Economic Analysis - TRAIN 2 A Net Negative For Investment - MAY 2018

BMI View: The DOF has submitted the second tax reform package to the House of Representatives, and the bill is now in deliberation. While the proposed tax reforms may be fiscally prudent, it will likely make the Philippines less competitive versus its regional peers. Investment could slow over the near-term as the proposed conditional corporate tax reduction and repealing of fiscal incentives create uncertainties for businesses.

The Philippine Department of Finance (DOF) submitted the second (of five) package of the government's Comprehensive Tax Reform Program (CTRP) to the congress in January and it is now in the official period of deliberation in the House of Representatives, as of March 5. While the proposed tax reforms in the second package would streamline the complex tax system, we believe it will likely weigh on the country's competitiveness, and create uncertainty for investors in the near-term. The sequel came after the first package was signed into law by President Rodrigo Duterte in December 2017, and aims to lower corporate income taxes and reduce fiscal incentives to investors to achieve the government's objective of making the tax system more efficient and fairer.

Details About TRAIN 2

Package two of the Tax Reform for Acceleration and Inclusion (TRAIN) proposes to gradually lower the corporate income tax rate from 30.0% to no less than 25.0%, while modifying tax incentives for companies to make these 'performance-based, targeted, time-bound, and transparent'. At present, the Philippine Economic Zone Authority (PEZA) grants an attractive package of incentives including income tax holiday for a maximum of eight years, followed by a perpetual 5.0% tax on gross income earned (GIE), and zero VAT on local purchases and up to 30.0% of local sales, among others. There are also 14 investment promotion agencies, more than 200 laws granting various types of investment and noninvestment tax incentives, and the Tax Code also provides several tax benefits.

The latest draft of the DOF's TRAIN 2 has called for an overhaul and streamlining of these incentives to make tax perks more equitable and effective in creating jobs, developing industries, and attracting more foreign direct investment, as well as generate more revenues to fund the government's PHP8.0trn 'Build, Build, Build' infrastructure program. As part of the proposal, the government is asking for a limit on PEZA incentives to a maximum of 10 years and to change the 5.0% tax on GIE to 15.0% tax on net income. The bill also calls for the repeal of more than 30 special laws that grant incentives to investors and for PEZA registered enterprises to export 90.0% of total sales, up from the current requirement of 70.0%.

Philippines Highest In The Region
East Asia - Corporate Tax Rate, %

Investment Could Slow In Near-Term

Despite the proposed corporate income tax cut, we note that tax rates in the Philippines will still be one of the highest and least competitive in the region, and the repealing of tax incentives to investors will likely make it worse. This comes at a time when other countries in the region are trying to offer more tax incentives in order to attract foreign direct investments. Not only that, the tax reduction is conditional and dependent upon the government's ability to reduce the cost of tax incentives - for every reduction in the cost of the tax incentives by 0.15% of GDP, there will be a 1.0% reduction in corporate tax rate. Although the quid pro quo approach may be fiscally prudent, it creates more uncertainty for businesses. We believe that this could weigh on investment over the near-term as investors adopt a wait-and-see approach.