Supreme Court Upholds Expanded VAT Law

UNCLAS SECTION 01 OF 04 MANILA 004112 SIPDIS STATE FOR EAP/PMBS, EAP/EP, EB/IFD STATE ALSO PASS EXIM, OPIC, AND USTR STATE ALSO PASS USAID FOR AA/ANE, AA/EGAT, DAA/ANE TREASURY FOR OASIA USDOC FOR 4430/ITA/MAC/ASIA & PAC/KOREA & SE ASIA/ASEAN Sensitive E.O. 12958: N/A TAGS: EFIN ECON EINV PGOV RP SUBJECT: Supreme Court Upholds Expanded VAT Law Refs: A) Manila 3061, B) Manila 2167, C) Manila 3163, D) Manila 3154, E) Manila 2781, F) Manila 2879 Sensitive But Unclassified ¶1. (SBU) Summary: On September 1, the Philippine Supreme Court upheld the legality of the Expanded Value Added Tax (EVAT) law but has yet to lift the temporary restraining order. The TRO that the Court issued on July 1 will remain in place for at least another fifteen days. During that interval, parties who challenged the law may appeal the Court's decision. Opposition lawmakers might file such an appeal as a delaying tactic, but GRP officials consider the chances of a Supreme Court reversal slim. They expressed optimism that the GRP will implement the revenue-raising measure within the fourth quarter of 2005. Implementing the EVAT is critical to GRP efforts to reduce the fiscal deficit and temper debt accumulation while funding essential social expenditures and infrastructure investment. End Summary. -------------- Supreme Court Upholds Amended EVAT Law -------------- ¶2. (U) On September 1, two months after it issued its TRO (Ref A),the Philippine Supreme Court issued a decision upholding the constitutionality and legality of the EVAT (Ref B). The Court dismissed all five petitions filed by opposition lawmakers and other parties challenging this tax law. -------------- But TRO Not Yet Lifted -------------- ¶3. (SBU) While favoring the GRP, the Supreme Court has yet to lift the TRO that it issued on July 1 just a few hours after the law went into effect. The Court resolution stated that the TRO would be removed "upon finality of herein decision." According to the usual practice, the Court gave petitioners another fifteen days within which to submit another appear based on new arguments. GRP lawyers expect opposition lawmakers to file an MOR at the last minute as a delaying tactic but considered the likelihood of the Supreme Court reversing its decision slim. They expressed optimism that the law would be in effect by the fourth quarter of 2005. -------------- Gives Ex-Finance Chief Slap on the Wrist -------------- ¶4. (U) In a separate decision, the Supreme Court cited former Finance Secretary Purisima for "indirect contempt" and ordered him to pay a fine of 20,000 pesos ($360). The former DOF chief, one of ten Cabinet-level officials who, on July 8, called for the President Arroyo to step down (Refs C and D),had allegedly insinuated that the Supreme Court may have been influenced by the President's Office to issue the TRO and delay the EVAT's implementation in order to hold off an unpopular tax at a sensitive political time. -------------- No Undue Delegation of Taxing Authority -------------- ¶5. (U) Addressing one of the most contentious provisions raised by opposition lawmakers, the Supreme Court upheld the standby authority granted to the Philippine President to increase the EVAT rate from 10% in 2005 to 12% by January 2006, subject to meeting any one of two conditions. These conditions were 1) the ratio of EVAT collections to GDP of the previous year exceeds 2.8% or 2) the ratio of the government deficit to GDP of the previous year exceeds 1.5%. Opposition lawmakers had challenged the provision as an allegedly unconstitutional delegation of tax authority reserved for the Philippine Congress. Although there were a few dissenting opinions, majority of the Supreme Court Justices interpreted this standby authority as mandating the President to increase the tax rate, rather than an optional act by the President, if any one of the stipulated conditions were met. GRP officials have reiterated that President Arroyo will raise the EVAT rate in 2006. -------------- --- Petroleum and Electricity Firms May Pass On EVAT -------------- --- ¶6. (U) Majority of the Supreme Court Justices also upheld the right of petroleum and electricity companies -- which will no longer be exempted from EVAT when it goes into effect -- to pass on the tax burden to their customers. The Justices noted that the EVAT, by its nature, was a consumption tax. In their petition before the Supreme Court, opposition lawmakers and other parties had alleged that the Congressional bicameral conference committee tasked to reconcile the House and Senate bills had overstepped its jurisdiction by deleting the no-pass