Income Taxation of Employees in the Philippines

By: Tax and Accounting Center Philippines

In this article, let us share you an overview on how to compute basic income taxation of employees in the Philippines. For all we know, withholding tax on compensation is made every after payroll throughout the employment but this may not completely pay the income tax liability at the end of the calendar year. Here is how income tax of pure compensation works.

Income tax exemptions of Minimum Wage Earners

To preserve the minimum living standard of the Filipinos, employees paid minimum wage based on the minimum wage set by the DOLE – Regional Tripartite Wages and Productivity Board (RTWPB) of their location are being exempted from income tax on their compensation income. This covers the following:

• Basic salary at minimum wage
• Holiday pays for regular and special holiday pays in the Philippines
• Hazard pay
• Overtime pay for work beyond eight hours
• Night shift differential at 10% increment for work done from 10:00 PM to 6:00 AM

Minimum wage earners in the Philippines are not subject to withholding tax and are not required to file income tax returns at the end of the year for obviously, they, will not be any tax due under such exemption. However, should there be other taxable income that they shall ear from the employer or from other sources, then, they will lose their tax-exempt status and will be taxable. In such case, their compensation shall be withheld and they might be required to filed income tax return in the Philippines.

Taxable Compensation in the Philippines

As a rule, any amount that the employer gives his employees are taxable compensation, unless otherwise exempted by express provision of laws, rules, and regulations (e.g. de minimis benefits, minimum wage, separation fees, etc.), or that other tax types apply such as fringe benefits subject to fringe benefits tax in the Philippines. The designation of allowances (attendance bonus, travel allowance, food allowance, representation allowance) and other provision is not controlling as to the taxability. To claim non-taxable compensation would be to prove that a provision of law, rule or regulation expressly provides such exemption.

Your gross pay is not the amount subject to withholding using the 2009 withholding tax table. Certain items are deductible from such amount and certain tax-exempt provisions might have been included so they will have to be deducted to arrive at the taxable amount for withholding tax on compensation.

Exemptions of SSS, PHIC, HDMF & Union Dues. This refers to the share of the contribution of the employees to Social Security System (SSS), Philippine Health Insurance Corporation (PHIC or PhilHealth), Home Development Mutual Fund (HDMF of Pag-ibig), and Union Dues for their membership in a legitimate labor organizations or labor unions. SSS and PHIC have their corresponding table of deductions that you need to use, HDMF allowed contribution shall not exceed P100, while union dues is dependent upon the required amount under their union’s policy. Contributing more that the mandatory contributions on SSS, PHIC, and HDMF is not allowed as deductions as it is only limited to the mandatory amount.

Health and Hospitalization Insurance Premium. This applies to employees who secured health and hospitalization insurance in the Philippines, with family gross income of not more than P250,000. They are allowed a deduction of actual premium pair or P200 a month (P2,400 a year), whichever is lower.

Personal Exemptions of Employees. Every is allowed a basic personal exemption (BPE) of P50,000, and its every qualified dependent child ( not more than 21 years old, unmarried, dependent for chief support, and living with the employee) up to four (4) is entitled P25,000 each of additional personal exemption (APE) or up to P100,000. Alas! personal exemptions for employee with four qualified dependents is P150,000 in a calendar year. This amount is intended to cover the personal living expenses of the employee and its qualified dependents. In the 2009 withholding tax taxable, the personal exemptions and additional personal exemptions are already included.

Other tax-exempt provisions. This may refer to other employee provisions not subject to tax or covered by other tax types. Example is the de minimis benefits exempted from tax (e.g. rice allowance, monetized unused vacation leave credits, etc.). Another example is the fringe benefits covered by fringe benefits tax for managerial and supervisory employees (e.g. housing, car plan, etc.).

Employer’s withholding every payroll

Every payday, the employer will compute the withholding tax on compensation. It will remit the withholding taxes on compensation in the Philippines using BIR Form No. 1601-C not later than the 10th day of the month following the applicable payroll month. During January after the end of the year, the employer will make annual computations of compensation paid during the calendar year. Based on payroll details and tax status of employee, it will make annual computations of income tax using the tax table for 5-32%. It shall file BIR Form No. 1604 CF and will provide BIR Alphalist of Employees as an attachment. Employer will then provide each employee a Certificate of Withholding Taxes on Compensation or BIR Form No. 2316. Here is how the annual income tax on compensation of employees are computed:

Gross Compensation, excluding tax-exempt salaries

Less: SSS, PHIC, HDMF

Equals  Taxable Net Income before Personal Exemptions

Less:

Basic Personal Exemptions

Additional Personal Exemptions

Health & Hospitalization Insurance Premium

Equals Taxable Compensation Income

Multiplied by tax table rate 5-32%

equals: Tax Due

less: WithholdingTax Credits covered by BIR Form No. 2316

less Tax Due and Payable.

Annual Income Tax Returns of Employees

The common question is – As an employee, am I required to file annual income tax return in the Philippines?

