With the ever-evolving world of commerce, employees have become more involved in everyday operations. For instance, employees would find themselves in inevitable circumstances where they would be the one to cover for business-related expenses out of their own pockets, such as transportation expenses or office supplies, then would later on reimburse such from their employers.
Nevertheless, regardless of how business practices change, there remain rules that have an impact on how taxpayers or employers would approach these “business-related expenses” in terms of deductibility. This is true since one of the most common Bureau of Internal Revenue (BIR) audit findings is related to those expenses which were not subjected to expanded withholding taxes (EWT) and as well findings related to improper substantiation resulting to disallowance of Value-added Tax (VAT). Hence, the following questions arise:
1) What happens during BIR Audits? and
2) How should employers treat such expenses moving forward?
What Happens During BIR Audits?
BIR-driven Tax Assessments typically starts with the issuance of a Letter of Authority (LOA) where the assigned examiner would normally compare the expenses reported on the taxpayer’s books, such as the audited financial statements or the taxpayer’s trial balance, against the expense which was claimed in the tax returns. Any resulting difference could lead to a deficiency tax as a result of an alleged non-deductible expense or unaccounted income.
One of the most common findings by the BIR are expenses that were not subjected to EWT pertain to employee reimbursements. As a result, a deficiency in EWT remittance plus penalties and interest would be exacted by the BIR to the taxpayers and a risk of having such expenses disallowed as a deduction from the gross income in the income tax return (ITR).
How Should Employers Treat Such Business-Related Expenses Reimbursed by Employees Moving Forward?
In order to appropriately identify as to how taxpayers could resolve such issues, let us look into the regulations related to the withholding of employee-reimbursed business expenses. Section 2.78.1 6(b) of the Revenue Regulation (RR) No. 2-98 as amended, states that any amount paid specifically, either as advances or reimbursements for travelling, representation, and other bonafide ordinary and necessary expenses incurred or reasonably expected to be incurred by the employee in the performance of his duties are not compensation subject to withholding, if the following conditions are satisfied:
Now that we are enlightened as to what will form part of the employees’ taxable income, let us move forward as to the effect of such reimbursements to the employers.
Substantiation and Withholding Requirements
Accordingly, for taxpayers to legitimately claim such ordinary and necessary expenses, Section 34 of the National Internal Revenue Code (NIRC) as amended, specified that to claim a deduction from the gross income, the taxpayer shall substantiate with sufficient evidence, such as official receipts or other adequate records, (i) the amount of the expense being deducted, and (ii) the direct connection or relation of the expense being deducted to the development, management, operation, and/ or conduct of the trade, business or profession of the taxpayer.
Furthermore, Revenue Memorandum Circular (RMC) No. 72-2004 clarified that taxpayers being classified as top twenty thousand corporations (TTC) / as large taxpayers (LT) should subject payments made to their regular suppliers, which were shouldered by their employees/agents to an EWT of 1% on purchase of goods or 2% on purchase of services. The RMC further clarified that the sales invoices/ official receipts should be in the name of the persons whom they represent and that the corresponding certificate of taxes withheld at source (BIR Form No. 2307) is issued. There is another option for taxpayers to eliminate the complexity of administrative task of compliance, one of which is for taxpayers to issue a company credit card to its employees since no withholding is required for transactions paid with company-issued credit cards.
Moreover, should the taxpayer/employer fail to subject such employee reimbursements to EWT, it would not only give rise to various tax penalties but as a significant effect, a possible disallowance of such expenses to the gross income. Nevertheless, as a remedy should the BIR raise a non-withholding or under withholding issue resulting to the disallowance of the said expense, Revenue Regulation (RR) No. 6-2018, reinstated the provisions for deductibility as stated in RR No. 14-2002. In the said RR, any income payment that is otherwise deductible under the Tax Code will now be allowed where no withholding was made, as long as the withholding agent pays the tax (or the difference between the correct amount and the amount of tax withheld, in the case of an erroneous under withholding), including the interest and surcharges incident to non-withholding (or under withholding), at the time of audit/investigation or reinvestigation/reconsideration. In a Court of Tax Appeal decision, the Court held that the audit/investigation or reinvestigation/reconsideration had already been concluded when the Final Decision on Disputed Assessment (FDDA) was issued. It is prudent, therefore, to settle the deficiency withholding tax at least before the issuance of the FDDA to be able to claim the related expense.
In addition, with the consideration of audit findings related to VAT taxpayers should also keep in mind the appropriate invoicing requirements as part of the substantiation requisites since improper supporting documents and improper invoicing requirements could as well result to audit findings related to VAT. Commonly, such findings pertain to 1) failure to support purchase of services with an official receipt and as well failure to support purchase of goods transactions with a sales invoice, 2) failure to separately indicate the input VAT in the receipt, and 3) failure to properly indicate the required taxpayer’s information such as the registered name, taxpayers identification number (TIN), the registered business address, and the business style or trade name of the taxpayer in the Sales Invoice (SI) or Official Receipt (OR).
Due to the complex nature of the substantiation and invoicing requirements, companies could impose a policy regarding employee reimbursements wherein should employees fail to meet the required substantiation and invoicing requirements, expenses may not be reimbursed.
Lastly, due to the growing complexities of day-to-day business transactions and as businesses move towards globalization, it is high time that the BIR issues guidelines in easing the process of withholding taxes on employee reimbursements. Until then, taxpayers being updated and informed with the tax rules are not sufficient to keep up with the evolving business and tax practices. Taxpayers should as well become proactive in conducting their internal tax compliance audits in order to revisit internal tax policies and align with the ever-changing landscape of Philippine taxation. As stated by the Greek philosopher Heraclitus, the only constant thing in life is change.
Let's Talk Tax is a weekly newspaper column of P&A Grant Thornton that aims to keep the public informed of various developments in taxation. This article is not intended to be a substitute for competent professional advice.
As published in BusinessWorld, dated 24 October 2023
