The recent
Supreme Court (SC) case on the timing of withholding tax on compensation income
has caused quite a stir among corporate taxpayers.
While the case dealt with a deficiency withholding tax assessment on unsubstantiated business expenses (representation, travel and entertainment), the SC also ruled on the subject of withholding tax on accrued bonuses based on the taxpayer’s earlier claim that the amount in question refers to bonuses accrued during the years 1996 and 1997 but paid out in 1997 and 1998.
According to the SC, the duty to withhold the
tax on compensation and bonuses arises upon their accrual. While the SC
decision has some basis, there are aspects of it that may be called
questionable or, at least, impractical if applied sweepingly. Thus, the
statement needs to be further reconciled in light of existing withholding tax
rules and regulations.
Since most companies will soon be accruing bonuses and other forms of compensation towards the end of the year for pay-out to their employees next year, they face similar issues tackled in the SC case on the timing of withholding and the related issue on the deductibility of the expense.
According to the taxpayer in the case, the duty of an employer to withhold tax on compensation only arises upon actual distribution to the employees. Since the bonuses accrued in 1996 and 1997 were finally determined and distributed only in the following year, i.e., 1997 and 1998 respectively, the taxpayer claimed that its duty to withhold tax on such bonuses should only arise in 1997 and 1998.
On the contrary, the SC held that determination is not a prerequisite for the withholding tax obligation to arise. Under the rules, employers are required to deduct and pay the tax on compensation upon payment to its employees, either actually or constructively.
Further, deductions from gross income should be claimed in the same taxable year when the compensation is “paid or accrued” or “paid or incurred” depending on the method of accounting adopted by the taxpayer.
Based on a 2007 jurisprudence outlining the rules on accrual, the SC reiterated that an expense is accrued when the obligation to pay is fixed, the amount can be determined with reasonable accuracy and is already knowable at yearend. Since the taxpayer in this case applied the accrual method of accounting, it accrued or recorded the bonuses in its books and claimed it as a deductible expense in the year of accrual.
According to the SC, the act of claiming the deduction confirms that the taxpayer recognizes a definite liability, and in that sense, the bonus has already been “allotted and made available” to the employees, giving rise to constructive receipt of the bonus by the employees. On this basis, the obligation to withhold the tax due on the accrued bonuses arose at the time of accrual and not at the time of actual payment.
It is critical to understand and interpret the rules correctly especially given these developments. To my mind, certain issues and practicalities, such as the following, should be addressed:
CONSTRUCTIVE RECEIPT OF INCOME
There were no significant changes to the principle of constructive receipt under Revenue Regulations (RR) 6-82, the applicable withholding tax regulations prior to 1998 and RR 2-98, the existing withholding tax regulations.
Under both RRs, 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 by him at any time although not then actually reduced to possession. In order to constitute payment, the compensation must be credited or set apart for the employee without any substantial limitation or restriction as to the time or manner of payment or condition upon which payment is to be made, and must be made available to him so that it may be drawn upon at any time, and its payment brought within his control and disposition.
The RR 2-98 just expanded the definition of “constructive receipt” with the addition of the following statement:
“A book of entry, if made, should indicate an absolute transfer from one account to another. If the income is not credited, but it is set apart, such income must be unqualifiedly subject to the demand of the taxpayer. Where a corporation contingently credits its employees with a bonus stock which is not available to such employees until some future date, the mere crediting on the books of the corporation does not constitute payment.”
With the foregoing definition(s), the question is, will the principle apply in a case where the employees do not acquire a demandable right over the income, such as when the employees’ claim over the bonuses, at the time of accrual, remains unknown and therefore, restricted? In this case, there should be no payment to speak of, whether actual or constructive. Can it then be argued that there is no obligation to withhold compensation tax at the time of accrual?
TIMING OF WITHHOLDING
Under RR 6-82, the employer is required to withhold tax from the employee’s compensation when paid, either actually or constructively.
On the other hand, RR 2-98 requires that withholding of tax on compensation payments be made upon receipt of income by the employees, which aligns with the cash basis of taxation for employees. However, while the timing of withholding may have been stated differently in RR 2-98, the term “receipt” can still be interpreted as referring to income actually or constructively received.
Thus, where constructive receipt is in question at the time of accrual, such as when the bonus amount per employee is not yet allocated, how will the taxes be computed and withheld considering that the employees fall under different income tax brackets? In relation to this, there may also be some reporting concerns on the year-end alphabetical list (as attachment to BIR Form 1604CF) and the BIR Form 2316, among others.
