INCOME TAXATION | Laws, Principles and Applications

CHAPTER 8
COMPENSATION INCOME

EMPLOYER-EMPLOYEE RELATIONSHIP

Employer – refers to any person for whom an individual performs any service
of whatever nature as employee of such person.

An employer is the person who has control over the payment of the employee
remuneration. However, if such person is a non-resident not engaged in trade
or business in the Philippines, the employer is deemed the person paying
remuneration in their behalf.

Employee – refers to any individual who is a recipient of wages and includes

officer, employee or elected official of the Government of the Philippines or any
political subdivisions, agency or instrumentality thereof. The term also
includes an officer of a corporation.

Elements of employer and employee relationship under case law:

1. Selection and engagement of employees – There is a screening process for
employees to hire.
2. Payment of wages – The employer usually fixes and controls the payment
of wages.
3. Power of dismissal – Employer has power to retrench or terminate
employees when incurring heavy losses or other reasonable basis.
4. Power of control – The employer has power to control the employee on the
means and methods by which the work is accomplished.

An arrangement which do not manifest all the elements is not an employer-

employee relationship but an independent contract for the provision of
services.

The following are not considered employees:

1. Consultants
2. Directors without management function
3. Talents and artists on TV shows or radio broadcasts

The income or fees of these individuals are not compensation income but are
business or professional income.

TYPES OF EMPLOYEES AS TO FUNCTION

1. Managerial employees – Those who are given powers or prerogatives to
lay down and execute managerial policies and/or to hire, transfer,
suspend, lay-off, recall, discharge, assign or discipline employees.

Courtesy of the author: REX B. BANGGAWAN, CPA, MBA

INCOME TAXATION | Laws, Principles and Applications

2. Supervisory employees – Those who effectively recommend such

managerial actions if the exercise of such authority is not merely
routinary or clerical in nature but requires the use of independent
judgment.
3. Rank and file employees – Those who hold neither managerial nor
supervisory functions

TYPES OF EMPLOYEES AS TO TAXABILITY

1. Minimum wage earners – Employees who are recipients of minimum
wage. They are exempt from income tax on their compensation.
2. Regular employees – Employees who are subject to the regular
progressive income tax.

It must be noted that the “special alien” classification was removed into law
by virtue of a presidential veto to the TRAIN law. The special alien under the
old law must be treated as regular employees.

Minimum Wage Earner

A minimum wage earner refers to a worker in the private sector who is paid the
minimum wage or to an employee in the public sector with compensation
income of not more than the statutory minimum wage (i.e., those with salary
grade 1 to 3) in the non-agricultural sector where he or she is assigned.

The statutory minimum wage refers to rate fixed by the Regional Tripartite Wage
and Productivity Board of the Department of Labor and Employment or
P5,000/month or P60,000/year, whichever is higher.

THE TAX MODEL ON COMPENSATION INCOME

Gross compensation income P xxx,xxx

Less: Non-taxable compensation xxx,xxx
Taxable compensation income P xxx,xxx

GROSS COMPENSATION INCOME

Gross compensation income generally includes all remunerations received
under an employer-employee relationship.

NON-TAXABLE COMPENSATION

A. Mandatory deductions
These includes employees’ mandatory contribution to GSIS, SSS,
PhilHealth, HDMF, and union dues

B. Exempt benefits
1. Benefits excluded and/or exempted under the NIRC, and special laws

Courtesy of the author: REX B. BANGGAWAN, CPA, MBA

INCOME TAXATION | Laws, Principles and Applications

2. Benefits exempt under treaty or international agreements

3. Benefits necessary to the trade, business, or conduct of profession of
the employer
4. Benefits for the convenience or advantage of the employer

EXEMPT BENEFITS UNDER THE NIRC, AS AMENDED, AND SPECIAL LAWS

1. Remunerations received as incidents of employment

a. Exempt retirement benefits under RA 7641 including exempt
retirement gratuities to government officials and employees
b. Exempt termination benefits
c. Benefits from the United States Veterans Administration
d. Social security, retirement gratuities, pensions, and similar benefits
from foreign government agencies and other institutions, private or
public
e. Benefits from SSS, under the SSS Act of 1954, as amended
f. Benefits from GSIS under the GSIS Act of 1937, as amended

2. De minimis benefits
3. 13th month pay and other benefits not exceeding P90,000
4. Certain benefits of minimum wage earners

De minimis benefits
De minimis benefits are facilities or privileges such as entertainment, medical
services, or courtesy discounts on purchases that are of relatively small value
and are furnished by the employer merely as a means of promoting the health,
goodwill, contentment, or efficiency of his employees. De minimis benefits are
petty fringe benefits exempt from income tax.

As originally conceived, other petty fringe benefits which fall within the purview
of de minimis even if not part of the de minimis list are normally treated as de
minimis and are also exempt from income tax.

However, the BIR and the Department of Finance changed the rule under RR5-
2011 wherein the term “de minimis benefits” was restricted to mean only the
following:

1. Monetized unused vacation leave credits of private employees not

exceeding 10 days during the year
2. Monetized unused vacation and sick leave credits paid to
government officials and employees
3. Medical cash allowance to dependents of employees not exceeding
P1,500 per employee per semester, or P375 per month
4. Rice subsidy not exceeding P2,000 or 1 sack of 50-kg rice per month
amounting to not more than P2,000

