How is Separation Pay Taxed?

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Since the COVID-19 pandemic struck, many businesses all over the world were deeply affected and the Philippines is one of them. Some businesses struggled and had no choice but to start cutting costs and laying off some employees just so that their business could survive. 

These businesses had to adapt to a new normal strategy and have made the work from home setup possible. This kind of operations was implemented to ensure that the business will still continue to grow and to secure the safety of the employees as well in spite of the raging pandemic. 

Some employees that found working in isolation has made their work monotonous and has worsened their anxieties. Sadly, due to mental health concerns, many employees have chosen to resign. The separation includes the payment of separation or final pay depending on whether or not the separation was voluntary or involuntary. Let’s talk about taxes levied on separation pay in each of these scenarios. 

Involuntary Resignation Due to Retrenchment 

According to the Supreme Court, retrenchment is the termination of employment that is initiated by the employer without fault and prejudice to the employee and dismissing them because of the loss they were facing in the operations of the business. 

If you have terminated an employee because of the closure of your business, installation of devices that save labor, redundancy, retrenchment, and if the employment is prejudiced towards your own employees’ health, the Labor Code states that you as the employer should give and provide separation pay for your employees. 

Moreover, tax services in Manila share that the Tax Code states that any amount received by employees from employers for their separation because of death, sickness, physical disability, or any cause that is beyond the control of the employee shall be exempted from tax. However, more than 10 days of accumulated benefits are subject to income tax or fringe benefits tax.

Tax exemptions, though, are constructed to benefit the taxpayer who has lost their income and at the expense of the government that receives the taxes. So as a result, for retrenched employees to be entitled to the income tax exemption, the employer needs to secure a Certificate of Tax Exemption or CTE from Income and Withholding Tax.   

To process and facilitate the tax exemption due to retrenchment, the Revenue Memorandum Order or RMO No. 66-2016 prescribed the following documents that must be submitted to the RDO or Revenue District Office where the business is registered:

  1. The employee or employer must present a letter request for exemption of separation benefits from income and withholding tax.
  2. 30 days before the effective date of termination, a written notice specifying the grounds for termination must be given to the employee and the respective Regional Office of the DOLE. 
  3. A Board Resolution, in the case of a juridical entity, or affidavit and in the case of a sole proprietor must be presented indicating the following:
  4. Retrenchment is necessary for businesses to likely prevent further losses
  5. Incurred losses aren’t just de minimis but are substantial, serious, real, and if only expected–are reasonably imminent with the right supporting evidence
  6. For the advance of the interest and to not defeat the right to security of tenure
  7. Selecting which employees to terminate will be done with criteria that are fair and reasonable.

It can be cumbersome to process the paperwork so you can seek professional help for tax and accounting services in the Philippines to facilitate the process.

Voluntary Resignation Due to Personal Reasons

There are many employees who decided to resign due to mental health issues these past two years. There are rising concerns regarding the taxability on the final salary of the employees who are resigning.  

Employees who voluntarily resign for whatever personal reasons are not entitled to separation pay unless provided and stipulated in their contracts or if it is stipulated in the Collective Bargaining Agreement.

Today, the BIR or the Bureau of Internal Revenue has not released any issuances regarding the clarification of the tax implications for voluntary resignations (due to mental health). 

Take note though that since it was the initiative of the employee to resign, there is a ruling from the BIR saying that the final salary is still subject to tax since whatever is being paid to employees is earned over the course of employment. If you’re uncertain, it’s best to seek the guidance of tax and audit services in the Philippines.

Final Word

Layoffs and resignations were unavoidable and prevalent over the last two years due to the economic and mental health implications of the Covid-19 pandemic. As time goes by, hopefully, employees will be able to return to their old jobs and businesses will thrive again. But bear in mind, the most important factor is everyone’s holistic –financial, mental, and physical health.

In challenging times, resignation, whether voluntary or involuntary, may be inevitable. Whether you’re an employer or employee, you must not be remiss in your tax obligations. Seeking help from tax and accounting services in Pasig can help so give us a call.