The COVID-19 pandemic distressed the overall economic fitness of countries all over the world in much the same way that it has compromised the physical health and well-being of global citizens. In the Philippines, among its adverse effects is the abrupt rise in the unemployment rate, as shown in the statistics that almost 27 million Filipinos were jobless in July.
The prolonged community quarantine in Metro Manila resulted in an economic downturn (a grinding halt, for some) as the business operations of establishments across many industries continue to be restricted. With no definite cure in sight after half a year of restrictions to date, some employers are faced with tough decisions in order to keep their businesses afloat. To cut their losses, many businesses have considered offering early retirement packages, a less drastic measure than lay-offs.
TAX-EXEMPT RETIREMENT BENEFITS
To alleviate the plight of displaced retirees, Section 5 of Republic Act No. 11494, otherwise known as the Recover as One Act (Bayanihan II) provides tax exemptions for retirement benefits granted between June 5 and Dec. 31, “provided that any re-employment of such official or employee in the same firm, within the succeeding 12-month period, shall be considered as proof of non-retirement and shall subject the benefits received to appropriate taxes.”
Bayanihan II was signed by the President on Sept. 11. Even without it, current law provides tax exemptions for retirement benefits subject to conditions. Under Section 32(B)(6)(a) of the Tax Code, tax-free retirement benefits are those received under the mandatory provisions of the Labor Code (i.e., when an employee retires upon reaching 60 years old but not beyond 65 years and has served his employer for at least five years) and those received from reasonable retirement plans of private entities, provided that the employee is at least 50 years of age, has served the same company for not less than 10 years at the time of retirement. Employees may avail of this exemption under the Tax Code only once. The tax exemption of retirement benefits is not liberally available due to these conditions which must be met.
Nonetheless, Bayanihan II broadened the income tax exemption of retirement benefits received by employees between June 5 and Dec. 31, as it does not impose any age or years of service requirement.
Certainly, this relaxed tax exemption is a welcome addition. However, there are issues and questions that need to be resolved as to its implementation and application.
TIMING OF RECEIPT VIS-A-VIS RETIREMENT DATE
One is primarily about the interpretation of the term “received” as used by the new law since the provision is explicitly time-bound. Does it include constructive receipt or only actual receipt of the retirement benefits?
The principle of constructive receipt requires, among others, that the income is available to the taxpayer without substantial limitation or restrictions. As such, if an employee’s effective retirement date falls before June 5, but the actual payout date of the retirement benefit takes place any time between June 5 and Dec. 31, would the tax exemption apply? Conversely, if an employee retired effective Dec. 31, with retirement benefits to be paid in 2021, would the tax exemption still be operative? Note that in this latter case, the effective retirement date falls within the exemption period; however, the date of the actual receipt is beyond the specified period.
Another crucial point is the restriction on re-employment within the subsequent 12 months by the same firm. Will this condition apply if the employee is rehired as an independent consultant or contractual worker? While independent consultants are technically not considered employees, will such instances be considered “re-employment” for purposes of claiming the tax exemption of retirement benefits received as a former employee of the firm?
The Tax Code provides that the exemption may only be availed of once. Given that the Bayanihan II is a special law, would this mean that an employee who previously received or subsequently receives retirement pay from another employer can still avail of the tax exemption under the Code?
SEPARATION PAY OR RETIREMENT PAY?
The tax exemption of retirement benefits under Bayanihan II is clearly meant to benefit employees who do not meet the conditions under the Tax Code. Otherwise, if the conditions are met, there is no need for this new law. For instance, exemption is also available for separation pay received by employees who are laid off due to business losses caused by the pandemic. It therefore begs the question — what additional advantage does this new law give to taxpayers?
In 2012, two rulings (BIR Ruling Nos. 455-12 and 555-12) were issued in which the BIR, in a case of involuntary separation, separately assessed the taxability of (1) separation pay and (2) the vested retirement pay (which formed part of the separation package) received by the employees. Since the subject employees did not meet the conditions under the Tax Code, the BIR ruled that the vested retirement pay was taxable.
Under Bayanihan II, in a similar case where an employee who is laid off receives his vested retirement pay as part of his separation package, the employee should be able to enjoy a tax exemption on both payments without question. The tax-free treatment of early retirement benefits should no longer be in question.
These are only some of the questions and concerns about the tax exemption of retirement benefits under Bayanihan II. The implementing rules and regulations ought to address them, and guide taxpayers on proper compliance.
Like any new law, Bayanihan II will be scrutinized and tested against enterprise and street-level experience. Regardless of some grey areas in its provisions, however, there is a reason for retirees to welcome the new tax exemption. In an economic recession driven by a pandemic, any benefit or relief goes a long way in trickling social assistance down to the roots.
The views or opinions expressed in this article are solely those of the author and do not necessarily represent those of Isla Lipana & Co. The content is for general information purposes only and should not be used as a substitute for specific advice.
Patricia Loren Roma-Carreon is a Senior Associate at the Tax Services Department of Isla Lipana & Co., the Philippine member firm of the PwC network.
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