipino Worker. 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. Saruman deposited his savings through the account of his resident wife.

The final tax shall be :

Interest income P 41,500.00
Final tax rate 15%
Final tax P 6225.50

Scenario 2: Mr. Saruman deposited his savings through a joint account with his resident wife.

The final tax shall be :

Interest income P 41,500.50
Portion 50%
Taxable interest income P 20,750.00
Multiply by: final tax rate 15%
Final tax P 3112.50

Scenario 3: Mr. Siman deposited his savings account through his own account.

In this case, the interest income shall be exempt from final tax.

Interest income subject to regular 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 ordinary course of business
2. Investment in bonds
3. Promissory notes
4. Foreign sources, whether bank or non-bank
5. Penalty for legal delay or default

DIVIDENDS

“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 other property. (Sec. 73, NIRC)

Types of dividends:
1. Cash dividends – paid in cash
2. Property dividends – paid in non-cash properties including stocks or securities of another corporation

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 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

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

1. Stock dividends
Stock dividends representing transfer of surplus to capital account shall not be subject to tax.
The distribution of stocks of another corporation as dividends is a taxable property dividend and not a stocks
dividend.

2. Liquidating dividends
Under our Tax Laws, liquidating dividend is not viewed as income but as 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.

Taxable Stock Dividends

Generally, stock dividends are exempt from income tax. As an exception, stock dividends are subject to tax at the
fair value of the stocks received under the following circumstances:

a. Subsequent cancellation and redemption

 If a corporation cancels or redeems stock issued as a dividend at such time and in such manner as to make
the distribution and cancellation or redemption, in whole or in part, equivalent to the distribution of a
taxable dividend, the amount so distributed shall be taxable to the extent it represents a distribution of
earnings or profit.

Example, a corporation declared stock dividends and immediately called the stock dividends for redemption and
cancellation. This act is equivalent to declaration of cash dividends.

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. (review intermediate
accounting topics on 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,
Remember: stock split will never be subject to income tax.

Dividend Tax Rules

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 Recipient of dividends
Source of dividends Individuals Corporations
Domestic corporation 10% final tax1 Exempt2
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 a 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.
3. If DCs and RCs received dividend income from foreign sources, subject to regular tax.

Illustrative 1
Terizla Company declared a total of P2,000,000 dividends. P800,000 is due to corporate shareholders while
P1,200,000 is due to individual shareholders.

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

Shareholders Amount Rate Amount ___

Individual shareholders P 1,200,000 x 10% P 120,000
Corporate shareholders 800,000 x 0% 0
Final tax P 120,000

Illustrative 2
Agogo Company declared a total of P1,000,000 dividends in March 2017. 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/ business 50,000
Non-resident corporations 100,000
Total dividends P 750,000

The total final tax to be withheld by Agogo Company shall be:

Shareholders Dividends 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-NETBs 50,000 x 25% 12,500
NRFCs 100,000 x 30% 30,000
Total P 750,000 P 112,500

Historical dividend tax rate

The imposable final tax rate vary depending on the source of the dividends declared:

Source Final tax

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Earnings from 2000 and thereafter 10%

Any distribution made to the shareholders or members of a corporation shall be deemed to have been made from the
most recently accumulated profits or surplus, and shall constitute a part of the annual income of the distribute for the
year in which received. (Sec. 73(C), NIRC)

Exempt Dividends
1. Inter-corporate dividends
2. Dividends from cooperatives

Inter-corporate dividends
Inter-corporate dividends received by a domestic corporation and resident foreign corporation from a domestic
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 illustrates the double taxation:

A Corp. B, Inc.
Dividends declared P 100,000 90,000
Less: 10% dividends tax 10,000 9,000
Net dividends P 90,000 P 81,000

This is a form of direct duplicate taxation. To eliminate the impact of double taxation, inter-corporate
dividends such as those declared by A Corp. to B, Inc. is exempted from final tax. When the dividend finally falls to
an individual shareholders, the 10% final tax applies.

The exemption extends to dividends received by business partnerships from domestic corporations since business
partnerships are considered corporations under the NIRC. However, the exemption does not extend to dividends
received by general professional partnership, exempt joint ventures and exempt co-ownership because they are not
considered corporations under the NIRC.

On the other hands, 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.

ENTITIES TAXABLE AS CORPORATION 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 Trust (REIT)
2. Business partnerships
3. Taxable associations
4. Taxable joint ventures, joint accounts or consortia
5. Taxable co-ownership

Real Estate Investment Trust or REIT

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-a publicly listed corporation established principally for the purpose of owning income-generating real estate assets.