through provision contained in both the bills passed by the two houses of Congress. -------------- -- 70% Cap On Input VAT Credits: GRP To Tweak IRRs -------------- -- ¶7. (U) The business sector remains concerned about a provision in the EVAT that imposes a 70% cap on input EVAT credits that can be subtracted from output EVAT payments during any taxable quarter (refs E and F). Petroleum dealers had challenged this provision before the Supreme Court, but a majority of the Justices voted to uphold it. DOF officials maintain that this provision was not initiated by the GRP and that the Government is sympathetic to business sector concerns, particularly high-volume but low-margin enterprises. Implementing Rules and Regulations (IRRs) had postponed implementation of this provision to December to give the DOF an opportunity to seek a legislative amendment increasing the 70% cap to 90% before that time. ¶8. 8. (SBU) Because of potential delays in the legislative process, Finance Department Undersecretary Emmanuel Bonoan -- who shepherded the amended EVAT law through the Philippine Congress and helped defend it before the Supreme Court -- told econoffs that the GRP now plans to address the issue by "tweaking" the IRRs towards a more business-friendly interpretation. The current interpretation imposes the 70% cap whether or not the input EVAT exceeds the output EVAT. The new interpretation would impose the 70% cap only if the input credits exceed the output tax (example below). Current Revised Interpretation Interpretation Input EVAT 80 80 Output EVAT 100 100 Creditable Input VAT 70 80 Uncredited Input EVAT For Carryover 10 0 -------------- --- EVAT: Fiscal Icing in 2005 But Critical in 2006 -------------- --- ¶9. (U) The Government did not impute incremental revenues from the EVAT law in the 2005 budget. If implemented in early October, the GRP estimates raising perhaps 10 billion pesos ($180 million) in 2005 from the measure. Implementation becomes critical in 2006, when the EVAT would boost revenues by 83 billion pesos ($1.5 billion) and keep the 2006 budget program on track. That amount would represent about 1.4% of 2006 GDP; about half of the targeted year-on-year expansion in tax collections; and nearly 64% of the envisioned expansion in cash disbursements. ¶10. (U) Implementing the EVAT law will also affect the Government's goal of financing a larger budget (septel) while keeping the fiscal deficit in check and tempering the pace of debt accumulation. With the amended EVAT, the GRP estimates that it will need to borrow 531.6 billion pesos ($9.5 billion) from domestic and overseas capital markets during 2006, 7.8% (44.8 billion pesos) less than in 2005, to plug the fiscal deficit and to service principal payments on its debt obligations. It hopes to reduce the ratio of its outstanding debts to GDP to 63% by the end of 2006, from 72% in 2004 and 70% in ¶2005. -------------- -------------- Philippine Government Fiscal Program -------------- -------------- Billion Pesos Growth (%) 2004 2005 2006 2005 2006 Actual Program Proposal REVENUES 699.8 783.2 968.6 11.9 23.7 Tax Revenues 598.0 706.2 874.3 18.1 23.8 % of GDP 12.6% 13.3% 14.6% of which: EVAT 0.0 0.0 83.0 % of GDP 0.0 0.0 1.4% Nontax Revenues 101.8 77.0 94.3 -24.4 22.5 DISBURSEMENTS 886.8 963.2 1,093.5 8.6 13.5 SURPLUS/DEF -187.1 -180.0 -124.9 -3.8 -30.6 % of GDP -3.9% -3.4% -2.1% -------------- -------------- Source: Department of Finance -------------- Comment -------------- ¶11. (SBU) Many economists, financial and investment analysts, and credit rating officials welcomed the Supreme Court decision on the Arroyo Administration's centerpiece revenue-raising legislation. Militant groups, however, have vowed to hold street protests. The political opposition is likely to capitalize on this alleged "anti-poor law" in the wake of soaring oil prices to move forward its anti-Arroyo campaign. Meanwhile, the GRP is working to beef up its public information drive, stressing that the law is a bitter but necessary pill to avoid the more disastrous effects of a fiscal crisis. The Government's ability to curb corruption, fight tax evasion, collect revenues efficiently, and improve the delivery of Government services will come under increasing scrutiny as it calls for further sacrifices in the midst of economic and political challenges. The government's track record in all of these areas has been unimpressive. The revenue collection by the Bureau of Internal Revenue did show modest improvement during the last year under former BIR commissioner Parayno, but the Philippines' tax to GDP ration still remains the lowest in East Asia. Johnson