Tax Articles

The Relevance of Creditable Withholding Tax System

By Atty. Fulvio D. Dawilan

This day starts the last week for the filing of the annual income tax returns and the payment of income taxes due for the year 2022, covering both individual taxpayers and corporate taxpayers using the calendar year as their taxable year. The computation of annual income tax due may either result in a tax liability still due to the government or an excess income tax payment.

And why does an excess income tax payment occur, when taxes are supposed to be determined, computed and declared based on the self-assessment scheme? There are a number of factors that may result in excessive income tax payment. But the more common reasons are the results of our existing tax system. The obligation to pay taxes on a quarterly basis sometimes result in more income tax payments made in the first three quarters of the year compared to the annualized computation after the end of the year. The other reason is the application of the creditable withholding tax system, where buyers of goods and services are required to deduct and remit to the tax authority a portion of the income, which is considered advance payment of the income tax due from the income recipient. Often, the excess is attributable to the unutilized creditable taxes withheld at source.

Our present tax law allows the Secretary of Finance to require the withholding of taxes on items of income payments to both natural and juridical persons, at the withholding tax rate of not less than 1% but not more than 15%. And by virtue of this authority, the withholding tax regulations impose upon the buyers of goods and services, who are designated as withholding agents, the obligation to pay withholding taxes. The rates of withholding taxes vary - ranging from 1% to 15% - depending on the class of payee/type of income payment.

The withholding tax system in effect provides a procedure for the collection of income tax from persons other than the income earner. As described by the Courts in a number of cases, this was devised to: (a) provide taxpayers a convenient manner to meet their probable income tax liability; (b) ensure the collection of income tax which can otherwise be lost or substantially reduced through failure to file the corresponding returns; and (c) improve the government's cash flow. Withholding of taxes results in administrative savings, prompt and efficient collection of taxes, prevention of delinquencies, and reduction of governmental effort to collect taxes through more complicated means and remedies. In essence, the withholding agents act as agents of the income earners for the payment of taxes and also agents of the government for the collection of taxes.

However, the system often proves to be disadvantageous to taxpayers. Aside from the fact that taxpayers loss the right to make use of their money because of the advance tax payment, the refund mechanism for the recovery of unutilized advance income tax payment does not favor the taxpayers. The rules require the taxpayer to observe a number of requirements to be entitled to a refund. Failure to comply with these requirements will most likely result in the denial of refund claims.

Supposedly, the unused advance income tax payment should be returned if the taxpayer opts to by just complying with the basic requirements. The basic requirements for the successful refund of unutilized creditable withholding taxes are: (a) the income upon which the taxes were withheld were included as part of the gross income declared in the returns of the taxpayer; (b) the fact of withholding is proven by withholding tax certificates issued by the withholding agents; and (c) the claim, both in the administrative and judicial levels, must be filed within two years from date of payment. However, the tax authorities sometimes add procedures, and the Courts had interpreted these otherwise simple procedures, making it difficult for taxpayers to comply. Apparently, in dealing with refund claims, the tax authorities and the Courts are usually guided by the principle that refund claims are similar to tax exemption which is construed strictly against the taxpayer. The result: denial of refund and consequently, loss of an involuntary advance income tax payment previously made.

For instance, the requirement to present creditable withholding tax certificates are now extended, not only to the year of the claim, but also to prior years, especially if the amount applied or partly applied against the current income tax due came from prior years. The reason is that if their existence is not substantiated, they cannot be used as credit against the current income tax due. Consequently, the current year’s income tax due should be paid by the current year’s withholding tax credits, resulting in the reduction or total elimination of the supposed refundable amount.

This loss to the taxpayer defeats the very intention of the withholding tax system, which is to approximate the tax due of the income earner at the end of a taxable period. The system should therefore ensure that it neither results in a gain nor loss to both the taxpayer and the government, and should be readily made available whenever the taxpayer opts to recover it in the form of refund. If that is not working, changes need to be made.

And that could be remedied by reviewing the implementation of the withholding tax system, especially on the determination of the withholding tax rates. The present withholding tax rates appear to be very high to some industries, classes of payees or types of income payments. The recent tax reforms reduced the highest withholding tax rate to 15%. But the rates assigned to some types of income payments still do not approximate the income taxes due that are expected from the nature of activities. These could be addressed through administrative issuances or through legislative intervention.