Reinstated Government Employees Crediting Prior Service Upon Refund OF Retirement Benefits

The Supreme Court recently settled a significant question for employees separated due to redundancy: does the tax exemption for separation pay disappear simply because the amount was computed using a retirement plan formula? In Mateo v. Coca-Cola Bottlers Phils., Inc. (G.R. No. 226064, February 17, 2020), the Court ruled that it does not. The character of the benefit—whether it is separation pay or retirement pay—depends on the reason for the employee's separation, not on the formula used to calculate the amount.

The Facts of the Case

The petitioner was a Sales Supervisor who was separated from service in 2007 when her previous employer ceased operations. She received separation benefits at that time. She was then hired by Coca-Cola Bottlers Phils., Inc. as a Sales Supervisor and later promoted.

In February 2012, the company informed her that her position was redundant due to a new Route to Market strategy. Her employment was terminated effective March 31, 2012. The company computed her separation benefits at P676,657.15 but later released only P402,571.85. Deductions included an outstanding loan balance and P134,064.95 for withholding tax.

The company explained that the retirement benefit was no longer tax-exempt because she had already availed of the tax exemption upon her separation from her previous employer. The petitioner questioned this, arguing that the amount she received was separation pay due to redundancy, which is exempt from income tax under the National Internal Revenue Code (NIRC).

The Issue

The central question was whether the company was liable for illegal deduction when it withheld tax from the amount received by the employee as a consequence of her involuntary separation from service due to redundancy.

The Ruling

The Supreme Court ruled in favor of the employee. The Court emphasized that the petitioner was separated due to redundancy under Article 283 of the Labor Code. This entitles her to separation pay equivalent to at least one month pay for every year of service.

The company's Retirement Plan provided that an involuntarily separated employee shall receive a separation benefit computed using the retirement formula or the termination benefit under law, whichever is higher. The Court noted that using the retirement formula because it was more advantageous does not convert the character of the benefit into retirement pay.

The Court distinguished between retirement benefits and separation pay. Retirement pay is received upon reaching retirement age or meeting tenurial requirements. Separation pay, on the other hand, is received due to termination for authorized causes such as redundancy. Since the petitioner was separated due to redundancy and did not voluntarily opt to retire, the amount she received was separation pay.

Tax Exemption Under the NIRC

The Court applied Section 32(B)(6)(b) of the NIRC, which exempts from income tax any amount received by an employee as a consequence of separation from service for any cause beyond the employee's control. Redundancy is clearly a cause beyond the employee's control.

The Court rejected the Court of Appeals' application of Section 32(B)(6)(a), which requires the taxpayer to have been in the service of the same employer for at least 10 years and to have not previously availed of the exemption. That provision applies only to retirement benefits, not separation pay. Since the amount received was separation pay, the conditions for retirement benefit exemption were irrelevant.

Practical Takeaways

• The reason for separation determines the tax treatment. If an employee is separated due to redundancy, retrenchment, or other authorized causes beyond their control, the separation pay is exempt from income tax under Section 32(B)(6)(b) of the NIRC.

• The computation formula does not change the nature of the benefit. Even if a company uses its retirement plan formula to compute separation pay because it results in a higher amount, the benefit remains separation pay, not retirement pay.

• The 10-year service requirement applies only to retirement benefits. Employees who receive separation pay do not need to have served the same employer for 10 years to enjoy the tax exemption.

• Employers must be careful in withholding taxes. Withholding tax from separation pay due to redundancy may constitute illegal deduction, exposing the employer to liability.

• Prior availment of the exemption does not bar a second claim. An employee who previously received tax-exempt separation pay from a former employer can still claim the exemption for separation pay from a subsequent employer.

This article is general information and not legal advice. For your specific situation, consult a lawyer or ask ASG Legal AI.