Taxes are the lifeblood of the government and “upon taxation depends the government’s ability to serve the people for whose benefit taxes are collected” (Vera v. Fernandez, G.R. No. L-31364 (1979)). Taxpayers usually resort to certain tax reduction measures to lower the amount of taxes that are due from them—the most common of which are tax avoidance and tax evasion. Tax avoidance—also called tax minimization—is the manner of reducing or totally escaping payment of taxes through legally permissible means. “This method should be used by the taxpayer in good faith and at arm’s length” (Commissioner of Internal Revenue v. Toda, Jr., G.R. No. 147188 (2004)). On the other hand, tax evasion—sometimes referred to as tax dodging—is an illegal means of escaping taxation, thus, it subjects the taxpayer to further civil or criminal liabilities.
To avoid civil and criminal liabilities, taxpayers who would want to get away with paying high amounts of taxes must know the limits set forth by law within which they can legally reduce the taxes due them.
The following are considered tax avoidance measures, which—although reducing the taxes due the taxpayer—are nonetheless generally regarded as legal, depending on the circumstances surrounding every transaction:
- Tax-free exchange
The tax-free exchange provision can be found in § 40(C)(2) of the National Internal Revenue Code (NIRC), as amended by the Corporate Recovery and Tax Incentives for Enterprises (CREATE) Act. Tax-free exchange provisions may be applied in the following instances:
- Merger or consolidation;
- Share-for-share exchange;
- Property-for-share exchange;
- Recapitalization;
- Reincorporation; and
- Transfer to a controlled corporation.
In the above-mentioned instances, the government merely defers the claim for taxes. Thus, the government may collect the applicable taxes due when the properties subject to the initial tax-free exchange transactions are sold or transferred and a gain is realized.
- Donations for estate planning
Basically, estate planning involves the systematic manner of managing one’s assets while still alive, and thereafter properly dealing with these properties upon death. The end goal of estate planning is to maximize the assets left for the benefit of the deceased’s family.
For instance, if a wealthy businessman owns various tracts of land here in the Philippines (with a fair market value of PHP 100 million) and a duly accredited foundation wants to construct a building thereon to be used for its developmental works, the businessman may donate the land to the said foundation. Such donation is exempt from donor’s tax per § 101(A)(2) of the NIRC, i.e., gifts made in favor of an accredited nongovernment organization, trust, or philanthropic organization and/or research institution or organization. As a result, in case the businessman dies, his estate tax liability will be reduced as his total estate—which is the basis of the computation of estate tax—will be lesser by PHP 100 million, i.e., the value of the land donated to the accredited foundation.
- Donation in installments
With the amendment introduced by the Tax Reform for Acceleration and Inclusion (TRAIN) Law, which took effect on 1 January 2018, the donor’s tax rate is now fixed at 6%—without distinction as to the relationship between the donor and the donee—of the annual net gifts in excess of PHP 250,000.00. The law does not expressly prohibit donations in installments. For instance, one can make a donation of PHP 250,000.00 in 2023, then another PHP 250,000.00 in 2024. In this case, the donor is not liable for a donor’s tax in both years since both donations did not exceed the PHP 250,000.00 threshold for exempt gifts, i.e., the aggregate value of donations for the entire year.
The donor must file a return within 30 days following each donation, and an annual return which covers all donations made within the calendar year. The donor’s tax due and payable is computed as:
Value of total donations made within the year
in excess of PHP 250,000.00 PHP xxx
Multiply by: the donor’s tax rate per TRAIN 6%
Donor’s tax due xxx
Less: donor’s tax paid within the year xxx
Donor’s tax payable xxx
Less: tax credit/s (if any) xxx
Donor’s tax due and payable PHP xxx
- Claim for allowable deductions
When properly substantiated and made in accordance with the provisions of the law, a taxpayer may claim allowable deductions—which is subtracted from the reportable gross income—and in effect reduce the tax due and payable.
However, it is well-settled that tax deductions being in the nature of tax exemptions are to be construed strictly against the taxpayer. “[W]hen a taxpayer claims a deduction, he must point to some specific provision of the statute in which that deduction is authorized, and must be able to prove that he is entitled to the deduction which the law allows” (H. Tambunting Pawnshop, Inc. v. Commissioner of Internal Revenue, G.R. No. 173373 (2013)). Thus, taxpayers must be diligent in keeping documents such as official receipts and other substantiating documents if they want to properly claim allowable deductions.
