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Pre-tax or after tax?

(Article published in the Sep 3, 2008 issue of Manila Standard Today)  

It was as difficult to make a reality as making money.  But, after languishing for many years in the making, PERA, or the Personal Equity and Retirement Act of 2006, was finally signed into law by President Gloria Macapagal-Arroyo two weeks ago, on 22 August. 

 All that remains to be done is for the Department of Finance, the Bureau of Internal Revenue, the Bangko Sentral ng Pilipinas, the Securities and Exchange Commission, and the Insurance Commission (with the BSP as the lead agency) to establish uniform rules and regulations to fill up definite and defined lacunae deliberate left blank by the law.  Thereafter, the tax incentives, which constitute the centerpiece of the law, will kick in starting 01 January 2009.

 Hopefully, the lure of tax incentives, assuming a critical mass of people having ability and discipline to set aside the money in sufficient quantities within a fixed time period, will induce many to avail themselves of the benefits of this new piece of legislation and, thereby, achieve the development objectives behind PERA.

 The objectives of the law are found in Section 2.  Section 2 proclaims it to be “the policy of the State to promote capital market development and savings mobilization by establishing a legal and regulatory framework of retirement plans for persons, comprised of voluntary personal savings and investment.”  The section further says that “the State recognizes the potential contribution of PERA to long-term fiscal sustainability through the provision of long-term financing and reduction of social pension benefits.”


Conspicuously unarticulated, to my disappointment however, is the equally, if not more paramount objective, of encouraging income earners to be income savers and capital investors, to   be capable of determining their own financial future, and to be in the end responsible for their own economic fate. 

 This purpose of empowering the income earner who is of more value than the system he works in, if my memory of PERA’s beginnings around 25 years ago, was the motivation that provided the sponsors the energy and the persistence to push for the idea through years of legislative apathy, if not resistance.  Its omission in the text of the law, I am afraid, deprives PERA’s advocates of a powerful argument to sway in their favor the resolution of certain tax issues lurking in the law’s gray areas.

 An example of a question hanging on the balance is whether the contribution to a PERA account ought to be made from pre-tax or from after-tax money.  Section 6 permits an employer to contribute to its employee’s PERA to the extent allowable to the Contributor.  The amount so contributed may then be deducted by the employer from its own gross income.  The law, however, does not say whether in computing for the employee’s taxable compensation income the employer’s contribution to his PERA is to be made part of his gross compensation. 

 It is not a valid to argue that this point has already been addressed by Section 8 that gives the Contributor an income tax credit equivalent to 5% of the total PERA contribution.  The 5% tax credit is not, for the employee-contributor, equivalent to receiving the contribution of the employer tax-free.  For instance, a gross income earner who is taxed at the top rate of 32% pays a Php 32,000.00 tax on the Pph100,000.00 maximum contribution; but that same contribution allows him only an income tax credit of Php 5,000.00.  Hence, taxing him on the contribution still leaves him out by Php 27,000.00.

 If that is all that the Arroyo administration is willing to cede to income earners, so be it; but let it say so.  As it was Senator Edgardo Angara, sponsor of the bill but certainly not the initiator of the idea behind PERA, was most extravagant in praising the law.  In singing his Hallelujahs, he obscures from view exactly what it is that PERA concedes to the taxpayer.

 A strict interpretation, which is the posture generally taken by the BIR and the courts, in cases of the grant of tax exemptions, will suggest that the amount contributed should be treated as part of gross compensation income and consequently subject to tax.

 It has become the battle cry of the BIR to look with disfavor on claims for exemption because tax exemptions, so Tax 101 says, are in derogation of sovereignty and therefore should be strictly construed.  I would not be surprised if the BIR were to take this hard stance and assert that the employer’s contribution is in effect additional compensation and therefore ought to be made part of the individual’s taxable base.

 A liberal interpretation, which is the posture generally taken by the BIR and the courts, in instances of social legislation, on the other hand, will consider the contribution an exclusion from income, and hence, tax-free. Retirement laws belong to the genre of legislation intended to benefit the less privileged worker (who, among other things, has only a limited number of items to claim as deductions against gross income) and thus are liberally construed and administered in favor of the persons to be benefited.  This was the ruling of the Supreme Court in the case of Borromeo v. Civil Service Commission, G.R. No. 96032, July 31, 1991.

 On this basic tenet, a former official of the BIR itself won in court his case against subjecting the cash equivalent of his terminal leave to the withholding tax (Commissioner of Internal Revenue v. C.A. and Castañeda, G.R. No. 96016, Oct. 17, 1991).

 Aside from PERA being a piece of social legislation, Section 10 provides an additional argument in favor of the liberal stance.  “All distributions according to Section 12 hereof,” Section 10 says, “are tax exempt.”  This provision cannot refer to the income of the investments and reinvestments of the amount in the PERA because the tax exemption of the income earned by the PERA is amply explicit in Section 9.  Section 9 says that “all income earned from the investments and reinvestments of the maximum amount herein is tax exempt.”

 Hence, Sec. 10 could only refer to the principal.  But, if  the intent of Congress were to be that the employee pay a tax on the contribution made by the employer, then Section 10, when referring to the principal, means nothing at all. Distribution of the capital of the employee, at the point of distribution, is not really income, says Tax 101; it is simply return of capital, and therefore, per se, not subject to the income tax in the first place.

 Hence, for Sec. 10 to have any significance at all, it must be accepted by the tax authorities that the implied assumption of Sec. 10 is that the amount to be contributed by an employer to an employee’s PERA is not, at that point taxable to him.  It consequently would have been taxable to him upon withdrawal; hence, there was a need for Sec. 10 to declare it tax-free.

 In order words, the employer’s contribution to a PERA for the account of an employee must, if Sec. 10 is to be given any significance, be an exclusion from the gross compensation income of an employee.  Otherwise, Sec. 10 would have no real purpose; a useless provision is what some decisions describe as “an abomination” in law.

 Of course, we can always hope that the liberal interpretation will carry the day when the bureaucrats start crafting the tax regulatons.  There is always the risk, if I may use vintage Rene Saguisag terminology, of the liberals winning over the strict interpreters.  We can always hope that my former classmate, Finance Secretary Margarito Teves, would be able to prevail over BIR Commissioner Lilian Hefti to recognize the intendment of the law, which is, like the benefit of private retirement plans under R.A. No. 4917 and related provisions fo the Tax Code, to allow a tax-free flow of the contributions from the employer, to PERA, and eventually to the employee.

 But, based on what I hear about the modus vivendi of the Secretary of Finance with his Commissioner of Internal Revenue, I am not prepared to put any money on it.