BIR Ruling [DA-445-03]

December 5, 2003 BIR RULING [DA-445-03] 32 (B) (6) (b); RR 10-2000 DA-099-02; 35-93 First Philippine Industrial Park, Inc . 7th Floor, The Taipan Place Emerald Avenue, Ortigas Center Pasig City Attention: Mr . Hector Y . Dimacali President and General Manager Gentlemen : This refers to your letter dated September 10, 2002, requesting for a proper interpretation of the Tax Code provision regarding the matter of vacation/sick leave conversions paid to your employees who were separated from the service due to redundancy. The facts, as you have represented, are as follows: Your company, the First Philippine Industrial Park (FPIP, for brevity) implemented an Employee Redundancy Program in August 2002. Eleven (11) employees were affected and were entitled to separation pay of 150% of the basic pay for every year of service. You did not withhold any tax thereon since the cause of their separation was beyond their control. In addition, the affected employees were entitled to vacation and sick leave conversions, the payment of the prorated 13th month pay, and their final pay for their last month of service. This time, you withheld the corresponding taxes in accordance with the provisions of the Tax Code. You state that your company has an existing policy of commuting vacation/sick leave credits for your employees subject to certain conditions. Thus, for purposes of the terminal pay computation, you withheld taxes on the commutation subject to the requirement of Revenue Regulations No. 10-2000 which exempts from withholding tax the monetized unused vacation leave credits of PRIVATE employees not exceeding ten (10) days during the year. Your query arose because of Regional Ruling No. RDA-RR#58-02 dated August 28, 2002, issued by the Regional Director of Revenue Region No. 9, San Pablo City which partly states that ". . ., the terminal leave pay, i.e. , the accumulated sick leave and vacation leave credits which is part of the tax-exempt separation pay is also exempt from tax. "The payment of their salaries, however, is subject to withholding tax." In reply, please be informed of the following: Pursuant to Section 1(7) of Revenue Regulations No. 10-2000; amounts of "vacation allowances or sick leave credits" which are paid to an employee constitute compensation. Thus, the salary of an employee on vacation or on sick leave which is paid, notwithstanding his absence from work, constitutes compensation. However, the monetized value of unutilized vacation leave credits of ten (10) days or less which are paid to private employees during the year are not considered as compensation subject to income tax and consequently to withholding tax. This is so, because the monetized vacation leaves are treated as facilities and privileges (such as entertainment, medical services or so-called "courtesy discounts" on purchases), otherwise known as " de minimis benefits," and are furnished or offered by an employer to his employees merely as means of promoting the health, goodwill, contentment, or efficiency of his employees. There is as yet no severance of employee-employer relationship. However, the vacation leave credits which is part of the tax exempt separation package, even in excess of ten (10) days is also exempt from tax pursuant to Section 32(B)(6)(b) of the Tax Code of 1997, which 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 because of death, sickness or other physical disability or for any cause beyond the control of the said official or employee is exempt from taxes regardless of any 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. TADaES The above-mentioned law requires the presence of two (2) conditions in order that the employee benefit 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 the employees of the Company under the Employee Redundancy Program is beyond their control, any and all amounts that they will receive as a result thereof, are exempt from income tax, and consequently, from the withholding tax prescribed by Section 79 of the Tax Code of 1997. Moreover, the commutation and payment of unused sick leave and vacation leave credits are likewise not subject to income tax and consequently to the withholding tax ( CIR vs. CA and Efren P. Castaeda , 203 SCRA 72 [1991]). The exemption is understood not to include the company payment of salaries and prorated 13th month pay. Summarizing hereunder is a tabulated form showing the tax consequences between the monetized vacation leave and accumulated vacation leave: Ten Days Monetized Accumulated Vacation Leave Vacation Leave (Separation Benefit) Exemption Tax Exempt Tax Exempt Limitation 10 days only Even in excess of ten days Tax Type De Minimis Benefit Exemption from income and Withholding tax Basis Revenue Regulations Sec. 32(B)(6)(b) No. 10-2000 Causes N/A Beyond the control of employees Employer- Employee No severance of employer- With severance of employer Relationship employee relationship employee relationship EHCDSI Very truly yours, Commissioner of Internal Revenue By: (SGD.) JOSE MARIO C. BUAG Deputy Commissioner Legal and Inspection Group