Chapter 15-A — Regular Income Taxation: Special Corporations CHAPTER 15-A REGULAR INCOME TAXATION: Special Corporations Chapter Overview and Objectives This chapter covers income tax rules applicable to special corporations. After this chapter, readers are expected to have obtained mastery of the following. 1. The general income tax rule for regular corporate taxpayers 2. The nature and types of exempt corporations 3. The classification rule for exempt corporations 4. Cost and expense allocation between exempt and taxable activities 5. The dominance test on private schools and non-profit hospitals 6. The taxation rules for FCDU/EFCDU and offshore banking units 7. The special rules on international carriers 8. The different tax rates for special non-resident foreign corporate taxpayers CORPORATE INCOME TAXATION Corporations are subject to final tax, capital gains tax, and the regular income tax. The final tax and capital gains tax of corporate taxpayers are discussed in the previous Chapters. This chapter focuses on the regular income tax of special corporation taxpayers and provides integration of the three tax schemes. As established in previous chapters, the regular income tax of corporations covers any income not subject to the final tax or capital gains tax for corporations. What are corporations? The term corporation shall include partnerships, no matter how created ot organized, joint-stock companies, joint accounts, associations, or insurance companies. The term corporation excludes general professional partnerships and a joint ventures or consortium formed for the purpose of undertaking construction projects or engaging in petroleum, coal, geothermal, and other energy operations pursuant to an operating consortium agreement under a service contract with the Government. GENERAL CLASSIFICATION AND TAXATION OF CORPORATIONS A. Domestic corporations - 25% regular corporate tax on income 638 bh 4chapter 15-A~ Regular Income Taxation: Special Corporations p. Resident foreign corporation - 25% regular corporate t: il saxablcincome ‘porate tax on Philippine ¢. Non-resident foreign corporation - 25% final tax on Philippine_gross Income ‘the CREATE law reduced the regular corporate income tax from 30% to 25% of taxable income effective July 1, 2020. Lower corporate tax for domestic corporations Under the CREATE law, domestic corporations are subject to a 20% regular corporate income tax under the following conditions: a, Asset test ~ Total assets, excluding land on which their office, plant and equipment are situated, does not exceed P100,000,000; and b. Income test ~ Taxable income does not exceed P5,000,000 Entities with assets not exceeding P100 million are referred to as micro-, small-, lower corporate tax, Domestic corporations are mandated to separately account in their Annual Financial Statements (AFS) the cost of the land on which their office, plant and equipment are situated. They are prohibited to lump the same in one account or consolidate its costs with other fixed asset accounts. Mlustration ‘A domestic corporation has the following partial detail of the costs and fair values of its assets in its AFS: Bookvalue Fairvalue Land where the office building stands P 30,000,000 —_P_35,000,000 Land where equipment warehouse stands 20,000,000 25,000,000 Vacant land (investment property) 10,000,000 12,000,000 Land held for sale (inventory) 30,000,000 40,000,000 House and lots for sale (inventory) 20,000,000 27,000,000 Office building 10,000,000 11,000,000 Factory building 15,000,000 14,000,000 Equipment 10,000,000 9,000,000 Other assets 5.000.000 __7,000,000 ‘Total assets 2150,000,000 P_180,00,000 ‘The corporation also have the following analysis of its reported pre-tax income for the taxable year: 639 aaChapter 15-A ~ Regular Income Taxation: Special Corporations Passive income subject to final taxes P 1,000,000 Capital gains subject to capital gains taxes 2,000,000 Taxable income subject to regular tax 4,000,000 Income exempt from income tax 3.000.000 P_10,000,000 Total pre-tax income For purposes of the asset test, accounting bo considered less the cost of lands used for office, ok values as reflected in the AFS are plant and equipment: Total assets per AFS P 150,000,000 Less: land held for use - Land used for the office building P 30,000,000 - Land used forthe equipment warehouse — 20,000,000 50,000,000 Adjusted total assets 2.100,000,000 For purposes of the asset test, the domestic corporation is a MSME since its total assets do not exceed