Are Interest Earnings of Foreigners’ Philippine Bank Deposits Subject to Withholding Tax?

Introduction

In the Philippine tax system, interest earnings from bank deposits represent a common form of passive income that is often subject to specific taxation rules. For foreigners—typically referring to non-resident aliens and foreign corporations—depositing funds in Philippine banks, the question of whether such interest is subject to withholding tax hinges on several factors, including the depositor's residency status, the currency of the deposit, applicable tax laws, and potential tax treaty benefits. This article provides a comprehensive overview of the relevant legal provisions under Philippine law, drawing from the National Internal Revenue Code (NIRC) of 1997, as amended, and related statutes such as Republic Act (RA) No. 6426 (Foreign Currency Deposit Act) and RA No. 9294 (amending RA 6426). It explores the tax treatment of interest earnings, exemptions, withholding obligations, and practical considerations for compliance.

The Philippine Bureau of Internal Revenue (BIR) administers these rules, ensuring that banks act as withholding agents to deduct taxes at source. Understanding these nuances is crucial for foreign depositors, financial institutions, and tax advisors to avoid penalties, such as those for underwithholding or non-remittance of taxes.

Legal Framework Governing Interest Earnings

The primary legal basis for taxing interest earnings in the Philippines is found in the NIRC, particularly Sections 24 to 28, which outline income taxation for individuals and corporations. Interest income is classified as passive income and is generally subject to final withholding tax (FWT), meaning the tax is withheld at source and constitutes the final tax liability, eliminating the need for further reporting in an annual income tax return for that specific income.

For foreigners, the tax treatment varies based on their classification:

Non-Resident Aliens (NRAs): Divided into those engaged in trade or business in the Philippines (NRAETB) and those not engaged (NRANETB).
Non-Resident Foreign Corporations (NRFCs): Entities not engaged in trade or business in the Philippines.

Resident aliens and foreign corporations engaged in business are treated similarly to Philippine residents or domestic corporations, but this article focuses on non-residents as the core definition of "foreigners" in this context.

Additionally, special laws govern specific deposit types:

RA 6426 (Foreign Currency Deposit Act of 1974), as amended by RA 9294 (2004): Establishes the Foreign Currency Deposit System (FCDS), providing tax incentives for foreign currency deposits to attract foreign capital.
Presidential Decree (PD) No. 1034: Reinforces confidentiality and tax exemptions for offshore banking units (OBUs).
Tax Treaties: The Philippines has double taxation agreements (DTAs) with over 40 countries, which may reduce or eliminate withholding taxes on interest for residents of treaty countries.

Revenue Regulations (RR) issued by the BIR, such as RR No. 14-2012 (on withholding taxes) and RR No. 5-2021 (implementing the CREATE Act), further clarify implementation, including rates and procedures.

Classification of Deposits and Tax Implications

Philippine bank deposits can be broadly categorized into peso deposits and foreign currency deposits, each with distinct tax rules for foreigners.

Peso Bank Deposits

Interest earnings from peso-denominated deposits (e.g., savings, time deposits, or demand deposits in Philippine banks) are generally taxable for non-resident foreigners.

For NRANETB: Interest is considered Philippine-sourced income under Section 42(A)(3) of the NIRC and is subject to a 25% final tax on gross income (Section 25(B)). However, for bank interest specifically, it is subject to 20% FWT under Section 25(A)(2) if derived from sources within the Philippines. Banks withhold this tax at source and remit it to the BIR.
For NRAETB: Treated similarly to resident aliens, with interest subject to 20% FWT under Section 25(A)(1). This applies if the alien is engaged in trade or business, such as through a permanent establishment.
For NRFCs: Interest is subject to 20% FWT under Section 28(B)(1), unless reduced by a tax treaty. If the corporation is engaged in business (resident foreign corporation), it falls under graduated corporate income tax rates, but passive interest is still subject to 20% FWT.

Exemptions for peso deposits are limited. For instance, long-term deposits (held for five years or more) may qualify for exemption under Section 24(B)(2) for individuals, but this is rarely applicable to non-residents due to residency requirements.

Foreign Currency Deposits (FCDs)

FCDs under the FCDS offer more favorable tax treatment, designed to encourage foreign investments.

