Senate Passes Value Added Tax Bill

UNCLAS SECTION 01 OF 03 MANILA 001840

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E.O. 12958: N/A
TAGS: EFIN ECON EINV PGOV RP
SUBJECT: Senate Passes Value Added Tax Bill

REF: Manila 0646

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1. (U) Summary: The Philippine Senate approved on April
13 proposed amendments to the value-added tax law.
Bicameral conference committee hearings are deliberating
over the House and Senate proposals, with a reconciled
bill targeted for signing by President Macapagal-Arroyo
on April 30. The executive branch is pushing for a
simple bill to increase the current unitary 10% VAT rate
to 12% and limit exemptions. The bills that emerged from
both chambers, however, attempt to satisfy a cacophony of
conflicting interests and contain provisions opposed by
the business sector, such as preventing power sector
firms from passing on VAT to their customers, increasing
the already high corporate income tax rate, and
staggering rebates for capital equipment over five years.
The Embassy continues to work with the American Chamber
and U.S. companies in affected sectors and explain to key
members of Congress the need for a fair and credible VAT
law. End Summary.


2. (U) On April 13, 2005 the Philippine Senate passed
its version of proposed amendments to the Philippines'
value added tax (VAT) law to raise revenues for the cash-
strapped Government. The House of Representatives had
earlier approved proposed amendments to the VAT law in
two separate bills (reftel) that would generally increase
the current VAT rate from 10% to 12%, except for reduced
rates on petroleum, power, and other "socially sensitive"
products, and narrow the list of VAT-exempt transactions.

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Senate Sticks to 10% VAT; Tinkers with Other Taxes
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3. (U) Senate Bill (SB) 1950 maintains the VAT at a
uniform rate of 10%, but compensates by raising
government revenue in the following ways:

-- Lifting exemptions on a wider range of transactions
than approved by the House, including withdrawing VAT
exemptions on certain nonfood agricultural products, on
the sale or importation of coal and natural gas, on the
importation and sale by electric cooperatives, on direct
sales by an artist of his works of art, on operators of
cabarets and night and day clubs, and on loans extended
by credit and multi-purpose cooperatives to non-members;

-- Subjecting services rendered by domestic air and water
carriers to VAT (in exchange for scrapping the 3%
franchise tax currently in place);

-- Temporarily increasing the Philippines' already high
corporate income tax rate from 32% to 35% until end-2008;

-- Increasing the gross receipts tax from 5% to 7% on
certain revenues of the banking sector and non-bank
financial intermediaries, such as royalties, property
rentals, and net gains on foreign currency debts,
derivatives and similar instruments.

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Casting the VAT Net Over the Fuel and Power Sectors
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4. (U) The Senate voted to cast the VAT net over the
currently VAT-exempt importation and sale of petroleum
products. SB 1950 would also impose VAT on the sales of
power generation companies (including Independent Power
Producers - IPPs) from non-renewable sources of energy,
which are currently zero-rated, and tax sales of power
transmission and distribution firms, which are currently
VAT-exempt. (Note: For zero-rated transactions, no
output VAT is paid and VAT paid on inputs may be refunded
or credited against other taxes. VAT-exempt transactions
are not entitled to input tax credits. End Note.)


5. (U) Reflecting intentions to temper the impact on
electricity rates, SB 1950 would repeal the 2% franchise
tax currently imposed on electric utilities and scrap
excise taxes on diesel (from 1.63 pesos/liter),bunker
fuel (from 30 centavos/liter),and kerosene (from 60
centavos/liter). The Senate bill also contains a "no
pass-through" provision that would prevent power
generation, transmission and distribution companies from
passing on the VAT to residential customers.


6. (U) Proposed legislation earlier passed by the House
of Representatives would lift the VAT-exempt status of
fuel products and zero-rated status of power generated
through non-renewable energy sources without touching
excise and franchise taxes. However, the House proposal
would apply the 12% VAT rate on a staggered basis (i.e.,
4% on the first year, rising to 6%, 8% and 12% during the
second, third, and fourth years, respectively). Power
generated from wind, biomass, and solar energy would be
VAT-exempt (instead of zero-rated) and the rest subject
to VAT. The House bill prevents IPPs from passing on the
VAT to any customers, and includes a "no pass-through"
provision for purchases of petroleum products as well.

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Battle Shifts to Bicameral Conference Committee
-------------- --


7. (U) A bicameral conference committee began
deliberations on April 15 to reconcile the Senate and
House versions of the proposed VAT amendments. Speaker
Jose De Venecia and Senator Franklin Drilon publicly
expressed confidence that a reconciled bill will be ready
for President Gloria Macapagal-Arroyo's signature by
April 30.


8. (U) Meanwhile, tax experts fear that the end result
will be a convoluted bill that, by seeking to satisfy
many conflicting interests, could eventually prove
difficult to administer. In addition to being more
complicated administratively by departing from a unitary
VAT rate, the Lower House's proposal to tax locally
manufactured "socially sensitive" products - i.e.,
mackerel/sardines, milk, refined sugar, cooking oil,
instant packed noodles, and generic medicines - at a
lower 6% VAT versus the 8% rate proposed for imported
counterparts is inconsistent with WTO commitments.
Econoffs have shared this observation with GRP officials
and legislators.


9. (U) Foreign and local business chambers here also
continue to express grave concern over provisions in
either or both Senate and House bills that would unduly
penalize the business sector and cloud the investment
climate -- particularly the proposed "no pass-through"
provisions for petroleum and power (septel),corporate
income-tax hike, and staggered crediting over a five-year
period of input VAT for purchases of capital equipment.


10. (SBU) Finance Secretary Purisima told econoffs that
the GRP wants a simple increase in the VAT to a unitary
12% rate and fewer exemptions to raise 62-89 billion
pesos ($1.1-1.6 billion) in annual incremental revenues.
While the DOF estimates that the House and Senate
versions could raise revenues very close to the DOF's
original proposal (i.e., about 60-85 billion),GRP
officials share concerns over the more convoluted bills
that have emerged thus far and the potentially adverse
impact of some provisions on the business climate and
investor perception. Although at a press conference
April 14, President Arroyo said she was letting the
legislators work out how to achieve her revenue goal,
more recent pronouncements by her staff state a clear
preference for a full 2% increase in the VAT rate,
perhaps allowing fewer provisions that might deter
investors and businesses.
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Comment
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11. (SBU) The passage of a VAT bill that generates
significant additional revenue without severe adverse
effect on the investment and business climate is critical
to improving the country's fiscal position, government
credibility and macroeconomic stability. With only two
revenue-enhancing bills passed to-date (i.e., higher
excise taxes for liquor and tobacco and a lateral
attrition program for revenue collection agencies),the
GRP is depending heavily on VAT legislation to deliver
the bulk of its 80-billion peso goal from new revenue
laws. Public resistance to new and/or higher taxes has
intensified so the VAT bill could be the "last hurrah"
for enacting new tax measures. Together with the
American Chamber of Commerce and U.S. power generation
firms operating here, the Embassy continues to encourage
VAT legislation that is credible, fair, WTO-consistent,
and will foster fiscal viability and growth as well as
the confidence of businesses and investors.

Ricciardone