Treaty relief revisions in the Philippines impacts U.S. multinationals

U.S. taxpayers investing or operating in the Philippines who are seeking to qualify for benefits under the U.S.-Philippines treaty (the treaty) are required to follow revised procedures and documentation requirements issued by the Bureau of Internal Revenue (BIR), the tax authority of the Philippines, effective March 31, 2021. Adhering to the updated procedures for claiming treaty benefits is now more important than ever as it provides a means through which a U.S. taxpayer may claim a credit on withholding taxes levied by the Philippines tax authority that would otherwise not be creditable due to the failure of the tax to satisfy the new attribution requirement in the 2021 final foreign tax credit (FTC) regulations (T.D. 9959).

The ability of a U.S. taxpayer to claim the benefits of the treaty in the Philippines has been the subject of varying interpretations and court decisions. This has, unfortunately, contributed to the denial of treaty benefits for failure to comply with the procedural requirements and resulted in taxpayers being assessed tax deficiencies. To resolve some of these issues, the BIR issued a Revenue Memorandum Order (RMO) No. 14-2021 on March 31, 2021. The RMO was meant to streamline the procedures and documents for claiming treaty benefits. The BIR subsequently issued Revenue Memorandum Circular (RMC) Nos. 77-2021 and 20-2022 to clarify and amend RMO No. 14-2021.

The new guidelines under RMO No. 14-2021, as clarified and amended, are as follows:

1.   Applying treaty rates at the time of payment: The Philippine withholding agent or payor may rely on the following documents at the time payment is made to support an exemption or application of a reduced withholding tax rate under the treaty:

• BIR Form No. 0901 (Application for Treaty Purposes);
  
• Form 6166 (Certification of U.S. Tax Residency) issued by the IRS; and
• the relevant provisions of the treaty.

2.   Request for confirmation: If the withholding agent concludes the treaty applies to exempt or reduce the rate of withholding, they must file a request for confirmation with the BIR’s International Tax Affairs Division (ITAD) to confirm the appropriate rate was applied. Failure to file the request for confirmation may lead to withholding using the 25% regular rate prescribed under the Philippine National Internal Revenue Code (NIRC) and not the applicable treaty rate.

The deadline for filing the request for confirmation depends on the type of income. For capital gains, the request for confirmation must be filed any time after the transaction but shall not be later than the last day of the fourth month following the close of the taxable year when the income was paid or when the transaction was consummated. For other types of income, the request for confirmation must be filed no later than the last day of the fourth month following the close of the taxable year when the income is paid or becomes payable, or when the expense/asset is accrued or recorded in the books, whichever comes first. For Tax Treaty Relief Application (TTRA), the same may be filed at any time after the receipt of the income.

The request for confirmation or TTRA must be supported by complete documents. RMO No. 14-2021 classified the requirements into general and specific requirements. The type of specific requirement will depend on the type of income payment (e.g., business profits, dividend, royalty, interest, capital gains). It is important to note that all documents executed outside of the Philippines must either be authenticated or certified via apostille in the foreign country.

If the BIR determines that the withholding tax rate applied is lower than the rate that would have been applied under the treaty, or that the non-resident income earner is not entitled to treaty relief, they will issue a ruling denying the request for confirmation or TTRA. The withholding agent must then pay the deficiency tax plus penalties. However, if the withholding tax rate applied is correct, the BIR will issue a Certificate of Entitlement to Treaty Benefit (COE).

3.   Claiming a refund based on treaty rate: If the regular rates have initially been imposed, the beneficial owner of the income may file a TTRA with ITAD to claim a refund based on the application of an exemption or reduced rate under the treaty.

Prior to RMO No. 14-2021, U.S. taxpayers that intended to avail themselves of treaty relief on dividends, interest, and royalties were covered by a simplified procedure. In particular, the parties just needed to submit a form with the Tax Residence Certificate issued by the foreign tax authority as the only attachment. No other documentary requirements were needed. However, under the RMC, all income payments are now subject to the requirement to file either a request for confirmation or TTRA, which require numerous supporting documents to be attached.

While the intent of the RMO to streamline the procedures and documents in order to procure treaty benefits is clear, the implementation process poses many challenges due to the volume of backlogs and lack of manpower resources at the BIR.

To limit the number of requests for confirmation and TTRAs being filed with the ITAD, the BIR subsequently clarified that taxpayers who were already issued COEs no longer need to file a request for confirmation or TTRA every time an income of similar nature is paid to the same nonresident. However, the taxpayer must comply with all the requirements provided in the COE. If any of the requirements mentioned in the COE are absent, a new request for confirmation or TTRA must be filed by the taxpayer. For business profits, income from services (dependent or independent), capital gains, and other income from non-recurring transactions, the requests for confirmation or TTRAs must still be filed following the procedures and requirements laid down in RMO No. 14-2021, as amended by RMC No. 77-2021.

Many taxpayers were expecting a simplified procedure for claiming treaty benefits. However, the new requirements under the RMO, such as the submission of general and specific documents, and the risk of being assessed a deficiency if they fail to apply the correct withholding tax rate, may not provide taxpayers with the relief they desired.

U.S. tax implications

The BIR has seemingly made obtaining treaty benefits on certain types of withholding a much more difficult and cumbersome process for transactions arising after March 31, 2021. For U.S. multinationals this could pose a challenge.

U.S. multinationals must be proactive in ensuring treaty rates are accurately applied at the time of payment. As mentioned earlier, applying the appropriate treaty rate at the time of payment requires the Philippine withholding agent have a Form 6166 (Certification of U.S. Tax Residency) on file. With the current backlog of paper filings at the IRS, receiving such a certification could take months. Ample planning and discussions with the withholding agent should begin well in advance of payment. Failure to comply may lead to withholding using the 25% regular rate prescribed under the NIRC and not the applicable treaty rate. While a refund is viable via a TTRA, this process could be lengthy and costly.

Obtaining the benefits of the treaty allows a U.S. taxpayer to avoid a taxable presence in the Philippines or apply a reduced tax rate on interest, dividends, or royalties. Following the implementation of the new attribution requirement in the updated U.S. FTC regulations, obtaining treaty benefits may now also allow a U.S. taxpayer to claim an FTC in the U.S. for Filipino withholding taxes that otherwise would be ineligible for a credit due to the lack of harmonization between the U.S. and Filipino source rules. Under the new source-based attribution test in section 1.901-2(b)(5), effective for taxes paid on or after Dec. 28, 2021, a foreign withholding tax may not be a creditable income tax in the U.S. sense unless the foreign law’s source rule for that category of gross income is similar to the U.S. source rule. However, a taxpayer that qualifies for treaty benefits may generally apply the double tax article in the treaty to classify withholding taxes imposed under the Philippines’ NIRC as creditable income taxes in the U.S. sense without satisfying the attribution test.

Although the Philippine procedural and documentation requirements discussed above may seem onerous, U.S. taxpayers cannot simply forego claiming treaty benefits on the assumption that they can credit the additional taxes in the U.S. Under the compulsory payment rule in section 1.901-2(e)(5), an FTC cannot be claimed on taxes that could have been avoided by application of the treaty.

U.S. multinationals with activity in the Philippines should carefully review transactions subject to these updated guidelines to ensure the application of treaty benefits and in determining the eligible FTC for U.S. tax purposes.