BDB Laws Tax Law For Business appears in the opinion section of Business Mirror every

Thursday.

Tax on Dividends
Businesses, especially those privately owned, are formed for the purpose of earning
profits that will increase the wealth of its owners. The owners have as one of their main
objectives the receipt or generation of a financial gain in exchange for their investment
and assumption of risk.
In a corporate business structure, the profits are distributed to the stockholders in the
form of dividends. The owners, however, may choose to retain the profits in the
business and help grow the business itself. Either way, this is without tax costs.
With the exception of dividends paid by a domestic corporation to another domestic
corporation or to a resident foreign corporation, distributions of dividends are subject to
final income taxes. Payments to resident individuals are taxed at the rate of 10% while
dividends due to non-resident individuals are subject to 20% final tax. For non-resident
corporate stockholders, the final tax rate is 30%, which may be reduced to 15% if the
tax sparing provision applies. A lower or preferential tax rate applies if the payment
qualifies under a treaty which the Philippines has with the country of which the
stockholder is a resident.
In order that these taxes on dividends will not become due, some stockholders would
prefer the retention of the income in the corporation without distribution. But this
retention is not without a tax cost. With certain exceptions, an improperly accumulated
earnings tax (IAET) is imposed on every corporation formed or availed for the purpose of
avoiding the income tax with respect to its shareholders or the shareholders of any other
corporation, by permitting the profits to accumulate instead of being divided or
distributed. The fact that income is accumulated beyond the reasonable needs of the
business is determinative of the purpose to avoid tax on the stockholders.
As explained in the implementing regulations, the rationale is that if the earnings and
profits were distributed, the shareholders would then be liable to income tax thereon,
whereas if the distribution were not made to them, they would incur no tax in respect to

the undistributed earnings and profits of the corporation. Thus, a tax is being imposed in
the nature of a penalty to the corporation for the improper accumulation of its earnings,
and as a form of deterrent to the avoidance of tax upon shareholders who are supposed
to pay dividends tax on the earnings distributed to them by the corporation.
On this basis, the non-distribution of income does not avoid the payment of taxes. Worst,
accumulated income subjected to IAET will not be exempt from the payment of tax on
the same income when finally declared as dividends. Thus, the same income may end
up being taxed twice.
This, notwithstanding, accumulation of income up to 100% of the paid-up capital of a
corporation is considered as reasonable accumulation for the needs of business.
Accordingly, no IAET should be imposed for as long as the accumulated income does
not exceed the paid-up capital.
Would it then help the corporation save taxes by increasing its paid-up capital?
Certainly. One way of achieving this is through the declaration of stock dividends. By
declaring stock dividends, the accumulated earnings or portion of it is transferred to
capital. This achieves two objectives the increase of the paid-up capital base and at
the same time reduces the retained earnings, which could potentially be the subject of
IAET.
Are stock dividends subject to the taxes on dividends noted earlier? Taxes are imposed
on dividends only where there are payments required to be made to the stockholders,
either in the form of cash or property. In a stock dividend, there is a mere transfer of
surplus to capital account and no payment is made to the stockholders. Thus, stock
dividends are ordinarily not subject to tax.
As explained by the Court in one case, stock dividends represent capital and do not
constitute income to its recipient so that mere issuance is not yet subject to income tax
as they are nothing but an enrichment through an increase in value of capital
investment. As capital, the stock dividends postpone the realization of profits because
the fund represented by the new stock has been transferred from surplus to capital and
no longer available for actual distribution. In a loose sense, stock dividends issued by
the corporation are considered unrealized gain and can not be subjected to tax until that
gain has been realized. Before the realization, stock dividends are nothing but a
representation of an interest in the corporate properties.
This presupposes that after the declaration of stock dividends, there is no change in the
proportional interest of the stockholders compared to their interest before the
declaration.
As there are additional tax costs in maintaining income over and above the paid-up
capital of a corporation, the capital structure is equally important as the retention of the
income earned from such capital. The amount of capital can be increased through stock
dividends while deferring the tax until such time that the investment is disposed, and
perhaps with a lower tax rate.

The author is a Senior Partner of Du-Baladad and Associates Law Offices (BDB Law). If
you have any comments or questions concerning the article, you can e-mail the author at
fulvio.dawilan@bdblaw.com.ph or call 403-2001 local 310.