Securing Tax Exemption on Separation Pay

Under the National Internal Revenue Code Section 32 (B) (6) (b), separation benefits received by an official or employee or by his heirs from the employer are exempt from income tax and likewise from withholding tax on compensation provided however that the cause of such separation is due to:

Death
Sickness or other physical disability and;
Any cause beyond the control of the said official or employee

Since a tax exemption is strictly construed against the one claiming the exemption because of its contrary to the lifeblood theory taxation. The burden of proving and request for rulings are usually secured by employee of private entities who are separated from employment. The employee submits to his employer the issued ruling to prove that his separation benefits are exempt from income tax and that no withholding taxes should be deducted therefrom. Without a ruling, the employer deducts withholding taxes and remits the same to the BIR to avoid the possibility of being assessed.

The Bureau of Internal Revenues (BIR) issued Revenue Memorandum Orders (RMO) No. 26-2011 and No. 66-2016 for the documentary requirements to be submitted to the Revenue District Officer (RDO) where the employer is originally registered before issuing Certificate of Tax Exemption (CTE) for each availing official/employee.

Letter request from the Official/Employee ( or by his heirs) or the Employer for the exemption of separation benefits from income tax and withholding tax
In case of:
1. Death — Certified true copy of Death Certificate
2. Sickness/Physical Disability
  1. Sworn Affidavits to be executed by the employer’s physician or the employee’s attending physician and the Head of Office/Entity or his representative, attesting to the fact that the retiring/separated official or employee is suffering from a serious illness or physical disability that affects the performance of his duties and endangers his life, if he continues working;
  2. Clinical Record of the official/employee concerned indicating the history of illness/physical disability and initial diagnosis; and
  3. Laboratory examination confirming the illness suffered by such official/employee or medical certificate confirming the physical disability of the official/employee.
3. Instances that beyond the control of the official or employee, regardless of age and length of service;
  1. Written notice to the employee and the appropriate Regional Office of the Department of Labor and Employment (DOLE) at least thirty (30) days before the effectivity of termination, specifying the ground for termination.
  2. Board Resolution, in case of a juridical entity, or sworn affidavit to be executed by the owner, in case of a sole proprietor, stating the following:
    1. For installation of Labor-saving Devices — That there has been an introduction of machinery, equipment or other devices, with brief description of the use of said machinery, equipment or device; That the introduction of the machinery, equipment or other device has been done in good faith and for valid reason; That there is no other option available to the employer than the introduction of machinery, equipment or other device; and That the selection of employees to be terminated has been made in accordance with a fair and reasonable criteria.
    2. For redundancy – That there has been superfluous positions or services of employees; That the positions or services are in excess of what is reasonably demanded by the actual requirements of the enterprise to operate in an economical and efficient manner; That the redundant positions have been abolished in good faith; and That the selection of employees to be terminated has been made in accordance with a fair and reasonable criteria.
    3. For retrenchment — That the retrenchment is reasonably necessary and likely to prevent business losses; 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; 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 That the selection of employees to be terminated has been made in accordance with a fair and reasonable criteria.
    4. For Closure or Cessation of Operation — That the management has decided to close or cease operation of the company; that the closure or cessation of operation has been made in good faith; and that there is no other option available to the employer except to close or cease operation.
  3. In case of redundancy, an additional proof should be provided such as but not limited to the new staffing pattern, feasibility studies/proposal, on the viability of the newly created positions, job description and the approval by the management of the restructuring.

Except form the above lists, the BIR may still require additional requirements to prove entitlement to tax exemption under the prevailing circumstances.

Since the legality of the termination from DOLE are not required under the above mentioned RMO, the employer bears the burden of proof that the separation was beyond the control of the official or employee and that the separation benefit wasn’t subjected in withholding tax on compensation. In case of illegality of termination or the cause of the termination are not listed on the above mentioned NIRC and was found during BIR audit, there will be assessment for deficiency corporate income tax and withholding tax on compensation, including interest and surcharges.