With stock markets emerging from the doldrums of the 2009 Economic Downturn, investors have been paying greater attention to equities. As Wall Street wakes up on “better-than-expected” economic news and favorable earnings reports, stockholders are looking forward to dividends. In the Philippines, a number of companies have been declaring dividends and minimization strategies on the taxes that are due on these dividends are once again at the fore of investors’ minds. This is true of non-resident foreign investors who are generally subject to higher rates of tax on dividends (anywhere from 20 to 30 percent depending on the taxpayer type). Contrast this with Filipino and resident alien individuals who are subject to a rate of 10 percent, and domestic corporations which are exempt on dividends received from another domestic corporation. This article examines two legitimate ways by which a non-resident foreign investor can lower the dividend tax rate.
As a rule, the tax is collected at the source when the issuer of dividends withholds the proper amount and remits this to the Bureau of Internal Revenue (BIR). In anticipation of dividend issuances, securities custodians usually advise their international clients to avail of lower tax rates under tax treaties. For this reason, I will take this up first. A tax treaty generally ensures that only one state party taxes the income earned by a citizen of another state within the former state’s jurisdiction; hence, their formal name Convention for the Avoidance of Double Taxation (Double Taxation Agreements or DTAs, for short). DTAs also provide favorable tax rates on certain income types, such as dividends. For example, the DTA between the Philippines and the United States says that the maximum rate of tax that either state can impose on dividends is 25 percent; if the recipient is a corporation holding at least 10 percent of the outstanding shares of the voting stock during a stated holding period, then the rate should not exceed 20 percent.
One question in the area of treaty relief is whether a non-resident collective investment vehicle (CIV) such as a trust can apply for treaty benefits on its own right, and not merely as an agent of the CIV’s investors. This has practical implications since its numerous investors or beneficiaries may encounter prohibitive transaction costs if they are required to claim treaty benefits individually. Additional transaction costs also arise if the CIV has to prove that each and every investor or beneficiary is entitled to treaty benefits. In either situation, this can result in the denial of treaty benefits to someone who is entitled to it and, ultimately, fail in the prevention of double taxation. Having the CIV claim treaty benefits on its own right, thus, seems a more efficient way of respecting treaty benefits.
The current state of tax treaties provides little clarity on the issue. Instead of relying on a uniform policy across the various tax treaties, one has to rely on the textual peculiarities of each treaty. For example, under the Philippines-Japan Treaty, in order to avail of the treaty rates the dividend recipient must be a resident of one of the contracting states and the beneficial owner of the shares of stock giving rise to the dividend. The BIR might decline to entertain a tax treaty relief application to a CIV even if such CIV is a resident of Japan unless it proves that it is also the beneficial owner of the dividends. As CIVs are, by their nature, investment pools, it would be challenging to explain to the BIR how a CIV’s structure or its legal relationship with its investors makes it the beneficial owner of the dividends. Contrast this with the Philippines-Germany Treaty where it appears sufficient that, in order to claim the treaty benefit, the applicant need only be a resident of either of the contracting states. Considering the absence of the beneficial owner requirement, there seems no need to prove to the BIR that a CIV which is a resident of Germany is also the beneficial owner of the dividend-bearing stock.
This issue is important against the backdrop of the growing global CIV industry which is estimated at USD 20 trillion! The practical implications of claiming treaty benefits by CIVs have been the subject of various OECD position papers, the most recent of which is contained in a public discussion draft dated 9 December 2009 to 31 January 2010, entitled “The Granting of Treaty Benefits With Respect to the Income of Collective Investment Vehicles”. One conclusion of that paper is that if an existing treaty does not recognize a CIV’s right to claim treaty benefits on its own right, countries should put into place procedures that allow a CIV to claim treaty benefits on behalf of its investors.
The second method of lowering the dividend tax is found in the Tax Code and can only be enjoyed by non-resident foreign corporations. Under Tax Code Section 28 (B) (5) (b), the dividend tax is 15percent if the corporation’s country of domicile allows a credit against the tax due of at least 15 percent of the taxes “deemed paid” in the Philippines on the dividend. In Procter and Gamble vs. Commissioner (G.R. No. 66838, 2 December 1991), the Supreme Court clarified that for the taxpayer to actually enjoy the 15 percent rate it is sufficient that the foreign law allows the tax credit without the taxpayer actually having to pay the foreign government the amount of dividend tax waived by the Philippine government.
When planning a tax-efficient receipt of dividends then, the main consideration is whether one gets more favorable treatment from applying the treaty or the Tax Code. But there are other practical considerations, too. BIR regulations require application with the BIR prior to the taxpayer’s availment of treaty benefits. These regulations have been cited approvingly by the Court of Tax Appeals in the case of Mirant vs. Commissioner (Case No. 6382, 7 June 2005). On the other hand, the taxpayer’s obtaining from the BIR a favorable interpretation of the Tax Code need not, strictly speaking, happen as rulings on general tax issues are more in the nature of being confirmatory. However, prudence dictates that the taxpayer obtain such a ruling prior to a BIR audit “just in case”.
With the Philippines’s capital market steadily growing and foreign investors taking more active positions in the local stock market the BIR will certainly be monitoring the take from taxes in this area and dividends are on the list. From the investors’ point of view it certainly pays to plan the tax prior to receiving the dividend pay-off.
(Noel P. Bonoan is the Chief Operating Officer and Vice Chairman of Tax of Manabat Sanagustin & Co., CPAs, a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity.
The views and opinions expressed herein are those of the author and do not necessarily represent the views and opinions of KPMG in the Philippines. For comments or inquiries, please email manila@kpmg.com or ebonoan@kpmg.com)