## _cr1260

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---

### Mission and purpose
- IMF Fiscal Affairs Department (FAD) mission visited Manila from September 6–19, 2011.
- Mission members: Mr. Kiyoshi Nakayama (head), Mr. Selcuk Caner, and Mr. Peter Mullins.
- Main task: provide advice on a road map for a pro-growth and equitable tax system.
- Meetings: senior officials from DOF, BIR, BOC, Senate Tax Study and Research Office, Department of Natural Resources, Department of Energy, BOI, PEZA, academia, think tanks, civil society, business community, accounting profession, JICA, and ADB.
- Report structure: Executive Summary and seven chapters: (1) Introduction and Progress in Tax Reform; (2) Tax Incentives; (3) Other Corporate Income Tax Issues; (4) Excise Taxes; (5) Personal Income Tax; (6) Mining Taxation; and (7) Road Map for Tax Reform.

### Key objectives guiding the mission
- Achieve an increase in tax revenue by 3.0 percent of GDP by 2016.
- Improve the Philippines' competitiveness under the ASEAN Economic Community (AEC) framework.
- Simplify the tax system.
- Improve the equity of the tax system.
- Improve the effectiveness of the tax system.

### Main findings — Tax incentives
- Preferred reform (Option 1): remove income tax holidays and the 5 percent tax on gross income earned (GIE) to enable a considerable cut in the corporate income tax (CIT) rate to at least 25 percent.
- Next-best reform (Option 2): significant rationalization of incentives.
- Suggested improvements to DOF rationalization proposal:
  - limit the period for all incentives to no more than 10 years;
  - provide only two rate options—an income tax holiday followed by a 7.5 percent tax on GIE, or simply the tax on GIE;
  - for existing recipients, allow time-bound incentives to expire, and phase out those that are not time-bound;
  - remove the VAT zero-rating for suppliers outside the zones to exporters within the zones;
  - reduce the list of Investment Priority Plan activities eligible for incentives;
  - include a sunset clause, of no more than 5 years, for all incentive laws.
- A serious rationalization of incentives, and addressing tax planning opportunities and non-compliance, would allow a reduction in the CIT rate to at least 25 percent; this could be phased in over time to ensure reform is at least revenue neutral.

### Main findings — Other corporate income tax issues
- Tax capital gains on the sale of shares and real estate not used in the company’s business as ordinary income.
- Introduce transfer pricing and thin capitalization rules.
- Cooperatives: recommended to
  - subject cooperatives to CIT and VAT, with distributions to members subject to withholding tax;
  - for small cooperatives with turnover below the VAT threshold, consider the 3 percent percentage tax or a de minimus rule to reduce administrative burden.

### Main findings — Excises
- Many excise rates need to be increased to recover lost revenue amounting to 1.8 percent of GDP since 1997, due to lack of indexation, outdated product classifications, and reduced petroleum excises.
- Adjustments desirable to DOF proposal:
  - start rate adjustments no later than the beginning of 2012;
  - use the Consumer Price Index (CPI) to adjust excise rates periodically (e.g., quarterly) rather than an index of cigarette prices;
  - adjust specific rates on tobacco products to reach the excise on tobacco products to GDP ratio attained in 1997;
  - complete the adjustment in three years;
  - move to a unified specific rate on tobacco products in the medium-term;
  - maintain a tax burden (all taxes) on cigarettes no less than 50 percent of the retail price.
- Petroleum excises: increase specific rate on gasoline from current levels and introduce an excise on diesel after sin tax reform is approved by Congress.
- Telecommunications: initiate a study on an excise on SMS and other mobile phone services; example estimate: total number of SMS in the Philippines in a year estimated as 600 billion in 2010; revenue from an excise of 10 centavos per text would be PHP60 billion.

### Main findings — Personal income tax (PIT)
- Index the rate schedule to inflation accumulated since 1997 to retain progressivity and reduce the number of brackets.
- Short term: broaden the lowest tax rate band to the income bracket currently subject to a 10 percent rate to mitigate projected tax burden increases on low-income taxpayers from indexed excises.
- Limit the Optional Standard Deduction (OSD) to those whose sales/receipts are less than the VAT threshold; alternatively reduce the standard deduction to 20 percent or less as proposed in House Bill No. 3992.
- Align lower interest withholding tax rates on Foreign Currency Deposit Units (FCDUs) and deposits with long maturity with the standard interest withholding tax rate (20 percent).

### Main findings — Mining taxation
- Existing regime: 5 percent royalty rate plus 2 percent excise and numerous additional national and local taxes and fees; regime is not designed to capture resource rents effectively.
- Calculation of net mining revenues (NMR) discriminates against capital because capital charges are not included in NMR calculation.
- The "additional government share" lacks progressivity.
- Current mining law lacks "ring-fencing" provisions, posing revenue risks under profit-based regimes.
- Recommended direction: design a fiscal regime to capture resource rents—an ad valorem tax for metals based on market value of production with a progressive mechanism to tax resource rents is preferred; specific royalty rates based on volume/quantity for high-volume-low-value minerals; front-end loading to secure revenue as soon as production commences.
- Further work: a specific tax policy mission on mining to estimate revenue impacts of various fiscal regimes.

### Quantified revenue impact (Table 2 estimates; percent of GDP)
- Excises (DOF bills)
  - Tobacco (DOF bill): 2012 = 0.33; 2013 = 0.40; 2014 = 0.46; 2015 = 0.48; 2016 = 0.51
  - Liquor (DOF bill): 2012 = 0.34; 2013 = 0.54; 2014 = 0.86; 2015 = 0.95; 2016 = 1.04
- Petroleum: unquantified in early years, 2016 = 0.42
- Mobile communications: 2016 = 0.67
- VAT
  - Repeal exemption post-2006: 2014 = 0.26; 2015 = 0.26; 2016 = 0.26
  - Refund mechanism: unquantifiable decline (▼)
  - Increase threshold: unquantifiable decline (▼)
- PIT
  - Index rate schedule to inflation post 1997: unquantifiable decline (▼) in 2016
  - Limit OSD to under VAT threshold: increases revenue 2012–2016 (↑ each year)
  - Unified W/H tax of 20 percent on interest: 2013 = 0.1; 2014 = 0.1; 2015 = 0.1
- CIT
  - Every 1 percentage point reduction in the CIT rate will cost 0.1 percent of GDP (will phase in corresponding to incentive rationalization).
  - Apply CIT rate to capital gains, transfer pricing, thin capitalization, and taxation of cooperatives: unquantified revenue increases (↑) across 2012–2016.
- Resource taxation: unquantified revenue increases (↑) across 2012–2016.
- Total estimated impact (accumulated since 2010, based on GDP in 2010):
  - 2012 total = 0.67 percent of GDP
  - 2013 total = 0.94 percent of GDP
  - 2014 total = 1.68 percent of GDP
  - 2015 total = 1.79 percent of GDP
  - 2016 total = 3.0 percent of GDP
- Increase by BIR reform (assumed contribution):
  - 2012 = 0.1; 2013 = 0.2; 2014 = 0.3; 2015 = 0.4; 2016 = 0.5 (percent of GDP)
- Tax/GDP path implied:
  - 2012 tax/GDP = 13.1
  - 2013 tax/GDP = 13.38
  - 2014 tax/GDP = 14.13
  - 2015 tax/GDP = 14.25
  - 2016 tax/GDP = 16.0
- Notes: ↑ = unquantifiable revenue increase; ▼ = unquantifiable revenue decline. *Figures based on GDP in 2010 and show an accumulated revenue increase since 2010.

### Operational recommendations and timing
- Start excise rate adjustments no later than the beginning of 2012 and complete specific tobacco adjustments within three years.
- Phase in CIT rate reductions in line with incentive rationalization to preserve revenue neutrality during transition.
- Undertake further analytical work (including a focused mining tax policy mission) to quantify revenue impacts and fine-tune fiscal instruments.

---

### I. Fiscal outcome and immediate causes
- Tax-to-GDP ratio fell to 12.1 percent in 2010.
- Fiscal deficit increased to 3.6 percent of GDP in 2010.
- Identified causes of declining tax revenue:
  - generous and expanding tax incentives;
  - tariff rate reduction;
  - deteriorating tax compliance caused by ineffective and inefficient revenue administration;
  - gradual erosion of excise revenue due to non-indexation.
- Temporary improvement in 2006 due to VAT reform, but cyclical factors and fiscal stimulus measures, together with deteriorating tax compliance, reversed gains.
- Government target: increase tax-to-GDP ratio to 16 percent of GDP (which is 3.4 percent higher than that in 2010).
- The 2012 budget projected that tax administration reform would increase revenue by 0.4 percent of GDP; reported outcome: tax administration reform has not registered an increase in revenue.

### Progress on 2010 FAD mission recommendations (selected)
- DOF bill (awaiting Senate discussion as of September 2011) rationalizes incentives by providing three rate options:
  - (1) 6 year income tax holiday followed by 5 percent tax on GIE for 19 years;
  - (2) 5 percent tax on GIE for 25 years;
  - (3) 15 percent CIT for 25 years.
- DOF excise bill proposes shifting from multi-tiered rate schedule to a unitary rate and indexing the tax rate to inflation; broadly follows 2010 mission recommendations.
- Revenue Regulation No. 14-2011 (issued July 29, 2011) prohibits tradability of Tax Credit Certificates (TCCs); BIR preparing for a proper VAT refund mechanism with funding for refunds projected in the 2012 budget.

### Assessment of World Bank recommendations and differences
- World Bank mission estimated recommendations would increase tax revenue by 3 percent of GDP by 2016.
- Divergences:
  - PIT top rate: World Bank recommends reducing top PIT rate from 32 percent to 25 percent; FAD mission considers this not viable given current fiscal condition and income inequity.
  - Withholding tax on interest: World Bank recommended unified 18 percent; present mission recommends unified 20 percent.
  - VAT: World Bank projected 0.26 percent of GDP from eliminating exemptions introduced since 2006 while establishing a refund system; FAD mission: revenue would be the same in the short term if FAD recommendations on VAT are adopted.

---

### II. Tax incentives — overview, effects, and reform options
- Existing regime: widely recognized as very generous and unnecessarily complex; estimated around 180 laws providing tax incentives.
- Types of incentives: income tax holidays for 3 to 8 years; 5 percent tax on GIE (in lieu of national and local taxes); increased tax deductions; tax credits; exemptions from VAT, import duties, and other fees and charges.
- Key concerns:
  - incentives are among the most ineffective forms—loss of current and future revenue, inequity, distortion of resource allocation, opportunities for tax abuse, attraction of footloose firms, inefficiency for unprofitable new enterprises.
- Philippines-specific problems:
  - incentives provided by multiple agencies and laws; weak monitoring; limited DOF involvement.
- Data limitations: previous studies estimate revenue forgone could be as high as 1 to 2 percent of GDP (examples: Manasan (2002) estimates cost 1.1 to 1.9 percent of GDP; Reside (2006) estimates revenue loss from redundant incentives could be 1 percent of GDP).
- International comparison:
  - Allowance of a 5 percent tax on GIE for an indefinite time is more generous than peers; CIT rate is one of the highest in the region.
  - FDI 2005–2010: South-East Asia inward FDI stock grew by 14.4 percent; Philippines declined by 12.9 percent.
- Reform options:
  - Preferred: remove all tax holidays and the 5 percent tax on GIE, reduce CIT rate (with grandfathering).
  - If infeasible: rationalize incentives—limit tax holidays to specific investments/sectors to no more than 5 years; remove 5 percent tax on GIE.
  - World Bank alternative: retain tax on GIE but increase rate to 7.5 percent.
- Comparison of two bills before Congress:
  - DOF Bill: one law, PEZA as sole agency for granting incentives, DOF to monitor tax expenditure data; three income tax options (6+19 with 5% GIE; 5% GIE for 25 years; 15% CIT for 25 years); VAT zero-rating and duty exemptions for firms within zones; exporter must export at least 70 percent.
  - BOI Bill: House-approved; time limits but expands incentives; multiple agencies; exporters must export at least 30 percent; various income tax options including 4–15 year holidays, 10 or 15 percent CIT, 5 percent GIE for 25 years.

### DOF bill assessment and recommended improvements
- DOF bill preferred to BOI bill.
- Further improvements recommended:
  - shorten time limits (most countries do not provide incentives beyond 10 years);
  - simplify rate options to two choices (income tax holiday followed by GIE or GIE only), consider increasing GIE to 7.5 percent;
  - remove VAT zero-rating for suppliers outside zones to exporters within zones;
  - grandfather time-bound incentives and phase-out non-time-bound incentives;
  - narrow IPP activities eligible for incentives (examples unlikely to warrant incentives: mining, telecommunications, property development);
  - include a sunset clause no more than 5 years.
- Which option:
  - Preferred: remove all tax holidays and the tax on GIE, with grandfathering, reduce CIT to at least 25 percent.
  - Politically feasible short-term: use DOF bill as base with recommended amendments.

---

### III. Other CIT issues — selected recommendations and findings

A. Tax Rate
- International trend: average CIT rate for ASEAN = 25.9 percent; Asia = 25.6 percent.
- Recommendation: reduce CIT rate to at least 25 percent (phased), conditional on serious incentive rationalization.
- Fiscal implication: a one percentage point reduction in the CIT rate would cost about 0.1 percent of GDP.

B. Cooperatives
- Current generous exemptions if accumulated reserves and undivided net savings are less than PHP10 million.
- As of December 31, 2010: 18,205 cooperatives registered; total membership ~7.2 million.
- Recommendation: tax cooperatives like other commercial enterprises (CIT, VAT, import duties) except small cooperatives (below VAT threshold) which could be subject to 3 percent percentage tax or de minimis rule; apply withholding tax on distributions (e.g., 5 percent) subject to de minimis.

