Economic zones become important destinations for investment in the Philippines

Benefitting from decades of investment and rising investor appetite for manufacturing projects, economic zones in the Philippines have risen to become an important export promotion tool and investment destination. Economic zone growth has soared in recent years, with the government’s Investment Priorities Plan, approved in 2017, offering incentives such as duty-free capital goods imports, corporate and income tax reductions, value-added tax (VAT) and tariff exemptions, and streamlined import and export procedures. Ongoing decentralisation efforts should also boost regional growth and inject new capital into provincial economies.

However, the upcoming passage of the second Tax Reform for Acceleration and Inclusion (TRAIN) package may affect economic zone investment. The TRAIN programme is expected to see a host of economic zone incentives reduced or removed in the coming years, with the Philippine Economic Zone Authority (PEZA) reporting a sharp decline in economic zone investment applications following approval of the first package. While the reforms are designed to bolster domestic consumption and support the state’s sweeping infrastructure development agenda, incentive reforms would likely weigh on growth.

Economic Zones

Economic zones are playing an important role in boosting Philippine exports. The World Trade Organisation (WTO) reports that as of October 2017, the Philippines was home to 376 PEZA-operated economic zones, made up of 74 manufacturing zones, 258 IT parks and centres, 22 agro-industrial zones, 20 tourism zones and two medical tourism parks. All but four zones have been developed and maintained by private operators, with 4047 businesses operating from economic zones as of July 2017, of which 69%, or 2785, are foreign-owned businesses, according to the WTO.

Japan tops the list of foreign investors, with 918 operational businesses in economic zones as of July 2017, followed by the US with 395 and South Korea with 303. Economic zones are major employers in the country, with 1.36m citizens working at a firm in one of these areas. They are also an important magnet for foreign investment, with inflows reaching P3.6trn ($71.1bn) between 1995 and September 2017, and exports hitting $684.2bn over the same period.

Investor Incentives

Under the PEZA’s jurisdiction, economic zones are dedicated export-oriented developments offering considerable incentives to businesses trading manufactured products or IT-enabled services. Companies must locate their activity inside a PEZA zone to benefit from incentives such as 100% foreign ownership, income tax holidays – such as a four- to six-year corporate income tax exemption (extendible to a maximum of eight years) – and a special reduced 5% tax on gross income in place of all other taxes after the expiration of these tax holidays.

PEZA investors are also exempt from import duties on capital equipment, spare parts, supplies and raw materials; a domestic sales allowance of up to 30% of total sales; export tax and wharfage fee exemptions; and exemption from local government fees such as the Mayor’s permit, business permits, health certificates, sanitary inspection fees and garbage fees. Additional incentives include special visas for foreign investors and their immediate family members, and simplified import, export and hiring procedures.

Decentralisation Reforms

The economic zone framework has been under review of late, and PEZA is restructuring to decentralise its operations under government mandates to reduce congestion in Metro Manila and boost inclusive nationwide growth.

In April 2018 Charito B Plaza, director-general of PEZA, told local media the authority is preparing for decentralisation reforms that will give local government units (LGUs) a larger share of economic zone income, with each zone expected to function as an independent, autonomous body after the process.

Economic zones will reportedly first be clustered by region, with each group falling under one administrator, thus aligning them with the four publicly managed zones. Project approvals and incentives will still be conducted by PEZA at its Manila headquarters, but some services will be delegated to the new zones, including the issuance of permits. The plan will eventually see LGUs benefit from 5% of each zone’s gross income, against current levels of 2-3%. Plaza told local media the move will support government plans to introduce a federalist political system (see Country Profile chapter).

To support decentralisation, PEZA has also announced plans to improve credit access to businesses located in economic zones, reporting in March 2018 that the state-owned Land Bank of the Philippines had agreed to launch a new credit facility offered to economic zone developers. This credit facility will be available to LGUs and national agencies managing public lands, thus helping them develop land into new economic zones and improving land utilisation. The Land Bank of the Philippines might also provide financing for investors looking to develop private land banks. PEZA is reportedly targeting two public economic zones per province for the new programme. The authority has signed similar credit financing agreements with six Japanese banks: Mizuho Bank, Bank of Tokyo Mitsubishi, Sumitomo-Mitsui Banking Corporation, Resona Bank, Ogahi-Kyoritsu Bank and Tokyo Star Bank.

Concerns

Perhaps more significantly, the TRAIN programme is expected to see yet-unspecified investor incentives reduced or removed, as the government seeks to boost tax revenues and deliver its infrastructure development programme, Build, Build, Build. The reforms are already affecting PEZA investment, and in March 2018 the authority warned that rising regional competition could drive investors out if concessions, such as VAT exemptions, are removed.

Much like the first TRAIN package, ratified in December 2017, the second bill of the programme, TRAIN 1-B, will also cut corporate income taxes, though this will occur alongside reductions in investment incentives. The second bill, filed with Congress in January 2018, takes aim at 333 laws and 14 government agencies that grant tax incentives, with the Department of Finance reporting that P301bn ($5.9bn) of corporate taxes had been waived in 2015 alone under the current incentive regime. TRAIN 1-B aims to replace the economic zone tax rate of 5% with a 15% levy on net income, while introducing revised incentive packages that are performance based.

According to Plaza, reduced tax incentives and rising levels of regional competition are making Philippine economic zones a harder sell. PEZA has announced it is working on a counter-proposal that would maintain some tax incentives, with new incentive packages based on the idea of remaining performance based, time bound, transparent and targeted.

Investment Impact

Investment figures from the first two months of 2018 put PEZA’s concerns into sharp relief. After warning about the imminent effects of TRAIN, approved investments in PEZA projects fell by 21.7% year-on-year in the January-February period, from P26.8bn ($529m) to P21bn ($395m). During the same period, however, the value of investment projects approved by the Board of Investments registered four-fold growth, from P26.2bn ($518m) to P132bn ($2.6bn). This represented 86.2% of the total approved investments registered with the two bodies. Noting that PEZA, foreign business chambers and foreign embassies submitted petitions to both Congress and the Department of Foreign Affairs to keep incentives in place, PEZA reported that the declining investment figures were not a result of not the agency’s performance, but rather due to investor fears over the future of economic zone incentives.

VAT Exemptions

Other incentives will reportedly not be affected, and just days after the new investment data was revealed, the Philippine Exporters Confederation announced that PEZA issued a memorandum circular reiterating that the VAT zero-rating incentive on sales of goods and services would remain in place. The Department of Finance clarified confusion over the TRAIN laws, reporting to PEZA that the programme would not affect VAT incentives.

Section 8 of the Republic Act – Law No. 7916, otherwise known as the Special Economic Zone Act of 1995 – provides that special economic zones are to be operated and managed as separate Customs territory. This law has not been amended or repealed by the TRAIN act, so the VAT exemption incentive for businesses in PEZA zones will remain in effect.

While uncertainty remains regarding the full extent of proposed incentive rationalisation, economic zones remain critical to attracting export-oriented and manufacturing investment. Despite the potential for near-term shocks from reforms, the corresponding improvement in supportive infrastructure bolsters the long-term outlook for economic zones.