ATENEO DE ZAMBOANGA UNIVERSITY

SCHOOL OF MANAGEMENT AND ACCOUNTANCY

SY 2016-2017
Passive Income and Final Income Taxation System
A. Passive Income
These are items of income with minimal involvement or participation from the taxpayer on the earning process.
They are also generally irregular in timing and amount. Hence, items of passive income are not exactly the bread and
butter for most income earners. When not reported by the taxpayers, their existence may be difficult to ascertain.
The government, therefore, runs a high risk of tax non-compliance when it comes to these sources of income.
Additionally, certain taxpayers pose the same threat of non-compliance for the obvious reason of proximity. Namely,
non-resident aliens not engaged in trade or business in the Philippines and non-resident foreign corporations which
usually do not have official places of business in the country may easily evade taxation of their income earned
herein, whether from passive or active sources.
As a solution, the government introduced the system of collection known as final withholding tax system. This
system imposes upon the entity (the withholding agent) making income payments to certain taxpayers and for
certain passive income, the responsibility to withhold the tax. The tax levied here is deemed as the full and final
income tax payment of the taxpayer on the said item of income. Consequently, the taxpayer will receive the income
net of tax and need not file an income tax return for the same.
Note: Final taxation does not apply to foreign passive income. Withholding systems are inherently territorial and
it is tantamount to encroachment on foreign sovereignty to be otherwise. Hence, all items of passive income
earned abroad can only be subject to regular/schedular taxation, as applicable.
B. Final Withholding Tax (FWT) System VS. Expanded/Creditable Withholding Tax (EWT) System
Summary of Differences
FWT
Subjects of tax are usually passive income
Taxpayer not required to file a return
Tax paid and withheld for is not creditable
against regular income tax
Withholding agents copy of return is BIR Form
1601-F
Taxpayers copy of return is BIR Form 2306

EWT
Subjects of tax are usually ordinary business
income
Taxpayer still required to file a return
Tax paid and withheld for is creditable against
regular income tax
Withholding agents copy of return is BIR Form
1601-E
Taxpayers copy of return is BIR Form 2307

When to file: The withholding tax return, either FWT or EWT, shall be filed in triplicate by the withholding agent on
or before the 10th day of the month following the month in which withholding was made, except for withholding
made in December which shall be filed on or before January 15 of the following year.

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Check the other PDF for the schedule of final taxes :D

* 1. The interest income referred above must strictly arise from bank deposits and deposit substitutes. (Deposit
substitutes are alternative forms of obtaining funds from at least 20 persons at any one time other than deposits,
through the issuance, endorsement or acceptance of debt instruments for the borrowers own account.
Government debt instruments and securities including Treasury bonds, Treasury bills ad Treasury notes shall be
considered as deposit substitutes irrespective of the number of lenders at origination.) Hence, interest income from
the following are subject to regular income tax and not to final withholding tax:
Lending activities, whether or not in the course of business
Investments in bonds
Promissory notes
Foreign sources, whether bank or non-bank
Penalty for legal delay or default
2. Foreign loans refer to all obligations (regardless of currency of denomination and form) owed by Philippine
residents to non-resident entities, including advances from foreign parent companies, shareholders and affiliates
and peso-denominated loans from non-residents.
^ 1. The dividend income referred above pertain to cash dividends, scrip dividends, property dividends and certain
stock dividends. For stock dividends to be taxable, there must be a change in the ownership structure of the
corporation as when stock dividends are issued in lieu of cash dividends or when the declaration is an optional stock
or cash dividend. Property and stock dividends, when taxable, are subject to tax based on the fair market value of
the property or stock.
2. The summary above assumes the items of income have a domestic situs of taxation. For dividend income, the
situs is determined by the domicile of incorporation of the corporation. Hence, dividends issued by an NRFC are
deemed to be income from outside the Philippines. If dividends are issued by an RFC, the predominance test
illustrated below is observed:
If for a period of 3 years preceding the dividend declaration, the ratio of the RFCs Philippine
Gross Income to its World Gross Income is:
SITUS
50% or below
Entirely outside
51% to 85%
Partly within and partly outside
86% and up
Entirely within
If the income is partly within and partly outside, the following formula is used:
RFCs Phil. Gross Income
X
Dividend Received = Dividend Income,
RFCs World Income
deemed within
Example:
A nonresident citizen stockholder received a dividend income of P300,000 in 2015 from a foreign
corporation doing business in the Philippines. The gross income of the foreign corporation from within
outside the Philippines for prior years are as follows:
Scenario 1:
Source of Income
From Within the Phil.
From Outside the Phil.
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2012
P16,000,000
P18,000,000

2013
P12,000,000
P14,000,000

2014
P14,000,000
P16,000,000

and

Q1: How much of the dividend income received by the taxpayer is considered income within?
Dividend Income,
=
(16M + 12M + 14M)
X
P300,000
Deemed within
(16M + 12M + 14M +
18M + 14M + 16M)
=
46.67% X P300,000
=
P0
Q2: How much should be withheld as final income tax?
Final Tax
=
Dividend within X
=
P0 X 10%
=
P0
Scenario 2:
Source of Income
From Within the Phil.
From Outside the Phil.