C. Taxation of Capital Gains
- Current special treatments include final taxes on sale of shares in non-listed companies and 6 percent final tax on real estate not used in the company’s business.
- Recommendation: treat capital gains on sale of shares and all real estate as ordinary income of a corporation. (Short Term)

D. Transfer Pricing
- BIR transfer pricing guidelines expected next year; modeled after OECD Transfer Pricing Guidelines.
- Recommendation: change the CIT return form to enable the BIR to identify related transactions. (Short Term)

E. Thin Capitalization
- Current rules cannot prevent thin capitalization; recommendation to introduce thin capitalization rules (debt-to-equity or earnings-stripping) after examining data on company funding. (Short Term)

---

### Information exchange and bank secrecy
- "Exchange of Information on Tax Matters Act of 2009" allows BIR Commissioner to access bank accounts to provide information requested by a tax treaty partner.
- Limitation: BIR still cannot access bank accounts for its own needs to combat tax evasion and avoidance.
- AMLC reporting: banks report transactions exceeding PHP500,000 in one banking day; BIR currently not allowed access to AMLC-held information.
- Recommendations:
  - Allow the BIR access to bank accounts for its own needs. (Short Term)
  - Allow the BIR access to data held by the AMLC. (Short Term)

---

### IV. Excise taxes — overview and recommendations

Overview and recent decline
- Excise tax revenues declined from 2.6 percent of GDP in 1997 to 0.8 percent of GDP in 2010.
- Causes: lack of indexation, outdated product classifications, reduction in petroleum excises.
- Recommendation: increase excises to return share to 1997 levels within three years; start adjustments immediately.

Specific vs. ad valorem and mixed use
- In imperfect competition (Philip Morris ~90 percent of market), specific taxes reduce relative price differences and mitigate mispricing; ad valorem taxes have multiplier effects.
- Optimal system may be a mix; for tobacco specific excises based on tobacco content are recommended.

Earmarking
- Earmarking excise revenues for health or other programs generates budget inefficiencies; case for earmarking is tenuous.

Tobacco excises — status and DOF proposal
- Excise revenues from tobacco declined from 0.6 percent of GDP in 1997 to 0.3 percent in 2010.
- Current specific excise on an average pack: PHP8.75; total tax burden on average pack: 44.37%; share of excise tax: 33.65% (based on 20 sticks).
- DOF proposes reducing 4 tiers to two tiers in 2012–2013, then a uniform rate; DOF current tier rates listed:
  - 2.72 pesos per pack for hand-packed and cigarettes valued less than 5 pesos;
  - 7.56 pesos for cigarettes priced between 5 to 6.50 pesos;
  - 12.00 pesos for cigarettes priced between 6.50 to 10.00 pesos;
  - 28.30 pesos for cigarettes priced over 20 pesos.
- Effect of increasing specific excise to PHP24.64 (fully phased-in):
  - Retail Price Including All taxes (P): 43.5
  - Specific Tax ts: 24.64
  - VAT (12%): 4.66
  - Total Tax: 29.30
  - Retail Price ex-taxes P0: 14.20
  - Total Tax Burden: 67.36%
  - Share of Excise Tax: 56.64%
- DOF phase-in design:
  - Brands with net retail price over PHP10 subject to PHP30 per pack immediately.
  - Brands with net retail price less than PHP10 subject to PHP14 and PHP22 in first two years and PHP30 after second year.
- Revenue projection: fully phased-in increase may increase excise yield by as much as 0.8 percent of GDP; DOF should aim to reach the tobacco excise-GDP ratio of 1997 by 2014.
- Indexation recommendation post-2014: use CPI rather than cigarette price index; maintain excise share over 50 percent and gradually increase to 70 percent as recommended by WHO.
- Employment effects: evidence suggests limited net employment loss; mitigation via crop diversification and retraining funded from a portion of new revenues is recommended.
- Recommendations (explicit):
  - Start rate adjustments no later than beginning of 2012. (Short Term)
  - Consider alternative phasing scenarios. (Medium Term)
  - Use CPI to adjust excise rates periodically (say, quarterly). (Medium Term)
  - Adjust specific rates to reach 1997 tobacco excise-GDP ratio. (Medium Term)
  - Complete adjustment in three years. (Medium Term)

Alcoholic beverages
- Excise revenues declined from 0.6 percent of GDP in 1997 to 0.3 percent in 2010.
- DOF proposes rationalizing and increasing excises, harmonizing by alcohol content, removing domestic/imported differentiation.
- New excises on wine products: PHP 300 per bottle for sparkling wine and P 50 per bottle for still wine.
- Recommendation: increase excises on all alcohol as proposed by DOF; set excises according to alcohol content; index using CPI. (Short/Medium Term)

Petroleum
- In 1997 excises on petroleum products raised PHP30.8 billion, 1.2 percent of GDP; in 2010 PHP9.7 billion, 0.1 percent of GDP.
- Current gasoline excise: 4.35 PHP/liter (reduced from 4.80 PHP in 2005); diesel exempt.
- Reinstating diesel excise at PHP1.63 would increase excise revenue to GDP ratio by almost 0.1 percentage point.
- Further increase to PHP3.5/liter on diesel and PHP5/liter on gasoline would increase excise revenues on petroleum products by 0.42 percent of GDP.
- Recommendations:
  - Increase gasoline excise after phasing in tobacco and alcohol excises. (Medium Term)
  - Start adjusting gasoline excise using CPI immediately. (Short Term)
  - Reinstate diesel excise after phasing in tobacco and alcohol. (Medium Term)
  - Adjust diesel excise using CPI after introduction. (Medium Term)

Telecommunications
- No additional taxes on mobile services other than VAT.
- Given volume and usage, mobile communications could be a significant revenue source.
- Recommendation: study an excise on SMS and other mobile phone services to determine revenue and economic effects. (Long Term)
- Example: total SMS estimated at 600 billion in 2010; excise of 10 centavos per text could yield PHP60 billion.

---

### Personal Income Tax — findings and recommendations

Rate schedule and indexing
- PIT rate schedule unchanged since 1997; personal allowance PHP50,000 in 2008.
- BIR data on taxpayers and withheld tax by bracket (Table 13):
  - 0–10,000 (5 percent): 916,405 taxpayers; Withheld tax: 2,005 (in PHP million)
  - 10,000–30,000 (10 percent): 266,716 taxpayers; Withheld tax: 66 (in PHP million)
  - 30,000–70,000 (15 percent): 419,952 taxpayers; Withheld tax: 226 (in PHP million)
  - 70,000–140,000 (20 percent): 597,296 taxpayers; Withheld tax: 1,507 (in PHP million)
  - 140,000–250,000 (25 percent): 730,046 taxpayers; Withheld tax: 7,548 (in PHP million)
  - 250,000–500,000 (30 percent): 519,113 taxpayers; Withheld tax: 17,790 (in PHP million)
  - 500,000 or more (32 percent): 203,410 taxpayers; Withheld tax: 48,814 (in PHP million)
  - Total: 3,652,938 taxpayers; Withheld tax: 77,954 (in PHP million)
- Complete data: total registered compensation income earners = 9,509,212; withheld tax from wages in 2010 = PHP 135,153 million.
- Recommendation: index the rate schedule to inflation accumulated since 1997 (accumulated inflation 1997–2011 = 212 percent) to retain progressivity; reduce number of brackets; short-term: abolish 10 percent rate and broaden lowest band to 0–30,000 (5 percent).

Proposed bracket change (Table 16)
- Current -> Proposed:
  - 0–10,000 (5 percent) -> 0–30,000 (5 percent)
  - 10,000–30,000 (10 percent) -> (no separate 10 percent bracket)
  - 30,000–70,000 (15 percent) -> 30,000–70,000 (15 percent)
  - 70,000–140,000 (20 percent) -> 70,000–140,000 (20 percent)
  - 140,000–250,000 (25 percent) -> 140,000–250,000 (25 percent)
  - 250,000–500,000 (30 percent) -> 250,000–500,000 (30 percent)
  - 500,000 or more (32 percent) -> 500,000 or more (32 percent)
- Recommendation: abolish 10 percent rate and broaden lowest band. (Short Term)

Taxation of self-employed
- Self-employed (2010):
  - Number of taxpayers: 1,695,347
  - PIT paid (in mil.PHP): 7,392
  - Average tax (b/a) in PHP: 4,360
- Wage earners (2010):
  - Number of taxpayers: 9,509,212
  - PIT paid (in mil.PHP): 135,153
  - Average tax (b/a) in PHP: 14,213
- Average tax paid by self-employed (PHP4,360) is 30.7 percent of average tax paid by wage earners.
- Issues with OSD (40 percent standard deduction) and VAT taxpayers opting for OSD.
- Recommendations:
  - Limit OSD to self-employed with sales below VAT threshold. (Short Term)
  - Alternatively reduce OSD to 20 percent or less. (Short Term)
  - Limit allowable deductions to expenses easily verifiable. (Short Term)

Remittances by citizen workers abroad
- Remittances amount to US$21 billion in 2010 (>10 percent of GDP).
- OCWs/OFWs not taxed in the Philippines on overseas employment income (Section 23 (c) of NIRC).
- Proposal: set a ceiling on tax-free remittances, e.g., equivalent of US$25,000 per year; taxes paid abroad can be credited. (Long Term)

---

### Mining taxation — overview, incentives, and reform recommendations

Current contribution and regime
- Mining industry's contribution to GDP: 1.4 percent of GDP in 2010.
- Fiscal regime: royalty (5 percent), excise (2 percent), multiple national and local taxes and fees; additional government share mechanism targeting 50 percent of NMR but NMR calculation excludes capital charges.
- Incentives in mining act:
  - Accelerated depreciation;
  - Property tax exemption of pollution control devices;
  - Up to five year loss carry forwards;
  - Imports of capital goods and inputs exempt from customs duty;
  - Tax credit certificates for VAT on imported goods;
  - Deduction for community expenses.
- Investment guarantees: repatriation rights; exchange rate guarantees; freedom from expropriation; requisition protections.
- Observations: loss carry forward period may be short; depreciation expense not included in NMR deductible expenses.

Principles and instrument choices
- Design goals: maximize net present value of tax revenue while providing incentives; profitability-based instruments preferred to capture resource rents.
- Preferred instruments:
  - Profit-based instruments (tax surcharge on cash flow, variable royalty linked to profitability, excess profit/R-factor mechanisms).
  - Royalties: ad valorem flat rate for high-value minerals; specific royalties for low-value bulk commodities; annual CPI adjustment for specific royalties.
- Administrative requirements: capacity to monitor production volumes, sales, fair market values; transfer price rules needed for related-party sales.
- Recommendations:
  - Request an FAD mission to assess and compare current mining fiscal regime with alternatives using project data. (Short Term)
  - Consider introducing mining tax provisions in a separate section in NIRC corporate tax chapter. (Medium Term)
  - Increase loss carryover years for mine operators. (Medium Term)
  - Use three depreciation categories for exploration, tangible assets, and other development costs. (Medium Term)
  - Establish ring-fencing around each mining license. (Medium Term)
  - Change restrictions on foreign ownership. (Medium Term)

---

### Income inequity, effectiveness, and political timelines
- The Philippines has the highest income inequity in Southeast Asia.
- Tax provisions that unduly benefit the wealthy should be changed (examples: exemptions on capital gains and preferential interest taxation).
- Improving effectiveness requires measures to verify compliance (example: withholding on payments to self-employed).
- Political timelines:
  - From now to the first half of next year: window of opportunity for tax reform.
  - For complex issues (excise on mobile communications; restructuring PIT schedule): avoid rough approaches; propose the latter half of 2016 as an appropriate time slot for careful consideration.

---

### Road Map — high-level elements and phasing (selected)
- Tax Incentives: options to abolish all tax incentives or raise tax on GIE to 7.5 percent; income tax holidays: (no extension); lower CIT rate (phase in).
- Other CIT issues: Transfer pricing; Thin capitalization; Apply CIT rate to capital gains; Tax cooperatives.
- Excises: Tobacco — Adjust and unify tax rates; Indexation; Alcohol — Adjust and unify; Indexation; Petroleum — normalize tax rates at PHP5 per liter; Tax diesel; Mobile communications — flagged for later consideration.
- VAT: Repeal exemptions post-2006; Establish proper refund system; Increase threshold to PHP3 million; Eliminate zero-rating for foreign currency denominated transactions; Limit zero-rating to exports only; Consider full deductibility of capital inputs; Option to increase VAT rate if revenue needed.
- PIT: Index rate schedule to inflation post 1997; Limit OSD to those under VAT threshold; Ceiling on tax free remittance by overseas workers.
- Financial sector: Unified 20 percent W/H tax on interest; Unified 5 percent GRT; Apply standard CIT rate to FCDU interest income from residents.
- Notes: "*Shaded parts are new recommendations. ** No specific timeline proposed for mining measures."

---

### Appendix highlights — revenue and regional comparisons
- Rationalization of fiscal incentives has potential to raise around 1 percent of GDP; elimination of incentives accompanied by CIT reduction to around 21 percent would be revenue neutral; reduction to 25 percent would be revenue positive.
- Excise tax reform would raise revenue of 0.8 percent of GDP.
- Reform of VAT and PIT would be revenue neutral; VAT rate increase could be considered if further revenue needed.
- Regional comparisons and detailed tables provided on investment tax incentives and mining/oil fiscal terms (country comparisons, royalty and tax structures).

*Source: IMF Fiscal Affairs Department mission report — Preface and Executive Summary and subsequent chapters excerpted from content unit _cr1260.*

### Preface.................................................................................................................

### _cr1260 - Preface.................................................................................................................

### Mission and purpose
- IMF Fiscal Affairs Department (FAD) mission visited Manila from September 6–19, 2011.
- Mission members: Mr. Kiyoshi Nakayama (head), Mr. Selcuk Caner, and Mr. Peter Mullins.
- Main task: provide advice on a road map for a pro-growth and equitable tax system.
- The mission met with senior officials from DOF, BIR, BOC, Senate Tax Study and Research Office, Department of Natural Resources, Department of Energy, BOI, PEZA, academia, think tanks, civil society, business community, accounting profession, JICA, and ADB.
- The report consists of an Executive Summary and seven chapters: (1) Introduction and Progress in Tax Reform; (2) Tax Incentives; (3) Other Corporate Income Tax Issues; (4) Excise Taxes; (5) Personal Income Tax; (6) Mining Taxation; and (7) Road Map for Tax Reform.

### Key objectives guiding the mission
- Achieve an increase in tax revenue by 3.0 percent of GDP by 2016.
- Improve the Philippines' competitiveness under the ASEAN Economic Community (AEC) framework.
- Simplify the tax system.
- Improve the equity of the tax system.
- Improve the effectiveness of the tax system.