P100 million. For purposes of the income test, only the taxable income subject to regular tax (i.e. P4 million) is considered. Since this is less than the PSM threshold, the corporation is a qualified MSME subject to 20% corporate tax. Summary of regular corporate tax rates Domestic | Resident foreign Taxpayer type corporation | _ corporation MSME corporate taxpayers = With < P5M taxable income 20% 25% = With > P5M taxable income 25% 25% Large corporate taxpayers ~__ With < PSM taxable income 25% 25% | = With > P5M taxable income 25% 25% Ilustration corporation with P100M assets had the following income and expense for 2021: Philippines —Total__ Gross revenues/receipts — P._ 1,800,000 P 1,200,000 P 3,000,000 Less: Business expenses —1.200,000 __ 800,000 __ 2,000,000 Netincome from operation P 600,000 P 400,000 P 1,000,000 Add: Interest from deposit 150,000 50,000 200,000 Net income P750,000 P__450,000 P 1,200,000 The regular income tax of a domestic corporation shall be computed as follows: Net income from operations (P600,000 + P400,000) P 1,000,000 Other income not subject to final tax 50,000 Taxable net income P 1,050,000 Multiply by: Corporate tax rate 20% Regular corporate income tax (RCIT) due P__210,000 640 bhChapter 15-A - Regular Income Taxation: Special Corporations since foreign corporations are not allowed the lower 20% corporat e tax, the regular income tax of a resident foreign corporation shall be computed as follows: Taxable net income (Philippines only) Multiply by: Corporate tax rate E eT Regular corporate income tax (RCIT) P_150,000 Anon-resident foreign corporation is not subj Subject to the regular corporate income tax but toa 25% final tax based on Bross income from all sources within. Resident payors shall withhold the following: Gross revenues/receipts P 1,800,000 Interest income from deposit “150,000 Total gross income within P 1,950,000 Multiply by: ——_25% Total final tax P__487,500 Note that for purposes of final tax, gross income on the sale of services means revenue or receipts without deduction for cost of services. SPECIAL CORPORATIONS Certain corporations are subject to a special tax treatments or preferential tax rates lower than the 25% regular corporate income tax. These are generally referred to as “special corporations.” For easier understanding, we will further sub-classify the three broad classifications of corporations. ‘SUB-CLASSIFICATION OF CORPORATE INCOME TAXPAYERS ‘A. Domestic corporations 1. Exempt domestic corporations a. Exempt non-profit corporations under the NIRC b. Government agencies and instrumentalities c. Certain government-owned and controlled corporations d. Cooperatives 2. Spectal domestic corporations oy proprictary educational institutions and non-profit hospitals b._ Foreign currency deposit units (FCDUs) and Expanded FCDUs ¢. PEZAor BOI-registered enterprises 3, Regular domestic corporations B. Resident foreign corporations 4, Special resident foreign corporations 641Chapter 15-A — Regular Income Taxation: Special Corporations a. Expanded FCDUs b. Regional Area Headquarters and Regional Operating Headquarters of Multinational Companies c. International carrier d. BO! or PEZA-registered enterprises 2. Regular resident foreign corporations C.__Non-resident foreign corporations 1. Special non-resident foreign corporations a. Non-resident cinematographic film owner, lessor or distributor b. Non-resident lessor of vessels, chartered by Philippine nationals ¢. Non-resident owner or lessor of aircraft, machineries, and other equipment 2. Regular non-resident foreign corporations The following section discusses in detail all relevant tax rules on exempt and special corporations. EXEMPT DOMESTIC CORPORATIONS The following corporations are exempt from the regular corporate tax: 1. Exempt non-profit corporations under the NIRC 2. Government agencies and instrumentalities 3. Exempt government-owned and controlled corporations 4. Cooperatives Qualification of Tax Exemption Income tax exemption relates only to income from related activities. Income from activities unrelated to the purposes for which an exempt corporation is organized and income from activities conducted for profit including income from properties are taxable regardless of the disposition made of such income, The Classification Rule Since exemption applies only to income from related activities, the income of exempt corporations are classified into income from related activities and income from unrelated activities. The income