The following payees of REIT dividends are exempt from 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 investors – exempt from REIT dividend tax until August 12, 2018 (7 years from the
effectively of RR13-2011 which took effect on August 12, 2011)

Business partnership, taxable associations, joint venture, join 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 ventures, respectively, in the same year the next 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 bonuses
are expensed 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.
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 0
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:

Profit sharing P 73,000 P 36,000

Multiply by: final tax rate 10% 10%
Final tax P 7,300 P 3,600

Note: A partner, member or venture who is an NRA-ETB, NRA-NETB or NRFC shall be subject respectively to
20%, 25% and 30% final tax rate.

Minimum Corporate Income Tax (MCIT)

Formula

Gross income (excluding capital gains with capital gain tax and not including passive income with final tax) Pxxx
Minimum income tax at 2% thereof Pxxx
This topic was discussed in detail in Chapter 2 (A study on income tax law and accounting under the TRAIN
Law by Virgilio Reyes 2019 ed.)

The Improperly Accumulated Earnings Tax

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Domestic corporations cannot avoid the dividends tax by simply not declaring dividends. Corporations which
accumulate earnings beyond the reasonable needs of business will be imposed the 10% Improperly Accumulated
earnings Tax, a penalty tax. This topic was discussed in detail in Chapter 2 (A study on income tax law and
accounting under the TRAIN Law by Virgilio Reyes 2019 ed.)

ROYALTIES
Passive royalty income received from source within the Philippines is subject to the following final 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. The 10% preferential royalty final tax on books and literary works pertain only to printed literatures.
Royalties on ebooks sold or in CD form are subject to 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

Royalties of a passive nature such as royalties of claim owners or land owners of mining properties, royalties of
investors from companies that manufacture and sell their invention, and royalty from licensing agreements that
transfers the use of trademark or technology are subject to 20% final tax. When royalties accrues 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. 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 the 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 in the
Philippines, the passive income from abroad shall be subject to regular tax.

Note: Royalties, active or passive, earned from sources without the Philippines are subject to regular income
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 a recipient without any effort on his part to join a contest. Example include prizes from
such awards as Nobel Prize, Most Outstanding Citizen, Most Benevolent Citizen of the year, and similar
awards.

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 2. Prizes from sports competitions that sanctioned by their respective national sport organizations.

Two (2) Requisites for exemption

1. The recipient was selected without any action on his part to enter the contest;.and
2. The recipient is not required to render substantial future services as a condition to receiving the price or
reward.

Taxable prizes
For individual income taxpayers, taxable prizes are subject to either final tax or regular tax depending on the amount
of the prize.
There may be events or competitions where corporations earn prizes. However, there is no final tax imposition on
corporate prizes under the NIRC. Hence, the same must be subject to regular income tax.

Recipient
Amount of taxable prize Individuals Corporations
Prizes exceeding P10,000 Regular tax
20% final
tax(RC,RA,NRC,NRAETB)

25% final tax for

NRANETB
Prizes not exceeding P10,000 Regular tax Regular tax

25% final tax for

NRANETB

Note: Remember also that final taxation does not apply to foreign passive income; hence, prizes from foreign
sources are subject to the regular income tax.

Winnings
For individual income taxpayers, winnings received from sources within the Philippines are generally subject to
20% final tax.
Similar to prizes, there is no final tax imposed on corporate winnings under the NIRC. Winnings that are not
subjected to final tax by the payor should be reported as part of the regular income. Also, winnings from foreign
sources are subject to regular income tax.

Recipient
Types of winnings Individuals Corporations
PCSO or lotto winnings 20% final tax if more than Exempt if not more than
P10,000 for RC,RA,NRC, 10,000, if more than
if not more than 10,000, 10,000, subject to 20%
exempt FT .

NRAETB –exempt NRFC - (30%)

NRANETB-25% Final
tax
Other winnings, in general 20% final tax Regular tax

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 25% final tax for NRFC-30%
NRANETB

Note: not included are winnings exempt from income tax such as but limited to:

*winnings under sec. 126 of the Tax Code (winnings from horse racing-subject only to OPT of 4% or 10%, as the
case may be)

*prizes and awards made primarily in recognition of religious, charitable, scientific, educational, artistic, literary, or
civic achievement but only if:
a. the recipient was selected without any action on his part to enter the contest or proceeding;
b. The recipient is not required to render substantial future services as a condition to receiving the prize or award

*All prizes and awards granted to athletes in local and international sports competitions and tournaments whether
held in the Philippines or abroad and sanctioned by their national sports associations.

TAX INFORMER’S REWARD

 A cash reward may be given to any person instrumental in the discovery of violations of the National
Internal Revenue Code or discovery and seizure of smuggled goods.
 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 provisions 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 the consanguinity of those officials or employee in a. and b.

Amount of Cash Reward – whichever is the 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.

