Tax on compensation income

The tax on compensation income is withheld at source under the creditable withholding tax system wherein the tax withheld is intended to equal or at least approximate the tax due of the payee on the said income. It was designed to enable (a) the individual taxpayer to meet his or her income tax liability on compensation earned; and (b) the government to collect at source the appropriate taxes on compensation.[1] Taxes withheld are creditable in nature.[2] Thus, the employee is still required to file an income tax return to report the income and/or pay the difference between the tax withheld and the tax due on the income.[3] For over withholding, the employee is refunded.[4] Therefore, absolute or exact accuracy in the determination of the amount of the compensation income is not a prerequisite for the employer's withholding obligation to arise.

It is true that the law and implementing regulations require the employer to deduct and pay the income tax on compensation paid to its employees, either actually or constructively.

Section 72 of the 1977 National Internal Revenue Code, as amended,[5] states:
SECTION 72. Income tax collected at source. — (a) Requirement of withholding. — Every employer making payment of wages shall deduct and withhold, upon such wages a tax determined in accordance with regulations to be prepared and promulgated by the Minister of Finance. (Emphasis supplied)
Sections 7 and 14 of Revenue Regulations No. 6-82,[6] as amended,[7] relative to the withholding of tax on compensation income, provide:
Section 7. Requirement of withholding. — Every employer or any person who pays or controls the payment of compensation to an employee, whether resident citizen or alien, non-resident citizen, or non­resident alien engaged in trade or business in the Philippines, must withhold from such compensation paid, an amount computed in accordance with these regulations.

I. Withholding of tax on compensation paid to resident employees. — (a) In general, every employer making payment of compensation shall deduct and withhold from such compensation income for the entire calendar year, a tax determined in accordance with the prescribed new Withholding Tax Tables effective January 1, 1992 (ANNEX "A").

Section 14. Liability for the Tax. — The employer is required to collect the tax by deducting and withholding the amount thereof from the employee's compensation as when paid, either actually or constructively. An employer is required to deduct and withhold the tax notwithstanding that the compensation is paid in something other than money (for example, compensation paid in stocks or bonds) and to pay the tax to the collecting officer. If compensation is paid in property other than money, the employer should make necessary arrangements to ensure that the amount of the tax required to be withheld is available for payment to the collecting officer.

Every person required to deduct and withhold the tax from the compensation of an employee is liable for the payment of such tax whether or not collected from the employee. If, for example, the employer deducts less than the correct amount of tax, or if he fails to deduct any part of the tax, he is nevertheless liable for the correct amount of the tax. However, if the employer in violation of the provisions of Chapter XI, Title II of the Tax Code fails to deduct and withhold and thereafter the employee pays the tax, it shall no longer be collected from the employer. Such payment does not, however, operate to relieve the employer from liability for penalties or additions to the tax for failure to deduct and withhold within the time prescribed by law or regulations. The employer will not be relieved of his liability for payment of the tax required to be withheld unless he can show that the tax has been paid by the employee.

The amount of any tax withheld/collected by the employer is a special fund in trust for the Government of the Philippines.

When the employer or other person required to deduct and withhold the tax under this Chapter XI, Title II of the Tax Code has witliheld and paid such tax to the Commissioner of Internal Revenue or to any authorized collecting officer, then such employer or person shall be relieved of any liability to any person. (Emphasis supplied)

Constructive payment of compensation is further defined in Revenue Regulations No. 6-82:

Section 25. Applicability; constructive receipt of compensation.

Compensation is constructively paid within the meaning of these regulations 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. To constitute payment in such a case, 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. (Emphasis supplied)

On the other hand, it is also true that under Section 45 of the 1997 National Internal Revenue Code (then Section 39 of the 1977 National Internal Revenue Code, as amended), deductions from gross income are taken for the taxable year in which "paid or accrued" or "paid or incurred" is dependent upon the method of accounting income and expenses adopted by the taxpayer.

In Commissioner of Internal Revenue v. Isabela Cultural Corporation,[8] the Supreme Court explained the accrual method of accounting, as against the cash method:

Accounting methods for tax purposes comprise a set of rules for determining when and how to report income and deductions.

Revenue Audit Memorandum Order No. 1-2000, provides that under the accrual method of accounting, expenses not being claimed as deductions by a taxpayer in the current year when they are incurred cannot be claimed as deduction from income for the succeeding year. Thus, a taxpayer who is authorized to deduct certain expenses and other allowable deductions for the current year but failed to do so cannot deduct the same for the next year.

The accrual method relies upon the taxpayer's right to receive amounts or its obligation to pay them, in opposition to actual receipt or payment, which characterizes the cash method of accounting. Amounts of income accrue where the right to receive them become fixed, where there is created an enforceable liability. Similarly, liabilities are accrued when fixed and determinable in amount, without regard to indeterminacy merely of time of payment.

For a taxpayer using the accrual method, the determinative question is, when do the facts present themselves in such a manner that the taxpayer must recognize income or expense? The accrual of income and expense is permitted when the all-events test has been met. This test requires: (1) fixing of a right to income or liability to pay; and (2) the availability of the reasonable accurate determination of such income or liability.

