By: Francisco D.P.L. Salazar

Foreign corporations intending to establish presence in the Philippines could set up a branch, Regional Office Headquarters (ROHq), or a domestic affiliate/subsidiary.

In making a decision about the best corporate vehicle to be set up, foreign companies should take note of the following:

(1)     With respect to taxation, there is no difference in setting up of either a branch or a domestic affiliate/subsidiary in the Philippines;

(2)     Creating a ROHq would create additional tax impositions on income sourced from the Philippines and remittances of income earned from sources within the Philippines do not require a Tax Treaty Relief Application. However, it is exempt from local taxes and enjoys a preferential tax rate for foreign and Filipino employees, among others; and

(3)     Sound business judgment requires that factors other than taxation be considered in selecting the vehicle to do business in the Philippines

If a foreign company decides to put up a branch or a ROHq in the Philippines, it will be considered a resident foreign corporation. Hence, it will be taxed based on its income from sources within the Philippines. If a foreign company decides to incorporate a domestic affiliate/subsidiary, the income of the domestic affiliate/subsidiary from sources outside and within the Philippines shall be subject to Philippine income tax. The difference in the tax base is due to the fact that a foreign company which has a branch or a ROHq in the Philippines is considered a single entity for taxation purposes, and, as a resident foreign company, it will only be taxed on income derived from sources within the Philippines. On the other hand, a domestic affiliate/subsidiary incorporated by a foreign company is vested with a separate juridical entity, and, as a domestic corporation, it is subject to tax on income from sources within and outside the Philippines.

As to the tax rates, a foreign branch and a domestic affiliate/subsidiary are both subject to 30% tax on their net income except that the 30% tax rate shall apply to income sourced from within the Philippines in case for a foreign branch, while the 30% tax rate shall be applied to income from all sources in case of a domestic affiliate/subsidiary. As regards the ROHq, a special income tax rate of 10% of the taxable income from sources within the Philippines shall apply.

Since, ultimately, the decision to put up a branch, a domestic affiliate/subsidiary, or a ROHq will be mostly dependent on the commercial prospects of the foreign company, as the head office or the parent company, other aspects of taxation must be considered. Analysis must not be limited to the profitability on the branch, domestic company or ROHq level but on the profits which may be derived by the foreign company seeking to establish a branch, a domestic affiliate/subsidiary, or a ROHq in the Philippines. Thus, the impact of taxation from the time the income is derived by the branch, domestic affiliate, and/or ROHq up to the moment that such income reaches the foreign company must be considered.

If a foreign company decides to incorporate a domestic affiliate/subsidiary, any dividend which may be paid by the domestic affiliate/subsidiary shall be subject to 15% final tax. This is because the foreign company is considered as a non-resident foreign corporation which has a separate juridical personality from its domestic affiliate/subsidiary.

Should the foreign company decide to put up a branch in the Philippines, a branch profit remittance tax of 15% on the total profits applied or earmarked shall be due and demandable.

If the foreign company opts to establish a ROHq, a 15% branch profit remittance tax will also be imposed on income payments to the foreign company.

From the foregoing, it is clear that when a foreign company decides to put up a branch, a domestic affiliate/subsidiary or a ROHq any remittance or dividends to be paid by the branch, ROHq, or domestic affiliate/subsidiary shall be subject to 15% branch profit remittance tax or dividend tax. Thus, it is important to minimize the tax on the branch profit or dividend payments to the head office or the parent company.

One way of reducing the 15% tax is by applying for tax exemption or preferential rates under tax treaties. In this way, if the country where the foreign company is a resident has a Tax Treaty Agreement with the Philippines, the dividend payment or branch profit remittance may be exempted or subjected to a lower rate.

However, one should not readily assume that the establishment of a ROHq is more profitable than putting up a Branch or a domestic affiliate/subsidiary owing to its lower tax rate of 10% of the net income and that its branch profit remittance tax may subject of preferential tax rate or may be exempted. A closer scrutiny will reveal that the establishment of ROHq will mean additional tax burden on the head office/principal company.

Under Philippine laws, a ROHq shall mean a foreign business entity which is allowed to derive income in the Philippines by performing qualifying services to its affiliates, subsidiaries or branches in the Philippines, in the Asia-Pacific Region and in other foreign markets. It enjoys the preferential tax rate of 10% of its net income. However, a ROHq is prohibited from offering qualifying services to entities other than their affiliates, branches or subsidiaries, as declared in their registration with the Philippine Securities and Exchange Commission (SEC) nor shall they be allowed to directly and indirectly solicit or market goods and services whether on behalf of their mother company, branches, affiliates, subsidiaries or any other company.

Thus, the establishment of ROHq would mean that a Branch or an affiliate/subsidiary which is subject to 30% tax must also be incorporated. Consequently, the creation of a ROHq that will receive income from a branch or affiliate/subsidiary would mean additional tax imposition of 10% and reduction of income from Philippines.

Further, the 15% branch profit remittance tax upon remittance of the operational income derived from Philippine source by the ROHq to its head office does not require a Tax Treaty Relief Application. This is because a ROHq is not considered a permanent establishment under BIR Ruling DA-ITAD 71-08, dated October 29, 2008.

The establishment of a ROHq may appear to be disadvantageous as regards the tax aspect but, in making a decision, a foreign company must also consider the following advantages of ROHq:

(1)        Exemption from all kinds of local taxes, fees or charges imposed by a local government unit, except real property  tax on land improvements and equipment;

(2)       Tax and duty-free importation of equipment and materials for training and conferences needed and solely used for the ROHQ functions, and which are not locally available, subject to prior BOI approval;

(3)       Preferential tax rates for foreign and Filipino employees.

In sum, setting up a branch would mean that the income derived by the a foreign company in the Philippines will be subjected to 30% income tax and 15% branch profit remittance tax, which may be reduced to 10% upon application for a Tax Treaty Relief. Incorporating a domestic affiliate/subsidiary would also subject the income derived by a foreign company in the Philippines to 30% and 15% dividend tax, which may also be reduced to 10% upon application for a Tax Treaty Relief. Finally, putting up a ROHq would mean that the income derived by a foreign company in the Philippines from its branch or affiliates will be subjected to 30% income tax, a 10% preferential rate on income derived by the ROHq, and a 15% branch profit remittance tax upon remittance of the operational income derived from Philippine source by the ROHq to its head office, which does not require a Tax Treaty Relief Application. However, a ROHq enjoys, among others, exemption from local taxes and duty-free importation of equipment and materials.

All told, the decision on what kind of corporate vehicle will be utilized for the doing of business in the Philippines will be dependent on the foreign company’s sound business judgment after considering all the relevant factors, not just taxation, but more importantly, the best corporate vehicle that would best address its business and operational requirements.