## _wp08207

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### I. INTRODUCTION
- After the successful VAT reform, reforming tax incentives is the next major tax policy item on the legislative agenda in the Philippines.
- Between 2002-05, substantial deficit reduction was achieved as a result of expenditure compression; this changed in 2006 as a result of the successful VAT reform, which netted almost 1½ percent of GDP in additional revenue.
- Authorities recognize the need to increase revenue in the medium term through tax administration reform and reforming tax incentives; they aim to reduce redundancy (the provision of tax incentives for activities that would have been undertaken anyway), which is estimated to cost about 1 percent of GDP in foregone revenue.
- Key analytical questions:
  - What are the characteristics of business taxation in the Philippines relative to neighboring countries? Focus: overall corporate income tax rate, tax incentives, and other provisions affecting incentives to invest such as depreciation methods and allowances, project profitability, and financing (debt vs equity).
  - What are the effects of tax holidays on incentives to invest? Review of theoretical and empirical literature suggests limited effectiveness of tax holidays, especially for long-term investment; stresses broader view of tax system including general CIT rate and depreciation allowances.
  - How do effective tax rates in the Philippines compare to those in neighboring countries? Methodology: extend Devereux and Griffith (2003) to accommodate evaluation of tax incentives and calculate the marginal effective tax rate (METR) and average effective tax rate (AETR) to assess impact of tax system including income tax holidays.
  - What is the likely effect of abolishing the income tax holiday on investment incentives? Analyze effect on effective tax rates of recent reform proposals (including Department of Finance-sponsored legislation to replace tax holidays with a reduced corporate income tax rate for select exporting companies or a 5 percent tax on gross receipts) and contrast with offering accelerated depreciation.

### II. A BIRDS-EYE VIEW OF THE TAXATION REGIME
- Corporate income tax (CIT):
  - Standard CIT rate increased to 35 percent in November 2005 as part of the EVAT reform.
  - Plans to reduce the rate to 30 percent by 2009; the reduced rate would be identical to rates in Indonesia and Thailand.
  - For domestic corporations, the tax base is net world-wide income; for resident foreign corporations, the tax base is net Philippine-source income.
- Depreciation allowances:
  - The Philippines does not prescribe the method or allowable rate; it allows straight-line, double-declining balance, or sum-of-the-years-digits methods, with rates based “on economic or useful lives of the asset or the ones used for financial reporting”.
- Personal income taxation:
  - The maximum rate of personal income taxation is comparable to other economies, but taxation of dividends, interest, and capital gains varies widely.
- Cross-country features (coverage, duration, loss carry-forward, post-holiday treatment, indirect incentives):
  - Duration of tax holiday period: Except for Cambodia and Vietnam, a project’s commencement period triggers start of holiday. Durations typically range between 3 and 8 years.
  - Loss-carry-forward provisions: range from 3 years in the Philippines and Lao to 5 years in other countries except Indonesia (10 years) and Malaysia (unlimited).
  - Reduced CIT rate after holiday: Lao P.D.R., Thailand, and Vietnam provide reduced CIT rates for years after the holiday; Cambodia ended this practice in September 2005; absent in the Philippines, Malaysia, and Indonesia. Some firms in the Philippines are subject to a 5 percent tax on gross income after the holiday expires.
  - Indirect incentives: Most countries provide exemption of import duties and VAT for qualifying export-oriented projects; Lao P.D.R., Thailand, and Vietnam use exemptions more selectively and tend to rely on reduced rates. The Philippines offers deductions for infrastructure spending and labor expenses under certain conditions.

### III. INTERNATIONAL EXPERIENCE WITH TAX HOLIDAYS
- Broad finding: tax holidays have small effects on long-term investment relative to their fiscal cost.
- Country and sector evidence (selected):
  - Malaysia: tax holidays failed to promote desirable investment or assist infant industries and disadvantaged groups.
  - Thailand: corporate tax holidays were ineffective; many projects receiving incentives had rates of return so high they would have occurred regardless (redundancy).
  - Transition economies: tax incentives are unlikely to significantly affect FDI decisions.
  - Central Europe: tax allowances and credits, combined with a moderate tax rate, were probably more cost effective than tax holidays in attracting FDI.
  - Brazil: tax incentives reduce revenue more than stimulate investment and significantly distort the tax system.
  - Mexico, Pakistan, Turkey: selective incentives like investment credits, allowances, and accelerated depreciation are more cost effective than selective CIT reductions.
- Reasons tax holidays are problematic:
  - Not cost effective: profits are exempt regardless of amount; most profitable investments (which would have occurred anyway) benefit most. Estimates for the Philippines indicate revenue loss from redundant incentives could be as large as 1 percent of GDP.
  - Attractive to footloose industries likely to exit after holiday, yielding small overall economic benefit; long-lived asset investments benefit least from tax holidays.
  - Open to abuse and tax avoidance (transfer pricing and other devices), especially with weak revenue administrations and through special economic zones.
  - Targeting export activities may be WTO-inconsistent except for the lowest income countries.
  - Home-country worldwide taxation without tax sparing can dilute holiday impact on repatriated profits, though firms can avoid this dilution by delaying repatriation or routing through third countries.
- Administrative complexity in the Philippines:
  - About ten investment promotion agencies (IPAs) and several national government agencies manage investment activities and administer tax incentives, including BOI, PEZA, SBMA, CDC, and others.
  - BOI-registered enterprises: income tax holiday up to eight years; tax and duty free importation of spare parts; tax credit on raw materials. Under Executive Order 226, incentives for duty and tax free importation of capital equipment and tax credit on domestic capital equipment expired in 1997. After income tax holiday lapse, standard CIT applies to BOI enterprises.
  - PEZA grants more generous incentives including income tax holiday, basic income tax rate of 5% of gross income, and tax and duty free importation of capital equipment, spare parts, and raw material inputs. Clark and Subic enterprises generally enjoy the same incentives as PEZA except for the income tax holiday.
  - Redundancy estimates: a recent study estimated at least 83% of all tax and duty exemptions granted to BOI-registered investments are redundant, and 10% in the case of PEZA, Subic and Clark.

### IV. EFFECTIVE TAX RATES — RATIONALE AND METHODOLOGY
- Rationale:
  - Combined effect of all tax rules is summarized in a single measure: the effective tax rate.
  - METR matters for incentives for incremental domestic investment.
  - AETR matters for discrete rent-earning investments of multinationals (location decisions).
  - Statutory rates matter for incentives for profit shifting.
- Methodology overview:
  - Construct a forward-looking hypothetical investment project to compute tax impact on cost of capital.
  - Devereux and Griffith (2003) developed a forward-looking measure of the “effective average tax rate” (EATR) based on a simple model accommodating discrete investment decisions for a value-maximizing firm.
  - The EATR determines the post-tax net present value of an investment project and thus its location; conditional on location, investment size depends on the “effective marginal tax rate” (EMTR).
  - The analysis extends Devereux and Griffith (2003) methodology to model a permanent one-unit increase in capital stock that is slowly disinvested through depreciation to capture multi-period tax holidays; returns to capital are tax-free during the tax holiday and taxed thereafter, with carry forward of unused depreciation out of the holiday period.

### V. KEY ASSUMPTIONS AND PARAMETER VALUES USED
- Inflation is set equal to 3.5 percent in all countries.
- Economic depreciation rates:
  - buildings: 3.61 percent
  - plant and machinery: 12.25 percent
- Philippines depreciation (baseline assumptions):
  - buildings: straight-line balance method at 5 percent
  - plant and machinery: declining-balance method at 25 percent
- The present discounted value of depreciation allowances divided by the statutory tax rate provides a measure of generosity—100 percent = equivalent of a pure cash-flow tax.
- The analysis does not account for the Philippines’ minimum corporate income tax (MCIT) equal to 2% of gross income (justification: corporations subject to tax incentives do not fall within MCIT coverage; for other firms excess MCIT over normal tax is carried forward and credited for the three immediately succeeding taxable years).
- Personal income taxation is ignored for simplicity given open capital accounts and similar taxation of capital gains and dividends across most countries in the sample; where taxed equally (most countries including the Philippines) effects are limited, with exceptions noted for Thailand and Indonesia.
- Scope of features incorporated:
  - Statutory corporate income tax rate inclusive of local rates.
  - Depreciation method and rate, distinguishing buildings versus plant and machinery.
  - Financing choice effects, in particular interest deductibility for debt-financed investment.
  - Sensitivity analysis across different profitability levels, debt versus equity financing, and alternative assumptions about economic depreciation versus tax depreciation.

