BY: Eustoria Marie Borja
Koror, Palau — The Bureau of Revenue & Taxation has issued a new Tax Circular, Ref No. TC 2024-04, dated September 30, 2024, providing vital clarification on the application of the Wages and Salary Tax (WST) for sole proprietors. The circular seeks to address concerns surrounding double taxation and outlines how business income for sole proprietors will be treated going forward.
The circular was issued in response to growing concerns over how income derived from a sole proprietor’s business would be taxed. Under Palau’s tax law, the Bureau determined that all income generated by a sole proprietor’s business should be considered business income, and not wages or salary, thus preventing the application of WST in such cases.
Key Points of the Circular
According to the Bureau’s review of Title 40 of the Palau National Code in 2023, it was established that for a true employer-employee relationship to exist, payment must come from one individual to another. Since a sole proprietor cannot pay themselves in such a relationship, payments made from their business to themselves should not be considered wages or salary but rather business profits. This decision was made to prevent the risk of double taxation and ensure the proper application of taxes on business income.
The circular emphasizes that all income a sole proprietor generates is recognized as income belonging to that individual and is subject to various forms of business taxation. These include, but are not limited to, the Business Profits Tax (BPT), Gross Revenue Tax (GRT), and the Additional Business License Fee (ABLF).
Effective Guidance on WST Application
Effective immediately, the circular specifies that a sole proprietor who receives payments in the form of wages or salary from their own businesses will no longer be subject to the Wages and Salary Tax. This guidance will ensure that taxpayers avoid being taxed twice on income derived from their own businesses.
The Bureau defines an “employee” under Title 40, Section 1002 of the Palau National Code as someone paid by another individual for services rendered. In order for the employer-employee relationship to exist, there must be a clear division between employer and employee, meaning that sole proprietors cannot simultaneously be both. Payments they receive from their business are classified as business profits and should be treated accordingly.
Clarification on Business Income and Gross Revenue
Additionally, the circular defines “gross revenue” as the total sum of all receipts from business activities within Palau, including gains from the disposition of assets, interest, dividends, royalties, and other sources. The income a sole proprietor receives from these sources is recognized as business income and is subject to the relevant business taxes. The Bureau stressed that portions of the revenue allocated to the sole proprietor should not be taxed as wages or salary, as income taxes have already been assessed on the business income.
Application of the Circular
This tax guidance will remain in effect until nullified. The circular was signed by Elway Ikeda, Director of the Bureau of Revenue & Taxation, and serves as the Bureau’s official stance on the taxation of sole proprietors’ income moving forward.
Key Takeaways from the Circular:
Clarification on Sole Proprietor Income: Income earned by sole proprietors from their businesses will not be taxed under Wages and Salary Tax (WST).
Employer-Employee Relationship: Sole proprietors cannot be both the employer and employee of their own business, eliminating the basis for WST.
Avoiding Double Taxation: Business income will only be subject to taxes such as BPT, GRT, and ABLF, not additional wages or salary tax.
This also means that employers will not be eligible for tax refunds which is based on Withholding Tax report. It means that business owners who also work in their own business will have to pay Social Security contributions and Health Care Fund insurance separately, not as percentage of their gross income.