Exemption for Non-Residents: Under Section 8 of RA 6426, as amended, interest income from FCDs of non-residents (both individuals and corporations) is exempt from all taxes, including withholding tax. This exemption applies regardless of the depositor's engagement in trade or business, provided the deposit is with an authorized FCDS bank or OBU.
Rationale and Conditions: The exemption aims to maintain confidentiality and attract foreign funds. Deposits must be from external sources (e.g., remittances from abroad), and withdrawals are restricted to foreign currency to prevent circumvention of exchange controls. Violations, such as unauthorized peso conversions, may trigger tax liabilities.
Exceptions: If the non-resident is deemed a Philippine resident for tax purposes (e.g., staying over 180 days in a year under Section 25), the exemption may not apply, and interest becomes subject to 15% FWT under Section 24(B)(1) for residents (reduced from 20% post-CREATE Act amendments). For FCDs of residents, the tax rate is 15% FWT.

Withholding Tax Rates and Procedures

Withholding tax is mandatory for Philippine-sourced interest paid to non-residents, with banks serving as withholding agents under Section 57 of the NIRC.

Standard Rates:
- Peso Deposits: 20% FWT for NRAs and NRFCs.
- FCDs: 0% (exempt) for non-residents; 15% for residents.
Expanded Withholding Tax (EWT): In some cases, if not classified as final tax, interest may be subject to 5-10% EWT, creditable against final tax liability, but this is uncommon for bank deposits.
Remittance and Reporting: Banks must remit withheld taxes via BIR Form 1601-F (monthly) and issue BIR Form 2307 (Certificate of Creditable Tax Withheld) to the depositor. Annual information returns (BIR Form 1604-F) are also required.

Penalties for non-compliance include surcharges (25-50%), interest (12% per annum), and potential criminal liabilities under Section 255 of the NIRC.

Impact of Tax Treaties

The Philippines' DTAs can override domestic rates, reducing withholding tax on interest for residents of treaty partner countries. For example:

Under the Philippines-US DTA, interest is taxed at a maximum of 10-15% for US residents.
Similar reductions apply in treaties with countries like Japan (10%), Singapore (15%), or the UK (15%).

To claim treaty benefits, non-residents must file BIR Form 0901 (Application for Treaty Relief) and provide a Tax Residency Certificate from their home country. The BIR issues a Certificate of Entitlement to Treaty Benefits (CETB) or ruling confirming the reduced rate. Without this, the full domestic rate applies.

Exemptions and Special Cases

Beyond FCD exemptions:

De Minimis Amounts: Small interest amounts may fall under de minimis exemptions, but this is negligible for bank deposits.
Government Deposits: Interest on deposits with the Bangko Sentral ng Pilipinas (BSP) or government securities may have separate rules, but not typically for private bank deposits.
Offshore Banking Units (OBUs): Deposits in OBUs are exempt from tax for non-residents under PD 1034, similar to FCDS.
PEZA and BOI Incentives: Foreign investors in economic zones may enjoy tax holidays, but these do not directly apply to bank deposit interest.
COVID-19 and Recent Amendments: The CREATE Act (RA 11534, 2021) reduced certain rates (e.g., FCD interest for residents to 15%), but non-resident exemptions remain intact. No major changes affected foreigners' bank deposits as of the latest known amendments.

Compliance Considerations for Foreign Depositors and Banks

Foreigners must ensure proper classification of their residency status, often requiring submission of documents like passports or visas to banks. Banks, in turn, must verify non-residency to apply exemptions, using BSP guidelines on account opening.

Common pitfalls include:

Misclassification leading to over- or under-withholding.
Failure to claim treaty benefits, resulting in higher taxes.
Currency conversion issues triggering tax on disguised peso deposits.

Audits by the BIR may scrutinize large deposits, especially if linked to Philippine-sourced income. Foreigners should consult tax professionals for advice on structuring deposits to maximize exemptions.

Conclusion

Interest earnings on foreigners' Philippine bank deposits are subject to withholding tax primarily for peso deposits, at rates of 20-25% depending on the depositor's status, while foreign currency deposits enjoy broad exemptions for non-residents under RA 6426. Tax treaties provide avenues for rate reductions, emphasizing the importance of proactive compliance. These rules balance revenue generation with incentives for foreign investment, reflecting the Philippines' efforts to integrate into the global economy. Depositors and institutions must navigate this framework carefully to ensure adherence and optimize tax outcomes.