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.