ITAD Ruling No. 104-04

September 13, 2004 ITAD RULING NO. 104-04 Articles 25 & 18, RP-US tax treaty Manuel R. Sanchez Attorney At Law 11 Imao Street, Corinthian Gardens Quezon City S i r : This refers to your letter dated October 2, 2002, requesting this Office to make the necessary representation, on your behalf, with the United States-Internal Revenue Service (US-IRS) and obtain a clarification of Article 18 of the Philippines-US tax treaty. It is represented that a tax assessment has been made against you by the US-IRS for not withholding the tax on your alimony payments to your former wife, a Filipina residing in the Philippines; that your position, as stated to the US-IRS, is that since there is no divorce in the Philippines, alimony payments take the form of wife and children support; that as such, support payments are not considered income to the wife and therefore not taxable; that any tax withheld on the support payments would constitute a reduction of the support agreement; that the US-IRS takes the opposite view, hence, this request; that you have approached this Office a couple of years ago with the same tax question and a letter 1 was written on your behalf signed by then Commissioner Beethoven L. Rualo, but the tax issue remained unresolved; that you believe that the tax assessment constitutes double taxation since you have paid taxes on your income, and now being taxed, again, on your alimony payments; and that in addition to your position, there were earlier discussions on the possibility of the alimony payments being considered as annuities, thus, could be taxed only in the country where the recipient is a resident. aDSAEI In reply, it is understood that this request has been made, in effect, pursuant to Article 25(1) of the Philippines-US tax treaty, to wit: "Article 25 "MUTUAL AGREEMENT PROCEDURE "(1) Where a resident or citizen of one of the Contracting States considers that the action of one or both of the Contracting States results or will result for him in taxation not in accordance with this Convention, he may, notwithstanding the remedies provided by the national laws of the Contracting States, present his case to the competent authority of the Contracting State of which he is a resident or citizen. Should the resident's or citizen's claim be considered to have merit by the competent authority of the Contracting State to which the claim is made, it shall endeavor to come to an agreement with the competent authority of the other Contracting State with a view to the avoidance of taxation not in accordance with the provisions of this Convention ."(Emphasis supplied) In view of the above, this Office decides to determine first whether your case has merit before we endeavor to come to an agreement with the US-IRS with a view to the avoidance of double taxation in accordance with the provisions of the Philippines-US tax treaty. Therefore, please be informed that Article 18 of the Philippines-US tax treaty provides as follows, viz : "Article 18 PRIVATE PENSIONS AND ANNUITIES "xxx xxx xxx "(2) Annuities paid to an individual who is a resident of one of the Contracting States shall be taxable only in that Contracting State. "xxx xxx xxx "(5) The term `annuities', as used in this article, means a stated sum paid periodically at stated times during the life, or during a specified number of years, under an obligation to make the payments in return for adequate and full consideration (other than services rendered) . (Emphasis supplied) "xxx xxx xxx Paragraph 5 of the foregoing provision defines the term "annuities." Alimony, on the other hand, is defined as an allowance for support fixed with a view to enable a party entitled thereto to confront obligations for current necessities ( Gorayeb vs. Hashim , 50 Phil 29). It is also defined as an allowance given to a woman for her support out of the income of her husband upon her legal separation or divorce from him or during a suit for the same ( BIR Ruling No. 344-99. ) Unlike alimony, the said tax treaty requires that the annuities are paid " under an obligation to make payments in return for adequate and full consideration (other than services rendered). " It is in this requirement that a whale of difference exists between alimony and annuities. CAIaHS Consideration is defined as anything that is bargained for by the promisor and given by the promisee in exchange for the promise ( Pirovano vs. Commissioner of Internal Revenue , 122 Phil 180) and requires a legal detriment to the promisee which must be more than a moral duty ( Lui vs. De Ocampo , 55 OG 1778). In this light, it must be emphasized that Article 68 of the Family Code of the Philippines imposes upon the spouses, among others, the rendition of mutual help and support. It is founded on the husband's duty to support his wife or vice versa . Thus, in giving support, it may not be said that there is a consideration that is "bargained for" as this is a duty imposed by law. In addition, it is noteworthy that the US Model (Tax) Treaty has a specific article on the treatment of alimony payments, to wit: "3. Alimony paid to a resident of a Contracting State shall be taxable only in that State. The term `alimony' as used in this paragraph means periodic payments made pursuant to a written separation agreement or a degree of divorce, separate maintenance, or compulsory support, which payments are taxable