BIR Ruling [DA-578-99]

October 6, 1999 BIR RULING [DA-578-99] Siguion Reyna, Montecillo & Ongsiako PHILCOM Building, 8755 Paseo de Roxas Makati City Attention: Atty . Ferdinand M . Hidalgo Gentlemen : This refers to your letter dated June 14, 1999 requesting on behalf of your client, Siemens Medical Systems, Inc., for a ruling as to the taxability of the separation pay package that its employees will receive as a result of their separation due to redundancy. llcd It is represented that Siemens Medical Systems, Inc., is a domestic corporation engaged in the business of marketing medical systems and equipment in the Philippines; that early this year, it reviewed the performance of its business to determine its viability in the light of the current economic crisis, the company's financial condition and the business prospect for the coming years; that the review showed that there is a need to downsize and integrate its business operation if only to insure profitable operation; that as a result of this, a number of its employees will be separated particularly those whose services will be considered in excess of its requirements; that the separation of these employees will be effective 60 days after notice; and that the terminated employees will then be paid a separation package that includes the following: a) Labor law mandated one (1) month pay for every year of service separation pay; b) Financial assistance equivalent to the employees one (1) month salary, one (1 ) month meal, clothing and rice allowance, and the equivalent of their variable income and bonuses in recognition of their performance during their employment with the company; c) Pro-rated 13th month pay; d) Cash conversion of unused leave credits; and e) Refund of provident plan contribution including employer's counterpart contribution. In reply, please be informed that pursuant to Section 32(B)(6)(b) of the Tax Code of 1997, as implemented by Revenue Regulations No. 2-98, 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 age or length of service . (Emphasis supplied) 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 above-mentioned law requires the presence of these two (2) conditions in order that the employee benefits may be granted tax exemptions: (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 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 your client is beyond their control, any and all amounts that they will receive as a result thereof, is exempt from income tax and consequently, from withholding tax prescribed by Section 79, Chapter XIII, Title II of the Tax Code of 1997, as implemented by Revenue Regulations No. 2-98. Moreover, the terminal leave pay, i.e., the accumulated vacation and sick leave credits which is part of the tax-exempt separation pay is also exempt from tax. (see Commissioner of Internal Revenue vs. Court of Appeals and Efren P. Castaneda, G.R. No. 96016 prom. October 17, 1991) However, the payment of the employees' salaries and the 13th month pay, bonuses and other benefits in excess of P30,000.00 shall be subject to income tax and consequently to withholding tax. Finally, the refund of the employees' contributions to the provident plan shall not be subject to income tax since the same are considered as mere return of capital pursuant to Section 36 of the Income Tax Regulations. However, the counterpart contribution of the employer which are actually distributed to the employees over and above his personal contributions shall be taxable to the said employees in the year in which so paid or distributed, considering that such distribution having been effected before their retirement from Siemens Medical Systems, Inc. Very truly yours, Commissioner of Internal Revenue By: (SGD.) SIXTO S. ESQUIVIAS IV Deputy Commissioner (Legal and Enforcement Group)