The tax sparing rule is a provision commonly found in double taxation agreements (DTAs) that allows a taxpayer to claim a foreign tax credit for taxes that are theoretically “spared” or exempted in a foreign country. It typically applies to taxes that would have been levied on a taxpayer if not for the tax incentives or exemptions granted by the foreign government, aimed at encouraging investment.
Tax sparing in the Philippines is a statutory mechanism under Section 28(B)(5)(b) of the National Internal Revenue Code of 1997, as amended, which reduces the final withholding tax (FWT) on dividends paid by a domestic corporation to a non-resident foreign corporation (NRFC) from 25% to 15%, subject to certain conditions.
This rule ensures that the Philippine incentive (the 15% reduction) is preserved only where the foreign investor’s country of residence either allows a tax credit for taxes deemed paid in the Philippines equivalent to the difference between the regular rate and 15%; or does not impose income tax on foreign-sourced dividends.
Tax Sparing Rule in the Philippines
Under Philippine tax law, dividends paid by a Philippine corporation to a non-resident foreign corporation may be subject to a reduced withholding tax rate,[1] provided that certain conditions are met.[2] This provision is commonly referred to as the “tax sparing” rule.
The preferential 15% rate applies if the NRFC’s country of residence either grants a tax credit to the NRFC for taxes deemed paid in the Philippines—equivalent to the difference between the regular rate and the reduced 15% rate—or does not tax foreign-sourced dividends. In essence, the tax sparing rule ensures that non-resident investors benefit from the reduced Philippine withholding tax without losing the corresponding foreign tax credit or exemption in their home jurisdiction.
Where a Double Taxation Agreement (DTA) exists, the investor may apply the lower of the treaty rate or the 15% tax sparing rate, subject to compliance with applicable procedural requirements. In the absence of a tax treaty, the domestic tax sparing provision may still apply, provided the statutory conditions are satisfied.
Requirements for Availing Tax Sparing Relief
To qualify for the preferential tax rate (usually 15% instead of the standard 25%) on dividends, the following conditions must be met:
- Proof of Residency: The foreign recipient must submit a Certificate of Residence issued by the tax authority of its country of residence, confirming that it is a tax resident of that jurisdiction.
- Proof of Tax Sparing: Documentation must be provided to demonstrate the foreign country of residence either grants a tax credit to the NRFC for taxes deemed paid in the Philippines equivalent to the difference between the regular rate and the 15% rate; or does not tax foreign-sourced dividends.
This may include copies of relevant foreign tax laws, official rulings, or tax certifications.
- Board Resolution: The Philippine company must provide a board resolution authorizing the dividend declaration and payment to the NRFC.
- Withholding Tax Return: The Philippine company must submit BIR Form 1604-CF and 1601-FQ, showing the remittance of the withholding tax.
- Application for Preferential Tax Rate Certificate: The Philippine company may be required, or may opt, to file a Request for Confirmation (RFC) or Tax Treaty Relief Application (TTRA) with the BIR–ITAD, particularly when applying preferential rates under tax treaties or tax sparing provisions, in accordance with prevailing BIR procedures such as RMO 46-2020.
- Other Supporting Documents: Additional documents such as Articles of Incorporation, General Information Sheet, and any other documents requested by the BIR may be required.
Jurisdictional Variations in Tax Sparing Treatment
Tax sparing arrangements are typically implemented through the Philippines’ network of double taxation agreements, where the dividend article may interact with the residence country’s foreign tax credit system.
In practice, treaty partners such as Japan, the United States, the United Kingdom, Germany, France, the Netherlands, Canada, Australia, and Singapore may allow relief through foreign tax credits or equivalent mechanisms under their domestic tax laws or applicable treaties, depending on the specific treaty provisions and the investor’s tax residency.
The availability and extent of relief therefore vary on a per-treaty basis rather than by a uniform global rule.
Key Takeaway
The Philippine tax sparing rule provides a mechanism for reducing the dividend withholding tax on payments to non-resident foreign corporations, provided reciprocity conditions are satisfied.
It is crucial for both the Philippine corporation and the foreign recipient to comply with statutory requirements and BIR procedural guidelines. Proper documentation, timely filing, and substantiation of foreign tax treatment are critical to successfully availing of the preferential 15% rate.
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[1] Section 28(B)(5)(b) of the National Internal Revenue Code (NIRC) of 1997
[2] Revenue Memorandum Order (RMO) No. 72-2010
