Under the National Internal Revenue Code of 1997 (NIRC), as amended by the Tax Reform for Acceleration and Inclusion (TRAIN) Law (R.A. No. 10963) and further refined by the Ease of Paying Taxes Act (R.A. No. 11976), withholding taxes are essential tools in the Philippines' income tax system. They ensure timely collection of taxes from various income sources, minimize tax evasion, and streamline the tax administration process by effectively collecting taxes at the source. In this context, the distinction between creditable withholding taxes and final withholding taxes is crucial.
Withholding Taxes: An Overview
Withholding taxes involve the advance collection of income tax on certain payments. This obligation generally falls on the payer, who acts as a withholding agent. By withholding taxes on payments for services, goods, and other taxable transactions, the Bureau of Internal Revenue (BIR) achieves more consistent revenue collection and minimizes issues in tracking income at the end of the year.
Key Types of Withholding Taxes
- Creditable Withholding Tax (CWT)
- Final Withholding Tax (FWT)
The determination of whether a withholding tax is creditable or final depends on the nature of the transaction and the recipient of the income.
Creditable Withholding Tax (CWT)
Creditable Withholding Tax (CWT) is also referred to as Expanded Withholding Tax (EWT). CWT applies to certain types of income payments where the amount withheld can be applied as a credit against the recipient’s income tax liability at the end of the taxable year.
Characteristics of Creditable Withholding Tax
- Applicability: It is imposed on various payments such as professional fees, rental income, commissions, interest on certain loans, and income from certain goods and services.
- Rates: The rates for CWT vary depending on the type of income and the taxpayer’s classification. Examples include 1% for income from the sale of goods and 2% for income from professional services.
- Credit Against Tax Liability: The amount withheld through CWT is credited against the total tax due of the payee. If the withholding exceeds the tax due, the taxpayer may claim a refund or carry over the excess as a tax credit.
- Periodic Reporting: Withholding agents must file monthly and annual returns to report the amounts withheld.
Key Provisions Under the TRAIN Law and the Ease of Paying Taxes Act
The TRAIN Law and the Ease of Paying Taxes Act simplified the CWT system by:
- Updating Rates and Thresholds: The TRAIN Law adjusted withholding tax rates and thresholds to better align with current income levels and inflation.
- Simplifying Compliance: The Ease of Paying Taxes Act mandates fewer but more streamlined filing requirements for withholding agents, aiming to improve taxpayer compliance.
- Enhanced Refund System: Both laws emphasize faster and more efficient processing of refunds for overpaid CWT.
Final Withholding Tax (FWT)
Final Withholding Tax (FWT) represents an outright tax on certain types of income, where the amount withheld is considered the full and final tax liability on that income. The income recipient has no further tax obligation on the withheld income, and it does not require inclusion in the recipient’s income tax return.
Characteristics of Final Withholding Tax
- Applicability: It applies mainly to passive income, such as interest, dividends, royalties, and other specific types of income. Foreign corporations and non-resident individuals are commonly subject to FWT on Philippine-sourced income.
- Rates: Rates vary depending on the type of income and the tax status of the recipient. For example, interest on bank deposits and yields from trust funds are subject to a 20% final withholding tax for residents, while non-residents have differing rates based on treaties and classifications.
- Finality: Since FWT is considered the final tax on certain income, it cannot be used as a credit against other tax liabilities. The income subject to FWT is also not included in the recipient’s gross income in the annual tax return.
- Role in Cross-Border Transactions: FWT plays a key role in international transactions, especially concerning treaty reliefs, where rates are sometimes reduced or exempted based on tax treaties between the Philippines and other countries.
Provisions Under the TRAIN Law and the Ease of Paying Taxes Act
- Adjustments to Rates: The TRAIN Law revised FWT rates for specific types of income to harmonize them with current economic policies.
- Treaty Relief Application: The Ease of Paying Taxes Act reinforces procedures for claiming treaty benefits, particularly the reduction or exemption of withholding rates on foreign-sourced income to avoid double taxation.
Key Differences Between Creditable and Final Withholding Taxes
| Aspect | Creditable Withholding Tax (CWT) | Final Withholding Tax (FWT) |
|---|---|---|
| Purpose | Advances income tax payments | Settles final tax obligation on specific income |
| Use as Tax Credit | Creditable against income tax due | Not creditable, no further tax required |
| Income Inclusion | Included in gross income for tax return | Not included in the annual income tax return |
| Applicability | Applies to active income sources (e.g., services) | Mainly on passive income (e.g., dividends, interest) |
| Rates | Vary by income type and taxpayer classification | Fixed per income type, sometimes per treaty provisions |
Withholding Agent Responsibilities
Withholding agents play a critical role in ensuring compliance with CWT and FWT obligations. They are responsible for:
Deducting the Required Tax: Based on rates stipulated under current tax laws and regulations.
Remitting to the BIR: On or before specified deadlines to avoid penalties.
Filing the Appropriate Forms:
- BIR Form 1601-EQ: Quarterly Remittance Return of Creditable Income Taxes Withheld.
- BIR Form 1604-E: Annual Information Return of Creditable Income Taxes Withheld.
- BIR Form 1601-FQ: Quarterly Remittance Return of Final Income Taxes Withheld.
- BIR Form 1604-F: Annual Information Return of Final Income Taxes Withheld.
Issuing Certificates of Creditable or Final Tax Withheld:
- BIR Form 2307: Certificate of Creditable Tax Withheld at Source, provided to payees for taxes withheld.
- BIR Form 2306: Certificate of Final Tax Withheld at Source for income subject to FWT.
Penalties for Non-Compliance
Non-compliance with withholding tax requirements can result in various penalties, including:
- Surcharges and Interest: A 25% surcharge on late filings or under-declarations, plus interest at 12% per annum.
- Compromise Penalties: Monetary fines for failure to comply with reporting or remittance requirements.
- Criminal Liability: Possible in cases of willful evasion or fraudulent practices, leading to prosecution under tax evasion laws.
Conclusion
The withholding tax system, through CWT and FWT, plays a crucial role in the Philippine tax framework under the NIRC, as amended by the TRAIN Law and the Ease of Paying Taxes Act. CWTs ensure advance collection of taxes from active income, with taxpayers able to use these as credits, while FWTs apply mainly to passive income, completing the taxpayer's obligation at the source.