What’s it gonna be, my way or the highway?

As you may be aware, Section 6(A) of the National Internal Revenue Code of 1997 or the Tax Code, as amended, provides the Bureau of Internal Revenue (BIR) Commissioner or their duly authorized representative the power to authorize the examination and assessment of any taxpayer for the correct amount of tax.

During tax assessments, the BIR provides business taxpayers with details of deficiency taxes along with their computations. For certain withholding taxes (i.e., creditable and final), rates are fixed and usually vary by nature of income. For withholding tax on compensation (WTC), we use the graduated tax rates ranging from zero percent to 35 percent as updated by the Tax Reform for Acceleration and Inclusion (TRAIN) Law*.

With that in mind, how does the BIR determine the tax rate to be applied in their assessment of WTC? Do they really use the right rate?

In the Supreme Court case of a domestic manufacturing corporation (petitioner) vs. Commissioner of Internal Revenue (CIR) (respondent) in November 2023, the CIR argued that the Court of Tax Appeals (CTA) First Division, as affirmed by the CTA En Banc, erred in ruling that the unaccounted compensation of the domestic manufacturing corporation for the taxable year 2001 should be subjected to WTC based on the effective tax rate computed based on the total withholding tax on compensation paid divided by the total amount of taxable gross compensation reported for the taxable year. The CIR further claimed that the maximum rate, which is 32 percent, should be used instead of the effective tax rate.

However, the SC found no basis for the CIR’s argument since the employees to whom the unaccounted compensation pertained were not individually identified. The maximum graduated rate cannot simply be applied to all unaccounted compensation, considering that non-supervisory employees (rank and file) are not getting the same rate of compensation as compared to regular managerial and supervisory employees.

The use of effective rate was also recognized in another SC case in April 2016 (CIR, petitioner, vs. a domestic fuel gas supplier, respondent), where the basis for computing the assessed withholding tax on compensation was the total withholding tax on compensation paid and the total taxable compensation income for the taxable year.

Having said that, bear in mind that it may not always be the case where effective tax rate will be applied. Based on the above case between the domestic manufacturing corporation and the CIR, it is evident that the crucial factor was whether the employees, to whom the compensation pertained, were individually identified or not. This way, the courts would be able to properly identify the withholding tax rate.

Let this case be a reminder that at the end of the day, it is incumbent for the BIR and the taxpayer to prove every aspect of their case with the aid of supporting evidence because failure to do so might be fatal to the case of one over the other.

*Prior to TRAIN Law, graduated tax rates for WTC ranged from five percent to 32 percent.

Peter John Vitaliano is a Manager from the Tax Compliance Team under the Tax Group of KPMG in the Philippines (R.G. Manabat & Co.), a Philippine partnership and a member firm of the KPMG global organization of independent member firms affiliated with KPMG International Limited, a private English company limited by guarantee. The firm has been recognized as a Tier 1 in Transfer Pricing Practice and in General Corporate Tax Practice by the International Tax Review. For more information, you may reach out to Peter John Vitaliano or Leandro Ben Robediso through [email protected], social media or visit www.home.kpmg/ph.