2012: The new rule on taxation of nonresident citizens

SUITS THE C-SUITE By Iryn S. Yap-Balmores
Business World (06/11/2012)

Companies in today’s business environment compete on a global level, making it more commonplace for employees to work across borders.

Businesses are looking increasingly at work arrangements such as seconding employees which allows them opportunities for training, specialization, and exposure to other countries and cultures. Being seconded overseas can further develop an individual’s career and also acts an incentive to help companies retain their good people. It also allows an entity within a global organization to share resources and emphasize to their employees its worldwide reach.

Secondment is not a new phenomenon. Filipinos working in multinational or global companies stand a chance of being sent to foreign offices. These arrangements usually last from a few months to a couple of years. Given this, how then do Filipinos account for their taxes when they are assigned abroad?
Prior to the passage of Republic Act (RA) 8424 or the Tax Reform Act of 1998, income tax was imposed on foreign-sourced income of nonresident Filipino citizens. The top marginal rate was 3% for foreign-sourced income over US$20,000.

With the passage of RA 8424, however, nonresident citizens became subject to tax only on their income from Philippine sources. Only resident citizens are taxed on their worldwide income. Clearly, for Philippine income tax purposes, it is vital to determine whether a Filipino is a resident or a nonresident citizen.

Taxation of Nonresident Citizens under the Tax Code and Previous Tax Rulings

Section 22 of the Tax Code defines a nonresident citizen as “a citizen of the Philippines who works and derives income from abroad and whose employment thereat requires him to be physically present abroad most of the time during the taxable year.” In Section 2 of Revenue Regulations (RR) No. 1-79, the term “most of the time” means presence outside the Philippines for not less than 183 days during the taxable year.

The provisions above have been the bases for BIR rulings which held that income of employees who were assigned overseas is not taxable in the Philippines under either of the following premises:

• Employees who are registered with the Philippine Overseas Employment Administration (POEA) are considered as overseas contract workers (OCWs), regardless of the number of days spent outside the Philippines during the taxable year; or

• Employees who may not be registered with the POEA, but who are physically present abroad for at least 183 days during the taxable year, are considered as nonresident citizens.

In these rulings, nonresidency of a Filipino and eligibility to qualify for tax exemption were determined on the basis of physical presence. The place where the salary was paid was deemed immaterial in determining residency – perhaps based on the underlying principle that the situs of taxation in the case of personal services is determined by the place where the services are rendered.

Thus, based on the Tax Code provision as interpreted in past BIR rulings, companies and employees often remember and use the 183-day threshold.

However, based on a recent BIR ruling, it appears that looking only at the 183-day rule is not enough.

BIR Ruling No. 517-2011

In this ruling dated December 22, 2011, the Bureau of Internal Revenue (BIR) held that a local company’s employees (they are engineers) assigned to render services abroad do not qualify as “nonresident citizens” and will thus be treated as resident citizens. Accordingly, compensation income from their assignment abroad, where such engineers are present in the foreign country most of the time during the taxable year (more than 183 days), are subject to Philippine income tax and consequently to creditable withholding tax on wages.

The local employer is a domestic corporation that sends its engineers to various countries for a maximum period of 214 days per calendar year. While working overseas, these engineers remain on the Philippine payroll. The BIR held that the engineers cannot qualify because the phrase “employment thereat” [as used in paragraph (3) of Section 22(E)] means that the individual must be employed in such country. For this purpose, it cited the definition of an “employee” under Section 2.78.3 of RR 2-98, that is, an individual performing services under an employer-employee relationship.

The BIR noted that the personnel are employed as full-time staff in the local company and the foreign assignment is considered part of their duties. As their salaries were paid by the local company whether they were in the Philippines or on foreign assignment, their temporary assignment does not make them employees of the foreign companies for which they rendered that service. The BIR further explained that as the employees of the local company, though working abroad, they are still under an employer-employee relationship with the Philippine entity and not with the foreign entity, and so they do not qualify them as non-residents under paragraph (3).

The basic principle in BIR Ruling No. 517-2011 – that an employer who claims compensation paid to an employee as an expense should withhold the requisite withholding tax on compensation – is sound. Some companies may argue that perhaps the BIR should also consider diverse arrangements between companies in the host and home countries, and the assignees. In construing who is the employer in these secondment arrangements, perhaps the BIR may clarify situations where the home country entity remains the legal employer in form, but the substance of the transaction is that the host country entity is the real employer of the individual, as it has the right to control and direct the individual on the means by which the services will be performed, the results to be accomplished, and ultimately, is the entity that receives the benefit of the services.

