THE 50:30:20 rule is the most popular rule on how your income should be spent. According to various studies, you should reserve 50% of your income for essentials like rent, food and transportation, 30% for discretionary spending, and at least 20% for savings.
The next question, though, is where you should put your savings. Depending on your risk appetite, you may prefer to maintain your funds in a savings deposit account, time deposits, stocks, bonds, mutual funds, or other forms of investment such as real estate. The same investment options are also available to corporate entities.
In determining the right investment for you or your company, factors that should be considered are the level of risk, the level of income/return which is commensurate to the level of risk, and of course, its corresponding tax impact now and in the future.
Taxation influences the consumption or savings behavior of taxpayers. Tax rates can also influence the choice of investment. Lower taxes can influence individuals or corporations to prefer certain types of investment. Higher taxes can discourage individuals or corporations from putting their savings in certain types of investment. Thus, it is worthwhile to revisit the current taxes applicable to investments and proposed revisions on such tax rates.
Below are the applicable taxes on income from investments of an individual and corporations:
SAVINGS ACCOUNTS/TIME DEPOSITS
Interest on peso savings accounts/time deposits is subject to 20% final withholding tax. Interest on certain time deposits of individuals with a term of at least five years may be exempt from final tax.
On the other hand, interest on foreign currency deposits of resident individuals and domestic corporations is subject to 15% final withholding tax, as recently amended by the TRAIN Law. Interest income on foreign currency deposits of resident foreign corporations remains subject to 7.5% final withholding tax.
Interest income from bonds considered deposit substitutes are also subject to 20% final withholding tax.
SHARES OF STOCK
Dividend income of an individual citizen and a resident alien received from domestic corporations is subject to 10% final withholding tax. Dividends received by domestic and resident foreign corporations from another domestic corporation are exempt from income tax.
Subsequent sale of non-listed shares in a domestic corporation by individuals and domestic corporations are now subject to 15% capital gains tax under the TRAIN Law. Sale of shares listed in the local stock exchange are subject to 0.60% stock transaction tax based on the gross selling price.
However, dividends received from foreign corporations and gains realized from sale of foreign shares by both individual resident citizens and domestic corporations are subject to regular income tax, i.e. graduated income tax for individuals and regular corporate income tax of 30% for domestic corporations.
Sale of real properties which are not used in business are subject to capital gains tax of 6% based on the gross selling price or fair market value whichever is higher.
Based on the above, depending on the type of investment, different tax rates apply. Dividend income is subject to a lower rate of 10% compared to the 15%/20% on interest income from investment in bonds, savings accounts.
Under the current administration’s tax reform plan, though, a single rate of income tax is being pushed. The TRAIN Law has increased to 15% the final tax on interest on foreign currency deposits and capital gains tax on sale of non-listed shares of individuals and domestic corporations. Final taxes on the same income by resident foreign corporations are also proposed to be increased to 15% under the recent Senate and House Bills covering tax reform package 2 now being introduced as Tax Reform for Attracting Better and High Quality Opportunities (TRABAHO) Bill.
Given these recent amendments and the proposed TRABAHO Bill, we may expect that a unified rate of 15% to be levied on interest, dividends and capital gains. Thus, interest income from peso deposits and other deposit substitutes such as bonds, may be lowered to 15% from the current rate of 20%. Dividend income of resident individuals may be increased to 15% from the current rate of 10%.
Thus, an individual or a corporation looking for the best investment for their savings, should consider these potential changes to final tax rates on investment income. A corporation with resident individual shareholders may consider declaring dividends now before the final tax on dividends is increased to 15%.
On another note, we hope that aside from the tax rates, the government can also revisit the tax base on capital gains tax from sale of real properties.
Currently, the sale of real properties not used in business is subject to 6% capital gains tax based on gross selling price or fair market value, whichever is higher. A seller may still be subject to capital gains tax even if the sale resulted in a loss.
Thus, the government may consider changing the tax base from gross selling price to “net gains” only. Only in cases where there is gain realized, i.e. when the selling price exceeds the cost basis of the asset, that capital gains tax should be imposed. A deduction for costs and other related expenses must also be allowed. Considering that this will have a significant impact on the amount of the tax base, corresponding adjustment on the capital gains tax rates may also be made if we want the base revision to be revenue-neutral. Subjecting capital gains to regular income tax rates, which is the regime currently applied on sale of real properties used in business, may be considered. This is also aligned with the current administration’s drive to simplify taxation.
In many instances, taxation has been used by government to influence the behavior of taxpayers. This assumes that the government is in the best position to decide or determine which activities or investments should be encouraged. The government though may not always be right. In certain cases, government intervention can disrupt optimum market behavior.
With the government’s plan to unify income tax rates on investments, it seems that the government wants the tax to be neutral for certain types of investments. That is, taxpayer behavior will not be influenced by the rate of tax. Instead, they will decide on the basis of potential benefits and risks. The savings and investment behavior of the people is a significant factor in the income equation for the economy. We trust that our legislators will carefully study the above proposed changes to achieve the optimum benefit from the tax reform.
Ma. Lourdes Politado-Aclan is a Director at the Tax Advisory and Compliance Division of P&A Grant Thornton. P&A Grant Thornton is one of the leading audit, tax, advisory, and outsourcing services firms in the Philippines.