BIR Ruling No. OT-700-20

December 29, 2020 BIR RULING NO. OT-700-20 Section 32 (B) (6), NIRC of 1997, as amended; RMC No. 39-2012; RR No. 2-98, as amended; BIR Ruling No. 224-2019; BIR Ruling No. 003-2004 AAA ____________________ ____________________ Sir : This refers to your letter dated August 16, 2020 requesting for a policy ruling that categorically excludes backwages, awarded through a judgement rendered in an illegal dismissal case, from the ambit of gross taxable income pursuant to Section 32 (B) (6) of the National Internal Revenue Code (NIRC) of 1997, as amended. In reply, please be informed that the tax treatment of backwages has already been clarified in Revenue Memorandum Circular (RMC) No. 39-2012, "Withholding of Income Tax on Backwages, Allowances, and Benefits Received by Employees through Garnishments of Debts or Credits Pursuant to a Labor Dispute Award" dated August 3, 2012. Backwages and the amount representing unpaid salaries are remuneration for services which are subject to income tax, and, consequently, to the withholding tax on wages. The employer is required to withhold the income tax corresponding to the income actually received as salaries by an employee found to be illegally dismissed, from the time he was reinstated (if he opts to be reinstated instead of separation). However, the illegally dismissed employee is accorded special treatment, i.e. , he is allowed to allocate or spread his backwages, allowances and benefits through the years he was suspended from service, having been denied payment of his wages when they were due because of circumstance not of his own making and, therefore, beyond his control. 1 Section 2.57 (B) of Revenue Regulations (RR) No. 2-98, as amended, provides as follows: "Section 2.57. Withholding Tax at Source. xxx xxx xxx (B) Creditable Withholding Tax. Under the creditable withholding tax system, taxes withheld on certain income payments are intended to equal or at least approximate the tax due of the payee on said income. The income recipient is still required to file an income tax return, as prescribed in Sections 51 and 52 of the NIRC, as amended, to report the income and/or pay the difference between the tax withheld and the tax due on the income. Taxes withheld on income payments covered by the expanded withholding tax (referred to in Sec. 2.57.2 of these regulations) and compensation income (referred to in Sec. 2.78 also of these regulations) are creditable in nature." (emphasis supplied) Whether an employee found to be illegally dismissed is reinstated or opts for separation he is required to report such income (backwages) for the years he was suspended from service, as he files and pays his corresponding income tax thereon by allocating or spreading his backwages, allowances and benefits through the years from the time of his suspension to actual reinstatement or actual separation (if he opts for separation instead of reinstatement), as the case may be, crediting in the process the corresponding income tax withheld from said wage payments. 2 The interpretation of tax provisions of the NIRC of 1997, as amended, embodied in RMC No. 39-2012 is an exercise of the Bureau's quasi-legislative function. This position is well grounded on Section 4 of the NIRC of 1997, as amended, viz. : "Section 4. Power of the Commissioner to Interpret Tax Laws and to Decide Tax Cases. The power to interpret the provisions of this Code and other tax laws shall be under the exclusive and original jurisdiction of the Commissioner, subject to review by the Secretary of Finance. xxx xxx xxx" The rules and regulations that the Bureau promulgates, which are the product of a delegated legislative power to create new and additional legal provisions that have the effect of law, should be within the scope of the statutory authority granted by the legislature to the administrative agency. It is required that the regulation be germane to the objects and purposes of the law, and be not in contradiction to, but in conformity with, the standards prescribed by law. They must conform to and be consistent with the provisions of the enabling statute in order for such rule or regulation to be valid. 3 In view of the foregoing, the requested policy ruling that categorically excludes backwages awarded from a judgment of illegal dismissal from the ambit of gross taxable income is not legally feasible as it would contradict the provisions of the NIRC of 1997, as amended. Please be guided accordingly. Very truly yours, (SGD.) CAESAR R. DULAY Commissioner of Internal Revenue Footnotes 1. BIR Ruling No. 224-2019, April 3, 2019. 2. BIR Ruling No. 003-2004, January 19, 2004. 3. Smart Communications, Inc. vs. National Telecommunications Commission , G.R. No. 151918, August 12, 2003.