Clark Firms Mull Closure with Huge Tax Burden

UNCLAS SECTION 01 OF 03 MANILA 005133

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TAGS: EINV PGOV EFIN RP
SUBJECT: Clark Firms Mull Closure with Huge Tax Burden


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Ref: Manila 3778

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Summary
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1. (SBU) Businesses in the Clark Special Economic Zone
face huge new financial liabilities after a recent Supreme
Court decision nullified their tax incentives. U.S. company
executives complain that the ruling replaces their 5% gross
income tax with the standard 32% corporate income tax and
other duties, and applies retroactively. AOL, for example,
may owe about $580 million. Although actual collection is
on hold while the Court debates a reconsideration request,
firms are forced to put aside funds for the higher tax
assessments and inform stockholders of the amount owed.
Several U.S. firms have postponed expansion plans and others
have started looking for relocation sites. In response to
protests by business organizations, the Philippine Congress
drafted bills to reinstate the tax incentives at Clark and
grant amnesty for prior year assessments. With other
priorities occupying Congressional attention, however,
legislative efforts to reverse the impact of the court
verdict may take time and require compromise, results that
will amplify business anxiety and further undermine
credibility in the Philippine investment climate. End
summary.

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Firms Face Vast Tax Liabilities
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2. (U) During an October 29 visit to the former Clark Air
Force Base, econoffs talked to U.S. company executives about
the recent Supreme Court decision that nullified tax
incentives for businesses in the Clark Special Economic
Zone. The executives expressed frustration and anxiety over
the sudden imposition of higher tax rates and vast
retroactive liabilities. The Court ruled that only Congress
could grant tax and duty-free incentives so companies are no
longer eligible to pay 5% gross income tax in lieu of the
32% corporate income tax and other duties. In addition,
they must pay back taxes since the start of their
operations, which for many companies is 5-10 years. As of
November 1, with the implementation of the expanded value
added tax (EVAT) law, companies in Clark will be assessed
the new higher corporate income tax rate of 35%.


3. (SBU) All the U.S. companies strongly opposed paying
back taxes and felt betrayed by government leaders who
signed contracts promising special tax rates and benefits.
Alan Arnett, Vice-President and General Manager for API,
which runs an aircraft parts distribution hub for Asia,
complained that by taking away tax benefits the government
had "changed the rules mid-game," hurting GRP credibility
and reducing the Philippines' competitive advantage. Noting
confusion about the impact of the newly implemented tax law,
Arnett said his accounting firm advised him to start paying
VAT right away. Nenette Qua, Senior VP and General Manager
of Amertron, an electronics manufacturer with 1200 employees
in Clark, complained that her company had signed contracts
with clients and could not go back and change its prices now
to reflect the higher costs. Even firms outside of
manufacturing or sales will face large back taxes. Ting
Tottoc, Human Resources Manager at America Online, which
runs a large help desk and customer service center, said the
Bureau of Internal Revenue computed AOL's retroactive taxes
as 32 billion pesos ($580 million) based on operating costs
for the last seven years.

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Should I Stay or Should I Go
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4. (SBU) Arnett said he placed API's multi-million dollar
expansion plans temporarily on hold until Congress finds a
way to reinstate the tax incentives. But the company is
experiencing major growth right now and cannot slow down to
wait for GRP to straighten out its policies. As a result,
soon after the Supreme Court decision was announced, API
began site selection for a new plant in China. Other U.S.
firms have also postponed additional investment and are
looking for relocation sites.
-- AOL's long-term lease expired in August and the company
has postponed renewing it. AOL may pack up and transfer its
operations to Bangalore if the incentives are permanently
withdrawn.

-- Bill Tackett, President of Infinno, a software
development company, said the incentives are the only reason
he set up his business in Clark. If these are lost, Infinno
will move to Subic or out of the Philippines entirely.

-- Gillian Sim, General Manager of UPS, which runs an intra-
Asian hub from Clark, said UPS will not leave immediately.
The company has invested millions of dollars in renovating
the airport and ground facilities, she noted, and may find
it difficult to identify a substitute location on short
notice.

-- Elizabeth Castro, BerthaPhil business park President,
said the ambiguous state of tax incentives discourages new
companies from locating in Clark. BerthaPhil is unable to
lease open business park facilities because companies will
delay signing a contract until they are guaranteed the tax
incentives.

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Sluggish Congressional Response
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5. (SBU) Although the executives expressed confidence that
the tax incentive issue will eventually be resolved, they
expected to pay some additional taxes. Tackett admitted
that "the government needs money" and lamented that it may
be unwilling to give up all the potential revenue. In the
meantime, the BIR issued a directive that firms should "hold
off" paying the new taxes until the Supreme Court has ruled
on this issue with finality. The Clark Development
Corporation filed a motion for reconsideration with the
Supreme Court that would postpone execution of its decision
for at least a year, during which time the matter could
hopefully be resolved in Congress.


6. (SBU) Business organizations have complained about the
impact of the ruling on firms in Clark and the Philippine
investment climate in general and urged Congressional action
to prevent any commercial fallout. The Clark Locator
Council announced that investors were planning to leave if
the government failed to reinstate tax incentives. The US-
ASEAN Business Council, which raised this issue during
President Arroyo's visit to New York in September, requested
a letter to confirm verbal assurances by Department of
Finance and Bureau of Internal Revenue to suspend "ordinary
business tax" collection until the situation is corrected in
Congress. The Joint Foreign Chambers of the Philippines
sent a letter requesting Arroyo to certify as "urgent" the
legislation to reinstate incentives and grant amnesty for
back taxes.


7. (SBU) GRP legislators expressed general support for tax
incentive legislation but have not made it a priority.
President Arroyo and House Speaker Jose de Venecia told U.S.
companies that 75% of Congress was in favor of a Clark
amnesty bill. Bernie Sayo, Presidential Legislative
Liaison, told econoffs that a House resolution has been
pending since May with no movement, though, and must be
transformed into a bill to amend the law. While business
councils acknowledge the "genuine" concern of Congress,
members still fear legislation will take months to pass
because of other political priorities, such as Constitution
change, and lingering controversies over the Presidential
impeachment attempt.


8. (U) The Senate drafted a bill to reinstate the tax
incentives and planned to release a Committee report, but
cannot finalize its version until the House passes its bill
first, according to Sayo. The report will recommend amnesty
from back taxes and reinstating incentives, said Attorney
Custodio of Senator Gordon's office. Lauro Ortile, Manager
of Corporate Planning at CDC, said legislators reassured him
that the bills resolving the issue would pass quickly, and
Clark investors are likely to receive even more generous
incentives than they had before.

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Comment
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9. (SBU) CDC and BOI officials are making every effort to
accommodate Clark businesses in the short-term and GRP
officials claim a resolution is near. Although business
leaders remain optimistic, Embassy is concerned that the
experience of U.S. investors in Clark may parallel that of
local and foreign banks in the Philippines that lost their
tax exemptions on foreign currency accounts without warning
and were assessed millions of dollars in back taxes after a
protracted resolution process (reftel). Even with a return
to the status quo ante, the Supreme Court ruling and
legislative foot-dragging over this matter have damaged the
credibility of the government and called into question its
ability to offer investment incentives without judicial
interference.

Jones