Understanding The Non-Taxable Compensation In The Philippines

Every payday, employees are elated to receive their monthly compensation. Once employees check their payslips, some wonder if their deductions are correctly calculated and properly deducted from their salary. To help employees and companies be informed of the associated rules and regulations, non-taxable compensation in the Philippines is briefly discussed in this article.

As a general rule, all forms of compensation are taxable, except for those specifically provided under the laws, rules, and regulations in the Philippines. The following are the non-taxable compensations:

• MINIMUM WAGE EARNERS

No withholding tax shall be required for those employees who are identified as minimum wage earners in the private or public sectors as defined in RR 2-98, as amended by RR 11-2018. There’s no effect on the net taxable compensation unless it exceeds the PHP 90, 000 annual limit of the 13th-month pay and other benefits and unless the annual net taxable income exceeds PHP 250, 000.00 during the year. Statutory minimum wages that are non-taxable are the following:

1. Basic Minimum Wage
2. Holiday pay
3. Overtime pay
4. Night shift differential
5. Hazard pay

• 13th MONTH PAY AND OTHER BENEFITS (MAXIMUM OF P90,000)

13th-month pay is required by law to provide additional compensation to low-income earners to protect the level of real wages from the ravages of global inflation. This is to show concern for the masses so that they can properly celebrate Christmas and the New Year. Employers are required to pay their rank-and-file employees their 13th month’s pay, regardless of the nature of their employment and irrespective of the methods by which their wages are paid. An employee at the management level is not entitled to the 13th month’s pay unless it is provided and granted by the company. The employee should work for at least one month during a calendar year to be entitled to a 13th-month pay benefit, and the computation will be further discussed in another article.

13th-month pay and other benefits will be treated as non-taxable as long as they do not exceed the PHP 90,000 annual limit. Other benefits may include those that are not expressly stated in the non-taxable deduction in BIR Form 2316. Examples of other benefits include communication allowance, transportation allowance, birthday bonus, performance incentive, loyalty award, referral incentive, and other related employee benefits.

• DE MINIMIS BENEFITS NOT SUBJECT TO WITHHOLDING TAX

De minimis benefits are facilities and privileges of relatively small value. This is not subject to income tax as well as withholding tax on the compensation income of both managerial and rank-and-file employees. De minimis benefits up to the maximum amount do not require an official receipt or sales invoice unless expressly stated in the regulation. The enumeration of the tax-exempt de minimis benefits under Train RA 10963 will be discussed in another article.

• SSS, GSIS, PHIC, and PAG-IBIG CONTRIBUTIONS AND UNION DUES (EMPLOYEE SHARE ONLY)

One of the exclusions from gross compensation and exemption from taxation is the mandatory employee share of the SSS, GSIS, PHIC, and Pag-IBIG contributions. Non-taxable compensation is up to the prescribed maximum amount of contributions; contributions in excess of those declared to government agencies will be treated as taxable compensation. SSS provides benefits and social security in the event of unemployment, maternity, sickness, disability, retirement, funeral, and death benefits. PHIC, otherwise known as PhilHealth, provides health insurance coverage and ensures affordable, acceptable, available, and accessible healthcare services for its members. HDMF, popularly known as Pag-IBIG, offers its members a savings program, short-term loans, and access to housing programs.

• SALARIES AND OTHER FORMS OF COMPENSATION

These are other non-taxable salaries and compensation that do not fit the definition of de minimis benefits and non-taxable other benefits. Some are still questioning whether dependents are still personal and whether additional exemptions for employees are deductible in compensation. Under the TRAIN Law, the PHP25,000 exemption per dependent up to 4 dependents, or a maximum of PHP100,000 per taxpayer, was removed. However, the threshold amount for personal tax exemption was raised to PHP250,000 of annual income from PHP50,000 under the previous regulation.

Perhaps, one part of the audit that needs close scrutiny is the Salaries and Wages. Why say so? As this account is material to the Income Statement, it is more than merely testing and validating the recording in the books with the payroll register when there is an accrual of wages payable or cash is paid when employee salaries are incurred. An auditor’s consideration on his audit is to look also at the tax compliance side of the payroll preparation if risks of material misstatements are present and thus, affecting the audit procedures done by the auditor.

In the Philippines, various returns /information are prepared related to Salaries and Wages to be submitted to the tax authority (BIR) monthly and annually.  Aside from that, certain components of the Salaries and Wages should be identified whether it is a part of a taxable compensation or not. Since the employer is an agent of the government to withhold taxes on the compensation of the employees, a competent HR or knowledgeable personnel in Ph’s salaries and wages system in charge of payroll preparation must be employed to have the least risk of misstatement in terms of Salaries and Wages account in the books.

Here are the usual  audit procedures done on Salaries and Wages:

1. Walkthrough Test: To gauge the reliability of the payroll accounting system, a walkthrough test is done. It involves step-by-step study from the start until the end of transaction processing. An auditor may observe and inquire without asking for specific documentation or evaluating the transaction’s paperwork or audit trail. 
2. Test of Controls: An audit procedure to provide evidence and demonstrate compliance. This test evaluates control strengths and identifies weaknesses. This is a helpful tool to assess the risk of misstatements that could go through the financial statements.
3. Substantive Testing: This test examines the financial statements and supporting documents of a transaction to identify if they contain errors or misstatements. These tests are needed as evidence to support the assertion that the financial records of a business are complete, valid, and accurate. If the findings of the risk of misstatement found in the test of control are minimal, the auditor will proceed to have a number of supporting papers prepared, and vice versa. Some common substantive procedures are analytical procedures, vouching, inspection, recalculation, observing, confirmation, and review of payroll tax compliance

A lack of payroll tax compliance is the auditor’s most frequent finding in the audit of salaries and wages, and any company should pay particular attention to this issue as it frequently arises in BIR tax audits:

• A summary of monthly returns on tax on compensation (BIR Form 1601C) do not tie up with book records and alphalist of employees. This results in a different interpretation of what gross compensation means and what part of it is taxable or non-taxable. Gross Compensation, as per tax laws means every form of remuneration payable for a given period to an individual for services provided including salaries, commissions, vacation pay, severance pay, bonuses, and any board, rent, housing, lodging, payments in kind, and any similar benefit received from the individual’s employer. 
• Treatment of taxable or non-taxable compensation of employees. If the compensation given is a de minimis specifically set out in the tax rules and other benefits within tax-exempt threshold of P 90,000, this is considered as tax-exempt. Otherwise, such part of benefits given to employees other than basic pay may be considered taxable.
• Proper base of computation of SSS Contribution Share. SSS Contribution is based on the monthly salary credit of the employees (based on SSS Table), not on basic pay. Whereas, Philhealth contributions are based on the monthly basic pay.  The only allowed deduction to arrive at taxable compensation is those only that are mandatory required by the government. In excess of such a contribution share of employees, it  will go through as deduction to arrive at the net pay of the employees.
• Final pay of employees are excluded in the monthly BIR Form 1601C during pay-out. This leaves the book records, alphalist of employees and summary of BIR Form 1601C unreconciled.
• SSS Loans and HDMF Loans – These items are not considered as deductible part of compensation to arrive at taxable compensation of employees.
• Tax refunds of employees declared in the BIR Form 1604 C do not reconcile with prepaid withholding tax on the books or remain unrecorded.

Knowing such findings or deficiencies in advance in line with the tax compliance of your payroll accounting will help expedite the audit procedures on the Salaries and Wages account. It is necessary to assess and improve the corresponding internal controls and if addressed correctly, the likelihood of a tax audit by the BIR in the future is reduced, if any.