FINAL INCOME TAXATION

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.

Final withholding system

The final withholding system imposes upon the person making income payments the responsibility to
withhold the tax. The tax which will be deducted at source is final. 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 only to certain passive income earned
from sources within the Philippines. Note that taxation is territorial and we cannot impose tax
obligation (filing or withholding) against non-resident subjects of foreign sovereignty. Hence, all items
of income earned from sources abroad, passive or active, are subject to tax under the general scope
of the regular income tax.

Rationale of Final Income Taxation

The final withholding tax is built upon the 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 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 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 the 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 aliens not engaged in trade or business (NRA-NETB) and non-resident foreign
corporations (NRFC), have high risk of non-compliance. These taxpayers do not have offices or fixed
places of business in the Philippines making tax compliance very unlikely due to their absence and
distance in the Philippines. Also, the Philippine government cannot impose upon them the obligation
to file return due to territorial consideration.

Thus, the law subjects them to final income tax wherein Philippine residents paying them income,
passive or active, are obligated to withhold the following final tax:

Non-resident person not engaged in trade or business General final tax rate
NRA-NETB 25%
NRFC 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 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 P 10,000
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. NRA-NETB, and
b. NRFC

INTEREST INCOME OR YIELD

Interest income 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%

*Exemption does NOT include NRA-NETB

Short term deposits are those made 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 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 determinations of P 10,000 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

Compute the final tax if the taxpayer is a(n):

1. Resident citizen
2. Non-resident citizen
3. Resident alien
 4. Non-resident alien engaged in trade or business (NRA-ETB)
5. Non-resident alien not engaged in trade or business (NRA-NETB)
6. Domestic Corporation
7. Resident Foreign Corporation
8. Non-resident foreign corporation

Note: The exemption of individuals on interest income on long-term deposits is anchored on the fact
that long-term deposits are usually channeled to the financing of long-term projects such as
infrastructures, property developments, and other construction project which are deemed essential to
the development of the country. Note that exemption is limited only to individual to the exclusion of
corporations.

Illustration 2
A resident taxpayer received a P 16,000 interest income from a bank. Determine the final tax
withheld at source.

Answer:

Illustration 3
Banko Negro 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

Compute the final tax of the following taxpayers:

1. Residents
2. RFC/DC
3. NRA-NETB
4. NRFCs

Compute the total final income tax to be withheld by Banko Negro.

Tax on pre-termination of long term deposits of individuals
If the deposit or investment placement of individual taxpayers is pre-terminate 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, 2016, Alice invested P 1,000,000 in Baguio Bank’s 5 year time deposit. The deposit
pays 10% interest annually. Alice pre-terminated the deposit on July 1, 2019.

1. Compute the final tax on pre-termination.

2. How much is the net proceeds to be released to the depositor?

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.

Other applications of the final tax on interest

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

Deposit substitute means an alternative form 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 need of their agent or dealer.

Government debt instruments and securities including Treasury bonds, Treasury bills and treasury
notes shall be considered as deposit substitutes 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-resident EXEMPT EXEMPT
Note:
1. Resident taxpayers include:
a. Resident citizens
b. Resident aliens
c. Domestic corporations
d. Resident foreign corporations
2. Non-residents taxpayer include:
a. Non-resident citizens
b. Non-resident aliens
c. Non-resident foreign corporations
3. NRA-NETB and NRFCs are also EXEMPT.
4. There is NO long-term or short-term classification of FOREIGN currency deposits.

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 Philippine peso is not globally accepted
currency. Our foreign trade will be limited without adequate foreign currency reserves 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.

Illustration 1
Mr. Siman 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 P 41,500.

Compute the final tax for the following cases:

1. If he deposited his savings through the account of his resident wife.
2. If he deposited his savings through a joint account with his resident wife.
3. If he deposited his savings through his own account.

Interest income subject to regular tax

Interest income from the following sources is subject to regular income tax, NOT TO FINAL TAX:
KLARO? Ayeee nabasa.
1. Lending activities, whether or not in the 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

End of Part 1
Reference: INCOME TAXATION by Sir Rex Banggawan CPA, MBA 2019 EDITION

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