Tax Articles

Withholding Tax on Compensation or FBT?

By: Atty. Mabel L. Buted

With today's state of competition, companies are competing not only on the marketing of their products and services, but also in attracting recruits for employment. And so, they would oftentimes offer attractive remuneration packages. This includes interest and consciousness on the correct tax treatment that comes with the employees' benefits.

Here in the country, the compensation and benefits received by the employees are usually subject to the withholding tax on compensation. But other benefits are subject to other form of tax – the fringe benefits tax (FBT). There are still instances, however, where the tax treatment are confusing, that even our tax authority keep changing the rules more often.

Compensation income paid to employees, regardless of their rank or position in the company, are subject to withholding tax. Compensation would come in all forms, whether it is paid in money or in some other medium like stocks, bonds or other forms of property, as long as it is given as a remuneration for the services rendered by the employee. It includes living quarters or meals furnished for the benefit of the employee, as well as fixed and variable allowances. The withholding tax ranges from 0% to 35% of the income, depending on the amount.

Benefits that are subject to FBT are only those granted to employees who hold a managerial or supervisory position. Fringe benefits refer to goods, services or other benefits granted, in addition to basic salaries. Examples of these fringe benefits subject to the FBT are the likes of certain privileges given to them for housing, use of the employer’s transportation vehicles, or reimbursement of personal expenses. The FBT rate is 35%. The monetary value of the benefits, calculated based on certain guidelines provided in the law (e.g., 50% of the value), is grossed up and subjected to the FBT rate. In effect, the FBT is shouldered by the employer, and is not deducted from the amount of the fringe benefits.

Like compensation subject to the withholding tax, fringe benefits may also be paid in cash or in kind. The thin line of distinction between the employee benefits that are subject to withholding tax and those that are subject to FBT are often confusing.

For example, housing benefits are subject to FBT. But there are rulings holding that housing benefits, given to managerial and supervisory employees in the form of allowances, are subject to FBT to the extent of the actual rental, and any excess of the fixed housing allowance over the amount of actual rental shall be taxable as compensation income subject to withholding tax.

In so far as stock awards are concerned, our tax authority has not been consistent in its pronouncement. But recently, the Department of Finance (DOF) issued RR No. 13-2022, providing that equity grants (in stock options, stock appreciation rights, and other option plans) awarded to employees are considered compensation subject to withholding tax. This rule will apply regardless of the employment status of the grantee-employee who could either be a rank-and-file, a manager or a supervisor. The equity grants, once exercised or availed, would be subjected to withholding tax at the graduated tax rate of 0% to 35%.

RR No. 13-2022 was issued following an opinion of the DOF in Opinion No. 016-2022 involving the same matter. The DOF took into consideration that the equity grants are provided not as a perk which is the conventional description of the benefits that are subject to FBT, but rather as payment in consideration of the services performed by the employees. Accordingly, equity-based compensations are consistently treated by the grantor companies as compensatory on account of the vesting period within which the employees are required to be employed by or render services to the employer. Thus, the DOF ruled that equity grants are taxable as compensation subject to withholding tax and not to FBT.

Before RR No. 13-2022, RMC No. 79-2014 required a different rule. In RMC No. 79-2014, income arising from equity grants were taxable based on the employment position of the employee. If he or she is a rank-and-file employee, the income was subjected to withholding tax on compensation; otherwise, the FBT applied. This distinction is no longer present in RR No. 13-2022.

It is important for the taxpayers to know the proper taxes that are imposable on their employees’ benefits to actually serve the purpose for giving these, and that is, to benefit and keep them, while they also comply with the law. This is especially relevant in cases when the applicable withholding tax rate is lower than the FBT rate. The same is true when the benefits are paid in property. The employee may not appreciate receiving non-cash benefits when the withholding taxes on these are withheld and deducted from their salaries paid in cash, whereas, if these are subject to FBT, they are able to get the value of the benefits in full.

The reason of the DOF in rendering the opinion provided us a helpful guide. Based on this, we can state that, if the benefits are granted primarily as consideration for the services of the employees, and not just “as a perk”, then these must be treated as compensation subject to withholding tax and not to FBT.

But even with the guidelines provided by the tax authority, the applications are still susceptible to conflicting interpretations. Refer to your consultants when in doubt!