Accrued bonuses: When to withhold?

September just kicked in reminding everyone that we are just a few months away from the season of giving.  It is also by this time when individuals from the working sector, whether from private or public, expect to receive one’s hard-earned additional income in the form of bonuses. However, such grant of incentive does not come without a price – taxes as enforced contributions are levied to apportion the costs of the government to support public needs, including every form of compensation for personal services.

Settled is the rule in so far as the income tax collected at source on compensation income is concerned, the requirement is that every employer must withhold from compensation paid in accordance with Revenue Regulations (RR) No. 2-98, as amended.   

However, this may be the clamour of taxpayers, whether on a corporate or individual standpoint, with regard the recent interpretation made by the Supreme Court (SC) in what has been perceived as a controversial and recurring issue notwithstanding the clear provisions of law and implementing regulations that are clearly established. 

In the case of Ing Bank N.V., one of the main issues submitted for resolution is whether the petitioner-taxpayer is liable for deficiency withholding tax on accrued bonuses for the taxable years ended 1996 and 1997. Petitioner-taxpayer maintains its position that the liability of employer to withhold the tax does not arise in the respective year of accrual, 1996 and 1997, until such bonus is actually distributed in the succeeding year. 

The SC in resolving the main issue anchored its position on Section 34 of the National Internal Revenue Code of 1997 (Tax Code), as amended, which provides the additional requirements for the deductibility of certain payments which refers to any amount paid or payable which is deductible from, or taken into account in computing gross income shall be allowed as a deduction from gross income only if it is shown that the tax required to be deducted and withheld therefrom has been paid to the Bureau of Internal Revenue (BIR).  

To supplement the above provision of the Tax Code, the SC highlighted existing withholding tax regulations reiterating the same deductibility requirement wherein any income payment which is otherwise deductible shall be allowed as deduction from the payor’s gross income only if it is shown that the income tax required to be withheld and has been paid to the BIR.

Grounded from the above stated provisions of law and regulations, the SC held that petitioner-taxpayer is liable for the withholding tax on the bonus at the time of accrual and not at the time of actual payment. Also, it was held that the absolute or exact accuracy in the determination of the amount of the compensation income is not a prerequisite for the employer’s withholding obligation to arise.

Accordingly, in the same case, the application of the “withholding tax on accrual” concept was clarified by SC in one of its landmark case, Commissioner of Internal Revenue vs Isabela Cultural Corporation, where the court explained the difference between the accrual method of accounting as against the cash method for tax purposes. On the one hand, accrual method relies upon the taxpayer’s right to perceive amounts or obligation to pay the same. On the other hand, cash method of accounting characterizes actual receipt of payment. An all-events test was also put in place which requires the (1) fixing of a right to income or liability to pay; and (2) the availability of the reasonable accurate determination of such income or liability. Hence, if the taxpayer used the accrual method, the actual deduction of the expense is proper upon accrual.  Stated differently, an expense is accrued and deducted for tax purposes when (1) the obligation to pay is already fixed; (2) the amount ca n be determined with reasonable accuracy; and (3) it is already knowable or the taxpayer can reasonably be expected to have known at the closing of its books for the taxable year.  Furthermore, it is submitted that the fourth requisite pertains to the additional condition for the deductibility of an expense requiring the tax to be withheld and remitted to the Bureau of Internal Revenue in accordance with Section 34(K) of the Tax Code.

The SC reiterated that the existing withholding tax regulations supports the rules requiring every employer to deduct and pay the income tax on compensation paid to its employees, either actually or constructively.  Accordingly, compensation is constructively paid when it is credited to the account of or set apart for an employee so that it may be drawn upon him at any time although not then actually reduced to possession. 

However, in this particular case, the application of the “withholding tax on accrual” concept may run counter with one of the basic and underlying assumptions in accounting providing the fundamental premise in the preparation of the financial statements – the accrual basis of accounting. One may recall that accrual accounting means that an expense is recognized when incurred regardless whether paid or not in accordance with the generally accepted accounting principles. This may not present any issue with regard the accrual of expenses if such amount is already fixed or the amount can be determined with reasonable accuracy and it is already knowable or the taxpayer can reasonably be expected to have known at the closing of its books for the taxable year. But what if an accrued expense, in the form of bonuses, is recognized only for the purpose of financial reporting as a mere estimate or with a set of conditions that must be complied with by the employee before entitlement, such as tenure or continuity of service until the actual pay-out the following year, which immediately negates the requisite of fixing a right to receive the income. Obviously, such is not the case contemplated by the SC when it rendered this decision simply because the tax required to be withheld by the employer does not yet arise as of that moment – upon accrual of expense as a mere estimate or with a specified condition. 

After all, settled is the rule that the interpretation of a provision of law should be read and construed in harmony with another which gives the effect to the statute as a whole. It is the elementary rule in statutory construction that when the law speaks in clear and categorical language, there is no room for interpretation or construction. A plain and unambiguous statute speaks for itself, and any attempt to make it clearer is vain labor and tends only to obscurity.   

This notwithstanding, it should also be stressed that there are technicalities left unresolved by the issuance of this decision. Will the BIR automatically subject to withholding tax the accrued bonus at the time of accrual? It should not be because the issue would be the proper computation of withholding tax on each employee. However, taxpayers and the tax authorities may have different interpretation and analysis of this SC decision.  Hence, it is really important that this issue should be addressed timely by the BIR to avoid any confusion. The proper implementing rules that will plug a loophole are called upon to support the overall tax compliance drive. 

Altogether, employers constituted as withholding agents are all but willing to comply with the rules and regulations promulgated by the BIR. It is with this fervent prayer that taxpayers be guided accordingly through relevant and timely issuances.  

Daryl Sales

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Punongbayan and Araullo