### VI. MAIN EMPIRICAL FINDINGS — COMPANIES NOT RECEIVING TAX INCENTIVES
- EMTR:
  - Marginal effective tax rate (EMTR) is similar to neighboring countries for both buildings and plant and machinery.
- EATR and statutory rate:
  - As profitability increases, average effective tax rate (EATR) converges to the statutory CIT rate, which is the highest in the Philippines among peers considered.
- Financing effects:
  - For debt-financed investments, effective tax rates are lower due to interest deductibility; marginal effective tax rates can be negative under interest deductibility (a firm benefits only if it has other profits against which these losses can be deducted or long loss-carry-forward provisions).
- Asset type:
  - Because the difference between tax and economic depreciation is smaller for buildings, effective tax rates are somewhat higher for buildings than for plant and machinery.
- Cross-country note:
  - Effective tax rates on capital tend to be higher in large and advanced economies; however, the Philippines’ average effective rates tend to be high relative to its stage of economic development.

### VII. MAIN EMPIRICAL FINDINGS — COMPANIES RECEIVING TAX INCENTIVES (TAX HOLIDAYS)
- Tax holidays substantially reduce effective tax rates, but rates remain positive because taxes are paid after the holiday and future payments are discounted.
- Effective tax rates for equity-financed investments made in the first year of the holiday in the Philippines:
  - plant and machinery: between 7-10 percent
  - buildings: about 11½ percent
- For debt-financed investments, effective tax rates are lower during the holiday since not all interest deductibility is exhausted during the holiday.
- The wedge between taxation of firms with and without tax incentives is particularly large in the Philippines, especially at high profitability levels.
- Firms can optimally select depreciation method and rates to increase the generosity of holidays:
  - Example—plant and machinery: choosing declining-balance at 6.2 percent per year can leave about 60 percent of the asset to be depreciated for tax purposes (baseline left about 10 percent), substantially lowering effective tax rates.
  - Buildings: alternative depreciation choice of about 11 percent per year reduces effective tax rates relative to baseline straight-line 5 percent.
- Accelerated depreciation may add benefits even when a firm receives a tax holiday.
- Sensitivity:
  - Effective tax rates are sensitive to project profitability, financing mix (debt vs equity), and assumed economic depreciation vs tax depreciation.
  - Tax holidays are most attractive for short-lived assets; for equity-financed projects, short-lived assets can face zero effective tax when fully depreciated before the holiday ends.
  - Effective tax rates increase rapidly as the holiday expires, particularly for highly profitable firms, inducing timing and organizational distortions (bunching at start, reorganizing near expiry, relocation).

### VIII. POLICY-RELEVANT IMPLICATIONS AND INTERPRETATION
- Tax holidays reduce effective tax burdens substantially but raise targeting concerns:
  - Incentives are most beneficial at high profit rates, raising risk of redundancy (granting holidays to investments that would have occurred without incentives).
  - The incidence of redundancy depends on whether rents are firm-specific or location-specific and on targeting quality.
- Holidays disproportionately reduce average rather than marginal tax rates for equity-financed investment, increasing incentives more for FDI and new investment than for incremental investment.
- Holidays are unattractive for incremental debt-financed investments unless negative taxes are offset or carried forward.
- Design considerations:
  - Allowing firms discretion over depreciation method can greatly increase the generosity of holidays; policymakers should account for this when estimating revenue costs and incidence.
  - The temporal profile of benefits (front-loaded during holidays) can induce timing distortions and location/entry/exit decisions that may undermine intended investment outcomes.
  - Short-lived, foot-loose investments receive the largest tax advantage from holidays, raising concerns about quality and permanence of attracted investment.

### IX. RECENT COUNTRY EXAMPLES OF MOVING AWAY FROM SPECIAL INCENTIVES
- Egypt (mid-2005):
  - Top marginal tax rates reduced from 32 to 20 percent for individuals and from 40 to 20 percent for corporations and partnerships.
  - Reform increased the exemption threshold, liberalized depreciation, broadened the tax base by eliminating deductions, and phased out tax holidays while grandfathering current beneficiaries.
- Mauritius (2006 budget):
  - Integration of EPZ and non-EPZ sectors and removal of tax credits and tax holidays.
  - Corporate tax rate reduced from 25 to 22.5 percent with a view to reducing to 15 percent by 2009.
  - Depreciation shifted from straight line to declining balance for most assets.
- Slovak Republic (2004):
  - Single rate of 19 percent adopted and applied to both corporate and personal income; corporation tax reduced from 25 percent.
  - Combined with more rapid depreciation, more generous carry forward rules, elimination of tax holidays for new enterprises.

### X. PHILIPPINES: LEGISLATION UNDER CONSIDERATION AND THE DOF-SUPPORTED BILL
- Legislative context:
  - Several bills under consideration would either abolish tax holidays or lengthen them; some House proposals extend tax holidays up to 20 years.
  - The Bill supported by the Department of Finance (DoF) replaces tax holidays with either a reduced CIT rate or a 5 percent tax on gross income.
  - Loss-carry forward duration permitted under the DoF bill is quite long; theoretical neutrality would allow carrying forward and backward indefinitely with interest, but many countries restrict carry forwards.
- DoF-sponsored Bill main features:
  - Phase out of income tax holiday (ITH) within three years.
  - Offer instead a 25 percent CIT rate on taxable income or a 5 percent tax on gross income earned in lieu of all national and local taxes, except real property tax on land.
  - Applies to registered exporting firms and firms located in the 30 poorest provinces.
  - Gross income defined as gross revenue net of sale discounts, sales returns, and allowances minus cost of sales or direct costs, but before deductions for administrative, marketing, selling, operating expenses, or incidental losses.
  - Institutional reform: DoF formulates and monitors tax and nontax incentives policies; Board of Investments (BoI) in charge of investment promotions; Philippine Economic Zone Authorities (PEZA) and other IPAs implement investment laws.
  - Other considerations: evaluate a tax expenditure budget; VAT exemptions and Customs Duty Refund Mechanism arrangements for firms registered with IPAs described.
- Effective tax rate analysis — DoF Bill versus tax holidays:
  - The DoF Bill abolishes tax holidays and gives select exporting firms the option of either a 25 percent CIT rate or a 5 percent tax on gross receipts.
  - The implied METR for equity-financed investments is found to be lower than under tax holidays and the AETR is lower still.
  - Effective tax rates under the DoF Bill are lower even for firms making investment in the initial year of an eight-year holiday period; in practice the average holiday granted in the Philippines is four years.
  - Maintaining a constant rate over the lifetime of investment projects avoids discouraging further investment as under tax holidays.
  - Firms using equity financing will prefer the 5 percent tax on gross receipts, especially if profitability is high.
  - For low and intermediate profitability, debt-financed firms will opt for the 25 percent CIT rate as interest deductibility remains.
  - For debt-financed investment projects AETRs would be lower than those at the start of even the maximum holiday period.
  - Firms facing considerable uncertainty (high discount rates) or large non-deductible costs also have stronger incentives under the DoF Bill than under current tax holidays, although to a smaller extent.
    - Even after doubling the real discount rate to 20 percent, the 5 percent tax on gross receipts still provides stronger incentives than for investments made with four years holiday granted or remaining.
    - For each ten-percent non-deductible costs as a share of pre-tax profits, the effective tax rate under the 5 percent tax on gross receipts option increases by 0.5 percentage point.
- Revenue and redundancy implications:
  - Reform would improve short- and especially medium-term revenue collection because effective tax rates under the DoF proposal lead to actual tax payments.
  - Reduction in redundancies expected; current beneficiaries would be grandfathered so higher revenue from exporting firms likely modest in the very short term.
- Comparisons with alternative reforms:
  - Replacing holidays with general CIT reduction and enhanced depreciation:
    - At the current 35 percent CIT rate, even a 100 percent depreciation allowance in the first year would not be able to offer the same investment incentives as under the current tax holiday or under the DoF-supported Bill, except for marginal investment or those debt financed with medium profitability.
    - Accelerated depreciation allowances would need to be complemented with a sizeable reduction in the corporate income tax rate to match incentives from holidays, which could be quite costly but would reduce incentives for transfer pricing and stimulate investment by firms not receiving special incentives.
- Institutional alignment:
  - Abolishing the tax holiday would bring incentives provided by BOI and PEZA more in line with those provided by SBMA and CDC, while adding the option for a reduced CIT rate.
  - DoF supported Bill proposes merging BOI and PEZA into a single Philippines Investment Promotion Agency and mandates submission of a tax expenditure budget each year to the Congressional Oversight Committee.
- International treaties:
  - FDI to the Philippines would benefit from entering additional bilateral tax treaties, particularly “tax sparing” agreements which credit the tax that would have been paid in the absence of a holiday.

