Tax and Accounting

Gross Income Exclusion and Tax Exemption of Damages on Account of Personal Injuries

Sec. 32(B) of Republic Act o.  8424, the National International Revenue Code of 1997,  excludes from gross income amounts received as compensation for personal injuries or sickness, including the amounts of the damages received on account of such injuries or sickness. It provides:

Sec. 32(B) Exclusions from Gross Income – The following items shall not be included in gross income and shall be exempt from taxation under this Title:

x x x x x  x x x x x

(4) Compensation for Injuries or Sickness – Amounts received, through Accident or Health Insurance or under Workmen’s Compensation Acts, as compensation for personal injuries or sickness, plus the amounts of any damages received, whether by suit or agreement, on account of such injuries or sickness.

In BIR Ruling No. 026-2018, dated 18 January 2018, the Commissioner of Internal Revenue declared that this provision does not apply to consequential damages representing loss of the victim’s earning capacity.

The factual backdrop of the Ruling may be summarized as follows:

The heirs of a murder victim filed an action for damages arising from crime against the persons alleged to have been responsible for the murder. After due hearing, judgment was rendered by the trial court ordering the defendants to jointly and severally pay  the plaintiffs:

  1. Indemnity for the death of the victim;
  2. Actual damages;
  3. Consequential damages representing loss of the victim’s earning capacity;
  4. Moral damages;
  5. Exemplary damages;
  6. Attorney’s fees;
  7. Interest on all the foregoing amount; and
  8. Cost of the suit;

The CIR quoted Sec. 32(B)(4) of the NIRC and made further reference to Sec. 63 of Revenue Regulations No. 02-40, which states:

SECTION 63. Amounts Received as Compensation for Injuries or Sickness – The amounts received by an insured, or his estate or beneficiaries through accident or health insurance or under workmen’s compensation acts as compensation for personal injuries or sickness are excluded from the gross income of the insured, his estate and other beneficiaries. Any damages recovered by suit or agreement on account of such injuries or sickness are similarly excluded from the gross income of the individual injured or sick, if living, or of his estate or other beneficiaries entitled to receive such amounts, if dead.

Applying the above provisions, the CIR ruled that the compensatory damages, actual damages, moral damages, exemplary damages, attorney’s fees, and the cost of the suit received by the heirs on account of the death of the murder victim are excluded from gross income.

The CIR, however, held that the consequential damages representing loss of the victim’s earning capacity are not excluded from gross income. In ruling so, the CIR ratiocinated that “such damages are merely replacement of income which would have been subjected to tax if earned”. Hence, the amount of the consequential damages representing loss of the victim’s earning capacity is subject to income tax on the part of the heirs.