The end of the year is fast approaching. Before we get to celebrate and revel in merrymaking this coming holiday season, you and your finance team will need to face one last fight: the year-end closing of books and complying with other reportorial requirements.
One of the requirements every year-end is the annualization of employees’ compensation income to determine each employee’s amount of tax due for the calendar year. Any excess tax withheld over the “should be” tax due shall be refunded to employees, while the deficiency tax shall be deducted from the last payment of the employees’ compensation for the calendar year.
The question is: are you ready to annualize? Are you aware of the changes in tax rules? Do you know what the issues are or other factors you have to consider in annualizing your employees’ compensation? Let us take a closer look at how you can prepare for annualization this year.
Since the introduction of the withholding tax system, many of the rules have changed. A recent and notable one is the treatment of certain employee benefits based on Revenue Memorandum Circular (RMC) No. 50-2018.
In RMC No. 50-2018, the Bureau of Internal Revenue (BIR) changed its position on the tax treatment of de minimis benefits that exceed the threshold provided under existing regulations. Further, the RMC clarified that, in case an employer provides benefits that exceed the de minimis amount, the excess shall be included in the P90,000 non-taxable 13th month pay and other bonuses. The amount exceeding the said P90,000 non-taxable benefits is now subject to income tax and, consequently, to withholding tax on compensation.
Previously, the tax treatment of excess de minimis benefits over the non-taxable 13th month pay and other benefits depended on the income recipient, i.e., it is subject to withholding tax on compensation, if the benefit is provided to rank-and-file employees, and to fringe benefits tax, for managerial or supervisory employees.
The change provides equality to all employees, since they will receive the same net amount of de minimis benefits, regardless of their position.
Another change brought about by RMC No. 50-2018 is the treatment of premiums on group insurance borne by the employer. The BIR clarified that this type of benefit should be part of the other benefits of employees that are subject to the 13th month pay and other benefits threshold.
Previously, the BIR was consistent in its position that the group insurance provided by the company to its employees is not considered a taxable benefit. Hence, this change in the BIR interpretation raised many concerns among taxpayers, as this could significantly affect the tax that will be deducted from employees’ salaries. Also, RMC No. 50-2018 does not specify the effectivity of the new tax treatment. Will the premiums paid this year, but prior to the issuance of RMC No. 50-2018, be considered taxable when the employer computes for the annualized withholding tax due of the employees? Or will this apply prospectively? How about employees who resigned prior to May 2018 (i.e., the date of issuance of RMC No. 50-2018), on which the annualized withholding tax was already computed? We hope the BIR can clarify this matter before the year ends.
Meanwhile, a welcome change to our taxation is the amendment of our 1997 Tax Code. Owing to the enactment of Republic Act (RA) No. 10963, known as Tax Reform for Acceleration and Inclusion (TRAIN) Law, employees now enjoy higher take-home pay thanks to a decrease in their personal income tax burden. Employees with an annual taxable compensation income of P250,000 and below are now exempt from income tax and, consequently, to withholding tax on compensation. While the tax brackets were updated, however, the top marginal rate has been increased to 35% (for employees whose annual taxable income exceeded P8,000,000, they have to pay higher income tax). Likewise, the threshold for 13th month pay and other benefits has also been increased from P82,000 to P90,000.
The basic personal exemption, additional exemption for dependents, and deduction for the amount of premiums paid on health and/or hospitalization insurance, unfortunately, were removed. This is because the threshold amount of tax exempt income was already raised to P250,000. This means that, regardless of the tax exemption status of employees, the first P250,000 of the employee’s annual compensation income is now exempt from income tax. This relieves employers of the burden of monitoring the tax exemption status of their employees.
Please note that Revenue Regulations (RR) No. 11-2018, as amended, increased the existing threshold of certain de minimis benefits: (1) Rice subsidy – from P1,500 to P2,000 per month; (2) Medical cash allowance to dependents of employees – from P200 to P250 per month; and (3) Uniform and clothing allowance – from P5,000 to P6,000 per year.
Another noteworthy point to consider in the annualization is the imposition of tax on the year-end accrual of bonus by the employer for its employees. In the case of ING Bank vs. Commissioner of Internal Revenue (Gross Receipts No. 167679), the Supreme Court held that the obligation of the payor/employer to deduct and withhold the related withholding tax arises when the income was paid, accrued, or recorded as an expense in the payor’s/employer’s books, whichever comes first. This means that, in addition to the tax already withheld on salaries received by the employees during the year, the employers may also be liable for the withholding tax on the bonus, even if the same has not yet been received by their employees.
Another commonly overlooked item during annualization is employee’s income from the previous employer(s), if the employee has two or more consecutive employers within the taxable year. In this case, the current employer who will annualize the said employee’s tax due at year-end shall include the employee’s amount of income from their previous employer(s) in computing the annualized income tax due of the employee.
For the tax withheld by the employer, they are required to issue BIR Form No. 2316 (Certificate of Compensation Payment/Tax Withheld for Compensation) as proof that the employee has already paid for the tax through the employer. This shall serve as the employee’s annual income tax return if the employee is qualified for substituted filing, as provided in RMC No. 1-2003.
Understanding the concept of annualization, staying up to date, and observing compliance with all the changes will reduce your company’s risk of being assessed for deficiency tax. This would also help employers in creating a competitive compensation package that would be favorable for employees.
Change is the only constant thing in this world, a mantra that seems to have been taken up by our tax authorities. The dynamic nature and behavior of taxation in the Philippines makes it more challenging for taxpayers to comply. Knowing year-end compliance requirements and keeping up to date with recent trends in taxation are among the ways businesses can mitigate the risk of possible exposure. At the end of the day, while compliance can be challenging (and costly), it is a form of investment for the welfare of your people, a valuable asset in any organization.
Christian Derick D. Villafranca is a senior of the Tax Advisory and Compliance Division of P&A Grant Thornton. P&A Grant Thornton is one of the leading audit, tax, advisory, and outsourcing services firms in the Philippines.