Employer-Employee Relationship & Compensation

Compensation Income

• Refers to any remuneration for services performed by an employee for their employer under an employer-employee relationship, unless specifically excluded by the Tax Code, per Sec 2 (a) BIR RR No. 8-2018.

Employer-Employee Relationship

• Exists when the person for whom services are rendered (Employer) has the right to control and direct the individual who performs the services (Employee).
• The employer has control over the result of the work and the details and means by which that result is accomplished, according to Sec 2 (e) BIR RR No. 8-2018.

Elements of Employer and Employee Relationship under case law

• Selection and engagement of employees involves a screening process.
• Payment of wages is usually fixed and controlled by the employer.
• Power of dismissal means the employer can terminate employees when facing heavy losses or other reasonable grounds.
• Power of control enables the employer to control the means and methods by which the work is accomplished.
• An arrangement lacking all elements isn't an employer-employee relationship but an independent contract for services.

Types of Employees as to Function

• Managerial: Those with powers to lay down and execute managerial policies and/or to hire, transfer, suspend, lay off, recall, discharge, assign or discipline employees.
• Supervisory: Those effectively recommending managerial actions, requiring independent judgment rather than merely routine or clerical tasks.
• Rank and file: Those holding neither managerial nor supervisory functions.

Types of Employees as to Taxability

• Minimum Wage Earners: Recipients of minimum wage as fixed by the Regional Tripartite Wage and Productivity Board of the DOLE that are exempt from income tax on their compensation.
• Regular Employees: Those who are subject to the regular progressive income tax.

The Tax Model on Compensation Income

• Gross Compensation Income includes all remunerations received under an employer-employee relationship.
• Non-Taxable Compensation includes mandatory deductions and exempt benefits.
• Taxable compensation income = Gross Compensation Income - Non-taxable compensation

Forms of Compensation Income

• Regular Compensation
• Supplemental Compensation

Regular Compensation

• Pertains to fixed remunerations received by an employee every payroll period.
• Includes basic salary and fixed allowances like cost-of-living, housing, representation, and transportation. Basic salary and fixed allowances paid to an employee every payroll period
• Exception Rule on the taxability of allowances:
  • Ordinary and necessary allowances for travelling, representation or entertainment expenses incurred in the employer's trade, business, or profession are not included if expensed are subjected to accounting or liquidation with excess advances being returned to the employer.

Supplemental Compensation

• Pertains to performance-based pays to employees with or without regard to the payroll period.
• Includes:
  • Overtime pay
  • Hazard pay
  • Night shift differential pay
  • Holiday pay
  • Commissions
  • Fees, including director's fees if the director is an employee
  • Emoluments and honoraria
  • Taxable retirement and separation pay
  • Value of living quarter or meals
  • Gains on exercise of stock options
  • Profit sharing and taxable bonuses
• Overtime, holiday, hazard and night differential pay constitutes additional compensation, except when derived by a minimum wage earner.
  • Commissions are incentives intended to stimulate sales, may be given as a profit sharing or performance bonus.
• Emoluments pertain to any pay in general and honoraria are additional payments for attending to special tasks or assignments.
  • When an employee receives free living quarters or meals in addition to salary for services rendered, the value to the employee of such living quarters or meals is included in compensation income.
  • However, when the same is furnished to an employee for the convenience of the employer or out of necessity of the employer's business, the value thereof is not compensation income, but a business expense.
• Stock Option Plans allow employers to motivate employees by giving stock options, enabling them to earn additional reward on the appreciation of the company’s stock price.
  • Profit sharing or taxable bonus is a reward for churning the business to post a profit.
  • A productivity incentive bonus links to improvements in productivity usually in terms of cost savings through waste reduction, efficient labor utilization or increase in volume of production.

Tax Exempt Compensation / Non-Taxable Compensation

• Consists of mandatory deductions and exempt benefits.

Mandatory Deductions

• Include employee's mandatory contributions to GSIS, SSS, PhilHealth, HDMF, and union dues.

Exempt Benefits

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

Remunerations Exempt under THE NIRC, as Amended and Special Laws

• Remuneration received as incident of employment:
  • Exempt retirement benefits under RA 7641.
  • Exempt retirement gratuities to government officials and employees.
  • Exempt termination benefits.
  • Benefits from the United States Veterans Administration.
  • Social security, retirement gratuities, pensions, and similar benefits from foreign government agencies.
  • Benefits from SSS and GSIS.
  • COVID-19 benefits to health workers.