from unrelated activities is subjected to regular income tax. Exempt corporations under the NIRC: 1) Labor, agricultural, or horticultural organizations not organized principally for profit 642~~ Chapter 15-A — Regular Income Taxation: Special Corporations 2) Mutual savings banks not having a capital stock represented by shares, and cooperative bank without capital stock organized and operated for mutual purposes and without profit 3) A beneficiary society, order, or association operating for the exclusive benefit of the members such as a fraternal organization operating under the lodge system, or mutual aid association or a non-stock corporation organized by employees providing for the payment of life, sickness, accident, or other benefits exclusively to the members of such society, order, or association, or non-stock corporation or their dependents 4) Cemetery company owned and operated exclusively for the benefit of its members 5: Non-stock corporation or association organized and operated exclusively for religious, charitable, scientific, athletic, or cultural purposes, or for the rehabilitation of veterans, no part of its net income or asset shall belong to or inures to the benefit of any member, organizer, officer or any specific person; Business league chamber of commerce, or board of trade, not organized for profit and no part of the net income of which inures to the benefit of any private stock-holder, or individual 7) Civic league or organization not organized for profit but operated exclusively for the promotion of social welfare 8) Anon-stock and nonprofit educational institution 9) Government educational institution 10) Farmers’ or other mutual typhoon or fire insurance company, mutual ditch or irrigation company, mutual or cooperative telephone company, or like organization of a purely local character, the income of which consists solely of assessments, dues, and fees collected from members for the sole purpose of meeting its expenses 411) Farmers, fruit growers’, or like association organized and operated as a sales agent for the purpose of marketing the products of its members and turning back to them the proceeds of sales, less the necessary selling expenses on the basis of the quantity of produce finished by them 6) tion 1 Bey Kalina a social welfare charitable non-profit corporation, reported the following statement of income and expenses: 643Chapter 15-A — Regular Income Taxation: Special Corporations Related Unrelated a a 1 Gross receipts P 1,200,000 P 800,000 P 2,000,000 Less: Cost of services __ 400,000 ___400,000 ___ 800,000 Gross income P 800,000 P 400,000 P 1,200,000 Less: Expenses 400,000 150,000 ___550,000 Net surplus PB_400,000 P__250,000 P 650.000 ‘The income tax due of the corporation shall be: Net income or surplus from unrelated activities P 250,000 Multiply by: Corporate tax rate ——2ek Regular corporate income tax P__62,500 Note: Exempt corporations are treated as regular domestic corporations with regard to their income from unrelated sources. Ilustration 2 Toma Sengla Tumba, a not-profit fraternal organization, received total membership dues of P300,000. To finance its community development project, it conducted a fund- raising drive by selling souvenir items to local tourists, The fund raising generated P200,000 income. ‘The organization shall pay income tax on the fund raising income: Net income from fund-raising activities P 200,000 Multiply by: Corporate tax rate aah Regular corporate income tax P__50.000 Note: Fund raising activities, being commercial in nature, are taxable. The membership dues are exempt. Requisites for exemption of non-stock, non-profit corporations 4. It must be a non-stock corporation or association organized and operated exclusively for religious, charitable, scientific, athletic, or cultural purposes, or for the rehabilitation of veterans. 2. Itshould meet the following tests: a. Organizational test - Its constitutive documents exclusively limit its purposes to one or more of the following: religious, charitable, scientific, athletic or cultural purposes, or for the rehabilitation of veterans. b, Operational test - The regular activities of the corporation or association must be exclusively devoted to the accomplishment of the aforementioned purposes. A corporation fails this test ifa substantial part of its operations is considered “activities conducted for profit.” 