Tax overhaul set to generate substantial revenue to support the Build, Build, Build agenda in the Philippines



In late 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. These initiatives are set to lower personal income taxes, expand the value-added tax (VAT) base, and increase taxes on petroleum products, automobiles and sweetened beverages. They are also expected to help raise the revenue necessary to deliver Build, Build, Build (BBB) – the government’s multibillion-dollar infrastructure initiative – and streamline the tax system while ensuring fairness and protecting low-income earners.

Tax collection had already been rising since President Duterte came to power in May 2016, with collection expected to support record infrastructure spending and broader macroeconomic expansion. However, increased VAT disproportionately affects low-income citizens, and rising inflation is pushing the central bank towards a mid-2018 interest rate hike. Moves to augment the conditional cash transfer programme with new subsidies are intended to protect the most vulnerable from some near-term shocks.

Wavering investor sentiment poses a more serious challenge: TRAIN lowers corporate income tax rates but also stipulates the rationalisation of investor incentives, leading to a decline in economic zone investment in early 2018 and raising doubts about the next packages.

Steady Improvement

Although tax collection has gradually improved, it remains relatively low. As it accounts for 91% of public revenue, tax collection is incredibly important to financial viability. World Bank figures show that tax revenue as a percentage of GDP rose from a 15-year low of 11.8% in 2004 to 13.7% in 2006, before falling to 12.2% in 2010. Collection rates have improved in recent years, reaching 12.9% in 2012, 13.3% in 2013, 13.6% in 2014, 13.7% in 2016 and 14.2% in 2017, according to the Asian Development Bank.

President Duterte’s first economic development strategy, the 10-point socio-economic agenda, highlights tax reforms to streamline collection with the aim of boosting infrastructure spending (see overview). Prior to TRAIN, a series of reforms had already put tax collection on an upward trajectory. However, government targets appear to be consistently more optimistic than results, and figures from the Bureau of Internal Revenue (BIR) show that while tax revenue has been growing at an accelerating pace, the country continues to have difficulty meeting its targets.

In 2015 the authorities collected P1.44trn ($28.4bn), falling short of their goal of P1.67trn ($33bn). Tax revenue increased significantly in 2016, growing by 9.7% to P1.58trn ($31.2bn). This accelerated in 2017, expanding by 12.7% to P1.78trn ($35.2bn). Despite these notable improvements, they still did not reach the targets of P1.62trn ($32bn) and P1.83trn ($36.2bn), respectively. This could be problematic, given the government’s sizeable investment requirements for the BBB infrastructure development programme: the so-called golden age of infrastructure will reportedly entail $158bn of spending in the lead-up to 2022.

The policies of President Duterte could help bring in this much-needed funding: BIR figures show that tax revenue has been growing under the current government in particular, having risen by 8.6% year-on-year (y-o-y) in the first year of the Duterte presidency.

Growing Collection

The taxpayer base grew by 5% in 2017, with 882,615 new individuals and 32,306 corporations having joined the tax system, according to the BIR. An additional 1463 employees were hired to help manage the new activity, and a number of procedures were streamlined as a result. Business registration procedures, for example, were cut from 13 to five documents and from seven to three steps.

Collection also improved after suspension enforcement campaigns that generated an additional P195m ($3.9m) of tax revenue, with the BIR moving to close 55 establishments with at least P40bn ($790m) of estimated liabilities during its “Oplan Kandado” campaign to crack down on tax evasion. In a strong signal to larger corporates, the BIR also filed three tax evasion cases against tobacco firm Mighty Corporation, whose P25bn ($494m) settlement was accepted on the condition that the company no longer engage in the tobacco business.

Train Overview

The government had previously attempted to reform the tax code, with the Department of Finance (DoF) introducing a bill in October 2016 designed to generate an additional P150bn ($3bn). However, special-interest lobbying and fear of imposing unpopular taxes, including a 12% VAT for mass-marketed housing, reduced most of the bill’s provisions.

