US Philippines Tax Treaty

US Philippines Tax Treaty

US Philippines Tax Treaty

US Taxation of Philippines Income, Pension & Investments:& IRS Offshore Reporting: The United States has entered into several tax treaties with different countries across the globe — including the Philippines. There are many US taxpayers who are originally from the Philippines and still maintain offshore accounts, assets & investments in the Philippines — and/or generate income from the Philippines. Since there is a tax treaty in place between the US and the Philippines, it helps to limit and minimize the taxation of certain income between the respective countries. Some treaties to reduce the tax rates, eliminate tax on certain types of income such as Business Income, Capital Gains and Real Estate — and/or restrict how pension income can be taxed. When there is no tax treaty in place the US government generally relies on basic US tax law principles in valuating how foreign income should be taxed. Let’s review the basics of the US Philippines Tax Treaty – and which income is taxable.

Saving Clause

As we work through the treaty, one important thing to keep in mind is the saving clause. The saving clause essentially 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 them under general tax principles in their respective countries.

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 will stand on issues involving the following tax matters:

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

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

        • Articles 19 (Social Security Payments)

        • 23 (Relief from Double Taxation)

        • 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 (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 pension. The US and Philippines 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 and U.S. tax treaty and pension payments — only the contracting state where the services where employment was 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, the United states would be the only contract ING state to have the opportunity to tax the taxpayer.

If alternatively, the pension is the result of an annuity payment but not necessarily born 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 two pension now is 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.

Social Security (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 is paying Social Security 2

A US person who resides in the Philippines, then only the United states will be able to tax that Social Security income.

Real Property (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 not shall be taxed or shall only be taxed. therefore, with 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 tax treaty is similar to many other tax treaties on this specific issue. Essentially what happens, is that the dividends for example may be taxable by both contracting.  So for example, a US Citizen who is earning dividend income from the United states but resides overseas can be taxed by both contracting states on the income.

But, there is a limitation on the amount of tax that can be imposed when the contract as in this example (United States) is taxing 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 and of course the double taxation rules will further limit any duplication in taxation.

Offshore Reporting (FBAR & FATCA)

When a US person has various Accounts, Assets or Investments in the Philippines, they have to be reported to the United States each year on various different forms depending on the value of and category of the assets/accounts.

Here are some common forms which may need to be filed:

5 International Tax Forms You May Have Missed

The following is a summary of five (5) common international tax forms.

FBAR (FinCEN 114)

The FBAR is used to report “Foreign Financial Accounts.” This includes investments funds, and certain foreign life insurance policies.

The threshold requirements are relatively simple. On any day of the year, if you aggregated (totaled) the maximum balances of all of your foreign accounts, does the total amount exceed $10,000 (USD)?

If it does, then you most likely have to file the form. The most important thing to remember is you do not need to have more than $10,000 in each account; rather, it is an annual aggregate total of the maximum balances of all the accounts.

Form 8938

This form is used to report “Specified Foreign Financial Assets.”

There are four main thresholds for individuals is as follows:.

      • Single or Filing Separate (in the U.S.): $50,000/$75,000

      • Married with a Joint Returns (In the U.S): $100,000/$150,000

      • Single or Filing Separate (Outside the U.S.): $200,000/$300,000

      • Married with a Joint Returns (Outside the U.S.): $400,000/$600,000

Form 3520

Form 3520 is filed when a person receives a Gift, Inheritance or Trust Distribution from a foreign person, business or trust. There are three (3) main different thresholds:

      • Gift from a Foreign Person: More than $100,000.

      • Gift from a Foreign Business: More than $16,076.

      • Foreign Trust: Various threshold requirements involving foreign Trusts

Form 5471

Form 5471 is filed in any year that you have ownership interest in a foreign corporation, and meet one of the threshold requirements for filling (Categories 1-5). These are general thresholds:

      • Category 1: U.S. shareholders of specified foreign corporations (SFCs) subject to the provisions of section 965.

      • Category 2: Officer or Director of a foreign corporation, with a U.S. Shareholder of at least 10% ownership.

      • Category 3: A person acquires stock (or additional stock) that bumps them up to 10% Shareholder.

      • Category 4: Control of a foreign corporation for at least 30 days during the accounting period.

      • Category 5: 10% ownership of a Controlled Foreign Corporation (CFC).

Form 8621

Form 8621 requires a complex analysis, beyond the scope of this article. It is required by any person with a PFIC (Passive Foreign Investment Company).

The analysis gets infinitely more complicated if a person has excess distributions. The failure to file the return may result in the statute of limitations remaining open indefinitely.

*There are some exceptions, exclusions, and limitations to filing.

Receiving a Gift or Inheritance From Philippines

If you are a U.S. Person and receive a gift from a Foreign Person, Foreign Business or Foreign Trust, you may have to file a Form 3520. The failure to file these forms may lead to IRS Fines and Penalties (see below).

Which Banks in the Philippines Report U.S. Account Holders?

As of now, there are nearly 2000 Foreign Financial Institutions, within the Philippines that report US account holder information to the IRS. The list can be found here: Philippines FFI List:.

What is important to note, is that the list is not limited to just bank accounts. Rather, when it comes to FATCA or FBAR reporting, it may involve a much more broad spectrum of assets and accounts, including:

  • Bank Accounts
  • Investment Accounts
  • Retirement Accounts
  • Direct Stock Ownership
  • ETF and Mutual Fund Accounts
  • Pension Accounts
  • Life Insurance or Life Assurance Policies

Totalization Agreement

The purpose of a Totalization Agreement is to help individuals avoid double taxation on Social Security (aka U.S. individuals living abroad and who might be subject to both US and foreign Social Security tax [especially self-employed individuals] from having to pay Social Security taxes to both countries).

As provided by the IRS:

      • “The United States has entered into agreements, called Totalization Agreements, with several nations for the purpose of avoiding double taxation of income with respect to social security taxes.

        These agreements must be taken into account when determining whether any alien is subject to the U.S. Social Security/Medicare tax, or whether any U.S. citizen or resident alien is subject to the social security taxes of a foreign country”

The United States has  entered into 26 Totalization Agreements, but not with the Philippines.

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.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure

Contact our firm for assistance.