### Main findings and policy recommendations

- Tax incentives
  - Preferred reform (Option 1): remove income tax holidays and the 5 percent tax on gross income earned (GIE) to enable a considerable cut in the corporate income tax (CIT) rate to at least 25 percent.
  - Next-best reform (Option 2): significant rationalization of incentives.
  - Suggested improvements to DOF rationalization proposal:
    - limit the period for all incentives to no more than 10 years;
    - provide only two rate options—an income tax holiday followed by a 7.5 percent tax on GIE, or simply the tax on GIE;
    - for existing recipients, allow time-bound incentives to expire, and phase out those that are not time-bound;
    - remove the VAT zero-rating for suppliers outside the zones to exporters within the zones;
    - reduce the list of Investment Priority Plan activities eligible for incentives;
    - include a sunset clause, of no more than 5 years, for all incentive laws.
  - A serious rationalization of incentives, and addressing tax planning opportunities and non-compliance, would allow a reduction in the CIT rate to at least 25 percent; this could be phased in over time to ensure reform is at least revenue neutral.

- Other corporate income tax issues
  - Tax capital gains on the sale of shares and real estate not used in the company’s business as ordinary income (as is the case for other capital gains).
  - Introduce transfer pricing and thin capitalization rules.
  - Cooperatives: current tax treatment is very generous relative to international practice and may create competitive distortions and revenue leakage. Recommended:
    - subject cooperatives to CIT and VAT, with distributions to members subject to withholding tax;
    - for small cooperatives with turnover below the VAT threshold, consider the 3 percent percentage tax or a de minimus rule to reduce administrative burden.

- Excises
  - Many excise rates need to be increased to recover lost revenue amounting to 1.8 percent of GDP since 1997, due to lack of indexation, outdated product classifications, and reduced petroleum excises.
  - Adjustments desirable to DOF proposal:
    - start rate adjustments no later than the beginning of 2012;
    - use the Consumer Price Index (CPI) to adjust excise rates periodically (e.g., quarterly) rather than an index of cigarette prices;
    - adjust specific rates on tobacco products to reach the excise on tobacco products to GDP ratio attained in 1997;
    - complete the adjustment in three years;
    - move to a unified specific rate on tobacco products in the medium-term;
    - maintain a tax burden (all taxes) on cigarettes no less than 50 percent of the retail price.
  - Petroleum excises: increase specific rate on gasoline from current levels and introduce an excise on diesel after sin tax reform is approved by Congress.
  - Telecommunications: initiate a study on an excise on SMS and other mobile phone services. Example estimate in the Executive Summary: total number of SMS in the Philippines in a year could be estimated as 600 billion in 2010; revenue from an excise of 10 centavos per text would be PHP60 billion.

- Personal income tax (PIT)
  - Index the rate schedule to inflation accumulated since 1997 to retain progressivity and reduce the number of brackets.
  - In the short term, broaden the lowest tax rate band to the income bracket currently subject to a 10 percent rate to mitigate projected tax burden increases on low-income taxpayers from indexed excises.
  - Limit the Optional Standard Deduction (OSD) to those whose sales/receipts are less than the VAT threshold. Alternatively, reduce the standard deduction to 20 percent or less as proposed in House Bill No. 3992.
  - Align lower interest withholding tax rates on Foreign Currency Deposit Units (FCDUs) and deposits with long maturity with the standard interest withholding tax rate (20 percent).

- Mining taxation
  - Existing regime: high royalty (5 percent royalty rate plus 2 percent excise) and numerous additional national and local taxes and fees; regime is not designed to capture resource rents effectively.
  - Calculation of net mining revenues (NMR) discriminates against capital because capital charges are not included in NMR calculation.
  - The "additional government share" lacks progressivity of regimes used by many countries to tax excess profits.
  - Current mining law lacks "ring-fencing" provisions, posing revenue risks under profit-based regimes.
  - Recommended direction: design a fiscal regime to capture resource rents—an ad valorem tax for metals based on market value of production with a progressive mechanism to tax resource rents is preferred; specific royalty rates based on volume/quantity for high-volume-low-value minerals; front-end loading to secure revenue as soon as production commences.
  - Further work: a specific tax policy mission on mining to estimate revenue impacts of various fiscal regimes and identify the best fit for the Philippines.

### Quantified revenue impact (Table 2 estimates; in percent of GDP)
- Excises (DOF bills)
  - Tobacco (DOF bill): 2012 = 0.33; 2013 = 0.40; 2014 = 0.46; 2015 = 0.48; 2016 = 0.51
  - Liquor (DOF bill): 2012 = 0.34; 2013 = 0.54; 2014 = 0.86; 2015 = 0.95; 2016 = 1.04
- Petroleum: unquantified in early years, 2016 = 0.42
- Mobile communications: 2016 = 0.67
- VAT
  - Repeal exemption post-2006: 2014 = 0.26; 2015 = 0.26; 2016 = 0.26
  - Refund mechanism: unquantifiable decline (▼)
  - Increase threshold: unquantifiable decline (▼)
- PIT
  - Index rate schedule to inflation post 1997: unquantifiable decline (▼) in 2016
  - Limit OSD to under VAT threshold: increases revenue 2012–2016 (↑ each year)
  - Unified W/H tax of 20 percent on interest: 2013 = 0.1; 2014 = 0.1; 2015 = 0.1
- CIT
  - Every 1 percentage point reduction in the CIT rate will cost 0.1 percent of GDP (will phase in corresponding to incentive rationalization).
  - Apply CIT rate to capital gains, transfer pricing, thin capitalization, and taxation of cooperatives: unquantified revenue increases (↑) across 2012–2016.
- Resource taxation: unquantified revenue increases (↑) across 2012–2016.

- Total estimated impact (accumulated since 2010, based on GDP in 2010):
  - 2012 total = 0.67 percent of GDP
  - 2013 total = 0.94 percent of GDP
  - 2014 total = 1.68 percent of GDP
  - 2015 total = 1.79 percent of GDP
  - 2016 total = 3.0 percent of GDP
- Increase by BIR reform (assumed contribution to fiscal measures):
  - 2012 = 0.1; 2013 = 0.2; 2014 = 0.3; 2015 = 0.4; 2016 = 0.5 (percent of GDP)
- Tax/GDP path implied:
  - 2012 tax/GDP = 13.1
  - 2013 tax/GDP = 13.38
  - 2014 tax/GDP = 14.13
  - 2015 tax/GDP = 14.25
  - 2016 tax/GDP = 16.0

- Notes provided in the Executive Summary:
  - ↑ = unquantifiable revenue increase; ▼ = unquantifiable revenue decline.
  - *Figures are based on the GDP in 2010 and show an accumulated revenue increase since 2010.

### Additional operational recommendations and timing
- Start excise rate adjustments no later than the beginning of 2012 and complete specific tobacco adjustments within three years.
- Phase in CIT rate reductions in line with incentive rationalization to preserve revenue neutrality during transition.
- Undertake further analytical work (including a focused mining tax policy mission) to quantify revenue impacts and fine-tune fiscal instruments (e.g., resource rent taxation, unified specific tobacco excise).

*Source: IMF Fiscal Affairs Department mission report — Preface and Executive Summary.*

### 1.      Tax revenue has declined over the last decade in the Philippines due to generous

### _cr1260 - 1.      Tax revenue has declined over the last decade in the Philippines due to generous

### A. Fiscal outcome and immediate causes
- Tax-to-GDP ratio fell to 12.1 percent in 2010.
- Fiscal deficit increased to 3.6 percent of GDP in 2010.
- Identified causes of declining tax revenue:
  - generous and expanding tax incentives;
  - tariff rate reduction;
  - deteriorating tax compliance caused by ineffective and inefficient revenue administration;
  - gradual erosion of excise revenue due to non-indexation.
- Temporary improvement in 2006 due to VAT reform, but cyclical factors and fiscal stimulus measures, together with deteriorating tax compliance, reversed gains.

### B. 2010 FAD technical assistance recommendations (February 2010)
- Main lines of recommended comprehensive tax reform:
  - rationalizing tax incentives;
  - full and automatic indexation of the main excises;
  - broadening the VAT base.
- Mission advised authorities to propose tax reform plans by the end of 2010 (post-election).

### C. Government stance and revenue administration reforms
- Post-election focus: enhancing collection by reforming tax administration rather than introducing new taxes.
- Tax policy may be revisited in 2012.
- Government target: increase tax-to-GDP ratio to 16 percent of GDP (which is 3.4 percent higher than that in 2010).
- The 2012 budget projected that tax administration reform would increase revenue by 0.4 percent of GDP.
- Reported outcome: tax administration reform has not registered an increase in revenue, though some slight progress has been made in recent months.

### D. Progress on 2010 FAD mission recommendations (selected items)
- Tax incentives
  - DOF bill (awaiting Senate discussion as of September 2011) rationalizes incentives by providing three rate options:
    - (1) 6 year income tax holiday followed by 5 percent tax on GIE for 19 years;
    - (2) 5 percent tax on GIE for 25 years;
    - (3) 15 percent CIT for 25 years.
  - Proposal partly in line with 2010 mission; current incentive regime provides tax holidays ranging from three to eight years followed by a 5 percent tax on GIE for an indefinite period.
- Excises
  - DOF bill to simplify and increase excise tax on tobacco and alcohol presented to LEDAC in August; included as a priority bill of the Aquino Administration.
  - Bill proposes shifting from multi-tiered rate schedule to a unitary rate and indexing the tax rate to inflation; broadly follows 2010 mission recommendations.
  - Ten other excise reform bills filed; most do not include indexation to inflation.
  - WTO ruling declared Philippine taxes on liquor imports as discriminatory and may affect excise bill discussions.
- VAT
  - Revenue Regulation No. 14-2011 (issued July 29, 2011) prohibits tradability of Tax Credit Certificates (TCCs); mission supports as first step toward abolition of TCCs.
  - BIR has started preparation for establishing a proper VAT refund mechanism; funding for refund payments is projected in the 2012 budget.
  - Business representatives criticized current refund system and indicated it is a main reason for companies to apply for PEZA tax incentives (which exempts VAT on imports and zero-rates supply by domestic companies to free zone companies).
  - Mission notes a proper VAT refund system is a prerequisite for abolishing tax incentives.

### E. Assessment of World Bank (June 2011) recommendations and differences with FAD mission
- World Bank mission estimated recommendations would increase tax revenue by 3 percent of GDP by 2016.
- Areas of divergence:
  - PIT rate schedule:
    - World Bank recommends reducing top PIT rate from 32 percent to 25 percent to align with CIT.
    - Present mission considers this not viable given current fiscal condition and income inequity, though alignment desirable longer term.
  - Withholding tax on interest:
    - World Bank recommended unified 18 percent withholding tax on interest.
    - Present mission recommends a unified 20 percent rate (current rate on interest from deposits or bonds with maturity of less than three years).
    - Rationale: current reduced or zero withholding on some interest benefits mainly wealthy households; with Philippines foreign currency reserve at 10 months of imports, no longer legitimate reason for preferential treatment for deposits in foreign currency.
  - VAT:
    - World Bank did not recommend full deductibility of VAT on capital inputs.
    - Re-establishing full deductibility requires careful consideration of VAT revenue impact but could have significant positive implications for competitiveness, as would a proper refund system.
    - World Bank projected an increase in revenue by 0.26 percent of GDP from eliminating exemptions introduced since 2006 while establishing a refund system.
    - FAD mission: revenue would be the same in the short term if the Philippines adopts all FAD recommendations on the VAT.

### F. Mission objectives and scope
- Mission revisited major taxes reviewed in 2010 to find viable options for a road map to increase tax revenue by 3.0 percent of GDP by 2016.
- Aide memoire covers new findings and analysis on:
  - tax incentives;
  - other CIT issues;
  - excises;
  - PIT;
  - mining taxation (preliminary review).
- For VAT and taxation of the financial sector, previous recommendations are deemed valid with nothing to add.
- Road map for tax reform provided in aide memoire.

