BIR Ruling [DA-046-03]

February 20, 2003 BIR RULING [DA-046-03] Romulo Mabanta Buenaventura Sayoc & De Los Angeles 30th Floor, CITIBANK Tower CITIBANK Plaza 8741 Paseo de Roxas Makati City Attention: Atty. Priscilla B. Valer Gentlemen : This refers to your letter dated January 21, 2003 requesting on behalf of your client. IBM Philippines, Inc. (IBM), for a ruling on the tax consequences relative to the separation benefits to be paid to its terminated employees by reason of retrenchment and redundancy. It is represented that due to the economic slowdown which has affected the technology sector, IBM implemented a Resource Action last year whereby some 28 employees were separated due to redundancy and/or retrenchment; that the tax exemption of the separation benefits paid to the 28 employees as well as the deductibility of the separation benefits from gross income was confirmed by the BIR in BIR Ruling No. SB-023-2001 dated December 19, 2001; that in order to further streamline the business operations, IBM continued the Resource Action so that IBM will have a level of manpower resources which is competitive to the market; that the affected employees are considered terminated within 30 days from receipt of notice; and that as a result of the termination, IBM will pay the affected employees a special separation package consisting of the following: 1. Separation benefits equal to one-half month basic salary per year of service plus an additional gratuity of one-half month basic salary per year of service, but the total will not exceed 12 months. Further, they will also get some monies from retirement benefits plan where applicable; 2. 30 days pay in lieu of notice. The affected employee need not work from date of communication; 3. Christmas bonus (full) until end of the year, and 4. Unused vacation leaves. In connection therewith, you now request confirmation of your opinion that "1. The separation benefits granted to the affected employees are exempt from income tax and consequently from withholding tax pursuant to Section 32(B)(6)(b) of the Tax Code of 1997; and "2. The expenses incurred by IBM in providing the separation benefits are deductible from gross income for being an ordinary and necessary trade or business expense pursuant to Section 34(A)(1)(a)(i) of the Tax Code of 1997." In reply, please be informed that under Section 32(B)(6)(b) of the 1997 Tax Code, any amount received by an official or employee or by his heirs from the employer as a consequence of separation of such official or employee from the service of the employer because of death, sickness or other physical disability or for any cause beyond the control of the said official or employee shall not be included in gross income and shall be exempt from taxation regardless of age and length of service. The law requires the presence of two (2) conditions in order that the employee benefits may be granted tax exemption, namely: (1) the employee is separated from the service of the employer due to death, sickness or other physical disability or for any cause beyond the control of the said official or employee; and (2) the employer pays benefits to the official or employee or his heirs as a consequence of such separation. The phrase "for any cause beyond the control of said official or employee" connotes involuntariness on the part of the official or employee, i.e., the separation was not of their own making. Considering that the separation of IBM employees is beyond their control, any and all amounts to be received by them as a result thereof, are exempt from income tax and consequently from withholding tax prescribed in Section 79 of the Tax Code of 1997, as implemented by Revenue Regulations No. 2-98, as amended. ( BIR Ruling Nos. 105-96 dated October 15, 1996; 082-92 dated March 17, 1992; and 088-96 dated August 6, 1996 ) Furthermore, the tax exemption will include the company's payment for cash equivalent of accumulated vacation and sick leave credits of the said employee. ( BIR Ruling No. 98-91 dated June 4, 1991, based on BIR vs. Castaeda and CTA, G.R. 96016, October 17, 1991 ) EACIaT However, the payment of the 30 days pay in lieu of notice which are considered salaries and the Christmas bonus in excess of the P30,000.00 threshold amount are subject to income tax and consequently to the withholding tax. ( BIR Ruling No. SB023-2001 dated December 19, 2001 ) The expenses incurred by IBM in providing the said benefits are deductible from gross income for being an ordinary and necessary trade or business expense pursuant to Section 34(A)(1)(a)(i) of the Tax Code of 1997. However, separation benefits paid out of the retirement plan cannot be deducted as business expense because they were already deducted from the gross income when the company made its contribution to the Plan. This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it will be disclosed that the facts are different, then this ruling shall be considered null and void. Very truly yours, (SGD.) MILAGROS V. REGALADO Assistant Commissioner Legal Service