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Separation from work…is there a bright side?

Separation from work…is there a bright side?

By Clarissa R. Hornilla

The impact of the economic crisis on business has been more severe than we expected.
 
Current difficulties have prompted some companies to downsize operations in the Philippines, restructuring existing entities through business combinations, or completely closing down. As a result, a lot of employees have been laid off from work.

Whatever the reason for losing one’s job, in the midst of an economic crisis, finding new work prospects is very challenging, especially for those over 40 years old. Although employers promise to give competitive and generous severance pay packages, losing a job is painful.

For ordinary Juan dela Cruz, who worries about where to get the money to sustain his family’s basic needs after being laid off, any reduction of his severance pay makes a big difference.

Should he still worry about the tax that will be deducted from his last pay? Are separation benefits taxable?

Section 32 (B)(6)(b) of the Tax Code, as amended, provides that any amount received by an official or employee, or by his heirs, from the employer as a consequence of separation from service because of death, sickness or other physical disability — or for any cause beyond the control of said official or employee, such as retrenchment, redundancy, or cessation of business — is exempt from income tax and, consequently, from withholding tax.

The phrase "for any cause beyond the control of the said official or employee" connotes involuntariness on the part of the official or employee. Separation from the service of the official or employee must not be asked for or initiated by him. This means the separation was not of his own doing.
For employee benefits to be granted tax exemption, two conditions must be present:

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.

However, the exemption shall be limited only to benefits given to the employee as a result of his separation.

As cited in previous tax rulings, these benefits include vested retirement benefits from the retirement plan, employee’s entitlement to the company’s share in the provident fund, financial assistance equivalent to 75% of final monthly salary for every year of service, separation pay for every year of service, and terminal leave pay, i.e., the accumulated vacation and sick leave credits, among others.

However, salaries and bonuses paid up to the date of termination are considered compensation subject to income tax and to withholding tax on compensation.

It is noted that the same treatment applies to benefits given to an employee who voluntarily resigns due to health reasons that have prevented him from returning to work.  The Tax Code provides that amounts received by an employee due to sickness or physical disability are also exempt from income tax.

Bureau of Internal Revenue (BIR) Ruling DA-383-06, dated June 21, 2006, ruled that if the employee has a complicated sickness and cannot return to work — as advised by his attending doctor — because his illness is aggravated by his work condition and his continued employment with the company might worsen the illness or even jeopardize his life, any and all amounts to be received by him/her as a result of separation from service are exempt from income tax and consequently from withholding tax.
However, the BIR required that a medical certificate from a Public Health Authority be submitted as proof that the employee’s condition renders him no longer fit to work.

The expenses incurred by the employer in providing these types of benefits are deductible from the gross income for being an ordinary and necessary trade or business expense. 

In the existing rules, it is not clear whether an approval or confirmation from the BIR must be obtained regarding the tax exemption of these benefits.  Notably, several taxpayers recently obtained tax rulings from the BIR on this matter, despite the fact that this has already been included in the "no-ruling areas" announced by the BIR.  It is almost certain, though, that in case the amounts of these benefits are significant, the BIR will evaluate closely the nature of these payments in case of a tax investigation.

Whether or not the separation is beyond the control of the said employee will be determined on the basis of prevailing facts and circumstances.

In this regard, employers are well-advised to keep documents to establish the circumstances for the separation of the employee and the amounts of benefits paid to them.

Moreover, they should comply with the existing requirement to attach a document, which establishes the nature of these separation benefits, in their monthly return for the period in which the amount was paid due to involuntary separation.

This article is not intended to be a substitute for professional advice.  For comments and inquiries, you may e-mail the author at Clarissa.Hornilla@ph.gt.com.  For other tax concerns, please check out our other tax services.