BIR Ruling [UN-235-94]

August 8, 1994 BIR RULING [UN-235-94] AMI Philippines, Inc. 9701 Dr. A. Santos Avenue Paraaque, Metro Manila Attention: Mr . Alberto Q . Villanueva Controller Gentlemen : This refers to your letter dated February 22, 1994 stating that you are a semi-conductor company registered with the Board of Investment (BOI) as exporter of semi-conductor devices; that you have been in the assembly and test operations for 13 years; that in order to enhance your competitive position and prevent further losses in the assembly business, you decided to close your operation; that you will enter into an agreement with another semi-conductor plant to subtract 100% of your assembly requirements which is about 45% to 50% of your total operations; that in view of this decision, you have to involuntarily separate about 285 to 300 assembly personnel and administrative staff and employees supporting your assembly operations; that you have adopted a retrenchment program where the selection of employees to be separated from the service depends upon the reserved right, sole will, judgment and decision of the company and that these employees will be paid a separation package of 150% of the latest salary rate per year of service, inclusive of retirement benefits plus one (1) month's pay in lieu of notice, or a minimum of two (2) months pay; that you will also pay them their final salary including encashment of unused sick leave and vacation leave balances, pro-rated 13th month pay and other fringe benefits. Based on the foregoing facts, you now request a ruling on whether the separation benefits that you will pay to your affected employees are exempt from tax. In reply, please be informed that pursuant to Section 28(b)(7)(B) of the Tax Code, as amended, any amount received by an official or employee or by his heirs from his employer as a consequence of separation by 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 is exempt from income tax 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 or initiated by him, which means that the official or employee being separated from the service has not requested for such separation as in this case, wherein the separation of the employees and officers of the company is brought about by its retrenchment program resulting in the reduction of the manpower of the company. The above-mentioned law requires the presence of these two (2) conditions in order that the employee 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 the benefit to the said official or employee or his heirs as a consequence of such separation. Since the separation of the employees and officers of AMI Philippines, Inc. is beyond their control, any and all amounts, consisting of 150% of employee's monthly basic pay per year of service, inclusive of retirement plan benefits plus one (1) month's pay in lieu of notice, or a minimum of two (2) months' pay and money value of unused vacation and sick leave credits and other fringe benefits, received by them as a result thereof, are exempt from income tax and consequently, from the withholding tax prescribed by Section 72, 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. Moreover, the terminal leave pay i.e. the accumulated vacation and sick leave credits which are part of the tax-exempt separation pay are also exempt from tax. (See Commissioner of Internal Revenue vs. Court of Tax Appeals and Efren P. Castaeda, G.R. No. 96916 prom. October 17, 1991) The tax exemption does not however, include the company's payment of salaries and pro-rated 13th and 14th months bonuses pay of the concerned officials and employees (BIR Ruling No. 28(b) (7) (B)/052-92/023-93/01-15-93). cdtech Very truly yours, ALICIA P. CLEMENO Acting Assistant Commissioner Legal Service