Are income from Mutual Funds and UITFs taxable?

James Ryan Jonas

Question: Do I need to pay taxes on my earnings once I redeem my Unit Investment Trust Funds (UITFs) or shares of mutual funds?

Answer: No, as long as proper taxes have already been collected prior to the redemption of your UITF participation. That’s according to Senen Quizon, a tax manager at Punongbayan & Araullo, who wrote the article “Taxation of Unit Investment Trust Funds (UITFs)” published in Business World Philippines on August 2006.

Quizon explains that although no specific tax provisions deal with UITFs, the tax treatment for UITFs should be no different from Common Trust Funds (CTFs) because they are considered similar products.

He continues in the article:

“… in Ruling No. 003-05, the BIR makes a distinction between a revocable or irrevocable trust which receives differential tax treatment.

According to BIR Ruling No. 003-05, an irrevocable trust is treated as a separate and distinct taxable entity from the person/s or parties that established the trust. Consequently, an irrevocable trust is subject to any applicable taxes on its investment income as well as its investors, if and when the trust income is subsequently distributed to them.

In contrast, a revocable trust, for which a different set of rules apply, is only a pass-through entity, and is not, for tax purposes, considered separate from the owner-trustor. In a revocable trust, all the income of the trust would be taxed to the trustor-grantor and is to be included in its taxable income. However, in case the income from investments of the revocable trust has already been subjected to final tax, the BIR held that such income should no longer be subject to tax when it is distributed to the investors. For example, the net gain (i.e., net of 1/2 of 1% tax and DST) derived by a revocable trust from its sale of shares of stock in the stock market should already be tax free when received by the trustor-beneficiaries since such income has been subjected to final tax.

All interest income and other monetary benefit from trust funds are imposed a 20% final withholding tax under Sections 24(B)(1) and 25(A)(2) of the Tax Code. Whether UITFs are subject to this tax depends on whether they are considered revocable or irrevocable trusts.

Quizon opines that UITFs are considered as revocable trusts since “the beneficial ownership in a UITF is maintained with the trustor-beneficiary, and considering that in case of death of the trustor, the UITF participation forms part of the trustor’s estate subject to estate tax.”

As such, UITFs should be treated as one and the same taxable entity as that of the trustor. Following then the BIR Ruling No. 003-05, UITFs upon redemption are no longer subject to the 20% withholding tax if applicable taxes have already been paid on the UITF investments.

Good news for UITF investors. That’s one tax burden less that they need to worry about.

Discuss this in the Mutual Funds, UITFs, and other investment products board in the PMT Forum.

James Ryan Jonas teaches business management, investments, and entrepreneurship at the University of the Philippines (UP). He is also the Executive Director of UP Provident Fund Inc., managing and investing P3.2 Billion ($56.4 Million) worth of retirement funds on behalf of thousands of UP employees.