Escareal v. Court of Tax Appeals

SIXTEENTH DIVISION [CA-G.R. SP No. 41989. September 30, 1998.] ORLANDO M. ESCAREAL , petitioner-appellant , vs . COURT OF TAX APPEALS, and COMMISSIONER OF INTERNAL REVENUE , respondent-appellees . D E C I S I O N GUERRERO , B.J. , J p : Petition for review under Rule 45 of the Revised Rules of Court of the decision dated 02 September 1996 1 of the Court of Tax Appeals (hereafter, the "CTA") in C.T.A.. Case No. 5194 entitled "Orlando M. Escareal, Petitioner, versus Commissioner of Internal Revenue, Respondent" which dismissed the petition for review (appeal) filed before it. The facts as found by the CTA are as follows: "On 16 September 1977, petitioner was hired by the Philippine Refining Inc., (now Unilever Philippines, Inc.), PRC for brevity, as a Pollution Control Manager, and subsequently designated as Safety Manager. On 15 June 1988, petitioner received a notice that the position of 'Safety and Pollution Control Manager will be declared redundant effective at the close of work hours on 15th July 1988.' "Petitioner challenged the validity of his termination from employment before the PRC, the Labor Arbiter, the National Labor Relations Commission and ultimately the Supreme Court which rendered a ruling dated 2 September 1992, stating that petitioner was illegally terminated from his employment and is therefore entitled to the award of backwages from 16 August 1988, to 21 July 1991, inclusive of allowances and monetary equivalent of other benefits due him for that period, as well as his retirement pay and other benefits provided under PRC's compulsory retirement scheme. "PRC was therefore obligated to pay the petitioner the sum of ONE MILLION TEN THOUSAND THIRTY ONE AND 25/100 PESOS (P1,010,031.25), representing backwages, bonuses and the cash value of his vacation leaves from 16 August 1988 to 21 July 1991 (Exh. A). The corresponding withholding tax amounting to P292,636.00 was withheld and remitted by the PRC to the BIR on 10 March 1993 (Exhs. B, B-1 and C). "On 28 December 1994, petitioner filed a claim for refund with the BIR in the amount of P292,636.00, alleging that the amount received from PRC are excluded from gross income and, therefore, exempt from the Income tax pursuant to Section 28 (b) (7) (B) of the National Internal Revenue Code (NIRC), as amended (Exh. D). On 30 January 1995, petitioner received a letter from Ms. Alicia P. Clemeno, Assistant Commissioner of the BIR, dated 19 January 1996 (Exh. E) which partially read as follows: LexLib 'In reply, please be informed that pursuant to Section 28 (b) (7) (B) of the Tax Code as amended, the backwages including bonuses paid to you cannot be considered as benefits paid as a consequence of an involuntary separation from the service of the employer within the contemplation of Section 28 (b) (7) (B) of the Tax Code but as remunerations from services that would have been rendered by you for your employer prior to 1993 when actually received or during the period of illegal dismissal from the service which was affirmed by the Supreme Court. Such being the case, said backwages are subject to income tax and consequently to the withholding tax on wages pursuant to Section 72, Chapter 10, Title II of the Tax Code as implemented by Revenue Regulations No. 6-82 as amended. 'However, considering that such backwages and bonuses received constitute remunerations for services that would have been performed by your sic) prior to the year (1993) when actually received or during the period of your dismissal from the service which no less than the Supreme Court has in effect affirmed to be illegal, and having been denied payment of wages when they were due because of circumstances not of your own making and therefore beyond your control, you should report as income and pay the respective income taxes by allocating or spreading the backwages and bonuses for the years 1988, 1989, 1990 and 1991 and crediting the corresponding income tax withheld from said wages payments excluding the accrued leave pay which has been ruled by the Supreme Court as not subject to income tax. (CIR v. Court of Appeals and Efren P. Castaneda, G.R. No. 96016) 'Accordingly, your claim for refund may be processed by this Office upon the submission of the following documents for verification purposes: '1. Certification from your employer showing a breakdown of the total backwages and other benefits received per year in the total amount of P1,010,031.00 including the total amount of withheld taxes; and '2. Certificate/proof of remittance of tax withheld. 