### II. Tax incentives — overview, effects, and reform options
- Overview
  - Existing regime is widely recognized as very generous and unnecessarily complex.
  - Numerous incentives delivered under many laws administered by BOI, PEZA, and other special economic zone authorities.
  - Estimated around 180 laws providing tax incentives.
- Types of incentives provided:
  - income tax holidays for 3 to 8 years;
  - 5 percent tax on GIE (in lieu of national and local taxes);
  - increased tax deductions;
  - tax credits;
  - exemptions from VAT, import duties, and other fees and charges.
- Effects and costs (key concerns)
  - Incentives, especially tax holidays and reduced tax rates, are among the most ineffective forms.
  - Key arguments against incentives:
    - loss of current and future revenue leading to higher taxes elsewhere, harming efficiency, compliance, and equity;
    - create inequitable and inefficient different tax treatments between and within sectors, distorting resource allocation;
    - create opportunities for tax abuse (e.g., transfer pricing);
    - tax holidays attract footloose firms or simply benefit firms that would have invested anyway;
    - benefits may be reversed if investor's residence country taxes worldwide income (transfer of revenue);
    - tax holidays inefficient for unprofitable new enterprises;
    - spending on social infrastructure could be more effective in attracting investment to less developed regions;
    - taxes are not the most important factor for investment decisions; other factors (market size, labor costs, infrastructure, stable environment) often more important.
  - Philippines-specific problems:
    - incentives provided by multiple agencies and laws causing competition and confusion;
    - significant resources duplicated across agencies;
    - weak monitoring of investor compliance with incentive conditions;
    - limited DOF involvement in granting decisions, resulting in lack of fiscal discipline.
  - Data limitations: insufficient data to obtain accurate estimate of cost; previous studies estimate revenue forgone could be as high as 1 to 2 percent of GDP.
    - Examples: Manasan (2002) estimates cost of fiscal incentives for 1998–2000 from 1.1 to 1.9 percent of GDP; Reside (2006) estimates revenue loss from redundant incentives alone could be 1 percent of GDP.
- International comparison
  - Legislated length of tax holidays relatively consistent with regional practice, but allowance of a lower tax rate (5 percent of GIE) for an indefinite time is more generous than peers (maximum period in almost all countries in region is 15 years, most less than 10 years).
  - CIT rate is one of the highest in the region; worldwide trend has been reduction in CIT rates.
  - FDI performance: South-East Asia inward FDI stock grew by 14.4 percent during 2005–2010, while for the Philippines it declined by 12.9 percent.
  - Non-tax deterrents to FDI cited: lack of adequate infrastructure, power costs, poor legal environment (land ownership and labor laws), difficulties in doing business.
  - Philippines regional advantages: age, quality, and education of workforce; widespread use of the English language.
- Reform options
  - Preferred 2010 option: remove all tax holidays and the 5 percent tax on GIE, while reducing the CIT rate (with appropriate grandfathering).
    - Expected outcome: simpler, more transparent, equitable, and efficient system consistent with international trends and more sustainable investment climate.
  - If preferred option infeasible: rationalize incentives with smaller CIT reduction:
    - limit tax holidays to a few specific investments/sectors with clear criteria and time period no more than 5 years;
    - remove 5 percent tax on GIE.
  - World Bank alternative: retain tax on GIE but increase the rate to 7.5 percent to allow access to simplified administration in PEZA zones while collecting more revenue; remove tax on GIE once BIR, BOC, and local government administrations improve.
- Two main bills before Congress (comparison highlights)
  - DOF Bill (ambitious reform; PEZA as sole agency for granting incentives; one law covering incentives; DOF to monitor tax expenditure data):
    - Income tax incentives: three rate options as listed earlier; losses—5 year carry forward; accelerated depreciation; double deduction for training and R&D.
    - Indirect tax incentives: VAT zero-rating and duty exemptions for firms within zones; VAT zero-rating for suppliers to exporters within zones.
    - Eligibility: Exporters and projects within the 30 poorest provinces undertaking activities in the IPP, strategic domestic projects; exporter must export at least 70 percent of production or exemption is lost; VAT and duty applies to domestic sales.
    - Allocation of tax on GIE: 3 percent to the national government, 2 percent to the local government.
    - Other: 1 percent levy on value of incentive to fund BOI investment promotion.
  - BOI Bill (House-approved; imposes time limits but expands range of incentives; multiple agencies for granting incentives; BOI oversight):
    - Income tax incentives: a number of options depending on activity/location/significance including 4 to 15 years income tax holidays; 10 or 15 percent CIT, or 50 percent reduction in CIT rate, for periods of 10 to 19 years (ensuring total incentives do not exceed 25 years); 5 percent tax on GIE for 25 years; losses—5 year carry forward; accelerated depreciation; double deduction for training and R&D.
    - Indirect tax incentives: VAT zero-rating and duty exemptions for firms within zones; VAT zero-rating for suppliers to exporters within zones.
    - Eligibility: exporters, domestic firms, and projects within 30 poorest provinces undertaking IPP activities and strategic domestic projects; exporter must export at least 30 percent of production; if exports between 30 and 70 percent incentive apportioned; VAT and duty applies to domestic sales.
    - Allocation of tax on GIE: 2 percent to the national government, 2 percent to the province or city, 1 percent to the municipality or city.
    - Institutional: multiple agencies; BOI focused on investment promotion; DOF represented on all boards of investment promotion agencies.

*Source: IMF staff aide memoire as presented in the provided content.*

### 22.      The DOF bill, which the mission prefers to the BOI bill, is a positive step

### _cr1260 - 22.      The DOF bill, which the mission prefers to the BOI bill, is a positive step

### Assessment of the DOF and BOI bills
- The DOF bill is preferred to the BOI bill and is described as a positive step towards reform with several improvements over the existing regime.
- Key improvements in the DOF proposal:
  - A single regime for all eligible enterprises will simplify the system and make it more equitable among incentive recipients.
  - Removing access to incentives for most domestically focused enterprises (other than those in specific locations) will reduce redundancy and remove egregious incentives (example: housing developers).
  - Institutional arrangements provide a more administratively efficient regime and ensure DOF input into the process.
  - Monitoring of tax expenditures by the DOF and consolidating incentives in a single law align with the 2010 mission recommendations and should increase simplicity and transparency.
  - In the long term, DOF should be the sole organization responsible for drafting legislation on tax incentives.
- The BOI bill is less attractive because:
  - It expands the range of incentives and makes the system more complex than the present regime.
  - It targets industrial activity as well as regions, distorting investors' choices and complicating administration.
  - It gives BOI an oversight role while retaining multiple agencies' roles in granting incentives and promoting investments.

### Further improvements recommended for the DOF regime
- Time limits
  - The period for providing incentives is still too long and should be reduced.
  - Most countries in the region do not provide incentives beyond 10 years (see Appendix II).
  - Rationale: incentives are typically to attract firms to undertake particular activities and/or assist establishment; once the objective is achieved the incentive should cease.
- Simplify rate options
  - Consider providing taxpayers only two rate options:
    - an income tax holiday followed by a tax on GIE; or
    - the tax on GIE only.
  - The proposal to offer a lower CIT rate raises the question of why not simply provide a lower CIT rate for all taxpayers rather than a 15 percent rate for some.
  - Consider increasing the rate of tax on GIE to 7.5 percent, as recommended by a recent World Bank mission.
- VAT zero-rating
  - Continued VAT zero-rating for suppliers outside the zones to exporters within the zones (proposed in both DOF and BOI proposals) is not supported.
  - Rationale: zero-rating is too prone to abuse, difficult to monitor, with leakage to the domestic market; it was introduced partly due to inadequacies of the VAT refund regime, which are being addressed.
- Grandfathering and alignment of existing firms
  - To align existing firms and reduce forgone revenue, if legally possible grandfather incentives provided to existing investors by:
    - allowing time-bound incentives to expire; and
    - phasing out incentives that are not time-bound within a reasonable time frame.
- Narrowing eligible activities
  - Reduce the list of activities under the Investment Priorities Plan (IPP).
  - Governments are generally not good at picking winners; better to limit activities eligible for incentives so a lower CIT rate can be provided to all corporate taxpayers.
  - Examples of IPP activities unlikely to warrant incentives: mining, telecommunications, and property development.
- Sunset clauses
  - Incentive laws should include a sunset clause of no more than 5 years to ensure incentives achieve their intended purpose.

### Which option for the Philippines?
- Preferred reform option:
  - Remove all tax holidays and the tax on GIE, with appropriate grandfathering provisions for existing investors, and reduce the CIT rate to at least 25 percent.
- Politically feasible short-term approach:
  - Use the DOF bill as a base with recommended amendments; it will not remove all concerns but will make the system simpler, more transparent, equitable, and efficient, and together with a reduction in the CIT rate should enhance the Philippines' attractiveness to investors.

### Recommendations on tax incentives
- Long Term
  - Reform tax incentives with the preferred option being to remove all tax holidays and the tax on GIE (with appropriate grandfathering provisions for existing investors), with a reduction in the CIT rate to at least 25 percent.
- Short Term (if preferred option not feasible, rationalize using DOF bill with amendments)
  - Limit the total period for all incentives to no more than 10 years;
  - Provide only two rate options: an income tax holiday followed by a 7.5 percent tax on GIE; or simply a 7.5 percent tax on GIE;
  - Remove the VAT zero-rating for suppliers outside the zones to exporters within the zones;
  - Grandfather existing recipients of incentives by allowing those incentives that are time-bound to expire, and phasing out those incentives that are not time-bound within a reasonable time frame;
  - Reduce the list of IPP activities eligible for incentives;
  - Include a sunset clause for all incentive laws of no more than 5 years.

### III. OTHER CIT ISSUES
#### A. Tax Rate
- Context and comparators
  - The CIT rate was reduced in 2009, but a further decrease may be necessary to remain regionally competitive.
  - International trend: decreasing CIT rates; average rate for the ASEAN region is 25.9 percent, consistent with the average for the entire Asia region at 25.6 percent.
- Recommendation and fiscal implications
  - A significant reduction in the rate, to at least 25 percent (phased in over a period of time), would be possible if there were a serious rationalization of incentives.
  - A one percentage point reduction in the CIT rate would cost tax revenues of about 0.1 percent of GDP, without offsetting revenue-raising measures.
  - A rate reduction may need to be phased in over time in line with reductions of incentives.
- Distributional considerations
  - Concerns that a CIT cut may be pro-rich and anti-poor are addressed:
    - Increased investment from a CIT cut should lead to greater employment opportunities benefiting all, including the poor.
    - Even with a rate cut to 25 percent, the effective tax on CIT profits distributed to shareholders is 32.5 percent (that is the CIT rate plus the 10 percent dividend withholding tax), which is still higher than the existing top PIT rate.
    - Cut in the CIT rate to be accompanied by rationalization of incentives, with many companies paying tax at higher rates, allowing for a more equitable tax system.
- Recommendation
  - Consider a reduction in the CIT rate, to around 25 percent, with the extent of the reduction, and potential phase-in time, dependent on base broadening through rationalization of incentives. (Medium Term).

#### B. Cooperatives
- Current treatment and thresholds
  - Cooperatives receive preferential tax treatment in the Philippines.
  - A cooperative is exempt from all taxes (including income tax, VAT and import duties) if its business transactions are with members only, or it transacts with non-members and its accumulated reserves and undivided net savings are less than PHP10 million.
  - If the cooperative exceeds the PHP10 million threshold it may be taxed on its business with non-members, although there are further exemptions for agricultural cooperatives, certain credit cooperatives, and for cooperatives where each member's contribution to share capital does not exceed PHP15,000.
  - As of December 31, 2010, 18,205 cooperatives are registered with the Cooperative Development Authority (CDA) and the total membership of the registered cooperatives amounts to some 7.2 million.
- Exemptions and administration
  - Distributions to members by cooperatives are also exempt from tax, covering patronage refunds and distributions based on member share capital (interest income), which are exempt from withholding taxes.
  - The tax treatment is very generous and open to abuse, has unintended outcomes, and is difficult to administer.
  - Concerns include: use of cooperatives to avoid employer legal responsibilities, cooperatives undertaking significant commercial enterprises leading to revenue leakage, and difficulties for the BIR in monitoring non-member transactions.
- Policy rationale
  - Main cooperative benefits (market access, economies of scale, buying power) can be obtained without tax exemptions.
  - Most cooperatives conduct business like other commercial enterprises and should be taxed similarly (income tax at the CIT rate, VAT, and import duties).
- Options for small cooperatives
  - Small cooperatives (gross turnover below the VAT threshold) could be subject to:
    - the 3 percent percentage tax on turnover and/or a de minimis rule to reduce administrative burden.
  - Payments to members (interest or patronage refunds) should be subject to creditable withholding tax, e.g., 5 percent, with a possible de minimis exemption for small amounts.
- Recommendations
  - Tax cooperatives, other than small cooperatives (i.e., with turnover below the VAT threshold), in the same manner as other entities conducting businesses (i.e., income tax at the CIT rate, VAT, and import duties). (Medium Term)
  - Small cooperatives could be subject to the 3 percent tax on turnover and/or a de minimis rule. (Medium Term)
  - Apply withholding tax to interest and patronage refunds paid by cooperatives, subject to a de minimis rule. (Medium Term)

#### C. Taxation of Capital Gains
- Current treatment
  - Capital gains earned by corporations are taxed as ordinary income, except:
    - gain from sale of shares in another company, or
    - sale of real estate not used in the company’s business.
  - Sale of shares in a non-listed company: first PHP100,000 of net capital gains subject to a final 5 percent tax, with any excess taxed at 10 percent.
  - Capital losses deductible only to extent of gains in the same year.
  - Net capital gains from sales of shares in listed companies are not subject to income tax but are subject to a percentage tax of 0.5 percent of the sale price.
  - Gains on real estate not used in the business of a corporation are subject to a 6 percent final income tax.
- Policy view
  - Special treatment of capital gains on sale of shares and real estate is generous and unnecessarily complicates the tax system.
  - Trend in most countries: tax these capital gains as ordinary income of the company.
  - Treating real estate gains consistently with other gains would remove disputes about whether an asset is used in the business.
- Recommendation
  - Treat capital gains on the sale of shares and all real estate (irrespective of its purpose) as ordinary income of a corporation. (Short Term)

#### D. International Taxation — Transfer Pricing
- Status and guidance
  - BIR transfer pricing guidelines expected to be issued next year.
  - Section 50 of the NIRC allows the BIR Commissioner to adjust transfer pricing; BIR has prudently not applied rules until guidelines are issued.
  - Guidelines are modeled after the latest version of the OECD Transfer Pricing Guidelines and provide sufficient guidance on basic methods.
- Risks and information gaps
  - The Philippines' relatively high CIT rate may induce MNEs to shift income abroad.
  - Transactions with related parties that enjoy tax incentives pose serious transfer pricing risks (example: supplier related to a free zone company underpricing sales to reduce group CIT).
  - Current CIT return form does not include information on related parties, making it difficult for the BIR to focus on such transactions.
  - Similar manipulations may occur within single companies where some parts enjoy incentives; lack of segmented information impedes detection.
- Recommendation
  - Change the CIT return form to enable the BIR to identify related transactions. (Short Term)

#### E. Thin Capitalization
- Issue and current rule gaps
  - Thin capitalization: excessive funding by interest-bearing loans from related parties rather than share capital.
  - Current Philippine rule on deductible expenses cannot prevent thin capitalization.
  - To counter the practice, tax rules need to deny interest deductions in defined cases.
- Common approaches
  - Debt-to-equity rules: express ratios of loan capital to share capital beyond which interest deductions are denied (common ratios between 1.5:1 and 3:1).
  - Earnings-stripping rules: limit interest deductions by reference to a proportion of taxpayer income.
  - Different ratios should apply to financial institutions which operate at higher debt levels.
  - In setting ratios, examine data on funding by Philippine companies to minimize interference with legitimate business activities.
- Interaction with incentives and FDI mode
  - Thin capitalization rule may increase investment in equity but UNCTAD cautioned on over-reliance on non-equity modes (NEMs) such as BPO and contract manufacturing, which are footloose.
  - Under current incentive regime, thin capitalization may not affect tax revenue or FDI mode in the short term because income tax holiday and 5 percent GIE tax are not affected by thin capitalization rules.
- Recommendation
  - Introduce a thin capitalization rule after examining data on funding by Philippine companies. (Short Term)

*Italic: IMF staff report content.*

### 43.      A new law that allows the BIR to exchange information (EOI) under a double

### A new law that allows the BIR to exchange information (EOI) under a double

### Exchange of information framework and bank secrecy
- A new law, "Exchange of Information on Tax Matters Act of 2009", was enacted last year.25
- Under the new law, the BIR Commissioner can access bank accounts in order to provide information requested by a tax treaty partner.
- Prior to the new law, bank secrecy was strictly protected by the Foreign Currency Deposit Act in which only the Secretary of Finance can make a request to access bank accounts.
- With the new law, the Philippines now can comply with the "internationally agreed standard on transparency and exchange of information".26
- However, the BIR still cannot access bank accounts for its own needs to combat tax evasion and avoidance.
- The existing rule creates a contradiction: bank secrecy is lifted only for foreign governments' needs; this rule should be changed.

