Tax cuts

First of two parts

IT SOUNDS counterintuitive, but one of the Philippine government's strategies to address hunger, joblessness and the economic slowdown arising from the pandemic is to reduce taxes paid by corporations.

Tax cuts are one of the salient features of the proposed Corporate Recovery and Tax Incentives for Enterprises (Create) Act that President Rodrigo Duterte has already certified as urgent.

Once it becomes law, income tax rates of small businesses and big corporations will be slashed to 25 percent from 30 percent (the highest in Asia), a move that is expected to reduce government revenues by P37 billion within six months of its passage, according to the Department of Finance (DOF).

The same bill also provides that every year for the next five years, one percentage point from the already reduced tax rate will be shaved off until it goes down to 20 percent. This will result in foregone revenues of P476.8 billion for the five-year period, the DOF said.

The bill, which originally started out as Package 2 of the Duterte administration's Comprehensive Tax Reform Program, became the Tax Reform for Attracting Better and High-Quality Opportunities (Trabaho) bill, and later, the Corporate Income Tax and Incentives Rationalization Act (Citira).

One year and a pandemic later, the bill now known as Create aims to achieve three goals: one, to make the Philippines become more attractive to foreign direct investments (FDIs); two, to simplify rules covering income tax breaks; and three, to provide critical support for businesses crippled by the largest economic contraction in the country's history.

By and large, it's a tall order.

The corporate tax cuts are just half of the story. The bill also seeks to expand the powers of the Fiscal Incentives Review Board (FIRB), an interagency body chaired by the DOF that grants tax perks to government corporations.

Under Create, the FIRB will also be authorized to grant tax incentives to private corporations, a mandate that will likely curtail the powers of 14 investment promotion agencies (IPAs) and 546 economic zones. Create will also replace more than 300 special laws that give tax perks and other incentives to investors.

Most crucially, Create, if passed, will do away with a special tax that has allowed some businesses to pay as little as 5 percent on gross income earned (GIE) for decades, instead of the full 30 percent income tax rate paid by most companies, in lieu of all other national and local taxes.

Leading economists from the University of the Philippines, Ateneo de Manila University and De a Salle University are skeptical of Create and have asked policymakers to break it up into three separate pieces of legislation.

"Create is both inequitable and inefficient,” said a joint statement issued in June 2020 by 24 economists, including National Scientist Raul Fabella and former National Economic and Development Authority (Neda) Chief Dante Canlas. “It is, in fact, a mere tax relief for incorporated businesses, equivalent to a subsidy, leaving out microenterprises and unincorporated small and medium enterprises. Create definitely falls short in terms of distributive justice.”

The statement added: “At this time when the economy and the tax base is shrinking, government urgently needs additional resources to cover its Covid-19 commitments, it is imprudent to shed off tax revenue.”

The economists’ proposal has so far no takers. The bill is waiting to be scheduled for plenary discussions at the Senate.

Tax savings to help preserve jobs

The logic of Create's proponents goes as follows: Corporate tax cuts will mean substantial savings for businesses, big and small, which they can reinvest in operations and/or help workers keep their jobs.

“Companies can make better use of this money than any government program in terms of retaining jobs, in terms of keeping businesses,” DOF Assistant Secretary Antonio Lambino II said in a September 2020 interview with the Philippine Center for Investigative Journalism (PCIJ).

“About 86 percent of those savings are reinvested, at least in terms of the Philippine experience,” Lambino added, citing agency estimates that used data from the 2015 edition of the Top 1000 Corporations in the Philippines, a yearly publication of BusinessWorld newspaper.

The average reinvestment rate is lower for companies receiving incentives, according to DOF findings shared with PCIJ.

Reinvestments for 2020 may drop to roughly half or P0.43 for every P1 of net income generated by companies and will gradually pick up from 2021, based on rough estimates from an enterprise survey conducted by the DOF.

Lack of data has prevented the DOF from making reinvestment estimates for micro, small and medium enterprises (MSMEs). This sector accounts for 99.5 percent or 998,342 of the total 1,003,111 business establishments, according to the 2018 List of Establishments of the Philippine Statistics Authority (PSA).

Once Create is passed, authorities can set conditions to help ensure that tax savings of companies, big and small, will ultimately benefit workers, said Filomeno Sta. Ana III, coordinator of policy and advocacy group Action for Economic Reforms (AER).

“During that period, companies should be disallowed from declaring dividends, buying back shares, or increasing salaries of their top executives,” he said. “As a result, gains from the tax cuts can be redirected for new investment, job preservation, or job creation.”

The Create bill will also impose a sunset provision on the special 5 percent tax on gross income that has indefinitely exempted investors in economic zones from paying the regular 30 percent tax on income. After a period of four to nine years, the 5 percent tax will be replaced with a special corporate income tax (SCIT) that will still allow investors to enjoy tax discounts of up to 74 percent. Tax liabilities may be reduced by as much as 48 percent, according to the DOF, and investors would still be exempt from paying six other types of taxes.

In 2018, actual foregone revenues from the special tax rate reached P62.933 billion, according to the latest data from the Department of Budget and Management (DBM).

This was almost 11 percent higher than the P56.731 billion in foregone revenues recorded a year ago.