Assuming that a reasonable allocation of the bonus per employee is available, will such estimated amounts and the related taxes withheld, be required to be reported on the employees’ BIR Form 2316? If so, will the employees then have the right to demand from the employer that same bonus amount that has been allocated to them although still estimated and not yet definite? Will there be any legal repercussions in case the actual bonus payout is lower than what has been earlier allocated? On the other hand, if not reportable on the year of accrual, how and when will the accrued bonus amount and related taxes withheld be reported on the BIR Form 2316?
Also, how will the employees’ eligibility for substituted filing be affected in the event that the actual bonus payout is different from the amount earlier allocated? In this case, the information declared in the alphabetical list and the BIR Form 2316 will not be the same. Will the employees be penalized for not filing a return in the previous year or will the employer be penalized for not correctly withholding the tax on the employees’ total compensation at yearend?
DEDUCTIBILITY OF THE EXPENSE
The additional requirement for deductibility of expenses under the 1977 Tax Code (prior to 1998) and the 1997 Tax Code (existing Code) has not changed. Under both Codes, an expense shall only be allowed as a deduction for tax purposes if it is shown that the tax required to be deducted and withheld therefrom has been paid to the BIR in accordance with existing withholding tax regulations.
Interestingly, the SC held that the withholding tax obligation of the employer (even for compensation income) shall arise at the time the income was paid, became payable, or accrued or recorded as an expense in the employer’s books, whichever comes first. In RR 2-98, however, it is quite clear that this three-trigger rule applies to payments other than compensation. Specifically for compensation, the timing of withholding remains to be at the time of the employees’ receipt of the income.
Thus, if the regulations require that the taxes be withheld from the employees upon receipt of the income (whether actually or constructively), then the condition for deductibility of the expense under the Tax Code shall be satisfied so long as it can be shown and proven that the taxes have been withheld and remitted by the employer during the proper period.
For instance, if the concept of constructive receipt is challenged on the year of accrual, then the withholding tax obligation should arise only on the date of actual payout, which is still in accordance with the regulations. Thus, provided that the obligation is carried out on the payout date, the expense should still be allowed.
The above issues are also obviously intertwined and therefore, it is critical to have a clear understanding of how the rules on withholding on accrued bonuses should be applied to avert erroneous interpretation/application. Alternatively, taxpayers may resort to finding relief under the rules of accounting on accrual (e.g., if there is basis not to accrue, but to recognize a mere provision) -- but this is an issue better left in the hands of my fellow auditors.
Raymund M. Gutib is a manager at the Tax Services Department of Isla Lipana & Co., the Philippine member firm of PricewaterhouseCoopers global network.
Since most companies will soon be accruing bonuses and other forms of compensation towards the end of the year for pay-out to their employees next year, they face similar issues tackled in the SC case on the timing of withholding and the related issue on the deductibility of the expense.
According to the taxpayer in the case, the duty of an employer to withhold tax on compensation only arises upon actual distribution to the employees. Since the bonuses accrued in 1996 and 1997 were finally determined and distributed only in the following year, i.e., 1997 and 1998 respectively, the taxpayer claimed that its duty to withhold tax on such bonuses should only arise in 1997 and 1998.
On the contrary, the SC held that determination is not a prerequisite for the withholding tax obligation to arise. Under the rules, employers are required to deduct and pay the tax on compensation upon payment to its employees, either actually or constructively.
Further, deductions from gross income should be claimed in the same taxable year when the compensation is “paid or accrued” or “paid or incurred” depending on the method of accounting adopted by the taxpayer.
Based on a 2007 jurisprudence outlining the rules on accrual, the SC reiterated that an expense is accrued when the obligation to pay is fixed, the amount can be determined with reasonable accuracy and is already knowable at yearend. Since the taxpayer in this case applied the accrual method of accounting, it accrued or recorded the bonuses in its books and claimed it as a deductible expense in the year of accrual.
According to the SC, the act of claiming the deduction confirms that the taxpayer recognizes a definite liability, and in that sense, the bonus has already been “allotted and made available” to the employees, giving rise to constructive receipt of the bonus by the employees. On this basis, the obligation to withhold the tax due on the accrued bonuses arose at the time of accrual and not at the time of actual payment.
It is critical to understand and interpret the rules correctly especially given these developments. To my mind, certain issues and practicalities, such as the following, should be addressed:
CONSTRUCTIVE RECEIPT OF INCOME
There were no significant changes to the principle of constructive receipt under Revenue Regulations (RR) 6-82, the applicable withholding tax regulations prior to 1998 and RR 2-98, the existing withholding tax regulations.