2012
P16,000,000
P8,000,000

Final tax rate

2013
P12,000,000
P10,000,000

2014
P14,000,000
P10,000,000

Q1: How much of the dividend income received by the taxpayer is considered income within?
Dividend Income,
=
(16M + 12M + 14M)
X
P300,000
Deemed within
(16M + 12M + 14M +
8M + 10M + 10M)
=
60% X P300,000
=
P180,000
Q2: How much should be withheld as final income tax?
Final Tax
=
Dividend within X
Final tax rate
=
P180,000 X 10%
=
P18,000
Scenario 3:
Source of Income
From Within the Phil.
From Outside the Phil.

2012
P16,000,000
P2,000,000

2013
P12,000,000
P2,000,000

2014
P14,000,000
P1,000,000

Q1: How much of the dividend income received by the taxpayer is considered income within?
Dividend Income,
=
(16M + 12M + 14M)
X
P300,000
Deemed within
(16M + 12M + 14M +
2M + 2M + 1M)
=
89% X P300,000
=
P300,000
Q2: How much should be withheld as final income tax?
Final Tax
=
Dividend within X
Final tax rate
=
P300,000 X 10%
=
P30,000

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3. The final tax rate on dividend income received by the NRFC shall be 15% if the tax sparing rule applies. The tax
sparing rule applies when the domicile of the NRFC reduces or allows as tax credit against its income from such
dividend an amount at least 15% of the tax on dividend. If the reduction or tax credit is below 15% or none at all, the
final tax rate shall be 30%.
4. The following rates shall be observed for final taxation of dividend income and the share in net income of
taxable partnerships, joint ventures and co-ownerships:
6% beginning January 1, 1998
8% beginning January 1, 1999
10% beginning January 1, 2000
~ An amount equivalent to 10% of the revenues, surcharges or fees recovered and/or fine or penalty imposed and
collected, or P1,000,000 whichever is lower, shall be given as rewards to persons instrumental in the discovery of
violations of the provisions of the internal revenue laws. On this reward amount or P1,000,000, whichever is the
case, a final withholding tax at 10% shall be imposed.
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Practice Questions
1. As a rule, the following are taxable income, except
a. Cash dividend
b. Property dividend

c. Scrip dividend
d. Stock dividend

2. Which of the following is part of gross income?

a. PCSO and Lotto winnings
b. Bank interests on long-term deposits

c.
d.

Proceeds of life insurance

Raffle prize not exceeding P10,000

3. Acting on the information given by Jude, the government seized and confiscated smuggled goods with a fair
market value of P300 million. Judes reward will be subject to a final tax of:
a. P30 million
c. P300,000
b. P3 million
d. P100,000
4. Which of the following dividends is subject to a final withholding tax of P1,500?
a. Dividend worth P15,000 declared by a domestic corporation and received by another domestic corporation.
b. Dividend worth P7,500 declared by a domestic corporation and received by a nonresident alien engaged in
trade or business in the Philippines.
c. Dividend worth P15,000 declared by a resident foreign corporation and received by a resident alien.
d. Dividend worth P4,000 declared by a domestic corporation and received by a nonresident alien not engaged
in trade or business.
5. Dividend income from domestic corporations are subjected to final tax effective?
a. 1997
c. 1999
b. 1998
d. 2000
6. Chandler, a resident citizen, deposited P2,000,000 to the 180-day time deposit of Banco de Baguio. The deposit
pays 8% interest. Compute the final tax on maturity of the deposit.
a. P6,000
c. P16,000
b. P8,000
d. P20,000
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7. Assume that Chandler is a nonresident alien not engaged in trade or business, compute the final tax on maturity
of the deposit.
a. P6,000
c. P16,000
b. P8,000
d. P20,000
8. Which is covered by final tax?
a. Interest income from foreign banks
b. P10,000 taxable prizes from the Philippines
c. Lotto winnings abroad
d. Share in net income of a general professional partnership
9. Rachel, Inc., a domestic corporation, was credited with 46,250 interest income in its depository account in an
FCDU Bank in the Philippines. How much final tax was withheld?
a. 0
c. 3,750
b. 3,468.75
d. 11,562.50
10. What is the final tax on interest income on a 6-year deposit preterminated less than 2 years before maturity?
a. 20%
c. 5%
b. 12%
d. 0%

11. Which of the following is exempt from final tax?

a. Winnings in competition sponsored by a local trading company
b. Prizes in a body building competition
c. Dividends from a foreign corporation
d. Winnings from casino
12. Phoebe, a resident alien, deposited 1,000,000 to a depository bank under the expanded foreign currency
deposit system. The five-year savings deposit pays 10% annual interest. Assuming a P45: 1 exchange rate, how
much final tax on interest would be withheld in the first year?
a. P0
c. P20,000
b. P7,500
d. P337,500
13. Joey is resident citizen owning a mining property in Bukidnon. He allowed a mining company to operate under a
condition that he will be paid 10% royalty on the gold production. The mining company produced P8,000,000
worth of gold during the year. How much net royalties will be paid to Joey?
a. P800,000
c. P640,000
b. P720,000
d. P160,000
14. Which is correct with the final income taxation?
a. It covers all items of passive income from whatever source.
b. It applies to all items of gross income of any nonresidents earned from sources within he Philippines.
c. Taxpayers need not file an income tax return.
d. It applies to passive income earned abroad.

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15. A resident citizen had the following incidental income in 2015:

Interest on Philippine currency bank deposit
Interest under the expanded foreign currency deposit system
Royalty from invention
Royalty from musical compositions
Dividend from domestic corporation
Share in net income of business partnership
How much is the total final taxes?
a. P53,000
b. P57,750

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c. P63,750
d. P70,000

P30,000
50,000
150,000
80,000
60,000
100,000