What is double nontaxation of income?

Tax law, as a rule, is constantly evolving and adapting, which is why tax authorities all over the world frequently issue new or enhanced rulings, policies and procedures to address new trends or situations that come up. It is, however, unusual to encounter new terms or definitions in new issuances.

Take, for example, the seldom used phrase “double nontaxation of income,” which was found in Revenue Memorandum Order (RMO) No. 51-2019. The RMO was issued by the Bureau of Internal Revenue (BIR) when it laid down its guidelines and procedures for the processing and issuance of Tax Residency Certificates (TRCs) requested by those claiming to be “residents” of the Philippines.

In theory, “nontaxation” occurs when income is left untaxed by a taxing jurisdiction. When this happens, say in the case of an individual receiving compensation from an international assignment — the impact would usually be, at the very least, on two taxing jurisdictions — the home and host countries. Put simply, these are contracting parties or states which are not able to impose tax on income earned by the individual, hence the term “double nontaxation.” While the chances of this happening are remote, considering the strict implementation of tax rules on cross-border transactions, such an occurrence could be the worst thing to happen in the eyes of a taxing authority.

However, RMO 51-19 seems to address this as it endeavors to ensure that no income payment is left untaxed because of actions resorted to by taxpayers (individuals or corporations alike), who seek to obtain unintended tax treaty benefits by securing a TRC.

WHAT IS A TAX RESIDENCE CERTIFICATE?
This is a document secured by Philippine “residents” from the BIR to avail of preferential tax treatment, under the applicable and effective tax treaties of the Philippines, on income derived from sources within the jurisdiction of the Other Contracting State (i.e., non-Philippine state). For instance, in the past, foreign nationals would present the TRC issued by the BIR to their countries’ internal revenue authorities to claim non-resident status so that they can enjoy exemption from their home countries’ tax.

In the Philippines, a TRC is a certificate issued by the International Tax Affairs office of the BIR to confirm the residency status in the Philippines of taxpayer applicants. These applicants claim to be “residents” of the Philippines and are subject to taxation in the Philippines for a given period of time. Documents are required for substantiation purposes before the application for TRC is processed and issued upon approval.

WHAT IS THE MAIN PURPOSE OF TAX TREATIES?
Tax treaties exist to avoid the effects and risks of double taxation with respect to taxes on income derived from sources outside of the Contracting State or the Philippines (in the case of taxpayers of the Philippines). In addition, they help ensure that exorbitant taxation in the source country is not a hindrance to cross-border investments, capital and trading activities. The taxing right is then allocated between the two states to make sure that income is taxed appropriately. At present, the Philippines is signatory to about 43 tax treaties worldwide.

For a tax treaty exemption to be invoked, taxpayers must prove their residency in the Philippines. This is done through the application of a TRC by “residents.”  Who are considered “residents?”

WHO IS ENTITLED TO SECURE A TRC FROM THE BIR?
In order to avoid double nontaxation of income, the tax bureau made it clear that only “residents” of a Contracting State who are subject to comprehensive liability to tax or full tax liability are entitled to TRCs. The BIR added that only those who are subject to tax on the basis of their worldwide income are entitled to claim treaty benefits. For individual taxation purposes, these taxpayers are categorized as “Resident Citizens.”

It should be noted, however, that we do not have a definition of the term Resident Citizen in our Tax Code. What we have in Section 22E of the Code is an enumeration of those who are considered Non-Resident Citizens (NRCs) and who are taxed on their Philippine-source income only.

These are Philippine citizens who:

Establish to the satisfaction of the Commissioner the fact of his physical presence abroad with a definite intention to reside therein.

Leave the Philippines during the taxable year to reside abroad, either as an immigrant or for employment on a permanent basis.

Work and derive income from abroad and whose employment thereat requires him to be physically present abroad most of the time during the taxable year.

A Philippine citizen who has been previously considered a 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.

Accordingly, those who do not fall under the definition of NRCs above may generally be considered Resident Citizens (RCs) who are subject to tax on their worldwide income.

These RCs may apply for Tax Residency Certificates. For the purposes of this article, whether they are entitled to the treaty preferential tax rates or exemption later is a topic for another time.

WHERE DOES THE CONFUSION LIE?
For proper application of TRC, there is a need to distinguish individuals, particularly foreign nationals, who are residents for treaty purposes and residents for domestic tax purposes. This is because they may also be treated as “residents” for domestic tax rules or for income tax purposes but cannot apply for a TRC simply because they are not taxed on their worldwide income.

Note that there are various categories of foreign national taxpayers in the Philippines. Foreign nationals (aka Aliens) are classified as either Resident or Non-Resident. We are guided by BIR Rulings 051-81 and 052-81 which mention that a foreign national assigned in the Philippines for a period of approximately  two years is considered a non-resident alien engaged in trade or business (NRAETB) in the country. Since there is no specific tax rule that states who would be considered as a Resident Alien in the Philippines, residents are instead considered to be those whose length of assignment are, from the start, indefinite or exceed two years. However, although they are considered residents, they are taxed only on income from sources within the Philippines.

In terms of who can properly secure a TRC, while it is true that foreign nationals are considered residents for income tax purposes or per domestic tax rules, they are not considered residents for treaty benefits purposes as they are taxed only on income from Philippine sources and therefore, cannot possess a tax residency certificate from the Philippine tax bureau. Doing so can possibly make them not taxable on income derived from their home country, which is not treated as subject to Philippine income tax either. If this is the case, this would mean double nontaxation of income.

ENSURING COMPLIANCE DESPITE THE PANDEMIC
Despite COVID-19, with foreign nationals in effect being stranded, residency in the country for the purpose of treaty exemption cannot be invoked by foreign nationals even though they have acquired resident alien status in the Philippines for domestic income tax purposes. Though foreign nationals may be forced to overstay due to the pandemic and have the assumption that the Tax Residency Certificate provides relief as regards taxation in their respective home countries, this will not work. There might not even be any residency status to begin with in this case as the tax bureau separately tackled this in its Revenue Memorandum Circular 83-2020, which provides guidance to individuals who are stranded in a country that is not their country of residence due to travel restrictions related to the pandemic.

With foreign nationals unable to return home and a large number of OFWs returning home for good due to various COVID-related reasons, companies and taxpayers may wish to review these guidelines to ensure compliance and avoid potential tax issues.

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.

Jose Rey R. Manuel is a Tax Senior Director from the People Advisory Services team of SGV & Co.