The COVID-19 pandemic brought with it an unprecedented and drastic change in how business was conducted. Businesses in many places were deeply affected, and the Philippines were no exception. Some companies managed to survive; others struggled, resorting to cutting costs or laying off employees in order to stay afloat and compete in the new normal. As a result, many employees were involuntarily separated from their employers.
On the other hand, in order to adapt to the new normal, some businesses implemented a work-from-home setup to help ensure business continuity, on top of securing the safety of their employees from contracting the virus. However, not all staff have the capacity to adapt with ease. For some, working in isolation means putting their mental health at stake, all the while finding it difficult to cope with anxiety in the virtual workplace, with many employees admitting that working from home has made their jobs monotonous. As a result, burnout became a problem, leading to resignations by employees concerned for their mental well-being.
Separation involves the payment of separation pay or final pay, depending on whether the employee’s departure was involuntary or voluntary. The most common questions arise in such situations involve the taxability of the payments received and the tax treatment of these payments.
INVOLUNTARY SEPARATION DUE TO RETRENCHMENT
The Supreme Court defined retrenchment as the termination of employment initiated by the employer through no fault of and without prejudice to the employees — dismissing them because of losses in business operations during times of recession, industrial depression, or seasonal fluctuations.
What can a retrenched employee expect from an employer? The Labor Code states that separation pay should be provided if the termination of the employee is due to closure or cessation of the business, installation of labor-saving devices, redundancy, retrenchment, and if the employee has been found suffering from any disease and whose continued employment is prohibited by law or is prejudicial to the employee’s health as well as the health of co-workers.
Is a retrenched employee’s separation pay subject to tax? The Tax Code, as amended, provides that any amount received by employees or their heirs from the employer due to separation because of death, sickness or other physical disability, or for any cause beyond the control of the employee, shall be exempt from tax. However, only the monetized value of unutilized vacation leave credits of 10 days or less is not subject to income tax. Conversely, the cash equivalent of vacation leave credits exceeding 10 days is subject to income tax or fringe benefits tax.
However, since tax exemptions are construed strictly against the taxpayer and liberally in favor of the government, retrenched employees are not automatically entitled to income tax exemptions on the separation pay received. To prove the eligibility for tax exemption of the separation pay, the employer or the employee must secure a Certificate of Tax Exemption (CTE) from Income Tax and Withholding Tax. To facilitate the processing of requests for tax exemption due to retrenchment, the following documents, as prescribed in Revenue Memorandum Order (RMO) No. 66-2016 must be submitted to the Revenue District Office or appropriate Large Taxpayers Office where the employer is registered:
1. Letter request from the Official/Employee (or by the heirs) or the Employer for the exemption of separation benefits from income tax and withholding tax.
2. Written notice to the employee and the appropriate Regional Office of the Department of Labor and Employment at least 30 days before the effectivity of termination, specifying the grounds for termination.
3. Board Resolution, in case of a juridical entity, or affidavit to be executed by the owner, in case of a sole proprietor, stating the following:
a. That the retrenchment is reasonably necessary and likely to prevent business losses;
b. That the losses, if already incurred, are not merely de minimis, but substantial, serious, actual, and real, or if only expected, are reasonably imminent with appropriate supporting evidence of said losses;
c. That the retrenchment is made in good faith for the advancement of its interest and not to defeat or circumvent the employees’ right to security of tenure; and
d. That the selection of employees to be terminated has been made in accordance with fair and reasonable criteria.
We have heard many stories from family and friends about employee resignations due to mental health issues, which raise some concerns on the taxability of the final salary of the resigning employees.
Resigning employees are not entitled to separation pay unless provided for by their employment contracts or as stipulated in the Collective Bargaining Agreement for companies with existing labor unions.
To date, the Bureau of Internal Revenue (BIR) has not yet released issuances clarifying the tax implications of resignations due to mental health. However, since it is the employee who initiates the termination of employment, existing BIR rulings state that the payment of the final salary is still subject to tax since what will be paid to the employees is “earned” over the course of the employment.
We are all paddling in the same ocean, but we are not in the same boat; some are in yachts, some in canoes, some barely swimming, and some need help to stay afloat. Layoffs and resignations were prevalent this year. Here’s hoping that as the calendar flips, employees get to retain their jobs and businesses will thrive again. Everyone’s health — physical, financial, and mental — matters above all.
Let’s Talk Tax is a weekly newspaper column of P&A Grant Thornton that aims to keep the public informed of various developments in taxation. This article is not intended to be a substitute for competent professional advice.
Runell Alvyn V. Sarmiento is a senior in charge from the Tax Advisory & Compliance division of P&A Grant Thornton, the Philippine member firm of Grant Thornton International Ltd.