Expats under split-pay arrangements

Expats under split-pay arrangements

By Alfredo Q. Merto

Multinational companies or foreign corporations that have come to establish their presence in the Philippines employ quite a number of expatriates. These expatriate employees, in recognition of their critical role in the success of the business, are offered reasonable compensation package to entice them to accept the Philippine assignment.

Many companies also adopt split-pay arrangements where a portion of the salaries is paid outside the Philippines. In certain cases, the salaries paid abroad are charged back at a later time to the Philippine company. In other cases, that portion of the salaries is shouldered by the foreign company (affiliate or parent) and is, therefore, never booked by the Philippine company as salaries expense.

Although there is nothing wrong with these arrangements, the company-employers based in the Philippines are often faced with the question of whether they are liable to withhold and remit the tax on the portion of salaries paid outside the Philippines, especially if the said employer does not book such salaries.

Are salaries paid abroad in respect to services performed by expatriates in the Philippines considered as taxable income in the Philippines? Are expatriates required to file annual income tax returns (ITR) at the end of the calendar year on such income paid outside the Philippines?

Fortunately, these are no longer gray areas. The Bureau of Internal Revenue (BIR) has already confirmed its position in a number of rulings issued to answer these questions.

In BIR Ruling No. DA-192-2008, the BIR definitively ruled that expatriate employees should declare as part of their salaries all compensation paid outside the Philippines relating to work performed in the country, whoever is the payor and wherever it is paid.

The Philippine employer may not be liable as a withholding agent if the salaries paid in the foreign country are not charged back to it. In such case, the expat employee will be liable to file an annual ITR and remit to the BIR the additional tax for the portion of the salaries paid offshore which have not been subjected to withholding tax.

This ruling is completely in accord with the provisions in the regulations on how expatriates are taxed in the Philippines and on the obligations of the employer.

Under Philippine tax laws, expatriates-employees are treated as alien individuals, either as a resident alien (RA) or a nonresident alien (NRA) depending on their intention or the duration of their stay in the Philippines. A NRA is further classified as engaged (NRAE) or not engaged (NRANE) in trade or business in the Philippines. If he comes and stays in the Philippines for an aggregate period of more than 180 days during any calendar year, he is said to be a NRAE in trade or business. Otherwise, he is classified as a NRANE in trade or business.

The classification is necessary to determine the applicable income tax rate, i.e., 5% to 32% in the case of NRAE and RA, and 25% final tax in the case of NRANE.

Whether resident or nonresident, however, alien individuals are taxed only on their Philippine-sourced income, that is, compensation for labor or personal services performed in the Philippines.

Notably, the law does not mention or qualify where payment should be coming from. Thus, whether paid here or abroad, the compensation for service rendered in the Philippines is considered income sourced within the Philippines.

On the other hand, under Revenue Regulation No. 2-98, exercise of control over the payment of salaries is one of the criteria in determining liability as a withholding agent. Consistent with this rule, the 2008 ruling confirmed that the employer in the Philippines will not be required to withhold tax on the portion of salaries paid outside the Philippines and shouldered by the foreign payor under the split-pay arrangement, for the reason that it has no control over the said payment.

The question now is how will the BIR collect the tax on th e portion paid outside the Philippines?

This finds solution under Sec. 51 of the Tax Code which requires every RA or NRA engaged in trade or business in the Philippines to file a Philippine ITR or annual information return. The expatriate falling under these classifications should include in his ITR the portion of salaries not subjected to withholding tax and pay the corresponding taxes due upon filing the return.

However, a NRANE in trade or business in the Philippines whose income has been subjected to the correct final withholding tax need not file an annual ITR.

Expat employees and their employers as well will not usually want to be exposed to deficiency taxes. It is, however, difficult to be compliant if the tax rules are not clear. Clarifications, such as this ruling on the tax liabilities of expat employees and the employer as a withholding agent should enable the expat employees and their employers to property comply with their tax obligations.

(The author is a senior tax manager at Punongbayan & Araullo, a member firm within Grant Thornton International Ltd. For comments and inquiries, please e-mail the author or call 886-5511.)