Illustration
Ms. Heidi Mendones provided information to the BIR leading to the recovery of P12,000,000 unpaid taxes. The cash
reward shall be computed as follows:

10% cash reward (P12,000,000 x 10%) P1,200,000

Cash reward limit P1,000,000

Cash reward (whichever is lower) P1,000,000

Less: 10% final withholding tax 100,000
Net amount to be released to the tax informer P 900,000

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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 corporations with tax-free or tax-reduction provision where
the obligor shoulders 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 covenant
bonds 30% final tax Regular income tax

Note:
1.
The final tax applies to all individuals, regardless of classification.
2.
There is no similar final tax provision for corporate recipients of “tax-free” interest; hence, the regular
income tax shall apply.
EXCEPTION TO THE GENERAL FINAL TAX ON NON-RESIDENT PERSONS NOT ENGAGED IN
TRADE OR BUSINESS IN THE PHILIPPINES

NRA-NETB NRFC
General Final Tax Rate 25% 30%
Exceptions:
1. Capital gain on sale of domestic stock 15% Capital gains tax 15% Capital gains tax
directly to buyer
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 equipments 25% of rentals 7.5% of rentals
5. Lotto and PCSO winnings 25% 30%
6. Interest income under the foreign
currency deposit system Exempt Exempt
7. Interest on foreign loans N/A 20%
15% if tax sparing rule is
8. Dividend income 25% applicable, otherwise, 30%
9. Tax on corporate bonds 30% 30%

Capital gains tax

As a rule, NRA-ETBs and NRFCs do not file income tax returns. Exceptionally, 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 or CAR) from the BIR that the tax on the transfer has been paid.

Special aliens
Special aliens are NRA-NETBs employed by regional or area headquarters and regional operating headquarters of
multinational companies, offshore banking units, or petroleum service contractors or subcontractors. Special aliens
are subject to RIT (graduated income tax) rates under the TRAIN Law.
Note: if non-residents, subject to 25% Final Tax

Illustration: NRA-NETBs

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In 2019, Mr. Chang Eh, an NRA-NETB, is a consultant to Raha Puti Manufacturing Company (RPMC), a domestic
manufacturer, RPMC also pays Mr. Eh royalty for using his invention. During the year, Mr. Eh purchased shares of
RPMC and sold them directly to a buyer.

Royalties from invention P 300,000

Professional fees 1,000,000
Gain on sale of domestic stocks directly to a buyer 40,000

Required: Compute the total final tax withheld at source.

Solution:

Royalties from invention P 300,000

Professional fees 1,000,000
Total gross income P1,300,000
Multiply by: final tax on NRA-NETB 25%
Total final withholding tax P 325,000

Note:
1. The final tax applies on gross income, whether active or passive. The same rule applies with NRFC except
that the final tax rate is 30%.
2. Mr. Eh shall file a capital gains tax return for the gain on the sale of domestic stocks.

The Tax Sparing Rule

NRFCs shall be subject to a 15% final tax on dividend income instead of the 30% general final tax if the country of
domestic of the NRFC credits against the tax due of such NRFC taxes presumed to have been paid by such NRFC
from the Philippines equivalent to 15% of the dividends.

In applying the tax sparing rule, the Supreme Court ruled that the NIRC does not require that the foreign law of the
non-resident corporation must give a deemed paid tax credit for dividend equivalent to the percentage points waived
by the Philippines pointing that the NIRC, merely require the country of the NRFC to a deemed paid tax equivalent
to that waived by the Philippines. (CIR vs. Procter & Gamble Philippines Manufacturing Corporation and the CTA
(G.R. 66836))

Thus, the requirement of the tax sparing rule is deemed satisfied if the country to which the NRFC is domiciled
imposes no tax on dividends from foreign sources. (BIR Ruling Nos. 104-2012, March 22, 2012)

Illustration: The Tax Sparing Rule with NRFCs

An NRFC is due to receive a dividend of P1,000,000 from a domestic corporation. The final tax to be imposed by
the Philippines which shall be withheld by the domestic corporation shall be 15%, not 30%, if the country of
domicile of the NRFC also reduces its income tax upon the P1,000,000 dividend by at least 15%, the dividend tax
percentage waived by the Philippines from the 30% general final tax rate. If the country of the NRFC does not
reduce its tax on the dividend by at least 15%, the Philippines shall impose the 30% final tax.

OTHER APPLICATIONS OF FINAL INCOME TAX

1. Fringe benefits of managerial or supervisory employees
2. Income payments of residents other than depository banks under the expanded foreign currency deposit
system (EFCDS) to offshore banking units (OBUs) and expanded foreign currency deposit units (EFCDUs)
3. Income payments to oil exploration service contractors or sub-contractors

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FRINGE BENEFITS TAX
Fringe benefits include all remunerations under an employer-employee relationship that do not form part of
compensation income. The fringe benefits of managerial and supervisory employees are subject to a final fringe
benefits tax.

