Introduction

In the Philippine tax system, the expanded withholding tax (EWT) serves as an advance collection mechanism for income taxes, ensuring that taxes on certain income payments are deducted at source and remitted to the Bureau of Internal Revenue (BIR). One key application of EWT is on payments for commercial leases, where a 5% tax is withheld on rental income derived from the lease of commercial properties. This tax applies broadly to transactions involving office spaces, retail outlets, warehouses, and other non-residential real properties used for business purposes.

The 5% EWT on commercial leases is designed to capture rental income at the point of payment, allowing the lessor to credit the withheld amount against their final income tax liability. This system promotes compliance and reduces the risk of underreporting by lessors. It is rooted in the National Internal Revenue Code (NIRC) of 1997, as amended, and various revenue regulations issued by the BIR. Understanding this tax is essential for lessees (as withholding agents), lessors (as income recipients), and tax practitioners to avoid penalties and ensure proper tax administration.

This article provides a comprehensive overview of the 5% EWT on commercial leases, covering its legal foundation, scope of application, computation methods, exemptions, compliance procedures, and consequences of non-compliance.

Legal Basis

The imposition of the 5% EWT on commercial leases is primarily governed by Section 57(A) of the NIRC, which authorizes the withholding of taxes on certain income payments subject to final or creditable withholding taxes. Specifically, rental payments fall under the category of income subject to creditable expanded withholding tax.

The implementing rules are detailed in Revenue Regulations (RR) No. 2-98, as amended by subsequent issuances such as RR No. 11-2018 (implementing the Tax Reform for Acceleration and Inclusion or TRAIN Law), RR No. 14-2018, and RR No. 21-2021. These regulations classify rentals as one of the income payments subject to a 5% creditable withholding tax under Section 2.57.2(A)(8) of RR No. 2-98.

Key amendments under the TRAIN Law (Republic Act No. 10963) adjusted thresholds for value-added tax (VAT) registration, which indirectly affects how EWT is applied to leases. For instance, lessors with annual gross receipts exceeding PHP 3 million are required to register for VAT, impacting the base for EWT computation. Additionally, the Corporate Recovery and Tax Incentives for Enterprises (CREATE) Act (Republic Act No. 11534) introduced changes to corporate income tax rates but did not alter the 5% EWT rate on rentals.

BIR rulings and revenue memorandum circulars (RMCs) further clarify specific scenarios, such as the treatment of security deposits, advance rentals, and subleases. For example, RMC No. 77-2012 addresses the withholding tax on rentals paid to non-resident owners, though this article focuses on domestic commercial leases.

Scope and Applicability

Withholding Agents

The obligation to withhold the 5% EWT lies with the payor of the rental income, known as the withholding agent. Under Section 2.57 of RR No. 2-98, withholding agents include:

Individuals engaged in trade or business, including professionals and sole proprietors.
Domestic corporations, partnerships, and associations.
Government agencies, instrumentalities, and local government units.
Non-resident aliens engaged in trade or business in the Philippines (in certain cases).

For commercial leases, the lessee (tenant) typically acts as the withholding agent if they are engaged in business activities. Even if the lessee is a non-stock, non-profit entity but engaged in income-generating activities, withholding may still apply. However, private individuals leasing for personal use (e.g., residential purposes) are not required to withhold.

Special categories of withholding agents include the Top 20,000 Private Corporations (under RR No. 6-2009), Top 5,000 Individuals, and government entities, which have expanded withholding obligations. These entities must withhold on all qualifying rental payments, regardless of amount.

Payees Subject to EWT

The 5% EWT applies to rental payments made to lessors who are:

Citizens or residents of the Philippines.
Domestic corporations or partnerships.
Estates or trusts.

The tax covers leases of commercial properties, defined as real properties used for trade, business, or professional purposes, excluding residential dwellings. Examples include office buildings, shopping malls, industrial lots, and commercial spaces in mixed-use developments.

It also extends to personal property leases if incidental to the real property lease (e.g., furniture in a furnished office). Subleases are treated similarly, with the sub-lessor acting as the payee for EWT purposes.

If the lessor is a non-resident alien not engaged in business or a foreign corporation, a different withholding regime applies (e.g., 25% final withholding tax), which is outside the scope of this 5% EWT discussion.

Types of Rentals Covered

Gross lease payments, including basic rent, common area maintenance fees, and utilities if billed by the lessor.
Advance rentals and security deposits, if applied as rent (forfeited deposits are subject to income tax but not necessarily EWT).
Leasehold improvements, if treated as additional rent under the lease agreement.
Variable rents based on sales or performance (e.g., percentage rent in retail leases).

Rentals paid in kind (e.g., goods or services) are valued at fair market value for EWT purposes.

Rate and Base for Computation

The withholding tax rate is fixed at 5% and is creditable, meaning the lessor can deduct it from their annual income tax due.

The base for computation depends on the lessor's VAT status:

Non-VAT Registered Lessors: The 5% EWT is computed on the gross rental payment, inclusive of any applicable percentage tax (3% under Section 116 of the NIRC for lessors with gross receipts not exceeding PHP 3 million).
VAT-Registered Lessors: The 5% EWT is applied to the rental amount excluding the 12% VAT. The lessee pays the VAT separately, and the lessor accounts for it in their VAT returns.

