Taxability of Earnings of the Employee-Members' Personal Contributions

October 4, 1988 BIR RULING NO. 481-88 53 (b) 4-86 481-88 Gentlemen : This refers to your letter dated May 10, 1988 requesting in behalf of your client, Franklin Baker Company of the Philippines Retirement Plan, a ruling confirming your opinion to the effect that distribution by the fund trustee to its member-employees of: cdt "1. amounts representing contributions made by such employees to the fund do not constitute income to the recipient employees and therefore such are not subject to income tax nor to withholding tax; "2. amounts representing earnings to the above: "i. already subjected to income tax to the fund are no longer subject to income tax to the recipient employees/beneficiaries; "ii. not subjected to income tax to the fund are subject to income tax to the recipient employees/beneficiaries under Sec. 21(a) of the NIRC and consequently subject to the creditable expanded withholding tax of 15% imposed under Sec. 1(f) of Revenue Regulations No. 6-85." It is represented that the aforementioned Retirement Plan is registered under R.A. No. 4917 as implemented by Revenue Regulations No. 1-68, as amended; that subsequent to its registration an amendment to the plan making members' contributions optional instead of compulsory was approved by this Office effective on November 2, 1982; that in a resolution passed by the Board of Trustees in January 1988, the plan was further amended making distribution of contributions made by the employee allowable even prior to retirement of separation; and that pursuant to the said resolution, the trustees started the distribution in February 1988 and withheld 20% tax on the amounts distributed, which was objected to by the employees. In reply, please be informed that any and all amounts which represent a return of personal contributions to the employee-members shall not be subject to tax. (BIR Ruling No. 04-86) Consequently, your opinion to the effect that amounts representing contributions made by the employees to the fund which are being distributed to them are mere return of capital and, therefore, not subject to income tax is hereby confirmed. Under Section 36 of the Income Tax Regulation, income in the broad sense, means all wealth which flows into the taxpayer other than as a mere return of capital. cdti However, your contention that the income or earnings of the employee-members' personal contributions are no longer taxable to the recipient employee-members since the same were already subjected to income tax to the fund cannot be sustained by this Office. This is so because Franklin Baker Company of the Philippines (Franklin Baker for short) Retirement Plan is not an ordinary trust or ordinary employees' trust for that matter. It is an employees trust and deferred compensation plan which has been adjudicated by this Office on September 16, 1974 as a reasonable private retirement benefit plan within the contemplation of Republic Act No. 4917 / now Section 28(b)(7)(A) of the Tax Code / as amplified by Revenue Regulations No. 1-68 and 1-83 ; hence, entitled to the following benefits and privileges, viz: 1. The retirement benefits to be received by the member-employees shall be exempt from all taxes [Sec. 28(b)(7)(A), Tax Code]; 2. The income of the Trust Fund from its investments are exempt from income tax [Sec. 53(b), Tax Code]. However, in view of the amendment of Section 21(c)(1) in relation to Section 50(a) of the Tax Code by Executive Order No. 37 which took effect on August 1, 1986, the Franklin Baker employees' Retirement Plan is subject to the 20% final tax on interest and/or yield on deposit substitute instruments; and interest on its savings and time deposits paid or accrued beginning August 1, 1986; and 3. The contributions of the company to the retirement fund are deductible from its gross income [Sec. 29(a)(1)(A), Tax Code]. It is to be noted that in a retirement plan under Republic Act No. 4917 [now Section 28(b)(7)(A), Tax Code], the employer, or officials and employees or both, contribute to a trust fund for the purpose of distributing to such officials and employees or their beneficiaries, the corpus and income accumulated by the trust in accordance with the plan . [Sec. 2(d), Revenue Regulations No. 1-68] Republic Act No. 4917 [Section 28(b)(7)(A), Tax Code] provides for exemption from income tax only of benefits received by officials or employees upon retirement, in accordance with the BIR-approved Retirement Plan rules or written program . In other words, in order to be exempt from the payment of income tax, the benefits must be paid or distributed to the officials or employees upon their retirement from the service and not while they are still in the employ of the company-employer. In the instant case, the earnings/income of the personal contributions of the employees