Leveling the Playing Field: Rationalizing Investment Tax Incentives Shortening the list of priority sectors in the IPP? Abolishing the BOI in favor of the PEZA? And other proposals that address the symptoms rather than the core of the problem To fix 2 overarching problems

Reforms need to address the core problems To minimize waste due to poor targeting (e.g. when not needed; when costs > benefits) To curb abusive practices whose primary purpose is to lower taxes for just a few taxpayers There is a need to change that way it is conferred, who confers it, and how performance is assessed after To fix 2 overarching problems

Un-complicating Investment Tax Incentives (ITI) reform ITI or fiscal incentives are special tax treatments conferred to entities in order to promote investments in specific activities (e.g. ITH, 5% GIE, double deduction for R&D, etc.) Is it an effective marketing tool? Is it a tax expenditure? Or perhaps it is both!

What is an “incentive”? Simply stated… We give an incentive to motivate someone to act in a way that we like These are the 2 conditions that make giving incentives worth it, otherwise it is not This should also be a guide to those granting fiscal incentives

Are these 2 conditions met? First – are fiscal incentives really what motivate registered firms to invest, in all instances? Or, is it profit? Second – definition of “we” is limited to just a subset, in practice limited to the DTI and IPAs.

Philippines Fiscal Incentives: published in the BESF All IPAs 2011 2012 2013 Number of firms 1,318 2,473 1,660 Growth 87% - 67% Source: DoF and DBM (BESF 2015, 2016) A few observations… Represents just a handful of firms with about 800 thousand SEC registered, and in the past an inclusive list of activities If the volatility is due to entry and exit from the ITI regime, then maybe this is a symptom of poor targeting? Or are firms simply remiss with their reports to tax authorities? Publication in BESF consistent with international good practice 800 thousand registered with SEC; 0.25% IPP includes Preferred activity (from green projects to mass housing to export manufacturing to loosely defined “Strategic Projects … with very high social economic returns”) Mandatory list Export activity

Philippines Fiscal Incentives: published in the BESF In Bn PhP 2011 2012 2013 Tax Expenditure 144.3 159.9 146.8 Ratio to GDP 1.5% 1.3% Source: DoF and BESF 2015, 2016 “flat” as a ratio to GDP despite fluctuating number of firms Equivalent to about PhP200 billion at present Not a trivial amount given that the NG deficit stood at PhP121 billion (1% of GDP) in 2015

FI policy in the Region is broadly similar, but execution is not Note: liberal definition of eligible sectors for all; but only PH has perpetual GIE tax and only PH has more than 2 implementing entities Incentives PH Thailand Indonesia Malaysia Vietnam Singapore Eligible sectors Sectors in IPP + ”pioneer”, exporters “Eligible industries form agri to manufacturing Pioneer industries (e.g. mining, oil, renewable, etc) Can opt for “pioneer” status or investment tax allowance High technology (research, IT, etc) Geographical regions Pioneer (manufacturing for global markets) Special Tax Treatment ITH For 3 – 8 years For 5 – 10 years For 2 – 4 years For 3 – 15 years VAT and Duty exemption on imports VAT and Duty exemption or reduced rates Limited application of VAT and Duty exemption Perpetual GIE tax (5%), liberal application of deductions 50% reduction in NTI for qualified investment for 5 yrs 30% reduction in NTI for qualified for 6 yrs Liberal application of deductions (e.g. double deduction for training, etc) 50% reduction on CIT rate after ITH for next 4 – 9 years 5 – 10% CIT for qualified investment Implementing arm 12 entities in total: BOI, PEZA, SBMA, CDC, CEZA + 7 more IPAs 2 entities: BOI and Industrial Estate Authority of Thailand (IEAT) 2 entities: BKMP and MoF (with veto power) 1 entity: Malaysian Investment Development Authority (MIDA) 1 entity: Foreign Investment Agency 1 entity: Economic Development Board

Philippines Fiscal Incentives: the problem of waste 12 PH entities conferring tax privileges, (mostly) independent from one another, with one purpose in mind – to promote investments “We” is incomplete unless these are also treated as tax expenditures

Philippines Fiscal Incentives: the problem of transfer pricing abuse Take 1 firm, X, with 2 activities: a “regular” activity where it pays 30% income tax, and a “special” activity where it pays the 5% GIE XR XS SalesR SalesS Less COGSR Less COGSS GIR GIS x 5% Less DdR Less DdS NTIR x 30% Dd NTI Abusive TP schemes may be used to shift deductions in order to lower taxes Tax Due =

This behavior occurs across all IPAs Source: FPI computations using data from DoF Note how deductions are much greater in the regular activity compared with exempt and special This resulted in a much lower “taxable base” for the same, by about half This behavior occurs across all IPAs 0.7% (sp) vs 2.1% (regular), otherwise is 4.5% for regular By shifting deductions, a firm can lower tax due by at least half

Lasting solutions that address the core problems With TIMTA (RA 10708) passed, we should now look to enact rules to manage FI more effectively, and to control abusive behavior. At minimum, this includes: Enacting a meaningful fiscal incentives rationalization (FIR) law Treats fiscal incentives as a tax expenditure Limits where benefit > cost and investments that need them Implements an effective re-capture provision Provides a sunset clause Defining “related parties” for the purpose of implementing tax laws, while strengthening regulations to minimize abuse