Officials of the Philippine Economic Zone Authority (Peza) warned that removing the five-percent incentive under Create would “erode the country's competitiveness in attracting new FDIs.”

“It may even trigger the exodus of existing [economic zone] locators or re-allocation of their production quotas to other countries where they can be more viable with their export operations,” a Peza official said. “All our Asean counterparts are [continuing] to enhance their incentives, and here we are trying to do the opposite.”

This sentiment was echoed by Peza Director General Charito Plaza.

“We shouldn’t change the export enterprises incentive package,” she said in an interview. “Our exporters have different branches all over the world. We’re not the only game in town. We’re competing with other countries that are also using ecozones and attracting investors through incentives.”

V. Bruce Tolentino, an economist and one of the private sector representatives in the Monetary Board, the Bangko Sentral ng Pilipinas’ (BSP) highest policy-making body, disagreed.

“Firms locate in the Philippines either because they can operate here efficiently or because we possess resources that they need,” Tolentino said in an email to PCIJ.

“Tax incentives are merely sweeteners, aimed primarily at producing better economic outcomes from firms already predisposed to investing in the country. This is why it is crucial to make the [tax incentives] regime performance-based. If they were predisposed to investing in the Philippines anyway, and we give them perpetual tax perks without conditions, there is no incentive to perform better,” he said.

He added: “If a company is profitable, it should not have to leave, especially since the costs of relocating may not justify whatever tax discount would be lost.”

Tolentino also pointed out that Create features an “enhanced deduction system” that could entitle companies to incentives higher than current levels.

“The main difference is that those deductions correspond to actual performance (in job creation, research and development, etc.) so there is an incentive to invest more in labor, research and development...training, and other economically desirable outcomes that benefit both the company and the country,” Tolentino said.

Is a VAT exemption a tax incentive?

Other stakeholders agreed with the country’s top economists and have also opposed the income tax cuts in Create, especially in light of the novel coronavirus disease (Covid-19) crisis that has claimed thousands of lives, shuttered businesses, and laid off millions in a continuing saga marked by despair and dislocation.

“Whether or not you're happy with the quality of services the government is providing, [the government] will still need to expand the pie to be able to have meaningful public expenditures for social services,” said Alvic Padilla, a former senior economic justice advisor for the UK-based Christian Aid. Nevertheless, Padilla said he was in favor of the provision to simplify tax incentives as outlined under Create.

In January 2020, Padilla led a multi-country effort to produce a study that dealt with tax incentives, titled, “The Use and Abuse of Tax Breaks.”

Published by the Financial Transparency Coalition, the study contained a special section on the Philippines, which cited data from the finance department's study about tax incentives.

Padilla said the estimated P301-billion foregone revenues due to tax incentives in 2015 “could have easily covered the annual national budget for health (P104.96 billion) or social security and welfare (P231.34 billion).”

The same thing could be said for 2018.

Based on the Department of Budget and Management (DBM) data for that year, the government's investment promotion agencies granted tax incentives worth P477.168 billion in 2018.

The amount could have easily covered the budgets of the health and the social welfare departments at P167.9 billion and P141.8 billion, respectively.

Some officials of IPAs — which grant income tax breaks to investors anywhere from four to six years — have criticized the DOF for "over-estimating" revenues foregone due to tax incentives.

The DOF estimates should not have included value-added taxes (VAT) and Customs duties because they are not incentives, several officials of the Board of Investments (BOI) and the Peza have said in separate interviews.

A noted tax lawyer, whose clients included Peza enterprises, shared the same opinion, asserting that VAT, a tax on goods and services borne by end-consumers, is covered by a separate law.

Of the P301.2-billion foregone revenues due to tax incentives in 2015, P18.1 billion came from Customs duties, P159.8 billion from the VAT on imports, and P37 billion from VAT on local goods and services, based on data emailed by the DOF.

Taken together, Customs duties and import and local VAT for 2015 were worth P214.9 billion, an amount that was almost three-quarters of the total.

“All over the world, VAT exemptions for exporters are not counted as incentives, so why does the DOF consider that as an incentive?” an official told PCIJ.

A DOF official defended its figures, explaining that these were arrived at by a special team of 30 members that checked, examined and encoded items from numerous documents, including 6,000 financial statements of companies that received incentives from 2015 to 2017.

The team also examined the August 2018 cost-benefit analysis of tax incentives produced by the Neda, which, among others, said that data about tax perks were hard to come by.

In accounting for revenues foregone due to tax incentives, the DOF team chose to include VAT and “other exemptions that were not received by regular corporations,” the DOF official said.

AER's Sta. Ana, who supports Create, shared that sentiment.

“Strictly speaking, only export goods are VAT-exempt or zero-rated. But clearly, the threshold for exemption even in the proposed reform is below 100 percent,” Sta. Ana said. “In that case, the VAT exemption for such firms is a tax incentive or a tax expenditure.”

He added: “It is in fact the power of the state, not just a prerogative, to impose taxes or withdraw taxes.” (To be continued)

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Robert JA Basilio Jr. is a freelance writer based in Quezon City. He can be reached via email at rjabasiliojr@gmail.com.