Employees earning pure compensation income from a single employer who withheld correct withholding tax on compensation is no longer required to file annual income tax return. The certificate of withholding tax on compensation or BIR Form No. 2316 would be equivalent to such annual income tax return and we call this as “substituted filing”. Minimum wage earners are likewise not required to file income tax returns.

Under Section 51(a)2(b) of the Philippines Tax Code, employees deriving compensation concurrently from two or more employees at any time during the year shall file an annual income tax return in the Philippines using BIR Form No. 1700 not later then April 15 of the following year. Likewise, employees with other taxable income outside employment subject to 5-32% is also required to file annual income tax return. Employees who are at the same time engaged in trade or business are required to file income tax return using BIR Form No. 1701 not later than April 15 of the following year.

Disclaimer: This article is for general conceptual guidance only and is not a substitute for an expert opinion. Please consult your preferred tax and/or legal consultant for the specific details applicable to your circumstances. For comments, you may please send mail at in**@ta************.org.

By: Garry S. Pagaspas, CPA

Let me share you an overview on how corporate income taxation applies in the Philippines, in general. Let us start with the understanding of the thing called “corporation” by its nature as defined in the Corporation Code of the Philippines and for tax purposes as defined by the National Internal Revenue Code of the Philippines. Please refer hereunder for easy reference:

Corporation Code of the Philippines

“Section 2. Corporation defined. – A corporation is an artificial being created by operation of law, having the rights of succession and the powers, attributes and properties expressly authorized by law or incident to its existence.“

National Internal Revenue Code (NIRC), as amended

“Section 22(B). The term “corporation” shall include partnerships, no matter how created or organized, joint-stock companies, joint accounts (cuentas en participation), association, or insurance companies, but does not include general professional partnerships and joint venture or consortium formed for the purpose of undertaking construction projects or engaging in petroleum, coal, geothermal and other energy operations pursuant to an operating consortium agreement under a service contract with the government. X x x”

From the two definitions, the NIRC definition is much broader because corporation includes partnerships, association, and other juridical entities. This follows that for income tax purposes, there are only two (2) main classifications:

• Corporate income taxpayer for juridical entities using BIR Form No. 1702 (annually)/BIR Form No. 1702(Q); and
• Individual income taxpayer for non-juridical entities including estates and trusts using BIR Form No. 1701(annually) and BIR Form No. 1701Q(quarterly for those engaged in trade or business or practice of profession.

Further, for income tax purposes, a corporation is further classified as follows:

• Domestic corporation (DC) means a corporation created or organized in the Philippines or under its laws. Securities and Exchange Commission (SEC) issues a Certificate of Registration to domestic corporations and its legal personality commence upon the date of approval of its Articles of Incorporation.
• Resident foreign corporation (RFC) applies to a foreign corporation engaged in trade or business within the Philippines. SEC normally issues a License to do Business in the Philippines to authorize their engagement in trade or business in the Philippines. Examples of this are Philippine branch of foreign corporation, regional operating headquarters of multinational companies, regional or area headquarters of multinational companies, representative offices.
• Non-resident foreign corporation (NRFC) applies to a foreign corporation not engaged in trade or business within the Philippines. No need for License to do business as they do not normally have presence in the Philippines but allowed to earn income in a way or another.

Taxability of income of corporations would depend on the nature of income and the type of corporation. It would be too confusing to discuss them all – DC, RFC and NRFC, so I just limit the discussions to domestic corporations. Income as to nature of income may be classified as follows:

• Exempt income where the law, treaty or the regulations expressly provides that the same is exempt from income. Examples of this would be inter-corporate dividend from a DC to another DC or RFC, income from a time deposit of more than five (5) years. While not subject to income tax, the details of this income are required to be declared in BIR Form No. 1702.
• Final Income subject to final withholding taxes of varying rates corresponding tax required upon their payment of such income. Examples of income subject to final taxes are interest income on Philippine bank deposits, royalties, and others. The amount withheld constitutes the final payment of the tax and no additional amount shall be due but the details of income are required to be declared in BIR Form No. 1702.
• Capital gains subject to capital gains tax of 6% based on fair market value of the real property sold, or 5%/10% of the net capital gains on sales of shares of a domestic corporation not thru the local stock exchange. Again, details of income are required to be declared in BIR Form No. 1702.
• Ordinary income or those incomes not falling under any of the above classifications that is subject to the normal corporate income tax of 30% starting January 1, 2009.

In this post, we will discuss ORDINARY income tax computations so you will be guided comes the ITR deadlines. Mathematically, computation is quite simple:

Gross Sales/Receipts

Less Sales returns and allowances

Equals  Net sales/receipts

Less Cost of Sales

Equals Gross Income

Add Other taxable income

Equals Total Gross Income

Less Allowable Deductions

Equals Taxable income

Multiplied by 30% rate

equals Tax Due (compared to minimum corporate income tax (MCIT) 2% of gross income, whichever is higher

less Tax Credits.

less Tax Due and Payable.

