Second of four parts
Said to be the first-ever revenue-eroding tax reform package and the largest economic stimulus program in the country’s history, Republic Act No. 11534 or the Corporate Recovery and Tax Incentives for Enterprises (CREATE) Act was signed by the President on March 26. It amends our tax and incentives laws with the goal of helping businesses move into their post-pandemic recovery while encouraging foreign investment.
In the first part of this series, we discussed the passing and goals of the CREATE Act and how it reduces Corporate Income Tax. In this second part, we continue by discussing additional changes: the exemption of foreign-sourced dividends, the repeal of improperly accumulated earnings tax (IAET), tax-free exchange, additional provisions to consider and provisions that were vetoed.
EXEMPTION OF FOREIGN-SOURCED DIVIDENDS
To better compete within ASEAN, the CREATE Act adds a new provision on foreign-sourced dividends for domestic corporations with outbound investment. Generally, dividends received by domestic corporations from their subsidiaries abroad are subject to tax. This new provision states that these dividends are now exempt from income tax, provided that the domestic corporation directly holds at least 20% of the outstanding capital stock of the foreign subsidiary for at least two years at the time of dividend distribution. The funds must also be reinvested in the working capital, capital expenditure, dividend payments, investment in domestic subsidiaries, and infrastructure projects of the domestic corporation within the next taxable year from the time when the dividends were received. All these conditions must be met, otherwise the foreign-sourced dividends are subject to Philippine tax.
This falls within the objective of encouraging businesses — particularly domestic corporations — to reinvest in the Philippines all profits earned here and overseas to help our economy recover from the downturn caused by the pandemic.
REPEAL OF IMPROPERLY ACCUMULATED EARNINGS TAX
There will be no more IAET from 2021 onwards, which is great news for corporations that accumulate earnings beyond the reasonable needs of their business or paid-up capital. The imposition of IAET, ironically, compels the distribution of profits to investors or shareholders, or to repatriate the foreign investor’s money out of the Philippines instead of reinvesting or spending it locally. To address this, the CREATE Act now encourages investors to keep their money in the Philippines and potentially reinvest it in business expansion and generate employment.
Since the repeal does not provide any retroactivity, it will follow the general effectivity date of the CREATE Act. As such, any excess retained earnings in 2020 and prior years will still have to be dealt with by the taxpayers and be appropriated or declared as dividends. Otherwise, it will be penalized through the imposition of 10% IAET on excess retained earnings.
The CREATE Act now expressly provides that a prior Bureau of Internal Revenue (BIR) confirmatory ruling will not be required to avail of the tax exemption in the case of business reorganizations, including mergers or consolidations, further control, recapitalization, and reincorporation. It likewise reiterates the TRAIN Law provisions that the sale or exchanges of property used for business for shares of stock are exempt from VAT and any gain or loss may not be recognized for tax purposes. This, however, only defers the payment of taxes since any subsequent transfer/s will be subject to applicable taxes on a substituted-cost basis. This new provision will ultimately reduce the problematic and long-running backlog of the BIR.
One notable wording added to the CREATE Act is on “further control” under Section 40 (c)(2). It has put to rest the further control issue, a gray area in the past, by expressly stating that an exchange is tax-free when the “transferor or transferors, collectively, gains or maintains at least 51% of the total voting power of all classes of stocks entitled to vote of the issuing corporation.”
The CREATE Act includes more provisions surrounding exemption from VAT. Upon effectivity of the Act, the sale, importation, printing or publication of educational reading materials, including those in digital or electronic format not principally used for advertisements, are exempt from VAT. Additionally exempted beginning Jan. 1, 2021 are the sale of medicines for cancer, mental illness, tuberculosis, and kidney diseases. Moreover, the sale or importation of COVID-19 drugs, vaccines and medical devices, COVID-19 treatment drugs for use in clinical trials, and the capital equipment, spare parts and raw materials for the production of personal protective equipment components are exempt from Jan. 1, 2021 to Dec. 31, 2023.
The President vetoed the increase of the VAT-exempt threshold for the sale of real property by real estate developers, the 90-day period for the processing of general tax refunds, the definition of investment capital and the special corporate income tax incentive for domestic enterprises. Also vetoed were new incentives for same activity of existing registered enterprises, limitations on the power of the Fiscal Incentives Review Board, specific industries under the activity tiers, the power to exempt any investment promotion agency from the reform, and the automatic approval of applications for incentives.
With the veto of the VAT-exempt provision on sale of real property, the sale of house and lot and other residential dwellings with a selling price of more than P2 million, along with residential lots regardless of the selling price, shall continue to be subject to 12% VAT beginning Jan. 1, 2021 except those qualified as socialized housing (based on price ceilings set by the Housing and Urban Development Coordinating Council) which remain VAT-exempt, pursuant to the TRAIN Law.
Originally, Congress proposed to increase VAT-exempt thresholds to P2.5 million for the sale of house and lot and other residential dwellings, and to P4.2 million for the sale of residential lots which could have benefitted those who can actually afford proper housing. However, the President vetoed it to avoid potential revenue losses of about P155.3 billion.
REDEFINING PHILIPPINE TAXATION FOR RECOVERY AND INVESTMENT
The passage of CREATE is certainly welcome to aid businesses during these challenging times, while also serving as a sign to investors that the Philippines is a worthwhile investment destination. Government efforts to redefine Philippine taxation by developing more globally competitive tax incentives and improving the current corporate tax system through wider tax bases, lowered tax rates and reduced tax leakage will hopefully progress the economy further along the path of post-pandemic recovery.
In the third and fourth parts of this series, we continue our discussion on the CREATE Act by covering the rationalization of incentives.
This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the authors and do not necessarily represent the views of SGV & Co.
Karen Mae L. Calam And Aiza P. Giltendez are a Tax Senior Manager and Manager, respectively, of SGV & Co.