BIR Ruling No. 517-2011 abandons previous BIR pronouncements on the same issue. Previously, emphasis was given on the number of days an individual spends within or without the Philippines and the location where the services are rendered in order to determine the situs of taxation. This time, it is the entity who holds the employment contract and pays the payroll costs that were considered material.
This is, of course, something that taxpayers with mobile employees should consider, particularly if the company had previously been issued a ruling on secondment arrangements upon which they have adopted tax practices and policies. While secondment is a welcome career opportunity for most, an employee must also be responsible for remitting the appropriate tax on his or her income earned from work performed overseas.

Iryn S. Yap-Balmores is Senior Tax Director of SGV & Co.

This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co.

Absent but present

With a month to go before 2016 ends, companies are now processing their payroll annualization, estimating the final amount of tax for individual employees. For a citizen working abroad during the taxable year, one very important matter to consider is his residential status, because it will determine how much of his income, if any, is taxable.

As provided in the Philippine Tax Code, a resident citizen is taxable on all income derived from sources within and without the Philippines, while a non-resident citizen is taxable only on income derived from sources within the Philippines.

Section 22 (E) of the Tax Code defines a non-resident citizen as any of the following:

(1) A Philippine citizen who establishes to the satisfaction of the Bureau of Internal Revenue (BIR) Commissioner the fact of his physical presence abroad with a definite intention to reside therein.

(2) A Philippine citizen who leaves the country during the taxable year to reside abroad, either as an immigrant or for employment on a permanent basis. 

(3) A Philippine citizen who works and derives income from abroad and whose employment thereat requires him to be physically present abroad most of the time during the taxable year. 

A person previously considered a non-resident citizen and who arrives in the Philippines at any time during the taxable year to reside permanently in the country shall likewise be treated as a non-resident citizen for the taxable year in which he arrives in the Philippines with respect to his income derived from sources abroad until the date of his arrival in the Philippines. 

The forgoing Tax Code provision mirrors the definitions under Section 2 of Revenue Regulations (RR) No. 1-79 dated Jan. 8, 1979. Under the RR, a non-resident citizen is one who establishes to the satisfaction of the Commissioner the fact of his physical presence abroad with the definite intention to reside therein, and shall include any Filipino who leaves the country during the taxable year as an immigrant, a permanent employee abroad, or a contract worker. 

The same RR also defined the term “most of the time” under Section 22(E)(3) above by establishing the 183-day physical presence rule that continues to be applied today.

However, the application of this rule is not as simple as it appears as exemplified in BIR Ruling No. 305-2016 where a government employee who was on assignment abroad for three years was held to be a resident citizen for tax purposes and as such, subject to tax on her worldwide income.

In the ruling, the critical points raised by the BIR are the temporary nature of the transfer (secondment) and the continuing employee-employer relationship with the Philippine employer.

Based on the Memorandum of Agreement between the government agency and the international organization, the individual remained an employee of the government agency during the period of secondment but was considered on leave without pay. The government agency continued to pay for the mandatory government contributions during the duration of her secondment. As such, the employee does not qualify as a non-resident citizen under Section 22(E)(3).

Further, the individual did not have any intention to reside in the foreign country either as an immigrant or on a permanent basis to make her a non-resident citizen under Section 22(E).

In 2011, the BIR issued BIR Ruling No. 517-2011 stating that employees who rendered services for more than 183 days in foreign countries were not considered non-residents on the basis that: (1) the employee-employer relationship continued to exist between the local company and employees; and (2) the salaries of the employees were paid by the local company. Section 2.78.3 of RR 2-98 states that an employee-employer relationship exists when the person for whom the services were performed has the right to control and direct the individual who performs the services, not only as to the result to be accomplished, but also as to the manner and means by which such results are accomplished. 

It can be inferred from both rulings that whichever party shoulders the compensation payment and whichever party has the right to control and direct the individual do not matter. The substance of the employee arrangements with foreign companies appears inconsequential to the issue. What seems to be the determining factor is whether the individual remains employed by the local employer, regardless of where the employee gets directions or compensation.

As the year is about to end, entities that second or transfer employees abroad for more than 183 days during the taxable year may need to revisit the provisions of their employees’ contracts of employment and arrangements with foreign companies to properly assess the residency status of their employees. 

Most taxpayers want to comply with tax rules and regulations. However, some of our existing ones are vague and can be interpreted differently. Hence, as part of the government tax reform plan to restructure individual tax rates, the BIR may need to revisit Section 22(E)(3), issue implementing guidelines, and provide clear-cut illustrations on when an individual qualifies as a non-resident. 

The views or opinions expressed in this article are solely those of the author and do not necessarily represent those of Isla Lipana & Co. The firm will not accept any liability arising from the article.