constitute benefits (not retirement benefits as envisaged by the trust fund trustee to the employees not upon their retirement but while they are still in the service of Franklin Baker . Consequently, pursuant to Section 53(b) of the Tax Code as amended, any and all amounts actually distributed or paid from the Franklin Baker retirement fund to an employee-member withdrawing his personal contributions shall be taxable to him in the year in which so paid or distributed, such distribution having been effected before his retirement from Franklin Baker . Neither Republic Act No. 4917 nor Section 28(b)(7)(A) of the Tax Code makes mention of exemption from income tax of the earnings or income of the retirement plan trust fund. Exemption from income tax of the earnings derived from investments of the employees retirement fund are governed by another provision of the Tax Code, i.e., Section 53(b) of the Tax Code. Under Section 53(b) of the Tax Code, income of the Trust Fund from its investments are exempt from income tax except however, as heretofore stated, the interest income and/or yield from Philippine bank deposits and deposit substitutes of the trust fund which is subject to the 20% final withholding tax. There are three parties in an employees' trust which has qualified as a reasonable private retirement trust plan under Section 28(b)(7)(A) of the Tax Code, namely: the trustor-employer, the trustee of the fund who must be independent from the employer-trustor and the beneficiary or employee-members. The trust fund while still with the trustee is exempt from income tax on income from investment of said fund, except of course on interest income and/or yield from Philippine bank deposits and deposit substitutes; and continues to be so exempt when paid or distributed to the employee-members upon retirement in accordance with the Plan rules . In fact, the trustee is exempt from filing income tax return. Conversely, if such earnings are paid or distributed to the employee-members withdrawing their personal contributions to the fund, before their retirement date or age as provided for in the Plan rules, the same are taxable to them in the year in which so paid or distributed, such distribution having been effected before their retirement from employer-company. Moreover, the provisions of Section 212 of the Income Tax Regulations and then Section 57 [now Section 54] of the Tax Code do not apply to an income tax exempt employees' trust, specifically that which qualifies as a private retirement benefit plan under Section 28(b)(7)(A) of the Tax Code because it has no net income to speak of. Net income as defined under Section 36 of the Income Tax Regulations implementing then Section 28 of the Tax Code means gross income less statutory deductions. Because of the deletion of the exempting and preferential tax treatment provisions under then Sections 21(d), 24(cc), and 53(d)(1) of the Tax Code by P.D. 1959 which took effect October 15, 1984, the single 15% (now 20%) rate is imposable on all interest income from deposits, deposit substitutes, trust funds and similar arrangement, regardless as to the tax status or character of the recipients thereof. (Revenue Memorandum Circular No. 31-84) Consequently, any final tax paid by the trustee of the retirement trust fund is a tax paid by the trustee for the trust fund and while the fund (personal contributions of employees and employer contributions) is still with the trustee and therefore cannot be credited in favor of the distributee-employee who is actually a distinct and separate party of the trust, independent from the taxpayer-trustee. By and large, it is not correct to apply to the earnings or income of the employees' personal contributions (part of the Franklin Baker retirement trust fund) the provision of Section 1(f) of Revenue Regulations No. 6-85 otherwise known as the Revised and Consolidated Expanded Withholding Tax Regulations which is applicable to trusts other than a qualified private employees' retirement trust fund. In view of the foregoing considerations, this Office is of the opinion as it hereby holds that the earnings of the employee-members' personal contributions (whether or not said earnings were subjected to income tax to the fund) which will also be paid or returned to them shall be subject to the withholding tax on wages (not to the creditable expanded withholding tax) and are taxable to the recipient employee-member to the extent of the entire amount thereof in the year in which so paid or distributed at the rates prescribed by Section 21(a) in relation to Section 71, Chapter X, Title II of the Tax Code, as amended by Batas Pambansa Blg. 135 and implemented by Revenue Regulations No. 6-82 as amended. (See also BIR Ruling No. 21(a)-000-00-216-83 dated December 7, 1983) cdtech Very truly yours, (SGD.) EUFRACIO D. SANTOS Deputy Commissioner