Taxability of retirement benefits

Generally, retirement benefits received by an employee pursuant to Republic Act (RA) No. 7641 and RA No. 4917 are tax-exempt, subject to certain conditions.

RA No. 7641, commonly known as the Retirement Law, grants an employee retirement benefits upon reaching the age of 60 years but not beyond 65 years, which is the compulsory retirement age, provided such employee has served at least five years and the retirement benefits are availed of only once.

On the other hand, RA No. 4917, which is reflected in Section 32(B)(6) of the National Internal Revenue Code (NIRC), allows employers to establish private retirement plans. It provides that the retirement benefits received by employees in accordance with a reasonable private benefit plan maintained by the employer is exempt from all taxes (among others), provided that the retiring employee or official has been in the service of the same employer for at least 10 years, is not less than 50 years of age at the time of retirement and the benefits granted are availed of only once.

On Jan. 22, the Bureau of Internal Revenue (BIR) issued Revenue Memorandum Circular (RMC) No. 13-2024, clarifying the tax treatment of retirement benefit expenses for financial reporting and tax purposes to bridge the gap between the two.

Financial accounting for post-employment benefits adheres to Philippine Financial Reporting Standards and Philippine Accounting Standards. The standards classify retirement plans into two types: (1) a defined contribution plan where the employer pays a fixed contribution to a fund; and (2) a defined benefit plan which requires a valuation prepared by an actuary using a projected unit credit method.

On the other hand, the tax rules qualify the tax treatment between employers with and those without a Tax Qualified Plan (TQP).

A TQP is a private retirement plan registered with the BIR and declared as reasonable within the contemplation of the NIRC. Establishing a TQP is required under RA No. 4917.

An employer with a TQP may deduct as retirement benefit expense its contributions based on the guidelines below:

1. Contributions to the retirement fund during the taxable year to cover the pension liability accrued during that year (“Normal Cost”); and
2. Contributions to the retirement fund during the taxable year in excess of the Normal Cost but only if such amount:

• Has not theretofore been allowed as a deduction; and
• Is apportioned in equal parts over a period of 10 consecutive years beginning with the year in which the transfer or payment is made.

Stated otherwise, retirement benefit contributions attributable to the current year are deductible in full, while contributions relating to previous years are to be amortized over the next 10 years.

The RMC also provided crucial information in applying for a Certificate of Qualification as a reasonable Employee’s Retirement Benefit Plan (Certificate of Qualification) in order to have an approved TQP. It formally laid down documentary requirements that had been consistently required even prior to the issuance of the RMC, with the application being filed with the BIR’s Legal and Legislative Division. Further, an application for a Certificate of Qualification must be filed within 30 days from the date of effectivity of the retirement benefit plan. Otherwise, a penalty will be imposed.

Pending the BIR’s approval of the TQP, any retirement benefits received under the plan are exempt from income tax. Consistent with the intention of RA 4917, the investment income received by the retirement plan is also exempt from income tax, while deductions from the contributions may also be claimed. However, the RMC provided a caveat that if the application for a Certificate of Qualification is denied, then the employer will be held liable for deficiency taxes. Thus, employers must ensure compliance with the requirements.

The RMC also emphasized the “same employer” rule in tacking on the 10-year service requirement for a multi-employer retirement plan. The rule requires that the employee work for the employer for at least 10 continuous years in order to qualify for the income tax exemption.

Auspiciously, it grants an exception in computing the 10-year period, that is if the employees are transferred due to a valid merger and no separation pay was received from the previous employer, which is also a participating company.

However, in my opinion, in the spirit of justice and fairness, it would have been better if the exemption applied more broadly to cases of transferred employees and not solely in case of mergers. Considering that laws involving retirement are social legislation, their interpretation should be liberally in favor of the employees. Specifically, could the tax exemption include situations where employees are transferred beyond their control, regardless of whether the move was due to a merger or otherwise?

For instance, in case of multinational employers, employees are sometimes assigned a tour of duty as part of their training to help them develop a well-rounded appreciation of the entire business. It seems fair to consider the total years of service across the various entities within the same group which, presumably are all participating companies in the same multi-employer TQP, when computing total years of service for the “same employer.”

In contrast to employers with a TQP, employers without one tend to have an uncomplicated discussion. Simply, the rules under Retirement Law apply. Accordingly, only the actual amount of retirement benefits paid to employees can be claimed as deduction from the gross income. Thus, when the retiring employee receives a half-month salary for every year of service, his employer can claim the same amount in full in the taxable year such an employee retires.

As a final note, while retirement for employees may come with a lot of uncertainty, perhaps the issuance of this RMC brings some clarity.