644: i Chapter 15-A — Regular Income Taxation: Special Corporations Allnet income or assets of the corporation o: iati ; h r association must be di its purposes and no part of its net income or asset accrues to or bi tie 7 member or specific person. see 4, It must not be a branch of a foreign non-stock, non-profit corporation. A non-profit organization is still allowed to engage in activities ia ‘ a rofit without losing its tax exemption but the consequence is being es a Pry on income conducted for profit, regardless of the disposition made of such income. Illustration pact Medical Center is organized as a non-stock, non-profit hospital catering to ethnic ‘community members. Members pay minor charges which are reimbursements in nature to replenish the working capital of the medical center. Daet Medical Center relies on contributions from members and foreign aid for facilities improvement. Since there is no “purpose to make a profit over and above the costs,” Daet Medical Contor is exernpt from income tax on services from paying members. Exception to the Classification rule: Non-profit educational institutions Under the Constitution, all revenues and assets of non-stock non-profit vjueational institutions used actually, directly, and exclusively for educational purpases shall be exempt from taxes and duties. Hence, the income from unrelated operations of these institutions is still exempt from income tax if used for educational purposes. IMlustration 1 Sutherland University, a non-profit educational institution, collected 4,000,000 school fees and assessments from its students. It also earned P200,000 from the rent orits properties and realized P400,000 in the sale ofits properties Sutherland University utilized the P200,000 rentals to fund an undergraduate Scholarship program and invested the P400,000 for the retirement benefits of university directors. In this case the P4M is an income from related activities. The P200,000 rentals and 400,000 gain on the sale of properties are income from unrelated activities. The P#M Income is exempt. The P200,000, even if arising from unrelated activities, is still exempt because it is diverted to an educational purpose. The 400,000 is subject to regular income tax because it isnot used for an educational purpose. Mlustration 2 | How would Sutherland University be taxed in the immediately preceding illustration if itis a: ‘a. Government school b. Private school 645ie, | Chapter 15-A — Regular Income Taxation: Special Corporations Answer: If Sutherland University is a government school: ‘The classification rule would apply because the Constitutional exemption appli to non-stock, non-profit educational institutions. As such, the P4M would be ny but the P200,000 and P400,000 income would be taxable. Sxemp, If Sutherland University is a private school: The dominance test for private schools will apply. This will be discussed later in ty, is Chapter. Certificate of Tax Exemption Ruling Non-profit corporations or associations must secure a Tax Exemption Ruling from the BIR to enjoy the tax exemption. The ruling shall be valid for a period of 3 years unless sooner revoked or cancelled. ’ The Tax Exemption Ruling shall be deemed revoked on the date there are materiaj changes in the character, purpose, or method of operation of the corporation or association which are inconsistent with the basis of the income tax exemption. In addition, it shall be revoked also on the basis of non-renewal of the tax exemption ruling or non-revalidation of previously issued rulings. Failure to file an income tax return shall also result in the loss of the tax exempt status. Government agencies and instrumentalities Government agencies and instrumentalities such as departments and bureaus are inherently non-profit because of their public service functions; hence, they are exempt from income tax. government agencies and instrumentalities from However, the income of unrelated activities or from their properties is subject to income tax. Government-Owned and Controlled Corporations (GOCCs) GOCCs are generally proprietary or commercial in nature and are subje regular corporate income tax except the following exempt GOCCs: Government Service Insurance System (GSIS) ct to the t. 2. Social Security System (SSS) 3. Philippine Health and Insurance Corporation(PHIC) 4. Home Development Mutual Fund (HDMF) - RA 11534 5, Local water districts - RA No. 10026 *PCSO was removed from the NIRC list by the TRAIN law effective January 1, 2018.chapter 45-A - Regular Income Taxation: Special Corporations cooperatives A cooperative is an autonomous association of persons