My problem with TRAIN 2

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Calixto V. Chikiamco


My problem with TRAIN 2

I have a full disclosure to make before I state my opinion on TRAIN 2 or the Tax Reform for Acceleration and Inclusion Package 2. I’ve been an owner for about 17 years now of a small Business Process Outsourcing (BPO) company. Unlike a call center where the output is voice, my BPO company’s output is music. It’s a digital musical services company that started offering ringtone production to companies all over the world (indeed, I had clients from the US, UK, Sweden, Mexico, South Africa, etc.) and then, when ringtone popularity waned with the advent of smartphones, pivoted to karaoke production for the Japanese market.

My company employs about 40 musicians in-house and outsources a portion to work-at-home musicians (including a veterinarian moonlighting as a midi arranger). We give steady income and provide benefits to musicians who otherwise face uncertain incomes from gig to gig. It’s a registered enterprise under the Philippine Economic Zone Authority (PEZA). It’s a 100% service exporter. We don’t do local. It’s all global.

We have had to overcome existential crises to be where we are now. One was the decline of ringtones, which we solved by shifting toward karaoke music production. The other was the steep appreciation of the peso relative to the Japanese yen when Abe started his quantitative easing. We had to solve it through innovations that increased productivity.

This business isn’t easy. High quality production depends on recruiting and training musicians with both musical and technical skills. Only one out of six applicants can make it through the rigorous process of screening and training. It may take as long as six months to train an arranger capable of meeting the exacting standards of Japanese karaoke music production. Creative people also tend to be restless. Even now, we still can’t expand because we can’t find enough qualified people.

My company is not an overgrown “baby” raking in fat profits as government officials would like to describe those enjoying tax incentives under PEZA. Even with the tax incentives, my ROE (return on equity) is less than 10%.

Aside from the tax incentives, I have had no help from government in building my company. In fact, government has only given us headaches, such as the imposition so many unnecessary holidays, mandating an increase in SSS contributions, and allowing a telecommunications duopoly to thrive and try to kill mobile content creators such as ourselves.

Now, on one hand you can say I’m biased against TRAIN 2 because I’ve a business to protect. On the other hand, you can say that I know whereof I speak. I’m not an ivory-tower economist. I know the responsibility of meeting payroll (early in my start-up years, even financing it from my credit card, but that’s another story.) Because my market is global, I know the responsibility of meeting clients’ exacting standards, no excuses allowed, not even holidays here. The business is not a gold mine, or I would have retired long ago, but I get the satisfaction of employing musicians trained and developed to be world-class, and it’s fun to be in a creative environment (We had seven bands in our last Christmas party formed by our own employees).

As a small BPO owner, my take on TRAIN 2 is that it commits the mistake of lumping the BPO industry with all the rest who have abused government tax incentives: Renewable Energy developers, mining companies, companies operating in PEZA zones but selling their goods domestically, telcos given BOI incentives, conglomerates doing social housing, etc.

Under TRAIN 2, existing BPOs as well as all those enjoying the 5% Gross Income Earned (GIE) incentives, will be forced to shift toward a 25% net income tax system (Under the Department of Finance version, it will be 25%; under the version of Rep. Dakila Cua, chairman of the House and Ways and Means Committee, the rate will be 20% but it will be phased in over a period of 10 years or a 1% reduction every year). This is bad for BPOs and bad for the economy. Why?

First, the shift will represent a shock to the industry, even if there could be a three-year transition period. The reason is that the BPO industry is currently facing headwinds in the form of constraints in the supply of a skilled work force and the emergence of Artificial Intelligence (AI) supplanting BPO jobs. BPOs would have to invest heavily in upskilling its work force to cope with the threats of AI and move toward more knowledge-based jobs.

Also, BPOs are already reeling from having to cope with government impositions that undermine its competitiveness, such as the 1% increase in SSS contributions and the declaration of so many holidays. Just this coming May, there will be the May 1 and the May 14 barangay election holidays. Congress is contemplating an Iglesia ni Kristo holiday to add to Chinese New Year and Islamic holidays Eid’l Fitr and Eid’l Adha.

Why should it matter that BPOs will be affected negatively by TRAIN 2? The BPO industry is vital to the Philippine economy as the largest earner of foreign exchange, OFW remittances aside, and is responsible for millions of jobs. Other industries like real estate and fast food are tied to its growth and health. The financial penalty of shifting from a 5% GIE to a 25% net income system will be large enough to discourage BPOs from growing their operations and encourage them to shift business elsewhere. Government can say that that remains to be seen, but can we afford the downside risk? This is a high-risk gamble that seems reckless.

Second, the shock to BPOs will be more than financial.

The 5% GIE is simple and easy to administer. Shifting to a net income system would make BPOs vulnerable to Bureau of Internal Revenue (BIR) harassment and erratic interpretation of tax laws. Transaction and accounting costs would rise. The Department of Finance’s own PowerPoint presentation says that the number one problem for foreign investors is an inefficient and corrupt bureaucracy, and not tax incentives. Are we to assume then that the corrupt and inefficient bureaucracy will disappear when TRAIN 2 becomes law, just as we are supposed to assume that an efficient Department of Transportation is perfectly implementing Build, Build, Build? Assuming efficient institutions is often a fatal flaw in economists’ models.

Third, TRAIN 2 will incentivize BPOs to either transfer jobs to other countries or game the system. BPOs are unique in that they operate almost entirely on the Internet. Therefore, job orders can immediately be transferred to other countries for some multinational BPOs. As the IT and Business Process Association of the Philippines (ITBPAP) leaders told me, TRAIN 2 will make Philippine BPOs 20% less cost competitive compared to India, and customers will flee.

More importantly, a net income system will incentivize BPOs to underinvoice their sales by routing their orders through third party companies in tax-friendly countries and leaving the profits in those countries. Again, because BPOs operate almost entirely through the Internet, BIR would none be the wiser.

Unlike manufactured goods that are tracked by customs authorities through ports, BPO services are very, very difficult to track. Here again, the government is assuming a competent and efficient BIR bureaucracy with the technical smarts and a global reach. Or, law-abiding BPOs may just abandon doing business in the country altogether. The additional revenue that the government is projecting by forcing BPOs to shift to a 25% net income system may be illusory.

Don’t get me wrong. I still support the rationalization of fiscal incentives. I support TRAIN 2’s objectives of leveling the playing field. I support the reduction in corporate income tax rates to 20% from 30%.

However, TRAIN 2 was crafted without studying the costs versus the benefits to the economy of maintaining the present 5% GIE for BPOs; without considering the large and vital role BPOs play as an earner of foreign exchange at a time when the economy is facing large and recurring trade and current account deficits; without considering the perverse incentive of TRAIN 2 toward creative transfer pricing; and without considering the weakness, corruption, and inefficiency of government institutions.

Pass TRAIN 2 but amend it.


Calixto V. Chikiamco is a board director of the Institute for Development and Econometric Analysis.