Courtesy of the author: REX B. BANGGAWAN, CPA, MBA

INCOME TAXATION | Laws, Principles and Applications

5. Uniform and clothing allowance not exceeding P6,000 per annum

(RR8-2012)
6. Actual Medical Assistance, e.g., medical allowance to cover medical and
healthcare needs, annual medical/executive check-up, maternity
assistance, and routine consultations not exceeding P10,000 per annum
7. Laundry allowance not exceeding P300 per month
8. Employee achievement award, e.g. for length of service or safety
achievement, which must be in the form of tangible property other than
cash or gift certificates, with an annual monetary value not exceeding
P10,000 received by the employee under an established written plan
which does not discriminate in favor of highly paid employees.
9. Gifts given during Christmas and major anniversary celebrations not
exceeding P5,000 per employee per annum (i.e., Christmas giftand
anniversary gifts)
10. Daily meal allowance for overtime work and night or graveyard
shift not exceeding 25% of the basic minimum wage on a per region
basis (i.e., overtime meal)
11. Benefits received by an employee by virtue of a collective
bargaining agreement (CBA) and productivity incentive schemes
provided that the total annual monetary value received from both CBA
and productivity incentive schemes combined do not exceed P10,000 per
employee per taxable year.

Note that only CBA benefits and productivity incentives amounting to

P10,000 or less is de minimis. If the amount exceeds P10,000, the entire
amount is a taxable “other benefits.”

Taxable de minimis benefits

1. Excess de minimis over their regulatory limits
2. Other benefits of relatively small value that are not included in the list of
de minimis benefits

Treatment of taxable de minimis benefits

a. For rank and file employees – taxable de minimis is treated as other
compensation income under the category “13th month pay and other
benefits”
b. For managerial and supervisory employees – taxable de minimis is
treated as fringe benefit subject to final fringe benefit tax (RR5-2011 and
RMC20-2011)

Commutation of accumulated leave credits

The terminal leave pay or the commutation of unused leave credits due to
involuntary separation from employment of the employee is now treated as de
minimis benefits subject to the 10-day leave credit limit and is no longer
exempt as part of exempt termination benefits.

Courtesy of the author: REX B. BANGGAWAN, CPA, MBA

INCOME TAXATION | Laws, Principles and Applications

13th month pay and other benefits not in excess of P90,000

The composition of the “13th month pay and other benefits” will be discussed
later under taxable benefits.

BENEFITS EXEMPT UNDER TREATY OR INTERNATIONAL AGREEMENTS

Employee benefits of non-Filipino nationals and/or non-permanent residents of
the Philippines from foreign governments, embassies or diplomatic missions,
and international organizations in the Philippines are exempt from income tax.

Exemption from withholding tax does not mean income tax exemption
Foreign government embassies, diplomatic missions and international
organizations are immune from income tax including the obligation to withhold
income tax by virtue of international comity as embodied in several
international agreements to which the Philippines is a signatory.

However, this exemption from the obligation to withhold tax does not mean
income tax exemption of their Filipino employees. In fact, most of the
international agreements to which the Philippines is a signatory limit
exemption only to non-Filipino national and/or non-residents of the
Philippines.

Filipino employees of foreign governments, international missions and

organizations are taxable as a rule except only to employees of the following
organizations:
1. United Nations (UN)
2. Specialized Agencies of the United Nations
3. Australian Agency for International Development (AUSAID)
4. Food and Agriculture Organizations (FAO)
5. World Health Organization (WHO)
6. United Nations Development Programme (UNDP)
7. International Organization for Migration (IOM)
8. International Seabed Authority (ISA0

These organizations have exemption provisions that extend even to their

Filipino employees. Other aid agencies or international organizations may have
tax free provisions in their articles of agreement for Filipino employees.

Confirmation of Tax Exemptions

The exemption of Filipino employees is not automatic. Filipinos claiming
exemptions under the terms of international agreements or under provisions of
special laws granting privileges to international organizations shall file an
application for confirmation of tax exemption with the BIR’s International Tax
Affairs Division (ITAD). The confirmation shall serve as proof of exemption.
Without the confirmation certificate, the employee is taxable.

Employees of Philippine embassies or consular offices

Courtesy of the author: REX B. BANGGAWAN, CPA, MBA
INCOME TAXATION | Laws, Principles and Applications

It should be recalled that employees working in Philippine embassies or

Philippine consulate offices are not considered non-resident citizens and are
therefore subject to Philippine income tax.

Summary of rules
Foreign embassy, Philippine embassy or
missions, or consulate office
organization
In the Philippines
- Filipino citizens Taxable* N/A
- Aliens Exempt N/A
Abroad
- Filipino citizens Exempt Taxable
- Aliens Exempt Exempt
*Taxpayer must prove if there is an exemption grant under contract or special law.

BENEFITS REQUIRED BY THE NATURE OF, OR NECESSARY TO, THE

TRADE, BUSINESS OR CONDUCT OF PROFESSION OF THE EMPLOYER
Benefits or allowances furnished by the employer to the employees to enable
them to appropriately and effectively execute their duties as required by their
employment are exempt from income tax. This is referred to as “necessity of
the employer rule.”

Examples:
1. Necessary traveling, transportation, representation, or entertainment
expenses that are subject to an accounting or liquidation in accordance
with specific requirements of substantiation of expense.
2. Allowances which essentially constitute reimbursement to government
personnel for expenses they incurred in the performance of their official
duties, such as:
a. Representation and Transportation Allowance (RATA) of public officers
and employees under the General Appropriation Act
b. Personnel Economic Relief Allowance (PERA) (RR10-2008)
3. Reasonable amounts of reimbursements or advances to employees for
travelling and representation which are pre-computed on a daily basis
and which are paid to any employee while on assignment or duty.

These amounts given to the employee are not income but are expenses of the
trade, business or profession of the employer that are incurred or paid through
the employee. These are not employee benefits since they are mere advances or
replenishments of what are supposed to be direct cash outflows from the
employer; hence, they are not considered as compensation income.

Courtesy of the author: REX B. BANGGAWAN, CPA, MBA