by Barney Almazar, Esq.
With the Philippine Peso outperforming the other currencies in South-East Asia, speculative investors will take their balance sheet to Manila’s emerging markets to profit from the country’s stronger currencies.
Capitalized upon international market imbalance, the business logic is actually very simple: buy money at low interest rates then profit from the spread by selling to countries where interest rates are higher and growth rates more robust.
Globally, interest rates remain low and are anticipated to remain low for the foreseeable future as indicated by the burgeoning amounts of sovereign debt coupled with impaired budgetary positions and an ageing population demanding more from governments.
As the world population ages, a great deal of retirement saving can be expected to chase yield. The Philippine population is rising by more than 2 million a year and one third of its 100 million population is under 15 years old.
One reason for high gain potential is that investor preferences are shifting towards emerging markets. The Philippines has caught global attention as the country’s economy gains speed. The young demographic of Manila makes it favorable to investors, not to mention having a similar workforce culture to the west. Investment prospects are not only limited to residential undertakings, but likewise include the strong retail and office sectors.
In fact, the excess capital that central banks across the globe injected into the market will positively affect property prices in Manila.
Execution, however, is an altogether different story. Financing offshore—whether through plain vanilla bonds, hedge funds, depository receipts, or bespoke structured debt products—requires careful tax planning to minimize the high cost of domestic (withholding) tax. Remember, the Philippines, unlike the UAE, impose taxes on income.
Elevating the importance of structuring transaction is the fact that the lender and the borrower belong to different taxing jurisdictions, an avenue for both governments to impose tax on the interest income among others. Financial lenders therefore, should take advantage of preferential tax rates under bilateral tax treaties, among others, to mitigate the risk of double taxation.
Use RP-UAE Tax Treaty to Your Advantage
A double taxation exists when the same income is taxed for the same tax period twice, when it should have been taxed but once, for the same purpose and with the same kind of character of tax. The main objectives of treaties are the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income. The Philippines has entered into more than 40 bilateral and international tax treaties and agreements.
The United Arab Emirates and the Philippines have executed a tax treaty on the avoidance of double taxation effective as early as December 2004. The treaty being in existence for almost 15 years have not been maximized by the strong Filipino population across the emirates.
For instance, the general withholding tax rate for interest on foreign loans under the Philippine Tax Code is 20%. Most Philippine treaties could reduce the rate to 15% while other treaties further reduce it to 10% depending on the nature of the debt product or the character of the lender. A treaty may further provide instances which exempt the interest payments from domestic income tax and consequently from withholding tax. Debt obligations guaranteed or insured by the government or an instrumentality thereof, is more likely to be exempt from tax by the revenue authorities for the country where the interest was earned.
The Philippine Bureau of Internal Revenue (BIR) would consider interest payments on foreign loans as income earned within the Philippines if the rights and obligation arising from the foreign transaction is located in the Philippine territory. Because of the “flow of wealth” doctrine, even a foreign lender who has never been to the Philippines can still be taxed by the BIR through the withholding agents of the latter.
The local borrower is considered as the withholding agent and is required to deduct and withhold tax at the time interest is paid or becomes payable or is accrued in the borrower’s book, whichever comes first. The term “payable” refers to the date the obligation becomes due, demandable and legally enforceable. An accrued expense, on the other hand, refers to an expense taken as a deduction for tax purposes. Timing is crucial as failure to properly file the tax treaty relief application (TTRA) with the International Tax Affairs Division of the BIR before the occurrence of the first taxable event shall have the effect of denying treaty benefits on the transaction. In such case, the regular rate of 20% will be imposed.
Debt and Equity Financing
Businesses may be financed through equity and/or debt funding. Under present laws, interest payments are fully deductible against taxable income while dividends are not. Financing through debt rather than equity would therefore translate to outright savings of 30% (in the form of a tax shield). Although inter-company dividends are taxed at 0% and interest payments are subjected to 20% final tax, financing through the latter would still have an advantage equivalent to 10%.
Even with the tax favored treatment of interest payments over dividends, companies must still maintain a reasonable ratio of debt over equity to minimize audits risks as Revenue Audit Memorandum Order No. 01-98 considers thin capitalization and earning stripping as the most common form of tax avoidance schemes.
While money may come easily, it is imperative for foreign lenders to ensure competitiveness by keeping rates low. After all, profits will truly be maximized by seizing opportunities that others miss.