- Tax credit
Tax credit is “an amount subtracted directly from one’s total tax liability. It is any amount given to a taxpayer as a subsidy, a refund, or an incentive to encourage investment.” (Fort Bonifacio Development Corporation v. Commissioner of Internal Revenue, G.R. No. 173425, (2013))
In the same case, the Court discussed certain provisions of the law allowing tax credits:
[I]n computing the estate tax due, Section 86(D) [of the NIRC] allows a tax credit—subject to certain limitations—for estate taxes paid to a foreign country. Also found in Section 101(C) is a similar provision for donor’s taxes—again when paid to a foreign country—in computing for the donor’s tax due. The tax credits in both instances allude to the prior payment of taxes, even if not made to our government.
Under Section 110, a VAT (Value-Added Tax)-registered person engaging in transactions—whether or not subject to the VAT—is also allowed a tax credit that includes a ratable portion of any input tax not directly attributable to either activity. This input tax may either be the VAT on the purchase or importation of goods or services that is merely due from—not necessarily paid by—such VAT-registered person in the course of trade or business; or the transitional input tax determined in accordance with Section 111(A). (Emphasis supplied.)
- Carryover of the excess Minimum Corporate Income Tax (MCIT)
“Under the MCIT scheme, a corporation, beginning on its fourth year of operation, is assessed an MCIT of 2% [1% during the pandemic recovery period] of its gross income when such MCIT is greater than the normal corporate income tax imposed under Section 27(A) [of the NIRC, as amended]. If the regular income tax is higher than the MCIT, the corporation does not pay the MCIT. Any excess of the MCIT over the normal tax shall be carried forward and credited against the normal income tax for the three immediately succeeding taxable years.” (Chamber of Real Estate and Builders' Associations, Inc. v. The Hon. Executive Secretary Alberto Romulo, G.R. No. 160756 (2010))
Thus, the excess MCIT may be used to reduce a corporation’s income tax due. However, it is important to note that the excess MCIT recognized for the year may only be used within the immediately succeeding three years, otherwise, the excess MCIT would expire.
- Assertion of applicable international convention or tax treaty in which the Philippines is a signatory
The RP-US Treaty and RP-West German Tax Treaty are just a few of the bilateral treaties entered into by the Philippines. The rationale for a tax treaty is explained, thus: “[T]he tax conventions are drafted with a view towards the elimination of international juridical double taxation, which is defined as the imposition of comparable taxes in two or more states on the same taxpayer in respect of the same subject matter and for identical periods.” (Commissioner of Internal Revenue v. S.C. Johnson and Son, Inc., G.R. No. 127105 (1999))
In the same case, the Court explained:
The treaties make it incumbent upon the state of residence to allow relief in order to avoid double taxation. There are two methods of relief—the exemption method and the credit method. In the exemption method, the income or capital which is taxable in the state of source or situs is exempted in the state of residence, although in some instances it may be taken into account in determining the rate of tax applicable to the taxpayer's remaining income or capital. On the other hand, in the credit method, although the income or capital which is taxed in the state of source is still taxable in the state of residence, the tax paid in the former is credited against the tax levied in the latter. The basic difference between the two methods is that in the exemption method, the focus is on the income or capital itself, whereas the credit method focuses upon the tax. (Citation omitted.)
In negotiating tax treaties, the underlying rationale for reducing the tax rate is that the Philippines will give up a part of the tax in the expectation that the tax given up for this particular investment is not taxed by the other country.
Since the effect of asserting tax treaties is in the nature of a claim for tax exemption, the same is construed strictly against the taxpayer. Thus, the taxpayer must assert and prove their eligibility for any exemptions or benefits granted under the tax treaties.
The Bureau of Internal Revenue website provides an updated list of countries with which the Philippines has existing tax treaties, including their respective Double Taxation Agreements which may be accessed here.
In practice, there is generally a thin line between tax evasion and tax avoidance. Thus, it is important to make sure that the tax reduction measures employed are legal and within the confines allowed by law, otherwise, a taxpayer may be subjected to both criminal and civil liabilities in the future.
For any legal assistance you may need, you may send your inquiries and other legal concerns to info@gqlaw.com.ph.