US embassy cable - 05MANILA1840

UNCLAS SECTION 01 OF 03 MANILA 001840 
 
SIPDIS 
 
SENSITIVE 
 
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 
 
E.O. 12958: N/A 
TAGS: EFIN, ECON, EINV, PGOV, RP 
SUBJECT: Senate Passes Value Added Tax Bill 
 
REF: Manila 0646 
 
Sensitive but Unclassified.  Please protect accordingly. 
 
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 
--------------------------------------------- ----- 
 
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. 
 
--------------------------------------------- ------ 
Casting the VAT Net Over the Fuel and Power Sectors 
--------------------------------------------- ------ 
 
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. 
 
--------------------------------------------- -- 
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