### Use of the DTA network
- The BIR should utilize the Philippines' extensive DTA network27 to tackle tax evasion or avoidance using overseas banks by Philippine taxpayers.
- All of the Philippines' tax treaty partners are members of the Global Forum on Transparency and Exchange of Information (Global Forum), which committed to comply with internationally-agreed tax standards.
- Under those standards, the BIR can obtain information including bank accounts as far as the BIR can specify a taxpayer.28

### AMLC reporting and BIR access
- Banks report to the Anti-Money Laundering Council (AMLC) under the Anti-Money Laundering Law (AMLL).
- The AMLL requires banks to report a transaction if the total amount exceeds PHP500,000 in one banking day as well as a suspicious transaction.
- Currently, the BIR is not allowed to access information held by the AMLC.
- Given the rapid growth of cross-border transactions, access to the AMLC's information would assist the BIR effort in mobilizing revenue.

### Recommendations (related to information access)
- Allow the BIR access to bank accounts for its own needs (Short Term).
- Allow the BIR access to data held by the AMLC (Short Term).

---

### IV. EXCISE TAXES

### A. Overview — Current situation
- Philippines' excise tax revenues significantly declined as a share of GDP, as well as compared to average levels in the region, due to low rates.
- The share of excises declined from 2.6 percent of GDP in 1997 to 0.8 percent of GDP in 2010.
- The decline in excise tax revenues also adversely affected the VAT because the VAT rate applies to duty- and excise-inclusive prices.
- Reasons for the decline in excise taxes:
  - Lack of indexation of the specific taxes on tobacco and alcoholic products.
  - Use of old prices in classifying such products.
  - Reduction in excise on petroleum products.
- Many excise rates need to be increased in order to increase the overall tax to GDP ratio.

### A. Reversing the decline in excise revenues
- Excises should be increased within a timeframe of three years in order to bring the share of excise taxes in GDP to their 1997 levels.
- The adjustment process of excise rates has to start immediately and spread over three years to limit any possibility of illegal activity and minimize adverse effects on consumers.
- The scope of excises can be extended to the telecommunication services as an additional revenue source.
- The mission recommends a gradual approach in implementing excise tax adjustment.

### A. Regional comparison (key points)
- Comparison shows the Philippines has one of the lowest excise tax revenues as share of GDP and of total tax revenues.
- Excise taxes as a share of GDP have been on a declining trend.
- One main reason for low tax yield is reliance on specific excise tax rates set at low levels without sufficient updates for inflation.

### B. Specific vs. Ad valorem tax rates and mixed use
- In competitive markets, choice between specific and ad valorem taxation is irrelevant; in imperfectly competitive markets it matters.
- In the Philippines, Phillip Morris accounts for 90 percent of the market, approximating a monopolist case.
- Under imperfect competition:
  - Specific taxation increases marginal costs by a fixed amount.
  - Ad valorem taxation acts as a proportional tax on costs and a proportional (lump-sum) tax on monopoly profits.
- Effects on price, quality, and revenue:
  - Specific rates reduce relative price differences between low-priced and high-priced brands.
  - Ad valorem rates increase absolute price differences.
  - Tobacco excise should be based on tobacco content rather than relative values; a specific tax mitigates negative externality and provides incentive for producers to improve quality.
  - Tobacco content for cigarettes (filtered and unfiltered) averages around one gram per stick; the rate for these two products should be the same.29
  - For cigars, tobacco content varies; a rate based on tobacco content (grams) would be more appropriate and aligned to the rate for cigarettes expressed in grams.
- Ad valorem multiplier effect:
  - Example: manufacturer facing a tax-exclusive ad valorem tax of 40 percent30
    - Case #1 Initial situation: Ex-factory price 1.00; Ad valorem tax (40%) 0.40; Retail price 1.40; Price change NA.
    - Case #2 Cost increase = 0.20: Ex-factory price 1.20; Ad valorem tax (40%) 0.48; Retail price 1.68; Price change 0.28.
    - Case #3 Cost decrease = -0.20: Ex-factory price 0.80; Ad valorem tax (40%) 0.32; Retail price 1.12; Price change - 0.28.
  - The multiplier effect provides a strong incentive for price competition and may incentivize cutting costs, including quality and diversity.
- Specific taxes:
  - Result in less intense price competition, higher quality, diversity and prices, and a larger number of manufacturers.
  - Constitute a de facto minimum price and push entire price spectrum higher by the same amount.
  - In an oligopolistic context, specific excises are also more likely to result in shifting the tax increase (passing more than the price increase to consumers).
- Optimal tax system:
  - No single result universally favors ad valorem or specific excises; choice depends on industry structure.32
  - A mix of ad valorem and specific excises can minimize distortions and maximize revenue for a given tax burden.
  - Improvements to quality and mispricing by vendors may dictate the use of specific excise rates instead of ad valorem rates as it seems to be the case for the Philippines.

### C. Earmarking excise taxes on tobacco and alcohol
- Earmarking excise revenues is advocated by some to finance health expenditures, projects for clean energy, restore the environment, or pay for road transport system maintenance.
- Bird and Jun (2007) classify eight types of earmarking by degree of specificity and strength of linkage between revenues and expenditures.
- Earmarking generates budget inefficiencies because it prevents allocation of budget expenditures to their best use.
- Tobacco or alcohol excise revenues could be used to finance health expenditure for treatment of related ailments—but this is problematic:
  - Difficult to establish a link between medical conditions related to tobacco and alcohol and financing for their treatment; earmarking is considered "irrelevant" because marginal expenditure decision rests with budgetary authorities.
  - Tobacco tax revenues exceed external cost associated with smoking because smokers tend to die earlier and may not attract age-related expensive treatment (Cnossen and Smart, 2005).
  - For alcohol, moderate drinkers would be asked to pay for costs attributable to abusive drinkers.
- The case for earmarking remains tenuous even if the benefit rationale is strong.

### D. Tobacco excises — current status and issues
- Excise revenues from tobacco products declined from 0.6 percent of GDP in 1997 to 0.3 percent in 2010.
- The government of the Philippines is in the process of increasing the excise on tobacco products.
- Currently cigarettes are classified according to prices into four tiers.33
- Such an excise tax structure with narrowly-defined price bands and big jumps in excise rates is difficult to administer and provides opportunities for mispricing cigarettes.
- To avoid abuse and improve cigarette quality, it would be beneficial to eliminate multiple excise rates.
- The specific excise tax rate on an average pack of cigarettes is PHP8.75.34
- The total tax burden of excise and VAT on the average pack is about 44 percent and the burden of excises is 33.65 percent.
- Tax burden estimates are made on an average pack of cigarettes with 20 sticks.

*Source: IMF staff report excerpt (content unit: _cr1260 - 43.      A new law that allows the BIR to exchange information (EOI) under a double)*

### 59.      The DOF proposes to reduce the current 4 tiers of excise rates to two tiers for

### 59.      The DOF proposes to reduce the current 4 tiers of excise rates to two tiers for

### DOF proposal for tobacco excise structure and indexing
- DOF proposes to reduce the current 4 tiers of excise rates to two tiers for 2012 and 2013 and switch to a uniform rate thereafter.
- According to the DOF‘s proposal the specific rates will be periodically adjusted by an index of prices.
- Current specific tier rates (as presented):
  - 2.72 pesos per pack for hand-packed and cigarettes valued less than 5 pesos;
  - 7.56 pesos for cigarettes priced between 5 to 6.50 pesos;
  - 12.00 pesos for cigarettes priced between 6.50 to 10.00 pesos;
  - 28.30 pesos for cigarettes priced over 20 pesos.
- The average price and excise rates presented are weighted averages provided by the Philippines authorities.

### Current tax burden on an average pack (current specific PHP8.75)
- Retail Price Including All taxes (P): 26.74
- Taxes:
  - Specific Tax ts: 8.75
  - Ad valorem ta*P: 0.0% / 0.00% / 0.00
  - VAT (tvat) 12%: 10.71% / 2.79
- Total Tax {ts+[ta+(1+ta)*tvat]*P}: 11.54
- Retail Price ex-taxes P0: 14.46
- Total Tax Burden: 44.37%
- Share of Excise Tax: 33.65%

### Effect of increasing specific excise to PHP24.64 (fully phased-in)
- Table 11 (fully phased-in effect to PHP24.64 per pack):
  - Retail Price Including All taxes (P): 43.5
  - Taxes:
    - Specific Tax ts: 24.64
    - Ad valorem ta*P: 0.0% / 0.00% / 0.00
    - VAT (tvat) 12%: 10.71% / 4.66
  - Total Tax {ts+[ta+(1+ta)*tvat]*P}: 29.30
  - Retail Price ex-taxes P0: 14.20
  - Total Tax Burden: 67.36%
  - Share of Excise Tax: 56.64%
- Table showing cigarette prices by brand groups (current vs DOF proposal):
  - Current excises (selected rows):
    - High-price: Local and Imported — Average Current Retail Price (a): 35.29; Value-Added Tax (b): 3.78; Applicable Excise Tax (c): 13.00; Average Current Net Retail Price (d)=(a)-[(b)+(c)]: 18.51; Weight by Consumption: 54.2%
    - Medium price — (a): 25.56; (b): 2.74; (c): 7.14; (d): 15.68; Weight: 12.3%
    - Low-price 1/ — (a): 13.35; (b): 1.43; (c): 2.47; (d): 9.45; Weight: 33.5%
    - Weighted average of all brands — (a): 26.74; (b): 2.87; (c): 8.75; (d): 15.13; Weight: 100.0%
  - MOF's Proposal (selected rows):
    - High-price: Local and Imported — (a): 52.40; (b): 5.61; (c): 30.00; (d): 16.79; Weight: 48.5%
    - Medium price — (a): 51.17; (b): 5.48; (c): 30.00; (d): 15.68; Weight: 100.2%
    - Low-price — (a): 26.26; (b): 2.81; (c): 14.00; (d): 9.45; Weight: 96.7%
    - Weighted average of all brands — (a): 43.49; (b): 4.66; (c): 24.64; (d): 14.19; Weight: 62.6%
- Source noted: DOF and staff calculations.

### Phase-in design, risks, and revenue implications
- DOF proposal contains a three-year phasing under which:
  - Brands with net retail price (net of taxes) over PHP10 will be subject to the PHP30 per pack rate immediately.
  - Brands with a net retail price less than PHP10 will be subject to an excise of PHP14 and PHP22 in the first two years and the PHP30 like high-priced brands after the second year of transition.
- Concerns:
  - Sudden large increases may lead to brand switching and illegal trade (contrabanding and counterfeiting).
- Alternatives proposed in the text:
  - Increase the rates by PHP10 each year over three years.
  - Alternatively, keep increases low in the first two years (e.g., PHP7 in 2012, PHP8 in 2013) with a large increase in the third year reaching PHP30 by 2014.
- Revenue projection:
  - The fully phased-in increase may increase the excise yield as much as 0.8 percent of GDP.
  - DOF should aim to reach the tobacco excise-GDP ratio of 1997 by 2014.
- Note on elasticity: Annual increase in excise revenues on tobacco products according to the DOF‘s plan are estimated using average tax elasticities for tobacco products from countries similar to the Philippines. The elasticity estimate used by the DOF is on the high side compared to those cited in WHO (2010).

### Indexation recommendation post-2014
- Recommendation: adjustments to the specific rates after 2014 should be based on the CPI rather than an index of tobacco products as proposed by the DOF.
- Rationale:
  - Basing the indexation on cigarette prices would subject tax revenues to fluctuations in cigarette prices due to industry competition and producer price strategies even when inflation rises.
  - The proposal by DOF increases the share of excises from about 33 percent to 56 percent.
  - Future indexation should maintain a specific excise rate such that the share of the excise in the price remains over 50 percent and gradually increases to 70 percent as recommended by the WHO.

### Employment effects of higher tobacco excises — findings and mitigations
- Uncertainty:
  - The effect of increases in tobacco excise taxes on employment is not obvious; difficult to separate tax effects from changes in population, technology, production technologies, and international supply of tobacco leaves.
- Key points:
  - Many jobs counted as tobacco-related are indirectly dependent on tobacco (e.g., retailers selling many products); truly dependent jobs are mostly in tobacco farming (often part time and multi-crop), tobacco leaf drying and warehousing (few jobs), and tobacco product manufacturing.
  - Shifts in spending away from tobacco generate new employment in other sectors; net impact generally positive.
  - Tobacco producers may increase exports when faced with declining domestic demand; export demand elasticity is relatively large (references given: Allen and Ballingall (2011) and Dixon and Rimmer (2002) with alcoholic beverages and tobacco elasticity estimates ranging from -2 to -4).
  - In many countries, employment in tobacco-dependent sectors has been falling due to improved farming techniques and more capital-intensive manufacturing—these factors often outweigh effects of tax increases.
  - Any tobacco-dependent job losses are likely to be offset by jobs created in other sectors as spending shifts.
  - Government spending of new tax revenues will create jobs in other sectors.
- Country examples:
  - Indonesia: tobacco farming and manufacturing contributes less than one percent of total employment in 2006; tobacco manufacturing wages averaged $876 per year where per capita income is $3,015 per year (2010). Farmers cultivate diverse crops, mitigating income losses.
  - Vietnam: tobacco cultivation and manufacturing account for a very small share of total employment; government policies promoting exports and industry restructuring (closure of seven factories) may have larger employment effects than tax changes.
  - Turkey: government-sponsored "alternative crop program" proved effective in moving many tobacco farmers to other crops; study (Caner and Vasquez, 2008) showed very little effect on farm employment from complying with EU excises.
- Policy mitigation suggestions:
  - Adopt programs to ease transition from tobacco farming and manufacturing to other economic activity.
  - Fund crop diversification programs and retraining programs from a small portion of new revenue from tax increases.
- Philippines-specific note:
  - Philip Morris accounts for more than 96 percent of the sales of tobacco products and is the largest buyer-supplier of tobacco in the Philippines; the company can increase exports to mitigate domestic demand declines and conducts surveillance to deter smuggling.
  - Given these circumstances, it is very unlikely to expect any decrease in employment or an increase in smuggled tobacco products.

