Capital income generally refers to income arising from the deployment of wealth such as interest generated from loans or fixed income securities, cash or stock dividends from equity investments and capital gains arising from the sale of equity or fixed income securities. To recall, the Department of Finance’s TRAIN Package 4 proposals cover capital income tax and financial intermediary taxes. In my previous columns about the various taxes in the financial markets, I discussed the objectives of the proposed TRAIN 4 tax reform proposals. To recap, a key objective is to SIMPLIFY what is presently a complicated tax structure that lends itself to confusion and difficulty in tax administration creating an uneven playing field among the players and rendering our local financial market uncompetitive, thus stunting capital market development.
To illustrate our stunted capital market size, as of 2016, our local currency bond market is about $98 billion, approximately 36 percent of our gross domestic product (GDP), as compared to Malaysia’s bond market of $260 billion which is 95 percent of its GDP and is the third largest in Asia after Japan and Korea. Thailand has an even bigger bond market at $303 billion while Singapore is at $230 billion and Indonesia $163 billion. In so far as our equity market is concerned, as of August 2017, our market capitalization stood at $274 billion compared to Thailand’s $1,024 billion, Singapore’s $760 billion, Indonesia’s $479 billion and Malaysia’s $418 billion. Among several factors, market transaction costs, which are predominantly made up of taxes, are considered major consideration for investors.
Based on data provided by the National Tax Research Center, in 2016 the government’s total tax collection from capital income and financial intermediaries amounted to P196.6 billion representing 12.5 percent of total BIR collection and 1.4 percent of GDP. Of this total, capital income taxes registered at P98.6 billion (6.3 percent of BIR collection and 0.7 percent of GDP) broken down as follows: interest income was at P54.4 billion (3.5 percent of BIR collections and 0.4 percent of GDP), P26.4 billion for dividends (1.7 percent of BIR collections and 0.2 percent of GDP) and P17.8 billion from capital gains, stock transactions and IPO taxes (1.1 percent of BIR collection and 0.1 percent of GDP).
In my previous column, I discussed the different taxes related to fixed income. Today, I would like to focus on taxes affecting equity investments. There are about 35 different types of unique tax rates and bases covering dividends, capital gains and stock transactions.
What are the different taxes on dividends and what is the proposal under TRAIN 4?
For citizens and resident aliens, the current tax rate is 10 percent. The tax is withheld at source by the payor upon payment and is a final tax, i.e., no additional income tax will be levied at the end of the tax year. For non-resident aliens engaged in trade or business in the country, the rate is higher at 20 percent and is a final tax. For non-resident aliens not engaged in trade or business in the country, the rate is much higher at 25 percent and again is a final tax but could be the tax treaty rate for citizens of countries which have a tax treaty with the Philippines. In order to harmonize the tax regime for all types of capital income, the proposal under TRAIN 4 is to increase it to 15 percent which is the same as the proposed tax rate for the other capital income, i.e., interest income. Note that although this rate would be higher for resident individuals, the rate would be lower for non-residents. This rate would be comparable to other countries. There are 33 of 42 countries in the world that charge 15 percent. The ASEAN average, however, is at 10 percent for residents and 11.7 percent for non-residents.
For domestic and resident corporations, dividends are currently exempted from taxes based on the principle that dividends were generated from corporate income that was already previously subjected to corporate income tax, i.e. no double taxation. Furthermore, when eventually declared by the corporation to their individual shareholders, the applicable dividend tax will be applied. For non-resident corporations however, the tax rate is 30 percent or the applicable tax treaty rate. For a branch of a foreign corporation, the profit remittance tax rate is 15 percent and for improperly accumulated earnings, the current tax is 10 percent.
Under TRAIN 4, dividends payable to resident corporations, both foreign and local, shall continue to be exempted except for sole corporations (companies owned solely by one individual) which shall be taxed at 15 percent similar to how resident individuals are to be taxed for their dividends.
Other than the tax on dividend income, another critical cost component to a stock market transaction for corporate shares listed in an exchange is of course the tax on the trading gains. The current tax regime is at 0.6 percent which essentially is a transaction tax but is deemed a final tax regardless of whether the sale results in a trading loss or gain. This rate was adjusted from 0.5 percent to 0.6 percent under the recently approved TRAIN 1 package.
Most of our ASEAN neighbors do not have a similar tax. The proposal under TRAIN 4 is to gradually bring this down by 0.1 percent per year until it reaches 0.1 percent. For unlisted stocks, the current capital gains tax is at 15 percent for resident and non-resident individuals as well as for domestic corporations. Resident and non-resident foreign corporations however enjoy a slight break at 5 percent and 10 percent. Under TRAIN 4, the proposal is to harmonize the rate at 15 percent. Finally, another market tax is the IPO (Initial Public Offering) tax which is assessed on the issuing corporation. The rates are at 1 percent, 2 percent or 4 percent depending on the level and value of shares to be sold to the market. No other country has this tax. Under TRAIN 4, this IPO tax will be scrapped.
Until next week again folks …. One big fight!