### XI. KEY CONCLUSIONS
- For companies that do not receive tax incentives, effective tax rates in the Philippines are higher than in neighboring countries.
- Tax incentives are broadly comparable in the Philippines and neighboring countries and reduce effective tax rates significantly; the wedge between taxation of companies with and without tax incentives in the Philippines is one of the largest.
- Tax holidays are most attractive for highly profitable investments and for short-lived assets; holidays reduce average more than marginal rates for equity-financed investment and are more effective for FDI and new investment than for incremental investment.
- Effective tax rates under maximum tax holidays increase as economic depreciation declines and increase rapidly as the holiday expires, especially for profitable firms.
- The DoF supported Bill compares favorably to other Bills tabled in the House for reforming incentives.
- Introducing the DoF legislation and abolishing tax holidays generally reduces effective tax rates and improves incentives to invest, while also improving short- and medium-term revenue collection; investment incentives would only decline for firms investing in short-term capital fully depreciated at the end of their holiday period.
- Reducing the general CIT rate and offering enhanced depreciation unilaterally would, at the current 35 percent CIT rate, reduce investment incentives or be very costly; even a 100 percent depreciation allowance in the first year would not match incentives under current holidays or the DoF Bill.
- The DoF supported Bill offers the opportunity for significant streamlining of the institutional structure governing granting and oversight of tax incentives.

*Source: _wp08207 (PDF chapter/section).*

### References..............................................................................................................

### References

### I. INTRODUCTION
- After the successful VAT reform, reforming tax incentives is the next major tax policy item on the legislative agenda in the Philippines.
- Between 2002-05, substantial deficit reduction was achieved as a result of expenditure compression; this changed in 2006 as a result of the successful VAT reform, which netted almost 1½ percent of GDP in additional revenue.
- Authorities recognize the need to increase revenue in the medium term through tax administration reform and reforming tax incentives; they aim to reduce redundancy (the provision of tax incentives for activities that would have been undertaken anyway), which is estimated to cost about 1 percent of GDP in foregone revenue.
- Key analytical questions posed:
  - What are the characteristics of business taxation in the Philippines relative to neighboring countries? Focus: overall corporate income tax rate, tax incentives, and other provisions affecting incentives to invest such as depreciation methods and allowances, project profitability, and financing (debt vs equity).
  - What are the effects of tax holidays on incentives to invest? Review of theoretical and empirical literature suggests limited effectiveness of tax holidays, especially for long-term investment; stresses broader view of tax system including general CIT rate and depreciation allowances.
  - How do effective tax rates in the Philippines compare to those in neighboring countries? Methodology: extend Devereux and Griffith (2003) to accommodate evaluation of tax incentives and calculate the marginal effective tax rate (METR) and average effective tax rate (AETR) to assess impact of tax system including income tax holidays.
  - What is the likely effect of abolishing the income tax holiday on investment incentives? Analyze effect on effective tax rates of recent reform proposals (including Department of Finance-sponsored legislation to replace tax holidays with a reduced corporate income tax rate for select exporting companies or a 5 percent tax on gross receipts) and contrast with offering accelerated depreciation.

### II. A BIRDS-EYE VIEW OF THE TAXATION REGIME
- Corporate income tax (CIT) in the Philippines:
  - Standard CIT rate increased to 35 percent in November 2005 as part of the EVAT reform.
  - Plans to reduce the rate to 30 percent by 2009; the reduced rate would be identical to rates in Indonesia and Thailand.
  - For domestic corporations, the tax base is net world-wide income; for resident foreign corporations, the tax base is net Philippine-source income.
- Depreciation allowances:
  - The Philippines does not prescribe the method or allowable rate; it allows straight-line, double-declining balance, or sum-of-the-years-digits methods, with rates based “on economic or useful lives of the asset or the ones used for financial reporting”.
- Personal income taxation:
  - The maximum rate of personal income taxation is comparable to other economies, but taxation of dividends, interest, and capital gains varies widely.
- Comparison with neighboring countries (coverage, duration, and other incentives):
  - Duration of tax holiday period: Except for Cambodia and Vietnam, a project’s commencement period triggers start of holiday. Durations typically range between 3 and 8 years.
  - Loss-carry-forward provisions: range from 3 years in the Philippines and Lao to 5 years in other countries except Indonesia (10 years) and Malaysia (unlimited).
  - Reduced CIT rate after holiday: Lao P.D.R., Thailand, and Vietnam provide reduced CIT rates for years after the holiday; Cambodia ended this practice in September 2005; absent in the Philippines, Malaysia, and Indonesia. Some firms in the Philippines are subject to a 5 percent tax on gross income after the holiday expires.
  - Indirect incentives: Most countries provide exemption of import duties and VAT for qualifying export-oriented projects; Lao P.D.R., Thailand, and Vietnam use exemptions more selectively and tend to rely on reduced rates. The Philippines offers deductions for infrastructure spending and labor expenses under certain conditions.

### III. INTERNATIONAL EXPERIENCE WITH TAX HOLIDAYS
- Broad finding: tax holidays have small effects on long-term investment relative to their fiscal cost.
- Country and sector evidence:
  - Malaysia: Boadway, Chua and Flatters (1995) find tax holidays failed to promote desirable investment or assist infant industries and disadvantaged groups.
  - Thailand: Halvorsen (1995) concludes corporate tax holidays were ineffective; many projects receiving incentives had rates of return so high they would have occurred regardless (redundancy).
  - Transition economies (OECD, 1995): tax incentives are unlikely to significantly affect FDI decisions.
  - Central Europe (Mintz and Tsipoulos, 1995): tax allowances and credits, combined with a moderate tax rate, were probably more cost effective than tax holidays in attracting FDI.
  - Survey of Fortune 500 companies (Wunder, 2001): nontax factors were main determinants of location decisions.
  - Brazil (Estache and Gaspar, 1995): tax incentives reduce revenue more than stimulate investment and significantly distort the tax system.
  - Mexico, Pakistan, Turkey (Bernstein and Shah, 1995): selective incentives like investment credits, allowances, and accelerated depreciation are more cost effective than selective CIT reductions.
- Reasons tax holidays are problematic:
  - Not cost effective: profits are exempt regardless of amount; most profitable investments (which would have occurred anyway) benefit most. Estimates for the Philippines indicate revenue loss from redundant incentives could be as large as 1 percent of GDP (Reside, 2006).
  - Attractive to footloose industries likely to exit after holiday, yielding small overall economic benefit; long-lived asset investments benefit least from tax holidays.
  - Open to abuse and tax avoidance (transfer pricing and other devices), especially in countries with weak revenue administrations and through special economic zones.
  - Targeting export activities may be WTO-inconsistent except for the lowest income countries.
  - Home-country worldwide taxation without tax sparing can dilute holiday impact on repatriated profits, though firms can avoid this dilution by delaying repatriation or routing through third countries.
- Administrative complexity in the Philippines:
  - About ten investment promotion agencies (IPAs) and several national government agencies manage investment activities and administer tax incentives, including BOI, PEZA, SBMA, CDC, and others.
  - BOI-registered enterprises: income tax holiday up to eight years; tax and duty free importation of spare parts; tax credit on raw materials. Under Executive Order 226, incentives for duty and tax free importation of capital equipment and tax credit on domestic capital equipment expired in 1997. After income tax holiday lapse, standard CIT applies to BOI enterprises.
  - PEZA grants more generous incentives including income tax holiday, basic income tax rate of 5% of gross income, and tax and duty free importation of capital equipment, spare parts, and raw material inputs. Clark and Subic enterprises generally enjoy the same incentives as PEZA except for the income tax holiday.
  - Redundancy estimates: a recent study estimated at least 83% of all tax and duty exemptions granted to BOI-registered investments are redundant, and 10% in the case of PEZA, Subic and Clark (Reside, 2006).

