BIR Ruling No. 497-11

December 15, 2011 BIR RULING NO. 497-11 Section 32 (B) (6) (b) NIRC; BIR Ruling No. DA-505-06; BIR Ruling No. 199-2011 United Dockhandlers, Inc. Radial 10 cor. Capulong St., North Harbor, Port of Manila Manila, Philippines Attention: Carlito B. Abon Chief Executive Officer Gentlemen : This refers to your letter, dated January 3, 2011, requesting on behalf of United Dockhandlers, Inc. (UDI) for a legal opinion as to the tax treatment of the separation benefits paid by UDI to some of its workers. It is represented that UDI was the former arrastre-stevedoring company in North Harbor and employing several workers. Sometime on November 19, 2009, the Philippine Ports Authority (PPA) entered into a Contract with the Manila North Harbour Port, Inc. (MNHPI) to manage and operate North Harbor, in lieu of UDI, among others; that by reason of the said Contract, the Alliance of Port Transport Workers-North Harbor (APTW-NH), wherein UDI's former workers belong as bonafide members, entered into a Memorandum of Agreement (MOA) with MNHPI on March 30, 2010, agreeing, among others, that the port workers will be absorbed by MNHPI; that some of UDI's workers, however, were not absorbed by MNHPI but instead paid by UDI separation pay which was subjected to withholding tax; and that the employees who were terminated from service were not covered by an employment contract but a certification of employment, dated June 3, 2011 (attached hereto as Annexes "A, A-1, A-2, and A-3" and made an integral part hereof), was issued by Mr. Carlito B. Abon, UDI's Chief Executive Officer. In reply, please be informed that pursuant to Section 32 (B) (6) (b) of the Tax Code of 1997, 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 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 nor initiated by him. aTIEcA The above-mentioned provision requires the presence of two (2) conditions in order that the 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. As noted, the workers who were paid their separation benefits were separated from employment due to the change of management by virtue of the Contract entered into between PPA and MNHPI. Accordingly, where the employees are separated involuntarily from the service due to a cause beyond their 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 and as implemented by Revenue Regulations No. 2-98, as amended. (BIR Ruling No. DA-505-06, dated August 18, 2006) Accordingly, no withholding taxes shall be deducted from the separation benefits and the entire amount thereof shall be given to the entitled separated employees. Moreover, pursuant to Section 2.78.1 (A) (7) of RR 2-98, as amended, the terminal pay, i.e., commutation and payment of monetized unused vacation leave credits not exceeding ten (10) days during the year are not subject to income tax and consequently to the withholding tax. Conversely, the cash equivalent of vacation leave exceeding ten (10) days is subject to tax. However, this same principle cannot apply to SICK leave credits since an employee must actually go on sick leave to be able to avail of said leave credits. It is, however, understood that this exemption does not include the payment of the separated employees' salaries and the payment of the 13th month pay and other benefits in excess of the Php30,000 threshold under Section 2.78.1 (A) (3) (a) and (A) (7) of RR 2-98, as amended. ( BIR Ruling No. 199-2011 citing BIR Ruling No. DA-594-04 dated November 23, 2004) This ruling shall continue to be valid unless revoked by this Office for violation of any provisions of Revenue Memorandum Order (RMO) No. 26-2011 and other applicable rules and regulations of the BIR, and the terms and conditions herein set forth. aHADTC Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue