Deducting Foreign Income Taxes

Foreign income taxes can be deducted from your taxable income if you claim them as a tax credit or a deduction. The purpose is to protect the taxpayer from international double/multiple taxation. If claimed as a tax credit, the foreign income tax is deducted from the Philippine income tax; if claimed as a deduction, deduct the foreign income tax from your gross income. Depending on your financial situation, choose either of the two to address your tax concerns.

The following people can claim foreign income taxes as deductions if they have foreign sources of income:

1.) Resident citizens

2.) Domestic corporations

3.) Members of general professional partnerships

4.) Beneficiaries of an estate or trust

The following can't claim foreign income taxes as tax credits because they're not liable to the Philippine government for taxes on foreign income sources; with some exceptions to be discussed within this article as well:

1.) Non-resident citizens

2.) OFWs/OCWs

3.) Resident aliens

4.) Non-resident aliens whether engaged in trade/business in the Philippines or not

5.) Resident foreign corporations

6.) Non-resident foreign corporations

Non-resident aliens and resident foreign corporations can claim taxes as a deduction from their gross income but only if these taxes are connected with their Philippine income sources and only to such extent. Regarding resident aliens, they can claim a deduction of the foreign taxes paid only to the extent that their Philippine net incomes bear to their total income from within and outside the Philippines. The formula is given here below:

Deductibe Foreign Taxes = Net Income from Within the Philippines  x Foreign Taxes Paid

                                          Net Income from All Sources

"All sources" means income sources from both inside and outside the Philippines.

There are 2 limits on the tax credit on foreign income taxes. These are the computations:

First Limit = Taxable Income (per foreign country) x Philippine Income Tax

                    Total Taxable Income

Second Limit = Taxable Income (all foreign countries) x Philippine Income Tax

                        Total Taxable Income

If the source of foreign income is only 1 foreign country, the tax credit is either the First Limit or the actual foreign income tax paid -whichever is lower!

If income comes from 2 or more foreign countries, the same "whichever is lower" rule applies, but it's between the total of the First Limit (do the same computation for every country) and the Second Limit after comparing both First and Second limits with the actual foreign income tax paid.

The "whichever is lower" rule is the government's idea to make sure it gets as much money from you as possible.