In the complex landscape of Philippine taxation, the treatment of interest income derived from bank loans is a critical area for both financial institutions and corporate borrowers. While most people are familiar with the Final Withholding Tax (FWT) on savings account interest, interest income earned by banks from loans extended to clients falls under a different category: Creditable Withholding Tax (CWT).
This article provides a comprehensive legal overview of the rules, rates, and compliance requirements surrounding CWT on bank loan interest income.
1. Legal Basis and Nature of CWT
The primary authority for withholding taxes in the Philippines is the National Internal Revenue Code (NIRC) of 1997, as amended (most recently by the TRAIN and CREATE laws). Specific implementation rules are found in Revenue Regulations (RR) No. 2-98, as amended.
Unlike Final Taxes (which settle the tax liability in full at the source), a Creditable Withholding Tax is a dynamic system where the tax withheld is treated as an advance payment of the payee’s (the bank's) quarterly or annual income tax liability.
2. The Scope: What is Covered?
When a borrower (usually a juridical entity or an individual engaged in business) pays interest to a bank for a loan, that interest is considered taxable income for the bank. Under Philippine law, certain types of income payments are subject to expanded withholding tax to ensure steady collection for the government.
- Payor: The borrower (the entity paying the interest).
- Payee: The bank or financial institution (the entity receiving the interest income).
- Subject Matter: Interest income arising from loans, credit lines, or debt instruments.
3. Applicable Tax Rates
The rate for withholding tax on interest income paid to banks is generally 2%, as provided under RR No. 2-98 (as amended by RR No. 11-2018).
| Type of Income Payment | Withholding Tax Rate |
|---|---|
| Interest income on loans paid to banks | 2% |
| Interest income on loans paid to non-bank financial intermediaries | 2% |
Note: This is distinct from the 20% Final Withholding Tax applied to interest earned by depositors on their savings or time deposits.
4. Obligations of the Borrower (The Withholding Agent)
The borrower has the legal responsibility to act as the withholding agent. Failure to perform these duties can lead to the disallowance of the interest expense as a deduction for the borrower's own tax purposes.
- Withhold the Tax: Deduct the 2% from the interest payment due to the bank.
- Remit to the BIR: Pay the withheld amount to the Bureau of Internal Revenue (BIR) using BIR Form 1601-EQ (Quarterly Remittance Return of Creditable Income Taxes Withheld).
- Issue Certificate (Form 2307): Provide the bank with the BIR Form 2307 (Certificate of Creditable Tax Withheld at Source). This is the most crucial step for the bank, as it serves as proof of the tax payment.
5. Rights of the Bank (The Payee)
Because this is a creditable tax, the bank does not lose this money. Instead:
- The bank receives the interest net of the 2% CWT.
- The bank collects the Form 2307 from the borrower.
- When the bank files its Corporate Income Tax Return (Form 1702), it attaches the Form 2307 to deduct/offset the withheld amount from its total income tax due.
6. Critical Compliance Points and Common Issues
The "Gross-Up" Clause
In many loan agreements, banks include a "gross-up" or "tax-free" clause, stating that the interest must be paid "net of all taxes." Legally, the borrower is still required to withhold and remit the 2% to the BIR. If a gross-up clause exists, the borrower essentially shoulders the tax as an additional cost of borrowing.
Timing of Withholding
Under RR No. 2-98, the obligation to withhold arises at the time the income payment is paid or payable, or the moment it is accrued (recorded as an expense in the borrower's books), whichever comes first.
Penalties for Non-Compliance
If a borrower fails to withhold the 2% CWT:
- Assessment: The BIR can assess the borrower for the deficiency withholding tax, plus 12% interest per annum and a 25% surcharge.
- Expense Disallowance: Under Section 34(K) of the Tax Code, an expense (interest) is not deductible from gross income unless it is proven that the required tax was withheld and remitted.
7. Exemptions
Certain entities may be exempt from being withheld upon, such as:
- General Professional Partnerships (GPPs).
- Entities with specific tax-exempt status (e.g., those registered with PEZA or BOI, depending on their specific incentive package).
- Inter-bank loans (often governed by different treasury tax rules).
Summary Table: CWT vs. FWT on Interest
| Feature | Creditable Withholding Tax (CWT) | Final Withholding Tax (FWT) |
|---|---|---|
| Applied to | Interest paid to the bank on loans. | Interest paid by the bank on deposits. |
| Standard Rate | 2% | 20% |
| Tax Nature | Advance payment of income tax. | Full and final settlement of tax. |
| Required Form | BIR Form 2307 (issued to bank). | No 2307 required for individual depositors. |
| Impact on Payee | Can be used as a tax credit. | Cannot be used as a credit. |