Desperately seeking for a tax shelter

"I have read that if you own a company, you enjoy some sort of tax shelter for property and other income-generating assets you have. Can you tell me how this applies to Philippine laws?" (Raquel of Sumatra, Indonesia)

Under Philippine laws, a corporation is considered as having a separate legal personality from its owners or shareholders. As such, it is separately subject to income tax and other applicable taxes on corporations, although its liability is generally limited to the extent of its assets.

The tax liability of the individual owners of the company, therefore, is distinct from the company’s own tax liability and one cannot be made liable for the other, except in cases where the fiction of corporate entity may be disregarded, such as when the corporation is used to perpetrate fraud. In these cases, the corporation and the stockholders composing it shall be treated as one and the same.

Therefore, if one contributes income-generating assets into a corporation as capital, ownership will be held by the corporation as a distinct legal person, and the shareholders will only have an indirect interest in the assets contributed.

Consequently, the income generated by the company from the said assets will generally form part of the company’s gross income, and the applicable income tax will have to be paid by the company after having deducted the allowable deductions that were incurred by the company in the conduct of its trade or business.

At this point, the individual owner who contributed his assets as capital is still not subject to tax on the income generated by his capital contribution. However, when the company declares to its shareholders dividends coming from its unrestricted retained earnings (i.e., profits), it is the individual shareholder who is now liable for any taxes that may imposed on the dividends he or she received.

Under the Tax Code, cash or property dividends received by an individual citizen or resident of the Philippines from a domestic corporation are generally subject to a final tax of 10%. If the dividend recipient is a non-resident alien, the tax is 20%, if he/she is engaged in trade or business in the Philippines, and 25%, if he/she is not engaged in trade or business in the Philippines.

Preferential tax rates on dividends may, however, apply if the country of residence of the non-resident alien has a tax treaty with the Philippines.

Under existing laws, a single individual cannot own a company. A domestic corporation is required to be incorporated by not less than five but not more than 15 natural persons, all of whom should own at least one share in the corporation’s capital stock and the majority of whom should be residents of the Philippines.

I guess you now can figure out why more individuals create a corporations for their businesses. Aside from being a good tax planning strategy, creating a corporation shields the personal capacities of individuals, who are exposed only to the extent of their contributions.

(Raymund S. Gallardo is tax partner of Laya Mananghaya & Co./KPMG. Questions and comments are welcome. Messages to the author can be sent by e-mail at [email protected]).