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Taxation of retirement benefits

Taxation of retirement benefits


Prior to January 01, 1998 when Republic Act (“RA”) No. 8424 or Tax Reform Act of 1997 took effect, the coverage of the income tax exemption of retirement benefits under Section 32(B)(6)(a) of the said Code was confined to retirement benefits received by officials and employees in private firms in accordance with a reasonable private benefit plan. A “reasonable private benefit plan” is a pension, gratuity, stock bonus or profit-sharing plan maintained by the employer for his officials and employees which is qualified as such by the Bureau of Internal Revenue (BIR) upon satisfaction of the requirements imposed under its Revenue Regulations No. 1-68, as amended.

Aside from the requirement that the plan should be reasonable, the Tax Code requires that the retiring employee should have been in the service of the same employer for at least ten years and is not less than fifty years of age at the time of his retirement. The taxpayer should not also have previously availed of the privilege under a retirement benefit plan for the same or another employer. The age and length of service requirements imposed under RA No. 4917 [now Section 32(B)(6)(a) of the Tax Code] are deemed by the BIR as minimum requirements for retirement benefits under a reasonable private plan to qualify for tax exemption. Thus, higher age and length of service requirements maybe required by the provisions or rules and regulations of the retirement plan and these shall prevail over the requirements imposed under the Tax Code in case of conflict. (BIR Ruling No. 052-2000, October 30, 2000)

To promote equity in the taxation of retirement benefits, RA No. 8424 extended the income tax exemption of retirement benefits under RA 4917 to those received by officials and employees in the private sector under the provisions of RA No. 7641. R.A. No. 7641 requires employers, in the absence of retirement plan or agreement, to pay employees upon reaching the age of sixty years or more, but not beyond sixty-five years and who have rendered at lease five years in the said establishment, a retirement benefit equivalent to at least one-half month for every year of service. Compared to RA No. 4917, RA No. 7641 specifies a shorter length of service but longer age requirement.

The BIR held in various rulings that the tax exemption privilege granted to retirement benefits under RA No. 7641 can only be invoked when there is no existing retirement plan, CBA, or other applicable employment contract in the establishment. In the presence of a retirement plan duly approved by the BIR, CBA, or applicable employment contract providing for retirement benefits, the same shall be followed provided that it shall not be less than those provided under RA No. 7641.

Applying the rules on the age and length of service requirements under the two laws, it is possible, for example, that a 61-year old employee who has rendered nine years of continuous service will be subject to tax if he receives the retirement benefits from a BIR approved retirement plan, but not if his employer does not maintain a retirement plan or if the retirement plan is not a BIR approved plan since he will both satisfy the age and length of years service requirements under RA 7641. Seeing apparently the absurdity of this situation, the BIR attempted to reconcile the tax exemption of retirement benefits under RA 4917 and RA 7641 by exempting from income tax the retirement benefits under a reasonable private benefit plan established by employer which is equal or less than the minimum retirement benefit provided by RA 7641, while maintaining the requirements or conditions of RA 4917 in case the retirement benefit exceeds the minimum amount of retirement benefit imposed under RA 7641. (DA-151-2004, March 31, 2004)

With all these developments and the complexities related to the availment and payment of retirement benefits, it maybe high time for the BIR to amend the existing revenue regulations, particularly RR No. 1-68 as amended, by incorporating th e rules promulgated by the BIR in its various rulings to clarify the issues and dispense with the need for taxpayers to secure a ruling on similar cases.

(Author is a tax manager at Punongbayan & Araullo, a member firm of Grant Thornton International. For comments and inquiries, please e-mail or call 886-5511.)