'Please submit the requested documents immediately in order that herein claim can be acted upon.' "On 6 February 1995, petitioner simultaneously filed an appeal with the respondent Commissioner of Internal Revenue (Exh. F) and with this Court. Petitioner is asking this Court to issue an order directing the respondent to refund the amount of P292,636.00, representing alleged illegally withheld income tax plus 6% interest per annum from the time the withholding was made up to the time the refund is effected. "On 1 March 1995, during the pendency of this case, respondent approved the refund of P113,064.20, pursuant to Section 204 of the NIRC, computed as follows: (Exh. G, Annex 'H' of Pet's. Request for Admission, pp. 59-60, CTA record) 'xxx xxx xxx "Not satisfied with the partial refund awarded by respondent, petitioner pursued his claim for refund with respect to the balance of P179,572.00 plus 6% interest per annum from the time of withholding up to the time the refund is effected. Petitioner alleged that backwages and bonuses are not subject to income tax because these are excluded from gross income under Section 28 (b) (7) (B) of the NIRC. The award for payment of backwages was due as a consequence of his illegal dismissal. And certainly beyond his control (sic)." 2 On 02 September 1996, the assailed decision was promulgated. The CTA stated therein that Section 28 (b) (7) (B) of the NIRC was not applicable. The Separation contemplated in the aforementioned provision of law is a valid severance from service beyond the control of the employee. In the case of petitioner, it was as if there was no severance from service because he was paid backwages up to the time of his compulsory retirement. The backwages and bonuses received by petitioner are part of gross income and, therefore, subject to income taxation. pred Thus, this petitioner for review, petitioner making the following assignment of errors: "1. THE RESPONDENT-APPELLEE CTA ERRED IN CONCLUDING THAT BACKWAGES AND BONUSES PAID AS A RESULT OF AN ILLEGAL DISMISSAL DO NOT FALL WITHIN THE PURVIEW OF SEC. 28 (B) (7) (B) OF THE NATION INTERNAL REVENUE CODE. "2. THE RESPONDENT-APPELLEE CTA ERRED IN NOT AWARDING INTEREST AT THE RATE OF 6% FROM THE TIME OF WITHHOLDING UP TO THE TIME THE AMOUNT CLAIMED IS REFUNDED." 3 The issue is whether or not backwages and bonuses paid as a result of an illegal dismissal are excluded from income tax under Section 28 (b) (7) (B) of the NIRC. PETITIONER'S ARGUMENTS: The Supreme Court in Escareal vs. NLRC 4 ruled that petitioner was illegally terminated from his employment; ". . . petitioner was so cruelly and callously dismissed". Section 28 (b) (7) (B) is applicable herein. The phrase "for any cause beyond the control of said official or employee" refers to involuntariness on the part of the employee, and must not have been asked for or initiated by him. It is clear from the factual findings of the Supreme Court in the Escareal case that petitioner's termination was beyond his control. Moreover, the payment of backwages does not erase the fact of separation of petitioner for a cause beyond his control. The award of backwages should be exempt from income tax because not to do so would defeat the purpose for which they are awarded. Section 72 (2) of the NIRC allows payment of interest at the rate of 6% per annum on tax refunds. On 01 March 1995, the CIR refunded to petitioner the sum of P113,064.00 representing illegally withheld income taxes. Notwithstanding, the CIR did not pay the 6% interest per annum. Considering that the withholding in this case was had in March, 1993, petitioner is entitled to payment of 6% interest per annum on the refunded sum of P113,064.00. COMMENT: 5 Backwages paid as a result of an illegal dismissal are not excluded from gross income. In order for exemptions under Section 28 (b) (7) (B) of the NIRC to be given effect, the following must concur: 1. the employee was separate from the service; and 2. such separation must have been due to death, sickness, or other physical disability or beyond the control of said employee. The first requisite is absent. Petitioner was not actually separated from the service. The backwages and bonuses awarded to petitioner must not be considered as benefits paid as a consequence of an actual involuntary separation from the service but as remuneration for earnings which he lost due to his illegal