De Minimis Benefits

• The Bureau of Internal Revenue (BIR) defines these as small perks that employers give to employees that are exempt from income tax, intended to improve employee morale and work experience.
• Considered De Minimis benefits as of RR Nos. 4-25, amending certain provisions of RR No. 11-18, and RR No. 2-98:
  • Monetized unused vacation leave credits of private employees up to ten (10) days.
  • Monetized value of vacation and sick leave credits paid to government officials and employees.
  • Medical cash allowance to dependents of employees up to Php 1,500 per semester of Php 250 per month.
  • Rice subsidy up to Php 2,000 or one sack of 50kg rice per month amounting to not more than P2,000.
  • Uniform and clothing allowance not exceeding Php 7,000 per annum. (Increased per RR No. 004-2025)
  • Actual medical assistance such as medical allowance to cover medical and healthcare needs, annual medical/executive check-up, maternity assistance, and routine consultations, not exceeding P10,000 per annum.
  • Laundry allowance up to Php 300 per month.
  • Employee achievement awards, for length of service or safety achievement, in any form, whether in cash, gift certificate or any tangible personal property, with an annual monetary value not exceeding Php 10,000 received by the employee under an established written plan which does not discriminate in favor of highly paid employees.
  • Gifts given during Christmas and major anniversary celebrations not exceeding Php 5,000 per employee per annum.
  • Daily meal allowance for overtime work and night/graveyard shift not exceeding 25% of the basic minimum wage on a per region basis.
  • Benefits under a Collective Bargaining Agreement and productivity incentive schemes provided that the total annual monetary value received from both CBA and productivity incentives schemes combined up to Php 10,000 per employee per annum.
• Taxable De Minimis Benefits: Excess de minimis over their regulatory limits; other benefits of relatively small value that are not included in the list of the de minimis benefits.

13TH Month Pay and Other Benefits

• Includes 13th Month Pay and Other Benefits.

13th Month Pay and Other Benefits:

• The 13th month pay of government employees consists of a Christmas bonus equivalent to one month salary plus a PhP5,000 cash gift.
• The 13th month pay of private employees is equivalent to one-month salary.
• Christmas Bonus for Government Employees is 13th month pay and other benefits, while for Private Employees it is also13th month pay and other benefits.
• Christmas Gift for Government Employees is 13th month pay and other benefits, while for Private Employees it is De minimis.
• Other Fringe Benefits:
  • For rank and file employees, it is treated as compensation income as part of "other benefits" under "13th month pay and other benefits".
  • For managerial or supervisory employees, it is treated as fringe benefits subject to fringe benefit tax.
  • If an employee is a rank and file employee, it is treated as a compensation income as part of "other benefits" under "13th month pay and other benefits".
  • If an employee is a managerial or supervisory employee, it is treated as fringe benefit subject to fringe benefit tax.
  • Is an exempt fringe benefit, regardless of the type of employee if the same was given by the employer for his convenience or business necessity such as when an employee is required to study to acquire expertise for the future use of the employer's business.
• Illustration 2: An employee receives a monthly rice allowance of PhP3,000 a month which is PhP1,000 in excess of the PhP2,000 a month de minimis limit for rice allowance.
  • If the employee is a rank and file employee - The PhP1,000 monthly excess constitutes in a taxable de minimis benefit taxable as compensation as part of "other benefits".
  • If the employee is a managerial or supervisory employee – as fringe benefit subject to fringe benefit tax.

13TH Month Pay and Other Benefits: Tax Treatment

• RR2-98 states that 13th month pay and other benefits are exempt from withholding from compensation if they do not exceed PhP90,000 with excess above to be treated as compensation income subject to the regular income tax.-
• Illustration 1:
• -*A government rank and file employee received a taxable "13th month pay and other benefits" in the amount of 22,000.
• Note on government employee:
  • Personnel Economic Relief Allowance (PERA) is not subject to income tax and withholding tax (Under RR8-2000 as affirmed by RR10-2008.
  • The PhP5,000 Christmas gift of government employees is designated by the NIRC to be part of "13th month pay and other benefits); hence, it is not a de minimis benefit.
  • Under RR5-2011, the monetization of vacation leave and sick leave credits of government officials is an exempt de minimis benefit without regard to the number of days.- Example:
    • A private rank and file employee working in a remote tower station of Fox Internet Company received a taxable total 13th month pay and other benefits of PhP 10,400
• Note on private employee:
  • Performance bonus is a supplemental or additional compensation
  • The laundry allowance limit is computed as 300 x 12 = PhP3,600
  • The Christmas gift is a de minimis benefits for private employees under RR5-2011
  • The housing privilege is exempt under the convenience of the employer rule.
  • The “13th month pay and other benefits" of rank and file employees includes “other fringe benefits

Certain Benefits of Minimum Wage Earners

• Are exempt from income tax on the following:
  • Basic minimum wage
  • Other benefits (HHON): Holiday pay, Hazard pay, Overtime pay, Night shift differential pay.
  • Additional compensation such as commissions, honoraria, fringe benefits, benefits in excess of the allowable amount of 90k, taxable allowances and other taxable income given by the employers to MWEs are subject to income tax.

Rules of change in status as Minimum Wage Earner during the year

• When an employee becomes a minimum wage earner during the year, the employee is subject to income tax only on compensation earned before becoming a minimum wage earner.
• When an employee ceases to be a minimum wage earner during the year due to increase in salary, only the income for the rest of the year is taxable.
• If the taxable income of the employee does not exceed PhP250,000 for the year, there will be no income tax due for the period under the tax table.