who voluntarily joined together to achieve their social, economic, and cultural needs and aspirations by making equitable contributions to the capital required, patronizing their products and services, and accepting a fair share of risks and benefits of the undertaking, Classification of registered cooperatives for taxation purposes: ‘A. Cooperatives which transact business only with members ‘These cooperatives are not subject to any taxes and fees under the NIRC and other tax laws, such as the following: 1. Income tax (on related regular income) 2. VAT and Percentage tax 3. Donor's tax 4, Excise tax 5. Documentary stamp tax Annual registration fee B. Cooperatives which transact business with both members and non- members 1. Those with not more than P10M accumulated reserve and undivided net savings are exempt from taxes, similar to cooperatives transacting business only with members. 2. Those with more than P10M accumulated reserve and undivided net savings are subject to the following tax at full rate: a. Income tax on the full amount allocated for interest on capital b. Value Added Tax (VAT) on transactions with non-members c. Percentage Tax on all sales of goods or services rendered to non- members d. Allother internal revenue taxes unless otherwise provided by the law The accumulated reserve, commonly referred to as the reserve fund, refers to the totality of the amounts legally required to be deducted annually from the annual net surplus (income) ofthe cooperative for its protection and stability. Under RA 9520, the net surplus of every cooperative shall be distributed as follows: 1, Reserve fund - at least 10% of the net surplus but must not be less than 50% of the net surplus in the first five years of operation 2, Education and training fund - not more than 10% of net surplus 3, Community development fund - not less than 3% of net surplus 4, Optional land and building fund - not to exceed 7% of net surplus 647 Pr.Chapter 15-A — Regular income Taxation: Special Corporations 5. Interest, which shall not exceed normal rate of return on investments, and patronage refunds which must not be less than 30% of the net surplus after deducting the statutory reserves 6. Any excess to reserve fund Taxability of Cooperatives to Internal Revenue Tax All cooperatives regardless of classification are subject to the following: The applicable income tax on unrelated income Capital gains tax Documentary stamp tax VAT on purchases of goods or services except VAT exempt importations Withholding tax on wages except for minimum wage employees All other taxes for which cooperatives are directly liable and not otherwise expressly exempted by any law DAWN ‘The taxable income of cooperatives is determined after provision for the general reserve fund. Illustration Jaro Farmers Cooperative (JFC) is a marketing cooperative with more than P300M in total assets. It sells the vegetable productions of its members. In compliance with legal requirements, JFC reserves the following percentage of net surplus: - Reserve fund - 10% + Education and training fund - 10% - Community development fund - 5% - Optional building fund - 5% Per by laws, the net surplus after the reserves is distributed as follows: - 50% as interest to capital, but must not exceed 18% normal return on average capital of members - 50% as patronage refunds to members Residual balance to reserve fund Members have P1,200,000 weighted average capital as of year-end. JFC’s income statement on its sixth year of operation is presented below: Sales P 3,100,000 Cost of sales Gross income P 1,500,000 Operating expenses Operating surplus P 900,000 648 h- chapter 45-A — Regular Income Taxation: Special Corporations operating surplus . P 900,000 Add: non-operating income: Rental of vacant facilities 200,000 Interest on investment in bonds 20,000 | Interest on bank account, net of final tax ___49000 Total surplus B.1124,000 required: Compute the taxable income assuming JFC is trading: Only with members b, With both members and non-members Solution: only with members ‘The net income from unrelated sources after the statutory reserve requirements if any, constitutes taxable income for purposes of the regular income tax. Hence, Rental income P 200,000 Interest on bonds investment Total income P 220,000 Less: Reserve fund requirement (10%) 22,000 Taxable income P_198,000 Note: 1. JCisexempt from any tax onits transactions with members. 