Revisiting the Tax Sparing rule

Edison U. Ortiz

In 1974, legislators recognized the importance of attracting foreign investment and provided a reduced tax rate for dividends received by non-resident foreign corporations (NRFCs) from domestic corporations. Instead of the regular corporate income tax rate of 30%, a 15% rate was imposed on dividends received. This was subject to the condition that the country in which the NRFC is domiciled shall allow credit against the tax due from the NRFC taxes paid in the Philippines. The credit is equivalent to a particular amount representing the difference between the regular corporate income tax rate and the reduced 15% tax rate.

This preferential tax rate is still present in the current Tax Code and is popularly known as the “tax sparing rule”. Based on rulings previously issued by the BIR and subject to future changes in their tax laws, foreign tax jurisdictions such as the US, Switzerland, Luxembourg, the Cayman Islands, Cook Islands, and Bermuda were determined to have tax rules that either allow the “deemed paid” tax credit or exempt the dividends from income tax.   

The current Tax Code provides that an NRFC may avail of this reduced tax rate if its country of domicile allows a minimum “deemed paid” tax credit amount equivalent to 15%, representing the difference between the 30% current regular income tax rate and the reduced 15% tax rate. It also means that the exemption from taxes allowed by the NRFC’s country of domicile is sufficient to apply the 15% reduced tax rate.

In 2016, the Bureau of Internal Revenue (BIR) issued guidelines on how to avail of this 15% preferential rate through Revenue Memorandum Order (RMO) No. 27-2016. However, RMO No. 27-2016 did not gain any traction and was eventually suspended by Revenue Memorandum Circular (RMC) No. 69-2016. The only viable option for taxpayers then was to request a confirmatory ruling from the BIR’s Law and Legislative Division. Even so, the release of confirmatory rulings took time due to the volume of taxpayer requests filed with the BIR covering issues other than the tax sparing provision. Essentially, the guidelines in the processing of requests for rulings did not provide the rules that would allow domestic corporations to declare and remit the dividends due to NRFCs prior to the release of the confirmatory ruling.      

Fast forward to late 2020, when the BIR issued RMO No. 46-2020 on Dec. 23, which sought to finally provide clarity to the claim of the 15% tax on intercorporate dividends. According to this RMO, the domestic corporation acting as a withholding agent may remit the dividends outright and apply thereon the reduced rate of 15% upon the submission of a specific BIR form and the required attachments.

Seemingly stemming from the policy of easing doing business in the Philippines, the RMO allows domestic corporations paying the dividends to apply the reduced rate of 15% without first securing a ruling from the BIR. Instead of a confirmatory ruling, the BIR issues a certification verifying the entitlement. In case of a denial, the BIR shall issue a ruling containing the factual and legal bases that led to such denial of the request for confirmation. This denial can eventually be subject to an appeal to the Department of Finance.

Should there be an existing tax treaty between the Philippines and the country of domicile of the NRFC, there is an option to apply for either the reduced 15% rate under the Tax Code or the preferential rate under the applicable tax treaty.

This RMO also emphasized that holders of Philippine Depositary Receipts (PDRs) may likewise be considered shareholders for the purpose of availing of the reduced 15% tax rate provided that the PDR is coupled with a right to purchase the underlying shares and that the right can be legally exercised without violating any foreign equity ownership restrictions and nationalization laws.

For NRFCs that have been consistently claiming the 15% reduced rate, it is essential to be acquainted with the list of documentary requirements for submission to the BIR International Tax Affairs Division (ITAD).

For prospective foreign investors and NRFCs expecting to receive dividends from domestic corporations, a careful analysis should be made to determine whether to invoke the 15% reduced rate under the Tax Code or to avail of the preferential rate under an existing tax treaty.

For domestic corporations acting as withholding tax agents, it shall likewise be prudent to maintain copies of the filed request for confirmation and its attachments for documentation purposes which will be useful during BIR audits.

This RMO can aid businesses through the timely repatriation of dividends to foreign investors to address these investors’ cash flows and other cash requirements. The outright claim of the preferential rate shall likewise result in the possible reduction in administrative costs concomitant with the prior rules which necessitated companies to secure confirmatory rulings. Owing to the streamlined processes brought by this RMO, the simplified procedures make it easier for companies to internally integrate the function of compliance oversight. The RMO provides further influential impact by removing uncertainties and promoting a sense of security to foreign investors due to the uniform rules and procedures in availing of the 15% rate.

NRFCs should likewise keep an eye on the Corporate Recovery and Tax Incentives for Enterprises Act or CREATE. This measure may lead to a further reduction in the minimum “deemed paid” tax credit to avail of the 15% reduced rate due to the proposed reduction in the regular corporate income tax rate. Moreover, with the intent to repeal the rules on Improperly Accumulated Earnings Tax (IAET), companies will have more flexibility in deciding whether to declare the earnings as dividends, utilize the same for future projects, or simply retain them. This makes the process much easier for those who opt to declare dividends under the tax sparing rule.

With the issuance of the RMO, companies may take comfort in the fact that there is consistency and uniformity in the documentary requirements in availing of the 15% preferential rate.

At the end of the day, while it has taken decades to finally gain clarity on the proper application of the tax sparing rule, we can see that the government’s focus on enhancing the ease of doing business is well and truly being addressed. It is particularly crucial at this challenging time to ease the burden of compliance with tax law, and for companies to better boost investor confidence in our country’s economic and business landscape.

This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the author and do not necessarily represent the views of SGV & Co.

Edison U. Ortiz is a Tax Senior Director of SGV & Co.

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