In the Philippine jurisdiction, the taxation of interest income is primarily governed by the National Internal Revenue Code (NIRC) of 1997, as amended by subsequent laws such as the TRAIN Law (Republic Act No. 10963) and the CREATE Act (Republic Act No. 11534).
While most interest income earned by individuals and corporations is subject to Final Withholding Tax (FWT), the treatment of interest income arising from bank loans involves specific nuances regarding whether the tax is "creditable" or "final," depending on the status of the lender and the nature of the transaction.
1. The Distinction: Final vs. Creditable Tax
To understand Creditable Withholding Tax (CWT) in this context, one must first distinguish it from Final Withholding Tax.
- Final Withholding Tax (FWT): Generally applies to interest income earned by passive depositors from bank deposits. The bank withholds the tax (usually 20%), and the income is no longer included in the taxpayer's gross income at the end of the year.
- Creditable Withholding Tax (CWT): This is a system where the payor withholds a percentage of the payment as an advance payment of the payee’s income tax. The payee can then use the Certificate of Creditable Tax Withheld at Source (BIR Form No. 2307) as a tax credit against their quarterly and annual income tax liabilities.
2. Is Interest on Bank Loans Subject to CWT?
Under Philippine tax regulations (specifically Revenue Regulations No. 2-98, as amended), interest income paid to banking institutions is generally not subject to CWT.
Instead, banks are subject to the Gross Receipts Tax (GRT) under Sections 121 and 122 of the NIRC. Since the bank’s primary business is lending, the interest they receive is considered "active" business income, not passive income. Consequently:
- Borrowers (whether individual or corporate) are not required to withhold tax on the interest payments made to local banks.
- The bank includes this interest in its gross receipts for the calculation of its internal taxes (Income Tax and GRT).
3. Scenarios Where CWT/Withholding May Apply
While standard loans from domestic banks are exempt from CWT at the hands of the borrower, there are specific contexts where withholding tax rules on interest are triggered:
A. Loans from Non-Bank Financial Intermediaries
If the lender is a non-bank financial intermediary or a "finance company" not classified as a bank, the rules may differ. However, under the expanded withholding tax system, most payments of interest to regular corporations are not listed as items subject to CWT unless they fall under specific BIR issuances.
B. Interest Paid to Foreign Banks (Non-Resident)
If a Philippine borrower takes a loan from a Foreign Bank (Non-Resident Foreign Corporation), the interest payments are subject to a Final Withholding Tax (usually 20% under the NIRC, or lower if a Tax Treaty applies), rather than CWT.
C. Inter-Corporate Loans (Non-Bank)
When one corporation (not a bank) lends money to another, the interest paid is generally subject to a 20% Final Withholding Tax if the loan is considered a "deposit substitute." If it is a simple loan between two companies, it is often argued that the interest is part of the lender's gross income, but the borrower is typically required to withhold 20% FWT under Section 24(B)(1) or 27(D)(1) of the Tax Code.
4. Documentary Stamp Tax (DST) Requirements
While not a "withholding tax" on income, every bank loan in the Philippines is subject to Documentary Stamp Tax (DST) under Section 179 of the Tax Code.
- Rate: P1.50 on each P200.00, or a fraction thereof, of the issue price of the loan instruments (Promissory Notes).
- Liability: Usually, the borrower shoulders this cost, though both parties are technically liable.
5. Deductibility of Interest Expense for the Borrower
For a borrower to claim the interest paid on a bank loan as a deductible expense from their gross income, they must satisfy the following:
- Indebtedness: There must be a valid, written loan agreement.
- Payment: The interest must be paid or incurred within the taxable year.
- The "Arbitrage Limit": Under the Tax Code, the deductible interest expense is reduced by a certain percentage of the interest income earned by the taxpayer that was subjected to final tax. As of the CREATE Act, this reduction is 20% of the interest income subject to final tax.
6. Summary Table
| Feature | Interest to Domestic Banks | Interest to Foreign Banks |
|---|---|---|
| Tax Type | Gross Receipts Tax (Paid by Bank) | Final Withholding Tax (Withheld by Borrower) |
| CWT Requirement | None | None (it is a Final Tax) |
| Withholding Rate | 0% | 20% (or Treaty Rate) |
| Required Form | N/A | BIR Form 1601-F |
Conclusion
In the Philippine context, borrowers do not withhold Creditable Withholding Tax on the interest portion of their bank loan repayments. The burden of taxation shifts to the bank via the Gross Receipts Tax and Corporate Income Tax systems. However, borrowers must remain vigilant regarding the payment of Documentary Stamp Taxes and the correct calculation of "interest arbitrage" to ensure the deductibility of their interest expenses for income tax purposes.