Creditable Withholding Tax

Here's my attempt to explain what Creditable Withholding Tax is and what it's for.

Once upon a time, the BIR collected a 10% tax from businesses to fund essential services like roads and infrastructure. This tax was based on businesses' gross sales.

Over time, businesses argued that it would be fairer if taxes were based on their profits. The BIR agreed and shifted to a 30% tax on income after expenses.

However, the BIR soon realized that businesses were cheating by underreporting revenue and inflating expenses to reduce their income.

To counter this, the BIR devised a new system. They required that for a business expense to be declared, they should withhold a portion of the payment and remit it to the BIR.

For example, if a Photocopier buys paper, it would pay 10% of the cost to the BIR and 90% to the Supplier. This ensured that the Photocopier would remit the 10% to the BIR to claim it as an expense. This remittance also served as proof of the transaction between the Photocopier and the Supplier (i.e., the supplier sold paper).

This system worked, preventing businesses from underreporting sales and inflating expenses.

Did the Supplier earn less because he only received 90% of the amount payable? No. When the Supplier calculates their income tax, they can deduct the 10% already paid by the Photocopier. In other words, the 10% was paid to the BIR at the time of the sale instead of at the end of the quarter.

Why is this relevant?

When selling properties classified as "ordinary assets" (like rental properties), CWT applies (instead of Capital Gains Tax). Sellers often think their net proceeds are simply what’s left after paying CWT and broker fees. In reality, CWT is just an advance on the larger income tax (around 30%).

Because of CWT, the BIR knows the seller’s revenue from the property sale. If the seller doesn’t declare any expenses (and likely they won't since they don't think they need to), the entire revenue will be subject to the 30% income tax as if it were a tax on gross sales.

And keep in mind, the BIR doesn’t send a bill for the income tax at the end of the quarter. This means the seller is often unaware of their tax debt, which grows by 20% annually (plus penalties). ☠️