Comparing apples and oranges: The different withholding tax treatment for service contractors

Comparing apples and oranges does not often result in similar treatment, as not all similar objects are treated (or taxed) alike. A common question from income payors or withholding agents is whether they should adopt the same tax treatment on payments to all kinds of service contractors, such as security agencies and manpower agencies providing messengerial, janitorial and other services.

For security agencies, Revenue Memorandum Circular (RMC) 39-2007 already clarified that payments made by clients to the security agency must generally provide a breakdown into two components: (1) the agency fee; and (2) the security guards’ salaries. The RMC provides that the agency fee will form part of the gross income of the security agency, and the client or user of security services should withhold and remit the two percent expanded withholding tax (EWT) on the agency fee. However, with respect to the income payment representing the amount segregated and earmarked as salaries of the security guards, although it is the client or user of security services who pays for the salaries of the security guards and claims the same as an expense for income tax purposes, it is the security agency that shall be responsible for the withholding tax on compensation (WTC) since it is the one which physically controls the salaries of the security guards.

The RMC provides that in view of the clear language of the law and its implementing regulations placing the primary obligation on the client to pay the salaries of the security guards coupled with the requirement that the monies received by the security agency representing salaries shall be earmarked and segregated for the said guards, the amount paid by the client representing the security guards’ salaries is excluded from the gross income of the security agency; hence, not subject to EWT.

With the issuance of RMC 39-2007, there were taxpayers who wondered if the RMC could likewise apply to other service contractors. A supplier of janitorial and messengerial services requested for the application of RMC 39-2007 on the treatment of its agency fees/gross receipts. However, the tax authorities ruled in its 2010 BIR Ruling that there is nothing in the context of RMC 39-2007 that would manifest or suggest the intention to have the RMC apply to manpower agencies providing janitorial and clerical services, other than the security agencies.

The tax authorities clarified that the security agency is placed in a tax situation different from other service providers because of the governing law and rules from which the tax treatment laid out in RMC 39-2007 are based.

Another service contractor providing janitorial manpower services sought clarification on whether the tax treatment laid out in RMC 39-2007 would apply to them. In the 2015 BIR Ruling, the tax authorities reiterated that RMC 39-2007’s applicability is limited to security agencies unless the issuance is amended and made applicable to other agencies.

In a 2023 BIR Ruling, the tax authorities echoed their earlier rulings that RMC 39-2007 should only apply to security agencies given that the circumstances for security agencies is different from that of other service contractors.

The tax authorities emphasized that the primary obligation to pay the salaries of the security guards lies on the client (as expressly provided in the governing law and regulations cited in the RMC that are specific to security agencies) while in case of other service contractors, such obligation lies on the said service contractors and not the client.

For this reason, it was confirmed that the gross payments to contractors relating to the provision of messengerial, janitorial and other manpower services are subject to two percent EWT as provided under the withholding tax regulations and RMC 39-2007 is inapplicable in determining the gross payments as basis of the EWT.

While both security agencies and other service contractors involved in these rulings offer manpower services, the tax authorities have been consistent in ruling that they operate in a distinct context. Considering the earlier rulings are quite dated, the 2023 BIR Ruling is a helpful reminder to minimize confusion in tax compliance.

Withholding taxes play a major role in the tax system of the Philippines. It is a tool for the effective and efficient collection of taxes and prevents tax evasion, insofar as withholding agents are required to deduct and remit taxes on behalf of their payees. Given this, taxpayers should be mindful of the rules on withholding taxes and developments in practice considering their obligation as withholding agents comes with risk of being assessed deficiency taxes in case of erroneous withholding and/or non-withholding.

Precious Anne Correa is a tax associate under the Tax Group of KPMG in the Philippines (R.G. Manabat & Co.), 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 Precious Anne P. Correa or Mary Karen E. Quizon-Sakkam through ph-kpmgmla@ kpmg.com, social media or visit www.home.kpmg/ph.

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 Internationalor KPMG in the Philippines.