November 8, 2006 BIR RULING NO.

013-06 32(B)(6)(b) 000-00 AFP Retirement and Separation Benefits System Camp General Emilio Aguinaldo Quezon City Attention: Mr. Cesar M. Jayme Jr. President & CEO Gentlemen : This refers to your letters dated March 16, 2006 and June 30, 2006 requesting for a ruling on whether or not the vested benefits to be received by the employees of AFP-RSBS under the Employees Retirement Benefit Plan (ERBP) are exempt from income tax and consequently from withholding tax. As represented, AFP Retirement and Separation Benefits System (AFP-RSBS) was created by Presidential Decree (PD) No. 361. Its purpose and functions are akin to those of the GSIS and the SSS, as in fact it is the system that manages the retirement and pension funds of those in the military service. Members of the Armed Forces of the Philippines (AFP) and the Philippine National Police (PNP) are expressly excluded from the coverage of The GSIS Act of 1997 (Section 3, Republic Act No. 8291). Therefore, soldiers and military personnel, who are incidentally employees of the Government, rely on the administration of the AFP-RSBS for their retirement, pension and separation benefits. For this purpose, the law provides that the contribution by military officers and enlisted personnel to the System shall be compulsory. Its enabling law further mandates that the System shall be administered by the Chief of Staff of the AFP through an agency, group, committee or board, which may be created and organized by him and subject to such rules and regulations governing the same as he may, subject to the approval of the Secretary of National Defense, promulgate from time to time. Moreover, the investment of funds of the System shall be decided by the Chief of Staff of the AFP with the approval of the Secretary of National Defense. Except for the PhP200,000,000.00 "seed money," the Government does not provide counterpart contribution to the System. The employees of the AFP-RSBS do not receive any salary from the Government and are not covered by the salary standardization law. Their remittances and contributions were made to the Social Security System and not to the GSIS. While there have been no appropriations for the contribution of funds to the AFP-RSBS, Section 2 of PD No. 361 provides that the Government is not precluded from later on adding to the funds in order to provide additional benefits to the men in uniform. AFP-RSBS was operating as a private entity for twenty-seven (27) years or since 1976. On November 12, 2003, however, Supreme Court Decision dated August 12, 2003 declaring that the institution is a government entity became final and executory.

On the other hand, the ERBP was established by the AFP-RSBS Board of Trustees in January 1989 in compliance with RA No. 7641 which encourages private corporations to provide their employees with retirement benefits over and above the government mandated Social Security System (SSS) benefits. It is a contributory retirement plan for AFP-RSBS employees which entitles the employees to proportionate vested rights upon the completion of at least ten (10) years of service in AFP-RSBS. With the Supreme Court ruling, the ERBP has been declared inoperative based on Section 10 of RA No. 4968 dated June 17, 1967 which states: "Hereafter no insurance or retirement plan for officers or employees shall be created by any employer. All supplementary retirement or pension plans heretofore in force in any government office, agency or instrumentality or corporation owned or controlled by the government are hereby declared inoperative or abolished: Provided, That the rights of those who are already eligible to retire thereunder shall not be affected." This law effectively prohibits AFP-RSBS from continuing with the provision of retirement benefits to its employees which is contained in its ERBP. On February 2, 2005, the Office of the Government Corporate Counsel (OGCC) rendered an opinion (Opinion No. 024, Series of 2005) regarding the AFP-RSBS query on the continuation or discontinuance of the ERBP, as follows: "On June 17, 1967, CA 186 was further amended by Republic Act (RA) No. 4968 (An Act Amending Further Commonwealth Act Numbered One Hundred and Eighty-Six, as amended), the pertinent portion of which reads as follows: 'Section 10. Subsection (b) of Section twenty-eight of the same Act, as amended, is hereby further amended to read as follows. (b) Hereafter no insurance or retirement plan for officers or employees shall be created by any employer. All supplementary retirement or pension plans heretofore in force in any government office, agency or instrumentality or corporation owned or controlled by the government, are hereby declared inoperative or abolished: Provided, That the rights of those who are already eligible to retire thereunder shall not be affected.' It is clear from the foregoing that save for the retirement plan under the Government Service Insurance System (GSIS), no other retirement program can be established in any government office, agency or instrumentality or corporation owned or controlled by the government. In fact, effective June 17, 1967, all supplementary retirement or pension plans which were then in force in any government office, agency, or instrumentality or corporation owned or controlled by the government, were declared inoperative or abolished. Hence, when the decision dated August 12, 2003 of the Supreme Court, wherein AFPRSBS was declared as a government entity, became final and executory, all rights and duties of the AFPRSBS have been conclusively determined by the Supreme Court and one of the necessary consequences of such determination is the abolition of the ERBP of the AFPRSBS, as mandated by Section 10 (b) of RA No. 4968." In June 2005, the AFP-RSBS Board of Trustees, on the basis of the OGCC opinion that the ERBP should be abolished, approved the distribution of the vested rights of the members of the ERBP. Vesting ceased in November 2003. Effectively, the employees have already lost more than two (2) years of vesting. It is only this year that a decision may be obtained regarding the distribution of the benefits. In effect, the stoppage was applied retroactively so that the reduced compensation package has been forced upon the employees since then. There are sixty (68) employees affected, sixty (60) of which are already in the age range of forty (40)