### Recommendations (explicit)
- Start the rate adjustments no later than the beginning of 2012. (Short Term)
- Consider alternative scenarios for phasing in the excise increases. (Medium Term)
- Use the Consumer Price Index (CPI) to adjust the excise rates periodically (say, quarterly) instead of an index of cigarette prices since cigarette prices may decline irrespective of movements in the general price level. (Medium Term)
- Adjust the specific rates on tobacco products to reach the excise on tobacco products to GDP ratio attained in 1997. (Medium Term)
- Complete the adjustment in three years. (Medium Term)

### DOF proposals and recommendations on other excises (summary)
- Alcoholic beverages:
  - Excise revenues on alcoholic beverages declined from 0.6 percent of GDP in 1997 to 0.3 percent of GDP by 2010.
  - DOF proposal rationalizes and increases excises on fermented liquors, wines, and distilled spirits; harmonizes excise rates along alcohol content; removes differentiation between domestic and imported brands with same alcohol content.
  - New excises on wine products: PHP 300 per bottle for sparkling wine and P 50 per bottle for still wine.
  - Table 12 sample figures (selected entries):
    - Retail Price Including All taxes (P) (examples): 66.5 / 104.0 / 300.0 / 87.9.8
    - Specific Tax ts (examples): 25.0 / 25.0 / 150.0 / 150.0
    - VAT (tvat) 12.0%: equivalent rates and amounts vary (examples given: 10.7% / 7.11 / 11.13 / 2.19 / 4.3)
    - Total Tax Burden (examples): 85.9% / 58.8% / 110.7% / 44.8%
    - Share of Excise Tax (examples): 37.6% / 24.0% / 50.0% / 17.0%
  - Recommendations for alcohol:
    - Increase excises on all alcohol as proposed by DOF. (Short Term)
    - New excise taxes on alcoholic beverages should be set according to alcohol content, domestic or imported. (Short Term)
    - Use the CPI to adjust excise rates periodically (say, quarterly) instead of a price index of alcoholic beverages. (Medium Term)
- Petroleum:
  - In 1997, excises on petroleum products raised PHP30.8 billion, 1.2 percent of GDP. In 2010, they raised PHP9.7 billion, 0.1 percent of GDP.
  - Excises on gasoline were PHP17 billion and excise on diesel was PHP 9 billion. Currently, diesel is exempt from excises and gasoline is subject to an excise of 4.35 PHP/liter (reduced from 4.80 PHP in 2005).
  - Reinstate diesel excise at old rate PHP1.63 would increase excise revenue to GDP ratio by almost 0.1 percentage point.
  - Further increase to PHP3.5/liter on diesel and PHP5/liter on gasoline would increase excise revenues on petroleum products by 0.42 percent of GDP (see Table 2 referenced).
  - Recommendation reiterated: increase excise on gasoline to PHP 5/liter and excise on diesel to PHP 3.5/liter (as recommended by the 2010 mission).
  - Recommendations for petroleum:
    - The specific rate on gasoline should be increased from its current levels after phasing in excises on tobacco and alcoholic beverages. (Medium Term)
    - Start adjusting the excise on gasoline using CPI immediately. (Short Term)
    - Reinstate the specific excise tax rate on diesel after phasing in excises on tobacco and alcohol beverages. (Medium Term)
    - Adjust the excise on diesel using CPI after its introduction. (Medium Term)
- Telecommunications:
  - Current situation: no additional taxes on mobile telecommunications services other than VAT.
  - Given volume and increase in usage, mobile communications could be a significant source of revenue with no or very little distortionary effects.
  - Authorities should explore taxing mobile phone communications at a very low rate per call to increase tax-to-GDP ratio and reduce the need to raise excises on petroleum, tobacco, and alcoholic products.

*Source: IMF staff summary of DOF proposals and analysis as provided in the content unit.*

### 78.      Three issues have to be considered in the taxation of mobile telecommunications

### Three issues have to be considered in the taxation of mobile telecommunications services

### Taxation of mobile telecommunications — key considerations and findings
- Three issues to consider when taxing mobile telecommunications services:
  - abnormal profits to the operators because of limited spectrum;
  - positive externalities benefiting existing users as the networks expand;
  - complex pricing schemes by the operating companies that make the tax base difficult to define.
- Usual arguments for excise taxation are difficult to justify in this sector, but specific charges on mobile services are used in some countries on the grounds that revenues can be used to further expand networks and thus increase welfare (example cited: UK).
- The excise on telecommunications can be considered a proxy for taxing economic rent obtained by a few operators; further study is required to determine to what extent auctioning of licenses in the Philippines captures this rent.
- Widespread use of mobile phones in the informal economy (as business inputs and for personal reasons) makes excise collection through a few telecom operators appealing for tax authorities — it may be the only practical way to tax undocumented economic activity where tax evasion is pervasive.
- Taxes may be applied on the handset, on the service, or both. Examples in the Asia Pacific Region where specific charges exist in addition to VAT: Bangladesh, Cambodia, Sri Lanka, Pakistan.
- Thailand repealed excise on mobile communications arguing it is no longer a luxury item.
- Turkey example of multiple telecom-specific excises and charges (numbers preserved exactly):
  - Value Added Tax: 18 percent
  - Special Communication Tax: 25 percent (on each mobile phone call)
  - Treasury Share Premium: 15 percent (on each mobile phone call)
  - Special Communications Tax on subscription initiation: US$18
  - Wireless License Fee: US$7.5
  - Wireless Usage Fee: US$7.5 per annum
  - Proposed additional Environmental Contribution Fund tax: US$9 (considered)
  - Collection from special charges on mobile services amount to 0.7 percent of GDP.

### Policy and revenue considerations for taxing services
- Preferred method: taxing the service (argued to have the lowest price elasticity).
- A study reviewing options and the revenue and economic effects of an excise on SMS and other mobile phone services is recommended to determine fiscal benefits from a fast-growing industry.
- Applying a very low rate broadly can mitigate potentially regressive effects.
- SMS scale and potential revenue in the Philippines (numbers preserved exactly):
  - Total number of SMS in the Philippines in a year estimated at 600 billion in 2010 (83million (cellular phone subscribers) X 600 (average SMS per month per subscriber) X12).
  - Revenue from an excise of 10 centavos per text can be as high as PHP60 billion.
- Recommendation:
  - Initiate a study on the revenue and economic effects of an excise on SMS and other mobile phone services. (Long Term)

### Personal Income Tax — Rate schedule (current situation and issues)
- Current situation:
  - The PIT rate schedule unchanged since 1997; personal allowance increased to PHP50,000 in 2008.
  - Number of taxpayers and withheld tax by bracket (Table 13, preserved exactly):
    - 0–10,000 (5 percent): 916,405 taxpayers; Withheld tax: 2,005 (in PHP million)
    - 10,000–30,000 (10 percent): 266,716 taxpayers; Withheld tax: 66 (in PHP million)
    - 30,000–70,000 (15 percent): 419,952 taxpayers; Withheld tax: 226 (in PHP million)
    - 70,000–140,000 (20 percent): 597,296 taxpayers; Withheld tax: 1,507 (in PHP million)
    - 140,000–250,000 (25 percent): 730,046 taxpayers; Withheld tax: 7,548 (in PHP million)
    - 250,000–500,000 (30 percent): 519,113 taxpayers; Withheld tax: 17,790 (in PHP million)
    - 500,000 or more (32 percent): 203,410 taxpayers; Withheld tax: 48,814 (in PHP million)
    - Total: 3,652,938 taxpayers; Withheld tax: 77,954 (in PHP million)
  - Source: BIR. Complete data available for those with only wage income in 2010. The total number of registered compensation income earners is 9,509,212, and withheld tax from wages in 2010 is PHP 135,153 million.
- Issues:
  - Under current law, the income entry level at which the maximum PIT rate applies for single individuals is 511 percent of per capita GDP in 2010 — lower than other emerging economies in the region except Malaysia (Table 14).
  - It is desirable to index the rate schedule to inflation accumulated since 1997 to retain progressivity in the medium term once data to simulate revenue impacts become available.
  - Inflation-adjusted rate schedule example (Table 15; accumulated inflation from 1997 to 2011 is 212 percent; to estimate taxpayers by bracket, schedule adjusted by 200 percent and upper limit of the bracket to which a 20 percent rate applies changed from PHP280,000 to PHP300,000):
    - 0-20,000 (5 percent): Taxpayers: 1,055,599 (current schedule taxpayers: 916,405)
    - 20,000-60,000 (10 percent): Taxpayers: 464,431 (current: 266,716)
    - 60,000-140,000 (15 percent): Taxpayers: 680,339 (current: 419,952)
    - 140,000-300,000 (20 percent): Taxpayers: 919,055 (current: 597,296)
    - 300,000-500,000 (25 percent): Taxpayers: 330,104 (current: 730,046)
    - 500,000-1,000,000 (30 percent): Taxpayers: 147,174 (current: 519,113)
    - 1,000,000 or more (32 percent): Taxpayers: 56,236 (current: 203,410)
    - Total: 3,652,938 taxpayers.
  - Indexation would reduce the number of taxpayers subject to the top two rates from 722,523 to 203,410 (stated in text).
  - Desirable to reduce number of brackets for simplicity.
  - Short-term mitigation: broaden the lowest tax rate band to the income bracket currently subject to 10 percent to partly offset projected increase in tax burden on low-income taxpayers from broadening VAT base and indexing excises. Decline in PIT revenue from this change would be minimal.
- Proposed tax brackets (Table 16, preserved exactly):
  - Current Brackets / Proposed Brackets:
    - 0–10,000 (5 percent) -> 0–30,000 (5 percent)
    - 10,000–30,000 (10 percent) -> (no separate 10 percent bracket in proposal)
    - 30,000–70,000 (15 percent) -> 30,000–70,000 (15 percent)
    - 70,000–140,000 (20 percent) -> 70,000–140,000 (20 percent)
    - 140,000–250,000 (25 percent) -> 140,000–250,000 (25 percent)
    - 250,000–500,000 (30 percent) -> 250,000–500,000 (30 percent)
    - 500,000 or more (32 percent) -> 500,000 or more (32 percent)
- Recommendations:
  - Overhaul the tax rate schedule to reflect inflation since 1997 once data that enable an estimate of the revenue impact become available. (Long Term)
  - Abolish the 10 percent tax rate and broaden the lowest tax rate band to the income bracket to which the 10 percent rate is currently applicable. (Short Term)

### Taxation of self-employed — findings and recommendations
- Current situation and data (Table 17, preserved exactly):
  - Self-employed (2006–2010 snapshot):
    - Number of taxpayers (2010): 1,695,347
    - PIT paid by a (in mil.PHP) (2010): 7,392
    - b/a (in PHP) (2010): 4,360 (average tax paid by self-employed)
  - Wage earners (2010 snapshot):
    - Number of taxpayers (2010): 9,509,212
    - PIT paid by a (in mil.PHP) (2010): 135,153
    - b/a (in PHP) (2010): 14,213 (average tax paid by wage earners)
  - The average amount of tax paid by the self-employed and professionals in 2010 is PHP4,360, which is 30.7 percent of the average tax paid by wage earners.
  - Implication: income earned by the self-employed and professionals are on average below the minimum wage.
- Issues:
  - Making payments to the self-employed subject to withholding tax or an information return could improve compliance.
  - Section 57 of the NIRC requires a payer to withhold creditable tax on payments to the self-employed at 15 percent or 10 percent. Dual withholding rates based on the current year‘s income of a recipient need review to reduce compliance costs of withholding agents.
  - When a payer is an individual, the withholding tax only applies to payments made in connection with the payer‘s trade or business, leaving only partial information available to the BIR.
  - Reporting by the self-employed mainly depends on voluntary compliance.
  - Optional Standard Deduction (OSD) concerns:
    - OSD allows a 40 percent deduction based on gross sales or gross receipts, with no limitations on gross sales and gross receipts.
    - VAT taxpayers (sales threshold currently PHP1.5 million) must calculate input credits based on invoices; compliance costs for VAT taxpayers may not change if they opt for OSD.
    - Allowing VAT taxpayers to opt for OSD is difficult to rationalize; OSD may contribute to low PIT contribution by the self-employed (data not available to verify).
    - House Bill No. 3992 proposes reducing the standard deduction to 20 percent or less and limiting allowable deductions to expenses easily verifiable and directly expended on production/provision of services.
  - World Bank recommendation to align top PIT rate with CIT rate noted; alignment may reduce arbitrage but practical considerations include:
    - majority of individuals subject to top PIT rate have wage income (reducing immediate arbitrage risk if CIT falls);
    - costs of incorporation are significant (SEC requires all corporations to submit financial statements annually);
    - given income inequity in the Philippines, reducing top PIT rate to 25 percent (as World Bank recommended) would compromise progressivity and should be considered carefully as part of comprehensive reform.
- Recommendations:
  - Limit the OSD to the self-employed whose sales are less than the VAT threshold. (Short Term)
  - Alternatively, reduce the percentage of the OSD to 20 percent or less without the ceiling of sales. (Short Term)
  - Limit the allowable deductions to those expenses which are easily verifiable and are directly expended on the production of goods or in the provision of service in the NIRC. (Short Term)