2. The interest on banks must be excluded as itis already subjected to final tax. 3, JRC shall report the same taxable income if it transacts business with non-members but with an accumulated reserve of less than P10,000,000, With both members and non-members ‘Assume that 20% of the sales were from non 10,000,000 accumulated reserves. members, and JFC has more than Operating surplus- non-members (P9O0K x 20%) 180,000 Unrelated income: Rent income, net 200,000 Interest on bonds investment 20.000 Total taxable surplus Pp 400,000 Less: Reserve fund requirement (10%) “49,000 er reserve from non-members P__360,000 Net surplus aft Operating surplus from members (P900K x 80%) P 720,000 Less: eee peserve fund (10%) P 72,000 Faucation and training fund (10%) 72,000 Community dev't fund (5%) 36,000 Optional building fund (5%) 36,000 __ 216000 Net surplus distributable B_s04000 649 PrChapter 15-A ~ Regular Income Taxation: Special Corporations Net surplus is distributable per by-laws as follows: ‘As interest on members’ capital* P 216,000 ‘As patronage refunds (50%) 252,000 Excess halance to reserve fund 36.000 B_504,000 Net surplus as distributed “Per JFC by-laws, intereston capital is the lower of: 50% of distributable surplus = 50% x P'504,000 = P252,000 19% normal return on capital = 18% x P1,200,000 = P216,000 ‘The taxable income and income tax due shall be computed as follows: Net surplus after reserve from non-members P 360,000 Net surplus distributed as interest to members ——216,000 ‘Taxable income P 576,000 Multiply by: Corporate tax rate ——_25% B144,000 Regular corporate income tax Note: 1. Under RA 9520, the ultimate distribution of the P216,000 interest to members shall no longer be subjected to final tax. 2, The patronage refund is not deemed income by law as it isa mere return of savings tothe members. ALLOCATION OF COMMON EXPENSES OF EXEMPT CORPORATIONS Expenses of an exempt corporation that are not directly traceable to either related and unrelated activities are allocated based on gross income. Mlustration Anon-profit entity presented the following analysis of its net surplus: Related Unrelated Ga io r Gross receipts P 1,200,000 P 800,000 P 2,000,000 Less: Cost of services 400,000 __800,000 Gross income P 800,000 P 400,000 P 1,200,000 Less: Direct expenses 280,000 70,000 350,000 Common expenses 180,000 Surplus P_670,000 ‘The taxable income from unrelated activities will be computed as follows: Gross income from unrelated activities P 400,000 Less: Direct expenses P 70,000 Allocated common expense (P400K/(P400K+P800K)) xP180K _ 60.000 ___ 130,000 2_270,000 ‘Taxable net income 650, ae chapter 45-A ~ Regular Income Taxation: Special Corporations ‘This common expense allocation procedure is also applicable to corporations with note: THIS i subject to special tax regimes or to preferential rates. income REPORTING REQUIREMENTS FOR EXEMPT CORPORATIONS Exempt corporations with no taxable income shall file BIR Form 1702-EX using itemized deductions only. If they are not delinquent in filing their return or have no violations on withholding taxes, they will not pay any tax. The information furnished by BIR Form 1702-EX is essential to the BIR’s tax mapping effort and a test of compliance of the corporation to the withholding tax regulations on income payments. Exempt corporations with taxable income subject to regular tax shall file BIR Form 1702-RT. If they also earn income subject to special tax rates, they are must file BIR Form 1702-MX. SPECIAL DOMESTIC CORPORATIONS 4. Private educational institutions 2. Non-profit hospitals 3, Foreign Currency Deposit Units or Expanded Foreign Currency Deposit Units 4, PEZA or BOI-Registered Enterprises PRIVATE EDUCATIONAL INSTITUTION AND NON-PROFIT HOSPITAL Private or proprietary educational institution and non-profit hospitals are subject to 10% tax on world taxable income subject to the pre-dominance test. To alleviate the impact of the pandemic, the 10% tax rate is temporarily lowered 1. 9p starting July 1. 