Annotated view of the 2017comprehensive tax reform

(Conclusion) 

Holistic approach

The holistic approach taken by the Department of Finance in formulating the comprehensive tax reform package includes complementary measures by agencies in the Cabinet Economic Development Cluster headed by Secretary Carlos Dominguez. These measures will support tax policy and administration reforms, and are aimed for better Customs administration to provide P208 billion and full efficiency in expenditure to yield P188 billion. With an investment-led deficit target of three percent of GDP, P478 billion will be borrowed. The entire fiscal space will be geared to achieve the goals in Ambisyon 2040 set by the National Economic and Development Authority (NEDA).

Package One

Package One, in House Bill 4774, will contain the much clamored-for personal income tax cut. Exempt net income threshold will be raised to P250,000, which is designed to provide income tax exemption to minimum wage earners and those with gross annual income up to P273,000. The tax brackets are adjusted for inflation. The median tax for those with net taxable income of P500,000, currently taxed at the top rate of 32 percent, will see their tax rate lowered to 20 percent. But those with net income over P5 million will be taxed higher at 35 percent, instead of the current 32 percent. Since this revised personal tax rate will be higher than the proposed 25 percent corporate tax rate in another package, possibly leading to opportunities for tax arbitrage where income will be sheltered in the corporation, there are suggestions to lower the top rate to 30 percent or, alternatively, raising the top income bracket to no less than P10 million, instead of P5 million as proposed.

Simplified tax on gross income

In addition, a simplified tax on gross income at the rate of eight percent will be introduced, in lieu of income tax and VAT, for micro-size businesses with gross sales of less than P3 million. A tax on gross will greatly simplify the tax for such businesses. Expectedly, affected sectors, such as cooperatives, have expressed concern over the loss of tax exemption privilege. A possible way to overcome the objection is to equalize the treatment of micro businesses and individual wage earners, such that the first P250,000 net income of micro-size businesses, similar to the exemption to be given to individuals, will likewise be exempted from income tax and VAT. This P250,000 exempt net income is equivalent to fairly credible eight percent net income rate and a gross revenue of P3 million. Applying this concept, a micro business with gross annual revenue of P3 million should be exempt from both income and VAT. The proposed eight percent tax on gross should apply only if gross revenue exceeds P3 million, but less than a prescribed ceiling of, say, P5 million. Businesses with gross receipts exceeding the cap shall be subject to the regular income tax and VAT. Equalizing tax treatment would meet the principle of equity in taxation. Hopefully, this initial step will be expanded later to include small enterprises.

VAT reform

Third, to compensate for the higher personal income tax exemption and lower tax brackets and plug leakages in the VAT system, the base will be broadened by limiting exemption to the most essential goods and services – raw agricultural and marine products, medical and dental care, and education. Exemption of senior citizens and persons with disability will be maintained. Marginal businesses, such as sari sari store and agricultural cooperatives, will enjoy exemption for sales below P3 million.

Housing developers have expressed concern over the loss of VAT exemption for transactions P3.1 million and below as it will raise home cost and impair affordability. As it stands, home buyers already struggle to pay the required 10-20 percent equity payment. Industry expectation was for socialized and low-income housing to remain VAT exempt to help reduce homelessness and the huge housing backlog, particularly in highly urbanized cities. The DOF pledged to compensate the VAT exemption loss with intervention on the cost side. If such measures will be seen as effective in compensating home buyers, the loss of VAT exemption will be rendered more palatable. The devil, as usual, is in the details. Alternatively, maintain the VAT exemption but lower the exempt threshold from the current P3.1 million to the level of low-cost housing. The argument that home developers actually remit just the output VAT, net of input VAT, is not appropriate as the VAT system requires the gross VAT to be added to the cost of inputs paid by developers.

Outdated excise taxes on petroleum products will also be adjusted to compensate for inflation. It is noted that fuel excise tax as a percentage of gross domestic product had declined over the years. The tax on diesel fuel will be restored. To soften the impact and shield the poor, including fisher folks, the tax adjustment will be staggered over a number of years and mitigating measures will be provided. These measures include targeted cash transfers of P300 to be given to 10 million poor households and Pantawid Pasada, a public transportation modernization program to upgrade PUVs for higher efficiency. Another safeguard is a halt indexation trigger when oil prices exceed $100 per barrel.

Excise taxes on automobiles will be updated with expensive vehicles carrying the brunt of the adjustment. Average excise tax rates are currently graduated from two, five, 13 and 31 percent. The new rates will be four, 11, 23 and 42 percent. Vehicles with a net manufacturing or importation price of over P2.1 million will see the highest tax increase.

Finally, estate and donor’s tax will be reduced to a flat rate of six percent, in effect unifying the two taxes to that of the final tax on sale of capital real property. A concern raised is the periodic adjustment in BIR zonal values, which will have the effect of reducing or negating the benefit from the tax rate cut. Another is the inappropriateness of applying the zonal value to estate properties as such values are based on commercial transactions. On the other hand, transfer mortis causa (occasioned by death) is of a completely different nature, it being involuntary, by operation of law and without a profit motive. The remedy sought is the exclusion of the primary home from the gross estate. This treatment will also be consistent with the special status accorded family homes in the Family Code.

Advocacy and reform

Policy advocacy oftentimes is a fruitless effort, but sometimes have a positive effect when policy makers keep an open mind and practice inclusiveness and constructive engagement in the reform process as now. The tax on gross receipts or GRT, advocated as “the first arrow” of reform and estate tax reform in Package One of the CTRP were advocated by the author’s “Tax system change: The 4 arrows,” which was published on June 20, 2016.

Other reform packages

The other components of the CTRP will be contained in several other packages and are eagerly anticipated. A key reform measure is the much awaited corporate income tax cut to 25 percent, staggered over time, from the current 32 percent. This will bring the tax closer to those of regional peers and enhance the competitiveness of local businesses in the region and global arena. The reform will also discourage corporate tax inversion wherein businesses migrate, through corporate merger, to a low tax jurisdiction as done by some American multinationals by shifting tax domicile to Ireland.

Partners, not adversaries

Instituting sweeping reform is a daunting undertaking considering the diverse interests at play. It requires striking a balance between the need for technical perfection and political considerations, and strong leadership in steering the CTRP through the legislative maze to enactment. But when appropriate reform is achieved, the reward can be great. For taxpayers, a “simpler, fairer, and more efficient tax system, characterized by low rates” will give them the opportunity to do right by the government and be true partners in nation building. It will do away with the past with its onerous taxes and stringent conditions in a perpetual game of cops and robbers where “PR” gets the upper hand over “RP.”

Eduardo H. Yap is a board governor of the Management Association of the Philippines (MAP), chairs the National Affairs Committee of the Financial Executives Institute of the Philippines (FINEX) and was a licensed certified public accountant (CPA).