### IV. EFFECTIVE TAX RATES
- Rationale for effective tax rates:
  - Combined effect of all tax rules is summarized in a single measure: the effective tax rate.
  - METR matters for incentives for incremental domestic investment.
  - AETR matters for discrete rent-earning investments of multinationals (location decisions).
  - Statutory rates matter for incentives for profit shifting.
- Methodology overview:
  - Construct a forward-looking hypothetical investment project to compute tax impact on cost of capital.
  - Devereux and Griffith (2003) developed a forward-looking measure of the “effective average tax rate” (EATR) based on a simple model accommodating discrete investment decisions for a value-maximizing firm.
  - The EATR determines the post-tax net present value of an investment project and thus its location; conditional on location, investment size depends on the “effective marginal tax rate” (EMTR).
  - Countries typically consider the EATR when discussing the need for tax holidays to remain internationally competitive.

*Source: _wp08207 - References*

### 11.      The analysis of the impact of the current tax regime is assessed by the difference

### _wp08207 - 11.      The analysis of the impact of the current tax regime is assessed by the difference

### Methodology for effective tax rate measurement
- EATR is computed as the difference in the net present value of income generated with and without taxes, scaled by the net present value of income in the absence of tax; thus EATR = weighted average of EMTR and the statutory tax rate (adjusted for personal income taxes if included).
- For a marginal investment project (an investment whose after-tax rate of return is zero) the EATR equals the EMTR.
- As the rate of profit increases, the EATR converges to the statutory corporate income tax rate.
- The analysis extends Devereux and Griffith (2003) methodology to model a permanent one-unit increase in capital stock that is slowly disinvested through depreciation to capture tax holidays that typically span multiple periods (see Klemm (2008) for details cited in the source text).
- Returns to capital are tax-free during the tax holiday and taxed thereafter, with carry forward of unused depreciation out of the holiday period.

### Key assumptions and parameter values used in calculations
- Inflation is set equal to 3.5 percent in all countries.
- Economic depreciation rates:
  - buildings: 3.61 percent
  - plant and machinery: 12.25 percent
- Philippines depreciation (baseline assumptions):
  - buildings: straight-line balance method at 5 percent
  - plant and machinery: declining-balance method at 25 percent
- The present discounted value of depreciation allowances divided by the statutory tax rate provides a measure of generosity—100 percent = equivalent of a pure cash-flow tax.
- The analysis does not account for the Philippines’ minimum corporate income tax (MCIT) equal to 2% of gross income (justification: corporations subject to tax incentives do not fall within MCIT coverage; for other firms excess MCIT over normal tax is carried forward and credited for the three immediately succeeding taxable years).
- Personal income taxation is ignored for simplicity given open capital accounts and similar taxation of capital gains and dividends across most countries in the sample; where taxed equally (most countries including the Philippines) effects are limited, with exceptions noted for Thailand and Indonesia.

### Scope of tax regime features incorporated
- Statutory corporate income tax rate inclusive of local rates.
- Depreciation method and rate, distinguishing buildings versus plant and machinery.
- Financing choice effects, in particular interest deductibility for debt-financed investment.
- Sensitivity analysis across different profitability levels, debt versus equity financing, and alternative assumptions about economic depreciation versus tax depreciation.

### Main empirical findings — companies not receiving tax incentives
- For companies not receiving tax incentives in the Philippines:
  - Marginal effective tax rate (EMTR) is similar to neighboring countries for both buildings and plant and machinery.
  - As profitability increases, average effective tax rate (EATR) converges to the statutory CIT rate, which is the highest in the Philippines among peers considered.
  - For debt-financed investments, effective tax rates are lower due to interest deductibility; marginal effective tax rates can be negative under interest deductibility (a firm benefits only if it has other profits against which these losses can be deducted or long loss-carry-forward provisions).
  - Because the difference between tax and economic depreciation is smaller for buildings, effective tax rates are somewhat higher for buildings than for plant and machinery.
- Internationally, effective tax rates on capital tend to be higher in large and advanced economies; however, the Philippines’ average effective rates tend to be high relative to its stage of economic development.

### Main empirical findings — companies receiving tax incentives (tax holidays)
- Tax incentives (tax holidays) substantially reduce effective tax rates.
- Effective tax rate under a tax holiday remains positive because taxes are paid after the holiday expires and firms discount future real payments.
- In the Philippines, effective tax rates faced by firms on equity-financed investments made in the first year of the holiday are:
  - plant and machinery: between 7-10 percent
  - buildings: about 11½ percent
- For debt-financed investments, effective tax rates are lower during the holiday since not all interest deductibility is exhausted during the holiday.
- The wedge (reduction) between taxation of firms with and without tax incentives is particularly large in the Philippines, especially at high profitability levels.
- Firms in the Philippines can optimally select depreciation method and rates to increase the generosity of holidays:
  - Example for plant and machinery: choosing declining-balance at 6.2 percent per year can leave about 60 percent of the asset to be depreciated for tax purposes (baseline left about 10 percent), substantially lowering effective tax rates.
  - For buildings, an alternative depreciation choice of about 11 percent per year reduces effective tax rates relative to baseline straight-line 5 percent.
- Accelerated depreciation (depreciation exceeding economic depreciation) may offer additional benefits even when a firm receives a tax holiday.

### Sensitivity and behaviorally relevant results
- Effective tax rates are sensitive to:
  - project profitability
  - financing mix (debt vs equity)
  - assumed economic depreciation rate versus tax depreciation
- Tax holidays are most attractive for short-lived assets:
  - For equity-financed projects, effective tax rates under the maximum tax holiday increase as economic depreciation declines; short-lived assets can face zero effective tax when they fully depreciate before the holiday ends.
- Effective tax rates increase rapidly as the holiday expires, particularly for highly profitable firms:
  - This creates incentives for firms to bunch investment at the start of holidays, to reorganize investments near expiry (e.g., register new company, form joint venture), or to relocate when the holiday ends.
  - Marginal effective tax rates toward the end of the holiday period can be higher than after the holiday ends, reflecting the interaction between foregone depreciation deductions and post-holiday tax liabilities.