The first TRAIN bill – signed into law in December 2017 and effective as of January 1, 2018 – introduced the most comprehensive tax changes in more than 20 years. The law is expected to raise P92bn ($1.8bn) during its first year of implementation, less than the P162bn ($3.2bn) originally sought, but nonetheless a significant boost to government coffers.

The first package will reduce personal income tax but boost excise tax on coal, petroleum, automobiles, sugar-sweetened beverages and cosmetic surgery. Average taxpayers will gain roughly P20,000 ($395) annually from the tax cuts, according to regional news sources. The real estate sector is also expected to benefit from increased revenue – anticipated to reach 0.7% of GDP – enabling the construction of roads, bridges and airports, and boosting connectivity to their projects. The long-awaited reforms have won praise from some stakeholders, most notably from global ratings agency Fitch, which cited the TRAIN package as motivating December 2017 decision to upgrade the Philippines’ sovereign credit rating to BBB with a stable outlook.

Exceeding Expectations

In March 2018 the BIR announced had exceeded its VAT tax collection target of P38.5bn ($761m) by 15% in the first two months of the year, reporting P44.5bn ($879m) of revenue. This represented a 74.2% y-o-y increase, with just P25.5bn ($504m) collected during the same period in 2017. Total tax collection grew over the same period, rising by 10.8% y-o-y to P281bn ($5.6bn), beating the BIR’s P242bn ($4.8bn) target by 16%.

The bulk of VAT income in the first two months of 2018 came from the tobacco industry, with collections of P24bn ($474m), 61% higher than the target of P14.9bn ($294m) and 74% over the P13.8bn ($273m) collected during the same period of 2017. Meanwhile, alcohol tax revenue jumped to P9.82bn ($194m), exceeding the P8.3bn ($164m) target by 18.2%. Automobile tax income also beat expectations, at P810m ($16m) against a P644m ($12.7m) target, while mineral taxation hit P464m ($9.2m), against a P308m ($6.1m) target. Petroleum VAT collection stood at P4.79bn ($94.6m), and sweetened beverage taxes earned P4.5bn ($88.9m). In January 2018 the BIR announced it expects to collect a record P2.04trn ($40.3bn) for the year, against its original target of P2trn ($39.5bn).

Obstacles

Although the TRAIN programme is expected to have broadly positive long-term effects on economic growth, the country faces several challenges. Inflation is one of the most serious concerns, with senator Panfilo Lacson telling local media in January 2018 that TRAIN could drive inflation to as high as 6% in 2018, up from 3.2% in 2017, in spite of projections from the National Economic Development Authority that it would add just 1%. Headline inflation hit 3.9% in February 2018 – the highest level since October 2014 – and another peak of 4.3% in March 2018, exceeding the central bank’s target range of 2-4%.

A bigger concern for stakeholders could be shaken investor confidence, with TRAIN’s second tranche expected to be passed this year, further augmenting tax collection. The DoF projected that the second package, TRAIN 1-B, would generate an additional P93bn ($1.8bn) over the 2018-22 period, although this was conditional on the package taking effect before the end of March 2018. TRAIN 1-B is expected to roll back corporate income tax rates from 30% – the highest rate in South-east Asia – to 25%, a welcome move for many companies doing business in the Philippines.

However, the second tranche of the TRAIN package also aims to rationalise investor incentives, including incentives in economic zones and the energy sector (see Trade & Investment and Energy chapters). The Philippine Economic Zone Authority (PEZA) currently offers eight-year income tax holidays for export-oriented companies – including business process outsourcing firms – after which their gross income is subject to a 5% perpetual tax in lieu of the 30% corporate tax rate. The DoF plans to introduce performance-based tax breaks, meaning some companies will not get tax holidays, while the 5% tax on gross income is set to be replaced with a 15% charge on net taxable income. TRAIN 1-B is being discussed, as Congress reconvened in May 2018.

Although the DoF previously announced that economic zone VAT exemptions would not be affected by TRAIN, PEZA has warned that concerns about incentive rationalisation have led to a decline in new foreign investment (see Trade & Investment chapter), casting doubt on the future of the remaining TRAIN packages.