dismissal. Backwages represent compensation that should have been earned but were not collected because of unjust dismissal Moreover, the BIR has ruled in several cases that backwages are subject to income tax and to withholding tax on wages pursuant to Section 72 of the NIRC, as implemented by Revenue Regulations Nos. 6-82 as amended. COURT'S RULING: The petition is without merit. The provision of law involved herein is Section 28 (b) (7) (B) of the National Internal Revenue Code (hereafter, "NIRC") which reads: "Sec. 28. Gross Income. "(a) General definitions. . . . "(b) Exclusions from gross income. . . . "(1) . . . "(7) Retirement benefits, pensions, gratuities, etc. "A) . . . "B) 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 due to death, sickness or other physical disability or for any cause beyond the control of the said official or employee." The backwages and bonuses received by petitioner-appellant from his former employer by reason of his illegal dismissal are not separation benefits excluded from gross income under Section 28 (b) (7) (B) of the NIRC. Bonuses are gratuities or acts of liberality of the giver which the recipient has no right to demand as a matter of right. Bonuses are demandable or enforceable obligations when they are part of the wage or salary or compensation of the employee. 6 In the case herein, the facts indicate that they are part of the salary of petitioner-appellant, hence included in gross income and, therefore, subject to income tax. Backwages are for earnings which a worker has lost due to his illegal dismissal. 7 We are of the view that like bonuses, backwages are not excluded in gross income and, therefore, subject to income tax as well. The exclusion provided in Section 28 (b) (7) (B) is in the nature of a separation pay benefit given to an employee as a consequence of his separation from the service due to the causes specified therein. The nature and essence of backwages indicate that they are not the class of income included in the aforementioned provision of law. Backwages and separation pay are distinct reliefs given to alleviate the economic damage suffered by an illegally dismissed employee. Backwages are forms of relief that restore the income that was lost by reason of unlawful dismissal. 8 They represent compensation that should have been earned by the employee but were lost because of the unjust or illegal dismissal. 9 Separation pay on the other hand is awarded when reinstatement is not possible. It is given as a form of financial assistance when a worker is dismissed in cases such as the installation of labor saving devices, redundancy, retrenchment to prevent losses, closing or cessation of operation of the establishment, or in case the employee was found to have been suffering from a disease such that his continued employment is prohibited by law. It is a statutory right defined as the amount that an employee receives at the time of his severance from the service and is designed to provide an employee with the wherewithal during the period that he is looking for another employment. It is oriented towards the immediate future, the transitional period the dismissed employee must undergo before locating a replacement job. 10 Thus, when an award of backwages is made, there is an acceptance that the employee was illegally or unjustly dismissed, and the backwages are the salaries he was supposed to have earned had he not been dismissed. It is as though he was not separated from employment, and as though he actually rendered service, thus the compensation. On the other hand, separation pay benefits, including that described in Section 28 (b) (7) (B) of the NIRC are those monies given an employee because of a separation from service, per se . The backwages petitioner-appellant received were given not because of his separation from service per se , but instead were awarded in representation of the salaries he should have actually earned had he not been illegally dismissed. cdll WHEREFORE, the petitioner for review is DENIED. Alio-Hormachuelos and Villarama, Jr . , JJ . , concur. Footnotes 1. Rollo , p. 06. 2. Rollo , p. 06 at pp. 06-21. 3. Petition for Review, Rollo , p. 08 at p. 10. 4. 213 SCRA 487. 5. Rollo , p. 59. 6. Manila Banking Corporation vs. NLRC, 279 SCRA 602 [1997]. 7. Citytrust Banking Corporation vs. NLRC, 258 SCRA 621 [1996]. 8. Lopez, Jr. vs. NLRC, 245 SCRA 644 [1995]. 9. General Textile, Inc. vs. NLRC, 243 SCRA 232 [1995]. 10. Lopez, Jr. vs. NLRC, supra .