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Final Tax and Creditable Withholding Taxes

Final Tax and Creditable Withholding Taxes: The Basics By Atty. Rolando T. Devesa

 

The withholding tax system might very well be the crowning jewel in the arsenal of tax collection weaponry. For one, the government’s cost in collecting taxes is brought to a minimum with the designation of private individuals and corporations as withholding tax agents.  More importantly, the withholding tax systems improve the government’s cash flow because of the advance collection of taxes.  

However, while the withholding tax system has apparent benefits tilted in favor of the government, it imposes burden on withholding agents including additional costs on the training of its accounting people.  On top of this, withholding agents are subjected to penalties in case of non-compliance with the rules on withholding.  It is not uncommon to find taxpayers facing the Bureau of Internal Revenue (BIR) assessments for violation of withholding rules and regulations.  

Accordingly, taxpayers must familiarize themselves with the following basic principles relative to withholding taxes:


Final tax differs from creditable withholding tax.

Under the final withholding tax system the amount of income tax withheld by the withholding agent is constituted as a full and final payment of the income tax due from the payee on the said income. The liability for payment of the tax rests primarily on the payor as a withholding agent. Thus, in case of his failure to withhold the tax or in case of under-withholding, the deficiency tax shall be collected from the payor/withholding agent. The payee is not required to file an income tax return for the particular income. 

On the other hand, under the creditable withholding tax system, taxes withheld on certain income payments are intended to equal or at least approximate the tax due of the payee on said income. The income recipient is still required to file an income tax return to report the income and/or pay the difference between the tax withheld and the tax due on the income.


Revenue Regulation (RR) No. 02-98 lists the type of income payments subject to withholding tax.

Compliance with the withholding tax rules will, of course, start with knowing what type of income payments are subject to withholding and at what tax rate. The basic BIR regulation to refer to as regards this information is RR Nos. 02-98, as amended.  This regulation has been amended several times since its first issuance, so you must keep abreast of the changes.


The time of the withholding is critical.

As a general rule, the obligation of the payor to deduct and withhold tax arises at the time an income payment is paid or payable, or the income payment is accrued or recorded as an expense or asset, whichever is applicable, in the payor’s books, whichever comes first.  The term “payable” refers to the date the obligation becomes due, demandable, or legally enforceable.  

Where the income is not yet paid or payable but the same has been recorded as an expense or asset, whichever is applicable, in the payor’s books, the obligation to withhold shall arise in the last month of the return period in which the same is claimed as an expense or amortized for tax purposes.


BIR Form No. 2307 is needed to claim a credit.

For a taxpayer whose income was subjected to creditable withholding tax, the amount withheld by the withholding agent can be credited against said taxpayer’s final income tax liability as determined upon the filing of his annual/final adjusted income tax return.

However, to be able to claim the credit, the taxpayer must make sure that the withholding agent issues him BIR Form No. 2307 showing the income payments made and the amount of taxes withheld.  Without this BIR form in his possession and attached to the final adjusted income tax return, the BIR will not allow any credit against his income tax liability as reflected in the final adjusted income tax return.

Since withholding agents, at times, do not give importance to the issuance of BIR Form No.  2307, the recipient of the income payment must make sure that this BIR form is furnished to him simultaneously with the income payment or within 20 days following the close of the taxable quarter employed by the payee.  

In case the withholding agent refuses to issue BIR Form No. 2307, the recipient of the income must remind him (the withholding agent) that refusal to do so is a ground for the mandatory audit of such withholding agent’s income tax liabilities.


Some expense can be disallowed as an expense.

An expense which is deductible for tax purposes, can be disallowed as an expense if such was not subjected to withholding tax or was subjected to a lower withholding tax rate.   However, a deduction may still be allowed (even if there was non-withholding or under-withholding) if at the time of the original  BIR audit and investigation, the withholding agent pays the basic withholding tax, including interest, and surcharges, if applicable.


Withholding taxes are not subject to compromise.

Withholding agents merely hold in trust the amount of tax they deducted from income recipients and as trustee, they are duty bound to remit to the government the tax withheld.
Thus, violations of withholding tax rules, as a general rule, is not subject to any compromise agreement with the BIR.

In transactions where existing BIR regulations on withholding taxes do not clearly apply, it would be preferable to secure a BIR ruling, as this will protect the withholding agent from potentially huge deficiency assessments on withholding of taxes.


This article is not intended to be a substitute for professional advice.  For comments and inquiries, you may e-mail the author at Rolando.Devesa@ph.gt.com.  For other tax concerns, please check out our other tax services.