G.R. No. A.M. No. 90-6-015-SC. October 18, 1990.
RE: REQUEST OF ATTY. BERNARDO ZIALCITA FOR RECONSIDERATION OF THE ACTION OF THE FINANCIAL AND BUDGET OFFICE.

FACTS

Atty. Bernardo F. Zialcita, a compulsory retiree from the judiciary, sought a refund of the withholding tax deducted from his terminal leave pay. The Court, in a prior resolution, granted his request, declaring terminal leave pay exempt from income tax and ordering a refund. It also ruled that no such tax should be withheld from the terminal leave benefits of all judicial retirees. The Commissioner of Internal Revenue, through the Solicitor General, filed a motion for clarification and/or reconsideration, arguing for the taxability of these benefits.

ISSUE

Whether the terminal leave pay received by a compulsory retiree from the judiciary is subject to income tax.

RULING

The Supreme Court En Banc denied the motion for reconsideration and affirmed the tax exemption of terminal leave pay. The legal logic is anchored on multiple statutory provisions and the nature of the benefit. First, Atty. Zialcita retired under Republic Act 660, incorporated in Commonwealth Act No. 186 . Section 12(c) of CA 186 grants the right to commute unused leave credits, and Section 28(c) explicitly exempts all benefits under the Act from all taxes. Therefore, the cash conversion of these leave credits is statutorily exempt.
Second, terminal leave pay is not compensation for services rendered. Terminal leave is applied for after severance from service; the employee is no longer working. Thus, the monetary value of accrued leave is not salary but a benefit accruing from retirement. Third, the National Internal Revenue Code (NIRC) supports this exclusion. Section 28(b)(7)(b) of the NIRC excludes from gross income any amount received from an employer due to separation for any cause beyond the employee’s control. Compulsory retirement, having a fixed age, qualifies as such a cause. Furthermore, terminal leave pay can be viewed as a “retirement gratuity” under Section 28(b)(7)(f) of the NIRC—a bounty given in recognition of past services, not as payment for current labor.
The Court emphasized that taxing this post-retirement benefit would constitute an inequitable burden on retirees who have contributed a lifetime of service. The resolution was clarified to apply specifically to officers and employees of the Judiciary who retire, resign, or are separated through no fault of their own. Other affected retirees were instructed to file written claims for refund with the Commissioner of Internal Revenue within two years.