The all-events test requires the right to income or liability be fixed, and the amount of such income or liability be determined with reasonable accuracy. However, the test does not demand that the amount of income or liability be known absolutely only that a taxpayer has at his disposal the information necessary to compute the amount with reasonable accuracy. The all-events test is satisfied where computation remains uncertain, if its basis is unchangeable; the test is satisfied where a computation may be unknown, but is not as much as unknowable, within the taxable year. The amount of liability does not have to be determined exactly; it must be determined with "reasonable accuracy." Accordingly, the term "reasonable accuracy" implies something less than an exact or completely accurate amount.[9] (Emphasis supplied, citations omitted)

Thus, if the taxpayer is on cash basis, the expense is deductible in the year it was paid, regardless of the year it was incurred. If he is on the accrual method, he can deduct the expense upon accrual thereof. An item that is reasonably ascertained as to amount and acknowledged to be due has "accrued"; actual payment is not essential to constitute "expense."

Stated otherwise, an expense is accrued and deducted for tax purposes when (1) the obligation to pay is already fixed; (2) the amount can be determined with reasonable accuracy; and, (3) it is already knowable or the taxpayer can reasonably be expected to have known at the closing of its books for the taxable year.

Section 29(j) of the 1977 National Internal Revenue Code[10] (Section 34(K) of the 1997 National Internal Revenue Code) expressly requires, as a condition for deductibility of an expense, that the tax required to be withheld on the amount paid or payable is shown to have been remitted to the Bureau of Internal Revenue by the taxpayer constituted as a withholding agent of the government.

The provision of Section 72 of the 1977 National Internal Revenue Code (Section 79 of the 1997 National Internal Revenue Code) regarding withholding on wages must be read and construed in harmony with Section 29(j) of the 1977 National Internal Revenue Code (Section 34(K) of the 1997 National Internal Revenue Code) on deductions from gross income. This is in accordance with the rule on statutory construction that an interpretation is to be sought which gives effect to the whole of the statute, such that every part is made effective, harmonious, and sensible,[11] if possible, and not defeated nor rendered insignificant, meaningless, and nugatory.[12] 

[1] Study on Strengthening the Withholding Tax System on Individual Taxpayers, NTRC Tax Research Journal, vol. XXIII.2, March-April 2011 <> 3 (visited May 4, 2015), citing Consideration of House Bill No. 1127, Congressional Record, 2nd Cong., 1st Session, Vol. I, No. 74, May 10, 1950, p. 2227: "The withholding tax system was first proposed on May 2, 1950 under House Bill (HB) No. 1127. The two main justifications for the proposal were that: first, it will provide a convenient manner for meeting the employee's income tax liability on wages and, second, it will assure the Government of the collection of the income tax on wages which otherwise would have been lost or substantially reduced through failure of the employees concerned to file the corresponding income tax returns. The proponents deemed it necessary to put the system in place for the reason that there are a large number of cases where an employee fails to file an income tax return (ITR) and/or pay the income tax for the 'simple reason that he/she did not set aside from his/her income sufficient amounts to meet his/her tax liability payable the following year.' Withholding of the tax on wages when these are earned was seen as the solution to the problem."

[2] Pres. Decree No. 1158 (1977), as amended, sec. 72(c) (sec. 79(c) of the 1997 TAX CODE), provides: SECTION 72. Income tax collected at source. — (a)...

(c) Refunds or credits. — (1) Employer. — When there has been an overpayment of tax under this section, refund or credit shall be made to the employer only to the extent that the amount of such overpayment was not deducted and withheld hereunder by the employer.

(2) Employees. — The amount deducted and withheld under this Chapter during any calendar year shall be allowed as a credit to the recipient of such income against the tax imposed under Section 21 (a) of this Title. Refunds and credits in cases of excessive withholding shall be granted under rules and regulations promulgated by the Minister of Finance.

Any excess of the taxes withheld over the tax due from the taxpayer shall be returned or credited within three months from the fifteenth day of April. Refunds or credits made after such time shall earn interest at the rate of six per cent (6%) per annum starting after the lapse of the three-month period to the date the refund or credit is made.

Refunds shall be made upon warrants drawn by the Commissioner of Internal Revenue or by his duly authorized representative without the necessity of counter-signature by the Chairman, Commission on Audit or the latter's duly authorized representatives as an exception to the requirement prescribed by Section 621 of the Revised Administrative Code.

[3] See 1997 TAX CODE, secs. 51 and 58 (C) and (D).

[4] 1997 TAX CODE, sec. 79 (C).

[5] Pres. Decree No. 1158 (1977), as amended/renumbered by Batas Blg. 135 (1981), Pres. Decree No. 1994 (1986), and Exec. Order Nos. 37 (1986) and 273 (1987).

[6] Re: Collection at Source of Income Tax on Compensation Income of Employed Resident Citizens and Aliens, Non-Resident Citizens and Non-Resident Aliens engaged in trade or business in the Philippines.

[7] BIR Revenue Regulations No. 6-82 was amended by B1R Revenue Regulations Nos. 12-86, 1-92, 3-92, and 4-93.

[8] 544 Phil. 488 (2007) [Per J. Ynares-Santiago, Third Division].

[9] Id. at 495-496.

[10] Pres. Decree No. 1158 (1977), as amended/renumbered by Pres. Decree No. 1351 (1978), Batas Blg. 135 (1981), Exec. Order Nos. 37 (1986) and 273 (1987), and Rep. Act No. 7496 (1992).

[11] Commissioner of Internal Revenue v. TMX Sales, Inc., G.R. No. 83736, January 15, 1992, 205 SCRA 184, 188 [Per J. Gutierrez, Jr., En Banc].

[12] Asturias Sugar Central, Inc. v. Commissioner of Customs, et al., 140 Phil. 20, 31 [Per J. Castro, En Banc].