Broadening the retirement tax exemption

The COVID-19 pandemic caused not only a global health crisis, but also economic slowdown and disrupted business operations. The adverse economic impact resulted in companies, if not going out of business, employing cost-reduction measures by reducing headcount using various means.

One of the schemes employees may consider is early retirement, which allows them to at least receive valuable benefits rather than drawing the short end of the stick and being left unemployed.

I’m reminded of my mother, who teaches at a private junior high school. Being accustomed to traditional teaching methods, she considered retiring due to the technological challenge of alternative learning programs for this school year. She plans to invest the retirement benefits in a mini-store or laundry.

EXEMPTION FROM TAX OF RETIREMENT BENEFITS UNDER BAYANIHAN II
With the recent approval of R.A. 11494, otherwise known as the Bayanihan to Recover as One Act (Bayanihan II), the government signaled its intention to reduce the adverse impact of COVID-19 through the provision of assistance, subsidies and other forms of socioeconomic relief.

Under Section 5 of Bayanihan II is a provision on tax-exempt retirement benefits granted by private firms between June 5, 2020 and Dec. 31, 2020.

Nevertheless, the law provides that any re-employment of such an employee by the same firm within the succeeding 12–month period will be considered proof of non-retirement and will subject the benefits received to appropriate taxes. Further, in addition to the payment of appropriate taxes, any person who willfully evades or defeats any imposable tax under this section may be held criminally liable and penalized under Section 255 of RA 8424, as amended.

EXEMPT RETIREMENT BENEFITS UNDER THE TAX CODE
The exemption of retirement benefits is not new. Section 32 (B) (6) (a) of the Tax Code, as amended, provides that retirement benefits are exclusions from gross income and exempt from tax. Exempt retirement benefits are (1) benefits received under Republic Act No. 7641 (Labor Code) and (2) benefits received in accordance with a reasonable private benefit plan maintained by the employers.

R.A. No. 7641 provides that, in case of retirement, the employee is entitled to receive such benefits as he may have earned under existing laws, any collective bargaining agreement, and other agreements. Further, the law states that, in the absence of a retirement plan or agreement, an employee may retire and be entitled to retirement pay upon reaching the age of 60 years or more, but not beyond 65, after serving at least five years in the establishment.

For retirement benefits received under a reasonable private benefit plan, the tax exemption can be availed of if the retiring official or employee has been in the service of the same employer for at least 10 years and is not less than 50 years of age at the time of his retirement, and that the benefits granted may be availed of by an official or employee only once.

TAX-EXEMPT SEPARATION PAY
If the employee is let go by the business to cut costs and help the company better deal with the pandemic, the employee may be entitled to separation pay.

Separation pay is also exempt from income tax under Section 32 (B) (6) (a) and (b) of the Tax Code of 1997. It states that any amount received by an employee as a consequence of separation for any cause beyond the control of the employee is exempt from taxes regardless of age or length of service.

The phrase “for any cause beyond the control” of the employee connotes involuntariness. Separation from the service must not be asked for or initiated by him.

This law requires the presence of two conditions in order that the employee benefits may be granted a tax exemption: (1) the employee is separated from the service due to a cause beyond his control; and (2) the employer pays benefits as a consequence of such separation.

Hence, if the employee was separated due to retrenchment, the same is considered beyond the control of the employee. The separation benefit is exempt from income tax.

OBSERVATIONS ON SECTION 5 OF BAYANIHAN II
Since retirement pay and separation pay are already exempt from tax, one wonders what type of retirement pay is contemplated under Bayanihan II.

What new type of exemption is covered by the tax-exempt retirement benefit under Bayanihan II?

We can recall that retirement benefits and separation pay under the Tax Code must meet specific requirements and conditions before they can be considered tax exempt.

Interestingly, the provision under Bayanihan II is plain and general and does not specify whether such retirement benefits will be received under R.A. 7641 or under a reasonable private benefit plan. Also, the law made no mention of the required retirement age or years of service rendered by the employee.

Thus, we can presume that the general character of the provision granted employers and employees the liberty to categorize benefits that they may give to leaving employees as retirement payments in order for such to be exempt from taxation. The unrestrictive character of the provision may also lead taxpayers to assume that an  employee may retire at any given age or number of years of service.

The general nature of the exemption may cover situations where an employee applies for voluntary early retirement which do not meet the requirements under the Tax Code for exemption.

Also, considering the simple and plain language of Bayanihan II, one wonders if it is required that the employer has an existing early retirement package before an employee may avail of the tax exemption. For companies without an existing early retirement package, can the employer and employee just draw up an agreement and call it an early retirement package? Will this new agreement qualify for exemption? Is there a need to get a confirmation from the BIR that the retirement benefit is exempt under the Bayanihan II Law before an employer can treat the benefit as tax-exempt?

The BIR has recently issued various Revenue Regulations implementing the tax provisions of the Bayanihan II. However, we are still waiting for the revenue regulations on exempt retirement benefits. Hopefully, the rules will be issued soon to answer some questions of employees and employers so employees can start availing of the tax exemption.

SOCIOECONOMIC RELIEF
The broad-ranging nature of this provision in Bayanihan II manifests the intention of the framers of this piece of legislation to attain the government’s objective of providing socioeconomic relief and mitigate the economic cost and losses stemming from the COVID-19 pandemic.

With hope, may the bayanihan spirit resonate through the implementing agencies, including the BIR, in their issuances of rules and regulations implementing the provisions of the Bayanihan to Recover as One Act.

Let’s Talk Tax is a weekly newspaper column of P&A Grant Thornton that aims to keep the public informed of various developments in taxation. This article is not intended to be a substitute for competent professional advice.

Edrian B. San Juan is an associate of the Tax Advisory & Compliance division of P&A Grant Thornton, the Philippine member firm of Grant Thornton International Ltd.

As published in BusinessWorld, dated 13 October 2020