Under both RRs, 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 by him at any time although not then actually reduced to possession. In order to constitute payment, the compensation must be credited or set apart for the employee without any substantial limitation or restriction as to the time or manner of payment or condition upon which payment is to be made, and must be made available to him so that it may be drawn upon at any time, and its payment brought within his control and disposition.
The RR 2-98 just expanded the definition of “constructive receipt” with the addition of the following statement:
“A book of entry, if made, should indicate an absolute transfer from one account to another. If the income is not credited, but it is set apart, such income must be unqualifiedly subject to the demand of the taxpayer. Where a corporation contingently credits its employees with a bonus stock which is not available to such employees until some future date, the mere crediting on the books of the corporation does not constitute payment.”
With the foregoing definition(s), the question is, will the principle apply in a case where the employees do not acquire a demandable right over the income, such as when the employees’ claim over the bonuses, at the time of accrual, remains unknown and therefore, restricted? In this case, there should be no payment to speak of, whether actual or constructive. Can it then be argued that there is no obligation to withhold compensation tax at the time of accrual?
TIMING OF WITHHOLDING
Under RR 6-82, the employer is required to withhold tax from the employee’s compensation when paid, either actually or constructively.
On the other hand, RR 2-98 requires that withholding of tax on compensation payments be made upon receipt of income by the employees, which aligns with the cash basis of taxation for employees. However, while the timing of withholding may have been stated differently in RR 2-98, the term “receipt” can still be interpreted as referring to income actually or constructively received.
Thus, where constructive receipt is in question at the time of accrual, such as when the bonus amount per employee is not yet allocated, how will the taxes be computed and withheld considering that the employees fall under different income tax brackets? In relation to this, there may also be some reporting concerns on the year-end alphabetical list (as attachment to BIR Form 1604CF) and the BIR Form 2316, among others.
Assuming that a reasonable allocation of the bonus per employee is available, will such estimated amounts and the related taxes withheld, be required to be reported on the employees’ BIR Form 2316? If so, will the employees then have the right to demand from the employer that same bonus amount that has been allocated to them although still estimated and not yet definite? Will there be any legal repercussions in case the actual bonus payout is lower than what has been earlier allocated? On the other hand, if not reportable on the year of accrual, how and when will the accrued bonus amount and related taxes withheld be reported on the BIR Form 2316?
Also, how will the employees’ eligibility for substituted filing be affected in the event that the actual bonus payout is different from the amount earlier allocated? In this case, the information declared in the alphabetical list and the BIR Form 2316 will not be the same. Will the employees be penalized for not filing a return in the previous year or will the employer be penalized for not correctly withholding the tax on the employees’ total compensation at yearend?
DEDUCTIBILITY OF THE EXPENSE
The additional requirement for deductibility of expenses under the 1977 Tax Code (prior to 1998) and the 1997 Tax Code (existing Code) has not changed. Under both Codes, an expense shall only be allowed as a deduction for tax purposes if it is shown that the tax required to be deducted and withheld therefrom has been paid to the BIR in accordance with existing withholding tax regulations.
Interestingly, the SC held that the withholding tax obligation of the employer (even for compensation income) shall arise at the time the income was paid, became payable, or accrued or recorded as an expense in the employer’s books, whichever comes first. In RR 2-98, however, it is quite clear that this three-trigger rule applies to payments other than compensation. Specifically for compensation, the timing of withholding remains to be at the time of the employees’ receipt of the income.
Thus, if the regulations require that the taxes be withheld from the employees upon receipt of the income (whether actually or constructively), then the condition for deductibility of the expense under the Tax Code shall be satisfied so long as it can be shown and proven that the taxes have been withheld and remitted by the employer during the proper period.
For instance, if the concept of constructive receipt is challenged on the year of accrual, then the withholding tax obligation should arise only on the date of actual payout, which is still in accordance with the regulations. Thus, provided that the obligation is carried out on the payout date, the expense should still be allowed.
The above issues are also obviously intertwined and therefore, it is critical to have a clear understanding of how the rules on withholding on accrued bonuses should be applied to avert erroneous interpretation/application. Alternatively, taxpayers may resort to finding relief under the rules of accounting on accrual (e.g., if there is basis not to accrue, but to recognize a mere provision) -- but this is an issue better left in the hands of my fellow auditors.
Raymund M. Gutib is a manager at the Tax Services Department of Isla Lipana & Co., the Philippine member firm of PricewaterhouseCoopers global network.
Economy : Business World : October 7, 2015
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