Franchise Tax Withholding in the Philippines: What Franchisees Must Know

Franchise tax withholding in the Philippines involves two distinct obligations. First, the franchise fee itself may be subject to value-added tax (VAT) or percentage tax, depending on the franchisor's gross receipts. Second, the franchisee as payor may be required to withhold income tax on payments made to the franchisor. These are separate taxes: the VAT or percentage tax is an indirect tax on the transaction, while the withholding tax is a direct income tax on the franchisor's earnings.

VAT and percentage tax on franchise fees

The Bureau of Internal Revenue (BIR) has clarified that services performed in the exercise of a profession or calling, as well as services rendered by various professionals and entities, are subject to either the 10% VAT under Section 108 of the National Internal Revenue Code (NIRC) of 1997 or the 3% percentage tax under Section 116, beginning January 1, 2003.

For franchise arrangements, the franchisor's gross receipts determine which regime applies. Those whose gross receipts exceed P550,000 in any 12-month period are mandatorily covered by the VAT system. Those whose gross receipts do not exceed P550,000 may choose between VAT or the non-VAT (percentage tax) system, but absence of choice automatically places them under the percentage tax system.

The P550,000 threshold includes the aggregate gross receipts from all taxable lines of activity and all establishments, including head office and branches, in any 12-month period.

VAT on the sale of services is computed by applying the factor of 1/11 on the total amounts received. The resulting amount is the output tax. For percentage taxpayers, the 3% tax is based on gross receipts.

Withholding tax on income payments to the franchisor

Separately from VAT or percentage tax, the franchisor's income may be subject to withholding tax. The BIR has clarified that the tax being withheld by the payor-withholding agent from income payments is an income tax on net taxable income, while the VAT or percentage tax is a tax on the business transaction.

This distinction matters for franchisees. When a franchisee pays franchise fees, royalties, or other compensation to the franchisor, the franchisee may be acting as a withholding agent. The withheld amount is remitted to the government and credited against the franchisor's income tax liability.

The withholding tax is a direct tax that cannot be shifted. The franchisor ultimately bears the burden. In contrast, VAT and percentage tax are indirect taxes that the franchisor may pass on to the franchisee.

The specific revenue regulation governing withholding on income payments is not among the documents available in the ASG law library, so the exact issuance and its rates are not cited here. Franchisees should confirm the applicable withholding rules with the BIR or counsel.

Registration and invoicing obligations

Franchisors and franchisees must comply with BIR registration and invoicing rules. Under Revenue Regulations No. 7-2024, implementing the Ease of Paying Taxes Act, all persons subject to internal revenue tax must register with the Revenue District Office having jurisdiction over their place of business.

VAT-registered persons must issue a duly registered VAT Invoice for every sale of goods or services, regardless of the amount. The invoice must state that the seller is VAT-registered, show the seller's Taxpayer Identification Number and branch code, indicate the total amount including VAT, and provide the date, quantity, unit cost, and description of the goods or services.

For sales of P1,000 or more to a VAT-registered buyer, the invoice must also show the buyer's registered name, address, and TIN.

Non-VAT registered persons issue non-VAT invoices, which serve as the basis for percentage tax liability.

The annual registration fee of P500 for every separate establishment has been repealed effective January 22, 2024.

How the franchisee should handle payments

When paying a franchisor, the franchisee should determine whether withholding applies. If the payment is for services subject to withholding, the franchisee must withhold the appropriate amount and remit it to the BIR.

The franchisee should also confirm whether the franchisor is VAT-registered or a percentage taxpayer. If VAT-registered, the franchisee may be entitled to claim input VAT on the franchise fees, provided a valid VAT invoice is issued. If the franchisee is not VAT-registered, the shifted VAT becomes part of the cost or expense.

For percentage taxpayers, the shifted percentage tax is treated as part of the cost of purchases or expenses in the books.

Frequently asked questions

Is franchise fee subject to withholding tax in the Philippines?

Franchise fees may be subject to withholding tax on income payments. The franchisee as payor may be required to withhold and remit the tax to the BIR. The specific issuance governing the rates is not in the ASG law library.

What is the difference between VAT and withholding tax on franchise fees?

VAT is an indirect tax on the sale of services, computed at 10% of gross receipts and may be shifted to the franchisee. Withholding tax is a direct income tax on the franchisor's net income, withheld by the payor and credited against the franchisor's income tax due.

Do I need to register with the BIR as a franchisee?

Yes. All persons engaged in business or practice of profession must register with the BIR before commencing business. Registration should be done with the Revenue District Office having jurisdiction over the place of business.

Practical takeaways

• Franchise fees may be subject to both VAT or percentage tax and withholding tax on income payments; these are separate obligations.
• VAT is mandatory if gross receipts exceed P550,000 in any 12-month period; otherwise, the percentage tax system applies by default.
• VAT-registered franchisors must issue VAT invoices; franchisees may claim input VAT if properly documented.
• The P500 annual registration fee for separate establishments has been repealed effective January 22, 2024.
• Franchisees acting as withholding agents must remit withheld taxes to the BIR and provide the franchisor with the corresponding certificate.

Primary sources

The rules discussed above are drawn from the following primary sources. Where the firm's library holds the document as a PDF it is embedded here in full; the rest are cited by title.

RMC No. 06-2003 — Clarifies certain issues relative to the services rendered by individual professional practitioners, general professional partnerships, entertainers and professional athletes who are subject to the Value-Added Tax or Percentage Tax beginning January 1, 2003 Digest | Full Text | Annex AOpen in Law LibraryDownload PDF

RR No. 7-2024 — Implements Section 113, 235, 236, 237, 238, 242, 243 of the Tax Code of 1997, as amended by RA No. 11976 (Ease of Paying Taxes Act), on the registration procedures and invoicing requirements (Date Posted: April 12, 2024)Open in Law LibraryDownload PDF

• REPUBLIC ACT NO. 590 - AN ACT TO AMEND CERTAIN SECTIONS OF COMMONWEALTH ACT NUMBERED FOUR HUNDRED AND SIXTY-SIX, AS AMENDED, OTHERWISE KNOWN AS THE NATIONAL INTERNAL REVENUE CODE, AND TO ADD TO TITLE II THEREOF A SUPPLEMENT PROVIDING FOR THE WITHHOLDING OF THE INCOME TAX ON WAGES, AND FOR OTHER PURPOSES.

This article is general information and not legal advice. For your specific situation, consult a lawyer or ask ASG Legal AI.