Tax and Legal Implications of Engaging Freelancers for Businesses in the Philippines

1) What are the tax risks for businesses when hiring freelancers instead of full-time employees?

The primary tax risk for businesses when hiring freelancers instead of full-time employees is the possibility of misclassification. In the Philippines, the tax rates and tax treatment applicable to the salaries of full-time employees differ from those imposed on the income of freelancers. Additionally, employers are required to remit mandatory government contributions for full-time employees, whereas no such obligation exists when engaging freelancers. Consequently, if it is later determined that an employer-employee relationship actually exists, the business may be exposed to retroactive tax assessments, penalties, and other liabilities.

2) How do tax authorities determine whether a freelancer arrangement should be reclassified as employment?

Tax authorities determine whether a freelancer arrangement should be reclassified as employment by applying the four-fold test, which examines the true nature of the working relationship regardless of how the parties label it. Under this test, an employer-employee relationship exists if the business:

1. Has the power to hire the worker;
2. Pays the worker’s wages;
3. Has the power to dismiss the worker; and
4. Exercises control over the means and methods by which the work is performed.

Among these factors, the control test is considered the most important.

3) What are the employer’s withholding or reporting obligations when working with freelancers?

Under the TRAIN Law as clarified under BIR Revenue Regulation No. 11-2018, there shall be withheld a creditable income tax at the rates herein specified for each class of payee from the following items of income payments to persons residing in the Philippines:

Professional fees, talent fees, etc. for services rendered – On the gross professional, promotional, and talent fees or any other form of remuneration for the services rendered by the following:

Individual payee:

• If gross income for the current year did not exceed PHP 3 mln - Five percent (5%)
• If gross income is more than PHP 3 mln - Ten percent (10%)

4) Are withholding taxes applicable when engaging cross-border freelancers?

It depends. Under Revenue Memorandum Circular No. 5-2024, withholding taxes apply when the income-generating activity performed in the Philippines is deemed essential to the service. In such cases, the income is considered Philippine-sourced and becomes subject to withholding tax. However, if the freelancer performs all essential services outside the Philippines, the income is treated as foreign-sourced for tax purposes.

5) How do double taxation treaties impact taxation of payments to foreign freelancers?

Double Taxation Treaties help determine how payments to foreign freelancers are taxed by preventing the same income from being taxed twice. These treaties either allocate taxing rights between the Philippines and the freelancer’s country of residence or, when the Philippines is allowed to tax the income, require the freelancer’s home country to grant relief through an exemption or tax credit. As a result, tax treaties can reduce or eliminate Philippine withholding tax on payments to foreign freelancers, depending on the specific treaty provisions.

6) What compliance documentation should businesses maintain when working with freelancers?

When working with freelancers, businesses should:

• maintain a contract of service as the primary compliance document;
• ensure the contract clearly states that no employer-employee relationship exists, which helps prevent misclassification and ensures proper legal and tax compliance;
• retain additional supporting documents, such as invoices and proof of payment, for record-keeping and tax reporting purposes.

7) What compliance requirements must companies meet when engaging freelancers?

When engaging freelancers, companies must:

• comply with withholding and reporting obligations;
• ensure that the correct amount of tax is withheld from payments to the freelancer;
• properly remit and report the withheld taxes using the applicable BIR forms;
• maintain accurate records of payments and tax filings for compliance purposes.

8) What are the legal and contractual best practices for structuring freelancer engagements to minimize tax risks?

To minimize tax risks when engaging freelancers, companies should:

• use a detailed service contract that clearly defines the terms of the engagement;
• specify in the contract that the freelancer retains control over how the work is performed, while the company only defines the objectives or outcomes to be achieved;
• structure the engagement to establish that the freelancer is an independent contractor, not an employee, thereby reducing the risk of misclassification and associated tax liabilities.

Authors: Krisanto Karlo Nicolas, Eufelia Rembelle Simbol