CHAPTER 10

COMPENSATION INCOME

Employer - refers to any person for whom an individual performs any service of whatever nature as employee
of such person.
Employee - refers to any individual who is a recipient of wages and includes officer, employee of elected
official of the Government of the Philippines.

Elements of employer and employee relationship under case law:

1. Selection and engagement of employees
2. Payment of wages
3. Power of dismissal
4. Power of control

The following are not considered employees:

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

Types of Employees as to function

1. Managerial employees
2. Supervisory employees
3. Rank and File employees

Types of Employees as to taxability

1. Minimum wage earners - exempt from income taxation
2. Special aliens - 15% final income tax on compensation income (Managerial or Technical position)
3. Regular employees - subject to the regular progressive income tax

THE TAX MODEL ON COMPENSATION INCOME

Gross Compensation Income P xxx
Less: Non-Taxable Compensation P xxx
Gross Taxable Compensation Income P xxx

GROSS COMPENSATION INCOME

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

NON-TAXABLE OR EXEMPT COMPENSATION

A. Benefits excluded and/or exempted under the NIRC and special laws
B. Benefits exempt under treaty or international agreements
C. Benefits necessary to the trade, business, or conduct of profession of the employer
D. Benefits for the convenience or advantage of the employer

A. Exempt Benefits Under the NIRC, as amended, and special laws

1. Remunerations received as incidents of employment
2. Employee mandatory contribution to GSIS, SSS, Philhealth, HDMF and union dues
3. Certain benefits of minimum wage earners
4. De minimis benefits
5. 13th month pay and other benefits not exceeding P82,000.

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.

The following shall be considered as “De Minimis” Benefits:

1. Monetized unused vacation leave credits of private employees not exceeding ten (10) days during the year.
2. Monetized value of 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
P250 per month.
4. Rice Subsidy of P2,000 or one sack of 50kg. rice per month.
5. Uniform and Clothing Allowance not exceeding P6,000 per annum.
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. Employees Achievement Awards, e.g. for length of service or safety achievement, which must be in the form
of a tangible personal property other than cash or gift certificate, with annual monetary value not exceeding
P10,000 received by the employee under established written plan which does not discriminate in favor of
highly paid employees.
9. Gifts given during Christmas and Major Anniversary Celebration not exceeding P5,000 per employee per
annum.
10. Daily Meal Allowance for Overtime work and night/graveyard shift not exceeding twenty-five (25%) of the
basic minimum wage on per region basis

All other benefits given by employers which are not included in the above enumeration shall not be
considered as “de minimis” benefits, Hence, shall be subject to income tax as well as withholding tax on
compensation income.

B. Benefits Required by the nature of, or necessary to, the trade, business 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 pr 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.
3. Allowances: RATA and PERA
4. 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.

C. Benefits for the convenience or advantage of the employer

Benefits or allowances which are intended for the furtherance of the interest of the employer’s business
or to ensure its smooth operations are likewise exempt from income tax. This is referred to as the
“convenience of the employer rule”

GROSS TAXABLE COMPENSATION INCOME

Classification of gross taxable compensation income

1. Regular compensation
a. Basic Salary
b. Fixed Allowances
2. Supplemental compensation - performance-based pays
3. 13th month pay and other benefits - residual category/incentives pay

REGULAR COMPENSATION INCOME

The regular compensation includes fixed remunerations due to be received by an employee every period such
as:
1. Basic Salary
2. Fixed allowances such a cost-of-living allowance, fixed housing allowance, representation, transportation,
and other allowances paid to an employee every payroll period

Exception rule on the taxability of allowances:

1. If the allowance is an ordinary and necessary expense of employee in the pursuit of his trade, business or
profession.
2. Expense is subject to accounting or liquidation
3. Any excess advances are returned to the employer
Non-Compensation items
1. Fees - Retainer fees of consultants, talents, and directors who have no management function in the
business are professional income, not compensation income of the recipient.
2. Commissions to non-employees such as independent sales agents are business income to the sales agent
3. Tips and Gratuities - paid directly to an employee by customers of the employer which are not accounted
for by the employee to the employer are not considered as compensation income, but are to be reported as
“other income” in the income tax return of the employee.

Valuation of compensation paid in kind

Compensation paid in kind is taxable at the fair value of the consideration received. If received in shares, the
fair value of the shares at the date services were provided is used.

