From TRABAHO (Tax Reform for Attracting Better and High-quality Opportunities) to CITIRA (Corporate Income Tax and Incentives Rationalization Act) and now CREATE (Corporate Recovery and Tax Incentives for Enterprises), the elusive Package 2 of the government’s tax reform program may finally see the light.
The negative effects on business and economic conditions brought about by the pandemic has forced the government to rethink its fiscal strategies. To help jumpstart the economy, the Department of Finance (DoF) is now proposing to Congress a recalibration of CITIRA to CREATE to be more relevant and responsive to the challenging times. As described by the DoF, the proposal is not an effort to raise taxes, but will decisively be revenue-negative and could be the largest fiscal stimulus program for enterprises in Philippine history.
One of the primary amendments is the immediate reduction of the corporate income tax rate from 30% to 25% beginning July 2020. A further reduction of 1 percentage point is expected annually from 2023 to 2027 until it reaches 20%. Previously, the proposed adjustment was 1 percentage point per year until we hit the 20% target rate in 2029.
The immediate reduction to 25% will help spur economic recovery so that funds will be available to invest in people and capital. It will also lessen the gap and allow the Philippines to somehow catch up with other ASEAN countries. Notably though, Indonesia, as part of its COVID-19 response measures, has reduced its income tax rate from 25% to 22% for financial years 2020 to 2021, and further down to 20% starting 2022.
CREATE also proposes an enhanced net operating loss carryover (NOLCO), which will extend the current three-year carryover period for losses incurred by non-large taxpayers in 2020 by two more years, or a total of five years. However, for this to have an impact, it should be coupled with the suspension of the 2% minimum corporate income tax (MCIT), if not an outright repeal.
Under the Tax Code, MCIT is imposed on a corporate taxpayer beginning the fourth taxable year immediately following the year it commenced business operations and is due when the MCIT is higher than the regular corporate income tax (RCIT). In other words, a corporate taxpayer shall pay either the 2% MCIT based on gross income or the 30% RCIT based on net taxable income, whichever is higher. So even if the taxpayer’s operations result in a net loss, it will still be liable to pay income tax in the form of MCIT.
While the Tax Code authorizes the Finance Secretary to provide MCIT relief to any corporation which suffers losses because of force majeure, among others, this is not automatic. The taxpayer would still need to file an application and securing the approval is a long and tedious process. Hence, unless the MCIT is suspended or repealed, the enhanced NOLCO may just end up being a token relief.
The more controversial provisions in CITIRA, which derailed its passage given the concerns raised by stakeholders, pertain to the rationalization of incentives which would affect those registered with different investment promotion agencies (IPAs) such as the Philippine Economic Zone Authority (PEZA). Under CREATE, certain flexibilities are being proposed with the intention of attracting new foreign investments and retaining existing ones.
Part of the rationalization is providing a new set of incentives which are performance-based, targeted, time-bound, and transparent. Registered projects or activities shall be entitled to income tax holiday (ITH), to be followed by a special corporate income tax rate (SCIT) of 8% in 2021, 9% in 2022 and 10% from 2023 onwards, based on gross income. Depending on the category of the activity — whether basic, enhanced or advanced — the ITH period can be a minimum of two years to a maximum of four years, and the SCIT can be three to four years. The SCIT may be further extended by another three or four years, at any one time, subject to qualifications set forth in the Strategic Investment Priorities Plan (SIPP). However, the total period of incentive availment shall not exceed 12 years.
A positive development in CREATE is that the SCIT will be paid in lieu of all national and local taxes. Previously, under CITIRA, real property tax was excluded from the coverage of the SCIT. The adjustment is in response to the appeals made by stakeholders to retain a one-stop shop approach for registered enterprises and avoid the bureaucracy of going through the difficult processes and various rules of local governments.
However, the 8%/9%/10% SCIT rates which remain unchanged from CITIRA appear to be on the high side and will double the current 5% gross income tax (GIT) incentive. In fact, new registrants will not be able to avail of the 8%/9% rates since by the time their ITH expires (two years at the earliest), the applicable SCIT rate will already be at the highest rate of 10% (beginning 2023).
From previous reports, the current 5% GIT is, on average, equivalent to the 15% RCIT based on net income. Given this ratio, it can be deduced that a 1% GIT is equivalent to 3% RCIT, in which case, the proposed SCIT rates of 8%, 9% and 10% will result in an equivalent RCIT of 24%, 27% and 30%, respectively. Thus, instead of being incentivized, it seems that registered enterprises will be paying higher taxes vis-à-vis a regular corporation as the RCIT is proposed to be reduced to 25% beginning July this year.
Considering the need to improve the country’s ability to attract investments and encourage existing ones to expand rather than drive them to leave, the proposed SCIT rates should be adjusted to a more acceptable and competitive rate of 7% maximum, which is the average effective RCIT rate of 21%.
Further, under CITIRA, registered enterprises will have a sunset period of two to seven years depending on the number of years they have been under the GIT regime. CREATE has adjusted the period to a minimum of four and a maximum of nine years. However, given the current business conditions and the uncertainty of future operations of existing registered enterprises, the transitory period should at least be five to 10 years. This will, to a certain extent, place the Philippines on a level playing field with our ASEAN competitors.
There is also a need to delete the provision in the bill requiring the surrender of the certificate of registration for existing projects or activities which will be deemed an express waiver of existing incentives if the new incentive package will be availed. The provision is inconsistent with the intention and creates uncertainty. As clarified by the DoF and Congress in various business industry meetings, after the sunset period, these registered projects or activities are still allowed to apply under the new incentive package if qualified under the SIPP.
While time is of the essence, adjustments to this critical measure can still be made. CREATE will either make or break our chances of boosting the Philippines’ potential as an investment destination and turn this COVID-19 crisis into a golden opportunity.
The article is for general information purposes only and should be used as a substitute for consultation with professional advisors.