For example:

If the monthly rent is PHP 100,000 (exclusive of VAT) and the lessor is VAT-registered, VAT is PHP 12,000, total payment PHP 112,000. EWT is 5% of PHP 100,000 = PHP 5,000.
If non-VAT registered, EWT is 5% of PHP 100,000 = PHP 5,000, and percentage tax may apply separately.

No minimum threshold exists for withholding; even small rental payments trigger the obligation. However, if the annual rental to the same lessor is PHP 10,000 or less, the payee may be exempt from income tax, but withholding still applies unless specifically exempted.

Computation Examples

To illustrate:

Basic Commercial Lease:
- Monthly rent: PHP 200,000 (VAT-exclusive, lessor VAT-registered).
- VAT: PHP 24,000.
- Total paid: PHP 224,000.
- EWT: 5% × PHP 200,000 = PHP 10,000.
- Net amount to lessor: PHP 224,000 - PHP 10,000 = PHP 214,000.
Advance Rental:
- Annual rent paid in advance: PHP 1,200,000 (gross, non-VAT lessor).
- EWT: 5% × PHP 1,200,000 = PHP 60,000.
- The entire EWT is withheld upon payment, and the lessor recognizes income ratably over the year.
Sublease with Percentage Rent:
- Fixed rent: PHP 150,000/month.
- Percentage rent: 2% of lessee's monthly sales of PHP 5,000,000 = PHP 100,000.
- Total rent: PHP 250,000 (VAT-exclusive).
- EWT: 5% × PHP 250,000 = PHP 12,500.

In all cases, the withholding agent must issue BIR Form 2307 (Certificate of Creditable Tax Withheld at Source) to the lessor.

Exemptions and Non-Applicability

Certain transactions are exempt from the 5% EWT:

Rentals paid to the government or its political subdivisions (exempt under Section 32(B)(7) of the NIRC).
Leases to minimum wage earners or low-income individuals, if the rental income qualifies for exemption under RR No. 14-98.
Agricultural land leases, unless commercial in nature.
Residential leases where the monthly rent does not exceed PHP 15,000 (exempt from VAT and potentially EWT if not business-related).
Leases between related parties in certain consolidated tax scenarios, subject to BIR approval.
Exempt entities like registered non-stock, non-profit educational institutions or hospitals, if the lease is incidental to their exempt activities.

BIR rulings may grant case-specific exemptions, such as for leases under public-private partnerships.

Compliance Requirements

For Withholding Agents (Lessees)

Monthly Filing: File BIR Form 0619-E (Monthly Remittance Return of Creditable Income Taxes Withheld - Expanded) by the 10th day of the following month.
Quarterly Remittance: File BIR Form 1601-EQ (Quarterly Remittance Return of Creditable Income Taxes Withheld - Expanded) and remit the tax within 25 days after the quarter's end.
Annual Information Return: File BIR Form 1604-E (Annual Information Return of Creditable Income Taxes Withheld - Expanded) by January 31 of the following year.
Issuance of Certificate: Provide BIR Form 2307 to the lessor quarterly or upon request.
Use the eBIRForms or Alphalist Data Entry and Validation Module for electronic submission.

For Payees (Lessors)

Report the gross rental income in their income tax returns (BIR Form 1700 for individuals, 1702 for corporations).
Credit the withheld tax using Form 2307 against their income tax liability.
If VAT-registered, file monthly/quarterly VAT returns (BIR Form 2550M/2550Q).
Maintain books of accounts and issue official receipts.

Both parties must retain records for at least 5 years for audit purposes.

Penalties for Non-Compliance

Failure to withhold, remit, or file returns incurs penalties under Sections 251-255 of the NIRC:

Surcharge: 25% (or 50% if willful neglect or fraud) on the tax due.
Interest: 12% per annum (reduced from 20% under TRAIN Law) on the unpaid amount.
Compromise Penalties: Ranging from PHP 200 to PHP 50,000 depending on the violation.
Criminal Liability: For willful failure, fines up to PHP 100,000 and imprisonment up to 10 years.
Civil Penalties: Deficiency assessments during BIR audits.

Common violations include under-withholding, late remittance, or failure to issue Form 2307, which can lead to disallowance of expense deductions for the lessee.

Recent Developments and Best Practices

With the easing of TRAIN Law thresholds, more lessors have become VAT-registered, affecting EWT bases. The BIR's digitalization efforts, such as the Electronic Filing and Payment System (EFPS), mandate electronic compliance for large taxpayers.

Best practices include:

Reviewing lease agreements for tax clauses (e.g., gross-up provisions where lessee absorbs the EWT).
Conducting due diligence on the lessor's tax status.
Using tax software for accurate computations.
Seeking BIR rulings for ambiguous cases, such as leases with foreign elements or special economic zones.

In summary, the 5% EWT on commercial leases is a critical component of the Philippine tax framework, balancing revenue collection with taxpayer compliance. Proper adherence ensures smooth business operations and minimizes exposure to penalties.