Final Tax on Fringe Benefits

• Under labor laws, fringe benefits pertain to all other benefits or incentives of employees other than the basic pay.
• The NIRC defines "fringe benefit" as goods, services or other benefits furnished by the employer to the employees.

General Categories of Fringe Benefits Subject to Final Tax

• Management perquisite benefits / Management Perks: Highly privileged incentives given only to a special group of employees that are non-performance based and given incentives to management employees.
• Employee personal expenses shouldered by the employer: An expense takes the nature of an employee's personal expenditure that is paid or assumed by the employer in default of a proximate business necessity, it is deemed a fringe benefit in its entirety even if the expense is receipted in the name of the employer.
• Taxable de minimis benefits: Excess de minimis over their limits; benefits not included in the de minimis list

Fringe Benefits Tax

• Covers only the taxable fringe benefits of managerial or supervisory employees.
• Is a final tax imposed on the fringe benefits furnished, granted or paid by the employer to the employee, excep rank and file employees, whether such employer is an individual, a professional partnership or a corporation, regardless of whether the corporation is taxable or not, or the government and its instrumentalities.
• For the purpose of fringe benefit tax, "fringe benefit" means any goods, services or other benefits furnished or granted in cash or in kind by the employer to individual employees (except rank and file employees)
  • Housing benefits, expense account, vehicles of any kind, household personnel, and interest granted at less than market rate(12%)
  • Membership fees, dues and other expenses borne by the employer for the employee in social and athletics clubs or other similar organizations
  • Expense for foreign travel, Holiday and vacation expenses Educational assistance to the employee or his dependents
  • Life or health and other non-life insurance premiums or similar accounts in excess of what the law allows.

Characteristic of Fringe Benefits Tax

• Final tax, imposed upon on the fringe benefits of managerial or supervisor employees, paid by the employer, and is a grossed-up tax.
• Due on remittance quarterly based on the accounting selected by through BIR Form 1603Q on or before the last day of the month following the quarter in which teh withholding was made.

Procedures in Computing Fringe Benefits Tax:

1. Determine the monetary value
2. Determine the cross-up rate and fringe benefit tax rate applicable for the taxpayer
3. Determine the grossed-up monetary value by dividing the monetary value by the gross-up rate.
4. Determine the fringe benefit tax by multiplying the fringe benefit tax rate to the grossed-up monetary value.

Rules on Valuation of Fringe Benefits

• Benefits paid in cash: The monetary value is the amount paid in cash except when the employer pays for the rent of the residence of the employee, MV is 50% of the rental payment.
• Benefits paid in kind: MV is the fair value of the thing given or its book value, whichever is higher.
• Benefits that are furnished: When given in the form of free use of the employer's property, then the MV is 50% of the rental value of the property. If the property has no available rental value, the depreciation value is used. For depreciation value, the presumptive useful lives of the property are: 20 years for real properties and 5 years for movable properties.

Fringe Benefit Tax Rates:

• The tax rate from benefits for resident/citizen employees is 35%, while it is 25% for non-resident aliens
• The grossed-up rate from benefits for resident/citizen employees is 65%, while it is 75% for non-resident aliens

Creditable Withholding Tax on Compensation Income

• A method of collecting the income tax at source upon receipt of the income that applies to all employed individuals whether citizens or aliens.
• The employer is constituted as the withholding agent.

Procedural Computation of the Withholding tax on compensation

• Determine the total monetary and non-monetary compensation of the employee for the payroll period: monthly, semi-monthly, weekly or daily. Segregate non-taxable benefits, mandatory contributions and supplemental compensation.
• Determine the bracket that applies to the regular compensation of the employee for the applicable payroll period. Determine the basic tax for the bracket.
• Add supplemental compensation to the excess of the regular compensation. Subject the total to the incremental tax rate for the bracket.
• Total the basic tax and the incremental basic tax.
• It must be noted that the total amount withheld on every payroll date may not exactly match the annual tax due. Due to this, the income of the employee needs to be reckoned at the end of the year and adjustment is made as necessary.
• Illustration: XYZ Company employs Mr. V, he has semi-monthly salary of PhP35,000 and he will be released PhP 38,412.55 of the semi-monthly pay after all computations are made

Deadline of Filing and Remittance of the Withholding Tax on Compensation:

• BIR Form 1601-C (Monthly Remittance Return of Income Taxes Withheld on Compensation) – on or before 10th day of the following month the withholding was made except for taxes withheld for December which is due on or before January 15 of the succeeding year.\
• BIR Form 1604-C (Annual Information Return of Income Taxes Withheld on Compensation) – on or before January 31 of the following calendar year in which the compensation income payments and passive income payments were made. Employer must furnish each employee a copy of BIR Form 2316 (Certificate of Compensation Payment or Income Tax Withheld) on or before January 31 of the succeeding year.

Explore scenarios defining employer-employee relationships for tax. Understand the key elements and distinctions, including managerial vs. supervisory roles. Test your knowledge of compensation income and minimum wage taxation.