A series of tax reforms set to generate substantial funds in the Philippines

In December 2017 the Philippines reached a major reform milestone when President Rodrigo Duterte officially approved the first of five Tax Reform for Acceleration and Inclusion (TRAIN) packages as part of the Comprehensive Tax Reform Programme (CTRP). Initially planned to roll out in 2019, the second stage of the TRAIN initiative, the Tax Reform for Attracting Better and High-Quality Opportunities (TRABAHO) bill, will target the corporate sector.

Prior to the CTRP, tax policy in the Philippines underwent two major periods of reform. The first took place in 1986, implemented by the government of former President Corazon Aquino, and the second in 1997, undertaken by former President Fidel Ramos’ administration. The general goals of each rendition have included widening the tax base; ensuring a fairer distribution of the tax burden; improving tax collection and administration; using taxes to incentivise businesses in particular industries and locations; closing loopholes; raising government revenue; and ensuring that the tax system does not obstruct economic and business growth.

Phase One 

The first stage of TRAIN introduced the most comprehensive tax changes in more than 20 years, with reforms directed mostly at reducing individual income taxes, while increasing excise taxes for a range of consumer goods. The reform plans to overhaul the 1997 income tax system for the 2018-22 period, with additional changes to be made from 2023 onward. Those in the lowest tax bracket, for example, earning an annual income of under P250,000 ($4650), saw their rate reduced from 5% to 0%; while those in the top tax bracket, earning over P2.41m ($44,800), saw a rate increase from 32% to 35%. Among other restructuring measures, self-employed and mixed-income earners have the option of paying an 8% flat tax rate on gross sales and receipts, while micro, small and medium-sized enterprises with annual sales of less than P3m ($55,800) are now exempt from paying value-added tax. To make up for lower income taxes, excise taxes were increased on petroleum products, cars, sugar-sweetened beverages, tobacco and alcohol, among others. The petroleum tax went up from P7 ($0.13) to P9 ($0.17) per litre of unleaded premium petrol, for example, while a new sweetened beverage tax was introduced of between P6 ($0.11) and P12 ($0.22), depending on the type of sweeteners used.

Automobile excise taxes doubled from 2% to 4% on vehicles valued under P600,000 ($11,200), with rates for more expensive vehicles ranging from 10% to 50%. However, electric vehicles and trucks commonly used for agricultural and commercial purposes are exempt. Other hikes included a series of increases in stamp, capital gains and transaction taxes, as well as other duties for stocks and debt instruments; a 5% extra tax on plastic surgery for cosmetic purposes; and a sharp increase in mining taxes. Taxes on the sale of cigarettes will also climb steadily until 2023. According to the Department of Finance (DoF), the new measures have helped raise government revenues, delivering 108.1% of their original targets, with tobacco, petrol, sugary drinks and stamp excises all over performing.

The TRABAHO bill addresses corporate income tax, which at 30% is seen as unusually high compared to regional neighbours such as Indonesia (25%), Malaysia (24%) and Vietnam (20%) PHASE TWO: Since the implementation of the TRAIN programme, legislators have been working on TRABAHO. This new round of reform addresses corporate income tax, which at 30% is seen as unusually high compared to regional neighbours such as Indonesia (25%), Malaysia (24%) and Vietnam (20%). This has resulted in certain companies deciding to relocate their operations to one of the Philippines’ special economic zones (SEZs), which offer tax holidays and a 5% flat tax rate on gross income earned, among various other benefits. However, a relatively small number of companies currently benefit from such incentive schemes, with just 2844 out of 915,000 firms in the country so far registered in SEZs, according to data released by the DoF.

The main focus of the TRABAHO bill is to rationalise investment incentives by making them performance-based and reduce the corporate tax rate to 20% in two-percentage-point instalments over a 10-year period. Tax holidays will also be limited to one, non-renewable three-year period and will be available to all companies operating in particular fields, not just those in SEZs. Key areas will include job creation, research and development, rural development and infrastructure. To replace the gross income earned tax, a 50% reduced income tax allowance will be introduced for a maximum five-year period. The Board of Investments will be tasked with determining the exact areas where these incentives will be available, while the Fiscal Incentives Review Board, chaired by the secretary of finance, will review and give approval for incentives. Tough new standards of transparency are also set to be put in place, with a view to facilitating scrutiny of the decision-making process that leads to a given company receiving a benefit.

Challenges 

In some ways similar to the first stage of TRAIN, the CTRP’s second stage has not been without its controversies. The bill failed to pass Congress in May 2019 as a result of disagreements stemming from the removal of the 5% gross income earned tax. However, four different revised versions of the bill were submitted to the 18th Congress in July 2019 and the final version of the law is expected to be passed by the end of 2019. Meanwhile, some lawmakers blamed TRAIN for adding to high inflation experienced in 2018. Opposition to the TRABAHO bill also reflects unease that it, too, might have negative consequences on the economy. In particular, stakeholders have expressed concern that the removal or rationalisation of incentives might negatively impact foreign direct investment (FDI), with businesses operating within SEZs potentially moving elsewhere. Indeed, the Philippine Economic Zone Authority (PEZA), which operates a number of SEZs, reported that PEZA-registered investment fell by 41% in 2018. The authority attributed this to uncertainty over the mid-term elections as well as the potential passage of the TRABAHO bill.

Additionally, it is still uncertain whether existing firms or just newcomers to SEZs will be affected by the coming rule changes. Both the Japanese and American Chambers of Commerce expressed concern that retroactively changing investment incentives could impact the perception of the Philippines as having a good business environment. At the same time, proponents of the reforms have criticised the fiscal incentives scheme in SEZs for being essentially endless. “The removal of incentives to companies in SEZs could be balanced with the improvement of infrastructure, in order to maintain the FDI inflows,” Fredieric Landicho, managing partner and CEO of Deloitte Philippines, told OBG.

Looking Ahead 

Debate over the TRABAHO bill’s merits is thus likely to continue throughout 2019, although the success of President Duterte’s allies in the congressional mid-term elections may give the reform the extra push it needs. If this happens, additional tax bills will likely be put forward, leading to further hikes in alcohol and tobacco taxes to fund the implementation of universal health care (see Health chapter). Succeeding phases of the tax reform programme are expected to tackle issues related to property valuations, followed by questions related to reductions in financial and passive taxes, capital markets development and tax amnesty.

All of these stages will inevitably take time to pass through Congress. Notwithstanding this, it seems likely that there will be a continuous wave of tax reforms over the coming few years. Their success will also be crucial for a range of key government programmes, from the Build, Build, Build national infrastructure development plan to the complete rollout of universal health care. Success will therefore also entail added pressure on the country’s current accounts, as these expansionary programmes require further imports of capital and intermediate goods, construction equipment, and materials and medical equipment, as well as the provision of a range of services. Sustained economic growth should help ameliorate any negative effects of the reforms. Over the longer term, meanwhile, a more streamlined and effective tax system would undoubtedly benefit both businesses and consumers, in addition to shoring up government coffers.