years old and above. The remaining eight (8) employees are in their thirty's (30's), the youngest of which will be thirty-four (34) this year. In reply, please be informed as follows: Under Section 32(B)(6)(b) of the Tax Code of 1997, the benefits to be received by the employees of AFPRSBS under the ERBP are exempt from withholding tax. Pursuant to Section 32(B)(6)(b) of the Tax Code of 1997, any amount received by an official or employee or by his heirs from the employer as consequence of separation of such official or employee from the service of the employer because of death, sickness or other physical distability or for any cause beyond the control of the said official or employee is exempt from taxes regardless of age or length of service. The phrase "for any cause beyond the control of said official or employee" connotes involuntariness on the part of the official or employee. The separation from the service of the official or employee must not be asked for or initiated by him. The above-mentioned law requires the presence of two (2) conditions in order that the employee benefits may be granted tax exemption, namely (1) the employee is separated from the service of the employer due to death, sickness or other physical disability or for any cause beyond the control of the said official or employee; and (2) the employer pays benefits to the official or employee or his heirs as a consequence of such separation. In BIR Ruling No. DA-658-99 dated November 29, 1999, the Management of National Steel Corporation (NSC) temporarily suspended operation. All employees who have earned and have available vacation leave credits must go on forced leave immediately, unless their services are still required. Employees who have exhausted their vacation leave credits will continue to attend to any available work as the demands of the company may warrant until the temporary suspension of operation takes effect. The company shall resume operations on or before the period of six (6) months. The company's announcement of forced leave and temporary shutdown triggered the involuntary availment of the benefits of the NSC Retirement Plan leaving the qualified employees with no other option except to involuntarily avail of the ERP (early retirement program), so they can legally look for another job or work with another company in order to sustain the basic needs of their family. This Office ruled in the said case that since the involuntary availment of the benefits of the NSC Retirement Plan is a consequence of the forced leave and the temporary closure of the company and, therefore, beyond the employees' control, any and all amounts to be received by them as a result thereof, are exempt from income tax and consequently from the withholding tax prescribed by Section 79, Chapter XIII, Title II of the Tax Code of 1997, as implemented by Revenue Regulations No. 2-93, as amended. In the case of the AFP-RSBS employees, the involuntary availment of the benefits under the ERBP is a consequence of the Supreme Court decision and, therefore, beyond the employees' control. Justice dictates that the vested benefits under the ERBP should be exempt from withholding tax. Under Section 32(B)(6)(a) of the Tax Code, retirement benefits received under RA No. 7641 shall be exempt from withholding tax provided that the retiring official or employee has been in the service of the same employer for at least ten (10) years and is not less than fifty (50) years of age at the time of his retirement and that the benefits granted shall be availed of only once. Section 6, Article XII of the AFP-RSBS Employees' Retirement Benefit Plan incorporates Section 32(B) (6)(a) of the Code, viz: "SECTION 6 Revenue Regulations

Republic Act No. 4917 provides that retirement benefits of employees of private firms shall not be subject to attachment, levy, execution or any other tax whatsoever. This law further provides that exemption from tax shall be granted only if the employee has been in the service of the same employer for at least 10 years and is not less than age 50 at the time of his retirement. In case the benefits payable under the Plan are subject to tax, the Trustees shall deduct from the Employee's benefits the corresponding withholding tax." We note that AFP-RSBS was operating as a private entity for twenty-seven (27) years or since 1976 before it was finally declared imbued with public interest, hence, a government entity by the Supreme Court. Because of the termination of the ERBP on August 12, 2003, the employees are forced to avail of the benefits thereunder. Accordingly, the option of having their vested rights continue until the age of fifty (50) to avail of a tax free retirement benefit has been lost through no fault of the employees. To subject the employees' benefits to withholding tax will not serve the ends of justice. No less than our Constitution adheres to the principles of social justice. Accordingly, justice dictates that this Office should rule in favor of the employees. The employees are protected under the Constitution and the Labor Code. The very essence of a retirement plan is preparation for retirement years. But with the termination of the ERBP, the employees now face very limited employment opportunities and, thus, limited options to resort to in preparing for retirement. With the Supreme Court decision terminating the ERBP, the employees likewise lost their right to receive the maximum benefit package under the ERBP. To rule that the vested benefits to be received by the employees under the ERBP are subject to income tax and consequently to withholding tax will violate the state policy on promotion of the health and welfare of the workers and full protection to labor as embodied in Sections 15 and 18, Article II of the 1987 Constitution; and Article 100 of the Labor Code which prohibits the elimination or diminution of employee benefits. In view of the exceptional circumstances surrounding your case, this Office hereby holds that the vested benefits to be received by the employees of the AFP-RSBS under the ERBP as a result of the Supreme Court decision terminating the ERBP, are exempt from income tax and consequently from the withholding tax prescribed by Section 79, Chapter XIII, Title II of the Tax Code of 1997, as implemented by Revenue Regulations No. 2-98, as amended. This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it will be disclosed that the facts are different, then this ruling shall be considered as null and void. Very truly yours, (SGD.) JOSE MARIO C. BUAG Commissioner of Internal Revenue