US embassy cable - 05MANILA5133

UNCLAS SECTION 01 OF 03 MANILA 005133 
 
SIPDIS 
 
Sensitive 
 
STATE FOR EAP/MTS 
STATE PASS USAID FOR AA/ANE and AA/G 
STATE ALSO PASS USTR AND OPIC 
TREASURY FOR OASIA - Meghtader 
 
E.O. 12958: N/A 
TAGS: EINV, PGOV, EFIN, RP 
SUBJECT: Clark Firms Mull Closure with Huge Tax Burden 
 
 
Sensitive but Unclassified - Not for Internet - Protect 
Accordingly. 
 
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