Withholding Tax on Janitorial Services: Tax Base—Gross Payment or Admin Fee Only? (Philippines)

Withholding Tax on Janitorial Services in the Philippines: Determining the Tax Base – Gross Payment or Administrative Fee Only?

Introduction

In the Philippine tax landscape, withholding taxes serve as a critical mechanism for the Bureau of Internal Revenue (BIR) to ensure the collection of income taxes at source. This is particularly relevant for payments made to service providers, including those offering janitorial services. Janitorial services, which encompass cleaning, maintenance, and sanitation activities typically outsourced to specialized contractors, are common in both private and public sectors. These services often involve a billing structure that includes components such as labor costs (salaries and benefits of janitors), supplies, overhead, and an administrative or management fee.

A recurring point of contention among taxpayers, withholding agents, and tax practitioners is the proper tax base for creditable expanded withholding tax (EWT) on payments for janitorial services. Specifically, the debate centers on whether the EWT should be applied to the entire gross payment made to the service provider or limited solely to the administrative fee. This article explores the legal basis, regulatory framework, practical applications, and implications of this issue under Philippine tax laws, drawing on the provisions of the National Internal Revenue Code (NIRC) of 1997, as amended, and relevant BIR issuances. Understanding this distinction is essential for compliance, as improper withholding can lead to deficiencies, penalties, or disputes during BIR audits.

Legal Framework Governing Withholding Taxes on Services

The foundation for withholding taxes in the Philippines is found in Section 57 of the NIRC, which mandates the withholding of taxes on certain income payments. This is further detailed in Revenue Regulations (RR) No. 2-98, as amended by subsequent regulations such as RR No. 11-2018 and RR No. 14-2002. Under these rules, the EWT system requires payors (withholding agents) to deduct and remit a percentage of the gross income payment to the BIR, which the payee can later credit against their final income tax liability.

For services like janitorial work, the applicable withholding rate is generally 2% of the gross amount paid, provided the payor qualifies as a withholding agent. Withholding agents include government entities, top withholding agents (as designated by the BIR under RR No. 11-2018, such as top 20,000 corporations, top 5,000 individuals, and others based on gross sales or receipts), and certain other specified entities. If the service provider is not subject to value-added tax (VAT) or is a non-VAT registered entity with annual gross receipts below the VAT threshold (currently PHP 3 million under RR No. 16-2005, as amended), the rate may be 1% for goods or 2% for services.

Janitorial services are classified as "other services" under Section 2.57.2(J) of RR No. 2-98, which covers payments made by top withholding agents to local suppliers of services not otherwise specified. This category explicitly includes manpower, janitorial, security, and consulting services. The regulations emphasize that the withholding obligation arises on "income payments," defined broadly to include any payment that constitutes income to the recipient.

Importantly, the NIRC and implementing regulations do not provide explicit exemptions or carve-outs for specific components of service billings unless they qualify as non-taxable reimbursements. This sets the stage for analyzing the tax base in the context of janitorial contracts.

Nature of Janitorial Services and Typical Contract Structures

Janitorial services in the Philippines are often provided through service contracts where the contractor assumes responsibility for deploying personnel, supplying materials, and managing operations. Under Department of Labor and Employment (DOLE) rules, particularly Department Order No. 174-17, legitimate service contracting (as opposed to prohibited labor-only contracting) requires the contractor to exercise control over the workers, provide substantial capital or investment, and bear the risk of loss.

In billing practices, janitorial service providers commonly itemize charges as follows:

• Labor costs: Salaries, statutory benefits (e.g., SSS, PhilHealth, Pag-IBIG contributions), 13th-month pay, and other employee-related expenses.
• Supplies and materials: Cleaning agents, equipment, and consumables.
• Administrative or management fee: A percentage (typically 10-20%) of the total costs, representing the contractor's profit margin, overhead, and management services.
• VAT: 12% on the taxable gross receipts, if the provider is VAT-registered.

The total gross payment is the sum of these components, excluding VAT if billed separately. However, the administrative fee is often viewed by some taxpayers as the "true" service fee, leading to the misconception that only this portion should be subject to withholding tax.

Determining the Tax Base: Gross Payment vs. Administrative Fee Only

The General Rule: Withholding on Gross Payments

According to RR No. 2-98, the tax base for EWT is the "gross amount of the income payment," which refers to the total amount paid for the services rendered, exclusive of VAT (if the VAT is separately billed and the provider is VAT-registered). This gross amount encompasses all billable items that form part of the contractor's revenue, without deduction for the contractor's expenses.

In the case of janitorial services, the entire billing— including labor costs, supplies, and the administrative fee— constitutes the gross receipts of the service provider. This is because the contractor is the employer of the janitors, and the costs incurred (e.g., salaries) are deductible business expenses for the contractor, not the client. The client is purchasing a bundled service, not reimbursing specific expenses. Therefore, the full payment is considered income subject to withholding at source.

