For income-taxation purposes, a foreign corporation may either be treated as resident or a nonresident foreign corporation. A foreign corporation that is engaged in trade or business within the Philippines is referred to as resident foreign corporation. On the other hand, a nonresident foreign corporation applies to a foreign corporation not engaged in trade or business within the Philippines.
The sources of taxable income in the Philippines for resident and nonresident foreign corporations are essentially the same. Both are subject to Philippine income taxes only with respect to income derived from Philippine sources. But one of the significant differences lies in the taxable base and the payment of taxes. A resident foreign corporation is subject to income tax based on its taxable income, which is the net taxable income. It is required to file the usual quarterly and annual income-tax returns and pay the taxes based on such returns. A nonresident foreign corporation, on the other hand, is subject to income tax based on its gross income. It is not required to file income-tax returns and its taxes are paid through the final withholding tax system.
While that is the basic rule based on domestic laws, the taxation of a foreign entity may be changed if it is a resident of a country of which the Philippines has an existing double-taxation agreement, or what is commonly referred to as tax treaty. Based on these treaties, a foreign entity that has a permanent establishment (PE) in the Philippines shall be taxable in the Philippines. On the other hand, a foreign entity that does not have PE in the Philippines may not be subject to Philippine income tax.
What seems to be unsettled, though, is the tax-compliance obligation by both the PE and the payor in relation to the income of the PE. There are decisions by the Tax Court holding that a PE should still be treated as nonresident foreign corporation for income-taxation purposes, in the absence of registration. As such, income taxes due on their income derived from Philippine sources shall still be subject to the final withholding taxes. The responsibility, therefore, in paying the taxes rests with the customer/payor, as a withholding agent.
The Bureau of Internal Revenue (BIR) had also issued a number of rulings confirming that payment to a foreign corporation with a PE in the Philippines is subject to the final withholding tax. In other words, the fact that a foreign corporation has a PE in the Philippines does not necessarily make the foreign corporation a resident foreign corporation. This notwithstanding, there are also rulings by the BIR which held that a foreign corporation that has created a PE in the Philippines is treated as a foreign corporation engaged in trade or business in the Philippines, otherwise known as a resident foreign corporation. In a more recent ruling (ITAD Ruling 007-16, dated March 4) which found the foreign entity to have a PE, while the BIR did not mention that the PE shall be considered a resident foreign corporation, it stated that that entity is subject to income tax at the rate of 30 percent under Section 28(a)(1) of the Tax Code. This provision apparently pertains to a resident foreign corporation. In essence, the foreign corporation was treated as a resident foreign corporation.
There was, however, no pronouncement as to how the resident foreign entity/PE should register to comply with its income tax obligation. Instead, the BIR required the subcontractor to file the quarterly and annual income-tax returns of the foreign entity. The apparent incompleteness or differences in the issuances/rulings is due to the fact that there is really no specific rule governing the registration and compliance by a PE. So it is interpreted on a case-to-case basis, depending on the facts and issues that are requested or brought before the tax authorities or the courts.
In some jurisdictions, the rules are quite clear for the treatment of PEs. We do not have clear rules in the Philippines. We hope our new tax administrators will include that in their agenda. Clarifications should include the withholding-tax obligations of the payor on the income payment to the PE. Likewise, the registration requirements and compliance obligations for PEs, not only for income taxes but also for value-added tax, should be made clear. Apparently, in the rulings where the BIR considered the foreign entity to be a PE and, therefore, liable to file and pay income tax, the VAT was still required to be paid through withholding by the payor.
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The author is a senior associate of Du-Baladad and Associates Law Offices (BDB Law), a member- firm of World Tax Services.
The article is for general information only and is not intended, nor should be construed as a substitute for tax, legal or financial advice on any specific matter. Applicability of this article to any actual or particular tax or legal issue should be supported, therefore, by a professional study or advice. If you have any comments or questions concerning the article, you may e-mail the author at reynaldo.prudenciado@bdblaw.com.ph or call 403-2001 local 380.