Jane R. Alcause-Fabro is a Director at the Client Accounting Services group of Isla Lipana & Co.,

(02) 845-27 28

jane.r.alcause@ph.pwc.com

An ‘out with the old’ VAT exemption

In September, the Department of Finance (DoF) submitted the first of six tax reform packages to Congress. The first package proposes to adjust the income tax brackets and to lower individual income tax rates, except for high earners who will be taxed at 35%. But while this proposal will generally result in less income tax paid by individuals, it will also mean reduced revenue collection for the government.

To mitigate this anticipated effect, the DoF also proposes certain offsetting measures. These include adjustments in the excise tax rates for petroleum products and automobiles, and the expansion of the value-added tax (VAT) base by removing current exemptions under existing tax laws.

Last month, the Senate Committee on Ways and Means held its first public hearing on the DoF-sponsored bill covering the first tax reform package. Various government agencies and affected sectors and organizations, including the Tax Management Association of the Philippines and our firm, were invited to express their sentiments and comments.

As may be expected, most representatives opposed the proposed increase in excise taxes, the 35% personal income tax rate, and the removal of the VAT exemptions if such measures would affect their particular sector, organization, or special group of people. But one particular organization -- the Coalition of Services of the Elderly (COSE) -- surprised me in its support of the DoF proposal to remove the VAT exemption of senior citizens. 

Although their statement was qualified as not being the official and collective position of the entire group, the COSE representative mentioned that they are amenable to the removal of the VAT exemption of senior citizens provided that pensions and other direct incentives and subsidies are given and/or increased, and made available to replace the lost exemption. 

Other senior citizen groups may have other sentiments on the matter. As the removal of this VAT exemption is a sensitive issue, perhaps these other elderly groups can also voice out their concerns. As one senator put it during the hearing, this matter is an emotionally charged issue since the elderly believe that the exemption currently granted is something they have earned having paid their dues for so long.

While I understand that the objective of the proposed tax reform is to adhere to the principle of equity and simplification, there is also the principle of compassion (which was also mentioned by one senator) that needs to be considered. 

Compared to other member countries of the Association of Southeast Asian Nations (ASEAN), we are the only country that gives VAT exemptions to senior citizens. While others may consider conforming to the other ASEAN countries on this matter (and remove the VAT exemption enjoyed by senior citizens), I am proud that the Philippines is unique enough to give this privilege as a sign of our respect to the elderly.

The VAT exemption is granted by Republic Act No. 9994, otherwise known as the “Expanded Senior Citizens Act,” with the following declared policies and objectives:

• To recognize the rights of senior citizens to take their proper place in society and make it a concern of the family, community, and government;

• To give full support to the improvement of the total well-being of the elderly and their full participation in society, considering that senior citizens are an integral part of Philippine society;

• To motivate and encourage senior citizens to contribute to nation building;

• To encourage their families and the communities they live with to reaffirm the valued Filipino tradition of caring for senior citizens;

• To provide a comprehensive health care and rehabilitation system for disabled senior citizens to foster their capacity to attain a more meaningful and productive ageing; and

• To recognize the important role of the private sector in the improvement of the welfare of senior citizens and to actively seek their partnership.

No less than the Constitution requires the State to prioritize the needs of the elderly, particularly in terms of health development, as well as social justice in all phases of national development. The State likewise values the dignity of every human person and guarantees full respect for human rights.

If we would take a look at the intention of the Expanded Senior Citizens Act, Congress gave the VAT privilege as a sign of our Filipino value of caring for senior citizens, regardless of social status. 

While I understand that COSE might have as its primary objective the creation of, if not better, pensions and subsidies, why can’t we just provide these pensions and subsidies without sacrificing the VAT exemption of senior citizens? In fact, there are other alternatives where the government can get its revenue collections. 

One of the things that I admire in the new administration is how it aims to address the long overdue reform of the tax laws. I can see why the people elected President Rodrigo R. Duterte. A lot of Filipinos feel his sincerity in bringing change to the Philippines by eradicating crime, primarily those relating to illegal drugs, fighting corruption in the government, strengthening foreign relations particularly with China and Japan, and protecting the underprivileged. Filipinos generally see President Duterte for his heart. 

I genuinely support the tax reform initiatives of the government. I believe that the DoF listens to each stakeholder that will be affected by the proposed tax reforms. But more than just listening, I do hope that it will also have the heart to reconsider repealing the VAT exemption given to the elderly. 

The views or opinions expressed in this article are solely those of the author and do not necessarily represent those of Isla Lipana & Co. The firm will not accept any liability arising from the article.

Benedict C. Villalon is an assistant manager belonging to the Tax Services Department of Isla Lipana & Co., the Philippine member firm of the PwC network. 

(02) 845-2728 

benedict.villalon@ph.pwc.com