Withholding tax on compensation is an approximate of income tax liability on compensation required to be withheld by the employer upon every payment or accrual or recording of salaries and wages in its books of accounts. It has been said that withholding tax has been a good contributor of internal revenue in the level of individual taxpayers perhaps because the employer automatically deducts the tax upon every payroll and that most sole proprietors are on small scale and once it grows, corporate entity conversion comes into play.
For you to further understand the withholding tax on compensation, let us discuss some of its features to serve as a guide for your application.
1. Applies to employer-employee relationship.
For this withholding tax on compensation to apply, you must establish the fact that there is an employer-employee relationship between the payor and the payee. In its absence, other tax type may apply such as expanded withholding taxes or final withholding tax.
Example: Mr. A rendered personal services to Company B who paid P100,000.00. What tax would apply? If Mr. A is an employee, withholding tax on compensation applies at the rate of 5-32%. If Mr. A is an independent contractor, then expanded withholding tax will apply at 10%/15% if services rendered refer to a professional service, or 2% if a prime contractor. If Mr. A is a non-resident alien and services were rendered in the Philippines, then, 25% final withholding tax applies.
Under the Labor Code of the Philippines, the following are the elements of employer-employee relationship:
In the absence of any of the four (4) elements, there could be no such employer-employee relationship and you cannot apply withholding tax on compensation. Common examples of this are the freelancers, online writers, and independent service providers.
2. Employee must be a natural person.
In business law, you will remember that compensation is a legal term used to refer to the fee of the service provider from another person without regard to their personalities – natural or juridical. For tax purposes however, the payee or recipient must be a natural person only in order for the withholding tax on compensation to apply. The reason is that withholding tax on compensation is an advance income tax of individual taxpayers receiving compensation income. Corporations and juridical entities falls on another income taxpayer classification – corporate income taxpayer, so they could not be applied withholding tax on compensation. Instead, you may be subject to expanded withholding tax depending on the nature of payment and applicable tax rate.
3. Employer must be a resident of the Philippines.
The reason is simple, the Philippine tax authorities – Bureau of Internal Revenue (BIR) has no jurisdiction over non-resident aliens and non-resident foreign corporations. In case of non-compliance, BIR may not be able to go after them for the consequences despite the presence of some bilateral agreements the Philippines has entered into with some foreign governments and international bodies. Besides, income from services is taxable in the place where the service is rendered and employees rendering work in the Philippines are taxable herein so corresponding income tax should be collected in the Philippines by local employers. In the case of overseas manpower agencies, their employers are the foreign companies and as such you cannot require them to withhold taxes. In case of short-term employment of non-resident citizen, then, the employee himself is required to report and pay income taxes and the foreign employer is still not required to withhold Philippine withholding tax on compensation. This is, however, without prejudice to the obligation of the foreign employer to withhold the withholding tax imposed by their foreign government.
4. Compensation must be paid or payable in cash or in kind.
For employers, obligation to withhold is upon payment of salaries and wages or upon accrual where they record the salaries expense in its books of accounts. For employees, however, taxability is upon actual receipt of the salaries, whether in cash or in kind. For employees, you follow the cash basis where you tax income from compensation upon receipt or collection so they will avoid making advances from personal funds for paying taxes on salaries not yet received.
5. Taxable amount is the gross compensation received in furtherance of employer-employee relationship.
As a general rule, gross taxable compensation comprises of anything that the employee receives by virtue of the employer-employee relationship and the name assigned to it is immaterial – salaries, wages, allowances, fees. Exception to this is those provided for by law – e.g.statutory minimum wage exemptions; or those provided by the rules and regulations – de minimis benefits; or provided by tax treaties with Philippines – e.g. the 90-day rule of the RP-US Tax Treaty. As long as there is employer-employee relationship, payments of the employer to the employee are presumed to be compensation, unless, proven otherwise like payment of advances, loans to employees, fringe benefits subject to fringe benefits tax, and the likes.
6. Amount withheld is deductible from employees income tax liability
As mentioned earlier, withholding tax on compensation every payroll is only a reasonable estimate of employees income tax liability and does not constitute accurate and full payment. At the end of the year, the employer is required to make annual computations of total compensation provided to each and every employee and the applicable total income tax liability to be compared to the total withholding taxes on compensation made during the year. If annual income tax due is higher over withheld taxes, employee is compensation as of January the following year is deducted by the entire amount of income tax due. For over withholding, the employee is refunded. I am pretty sure, employees would be happier for refund than additional tax liability.
If you are a pure compensation income earner, then, the employer’s annualization would constitute your annual income tax return under substituted filing. If you have other taxable income, such as from trade or business or practice of profession, then, you will have to file annual income tax returns where you will need to declare your compensation for income tax computations, and deduct the withheld taxes based on the BIR Form No. 2316 issued by your employer/s.
7. Employer is required to file tax returns and reports regularly
Since our tax system is based on voluntary compliance and pay-as-you-file (not pay as you like), employers are required to file monthly withholding tax returns-BIR Form No. 1601C, annual summary reports like BIR Form No. 1604CF with attached Alphalist of employees, and provide each employee a Certificate of Withholding Tax Withheld on Compensation (BIR Form No. 2316) annually or upon separation or termination of employment. Failures of the employer to comply the said reports are subject to penalties.
8. Withholding tax rates may vary depending on the tax classification of the employee
For citizens and resident alien employees, the withholding tax rates are based on the withholding tax table with rates ranging from 5% – 32% after considering their annual personal exemptions – P50,000 basic personal exemptions regardless of status, and P25,000.00 for every qualified dependent child of not more than 21 years of age up to maximum of four (4) or P100,000. For non-resident aliens not engaged in trade or business, the rate is 25% based on gross compensation and the same is final withholding tax. For special alien employees of special entities (ROHQ, RAHQ, OBU, etc), the rate is 15% based on gross compensation and the same is final tax.
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.
Quality Seminars, Trainings and Workshops. We conduct tax seminars and workshops on withholding tax such as the following:
Tax Management and Compliance Consultancies. With our tax services, we can assist you ensure tax compliance and in the management of such continuing compliance. Proper compliance would bring about tax savings form avoiding being penalized to tax minimization strategies. Likewise, we could assist you in securing a BIR ruling confirming the applicable tax exemptions.
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