SUPPLEMENTAL COMPENSATION
Supplementary or additional compensation includes “performance-based” remunerations to an employee
in addition to the regular compensation with or without regard to the payroll period.

The following are the additional compensation under current tax rules:
1. Overtime pay
2. Hazard pay
3. Night shift differential pay
4. Holiday pay
5. Commissions
6. Fees, including director’s fees (if director is an employee)
7. Emoluments and honoraria
8. Taxable retirement and separation pay
9. Value of living quarters or meals
10. Gains on exercise of stock options
11. Profit sharing and taxable bonuses

13th MONTH PAY AND OTHER BENEFITS

1. 13th month pay
2. Other Benefits
a. Christmas bonus of private employees
b. Cash gifts other than Christmas or anniversary gifts of private employees
c. Additional compensation allowance
d. 14th month pay, 15th month pay, etc.
e. Other fringe benefits of rank and file employees

Government Employees Private Employees

Christmas bonus 13th month pay and other benefits 13th month pay and other benefits
Christmas gift 13th month pay and other benefits De minimis

TAX TREATMENT OF GROSS TAXABLE COMPENSATION INCOME

The ultimate taxation of gross taxable compensation income will depend upon the type of employee involved.
The following table summarizes the rules:
Types of Employee Income Tax Treatment
Regular Employee Progressive Tax
Special Employee 15% Final Tax on gross income
Minimum Wage Earner Exempt
TAXABILITY OF MINIMUM WAGE EARNER (MWE)
1. Taxable Income From Employment
2. Taxable Income Outside Employment

BENEFITS NOT SUBJECT TI WITHHOLDING TAX ON COMPENSATION UNDER RR2-98, AS AMENDED:

a. Remuneration received as an incident of employment (RA 7641; those with approved reasonable
private retirement plan; Social Security Act of 1954, as amended; GSIS Act of 1937, as amended; and
etc.
b. Remuneration paid for agricultural labor;
c. Remuneration for domestic services;
d. Remuneration for casual labor not in the course of an employer's trade or business;
e. Compensation for services by a citizen or a resident of the Philippines for a foreign government or
international organization;
f. Damages (Actual, moral, exemplary and nominal);
g. Life insurance;
h. Amounts received by the insured as a return of premium;
i. Compensation for injuries or sickness;
j. Income exempt under treaty
k. 13th Month pay and other benefits
l. GSIS, SSS, Medicare and other contributions (employee's share only)
m. Compensation income of minimum wage earners (MWEs) who work in the private sector and being
paid the Statutory Minimum Wage (SMW), as fixed by the Regional Tripartite Wage and Productivity
Board (RTWPB)/National Wages Productivity Commission (NWPC), applicable to the place where
he/she is assigned;
n. Compensation income of employees in the public sector with compensation income of not more the
the SMW in the non-agricultural sector as fixed by the RTWPB?NWPC applicable to the place where
he/she is assigned.
o. De Minimis benefits
p. Fringe benefits given to employees other than rank and file and subjected to Fringe Benefit Tax (FBT);
q. Personnel Economic Relief Allowance (PERA) given to government employees; and Representation and
transportation allowance (RATA granted to public officers and employees under the General
Appropriations Act.

DEADLINE OF FILING AND REMITTANCE OF THE WITHHOLDING TAX ON COMPENSATION

Employers shall file the BIR Form 1601-C (Monthly Remittance Return of Income Taxes Withheld on
Compensation) on or before the 10th day of the following month the withholding was made except for taxes
withheld for December which shall be filed/paid on or before January 15 of the succeeding year.

Employers are also required to file BIR Form 1604-CF (Annual Information Return of Income Taxes
Withheld on Compensation and Final Withholding Taxes) on or before January 31 of the following calendar
year in which the compensation income payments and passive income payments were made.

TREATMENT OF WITHHOLDING TAX ON COMPENSATION

To the employee, the withholding tax on compensation is a tax credit which is deductible against his
consolidated or annual income tax due.

If the employee has other items of income that are subject to regular income tax such as income from
business or profession, income from other employment or casual income, he must file a consolidated income
tax return to include such items of income for the entire taxable year. The withholding tax on compensation is
credited against the total tax due in the consolidated income tax return.

Substituted filing of tax return

Under the substituted filing system, the employer files the income tax return of the employee. If the amount
of tax is correctly withheld by the employer, the employee no longer needs to file an annual income tax
return.