The resulting amount will then be the amount that shall be paid to the BIR using BIR Form No 1702Q (Click to download Form) for quarterly filing not later than 60 days from end of the quarter, and BIR Form No. 1702 (Click to download Form) for annual filing not later than the 15^th day of the fourth month following the end of taxable year – calendar or fiscal year. If PEZA registered, 2% shall be paid to the municipality where business is located. We will concentrate however on non-PEZA corporations and partnerships for simplicity.

Net Sales/Receipts refers to the gross sales/receipts less cost of sales for seller of goods, or gross receipts less the sales discounts granted, and sales return actually made buy the buyers.

Cost of sales or service refers to the direct costs directly traceable to the finished product or service such as the direct materials used, the cost of workforce in the production, and the factory overhead incurred. This however does not mean that other expenses are not deductible. They are deductible under allowable deductions.

Other taxable income refers to other ordinary income earned during the period on top of the main activity of the corporate taxpayer. Example is interest income from affiliates or subsidiaries, income from sale of assets used in business, and other similar items auxiliary to the operations. Capital gains, exempt income and final income are not included herein.

Total Gross income is the amount being multiplied by 2% for computing minimum corporate income tax (MCIT), and the base for 40% optional standard deduction. MCIT is required for entities beginning the fourth (4) year of operations, except for certain industries exempted from MCIT like banks, insurance companies, finance companies, and the likes expressly provided in the Tax Code. Total gross income is the amount of taxable income before allowable deductions for other business expenses.

Allowable deductions refer to the ordinary, necessary and reasonable business expenses of the taxpayers in the conduct of trade or business. For tax purposes, taxpayer has the choice between the itemized deductions and the optional standard deduction (OSD) introduced by Republic Act No. 9504. Itemized deductions are those expenses traceable to the conduct of operations such as salaries, travel, rental and entertainment expenses, interest, taxes, losses, bad debts, depreciation, depletion, charitable and other contributions, research and development, pension trust, and the likes. In itemized deductions, claimed expenses are required to be substantiated with sufficient documents, if any, like official receipts, invoices, and the likes; must observe the limitations on deductibility on certain items, like interest expense, representation and entertainment, and the likes; and must have been withheld the proper amount upon its payment or accrual. For failure to do so, the expense will not be allowed as deduction and the corporate taxpayer maybe assessed with additional income taxes, plus penalties, if owing.

On the other hand, OSD is an alternative of the taxpayer where 40% is being allowed to be deducted from the gross income without need of substantiation but is irrevocable during the taxable year applied. However, the obligation to withhold on related expenses still remains. As to which is more beneficial between the two, would depend on the circumstances of the corporation because it may be affected by the nature of the industry, the amount of mark-up and other factors. If you would opt for OSD, then, you apply the same on the first quarter of the year and all throughout within the same taxable year.

For tax due purposes, the amount arrived at above using the 30% of taxable income is being compared with the MCIT of 2% of gross income and the higher amount is the one deducted with the allowable tax credits, if any.

Tax credits on the other hand refers to those allowed to be deducted from the tax due like creditable withholding taxes (CWTs) supported by Certificates (BIR Form No. 2307) issued by clients and customers who withheld certain amounts of income tax upon payments. Income taxes paid abroad also fall under this category subject to certain conditions. For subsequent taxable years, prior year’s excess tax credits are also deductible, or taxes in the original return filed, if you are filing an amended tax return.

The new November 2011  version of Corporate Income Tax Return

After computing the above, you are now ready to prepare and file the income tax return (ITR). With the revision of the BIR Form No. 1702 last 2011 (Click to Download), the annual ITR seems to be another challenge. I strongly suggest that you exert extra effort and due diligence in the preparation of these returns. Hire a knowledgeable one or educate yourself with the technicalities to save your funds from being wasted on penalties. Unintended and simple errors and misstatements may prove to be costly, if not, much discomfort on your part. You can amend or revise duly field tax returns as a matter of right within three (3) years from filing not later than due date or from late filing (if filed beyond due date) provided there is yet no ongoing examination of the tax authorities. See to it that computations are in order, that substantiations and documents required as a condition for deductibility of expenses are on file, and that the claimed creditable withholding taxes are properly supported with certificates.

Related Articles:

8 Ways to Learn BIR Tax Compliance

How to Compute OSD

Tax Savings under OSD

(Garry S. Pagaspas is a Resource Speaker with Tax and Accounting Center, Inc. He is a Certified Public Accountant and a degree holder in Bachelor of Laws engaged in active tax practice for more than seven (7) years now and a professor of taxation for more than four (4) years now. He had assisted various taxpayers in ensuring tax compliance and tax management resulting to tax savings rendering tax studies, opinions, consultancies and other related services. For comments, you may please send mail at garry.pagaspas(@)taxacctgcenter.ph.

Disclaimer: This article is for general conceptual guidance only and is not a substitute for an expert opinion. Please consult your preferred tax and/or legal consultant for the specific details applicable to your circumstances. For comments, you may also please send mail at info(@)taxacctgcenter.ph, or you may post a question at Tax and Accounting Center Forum and participate therein.

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