Let's Talk Tax

New guidelines in securing tax exemption ruling for separation pay

Here is some good news:

Issuance of rulings on the tax exemption of benefits paid to employees separated because of retrenchment or closure of the business are now devolved to the Revenue District Offices (RDOs) of the Bureau of Internal Revenue (BIR).

As we all know separation pay received by an employee, or his heirs, because of death, sickness, or other physical disability, or for any cause beyond the control of the employee, is exempt from income tax, and consequently from withholding tax pursuant to Section 32(B)(6)(b) of the Tax Code. Cause beyond the control of the employee includes retrenchment due to redundancy or installation of labor-saving devices, or due to closure of the business.

Back in 2011, the BIR addressed the dilemma of many separated employees by providing a more convenient way of securing the required ruling or Certificate of Tax Exemption (CTE) for benefits received for separation due to sickness, death or other physical disability. In Revenue Memorandum Order (RMO) No. 26-2011, the BIR laid down the proc edures including the list of required documents. More important, it delegated the processing of requests to the RDO or appropriate Large Taxpayers (LT) Office where the employer is registered. At that time, it came to the attention of the BIR that employers withhold the taxes if the employee cannot present a tax exemption ruling. Even if the ruling is subsequently issued, applying for refund of the taxes withheld from the BIR is not easy.

Under RMO 26-2011, requests for rulings relating to other causes beyond the employee’s control continued to be handled by the Legal and Legislative Division of the BIR National Office. Due to the bulk of requests being processed at the National Office, the chances of getting a ruling or CTE in a short span of time are unlikely.

Five years later, and just in time for the computation of employees’ annualized withholding tax on compensation for 2016, the BIR issued RMO No. 66-2016, which fully transferred the processing of requests for CTE on separation pays to the RDO or appropriate LT office where the employer is registered.

Why is it advantageous to secure a tax exemption ruling?

Although there are tax laws and regulations which serve as basis on the correct tax treatment of various transactions, it is still advisable that a ruling be secured to ensure that the appropriate tax treatment is observed. Moreover, the tax ruling secured by a taxpayer proves to be beneficial since it serves as a substantial support for the tax treatment applied by the taxpayer in case of BIR audits where the examiners have different interpretations.

Note that the DoLE does not confirm the legality of the termination of the employee. The validity is only put to a test in case the employee objects and files a case for illegal dismissal. Hence, in case of BIR audit, the employer bears the burden of proving that the separation is beyond the control of the employee and that the separation pay is not subject to withholding tax. If the examiner refuses to accept the proof presented by the company, there will be assessment for deficiency corporate income tax and withholding tax on compensation, including interest and surcharge. By that time, the benefits have been paid and the employer cannot anymore run after the separated employee.

The protection afforded by the ruling is worthwhile especially if the number of employees involved, and the amount of benefits paid, is significant, such as in cases of massive retrenchment.

The RMO also provided the list of documentary requirements for each case which shall be attached to the letter request.

  1. Written notice to the employee and the appropriate Regional Office of the Department of Labor and Employment (DoLE) at least 30 days before the effectivity of termination, specifying the ground for termination.
  2. Board Resolution, in case of a juridical entity, or sworn affidavit to be executed by the owner, in case of a sole proprietor, stating the following:
    1. In case of retrenchment -- that the retrenchment is reasonably necessary and likely to prevent business losses; that the losses, if already incurred, are not merely de minimis, but substantial, serious, actual and real, or if only expected, are reasonably imminent, with appropriate supporting evidence of said losses; and that the retrenchment is made in good faith for the advancement of its interest and not to defeat or circumvent the employees’ right to security of tenure.
    2. In case of redundancy -- that there have been superfluous positions or services of employees; that the positions or services are in excess of what is reasonably demanded by the actual requirements of the enterprise to operate in an economical and efficient manner; and that the redundant positions have been abolished in good faith.

Adequate proof of redundancy such as but not limited to the new staffing pattern, feasibility studies/proposal, on the viability of the newly created positions, job description and the approval by the management of the restructuring.

  1. In case of installation of labor-saving devices -- a brief description of the use of said machinery, equipment or device; that the introduction of the machinery, equipment or other device has been done in good faith and for valid reason; and that there is no other option available to the employer than the introduction of machinery, equipment or other device.
  2. In all cases of retrenchment -- that the selection of employees to be terminated has been made in accordance with fair and reasonable criteria.
  3. In case of closure or cessation of operation -- that the management has decided to close or cease operation of the company; that the closure or cessation of operation has been made in good faith; and that there is no other option available to the employer except to close or cease operation.

It shall be noted that the above lists of documents are not exclusive. The BIR may still require additional documents to prove that the separation pay received by the official or employee is indeed qualified for tax exemption under the prevailing circumstances.

Although it is apparent that the issuance aims to simplify the procedures for convenience of the taxpayers, it would be much appreciated if the BIR can also speed up the processing of the requests by providing a timeline for the issuance of the ruling. While we all believe the processing time will be significantly shortened with this decentralization, it is best if the taxpayer knows how long he has to wait.

We appreciate that the new administration is gearing towards expediting its processes with the goal of providing better services to the taxpayers.

Arianne Cyril L. Mandac is a senior of the Tax Advisory and Compliance Division of Punongbayan & Araullo. P&A is a leading audit, tax, advisory and outsourcing services firm and is the Philippine member of Grant Thornton International Ltd.

As published in Business World, dated 13 December 2016