Business Taxation 101: Situs of Taxation

By: Atty Christian Andrew Labitoria Gallardo

Now that we already know the difference between an ordinary asset and a capital asset, as well as the type of transactions subject to capital gains tax, we can now focus on income taxation proper. Now the question is: what type of earnings are subject to income tax?

There are many variables affecting the taxability of a certain transaction. The primary consideration however is the situs of taxation. It must be remembered that Philippine taxation is territorial in nature. This means that, in order for a certain transaction to be subject to Philippine taxation, it must have a “link” to the country, either because the party is a Filipino, or because the essential parts of the transaction took place in the Philippines.

Hence, by virtue of the “link” from both their nationality and residence, the income of resident citizens and domestic corporations, whether “sourced “inside the Philippines or outside thereof, is subject to Philippine income tax. On the other hand, by virtue of the “link” deriving from their nationality, non-resident Filipino citizens are subject to Philippine income tax only in relation to the income “sourced” within the country. Similarly, by virtue of the “link” from their residence, resident aliens and foreign corporations are likewise subject to Philippine income tax in relation to income “sourced” in the Philippines. Let us have a concrete example. Mang Kanor, a Filipino citizen of senior age residing in the Philippines and working as a consultant of Scuderia Ferrari Philippines, is earning a monthly income of P 200,000.00. During his prime years however, he was the Vice President of Scuderia Ferrari S.p.A in Italy, and by virtue of working there for ten years until he reached the age of 60, he became entitled to a pension plan which allows him a total of around 3,388,000.00 Italian Lire, or around P 100,000.00. Since he is a resident citizen of the Philippines, his entire P 200,000.00 monthly income and P 100,000 pension is subject to Philippine income tax. On the contrary, if Mang Kanor is an Italian citizen who is only residing in the country, only his P 200,000.00 income as a consultant in a domestic corporation is subject to Philippine income tax.

Now how do you exactly determine if the “source” of the income is within the country? It is subject to the following rules:

I. Services: For salaries and wages derived from performing a service, the place of performance of the service is the sole consideration. If the service is performed in the Philippines, the income is deemed sourced from the Philippines regardless if the employer or client is a Filipino or a foreigner. Corollary, if the service is performed abroad, the income is deemed source outside the Philippines even if the employer has a subsidiary in the Philippines.

II. Interests: For interest income, the residency of the individual or corporation owing the interest must be considered. If the interest-bearing obligation, such as a debt, is owed by a Philippine resident, the interest derived by the creditor is considered “sourced” from the Philippines, regardless of the citizenship of the debtor. Corollary, if the debtor owing the interest is a Filipino residing abroad, the interest is not deemed “sourced” in the Philippines.

III. Dividends: Dividends declared by domestic corporations are automatically deemed “sourced” within the Philippines. On the other hand, if the corporation is foreign, the source of the gross income for the last 3 years must be determined. If at least half (50%) of the gross income for the last 3 years of the foreign corporation is derived from sources within the Philippines, the dividends declared by such foreign corporation is deemed “sourced” within the Philippines, but only up to extent of the ratio of the Philippine-sourced income in relation to the entire income. On the other hand, if less than half (50%) of the gross income for the 3 years prior to the taxable year of the foreign corporation is derived from sources outside the country, it is deemed “sourced” outside the country.

Confusing? Alright, let us cite an example. If Sarao Motors Inc, a domestic corporation, declares cash dividends to its stockholders, such dividends are automatically deemed “sourced” within the Philippines, even if the recipient is a foreigner. On the other hand, if Daimler-Benz AG, a foreign corporation, declares cash dividends, the source of its income for the past 3 years must be considered. Let us say 60% of the gross income for the past 3 years was derived in the Philippines, up to 60% of the cash dividends declared must be deemed “sourced” within the Philippines. On the other hand, if let us say, only 20% of the gross income of Daimler-Benz AG was derived in the Philippines, the entire cash dividend is deemed “sourced” outside the Philippines.

IV. Rents and Royalties: For rents and royalties, the location of the property from which the rent is derived is the sole concern. If the property is located in the Philippines, the rent or royalty received from such is deemed “source” within the Philippines, regardless of the citizenship or residence of the person deriving such profit.

V. Sale of Personal and Real Property: In determining the “source” of income from sale of personal property, the place of sale shall be considered., regardless of the citizenship or residence of the parties. On the other hand, in determining the “source” of income from sale of “real” property, the location of the real property sold shall be considered, regardless of the place where the sale was perfected.

In summary, in determining whether an income is taxable in the Philippines, two factors must be considered: (I) The citizenship and residence of the person obtaining the gain and (II) the “source” of income. To be taxable, the person deriving the profit must be either a citizen or resident of the country, and the “source” of the income must be in the Philippines.

Cover Photo from: Kelly Sikkema of unsplash.com

[1] Attorney Christian Andrew Labitoria Gallardo is a recent bar passer and a graduate of the Ateneo School of Law with a Juris Doctor degree. He is currently an associate of the Sangalang and Gaerlan, Business Lawyers, a law firm specializing in labor, corporate and business law. You may reach him through a phone call or message (09157042132) or via email (andrew.gallardo@paladinslaw.org)