Are gains from US equity feeder funds taxable by the BIR?

I previously wrote about the lack of information on how the Philippine Bureau of Internal Revenue taxes foreign capital gains, dividends, and interest income. We know that the U.S. imposes a final withholding tax of 25% and 15% on dividend and interest income, respectively for Philippine residents based on the U.S.-Philippines tax treaty. On the other hand, capital gains received by non-resident aliens are not taxed by the U.S.

The BIR has no published rule that sets an explicit final tax rate on foreign capital gains income. Local stock market sales are taxed based on the gross sales amount. Capital gains on shares on unlisted domestic corporations are taxed at 15%. The going assumption then is that any income not subject to an explicit final tax rate is subject to the graduated personal income tax rates.

The taxation of UITFs that invest in Philippines equities is well understood. Domestic company dividends that the UITF receives are already supposedly net of the 10% final tax. If the UITF has to sell stocks to fund redemptions, those sales are subject to the 0.6% sales tax. If the UITF has any interest income, those are subject to 20% final tax. Those taxes are all handled within the fund. Any other income that the fund receives that are not subject to any explicit final tax are supposedly subject to the 30% corporate income tax. I think any income subject to corporate income tax would be minimal as most of a fund’s income are passive and already subject to final tax. All the fund’s expenses, including taxes, are already reflected in the NAV. When a UITF investor makes a redemption, any gains are no longer subject to tax. The NTRC (National Tax Research Center) Tax Research Journal has published A Review of the Taxation of Collective Investment Schemes in the Philippines with more information.

There are unit investment trust funds (UITF) offered by local banks that are simply feeder funds for U.S. index ETFs like VTI and SPY. Many of these funds explicitly block those that are “considered U.S. Persons under the U.S. securities and tax laws” to invest. I would guess that all all of the other funds also have the same restrictions so as not to deal with FATCA compliance.

I assume that U.S. dividends received by the UITF feeder fund are also already net of the 25% U.S. withholding tax. Since the BIR does not have explicit final tax rates on foreign capital gains, is the UITF actually paying 30% corporate income tax on capital gains when they sell? Somehow, I doubt that that is happening. That would really cripple the returns of the UITF feeder fund. So the big question is, if the UITF is not paying any tax on foreign capital gains within the fund, when an investor makes a redemption, are any gains then subject to the investor’s personal income tax rates? That may not be a million-dollar question but the answer may still be a significant hit to the bottom line.

What is interesting is that at least two US feeder funds have specific cautionary notes on possible tax consequences of investing in their U.S. feeder funds, that are not mentioned in the fact sheets of their domestic funds:

Prospective participants should also consult their own tax advisors as to the specific Philippine tax consequences of acquiring, holding and redeeming of any units of the Fund, as well as the consequences arising under the laws of any other taxing jurisdiction.

BDO US Equity Feeder Fund

Except when specifically required by law, the Trustee shall have no responsibility to withhold income or other taxes on revenues from the Fund.

Each participant should consult its own tax advisor as to the specific tax consequences of his/her investment in and redemption of units of participation in the Fund, including the applicability and effect of local and national laws of the Philippines, as well as consequences arising under the laws of any other taxing jurisdiction.

SB US Equity Index Feeder Fund

These caveats make me think that these funds do not pay corporate income tax on the foreign capital gains. Investors assume, rightly or not, that UITF gains are not subject to taxes. If investors still have to pay personal income taxes on gains from U.S. feeder funds, then these banks should have the responsibility to tell their clients. These cover-your-ass statements like “consult your own tax advisor” are inadequate and border on the irresponsible.

One actively managed foreign equity mutual fund is at least a little bit more honest about the tax implications. The self-descriptive Odyssey Asia Pacific High Dividend Equity Fund which counts TSMC and Samsung in its holdings, says that (emphasis mine):

Under existing tax laws and regulations, the Trustee as Fund Manager may be required to withhold
tax on income from investments of the Fund. Based on legal opinion from an external counsel, the Trustee is not obligated and therefore will not withhold tax on yield/gain from offshore investments of this Fund. It will be the Trustor’s responsibility to pay appropriate taxes for which he/she may consult his/her own tax counsel/accountant for advice.

Odyssey Asia Pacific High Dividend Equity Fund Explanatory Memo

This Odyssey fund is run by BPI but this tax warning is not present in BPI’s other foreign equity UITFs. If one of their funds is not withholding tax from offshore investments, based on advice of their counsel, it is extremely likely that the other foreign equity funds do not do so either. This exposes their clients to a surprise tax bill if the BIR comes looking.

It looks increasing likely that foreign capital gains, not being subject to any explicit final tax, fall into the catch-all category of non-business/non-professional income that is subject to personal income tax rates. I would prefer this to having the fund pay and withhold the 30% corporate income tax on the gains since personal income tax rates are generally more favorable in the lower brackets.

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