### Policy-relevant implications and interpretation
- Tax holidays reduce effective tax burdens substantially but raise targeting concerns:
  - Incentives are most beneficial at high profit rates, raising risk of granting holidays to investments that would have occurred without incentives (redundancy).
  - Whether redundancy occurs depends on whether rents are firm-specific or location-specific and how well-targeted the holiday is.
- By disproportionately reducing average rather than marginal tax rates for equity-financed investment, holidays increase incentives more for FDI and new investment than for incremental investment.
- Holidays are unattractive for incremental debt-financed investments unless negative taxes are offset or carried forward.
- Design considerations highlighted by the analysis:
  - Allowing firms discretion over depreciation method can greatly increase the generosity of holidays; policymakers should account for this when estimating revenue costs and economic incidence.
  - The temporal profile of benefits (front-loaded during holidays) can induce timing distortions and location/entry/exit decisions that may undermine the intended investment outcomes.
  - Short-lived, foot-loose investments receive the largest tax advantage from holidays, raising concerns about the quality and permanence of attracted investment.

*Source: IMF staff analysis as presented in the supplied content unit.*

### 26.      Several countries have recently started to move away from special incentives

### _wp08207 - 26.      Several countries have recently started to move away from special incentives

### Recent country examples of moving away from special incentives
- Egypt:
  - New income tax law passed in mid-2005.
  - Top marginal tax rates reduced from 32 to 20 percent for individuals and from 40 to 20 percent for corporations and partnerships.
  - Rates for petroleum, the Suez Canal authority, and the central bank left at 40 percent.
  - Reform increased the exemption threshold, liberalized depreciation, broadened the tax base by eliminating deductions, and provided for the phasing out of tax holidays while grandfathering current beneficiaries.
  - Accompanied by extensive tax administration reforms, including the introduction of self-assessment and a reform of the tax treatment of SMEs.
- Mauritius:
  - 2006 budget speech announced integration of EPZ and non-EPZ sectors and removal of all existing provisions relating to tax credits and tax holidays.
  - Corporate tax rate reduced from 25 to 22.5 percent with a view to reducing it to 15 percent by 2009 (with the intention of also taxing personal income at the same flat rate).
  - Depreciation shifted from straight line to declining balance for all assets, except non-hotel buildings.
  - Ceiling for equipment or machinery to be fully expensed in the first year raised from Rs 10,000 to Rs 30,000.
- The Slovak Republic:
  - In 2004 a single rate of 19 percent adopted and applied to both corporate and personal income.
  - Corporation tax reduced from 25 percent.
  - Combined with more rapid depreciation, more generous carry forward rules, elimination of tax holidays for new enterprises, and tighter rules on provisioning and reserves.

### Philippines: Bills under consideration and the DoF-supported Bill
- Legislative context:
  - Several bills under consideration would either abolish tax holidays or lengthen them; some House proposals extend tax holidays up to 20 years.
  - The Bill supported by the Department of Finance (DoF) replaces tax holidays with either a reduced corporate income tax (CIT) rate or a 5 percent tax on gross income.
  - Loss-carry forward duration permitted under the DoF bill is quite long; theoretical neutrality would allow carrying forward and backward indefinitely with interest, but many countries restrict carry forwards to limit revenue and monitoring costs.
- DoF-sponsored Bill main features (from Box 1; DoF sponsored is House Bill No. 2278 and similar):
  - Phase out of income tax holiday (ITH) within three years.
  - Offer instead a 25 percent CIT rate on taxable income or a 5 percent tax on gross income earned in lieu of all national and local taxes, except real property tax on land.
  - Applies to registered exporting firms and firms located in the 30 poorest provinces.
  - Gross income defined as gross revenue net of sale discounts, sales returns, and allowances minus cost of sales or direct costs, but before deductions for administrative, marketing, selling, operating expenses, or incidental losses.
  - Institutional reform: DoF formulates and monitors tax and nontax incentives policies; Board of Investments (BoI) in charge of investment promotions; Philippine Economic Zone Authorities (PEZA) and other IPAs implement investment laws.
  - Other considerations: evaluate a tax expenditure budget; VAT exemptions and Customs Duty Refund Mechanism arrangements for firms registered with IPAs described.

### Effective tax rate analysis and investment incentives
- DoF-sponsored Bill versus tax holidays:
  - The DoF Bill abolishes tax holidays and gives select exporting firms the option of either a 25 percent CIT rate or a 5 percent tax on gross receipts.
  - The implied METR for equity-financed investments is found to be lower than under tax holidays and the AETR is lower still.
  - Effective tax rates under the DoF Bill are lower even for firms making investment in the initial year of an eight-year holiday period; in practice the average holiday granted in the Philippines is four years.
  - Maintaining a constant rate over the lifetime of investment projects avoids discouraging further investment as under tax holidays.
  - Firms using equity financing will prefer the 5 percent tax on gross receipts, especially if profitability is high.
  - For low and intermediate profitability, debt-financed firms will opt for the 25 percent CIT rate as interest deductibility remains.
  - For debt-financed investment projects AETRs would be lower than those at the start of even the maximum holiday period.
  - Firms facing considerable uncertainty (high discount rates) or large non-deductible costs also have stronger incentives under the DoF Bill than under current tax holidays, although to a smaller extent.
    - Even after doubling the real discount rate to 20 percent, the 5 percent tax on gross receipts still provides stronger incentives than for investments made with four years holiday granted or remaining.
    - The definition of gross receipts in the DoF bill does not allow deduction of marketing, administrative, and selling costs; for each ten-percent non-deductible costs as a share of pre-tax profits, the effective tax rate under the 5 percent tax on gross receipts option increases by 0.5 percentage point.
    - Sensitivity simulation noted: p = 0.20; equity financed; plant and machinery; non-deductible costs equal to 50 percent of pre-tax profits in some scenarios.
- Revenue and redundancy implications:
  - Reform would improve short- and especially medium-term revenue collection because effective tax rates under the DoF proposal lead to actual tax payments.
  - Reduction in redundancies expected; current beneficiaries would be grandfathered so higher revenue from exporting firms likely modest in the very short term.

### Comparisons with alternative reforms and regional context
- Replacing holidays with general CIT reduction and enhanced depreciation:
  - It is difficult to determine how much the general CIT rate could decline, while enhancing depreciation allowances, to be revenue neutral without detailed firm-level data.
  - At the current 35 percent CIT rate, even a 100 percent depreciation allowance in the first year would not be able to offer the same investment incentives as under the current tax holiday or under the DoF-supported Bill, except for marginal investment or those debt financed with medium profitability.
  - Accelerated depreciation allowances would need to be complemented with a sizeable reduction in the corporate income tax rate to match incentives from holidays, which could be quite costly but would reduce incentives for transfer pricing and stimulate investment by firms not receiving special incentives.
- Institutional alignment and streamlining:
  - Abolishing the tax holiday would bring incentives provided by BOI and PEZA more in line with those provided by SBMA and CDC, while adding the option for a reduced CIT rate.
  - DoF supported Bill proposes merging BOI and PEZA into a single Philippines Investment Promotion Agency and mandates submission of a tax expenditure budget each year to the Congressional Oversight Committee.
- International treaties:
  - FDI to the Philippines would benefit from entering additional bilateral tax treaties, particularly “tax sparing” agreements which credit the tax that would have been paid in the absence of a holiday.

### Key conclusions (summary of Section VI)
- For companies that do not receive tax incentives, effective tax rates in the Philippines are higher than in neighboring countries.
- Tax incentives are broadly comparable in the Philippines and neighboring countries and reduce effective tax rates significantly; the wedge between taxation of companies with and without tax incentives in the Philippines is one of the largest.
- Tax holidays are most attractive for highly profitable investments and for short-lived assets; holidays reduce average more than marginal rates for equity-financed investment and are more effective for FDI and new investment than for incremental investment.
- Effective tax rates under maximum tax holidays increase as economic depreciation declines and increase rapidly as the holiday expires, especially for profitable firms.
- The DoF supported Bill compares favorably to other Bills tabled in the House for reforming incentives.
- Introducing the DoF legislation and abolishing tax holidays generally reduces effective tax rates and improves incentives to invest, while also improving short- and medium-term revenue collection; investment incentives would only decline for firms investing in short-term capital fully depreciated at the end of their holiday period.
- Reducing the general CIT rate and offering enhanced depreciation unilaterally would, at the current 35 percent CIT rate, reduce investment incentives or be very costly; even a 100 percent depreciation allowance in the first year would not match incentives under current holidays or the DoF Bill.
- The DoF supported Bill offers the opportunity for significant streamlining of the institutional structure governing granting and oversight of tax incentives.