2020 to June 30, 2023. The same shall revert back to 10% effective July 1, 2023. what isa private or proprietary educational institution? A proprietary ‘educational institution is any private school maintained and administered by private individuals or groups with an issued permit to operate from any of the following: 1 Department of Education (DepEd) 2. Commission on Higher Education (CHED) 3. Technical Education and Skills Development Authority (TESDA). The Pre-dominance Test If the gross income from unrelated trade, business or other activity exceeds fifty (50%) of the total gross income derived by such educational institutions tals from all sources, the 25% regular corporate income tax applies. percent or hospi 651 aChapter 15-A - Regular Income Taxation: Special Corporations Unrelated trade, business or activity Unrelated trade, business or other activity means any trade, business or oth, activity, the conduct of which is not substantially related to the exercise ¢ performance by such educational institution or hospital from its primary Purpose or function. Iustrations 1 A private educational institution reported the following during the year 2021: Related Unrelated Gross receipts P 1,100,000 P 900,000 P 2,000,000 Less: Cost of services 400,000 Gross income P 700,000 P 500,000 P 1,200,000 Less: Deductions 400,000 ___100,000 ___500,000 B_300,000 P__400,000 P__700,000 Net income The gross income from related activities (P700K/P1,200K = 58%) passes the predominance test. The income tax due shall be computed as follows: Taxable net income P 700,000 Multiply by: Corporate tax rate a Income tax due P2000 Ilustration 2 Anon-profit hospital with more than P200M in total assets, net of cost of landholdings, reported the following during a year: Related Unrelated P 1,000,000 P 1,100,000 P 2,100,000 Gross receipts Less: Cost of services __500,000 300,000 P 500,000 P 700,000 P 1,200,000 0 Gross income Less: Deductions 100,000 _ 400,000 ___500,000 P_400,000 p__300,000 P__700,000 Net income The gross income failed the pre-dominance test (P500K/P1,200K = 42%); hence, the non-profit hospital shall be taxable as a regular corporation: Taxable net income P 700,000 Multiply by: Corporate tax rate 25% Regular corporate income tax P__175,000 652er crapter 45-A — Regular Income Taxation: Special Corporations ry of Tax Rules on Educational Institutions and Hospitals summa} owner Educational institutions Hospitals private 10% (1%) of taxable income 25% (20%) of taxable income rriproft Exempt 10% (196) of taxable income Government Exempt Exempt pORBIGN/EXPANDED CURRENCY DEPOSIT UNIT Foreign currency deposit units (FCDUs) and Expanded FCDUs (EFCDUs) refer Formunit or department of a local bank or a local branch of a foreign bank ed by the BSP to engage in foreign currency-denominated transactions authoria' RA 6426, as amended. pursuant to ‘A local bank refers to a commercial bank, universal bank, and a thrift bank organized under the laws of the Philippines (RR10-98). The bank shall secure a Sepayer Identification Number (TIN) for its EFCDU or FCDU separate from the TIN of ts regular business unit (RBU). Authorized transactions of FCDU FCDUs are limited under their license to short-term foreign currency-denominated transactions. They are authorized to accept deposits and trusts accounts, borrow on- short-term maturity, and invest in short-term maturity deposits, readily marketable debt securities, and short-term foreign currency loans. They are also authorized to enter into currency swap with the BSP, other FCDUs/EFCDUs or OBUs, enter into security lending activities as lender, and engage in repurchase agreement on foreign currency denominated securities. Authorized transactions of EFCDU The license to operate an EFCDU authorizes engagements in the same transactions allowed to FCDUs plus authorization to enter into foreign exchange trading, issue ests of credit for non-resident exporters, accept or negotiate drafts or bills of exchange drawn under letters of credits or make payments to the order of a non- Fesident exporter upon request of their foreign correspondent bank, purchase export bills of resident exporters, enter into securities lending activities, and repurchase agreements involving foreign currency denominated securities. Distinction of FCDU, OBU and EFCDU FCDUs are ete short-term foreign currency transactions while EFCDUs are allowed both short-term and longer-term foreign currency-denominated transactions. o ue cou Ee oe domestic local bank, An Offshore Banking Unit (OBU) isa fonominate ivonaantien a ; which is authorized to conduct foreign currency An EFCDU may be a division of a domestic bank or a 653 __—_fa____Chapter 15-A — Regular Income Taxation: Special Corporations resident foreign bank authorized to conduct banking under the expanded fo, a eign currency deposit system. Tax on EFCDUs The income of depositary banks under the Expanded Foreign Currency Depo, System from foreign currency transactions with: A. Non-residents (offshore income) - exempt from income tax B. Residents 1. Banks under the foreign currency deposit system