US Philippines Tax Treaty

US Philippines Tax Treaty

US Philippines Tax Treaty

US Philippines Tax Treaty: The United States and the Philippines entered into a tax treaty nearly 50-years ago. The purpose of the tax treaty is so Taxpayers and can assess what their tax liability will be for certain sources of taxable income — and how the IRS will treat that income. While the treaty is not the final word in how items of income between the contracting states will be taxed, it does help residents better understand how either the US Government and/or the Philippines will tax certain sources of income – and whether or not the saving clause will further impact the outcome. Let’s review the basics of the US Philippines Tax Treaty – and how certain sources of income may be taxed.

What is the Saving Clause?

As we work through the treaty, one important thing to keep in mind is the saving clause. The saving clause is a country’s ability to retain the right to tax the taxpayer under their own respective general tax rules and not the benefits afforded under the treaty. Essentially, it provides that despite any information provided in the treaty, both countries reserve the right to tax certain citizens and residents as they would otherwise tax under the general tax principles in their own country.

What does the Saving Clause Say?

      • Notwithstanding any provisions of this Convention except paragraph (4), a Contracting State may tax its residents (as determined under Article 3 (Fiscal Residence)) and its citizens as if this Convention had not come into effect.

Limitations on the Saving Clause 

Despite any limitation created by the saving clause, certain portions of the tax treaty are immune from the saving clause — which means the tax treaty should prevail on issues involving the following tax matters (despite the language in the Saving Clause):

      • The provisions of paragraph (3) shall not affect:

        • (a) The benefits conferred by a Contracting State under

          • Article 19 (Social Security Payments)

          • Article 23 (Relief from Double Taxation)

          • Article 24 (Non-discrimination), and 25 (Mutual Agreement Procedure); and

        • (b) The benefits conferred by a Contacting State under

          • Article 20 (Governmental Functions)

          • Article 21 (Teachers)

          • Article 22 (Students and Trainees), and

          • Article 28 (Diplomatic and Consular Officers) upon individuals who are neither citizens of, nor have immigration status in that Contracting State.

Private Pensions and Annuities (US/Philippines Tax Treaty Article 18)

When it comes to tax treaties, one of the main purposes of the tax treaty is to determine taxation issues on matters involving foreign pension. The US and Philippine tax treaty provides the following as to private pension:

      • (1) Except as provided in Article 20 (Governmental Functions), pensions and other similar remuneration paid to an individual in consideration of past employment shall be taxable by the Contracting State where the service is rendered.

      • (2) Annuities paid to an individual who is a resident of one of the Contracting States shall be taxable only in that Contracting State.

      • (3) Child Support payments made by an individual who is a resident of one of the Contracting States to an individual who is a resident of the other Contracting State shall be exempt from tax in that other Contracting State.

      • (4) The term “pensions and other similar remuneration”, as used in this article, includes periodic payments other than social security payments covered in Article 19 (Social Security Payments) made- (a) By reason of retirement or death and in consideration for services rendered or (b) By way of compensation for injuries or sickness received in connection with past employment.

      • (5) The term ”annuities”, as used in this article, means a stated sum paid periodically at stated times during life, or during a specified number of years, under an obligation to make the payments in return for adequate and full consideration (other than services rendered).

      • (6) The term “child support payments”, as used in this article, means periodic payments for the support of a minor child made pursuant to a written separation agreement or a decree of divorce, separate maintenance or compulsory support.

What does this Mean?

The general rule is that subject to article 20 government functions, when it comes to the Philippine/US Tax Treaty and pension payments  — only the contracting state where the employment services were rendered that resulted in the pension payments — has the right to tax the income. In other words, if a US person was residing in the Philippines and was receiving payments for services rendered in the United States, then United states would be the only contracting state to have the opportunity to tax the taxpayer.

If alternatively, the pension is the result of an annuity payment but not necessarily derived from employment — then it is taxable in the country where the taxpayer resides. It should be noted, that there is a distinction between paragraph 1, which refers to pension earned for past employment and paragraph 2 which refers to annuities but does not necessarily need to be the result of employment.

Saving Clause

The saving clause may impact the application of this rule, since it was not identified in paragraph four of Article 6 (e.g., not exempt from the Saving Clause).

Social Security (US/Philippines Tax Treaty Article 19)

      • Social Security Payments Social security payments and other public pensions paid by one of the Contracting States to an individual who is a resident of the other Contracting State (or in the case of such payments by the Philippines to an individual who is a citizen of the United States) shall be taxable only in the first-mentioned Contracting State.

      • This article shall not apply to payments described in Article 20 (Governmental Functions).

What does this Mean?

It means that when it comes to Social Security and other public pensions, generally the pensions and Social Security will only be taxed in the first mentioned state. In other words, if the United States pays Social Security  to a US person who resides in the Philippines, then only the United states will be able to tax that Social Security income.

Real Property (US/Philippines Tax Treaty Article 7)

      • (1) Income from real property, including royalties and other payments in respect of the exploitation of natural resources and gains derived from the alienation of such property or of the right giving rise to such royalties or other payments, may be taxed by the Contracting State in which such real property or natural resources are situated.

      • For purposes of this Convention, interest on indebtedness secured by real property or secured by a right giving rise to royalties or other payments in respect of the exploitation of natural resources shall not be regarded as income from real property.

What does this Mean?

If you notice, this paragraph uses the words “may be taxed” and neither the terms shall be taxed nor shall only be taxed. Therefore, what this paragraph is essentially saying is that either contracting state has the opportunity to tax real property income.

Dividend, Interest & Royalties

When it comes to passive income such as dividend, interest and royalties, the Philippine/US Tax Treaty is similar to many other tax treaties on this specific issue. Essentially what happens, is that while dividends (for example) may be taxable by both contracting states — the tax rate may be limited. For example, if a US Citizen receives dividend income from the United States — but resides overseas — the person can be taxed by both contracting states on the income, but there is a limitation on the amount of tax that can be imposed. In this example, the limitation would be on the United States when it taxes the dividend income derived from sources within the United States — by a resident of the Philippines.

These sections can get very complicated, but the most important takeaway is that there is a limitation to the amount of tax that can be issued. In addition, the double taxation rules will further limit any duplication in taxation.

US & Philippines Tax Treaty is Complex

In conclusion, the US and Philippines tax treaty is a great source of information to help better understand how certain income may be taxed by either country depending on the source of income, the type of income and the residence of the taxpayer. The tax outcome may be changed depending on whether or not the savings clause impacts how tax rules will be applied for certain types of income.

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