Cablegate: Bill Gives President Vat Increase Authority

Published: Thu 12 May 2005 05:41 AM
This record is a partial extract of the original cable. The full text of the original cable is not available.
E.O. 12958: N/A
SUBJECT: Bill Gives President VAT Increase Authority
REFS: A) Manila 1840
B) Manila 1839
C) Manila 0646
Sensitive but Unclassified - Protect accordingly.
1. (U) Summary: Congress ratified final language this
week that keeps the value added tax (VAT) rate at 10% but
mandates the President to raise the VAT rate to 12% in
2006. President Arroyo will sign the legislation next
week and promised to approve the VAT hike in January.
The bill eliminates VAT exemptions on many sectors,
including electricity, but allows power companies to pass
the tax on to their customers (Ref B). Other measures
expected to raise revenue but discourage investment
include an increase in the corporate income tax from 32%
to 35% until 2009 and a five-year reimbursement period
for VAT on capital inputs. The GRP expects full-year
incremental revenues to exceed 100 billion pesos ($1.8
billion) when the VAT rate is raised to 12%, helping the
country reduce its budget deficit and avert a fiscal
crisis. End Summary.
2. (U) On May 10, after nearly a month of
deliberations, the bicameral conference committee
tackling the proposed value added tax (VAT) legislation
agreed on a "reconciled" House and Senate proposal. The
Senate subsequently ratified the measure later that day
and the House of Representatives on May 11. President
Macapagal-Arroyo is expected to sign the legislation into
law next week. The legislation maintains the VAT rate at
a uniform 10%, as proposed by the Senate, but gives the
President conditional authority to raise the VAT to 12%
effective January 2006 to placate the House, which argued
vehemently in support of the higher rate. The President
"shall" raise the rate if 2004-05 VAT collections as a
percentage of GDP exceeds 2.8% (as proof that the GDP is
collecting VAT efficiently), or if the 2005 National
Government deficit as a percentage of GDP exceeds 1.5%.
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Exemptions Lifted But "No Pass Through" Disallowed
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3. (U) The reconciled bill eliminates the VAT-exempt
status of certain non-food agricultural products; the
sale or import of coal, natural gas, and petroleum
products; the sale or import of raw materials to make
petroleum products; the import by transport operators of
passenger or cargo shipping vessels of more than 5,000
tons; sales by the artist of literary works and musical
compositions; sales by electric cooperatives; and
services rendered by doctors of medicine and lawyers.
Sales of power generation companies, which are currently
zero-rated, are subject to VAT, as are sales of power
transmission and distribution companies, which are
currently VAT-exempt. The bill scraps the provisions in
both the Senate and House versions to prevent power
generation and transmission companies from passing the
VAT on to their customers. To temper the impact of VAT
on fuel and electricity rates, the bill repeals the 2%
franchise tax on electric utilities; reduces the excise
tax per liter of regular gasoline to 4.35 pesos (from
4.80 pesos); and scraps the excise taxes on bunker fuel,
diesel, kerosene, and natural gas.
Corporate Income Tax Raised
4. (U) To compensate for maintaining the VAT rate at
10%, the legislation adopted the Senate's proposals to
raise revenues from other taxes. The bill raised the
country's already-high corporate income tax rate from 32%
to 35% until 2009. Although local chambers of commerce
supported an increase in the VAT rate, they warned that
the higher corporate tax will hurt local companies and
discourage new investment. In another disincentive to
investors, the bill staggers credits on input VAT paid on
capital equipment over a five-year period. The
telecommunications industry and other capital-intensive
sectors opposed this provision as a de facto interest-
free loan from the private sector to the Government. The
bill lifts VAT exemptions on domestic passenger and cargo
services in exchange for scrapping the 3% tax on
passenger transport. The bill also increases the gross
receipts tax from 5% to 7% on certain bank and financial
intermediary revenues (such as royalties, property
rentals, and net trading gains on foreign currency, debt
securities, derivatives, and similar instruments).
President Promises to Raise VAT to 12%
5. (U) When signed and implemented, the Department of
Finance (DOF) hopes to raise about 29 billion pesos ($535
million) from the new VAT law during the second half of
2005. Full-year incremental revenues have been estimated
at 58 billion pesos ($1.1 billion), assuming a VAT rate
of 10%. DOF officials told econoff that any one of the
conditions to increase the VAT rate to 12% by 2006 was
"easily achievable." The Government registered a tax-VAT-
to-GDP ratio of 2.9% during 2004, which the officials
expected to improve further with the incremental revenues
expected from the new VAT law during the second half of
2005. The National Government deficit during 2004
equaled 3.9% of GDP and, although expected to improve
during 2005, is not likely to decline to 1.5% of GDP
during the year. DOF officials estimate that increasing
the VAT rate to 12% would boost incremental annual
revenues to over 100 billion pesos ($1.8 billion).
6. (SBU) In a statement following House passage of the
revised VAT bill, President Arroyo promised to use her
authority to increase the VAT rate to 12% in January.
DOF officials noted that House Ways and Means Chair Jesli
Lapus had stressed in bicameral committee meetings that
the language stating that the President "shall" (versus
"may") raise the VAT rate after specified conditions are
met should be interpreted as a directive rather than an
option. Opposition legislators threatened to challenge
the constitutionality of the provision for standby
authority, arguing that this unduly delegated legislative
powers to the President. Finance officials and a member
of the President's Legislative Liaison Office told
econoff that the constitutional challenge was unlikely to
succeed as there are precedents granting the President
similar standby authority under the Philippines' National
Internal Revenue Code.
7. (SBU) Although it took months longer than expected
and morphed from a simple VAT rate increase to encompass
many other taxes, the legislation is a critical step in
the GRP's efforts to avert a fiscal crisis and restore
its financial credibility. After promising last July to
increase annual revenue by 80 billion pesos ($1.5
billion) from tax legislation, Congress has only passed a
watered-down law to raise excise taxes on alcohol,
cigarettes, and tobacco (ACT), and a law rewarding and
punishing employee performance in revenue collection
agencies. The expected incremental revenues from these
laws and the new bill could exceed 120 billion pesos
($2.2 billion) starting in 2006, and could help the GRP
achieve deficit-reduction targets sooner. The GRP
discarded the "no pass-through" to consumers on the
electricity VAT, a provision that would have wiped out
profits for power producers. The increase in corporate
income tax and staggered VAT input reimbursement may
dissuade investors from coming or remaining. By setting
easy criteria to meet, the members of Congress running
for re-election in 2007 will share the political costs of
the VAT hike with President Arroyo. Congress is expected
to take up one last revenue-enhancement measure this year
- the rationalization of fiscal incentives.
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