to the recipient under the laws of the State of which he is a resident. The above provision defines the nature of alimony payments and their treatment under a separate article clearly rules out a possible similarity with annuities. While most of the US tax treaties contain the above provision, a number of treaties, including the Philippines-US tax treaty, however, do not have the Alimony article. And in the absence of such provision, alimony payments are to be covered by the Other Income article or similar provision. It is unfortunate that the Philippines-US tax treaty likewise does not contain an Other Income article or similar provision. The Annuities provision generally would be inapplicable since the treaty definition of an "annuity" requires that it be issued for consideration. ( Refer to INCOME TAX TREATIES OF THE UNITED STATES by Peter H. Blessing, 1996, p. 1724) Inasmuch as alimony payments are not covered by the Philippines-US tax treaty, the respective domestic law of the Contracting States on the subject shall apply. In the case of the Philippines, alimony is not subject to tax. As such, there can be no valid diminution of the court-ordered support payment by way of tax imposition insofar as the Philippines is concerned. On the other hand, US imposes a tax at the rate of 30% on alimony payments which are sourced therefrom. cDAEIH An understanding of the circumstances surrounding the subject alimony payments clearly show that the same are sourced from US paid to a Philippine resident. Being taxable in US, the US-IRS may, therefore, employ the withholding tax system to collect such tax on US-sourced alimony payments especially on nonresident individuals and may penalize the payor in case of non-withholding. Thus, the tax assessment issued against you by the US-IRS for not withholding the corresponding tax on your alimony payments must not be confused with the tax-exempt nature of said payments in the Philippines, in due recognition of the right of the US to tax US-sourced income. Moreover, it is your belief that the tax assessment issued against you by the US-IRS constitutes double taxation since you have already paid taxes on your income, and out of such income, where your alimony payments are sourced, the same is being taxed once more. To constitute double taxation in the objectionable or prohibited sense, the same property must be taxed twice when it should be taxed but once; both taxes must be imposed on the same property or subject matter, for the same purpose, by the same State, Government, or taxing authority, within the same jurisdiction or taxing district, during the same taxing period, and they must be the same kind or character of tax. ( Villanueva vs. City of Iloilo , L-26521, December 28, 1968; 26 SCRA 594) It is apparent that the tax on your income and the tax on your alimony payments are not imposed for the same purpose since in the former the same is imposed upon the performance of an act, the enjoyment of privilege, or the engaging in an occupation. In the latter case, however, the tax assessment has been made against you as a penalty for not withholding the tax on the supposed income of a nonresident person, and thus, the real taxpayer is actually not you but your nonresident wife-beneficiary. It should be clarified that the foregoing concept of double taxation is not that contemplated in the Philippines-US tax treaty as will warrant the application thereof in your case. In Commissioner of Internal Revenue vs. S.C. Johnson and Son, Inc., et al . (G.R. No. 127105, June 25, 1999), the Supreme Court declared: "The RP-US Tax Treaty is just one of a number of bilateral treaties which the Philippines has entered into for the avoidance of double taxation. The purpose of these international agreements is to reconcile the national fiscal legislations of the contracting parties in order to help the taxpayer avoid simultaneous taxation in two different jurisdictions. More precisely, the tax conventions are drafted with a view towards the elimination of international juridical double taxation, which is defined as the imposition of comparable taxes in two or more states on the same taxpayer in respect of the same subject matter and for identical periods . The apparent rationale for doing away with double taxation is to encourage the free flow of goods and services and the movement of capital, technology and persons between countries, conditions deemed vital in creating robust and dynamic economies. Foreign investments will only thrive in a fairly predictable and reasonable international investment climate and the protection against double taxation is crucial in creating such a climate. " Double taxation usually takes place when a person is a resident of a contracting state and derives income from, or owns capital in the other contracting state and both states impose tax on that income or capital ." (Emphasis supplied) In view of the foregoing pronouncement, there is no double taxation in the tax treaty sense to speak of in your case since alimony payments are not deemed taxable income in the Philippines. acAESC In fine, we regret to inform you that the tax treaty remedy requested in relation to the tax assessment issued against you by the US-IRS cannot be given due course for lack of merit. Please be guided accordingly. Very truly yours, (SGD.) GUILLERMO L. PARAYNO, JR. Commissioner of Internal Revenue