US embassy cable - 05MANILA2167

UNCLAS SECTION 01 OF 03 MANILA 002167 
 
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: Bill Gives President VAT Increase Authority 
 
REFS: A) Manila 1840 
      B) Manila 1839 
      C) Manila 0646 
 
Sensitive but Unclassified - Protect accordingly. 
 
1.  (U)  Summary:  Congress ratified final language this 
week that keeps the value added tax (VAT) rate at 10% but 
mandates the President to raise the VAT rate to 12% in 
2006.  President Arroyo will sign the legislation next 
week and promised to approve the VAT hike in January. 
The bill eliminates VAT exemptions on many sectors, 
including electricity, but allows power companies to pass 
the tax on to their customers (Ref B).  Other measures 
expected to raise revenue but discourage investment 
include an increase in the corporate income tax from 32% 
to 35% until 2009 and a five-year reimbursement period 
for VAT on capital inputs.  The GRP expects full-year 
incremental revenues to exceed 100 billion pesos ($1.8 
billion) when the VAT rate is raised to 12%, helping the 
country reduce its budget deficit and avert a fiscal 
crisis.  End Summary. 
 
2.  (U)  On May 10, after nearly a month of 
deliberations, the bicameral conference committee 
tackling the proposed value added tax (VAT) legislation 
agreed on a "reconciled" House and Senate proposal.  The 
Senate subsequently ratified the measure later that day 
and the House of Representatives on May 11.  President 
Macapagal-Arroyo is expected to sign the legislation into 
law next week.  The legislation maintains the VAT rate at 
a uniform 10%, as proposed by the Senate, but gives the 
President conditional authority to raise the VAT to 12% 
effective January 2006 to placate the House, which argued 
vehemently in support of the higher rate.  The President 
"shall" raise the rate if 2004-05 VAT collections as a 
percentage of GDP exceeds 2.8% (as proof that the GDP is 
collecting VAT efficiently), or if the 2005 National 
Government deficit as a percentage of GDP exceeds 1.5%. 
 
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Exemptions Lifted But "No Pass Through" Disallowed 
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3.  (U)  The reconciled bill eliminates the VAT-exempt 
status of certain non-food agricultural products; the 
sale or import of coal, natural gas, and petroleum 
products; the sale or import of raw materials to make 
petroleum products; the import by transport operators of 
passenger or cargo shipping vessels of more than 5,000 
tons; sales by the artist of literary works and musical 
compositions; sales by electric cooperatives; and 
services rendered by doctors of medicine and lawyers. 
Sales of power generation companies, which are currently 
zero-rated, are subject to VAT, as are sales of power 
transmission and distribution companies, which are 
currently VAT-exempt.  The bill scraps the provisions in 
both the Senate and House versions to prevent power 
generation and transmission companies from passing the 
VAT on to their customers.  To temper the impact of VAT 
on fuel and electricity rates, the bill repeals the 2% 
franchise tax on electric utilities; reduces the excise 
tax per liter of regular gasoline to 4.35 pesos (from 
4.80 pesos); and scraps the excise taxes on bunker fuel, 
diesel, kerosene, and natural gas. 
 
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Corporate Income Tax Raised 
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4.  (U)  To compensate for maintaining the VAT rate at 
10%, the legislation adopted the Senate's proposals to 
raise revenues from other taxes.  The bill raised the 
country's already-high corporate income tax rate from 32% 
to 35% until 2009.  Although local chambers of commerce 
supported an increase in the VAT rate, they warned that 
the higher corporate tax will hurt local companies and 
discourage new investment.  In another disincentive to 
investors, the bill staggers credits on input VAT paid on 
capital equipment over a five-year period.  The 
telecommunications industry and other capital-intensive 
sectors opposed this provision as a de facto interest- 
free loan from the private sector to the Government.  The 
bill lifts VAT exemptions on domestic passenger and cargo 
services in exchange for scrapping the 3% tax on 
passenger transport.  The bill also increases the gross 
receipts tax from 5% to 7% on certain bank and financial 
intermediary revenues (such as royalties, property 
rentals, and net trading gains on foreign currency, debt 
securities, derivatives, and similar instruments). 
 
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President Promises to Raise VAT to 12% 
-------------------------------------- 
 
5.  (U)  When signed and implemented, the Department of 
Finance (DOF) hopes to raise about 29 billion pesos ($535 
million) from the new VAT law during the second half of 
2005.  Full-year incremental revenues have been estimated 
at 58 billion pesos ($1.1 billion), assuming a VAT rate 
of 10%.  DOF officials told econoff that any one of the 
conditions to increase the VAT rate to 12% by 2006 was 
"easily achievable."  The Government registered a tax-VAT- 
to-GDP ratio of 2.9% during 2004, which the officials 
expected to improve further with the incremental revenues 
expected from the new VAT law during the second half of 
2005.  The National Government deficit during 2004 
equaled 3.9% of GDP and, although expected to improve 
during 2005, is not likely to decline to 1.5% of GDP 
during the year.  DOF officials estimate that increasing 
the VAT rate to 12% would boost incremental annual 
revenues to over 100 billion pesos ($1.8 billion). 
 
6.  (SBU)  In a statement following House passage of the 
revised VAT bill, President Arroyo promised to use her 
authority to increase the VAT rate to 12% in January. 
DOF officials noted that House Ways and Means Chair Jesli 
Lapus had stressed in bicameral committee meetings that 
the language stating that the President "shall" (versus 
"may") raise the VAT rate after specified conditions are 
met should be interpreted as a directive rather than an 
option.  Opposition legislators threatened to challenge 
the constitutionality of the provision for standby 
authority, arguing that this unduly delegated legislative 
powers to the President.  Finance officials and a member 
of the President's Legislative Liaison Office told 
econoff that the constitutional challenge was unlikely to 
succeed as there are precedents granting the President 
similar standby authority under the Philippines' National 
Internal Revenue Code. 
 
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Comment 
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7.  (SBU)  Although it took months longer than expected 
and morphed from a simple VAT rate increase to encompass 
many other taxes, the legislation is a critical step in 
the GRP's efforts to avert a fiscal crisis and restore 
its financial credibility.  After promising last July to 
increase annual revenue by 80 billion pesos ($1.5 
billion) from tax legislation, Congress has only passed a 
watered-down law to raise excise taxes on alcohol, 
cigarettes, and tobacco (ACT), and a law rewarding and 
punishing employee performance in revenue collection 
agencies.  The expected incremental revenues from these 
laws and the new bill could exceed 120 billion pesos 
($2.2 billion) starting in 2006, and could help the GRP 
achieve deficit-reduction targets sooner.  The GRP 
discarded the "no pass-through" to consumers on the 
electricity VAT, a provision that would have wiped out 
profits for power producers.  The increase in corporate 
income tax and staggered VAT input reimbursement may 
dissuade investors from coming or remaining.  By setting 
easy criteria to meet, the members of Congress running 
for re-election in 2007 will share the political costs of 
the VAT hike with President Arroyo.  Congress is expected 
to take up one last revenue-enhancement measure this year 
- the rationalization of fiscal incentives. 
 
Ricciardone