### Remittance of citizen workers abroad — findings and recommendation
- Current situation:
  - Remittances by Philippine citizens abroad amount to US$21billion in 2010 and comprise more than 10 percent of GDP.
  - Overseas Contract Workers (OCWs) and Overseas Filipino Workers (OFWs) are not taxed in the Philippines on income derived from their overseas employment (Section 23 (c) of the NIRC).
- Issues:
  - Exemption can be justified because income is already taxed in source jurisdiction and because of hardship of being away from families, but current rule sets no limit on exempt remittances, potentially enabling wealthy individuals to return untaxed income in the guise of OCW/OFW remittances.
  - Average amount of remittance per worker in 2010 is about US$2,600 per year.
  - Proposal: set a ceiling high enough not to affect legitimate remittances, for example the equivalent of US$25,000 per year; taxes paid abroad can be credited against Philippine tax.
  - Use of cross-border remittance data held in AMLC (noted in Chapter III) could help prevent abuse without affecting legitimate remittances.
- Recommendation:
  - Set a ceiling, say, the equivalent of US$D25,000, on tax free remittances by Philippine citizens working abroad. (Long Term)

### Mining taxation regime — overview and issues
- Current situation and contribution:
  - Mining industry’s contribution to GDP: 1.4 percent of GDP in 2010.
  - Share of mining in exports and investment remains low despite incentives (Table 18).
  - Contribution of mining to government revenues is even lower than its contribution to GDP (Table 19).
  - Low revenues may be due to many firms engaged in exploration and few in production.
- Fiscal regime characteristics:
  - Fiscal regime consists of a royalty, an excise tax on the same base as the royalty, and multiple taxes and fees at national and local levels (Table 20 referenced).
  - Current regime characterized as levying a high royalty rate (5 percent royalty rate plus 2 percent excise) and additional taxes and fees that are not conducive to mining sector development as a source of growth.
  - Mining companies also required to contribute to three funds for contingent liabilities for mine rehabilitation.
  - Despite seemingly high royalty and excise rates, the regime does not adequately capture high rents as evidenced by low revenue yield.
  - Multitude of taxes and fees may be contributing to poor mining development; streamlining rates and fees at national and local levels into one or two payments could be expected to increase mining development.
- Reliefs and allowances:
  - Current regime provides relief for capital goods and imported inputs; exploration costs are recoverable up to five years.
  - Imports of capital goods and inputs are exempt from customs duty.
  - Tax credit certificates (TCC) are issued for VAT payments on imported goods.
  - A deduction from taxable income is provided for community expenses. 

*Source: _cr1260 - 78.      Three issues have to be considered in the taxation of mobile telecommunications*

### 94.      A set of incentives are provided in order to attract investment into mining (Table

### _cr1260 - 94.      A set of incentives are provided in order to attract investment into mining (Table

### Mining investment incentives and guarantees
- Incentives listed in the mining act:
  - Accelerated depreciation.
  - Property tax exemption of pollution control devices.
  - Up to five year of loss carry forwards.
  - Detailed classification of depreciable assets for exploration consolidated into three broad classes: structures, machinery and equipment and vehicles.
- Investment guarantees allowed by the mining regime:
  - Repatriation of investment.
  - The right to repatriate earnings from investment in the currency of the investment.
  - Exchange rate guarantee for the remittance of foreign loan obligations.53
  - Freedom from expropriation.
  - Requisition of investment.
- Observations on incentives:
  - The loss carry forward period should be considered short for cost recovery.
  - Depreciation expense is not included in the deductible expenses used in the calculation of NMR.54

### Current approach to capture resource rents
- Fiscal regime summary:
  - The fiscal regime does not include the basic features of a progressive system to capture rents.
  - Resource rent is captured as an "additional government share."
- Calculation steps described:
  - "Basic government share" = sum of all taxes and royalties paid to the national and local governments.
  - Net mineral revenue (NMR) = gross sales less all operational expenses, interest expenses, development expenses and the royalty to the land owners.54
  - "Additional government share" = difference between 50 percent of the NMR less basic government share. If positive, this difference is paid to the government.
  - At any time the government's total revenue share is 50 percent of the NMR.
- Note:
  - The bearer of the exchange rate risk is not specified in the mining act; however, the government is expected to compensate the companies in case of a large currency depreciation.53

### Current structure of the mining fiscal regime (selected rates and fees)
- National:
  - CIT — BIR — 30%
  - Excises — BIR — 2%
  - Royalty — MGB — 5%
  - Additional Government Share — MGB (Basic Government share - 0.5*(NMR))1/
  - Fees — MGB — 6
  - Customs — BOC
  - VAT — BIR — 12%
  - Waste and Tailings Fee — MGB — Semi annual payment
- Withholding Taxes:
  - Payroll — BIR — 2%
  - Interest Income — BIR — 20%
  - Interest Payments to Foreign Loans — BIR — 15%
  - Royalties on Technology Transfer — BIR — 40% of Royalties
  - Dividend Payments — BIR — 15%
  - Profit Remittence to Principal — BIR — 15%
  - Royalties to Landowners/Claims of Owners — BIR — 20%
- Local Governments:
  - Business Tax — LGU — Maximum 2% of sales
  - Real Property Tax — LGU — (Max. 3%)* (Assessment Ratio*FMV) /2
  - Registration Fee — LGU — Set by LGUs /3
  - Occupation Fee — LGU — (P75 or 100)/hectar, P5 for exploration (30% province 70% municipality)
- Additional characteristics (from Table 21):
  - Pollution control devices — Exemption from real property tax
  - Income tax carry forward losses — 5 years within first 10 years
  - Income tax accelerated depreciation — Up to 2*normal depreciation if life >10 years, normal if less than10 years
  - Investment guarantees — 6 guarantees on repatriation and remittences
  - Recovery Period — Maximum 5 years
  - Mine rehabilitation fund — Deposited in a trust fund in a government bank (10% of needed funds or 5 million pesos)
  - Waste and Tailings Fund
  - Final Mine Rehabilitation and Decomissioning Fund (FMRDF) — Annual Amount = Cost of FMRDP * % Required by rules and regulations on FMRDF.
- Sources and notations:
  - 1/NMR = Net Mining Revenue
  - 2/ FMV = Fair Market Value
  - 3/ LGU = Local Government Unit

### Necessary reforms — issues for consideration
- Tax code and structure:
  - Introduce a separate section on mining taxation in the Corporate Tax Chapter of the NIRC to clarify treatment of components of income and deductions for mining companies (e.g., dividend withholding taxes, loss carry forwards, deductible expenses and depreciation allowance). (Paragraph 96)
- Management fees and transfer pricing:
  - Enforce transfer price rules applicable to all taxpayers for mining companies.
  - Consider disallowing management fees in excess of 2 percent of revenue as a business expense (or include a special rule in a separate mining section in Chapter IV of the NIRC). (Paragraph 97)
- Ring-fencing:
  - Establish ring-fencing to limit consolidation of income and deductions across different activities or projects; tax accounts for the CIT and any surcharge should be ring-fenced by mining license.55
  - Exceptions: failed explorations and mines that require joint operations may be exempted from ring-fencing. (Paragraph 98)
  - Currently there are no ring-fencing provisions.55

### Principles of natural resource taxation and design features
- Key design characteristics a mining fiscal regime should have:
  - Maximize the net present value of tax revenue, subject to providing adequate incentives for exploration and development.
  - A system based on profitability capturing more revenues during periods of high profits.
  - Providing predictable and stable tax revenues.
  - Protect against tax avoidance.
  - Encourage exploration and expansion of the tax base.
  - Low administrative fees and transaction charges. (Paragraph 99)
- Choice of instruments:
  - Neither a flat-rate royalty nor a profit tax (such as the CIT) will tax rents effectively; an additional instrument is needed. (Paragraph 100)
  - If the goal is to capture a share of supernormal profits, the tax base should be a measure of profits and not sales or turnover. A profit-based instrument is preferred. (Paragraph 101)
  - A variable royalty rate depending on the ratio of EBIT to sales value would be preferred; migration towards a tax surcharge on cash flow method (or profit-based) is recommended. (Paragraph 101)

### International practice and alternative instruments for capturing resource rents
- Common instruments described:
  - Excess profit tax based on payback ratio or "R-Factor" (rate depends on R-Factor; does not take explicit account of time value of money). (Paragraph 103)
  - Variable income tax (lower rate in years of poor profitability, higher in years of high profitability). (Paragraph 103)
  - Tax surcharge on cash flow (base determined by adding back depreciation and interest to taxable income before loss carryover, deducting any capital expenditure in full). (Paragraph 103)
- Royalty options and features:
  - Three commonly used royalty options:
    1. Flat rate ad valorem or specific royalty on sales at a uniform rate for all metals and high value industrial minerals.
    2. Specific royalty for quarrying and construction material.
    3. Variable royalty mechanism (e.g., South Africa) accommodating divergent cost structures with a low minimum rate. (Paragraph 105)
  - Royalties raise marginal cost of extraction and front-load revenue; rates vary widely. (Paragraph 106)
  - Royalties can be specific (weight/volume) or ad valorem (value). A single ad valorem flat rate for high-value minerals is often preferable; specific royalties suit low-value bulk commodities and should be adjusted annually with CPI. (Paragraph 107)
  - Example: South Africa imposes a variable royalty with graduated rates depending on ratio of EBIT to sales value; minimum rate 0.5 percent and maximum rate 5 percent for refined minerals and 7 percent for unrefined minerals. The SA formula applies to gross sales value (excluding costs to transport final product); SA law includes transfer pricing rules and a general anti-avoidance provision. The EBIT mechanism allows deduction of capital costs but disallows all financing costs.56 (Paragraph 108)

### Administrative requirements
- Key administrative needs:
  - Capacity to monitor production volumes, sales and fair market values closely.
  - Legislative amendments for royalties need accurate provisions for determination of actual sales value; transfer price rules required if related party sales occur.
  - If a single royalty rate is used, determining mineral content in sold products (e.g., concentrate) is not required. (Paragraph 109)

### Recommendations (timing indicated where provided)
- Request an FAD mission to assess and compare the current mining fiscal regime with alternative regimes using project data. (Short Term)
- Consider introducing mining tax provisions in a separate section in the NIRC Chapter on tax on corporations. (Medium Term)
- Increase the number of years over which losses can be carried over for mine operators (in Chapter on tax on corporations). (Medium Term)
- Use three depreciation categories for exploration, tangible assets, and other development costs. (Medium Term)
- Establish a ring-fence for tax purposes around each mining license. (Medium Term)
- Change restrictions on foreign ownership. (Medium Term)

*Source: IMF staff report content in the supplied PDF excerpt.*

### 114.     The Philippines has the highest income inequity in Southeast Asia. While the tax

### _cr1260 - 114. The Philippines has the highest income inequity in Southeast Asia. While the tax

### Income inequity and tax provisions
- The Philippines has the highest income inequity in Southeast Asia.
- Tax provisions that unduly benefit the wealthy should be changed (examples given):
  - exemption or reduced tax rate on capital gains from sales of shares
  - exemption or reduced tax rate on interest on bank deposits with long maturity
- Inertia in correcting inequity in the tax system and tax administration would undermine the integrity of the whole tax system.

### Improving the effectiveness of the tax system
- Given current tax administration and taxpayers’ morale, voluntary compliance alone is unlikely to work effectively.
- Desirable measures to verify taxpayers’ compliance with a minimum incremental increase in burden on taxpayers and third parties (example):
  - a withholding tax on payments to self-employed.
- At least, tax provisions that are prone to abuse should be changed.
- Effectiveness is key for using the tax system to achieve policy objectives.

### Political timelines for reform
- Strong political will is indispensable for tax reform; a road map should be based on political timelines.
- Suggested windows:
  - From now to the first half of next year: a window of opportunity for tax reform.
  - For issues requiring prudent consideration or comprehensive treatment (examples: excise on mobile communications; restructuring a PIT rate schedule), avoid rough-and-ready approaches; the latter half of 2016 (first six months of the next President) is proposed as an appropriate time slot.

### Road Map for Feasible Tax Reform Plans (high-level elements)
- Table includes phased measures across 2011–2017 for multiple tax areas. Selected items (preserve phrasing and timing as in source):
  - Tax Incentives: options to abolish all tax incentives or raise tax on GIE to 7.5 percent; 5 percent tax on GIE (need to grandfather for 5 years) noted.
  - Income Tax Holidays: (no extension) indicated.
  - Lower CIT rate (phase in).
  - Increase loss carry over to 5 years.
  - Other CIT issues: Transfer pricing; Thin capitalization; Apply CIT rate to capital gains; Tax cooperatives.
  - Excises: Tobacco — Adjust and unify tax rates; Indexation. Alcohol — Adjust and unify tax rates; Indexation. Petroleum — Normalize tax rates at PHP5 per liter; Tax diesel. Mobile communications — flagged for later consideration.
  - VAT: Repeal exemption post-2006; Establish a proper refund system; Increase threshold to PHP 3mil.; Eliminate zero-rating for foreign currency denominated transactions; Limit zero-rating to exports only; Full deductibility of capital inputs; Increase tax rate.
  - PIT: Index rate schedule to inflation post 1997; Limit OSD to those under VAT threshold; Ceiling on tax free remittance by overseas workers.
  - Financial sector taxation: Unified 20 percent W/H tax on interest; Unified 5 percent GRT; Apply the standard CIT rate to FCDU interest income from residents.
- Note: "*Shaded parts are new recommendations. ** No specific timeline was proposed for mining measures."

### Appendix 1 — Main Recommendations of the 2010 FAD Mission (short term)
- Corporate income tax — reform plan for tax incentives to be announced before end of 2010 for medium-term implementation. Two options proposed (preference for Option 1):
  - Option 1 — Low rate/broad base:
    - Remove all tax holidays and the 5 percent gross income tax — grandfather existing investors for time-bound incentives; phase out non-time-bound incentives within a reasonable time frame.
    - Reduce the CIT rate to between 20–25 percent; consider phasing to avoid sharp revenue decline.
    - Increase the loss carry forward period to 5 years.
    - If incentives granted for investment, provide accelerated depreciation or investment tax credits specified as proportionate rates on investment in targeted activities/locations.
    - In special economic zones: do not provide income tax incentives; restrict incentives to exemptions for import duties and zero-rating VAT on exports; remove current VAT zero-rating for suppliers to zones; limit zones to designated, closely monitored areas.
  - Option 2 — Rationalize existing incentives:
    - Ensure incentives available to all eligible taxpayers.
    - Limit tax holidays to a few specific investments/sectors, duration no more than 5 years (no extensions).
    - Remove the 5 percent gross income tax; apply standard CIT when tax holidays expire.
    - Grandfather time-bound incentives; phase out non-time-bound incentives.
    - Restrict tax incentives in special economic zones to import duty exemptions (no income tax exemptions); remove VAT zero-rating for suppliers to zones; limit zones to closely monitored areas.
    - Authorize only one agency to grant tax incentives; ongoing monitoring by BIR and BOC.
    - Ensure DOF strong role in granting incentives; estimate revenue costs of any new incentives.
    - Legislate incentive laws to be maintained in one law, preferably the National Internal Revenue Code (NIRC).
    - Impose a sunset clause for all incentive laws, of no more than 5 years.
  - Require DOF to keep records of estimated and actual cost of all concessions and publish them as a tax expenditure statement.

