US embassy cable - 05MANILA4112

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. 
 
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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. 
 
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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. 
 
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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. 
 
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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 
 
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Comment 
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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