Beyond substituted filing

For many employees, tax compliance is often perceived as complete upon receipt of their Certificate of Compensation/Tax Withheld or the Bureau of Internal Revenue (BIR) Form 2316 from their employer.

Since taxes are withheld from salaries throughout the year, it is easy to assume that all tax obligations have already been settled. However, this may not always be the case. Certain employees may still be required to file an Annual Income Tax Return (AITR) despite receiving a BIR Form 2316.

One of the most common misconceptions is that all employees automatically qualify for substituted filing. Under Section 51(A)(2)(b) of the National Internal Revenue Code (NIRC), as implemented through Revenue Regulations 2-98, as amended, substituted filing generally applies only when all of the following conditions are met:

• The employee earned purely compensation income during the taxable year;

• The employee worked for only one employer during the taxable year and

• The correct amount of income tax was withheld by the employer.

When these requirements are satisfied, BIR Form 2316 serves as the employee’s substitute income tax return, eliminating the need to separately file an AITR.

However, employees who had two or more employers during the year, whether simultaneously or successively, generally do not qualify for substituted filing and are instead required to file their own AITR with the Bureau of Internal Revenue (BIR).

This issue becomes particularly relevant during the year-end annualization process. Under the withholding tax regulations, employers are required to determine the correct income tax due on an employee’s total compensation income for the year and reconcile it against taxes previously withheld.

For employees who changed employers during the year, timely submission of BIR Form 2316 issued by the previous employer is important. Failure to provide the necessary information may affect the accuracy of the annualization process and result in additional tax withholding or other payroll adjustments at year-end.

Having multiple employers during the year is not the only situation in which substituted filing may not apply and the filing of an AITR may still be required. One common example involves globally mobile employees and individuals on international assignments. This includes inbound assignees, such as Filipino nationals and foreign individuals assigned to work in the Philippines from another location, as well as outbound assignees, or Filipino employees assigned overseas.

These employees often have more complex payroll and compensation arrangements than regular employees, with compensation paid or borne by multiple entities and assignment-related benefits and allowances forming part of their overall compensation package. The global employee’s tax residency position can also affect both the scope of income subject to Philippine taxation and the applicable tax compliance requirements.

Given the complexities associated with global mobility arrangements, certain compensation items or benefits may not be fully reflected in a single BIR Form 2316.

Depending on the compensation arrangement and the individual’s tax residency status, these employees may not qualify for substituted filing and may be required to file an AITR to properly report their taxable income in the Philippines.

Employees should also consider whether they earned income outside their regular employment. With the growth of freelancing, consulting services, content creation, online selling and other income-generating activities, it has become increasingly common for individuals to derive income from multiple sources.

For Philippine tax purposes, individuals who earn compensation income and income from business or professional activities may be classified as mixed-income earners.

These individuals generally do not qualify for substituted filing and are typically required to file an AITR to report income from all sources earned during the year.

Depending on the nature of the activity, registration and other tax compliance requirements may likewise apply.

While individual taxpayers remain responsible for determining their filing obligations and complying with applicable tax requirements, employers can also play an important role in supporting tax compliance within the workforce.

As part of their onboarding and offboarding processes, employers may consider reminding employees about the importance of providing relevant tax documents and disclosing circumstances that could affect their filing status. Employers may also establish procedures to identify employees with prior employment, international assignments or other sources of income that could impact year-end tax compliance. Such measures may reduce compliance gaps and help mitigate administrative risks associated with employee tax obligations.

With year-end annualization fast approaching, now is a good time for employees to revisit their tax filing status. Simple questions such as: “Did I have more than one employer this year?” “Was I assigned overseas or to the Philippines during the year?” or “Did I earn income outside my regular employment?” may seem straightforward, but the answers can have significant implications for an individual’s tax filing obligations.

Understanding when substituted filing applies and recognizing situations where an AITR may still be required can help employees comply with Philippine tax regulations and avoid unexpected tax consequences.

Nelfa Bermudo is an assistant manager from the Global Mobility Services team under the Tax Group of R.G. Manabat & Co. (KPMG in the Philippines), 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 Nelfa Bermudo or Karen Jane Vergara-Manese through [email protected], social media or visit https://kpmg.com/ph/en.

This article is for general information purposes only and should not be considered as professional advice to a specific issue or entity. The views and opinions expressed herein are those of the author and do not necessarily represent KPMG International or KPMG in the Philippines.