*Source: _wp08207 - 26.      Several countries have recently started to move away from special incentives (PDF chapter).*

### REFERENCES

### REFERENCES

### Bibliographic citations
- Aldaba, R. M., 2006, “FDI Investment Incentive System and FDI Inflows: The Philippine Experience,” Philippine Institute for Development Studies, Discussion Paper Series No. 2006–20, November.
- Bernstein, J. I., and A. Shah, 1995, “Corporate Tax Structure and Production”, in: A. Shah, Fiscal Incentives for Investment and Innovation, 503-43 (New York: Oxford niversity Press).
- Boadway, R., D. Chua, and F. Flatters, 1995, “Investment Incentives and the Corporate Income Tax in Malaysia”, in: A. Shah, Fiscal Incentives for Investment and Innovation, 341–73 (New York: Oxford University Press).
- Chalk, N.A., 2001, “Tax Incentives in the Philippines: A Regional Perspective,” IMF Working Paper 01/181 (Washington, D.C.: International Monetary Fund).
- Devereux, M., and R. Griffith, 2003, “Evaluating Tax Policy for Location Decisions,” International Tax and Public Finance, Vol. 10, pp. 107–26.
- Devereux, M., R. Griffith, and A. Klemm, 2002, “Corporate Income Tax: Reforms and Competition,” Economic Policy, Vol. 17(35), pp. 451–95.
- Doyle, C., and S. van Wijnbergen, 1984, “Taxation of Foreign Multinationals: A Sequential Bargaining Approach to Tax Holidays,” CEPR Discussion Paper 25, August.
- Estache, A., and V. Gaspar, 1995, “Why Tax Incentives do not Promote Investment in Brazil,” in: A. Shah, Fiscal Incentives for Investment and Innovation, 309–40 (New York: Oxford University Press).
- Fletcher, K., 2002, “Tax Incentives in Cambodia, Lao PDR, and Vietnam,” Paper prepared for the IMF Conference on Foreign Direct Investment: Opportunities and Challenges for Cambodia, Lao P.D.R., and Vietnam, Hanoi, Vietnam, August 16–17.
- Gordon, R.H. and J.R. Hines, 2002, “International Taxation,” in: A.J. Auerbach and M. Feldstein, Handbook of Public Economics, Vol. 4, pp. 1935–95 (Amsterdam: North-Holland).
- Guin-Siu, M.T., (2004), “Tax Holidays,” FAD guidance note (Washington, D.C.: International Monetary Fund).
- Halvorsen, R., 1995, “Fiscal Incentives for Investment in Thailand,” in: A. Shah, Fiscal Incentives for Investment and Innovation, 399–436 (New York: Oxford University Press).
- Klemm, A., 2008, “Effective Average Tax Rates For Permanent Investment,” IMF Working Paper No. 08/56.
- Mintz, J. M., 1990, “Corporate Tax Holidays and Investment,” The World Bank Economic Review, Vol. 4, No. 1, 81–102.
- Mintz, J.M., and T. Tsiopoulos, 1995, “Corporate Income Taxation and Foreign Direct Investment in Central and Eastern Europe”, in: A. Shah, Fiscal Incentives for Investment and Innovation, 455–80 (New York: Oxford University Press).
- OECD, 1995, Taxation and Foreign Direct Investment: the Experience of the Economies in Transition (Paris: Organization for Economic Cooperation and Development).
- Reside, R.E., 2006, “Towards Rational Fiscal Incentives (Good Investments or Wasted Gifts?),” Economic Policy Reform Advocacy Fiscal Sector Report No. 1.
- Wei, S.J., 2000, “How Taxing Is Corruption On International Investors?,” Review of Economics and Statistics, Vol. 82, No. 1, 1–11.
- World Bank, 2004, Seizing the Global Opportunity: Investment Climate Assessment and Reform Strategy (Washington, D.C.: World Bank).
- Wunder, H., 2001, “The Effect of International Tax Policy on Business Location Decisions,” Tax Notes International, Vol. 24, 1331–55.
- Zee, H., J. Stotsky, and E. Ley, 2002, “Tax Incentives for Business Investment: A Primer for Policymakers in Developing Countries,” World Development, Vol. 30, No. 9, 1497–1516.

*Source: REFERENCES (content unit _wp08207 - REFERENCES)*

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### Table 2. Investment Incentives — Cambodia, Lao P.D.R., Thailand, and Vietnam

### I. Profit Tax — Key statutory rates and allowances
- Standard CIT (for legal persons):
  - Cambodia: 20%
  - Lao P.D.R.: 35%
  - Thailand: Generally 30%, but progressive rate for small businesses (with paid-up capital below 5 million baht) or company registered at the Stock Exchange of Thailand from 20% to 25% to 30%.
  - Vietnam: 28%

- Personal income tax (PIT) rate and PIT on dividends, interest, and capital gains:
  - Cambodia: Progressive; 0-20 percent depending on amount of taxable income.
    - Interest: 4 percent.
    - Dividends: 0 percent.
    - Capital gains: 0 percent.
  - Lao P.D.R.: Progressive; 0-45 percent depending on amount of taxable income.
    - Interest: 10 percent.
    - Dividends: 10 percent.
    - Capital gains: 10 percent.
  - Thailand: Progressive; 0-37 percent depending on amount of taxable income.
    - Interest: 15 percent.
    - Dividends: 10 percent.
    - Capital gains: 0 percent.
  - Vietnam: Progressive; 0-40 percent depending on amount of taxable income.
    - Interest: 0 percent.
    - Dividends: 0 percent.
    - Capital gains: 0 percent.

- Depreciation (method and allowance; buildings versus plant and machinery):
  - Cambodia: Buildings: straight-line-basis; 5 percent. Plant and machinery: 25 percent declining balance or 12.5 percent straight line.
  - Lao P.D.R.: Buildings: straight-line-basis; 6 percent. Plant and machinery: straight-line-basis; 5 percent.
  - Thailand: Buildings: straight-line-basis; 5 percent. Plant and machinery: straight-line-basis; 20 percent.
  - Vietnam: Buildings: straight-line-basis; 5 percent. Plant and machinery: straight-line-basis; 10 percent.

### II. Tax Incentives — eligibility, holidays, post-holiday rates, and trade tax treatment
- Sectors, geographical areas, and labor qualified for incentives:
  - Cambodia: Pioneer or high-tech, job creation, export, tourism, agro-and processing, infrastructure, energy, rural development, environment, and SEZ's.
  - Lao P.D.R.: Regions 1, 2, and 3 (see below).
  - Thailand: Technology, use domestic sources, job creation, basic and support industry; earn foreign exchange; growth outside BKK; infrastructure, energy conservation and environment protection.
  - Vietnam: Forestation, infrastructure construction, mass-transit, export production and trading, offshore fishing, agricultural processing, research and services of science and technology, plant variety production, and animal breeding.

- Tax holidays (durations and timing):
  - Cambodia:
    - Holiday not limited by commencement of operations.
    - Either: 6 to 9 years starting in first year of sales; or: 3-6 years from the last day of the tax year immediately preceding the tax year in which profits are first derived.
    - 5-year loss carry forward.
  - Lao P.D.R.:
    - 3 to 7-years from the commencement of operations:
      - 7 years in region 1: inaccessible areas;
      - 5 years in region 2: partly accessible;
      - 2 years in region 3: accessible areas;
    - Up to 3-year loss carry forward.
  - Thailand:
    - 3 to 8-years from the commencement of operations:
      - 3 years in IE of Zone I;
      - 3-5 years in Zone II (5 years in IE);
      - 8 years in Zone III.
    - 5-year loss carry forward.
  - Vietnam:
    - Holiday not limited by commencement of operations or by sales taking place.
    - 1 - 8 years from the last day of the tax year immediately preceding the tax year in which profits are first derived:
      - IZ providing services: 1 year
      - EPZ providing services: 2 years
      - IZ production enterprise: 2 years
      - IZ exporting 50 percent or more of products: 2 years
      - All zones – infrastructure construction/provision projects: 4 years
      - EPZ production enterprise and OEZ (Chu Lai): 4 years
      - HTZ (high-tech zone): 8 years
    - 5-year loss carry forward.

