On Company Layoffs and Taxes

The COVID-19 pandemic has driven some employers to lay-off some employees as a cost-saving mechanism. While the law requires that a terminated employee must be paid his or her separation pay, some have asked: separation pay due to retrenchment – taxable or not?

Separation benefits due to retrenchment/redundancy/partial cessation of business operations are exempt from income tax and withholding tax.[1]

Any amount received by an employee or by his heirs from the employer as a consequence of separation from the service due to either death, sickness or other physical disability or for any cause beyond the control of the said employee shall not be included in the gross income and shall be exempt from taxation under Title II of the NIRC, as amended.

Accordingly, the separation pay to be received by the retrenched employees as a result of their separation from the service is exempt from income tax and consequently from withholding tax.

How to claim exemption?

To obtain tax exemption ruling on separation benefits, submit the documentary requirements  to the Revenue District Office (RDO) or appropriate Large Taxpayers (LT) Office where the employer is originally registered. 

The following documents are required:

1. Letter request from the employer for the exemption of separation benefits from income tax and withholding tax;
2. Written notice to the employee and the appropriate Regional Office of the Department of Labor and Employment (DOLE) at least thirty (30) days before the effectivity of termination, specifying the ground for termination;
3. A Board Resolution – stating the following:
4. That the retrenchment is reasonably necessary and likely to prevent business losses;
5. That the losses, if already incurred, are not merely de minimis, but substantial, serious, actual and real, or if only expected, are reasonably imminent, with appropriate supporting evidence of said losses; 
6. That the retrenchment is made in good faith for the advancement of its interest and not to defeat or circumvent the employees’ right to security of tenure; and
7. That the selection of employees to be terminated has been made in accordance with a fair and reasonable criterion.[2]

[1] Section 32 (B) (6) (b) of NIRC, as amended and BIR Rulings: 057-2014/ 123-2014 / 124-2014 / 135-2014 

[2] BIR RMO No. 66-2016 (06 December 2016)