- VAT (short term):
  - Announce in next budget that exemptions targeting individuals (examples: senior citizens exemption and boy scouts exemption) will be reviewed in three years to determine objective achievement and cost.

- Excise taxes (short term):
  - Clarify application of excise taxes on imported goods by specifying customs duty is included in base of ad-valorem excises.
  - Tobacco:
    - Eliminate price categorization of cigarettes; set specific rates (per unit or pack) to reach a revenue target, starting at lower end of most popular cigarettes and gradually increasing to meet target.
    - Tax cigars, chewing and other bulk tobacco at different rates based on units (cigars) and kilograms (other tobacco products).
    - Provide for full and automatic indexation of specific tax rates in law without requiring Congress approval.
  - Alcohol:
    - Eliminate price categorization; impose a three-rate specific structure based on alcohol content (examples: beer and the like; wine and the like, including sparkling wine; other alcohol products).
    - Provide for full and automatic indexation of specific tax rates in law without requiring Congress approval.
  - Petroleum products:
    - Normalize tax rates at 5 pesos per liter for all gasoline and oil currently taxed.
    - Tax kerosene, diesel, gas and LPG, and fuel oil at 3.5 pesos per liter.
  - Automobiles:
    - Set lower tax rate at 5 percent instead of 2 percent.
    - Consider imposing three higher rates on full value rather than excess relative to previous price bracket, and adjust rates downward to 15, 25, and 50 percent (on same price structure).
  - Taxation of financial sector — Withholding tax on interest:
    - Align lower interest withholding tax rates on FCDUs and those dependent on period to maturity with standard interest withholding tax rate, phased over a number of years.
  - Personal income tax:
    - Repeal the minimum wage earner exemption.

### Appendix 1 — Main Recommendations (medium term)
- VAT (medium term):
  - Eliminate exemptions for cooperatives (at minimum limit to agricultural cooperatives).
  - Eliminate exemptions for inputs into production of exempt final consumption goods (examples: fertilizers and animal feed).
  - Eliminate exemption for social housing.
  - Terminate practice of providing VAT exemptions or other special treatment in other laws; tax code should be the only law containing tax provisions.
  - Review adequacy of current threshold given VAT population and BIR capacity; consider increasing threshold to between PHP3 and PHP5 million.
  - Eliminate provisions for zero-rating of transactions paid for in foreign currency (other than direct exports).
  - Limit zero-rating to exports only; eliminate zero-rating for supplies to export-oriented enterprises and free-zone enterprises.
  - Consider re-establishing full deductibility of VAT on capital inputs after careful consideration of impact on cost of capital and VAT revenues.
  - Terminate practice of allowing trade in TCCs (first step toward abolition of TCCs).
  - Establish a proper VAT refund mechanism by estimating current outstanding excess VAT credits and developing a plan to pay such credits. Consider administrative safeguards (limit credit to large amounts and to taxpayers known by tax administration with tax standing in order for at least three years).

- Taxation of the financial sector (medium term):
  - Gross Receipts Tax (GRT) and Documentary Stamp Tax (DST):
    - Replace different GRT rates applying to bank income with a single rate, for example 5 percent.
    - Rationalize DST rates on insurance products to 2 rates (distinguish life insurance and similar products vs property insurance and similar products).
    - Remove DST on recurrent transactions such as bank checks, bonds, drafts and certificates of deposits.
    - Remove DST on original share issues.
  - Taxation of FCDUs:
    - Apply the standard CIT rate to FCDU interest income from residents (replacing current 10 percent rate) and consider increasing CIT rate on FCDU foreign source income.

- Personal income tax (medium term):
  - Overhaul tax rate schedule to reflect inflation since 1997; start with lowest and highest brackets.
  - Consider lowering ceiling for entertainment expenses and broadening scope of withholding taxes on payments to self-employed.
  - Move to either the TEE or EET model of pension taxation.

### Revenue impact (mission estimates)
- Rationalization of fiscal incentives has potential to raise around 1 percent of GDP.
  - The mission’s recommended approach: eliminate fiscal incentives accompanied by a reduction in the CIT rate.
  - Under this approach, a reduction to around 21 percent would be revenue neutral, while a smaller reduction, to say 25 percent, would be revenue positive.
- Excise tax reform would raise revenue of 0.8 percent of GDP.
- Reform of the VAT and PIT would be revenue neutral. If a revenue increase is needed, a VAT rate increase could be considered.
- These revenue estimates are indicative; authorities are strongly suggested to undertake more analytical work requiring DOF, BIR, and BOC to ensure availability of better statistical information for tax policy development.

### Appendix 2 — Regional comparison of investment tax incentives (selected highlights)
- Table compares CIT Rate and variety of tax holidays, other income tax incentives, and other tax incentives across countries including the Philippines, Cambodia, China, Malaysia, Indonesia, Lao PDR, Singapore, Thailand, Vietnam, and others.
- Philippines specifics excerpted from table:
  - CIT Rate: (table header indicates) Philippines30Sector or region, min. 50 percent of production exported, 70 percent foreign ownership.
  - Tax Holidays: 3 to 8 years after start of commercial activity; 5 percent tax on gross income earned after tax holidays indefinitely.
  - Other incentives listed: 100 percent additional deduction in infrastructure spending in Less Developed Areas; 50 percent additional deduction of incremental labor cost; tax credit for duties and taxes for inputs of export products; exemption from VAT and duties on imported supplies; 10 year exemption from wharfage fee; 10 year exemption on taxes and fees on selected imported agricultural products; VAT and duty exemption on inputs; Exempt from 1 percent turnover tax; 50 percent CIT rate reduction for 3 years; 15 percent rate for new/high technology; Accelerated depreciation; 10 year loss carry forward in economic development zones or in priority sectors (standard carry forward is 5 years); 50 percent reduction in land and building taxes; Investment tax allowance of 30 percent reduction in income tax (6 years maximum); Maximum 5 percent import duty on imports of capital goods and raw materials for 2 years; Accelerated depreciation.

### Appendix 3 — Fiscal regime for gold mining in selected gold producing countries (selected entries)
- Table compares Country, Regime, Royalty rate, Royalty base, Corporate Income Tax, Depreciation rule, VAT, Import duties, Export Tax, Loss carry forward, Additional profit tax, Dividend Withholding Tax, Interest Withholding Tax, State Participation (% of taxpayer equity) for countries including Australia, Botswana, China, Ghana, Indonesia, Liberia, Mozambique, Mongolia, Papua New Guinea, Sierra Leone, South Africa, Tanzania, Zimbabwe.
- Selected numerical items (preserve exact phrasing):
  - Australia: WA: 2.5% [gold]; WA: net revenues [gold]; CIT 29% 4/; 100% straight line over effective asset life (15-20 years for most mining development) 2/; VAT: 10% [none for exported minerals]; Dividend Withholding Tax 0%; Interest Withholding Tax 10%; no participation.
  - China: Royalty 4% [gold] plus specific royalty per tonne mined; Corporate Income Tax 25% [local taxes also apply]; Depreciation rule: 10 years straight line; Dividend Withholding Tax 10%; Interest Withholding Tax 10%; no participation.
  - Indonesia: Royalty 3% [gold]; Royalty base Gross revenue; Corporate Income Tax 25%; Depreciation rule 100% [exploration]; Dividend Withholding Tax 20%; Interest Withholding Tax 20%; no participation.
  - Mozambique: Royalty 10% [gold]; Corporate Income Tax 32%; Depreciation rule 10 years straight line; Dividend Withholding Tax 20%; Interest Withholding Tax 20%; State Participation 0% [assumed].
  - Notes include:
    - 1/ Profitability ratio is defined as taxable income/ gross income.
    - 2/ Operational ratio defined as (net revenue minus operating costs, interest, and capital allowance) / net revenue.
    - 3/ For simplicity, modeled as exempt throughout the lifetime of the project since most costs are incurred in the first years.
    - 4/ Rate effective 2013. Current CIT rate is 30%.

*Italic: IMF staff report excerpted content as provided in source.*

### Appendix 4. Oil Extraction Fiscal Terms in Selected Countries1/

### Appendix 4. Oil Extraction Fiscal Terms in Selected Countries1/

### Notes
- Source: FAD‘s Fiscal Analysis of Resource Industries (FARI) database.
- 1/ The fiscal terms in the comparator countries may vary contract by contract. The terms above are those used in the model simulations.
- 2/ In royalty and tax systems, the investor receives 100 percent of revenues remaining after royalties for recovery of costs. This is analogous to a 100 percent cost recovery limit under PSC systems.

### Country fiscal terms (as reported)
- Angola
  - Regime: PSA
  - Signature/Production Bonus: 50%50%
  - Cost recovery limit: Unlimited
  - Profit sharing (% profit oil to government): Nil
  - Corporate Income Tax: 10%10%15%
  - Loss carry forward: (not separately listed)

- Australia
  - Regime: Tax / Royalty
  - Signature/Production Bonus: 100% 2/30%
  - Cost recovery limit: Straight-line, 20/5 years (development/rep lacement costs)
  - Profit sharing (% profit oil to government): Unlimited
  - Corporate Income Tax: IRR-based, 40%
  - Loss carry forward: Nil
  - Supplementary Profit Tax: Nil
  - Dividend Withholding Tax: Nil
  - Interest Withholding Tax: Nil
  - State Equity Participation: (not listed)

- Cameroon
  - Regime: PSC
  - Signature/Production Bonus: 60%
  - Cost recovery limit: R-factor based; 20% - 60%
  - Profit sharing (% profit oil to government): 40%
  - Corporate Income Tax: Unlimited
  - Loss carry forward: Nil
  - Supplementary Profit Tax: 16.50%
  - Dividend Withholding Tax: 16.50%
  - Interest Withholding Tax: 25%
  - State Equity Participation: (not listed)

- Equatorial Guinea
  - Regime: PSC
  - Signature/Production Bonus: Sliding-scale, production–based; 13%-16% 70%
  - Cost recovery limit: Sliding-scale, production-based; 10%-60% 35%
  - Profit sharing (% profit oil to government): 5 years
  - Corporate Income Tax: Nil
  - Loss carry forward: Nil
  - Supplementary Profit Tax: Nil
  - Dividend Withholding Tax: 15%
  - Interest Withholding Tax: (not listed)
  - State Equity Participation: (not listed)

- Ghana
  - Regime: PSC
  - Signature/Production Bonus: 100%
  - Cost recovery limit: Sliding scale, IRR-based. 12-28%35%Unlimited
  - Profit sharing (% profit oil to government): Nil
  - Corporate Income Tax: Nil
  - Loss carry forward: Nil
  - Supplementary Profit Tax: 10% carried plus 10% paid
  - Dividend Withholding Tax: (not listed)
  - Interest Withholding Tax: (not listed)
  - State Equity Participation: (not listed)

- Gabon
  - Regime: PSC
  - Signature/Production Bonus: Sliding-scale, production–based; 5%-11%70%
  - Cost recovery limit: Sliding-scale, production-based; 50%-63%35%3 years
  - Profit sharing (% profit oil to government): 20%
  - Corporate Income Tax: 20%
  - Loss carry forward: 18%
  - Supplementary Profit Tax: (not clearly separated)
  - Dividend Withholding Tax: (not clearly separated)
  - Interest Withholding Tax: (not clearly separated)
  - State Equity Participation: (not listed)

- Mozambique
  - Regime: PSA
  - Signature/Production Bonus: 65%
  - Cost recovery limit: R-factor based; 10% - 50%32%
  - Profit sharing (% profit oil to government): 5 years
  - Corporate Income Tax: Nil
  - Loss carry forward: 20%
  - Supplementary Profit Tax: 20%
  - Dividend Withholding Tax: 10%
  - Interest Withholding Tax: (not listed)
  - State Equity Participation: (not listed)

- Namibia
  - Regime: Tax / Royalty
  - Signature/Production Bonus: 100% 2/35%
  - Cost recovery limit: Unlimited
  - Profit sharing (% profit oil to government): IRR-based, 15%-50%
  - Corporate Income Tax: 10%
  - Loss carry forward: Nil
  - Supplementary Profit Tax: Nil
  - Dividend Withholding Tax: Nil
  - Interest Withholding Tax: (not listed)
  - State Equity Participation: (not listed)

- Timor Leste
  - Regime: PSA
  - Signature/Production Bonus: 100%
  - Cost recovery limit: Fixed;40%30%Unlimited
  - Profit sharing (% profit oil to government): IRR-based, 22.5%
  - Corporate Income Tax: Nil
  - Loss carry forward: Nil
  - Supplementary Profit Tax: 20%
  - Dividend Withholding Tax: Nil
  - Interest Withholding Tax: 5%
  - State Equity Participation: N/A

- (Additional fragmented entries present in source; reproduced exactly where they appear)
  - Straight-line, 3 years
  - Nil 5% Straight-line, 10 years
  - Nil 10% Straight-line, 5 years
  - PB, SB Straight-line, 5 years
  - PB 10% Straight-line, 4 years
  - Nil N/A PB Nil Straight-line, 5 years
  - PB Straight-line, 5 years
  - Royalty rate Depreciation rule: Nil Nil
  - Sliding scale, IRR-based. 30%-90%
  - Straight-line, 5 years
  - Nil

*Italic: Appendix 4. Oil Extraction Fiscal Terms in Selected Countries, as provided in the source PDF.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr1260.pdf_