- Reduced CIT after tax holiday period, incentives instead of a tax holiday, or other incentives:
  - Cambodia:
    - After tax holiday: 9% (QIP's) for five years (starting from the tax year occurring after 2003 LoI promulgation) and 20% thereafter.
    - Instead of tax holiday: 40% special depreciation for QIP’s not using tax holiday period.
  - Lao P.D.R.:
    - Instead of tax holiday: 10% (region 1).
    - 7.5% for 3 years and then 15% (region 2);
    - 10% for 2 years and then 20% (region 3).
    - 0% if profit is reinvested.
    - 50% reduction for 5 years in Zone III provided that capital investment is at least 10 million baht.
    - Exemption of withholding tax.
  - Thailand:
    - After tax holiday:
      - IZ providing services: 10% for 2 years;
      - EPZ providing services: 7.5% for 3 years;
      - IZ production enterprise: 7.5% for 3 years;
      - IZ exporting 50% or more of products: 7.5 percent for 3 years;
      - All zones – infrastructure construction/provision projects: 5% for 4 years;
      - EPZ production enterprise: 5% for 4 years;
      - OEZ (Chu Lai): 5% for 9 years.
    - HTZ: no reduction in CIT.
  - Vietnam:
    - Instead of tax holiday: reduced CIT (depending on sector/area): 10% (for 15 yrs), 15% (for 12 yrs), or 20% (for 10 yrs).
    - Reduction of withholding tax to 3% (normal rate is 7%).

- Import duties and VAT exemptions (select treatments):
  - Cambodia:
    - 100% duty and VAT exemption on inputs for qualified sectors under II.1.
    - Exempt from 1% turnover tax for QIPs.
  - Lao P.D.R.:
    - VAT exemption on both inputs and sales of supporting industries (their contractors receive only VAT exemption on sales) to export-oriented garment and footwear sectors.
  - Thailand:
    - Duty and taxes on import of:
      - Tools, spare parts, vehicles directly used for production;
      - Raw materials unavailable or insufficient locally;
      - Semi-processing products for export;
      - Export (at least 70% of the total production).
  - Vietnam:
    - Exemptions and reduced import duty and VAT rates on inputs on exports and in certain sectors.
    - VAT and import duty exemptions for:
      - Commodities (except materials) imported for export processing;
      - Machineries, devices, and means of transportation of foreign contractors imported for ODA projects or exported upon completion;
      - Import for export or vice-versa for exhibition;
      - Goods imported to form fixed assets (equip, machineries, specialized means of transport, materials);
      - Imported raw materials, parts, accessories, and materials for exportation.

*Source: Table 2. Investment Incentives in Cambodia, Lao P.D.R., Thailand, and Vietnam (content unit _wp08207 - REFERENCES)*

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### Table 2. Investment Incentives — Malaysia, the Philippines, and Indonesia

### I. Regular business taxation regime — statutory rates and allowances
- Standard CIT rate on dividends and retained earnings (for legal persons):
  - Malaysia: 28%
  - Philippines: 35%
  - Indonesia: 30%

- Personal income tax (PIT) rate and PIT on dividends, interest, and capital gains:
  - Malaysia: Progressive rate from 0-28 percent depending on amount of taxable income.
    - Interest: 28 percent.
    - Dividends: 0 percent.
    - Capital gains: 0 percent.
  - Philippines: Progressive rate from 5-32 percent depending on amount of taxable income.
    - Interest: 20 percent.
    - Dividends: 10 percent.
    - Capital gains: 10.5 percent.
  - Indonesia: Progressive rate from 5-35 percent depending on amount of taxable income.
    - Interest: 15 percent.
    - Dividends: 15 percent.
    - Capital gains: 35 percent.

- Depreciation (method and allowance; buildings versus plant and machinery):
  - Malaysia: Buildings: straight-line-basis; 10 percent first year, 3 percent thereafter. Plant and machinery: straight-line basis; 14 percent for 6 years.
  - Philippines: Buildings and plant and machinery: Straight-line, double-declining balance, or the sum-of-the-years-digits methods; Rates not defined; based on economic or useful lifes of the asset or the ones used for financial reporting.
  - Indonesia: Buildings: straight-line-basis; 5 percent. Plant and machinery: 25 percent declining balance or 12.5 percent straight line.

### II. Tax Incentives — sectors, holidays, post-holiday treatment, and other incentives
- Sectors, geographical areas, and labor qualified for incentives:
  - Malaysia: High-technology or resource based industries, R&D, shipping, fund management, hypermarkets, waste recycling, manufacturing, offshore trading, technical and vocational training, agriculture and agro-based industry, communication, utilities, and transportation, hotel, tourism, and service sectors, environmental conservation and in certain areas.
  - Philippines: Areas of investment identified annually in the Investment Priorities Plan (IPP), or if at least 50 (70) percent of production is for exports for domestically-owned (majority foreign-owned) firms.
  - Indonesia: These include investment priority sectors, strategic role in economic development, employment creation, location, and partnership with cooperative.

- Tax holidays (durations and timing):
  - Malaysia:
    - Holiday starts at commencement of production.
    - 5 years: a contract research and development company or a high technology companies (such as automation, bio-technology, electronics, building material sciences, information technology and renewable energy technology). A high technology company is expected to expend at least 1% of its annual sales turnover on research and development activities and 7% of its workforce should consist of Science graduates.
    - 10-5 years: exemption of 75%-85% of profits for other companies with a pioneer status concession (10 years available for commercialization of R&D findings).
    - Unlimited loss carry forward and tax depreciation.
  - Philippines:
    - 3 to 8-years (BOI, PEZA) from the scheduled start of commercial operations:
      - 6 years: new projects with pioneer status or projects in Less Developed Areas;
      - 4 years: new non-pioneer projects;
      - 3 years: expansion and modernization projects (ITH limited to incremental sales in revenue/volume);
      - Additional (up to 2) years can be granted depending on raw materials content, capital to worker ratio, or net foreign exchange earnings.
    - Up to 3-year loss carry forward.
  - Indonesia:
    - 3-8 years from the commencement of commercial operations, or five years after the project is licensed, whichever comes first:
      - domestic and foreign investors will be granted a tax holiday for a maximum period of time for 3 years (5 years in location outside of Bali and Java islands). The criteria for such tax incentives is provided in a Presidential Decree No.7/1999 although it is not consistently applied and under revision pending implementing regulation to the new investment law;
      - an additional holiday year is offered for each of the following criteria being met: if the company (i) employs more than 2000 workers; (ii) at least 20% shareholding by cooperatives; and (iii) at least US$200 million investment realization (excl. land and building).
    - 10-year loss carry forward for companies in economic development zones or in priority sectors (standard loss-carry forward provision is 5 years).

