Taxing citizens with new perspectives

How the Philippines taxes its citizens should be straightforward. Citizens are taxed based on tax status and residency. Tax status is inconsequential across taxpayers whether single, married or head of the family because they are allowed the same basic personal exemption deduction. Tax residency, on the other hand, can largely impact the tax liability of a citizen taxpayer. 

A citizen of the Philippines can either be a tax resident or a non-resident.  It is important to distinguish taxable income bases between these two types of taxpayers. A resident citizen is taxed on all of his net taxable income from worldwide sources. In contrast, a non-resident citizen is taxed on his net taxable income derived from sources within the Philippines only.  This distinction makes shifts in residency by a citizen taxpayer radically significant to him tax-wise.

A citizen is generally considered “resident” unless he satisfies the criteria for a “non-resident.” Section 22 (E) of the Tax Code of 1997, as amended, defines the term ‘non-resident citizen’ as four kinds of citizens:

1) A citizen of the Philippines who establishes to the satisfaction of the Commissioner the fact of his physical presence abroad with a definite intention to reside therein.

2) A citizen of the Philippines who leaves the Philippines during the taxable year to reside abroad, either as an immigrant or for employment on a permanent basis.

3) A citizen of the Philippines who works and derives income from abroad and whose employment thereat requires him to be physically present abroad “most of the time” during the taxable year. The regulations clarify the phrase “most of the time” to mean presence abroad for at least 183 days in the calendar year (Section 2(c), Revenue Regulations No. 1-79). 

4) A citizen who has been previously considered as non-resident citizen and who arrives in the
Philippines at any time during the taxable year to reside permanently in the Philippines shall likewise be treated as a non-resident citizen for the taxable year in which he arrives in the Philippines with respect to his income derived from sources abroad until the date of his arrival in the Philippines.

The rules on achieving non-resident status for a citizen can look quite clear-cut but it is really more complicated than it seems.

In the previous rulings of the Bureau of Internal Revenue (BIR), BIR Ruling 013-2003, BIR Ruling No. [DA-(I-003) 081-09], and BIR Ruling No. [DA-369-05], the 183-days physical presence test was used as a primary basis in determining if a citizen qualifies as a non-resident under Section 22 (E)(3).  Aggregated presence during the year outside the Philippines was held as satisfying the said days test abroad. 

In the recent BIR Ruling No. 517-2011, the BIR reinterpreted Section 22 (E)(3) by highlighting the phrase “whose employment thereat requires him to be physically present abroad”. It said that such provision contemplates of a citizen’s “employment thereat” and cited further the “right-of-control” to test if he is employed in such country. The right-of-control in an employer-employee relationship exists when the person for whom the services were performed has the right to control and direct the individual who performs the services, not only as to the result to be accomplished, but also as to the details and means by which such results are accomplished. This ruling stressed that the element of an employer-employee relationship, among others, must be demonstrated between a foreign company and a citizen for him to be considered for a non-resident status.

Through this ruling, the BIR emphasized compliance to other conditions of Section 22 (E)(3) in addition to the 183-days requirement of physical presence abroad to establish non-resident status among citizens. 

Some interesting and practical points from BIR Ruling No. 517-2011 are:

1. The BIR held that the compensation received by the employees during the period of overseas assignment was not considered as income derived abroad, but compensation derived from services rendered under their employer-employee relationship with the Philippine company who is the payor of the compensation. Consequently, the said compensation income is subject to withholding tax on compensation.

Interestingly, some may view this as contrary to the situs rule where compensation is sourced to the place where the services giving rise to such compensation is rendered regardless of the residence of the payor, of the place in which the contract for service was made, or of the place of payment. 

2. The employees had frequent travels to one or more locations abroad during the year whereby each travel lasted between one to four months but aggregating to 183 days or more during the said year. For example, employee Mr. X, a citizen of the Philippines, had the following business travels abroad during the year.

Country           Days

A - Thailand    54

B - Pakistan     145

C - Cambodia  46

D - India         14

Total    259

Since Mr. X’s travels will not likely trigger tax residency to any of countries A to D, it is logical that he does not break his Philippine residency. However, being a non-resident in countries A to D does not necessarily mean that he will not be taxable in those countries. Since Cambodia is a non-treaty country with the Philippines, he will be taxable in that country based on their domestic tax rules. 

When compensation received during the time he is in Cambodia is considered as Philippine-sourced because of his employer-employee relationship with the Philippine company, can he be allowed credit for foreign taxes?

If all his income is considered Philippine-sourced, he will report zero foreign income. Under Section 34(C)(4) the maximum amount of a tax credit is subject to a limitation which uses the ratio of foreign income to worldwide income. If foreign income is zero, the limitations on credit will scale down the allowable tax credit to zero.

This new ruling may change the way citizens should view Philippine tax rules.  It is a call to revisit tax rules and regulations that may impact their income and not just rely on common tax practices. As taxpayers strive to comply with the evolving tax rules, responding to the practical consequences of such compliance is a never ending challenge.

Karen Vergara-Manese is a senior manager from the tax group of Manabat Sanagustin & Co. (MS&Co.), the Philippine independent member firm of KPMG International.

This article is for general information purposes only and should not be considered as professional advice for a specific issue or entity.

The views and opinions expressed herein are those of the author and do not necessarily represent the views and opinions of KPMG International or MS&Co. For comments or inquiries, please email [email protected].