BIR Ruling [DA-256-06]

April 12, 2006 BIR RULING [DA-256-06] Rev. Regs. No. 2-98; BIR Ruling No. 057-83, 238-86, DA-205-02 & DA-485-03 Atty. Alfredo C. Olvida FFW Office 302 Lozano Bldg. C.M. Recto Avenue Davao City S i r : This refers to your letter dated August 8, 2005 requesting on behalf of your clients, Victoria Raeses and George Vergara for the correct procedure in computing income tax withheld from the award of back pay arising from illegal dismissal. CDHacE As represented, Victoria Raeses and George Vergara were rank-and-file employees of the University of the Immaculate Conception (UIC) situated at Fr. Selga St., Davao City. In April 1994, Victoria Raeses and George Vergara were terminated from their employment by UIC. Both filed complaints for illegal termination with back wages, with the National Labor Relations Commission (NLRC), Arbitration Branch, Region XI, Davao City. Victoria Raeses and George Vergara were found to have been dismissed without just cause and ordered reinstated pursuant to the decision of the Labor Arbiter in re: Case Nos. RAB-11-03-00229-04 and RAB-11-04-00312-94 dated June 1, 1995 and upheld by the Court of Appeals and Supreme Court. In October 2000, UIC reinstated Victoria Raeses to her former position while George opted not to return in view of his new employment. On June 30, 2005, Victoria Raeses and George Vergara were paid their backwages in the amount of PhP335,000.00 and PhP270,000.00, respectively. The UIC deducted withholding tax from Victoria Raeses and George Vergara in the amount of PhP75,500.00 and PhP43,000.00, respectively. Except for one (1) year, the personal exemption and additional exemption for dependents were not deducted from their gross back wages covering the period 1994 up to 1999. The Revenue District Office-Davao City did not find any irregularity in the computation. Hence, this request. In reply, please be informed that every employer must withhold from compensation paid an amount computed in accordance with Section 2.79 of Revenue Regulations (Rev. Regs.) No. 2-98, as amended. In general, the employer shall deduct and withhold from such compensation a tax determined in accordance with the prescribed withholding tax tables of Rev. Regs. No. 2-98. There are four (4) withholding tables prescribed in the regulations: monthly, semi-monthly, weekly and daily tax tables. If the compensation is paid other than daily, weekly, semi-monthly or monthly, the tax to be withheld shall be computed annually or quarterly and semi-annually. Annualized withholding tax method shall be used when the employer-employee relationship is terminated before the end of the calendar year (as in the case of George Vergara). Under Section 44 of the Tax Code of 1997, if the taxpayer is an individual, the net income shall be computed on the basis of the calendar year. All items of income shall be included in gross income or gross compensation income, as the case may be, for the taxable year in which they were received by the taxpayer except those expressly excluded and already subjected to the final income tax, and exemption as well as deductions taken accordingly pursuant to Sections 24, 33 and 34 in relation to Section 45, all of the Tax Code, of 1997. Salaries, commissions, tips, director's fees, and other forms of compensation are income in the year received, and not in the year earned [par. 717, p. 231, U.S. Master Tax Guide (1969)]. Thus, a taxpayer whose income is from salary or the like is required to file his income tax return on the cash basis. This, however, is not true in illegal dismissal cases. In cases of illegal dismissal, the employees should be accorded special treatment i.e., allowed to allocate or spread their back wages, allowances and benefits through the years 1994 to 2000, having been denied payment of their wages when they were due because of circumstances not of their own making and, therefore beyond their control. Thus, Victoria Raeses and George Vergara come within the scope of the inequity for which this ruling is precisely designed to remedy. Considering that such back wages, allowances and benefits constitute remuneration for services that would have been performed by the said employees for UIC prior to the year (2005) when actually received, or during the period of their suspension from the service (1994 to 1999), it is felt that a liberal construction of the statute is called for in this particular case if only to protect said employees who, in fact, had been deprived of the payment of their wages and other forms of remuneration, from the payment of a tax heavier than what would have been imposed if their employer had promptly met its obligation. In the case of Commissioner of Internal Revenue v . Joseph G.R. Robillard & Margaret H. Robillard (C.A., 308 F. 2d 518, 519), it was held that income received by a taxpayer in 1957 as "back pay" or additional pay for services rendered to his employer for the period from July 1, 1955 through December 1956 which, indubitably, would have been paid prior to 1957 except for the intervention of an event similar in nature to a dispute as to the liability of the employer to pay the remuneration in question, is entitled to a special treatment and was properly allocable to the taxable years 1955 and 1956. Section 2.57. (B) of Revenue Regulations No. 2-98, as amended, implementing Republic Act No. 8424, "An Act Amending The National Internal Revenue Code, As Amended" relative to the Withholding on Compensation, provides, viz: "Sec. 2.57. Withholding of Tax at Source (A) . . . (B) Creditable Withholding Tax . Under the creditable withholding tax system, taxes withheld on certain income payments are intended to equal or at least approximate the tax due of the payee on said income. The income recipient is still required to file an income tax return, as prescribed in Sec. 51 and 52 of the NIRC as amended, to report the income and/or pay the difference between the tax withheld and the tax due on the income. Taxes withheld on income payments covered by the expanded withholding tax (referred to in Sec. 2.57.2 of these regulations) and compensation income (referred to in Sec. 2.78 also of these regulations) are creditable in nature." Accordingly, UIC shall withhold only the income tax corresponding to the income actually received as salaries by Victoria Raeses starting October 2000 when UIC reinstated her. On the other hand, Victoria Raeses and George Vergara shall report such income (back wages) for the years 1994-1999, as they file and pay their corresponding income tax thereon by allocating or spreading their back wages, allowances and benefits through the years from the time of Victoria Raeses' suspension to her actual reinstatement and in the case of George Vergara, from the time of his suspension to his actual separation since he opted for separation instead of reinstatement, crediting in the process the corresponding income tax withheld from said wage payments. HTcADC Thus, in computing Victoria Raeses' and George Vergara's respective net income tax, the amount deducted and withheld during calendar years 1994-1999 by UIC shall be allowed as a credit against the tax imposed under Section 24(A) of the same Code pursuant to Section 79(C)(2) of the Tax Code of 1997. Moreover, Victoria Raeses and George Vergara are allowed to deduct personal and additional exemptions during the said years in accordance with Section 35(A) and (B) of the Tax Code of 1997. Finally, anent George Vergara's separation benefits, please be informed that Section 32(B)(6)(b) of the Tax Code of 1997 provides that 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 due to death, sickness or other physical disability or for any cause beyond the control of said official or employee is exempt from taxes regardless of age or length of service. The phrase "for any cause beyond the control of said official or employee" connotes involuntariness on the part of the official or employee. The separation from the service of the official or employee must not be asked for or initiated by him. The abovementioned 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. Since the separation of George Vergara is due to the exercise of management's prerogative to terminate his employment (although he was found to be illegally dismissed by the NLRC), the same connotes involuntariness for being beyond the control of the aforenamed employee. Hence, any and all amounts received by him as a result thereof, consisting of the separation pay package and other benefits, are exempt from income tax and consequently from the withholding tax prescribed by Section 79, Chapter X, Title II of the Tax Code of 1997 as implemented by Revenue Regulations No. 2-98, as amended. The payment of salaries, however, is subject to income tax and consequently to withholding tax. 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 as null and void. Very truly yours, (SGD.) PABLO M. BASTES, JR. OIC-Head Revenue Executive Assistant Legal Service