- Reduced CIT after tax holiday period, incentives instead of a tax holiday, or other incentives:
  - Malaysia:
    - Double deduction incentives for approved training expenditure;
    - Industrial adjustment allowances may be granted up to 100% of capital expenditure;
    - Tax exempt dividends out of exempt income;
    - Accelerated depreciation available for computers, information technology, environment protection, and waste recycling equipment, and agricultural industries.
  - Philippines:
    - Full deduction of infrastructure spending in less-developed areas;
    - 50% deduction of incremental labor expenses if the prescribed ratio of capital assets to annual labor is met (100% percent if located in a less-developed area);
    - Tax credit for income taxes paid to a foreign country if no deduction claimed and for duties and taxes paid for inputs for export products and breeding stocks and genetic materials.
    - PEZA: after tax holiday, exemption from national and local taxes, but instead 5 percent tax on gross income.
    - Investment tax allowance: 6 years maximum, 30 percent reduction in taxable income.
  - Indonesia:
    - Accelerated depreciation and amortization;
    - 10% income tax on dividend payments (or lower if tax treaty exists) to nonresidents.
    - 50 percent reduction in land and building tax in certain regions and sectors.

*Source: Table 2. Investment Incentives in Malaysia, the Philippines, and Indonesia (content unit _wp08207 - REFERENCES)*

### 4. Import duties and VAT exemptions

### 4. Import duties and VAT exemptions

### Exemptions and concessions (enumerated)
- Duty free import of raw materials and spare parts for re-exports;
- Import duty and sales tax exemption on machinery and equipment not produced domestically;
- Sales tax and excise exemption on locally purchased machinery and equipment.
- Exemption from taxes and duties on imported supplies and spare parts.
- Maximum 5 percent import duty on imports of capital goods and raw materials for 2 years from the date of commercial production;
- Special duty drawback and VAT exemption for companies with an export ratio above 65 percent.
- VAT and sales tax, import duty, and excise exemption in bonded zones.

### Sources cited in the section
- KPMG Asia Pacific Taxation, 2003; Fletcher 2002, Tax Incentives in Cambodia, Lao P.D.R. PDR, and Vietnam, IMF (unpublished); Cambodia: Investment Law 1994 and its 2003 Amendment, and Law on Taxation; Lao P.D.R. PDR: Law on the Promotion of Foreign Investment and its draft subdecree, 10/22/2004; Thailand: Board of Investment, Labor Law and Land Law; Vietnam: Law on Foreign Investment, Labor Law and Land Law; Business Issues Bulletin Number 2, IFC/MPDF, 2004; Chalk, 2001, Tax Incentives in the Philippines, IMF Working Paper 01/181, Washington, DC; FIAS, 2007, Transition Issues in Investment Incentives Reform, Draft, April; Various editions of deloitte tax guides.

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### APPENDIX: DERIVATION OF EFFECTIVE TAX RATES

### Measure definition and adaptation
- Devereux and Griffith (2003) developed a measure of the effective average tax (EATR), defined as the ratio of the present discounted value of taxes over the present discounted value of the profit of a project in the absence of taxation. This measure includes the effective marginal tax rate (EMTR) as a special case, when the post-tax economic rent is exactly equal to zero.
- The original derivation is for a one period perturbation in the capital stock (investment of one unit of capital held for one year and then sold at its remaining value of ()() 11δπ−+ , where δ is true economic depreciation and π is inflation).
- The framework is adapted here to a permanent increase in the capital stock by one unit, which is slowly disinvested over time through depreciation. Returns to capital are tax free during the tax holiday and taxed thereafter. Notation follows Devereux and Griffith.

### Core definitions and equations
- Devereux-Griffith EATR is defined as:
  - *EATR /(1) RR pr − = + , where R* is the present discounted value of the economic rent earned in the absence of taxation, R is the same in the presence of taxation, p is the pre-tax net profit and r is the real interest rate.
- For an infinite investment horizon the denominator is changed to account for profits in all future periods. Assuming net rate on capital remains constant at p, and capital stock declines yearly by the true economic depreciation rate:
  - () *EATR / RR pr δ − = +                                                                                      (1)
- The present discounted value of the economic rent is equivalent to the change in the value (V) of the firm:
  - () 0 1 tsts t s s dDdN RdV γ ρ ∞ ++ = − == + ∑ ,                                                        (2)
  - where D are dividends, ()() 1/1 d mzγ = − −    − is a factor measuring the difference in treatment of new equity and distributions with m d the personal tax on dividends and z the tax on capital gains, N stands for new equity issues and ()1 i miρ = − is the investor’s discount rate, with m i the personal tax rate on interest and i the nominal interest rate.
- Dividends equation (flow of funds):
  - ()()()() () 11 1111 T ttttttt DpKIBiBIKNδπ ττ τφ −−− = + + − − + − + − + + + ,                      (3)
  - where K it the capital stock, τ is the corporate tax rate, I is the investment undertaken, B is new debt issued, φ is the official depreciation allowance, and K T is the tax-written-down value of capital.
- Under a permanent investment (1,01 tts dIdIs + == ∀ ≥ ) the tax-free present discounted value of profits (setting taxes to zero) is:
  - ()( )()()()() 2 * 11111 11... 111 p pr R iiir π δ  πδ  πδ δ ⎛⎞ + +   +−  +−⎛⎞ − = − ++++  = ⎜⎟ ⎜⎟ ⎜⎟ +++ + ⎝⎠ ⎝⎠ ,                        (4)
- In the presence of taxation, assuming investment financed by retained earnings (B = N = 0), one step yields:
  - ()()()() () ()() 1 1 100 11  1 111 ts ss T ts ts sss sss dIdK p dI R δτπ δ γτφ ρρρ + − ∞ ∞ ∞ − + + == = ⎛⎞ + + − + − = − + ⎜⎟ ⎜⎟ +++ ⎝⎠ ∑∑∑                      (5)
- The second sum is independent of any tax holiday:
  - () 1 1 ts s dI ρ + = + ∑                                                                                                      (6)
- Accounting for a tax holiday of Y years (first sum) leads to a more complex expression (summation with Y and infinite tails), summarized in the source as equation (7) and yielding terms involving τ, π, δ, ρ, p and Y.
- The third sum represents the present discounted value of depreciation allowances, labeled A. Calculation of A depends on depreciation rules (declining-balance or straight-line) and any carry-forward assumptions (see footnote in source).
- Combining components and allowing for financial effect F:
  - ()() () () 111 11 11 Y p RAF δπδπ γτ ρπδ  πρ ⎛⎞ ⎛⎞ ++−+⎛⎞ ⎜⎟ ⎜⎟ = − − ++ ⎜⎟ ⎜⎟ −+ ++ ⎜⎟ ⎝⎠ ⎝⎠ ⎝⎠                                                (8)
- Financing (new equity and debt) differs with and without tax holidays. New equity issuance and debt repayment rules are adjusted so that financing matches full expenditure when depreciation allowances do not provide tax savings. Financial effects F are derived from equations (2) and (3) and detailed in the source; explicit expressions for debt effects appear in equations (10) and (11) for absence and presence of tax holidays respectively.

### Depreciation allowances (A) formulations (from footnote)
- Assuming no carry-forward of unused allowances:
  - Declining-balance: 11 1 Y A ρφ τφ ρφρ ⎛⎞ +− = ⎜⎟ ++ ⎝⎠
  - Straight-line: ()1 1 111 11 Y A Y ρ τφ  ρ ρρρ ρ ⎛⎞ + ⎛⎞⎛⎞ = ⎜−⎟ ∀ ≤ ⎜⎟ ⎜⎟ ⎜⎟ ++ ⎝⎠ ⎝⎠ ⎝⎠
  - If methods are switched or rates change, the formulae are more complicated. Up to three rate and method changes are taken into account in the program calculating the tax rates.

### EMTR calculation steps and formulae
- To calculate the EMTR, set the post-tax economic rent R (equation (8)) equal to zero and solve for the required level of pre-tax net profit p. This yields:
  - ()() () () () 11 1111  1 Y AF p γρπδ π δ πτδπ ρ − − − + + = − + − − + + %                                                                                                       (12)
- The EMTR can then be calculated by obtaining R* for p% and substituting into (1) or equivalently as:
  - EMTR pr p − = % %.                                                                                                  (13)

Italicized source line:
*Source: _wp08207 - 4. Import duties and VAT exemptions (PDF chapter/section).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2008/_wp08207.pdf_