This interpretation aligns with the BIR's consistent position that gross receipts for tax purposes include all amounts received or accrued for services performed, as defined in Section 32(A) of the NIRC. Excluding portions like labor costs would undermine the withholding system's purpose of capturing potential income tax liability early.

Exceptions and Analogous Situations

While the general rule favors withholding on the gross payment, certain analogous scenarios in Philippine tax practice provide nuance:

• Pass-Through Costs in Other Industries: For example, in advertising services (under BIR Ruling No. 040-2001), withholding tax is applied only to the agency fee, excluding media placement costs that are merely passed through to the client without markup. Similarly, in travel agencies, commissions are the base, not the full ticket price. However, janitorial services differ because labor and supply costs are integral to the service delivery and are marked up or absorbed as part of the contractor's operations, not pure reimbursements.
• Reimbursable Expenses: If a contract explicitly designates certain items as reimbursements for actual out-of-pocket expenses incurred on behalf of the client (e.g., specific supplies purchased at the client's request), these may be excluded from the tax base if supported by documentation like third-party invoices. However, labor costs in janitorial contracts rarely qualify as reimbursements, as the janitors are employees of the contractor, not the client.
• Labor-Only Contracting: If the arrangement is deemed labor-only contracting (prohibited under DOLE rules), the client becomes the de facto employer, and payments might be treated as direct salary reimbursements not subject to EWT. However, such arrangements are illegal and expose parties to labor penalties, making them irrelevant for legitimate tax compliance discussions.

BIR issuances, such as Revenue Memorandum Circular (RMC) No. 39-2007 on VAT for manpower services, reinforce that gross receipts include amounts designated as salary reimbursements, as these are part of the consideration for the service. Although RMC No. 39-2007 focuses on VAT, its principles extend to income tax and withholding, given the interconnected nature of these taxes.

Common Misconceptions and Risks

A prevalent misconception is that withholding should be limited to the administrative fee, viewing it as the only "profit" element. This stems from informal practices or misinterpretations of contract breakdowns. However, BIR audits often challenge this, assessing deficiencies on the full gross payment. Penalties under Section 251 of the NIRC can reach 25% surcharge plus 12% interest per annum, compounded with potential compromise penalties.

Court decisions from the Court of Tax Appeals (CTA) and Supreme Court further support the gross payment approach. For instance, in cases involving similar service contracts (e.g., security services), the CTA has ruled that itemized billings do not automatically segregate taxable bases unless they meet strict reimbursement criteria.

Practical Implications and Compliance Strategies

Computation of Withholding Tax

Assume a janitorial contract with the following monthly billing (exclusive of VAT):

• Labor costs: PHP 100,000
• Supplies: PHP 20,000
• Administrative fee: PHP 15,000
• Total gross payment: PHP 135,000
• VAT (12%): PHP 16,200
• Total billed: PHP 151,200

The EWT at 2% would be PHP 2,700 (2% of PHP 135,000), withheld and remitted via BIR Form 2307. The service provider credits this against their quarterly income tax.

Documentation and Reporting

Withholding agents must issue BIR Form 2307 to the payee and file BIR Form 1601-EQ quarterly. Service providers should ensure contracts clearly state terms to avoid disputes, and maintain records distinguishing true reimbursements. Annual Information Returns (BIR Form 1604-E) must report all withholdings.

Audit and Dispute Resolution

During BIR examinations, discrepancies in tax bases can lead to Letter of Authority (LOA) assessments. Taxpayers may seek BIR rulings for clarification on specific contracts via the BIR's Ruling and Interpretation Division. Appeals can be filed with the CTA if administrative remedies fail.

Impact on Businesses

For clients (e.g., corporations), proper withholding reduces audit risks and ensures deductibility of expenses under Section 34 of the NIRC. For service providers, understanding the tax base aids in pricing strategies and cash flow management, as withheld amounts are advances on their tax liability.

Recent Developments and Amendments

As of the latest amendments under the Tax Reform for Acceleration and Inclusion (TRAIN) Law (Republic Act No. 10963) and the Corporate Recovery and Tax Incentives for Enterprises (CREATE) Act (Republic Act No. 11534), the core rules on EWT for services remain unchanged. However, increased thresholds for top withholding agents and digital filing requirements under RR No. 9-2021 emphasize compliance efficiency. No specific amendments have altered the tax base for janitorial services, maintaining the gross payment standard.

Conclusion

In summary, the proper tax base for withholding tax on janitorial services in the Philippines is the gross payment, encompassing all components of the billing exclusive of VAT, rather than solely the administrative fee. This aligns with the BIR's interpretation of gross income payments under the NIRC and RR No. 2-98, ensuring equitable tax collection. While exceptions exist for genuine reimbursements, they are narrowly applied and require robust documentation. Businesses engaging in or providing janitorial services must adhere to this principle to mitigate risks, foster compliance, and avoid costly penalties. Consulting with tax professionals for contract-specific advice is recommended to navigate any gray areas effectively.