BIR Ruling [DA-499-99]

September 3, 1999 BIR RULING [DA-499-99] SGV & Co. 6760 Ayala Avenue Makati City Attention: Atty . M . F . A . Balili Tax Division Gentlemen : This refers to your letter dated July 9, 1999, requesting on behalf of your client, Gillette (Philippines), Inc. ("GPI"), for a ruling that the separation benefits paid to employees as a result of a reorganization are exempt from income tax on the part of the affected employees, and are consequently exempt from withholding tax, pursuant to Section 32(B)(6)(b) of the Tax Code of 1997, and that the said separation benefits are deductible expense to GPI pursuant to Section 34(A)(1)(a) of the Tax Code of 1997. It is represented that GPI is a domestic corporation, duly organized and existing under Philippine laws; that in view of the globalization of the market, economic conditions have dramatically changed and worldwide competition has intensified, that GPI will be implementing a restructuring program as part of a worldwide restructuring by Gillette, that domestically, it is intended to streamline internal operations and improve efficiency, that in the case of GPI, the restructuring will include rationalization of functions that will make certain position/functions redundant; that affected employees will be retrenched and will be paid separation benefits in excess of what is statutorically mandated; that the restructuring being an extraordinary circumstance, all the separation benefits consequent of the said restructuring/retrenchment will be paid from GPI's operating revenues in order not to deplete the resources of GPI's Retirement Plan. In reply, please be informed that pursuant to Section 32(B)(6)(b) of the Tax Code of 1997 [formerly Section 28(b)(7)(B) of the Tax Code, as amended] "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 the said official or employee", shall not be included in gross income and shall be exempt from taxation regardless of age or length of service. The above mentioned law requires the presence of two (2) conditions in order that the employee benefits may be granted tax exemption: (1) the official or 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 employees; and (2) the benefits to be given are as a consequence of such involuntary separation. Since the proposed separation of redundant GPI personnel is beyond the concerned employees' control, any and all amounts received by them 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 [formerly Section 72, Chapter 10, Title II of the Tax Code, as amended by Batas Pambansa Blg. 135 and implemented by Revenue Regulations No. 6-82, as amended]. Such tax exemption is understood not to include the company's payment of salaries of the retrenched/separated employees. On the other hand, in computing taxable income subject to tax under Section 27(A) of the Tax Code of 1997 [formerly Section 24(a) of the Tax Code as amended], a corporate taxpayer, like GPI is allowed, inter alia , to deduct from its gross income all ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries, wages, and other forms of compensation for personal services actually rendered. [Section 34(A)(1)(a)(i) of the Tax Code of 1997, formerly Section 29(a)(1)(A) of the Tax Code, as amended]. The payment of separation pay or redundancy package is a business expense that meets the following criteria for its deductibility: 1. The expense is ordinary and necessary; and 2. It is paid or incurred in carrying on a trade or business. As held in the case of Collector of Internal Revenue vs. Philippine Education Company, Inc. 99 Phil. 321, (No. L-8505, May 30, 1956): ". . . the term ordinary as used in the statutes, does not require that the payments be habitual or normal in the sense that the same taxpayer will have to make them often; the payment may be unique or non-recurring to the particular taxpayer affected. Furthermore, an expense will be considered necessary where the expenditure is appropriate and helpful in the development of the taxpayer's business. It is sufficient that the expense was incurred for purposes proper to the conduct of the corporate affairs or for the purpose of realizing a profit or for minimizing a loss." Separation pay is required in the cases enumerated in Article 283 and 284 of the Labor Code which include retrenchment and redundancy. This provision is a statutory right designed to provide the terminated/separated employee with the wherewithal need during the period that he is looking for another employment. ( Santos vs . NLRC, 154 SCRA 166, 172 ) Hence, as far as the separation benefits to be paid by GPI, they should not be equated or pegged down by the benefits under GPI's Retirement Plan, since the benefits are meant to alleviate and help tide over the redundant/terminated employees until they find a new employment or means of livelihood. In the light of the aforecited Supreme Court ruling, the restructuring to be undertaken by GPI, which will declare a number of redundant positions, necessarily and logically resulted in the need for separation benefits that will be granted to the affected/redundant employees. The said separation benefits certainly constitutes an ordinary and necessary expense that will be incurred within the current taxable year in connection with the business of GPI. Accordingly, this Office is of the opinion as it hereby holds that the separation benefits to be paid by GPI from its operating revenues shall qualify as deductible expense pursuant to Section 34(A)(1)(a)(i) of the Tax Code of 1997. 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, and/or any of the requirements imposed in this letter are not complied with, then this ruling shall be considered null and void. Very truly yours, Commissioner of Internal Revenue By: (SGD.) SIXTO S. ESQUIVIAS IV Deputy Commissioner Legal and Enforcement Group