Taxpayers are looking forward to the proposed tax reform of the Department of Finance (DoF). While the first package of the tax reform is now pending with the Senate, the DoF is starting to work on the second package. Both packages propose a reduction in income tax rates for both individuals and corporate taxpayers.
While the reduction in the income tax rate is a welcome change, I am still hopeful that the reform in the withholding tax (WHT) system is also included.
In the WHT system, there are three parties involved: the Bureau of Internal Revenue (BIR); the withholding agent; and, the taxpayer from whom the tax is withheld.
For the BIR, the WHT system is a mechanism to ensure the collection of taxes which could otherwise be lost or substantially reduced due to the failure to file tax returns. The system was also designed to improve the government’s cash flow through the advanced collection of the taxpayers’ tax liabilities. Over the years, it has proven to be an effective way of collecting taxes since a large portion of tax revenue is sourced from WHT.
On the part of the taxpayer, the WHT system provides a convenient manner to meet their probable income tax liability. However, not all taxpayers are happy with the thought of paying their taxes in advance since they are being deprived of the opportunity to use the withheld income first before paying their taxes. Moreover, taxpayers who are earning a small margin from their businesses may undoubtedly generate large amounts of excess or overpaid creditable withholding tax.
On the other hand, for withholding agents, WHT is just an additional burden since not only are they tasked to collect taxes on behalf of the government, they are also at risk of being subjected to possible penalties in case of failure to withhold. And such penalties are too high. Aside from being liable for the unremitted tax including interest and penalties, they will not be allowed to deduct the related expenses in computing the taxable income. And as much as withholding agents would like to avoid these penalties, unfortunately, due to the various tax rates, complex compliance requirements being imposed by the BIR, and for practicality issues, it is almost impossible to fully comply. This is true especially for the Top 20,000 Corporations which are required to withhold 1% and 2% on all local purchases of goods and services, respectively. The most common problem of a Top 20,000 Corporation is finding it impractical to withhold on petty cash expenses incurred by employees for office supplies, meals, representation expenses and transportation. While each petty cash reimbursement may be small, the aggregate amount may be significant.
Due to the difficulty of complying with the WHT rules, it is not surprising that most of the BIR assessments involve withholding taxes. The irony on the part of the withholding agent is that even though the WHT is not a tax on their part, the penalty for non-withholding is heavier than the tax that should have been paid by the taxpayer. For example, if the withholding agents have income payments for rentals of P100,000 and fail to withhold the required 5% WHT, the withholding agents shall be liable to pay the unremitted tax of P5,000 plus interest and penalties. Not only that, the withholding agents shall also be required to pay the deficiency income tax of P30,000 (P100,000 multiplied by 30% regular income tax) for the disallowed deduction of rental expense plus the corresponding penalties. It should also be noted that the withholding agents may find themselves paying a huge amount of interest that may even be higher than the deficiency tax itself if the assessment is extended for a long period of time. Hence, it is no wonder that most find the penalty system harsh, unfair, and oppressive for withholding agents who are merely assisting the BIR in doing its job of collecting taxes.
Clearly, the BIR needs to simplify the WHT system for easier compliance and reduce the harsh penalties imposed on withholding agents. To do this, the government may consider the following: (1) simplifying the WHT by providing a uniform rate for all types of income payments; (2) giving the choice for the timing of withholding (either accrual or upon payment) to the withholding agent; (3) exempting the withholding agents from withholding tax on reimbursements; and, (4) abolishing Section 34(K) of the tax code, which provides disallowance of expenses due to failure to withhold.
Even with the addition of the above wish list, the government will not lose any tax revenue. After all, the WHT is just an advanced payment of tax. Also, the WHT system was created to improve the government’s cash flow and should not be seen as a way of generating additional revenue that will unjustly enrich the government from unnecessary penalties that are imposed on withholding agents for their failure to withhold.
The main purpose of the tax reform is to design a tax system that is simpler, fairer and more efficient for all. If the government will be true to its promise, it cannot ignore the sentiments of the taxpayers regarding the flaws and unresolved issues of our current WHT system. The taxpayers could only hope and pray that this issue will not be left out in the government’s tax reform program.
Juvy H. De Jesus is a senior with the Tax Advisory and Compliance division of P&A Grant Thornton.
As published in BusinessWorld, dated 25 July 2017