such as: a. Offshore banking units (OBUs) b. local commercial banks and branches of foreign banks authorized by the BSP to transact business with FCDUs ~ exempt from income tax 2, Other residents (onshore income) a. interest income only ~ 10% final tax b. other income, such as commissions and gains - regular corporate income tax (Deutsche Bank AG Manila Branch vs. Commissioner of Internal Revenue, CTA Case No. 6566, May 17, 2005) If the interest income is not subjected to final tax by the borrower, the FCDU or EFCDU shall report the same in its gross income in the income tax return and shall be subject to the same 10% tax. It shall be separately presented from other income subject to the 25% regular corporate income tax. Taxation of FCDUs In practice, the BIR does not distinguish EFCDU from FCDUs. Consequently, FCDUs are taxed the same way as EFCDUs. Summary of Tax Rules on FCDUs/EFCDUs ROME Resi (E)FCDUs Other Non- or OBUs Residents _Residents Income from forex transactions Interest income from: - Forex loans &receivables exempt 10% FIT — exempt - Forex deposits exempt = exempt Other forex income exempt RcIT exempt Income from non-forex transactions RIT RCIT RCIT 654chapter 45-A - Regular Income Taxation: Special Corporations qax on income of depositors under the EFCDS Any income of nonresidents from transactions with depository banks under the panded system shall be exempt from income tax. Interest income of residents fran depositary bank under the FCDS/EFCDS is subject to 15% final tax. ax on Regular Banking Units or RBUs ‘the income from the regular banking unit of domestic banks is subject to the 25% regular corporate income tax. tustration ‘the expanded foreign currency deposit unit of a domestic commercial bank derived the following income from its foreign currency and other transactions: Received from Residents FCDUs/ Non- Income items EFCDUs Other cena Residents Interest income from loans & receivables 5,000,000 | _P10,000,000 |_P4,000,000 Interest income - foreign currency deposits 200,000 Forex trading gains 300,000 200,000 |__100,000 Consultancy fees 250,000 500,000 | __100,000 Rentincome 50,000 120,000 80,000 Required: Identily the exempt income, gross income subject to final tax, and those subject to regular tax, Solution: Exempt income items are indicated in italics, income items subject to final tax are in bold-italics and those subject to regular tax in bold font. | OBUsor — Non- Income items FeDUs/ Other Je idents EFCDUs Residents income from forex loans _ | P10,000,000 | P4000, 200 est income from forex deposits trading gains _ 200,000 100,000 Ce 500,000 | 100,000 [Rent income 120,000 | 80,000 | ‘The total final tax on the P10,000,000 shall be withheld by Philippine resident borrowers. 655 he.Chapter 15-A ~ Regular Income Taxation: Special Corporations ‘The FCDU of the domestic bank shail include the following in its gross income gy to the regular corporate income tax: ject Forex trading gains to other residents P 200,000 On-shore income from non-forex transactions Consultancy fees (P250,000 + P500,000) P 750,000 Rent income (P50,000 + P120,000) 170,000 920,000 Off-shore income from non-forex transactions Consultancy fees P 100,000 Rent income 80,000 ___180,000 Gross income 21,300,000 Allocation of Cost and Expenses of Banks RR4 - 2011 prescribes the allocation method of cost and expenses of banks between their exempt and taxable operations as follows: a. Specific identification - Expenses directly traceable to an income are allocate to that income. b. Pro-rata allocation - Expenses that are not directly traceable to an income are allocated pro-rata on the ratio of all income. Under the matching principle, only expenses traceable or reasonably allocable to RBU and FCDU income subject to regular tax are deductible in the determination of taxable net income. Mlustration 1 A domestic bank with P400M in total assets reported the following summary of income and expense as to source: Non- OBU/FCDU__Others _ Resi —Total__ RBU gross income F - P- 1,200,000 P 150,000 P 1,350,000 FCDU interest income 1,000,000 800,000 400,000 2,200,000 RBU expenses me 600,000 50,000 650,000 FCDU expenses 300,000 200,000 60,000 __560,000 Net income P2.340,000 Required: Determine the final income tax and the income tax due. Solution: The final tax withheld is P80,000 computed as 10% x P800,000. The P1M income fro™ OBU and FCDUs and the P400,000 FCDU income from non-residents is tax-exempt. ‘The income tax due of the bank shall be computed as follow: 656