In the evolving Philippine "gig economy," hiring freelance independent contractors offers businesses flexibility and specialized expertise. However, this arrangement is governed by strict legal and tax frameworks. Unlike traditional employees, freelancers are considered self-employed individuals or sole proprietors. Failing to distinguish between an "independent contractor" and an "employee" can lead to significant legal liabilities and tax penalties.
I. The Contractual Foundation: Independent Contractor Agreements
The relationship between a hiring party (the "Principal") and a freelancer must be explicitly defined by a Contract for Service or Service Agreement. This document is the primary evidence that no employer-employee relationship exists.
Key Contractual Provisions:
- Nature of the Relationship: A clear statement that the freelancer is an independent contractor and not an employee. There should be no "Control Test" markers—meaning the Principal should control the result of the work, but not the means and methods by which the freelancer achieves it.
- Scope of Work (SOW): A detailed description of the deliverables, milestones, and deadlines.
- Payment Terms: Specification of the service fees, billing cycles, and any late payment interests.
- Non-Disclosure and Intellectual Property: Provisions ensuring that work created during the engagement belongs to the Principal and that sensitive company information remains confidential.
- Termination Clause: Defined grounds for ending the contract and the required notice period for both parties.
- Indemnification: A clause stating that the freelancer is responsible for their own taxes and government contributions (SSS, PhilHealth, Pag-IBIG).
II. Tax Obligations: Withholding Tax Requirements
Under the National Internal Revenue Code and subsequent Bureau of Internal Revenue (BIR) regulations (such as RR No. 11-2018), the Principal is mandated to act as a Withholding Agent.
1. Expanded Withholding Tax (EWT) Rates
The rate of withholding tax depends on the freelancer’s annual gross income and their submission of required BIR documents:
- 5% Withholding Tax: Applicable if the individual’s gross income for the current year is ₱3 million or below.
- 10% Withholding Tax: Applicable if the individual’s gross income for the current year exceeds ₱3 million, or if the freelancer fails to provide a "Sworn Declaration of Gross Receipts/Sales."
2. The Creditable Nature of Withholding
The tax withheld by the Principal is not a final tax but a creditable one. The Principal must provide the freelancer with BIR Form 2307 (Certificate of Creditable Tax Withheld at Source). The freelancer will then use this form to deduct the withheld amount from their quarterly and annual income tax liabilities.
3. Compliance Requirements for the Principal
- Remittance: The withheld taxes must be remitted to the BIR using Form 0619-E (monthly) and Form 1601-EQ (quarterly).
- Reporting: The Principal must include the freelancer in their Alphlist of Payees submitted to the BIR annually.
III. Value-Added Tax (VAT) vs. Percentage Tax
The Principal must determine if the freelancer is VAT-registered or Non-VAT registered, as this affects the billing:
- VAT-Registered: If the freelancer earns more than ₱3 million annually, they must charge a 12% VAT on top of their service fees. The Principal can use the freelancer’s VAT official receipt to claim Input VAT credits.
- Non-VAT Registered: If the freelancer earns below the ₱3 million threshold, they are subject to a 3% Percentage Tax (unless they opted for the 8% flat income tax rate, in which case they are exempt from Percentage Tax).
IV. The "Control Test": Avoiding Labor Risks
The Department of Labor and Employment (DOLE) uses the Four-Fold Test to determine if a worker is actually an employee despite having a "freelance" contract:
- The selection and engagement of the worker.
- The payment of wages/fees.
- The power of dismissal.
- The power of control (The most important).
If the Principal dictates the working hours, provides the equipment, and supervises the step-by-step process of the work, the freelancer may be legally reclassified as a regular employee. This would entitle them to 13th-month pay, service incentive leaves, and mandatory benefits, regardless of what the contract says.
V. Summary of Responsibilities
| Feature | Independent Contractor (Freelancer) |
|---|---|
| Tax Form to Issue | Official Receipt (OR) or Service Invoice |
| Withholding Tax | 5% or 10% (Creditable) |
| Document Required | BIR Form 2307 (provided by Principal) |
| Gov't Contributions | Solely the responsibility of the Freelancer |
| Labor Relationship | Governed by the Civil Code (Contract Law) |
Proper documentation and strict adherence to BIR withholding schedules are essential for Philippine businesses to remain compliant while leveraging the talent of the freelance workforce.