INTEREST AND OTHER INCOME PAYMENTS TO DEPOSITARY BANKS UNDER THE EXPANDED
FOREIGN CURRENCY DEPOSIT SYSTEM
Residents, other than depositary banks under the expanded foreign currency deposits system, shall withhold 10%
final tax on income payments such as interest income on loans from offshore banking units (OBUs) and expanded
foreign currency deposit units (FCDUs).

INCOME PAYMENTS TO SUB-CONTRACTORS OF PETROLEUM SERVICE CONTRACTORS

Under PD 1354, every subcontractor, whether domestic or foreign entering into a contract with a service contractor
engaged in petroleum operations in the Philippines shall be liable to a final income tax equivalent to eight percent
(8%) of its gross income derived from such contract, such tax to be in lieu of any and all taxes, whether national or
local.

Provided, however, that any income received from all other sources within and without the Philippines in the case of
domestic subcontractors and within the Philippines in the case of foreign subcontractors shall be subject to the
regular income tax under the NIRC.

The term “gross income” means all income earned or received as a result of the contract entered into by the
subcontractor with a service contractor engaged in petroleum operations in the Philippines under Presidential Decree
No. 87.

Note that the 8% final tax applies only to subcontractors, whether individuals or corporations, resident or non-
resident. Petroleum service contractors are subject to the regular income tax.

Persons or entities contracted by a petroleum service contractor to locally supply goods and materials that are
required by and in, or that are inherently necessary or incidental to, its exploration and development of petroleum
mineral resources and are entitled to the preferential 8% final tax on their gross income derived from such contracts.
(BIR Ruling No. 024-2001, June 13, 2001)

FINAL WITHOLDING TAX RETURN

The final withholding tax return (BIR Form 1601-F), Monthly Remittance Return of Final Income Taxes
Withheld, shall be filled in triplicate by every withholding agent or payor who is either an individual or corporation.

Deadline and place for manual filing

The return shall be filed and the tax be paid or before the 10th day of the month following the month in which
withholding was made with:
a. The authorized agent bank of the revenue district office having jurisdiction over the withholding agent’s
place of business
b. In place where there are no authorized agent banks, to the revenue collection officer
c. The authorized city or municipality treasurer within the revenue district where the withholding agent’s
place of business is located

Deadline for eFPS filing

In accordance with the schedule set forth in RR No. 26-2002, the deadline for e-filing of returns is as follows:

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Group A – Fifteen (15) days following the end of the month
Group B – Fourteen (14) days following the end of the month
Group C – Thirteen (13) days following the end of the month
Group D – Twelve (12) days following the end of the month
Group E – Eleven (11) days following the end of the month

Penalties for Late Filing or Remittance of Final Income Taxes Withheld

The same penalties for late payment of income taxes as discussed in Chapter 4 apply for non-withholding or non-
remittance of final taxes.

ENTITIES EXEMPT FROM FINAL INCOME TAX

1. Foreign governments and foreign government-owned and controlled corporations
2. International missions or organizations with tax immunity
3. General professional partnership
4. Qualified employee 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.

Exercises
1. Which is correct with the final income taxation?
a. It covers all items of passive income from whatever sources
b. It applies to all item of gross income of any non-residents earned from sources within the
Philippines
c. Taxpayers need not file an income tax return
d. It applies to passive income earned abroad
2. Which is a correct statement regarding final income tax
a. Items of income subjected to final tax can still be subjected to regular tax
b. Items of income exempt under final tax are subject to regular tax
c. Final income applies to all passive income from the Philippines
d. Final tax applies only in certain passive income earned within the Philippines
3. Interest income from which of the following sources is subject to final income tax?
a. Lending
b. Mortgage loans
c. Bond investments
d. Money market placements
4. The final tax does not apply on interest (select the best answer)
a. Long-term deposit
b. Promissory notes
c. Deposit substitute
d. Trust funds
5. Which interest income is not subject to any income tax?
a. Interest income from discount notes
b. Interest income from bonds issued by a bank
c. Imputed interest
d. Interest income from deposit substitute

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6. Ed received P45,000 interest from short-term deposits. Compute the final tax on interest.___________
7. Andre, resident citizen, deposited P2,000,000 to the 180-day time deposit of banco de Ora. The
deposit pays 8% interest. Compute the final tax on maturity of the deposit.___________
8. Assume that Andre is a nonresident alien not engaged in trade or business;compute the final tax on
maturity of the deposit.______________________
9. On January 1, 2018, Mr. Clean invested P2,000,000 in a 6-year time deposit of Jolo Unibank which
pays 10% annual interest. Compute the final tax to be withheld by Jolo Unibank on December 31,
2018.______________
10. Assume that Mr. Clean pre-terminated the time deposit on July 1, 2022; compute the final tax to be
withheld on pre-termination._________________

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