Restructuring our income tax system

The Duterte administration has taken a bold step in prioritizing to reform our two-decade-old tax system on its first year (not 100 days). Under the leadership of Finance Secretary Carlos Dominguez, the Department of Finance (DoF) proposed a comprehensive tax reform package to make our tax system simpler, fairer and more efficient.

One year after submitting package one of the tax reform bill called Tax Reform for Acceleration and Inclusion (TRAIN) to Congress, the Senate will now deliberate on their proposed version (SB 1592) which introduced amendments in the House version (HB 5636), to wit:

a. On personal income tax, exemption was lowered from P250,000 (HB 5636) to P150,000 but allowing additional exemption of P25,000 each up to 4 dependents. It also retained the maximum rate at 32% for those earning P2 million and above, which is lower than the House version’s ultra-rich rate at 35% for those earning P5 million and above;

b. On sugar tax, the Senate proposed a two-phased approach lowering the P10 per liter to P5 per liter for those with caloric sweeteners, P3 per liter for those with non-caloric sweeteners and P10/liter for those with high-fructose corn syrup in the first two years, and P0.05 per gram of sugar per drink in the succeeding years. SB 1592 also exempted milk products and 3-in-1 coffee;

c. On fuel tax, the Senate version lowered the proposed excise tax on petroleum from P3 per liter to 1.75 per liter in the first year and adopted a P1 per liter during the first 3 years for LPG;

d. On automobile tax, the Senate adopted the same 5-tier regime but still lower than the original proposal of DoF to impose a 200% excise tax for luxury cars (above P2.1 million net manufacturer’s price or importer’s selling price);

e. On value-added tax (VAT), the Senate retained the same VAT exemptions on raw food, health care, social housing, BPOs, senior citizens, PWDs, cooperatives and increased the VAT threshold from P1.5 million to P3 million.

To increase or decrease tax rates is a tax policy reform, but whether this will be collected correctly and on time is a matter of tax administration. The inefficiency of our tax system resulted in high tax rates, high compliance costs, and low compliance from a very narrow taxpayer base, especially from self-employed and professionals (SEPs).

The comprehensive tax reform must not disregard the fact that our tax administration, i.e., Bureau of Internal Revenue (BIR) and Bureau of Customs (BoC), needs an overhaul as well starting with exempting their personnel from salary standardization, implementing the Attrition Law, appropriating budget to automate and professionalize tax assessment, and collection of right taxes.

Ironically, DoF seems to be dismissing the importance of making two revenue agencies more efficient after they have reported that we can still collect at least P231 billion or equivalent of 2% of GDP if the P1.8 trillion importation gap or smuggling is resolved by BoC and additional P726 billion or 6.44% of GDP if we simplify, address inefficiencies and remove loopholes in BIR.

With the unresolved drug-related smuggling involving Customs officials and hundreds of pending tax evasion cases with the Department of Justice, including the pending cases of more than 400 erring BIR examiners, we may have to focus on the three main problems of our tax system: high tax rates, high compliance costs, and low compliance from a very narrow taxpayer base, especially from SEPs.

In our current tax system, more than 60% of our total revenue collections are from income tax payments followed by VAT at 20%. The goal is to shift toward 40% tax collections from indirect taxes by limiting VAT exemptions and broadening the taxpayer base for both income tax and VAT without increasing rates.

Here are some key strategies in restructuring our tax system:

1. Broadening taxpayer base. Increase registered employees from 13 million to 30 million; small and medium enterprises (SMEs) from 2 million to 5 million, licensed professionals from 200,000 to 2 million; and large corporations from 2,000 to 5,000 to broaden the income taxpayer base while limiting VAT exemptions to agriculture, health, banks, education and purchase of medicines by senior citizens and PWDs to expand VAT base.

2. Lower income tax for employees. Almost 20% of total collections are from withholding taxes from employees, representing more than 80% of contributions from individual taxpayers while the rest of SEPs conveniently under-declare or not report any income at all.

Further, only 20% of registered employees have more than P500,000 taxable compensation income, while 60% remain as minimum wage earners. It will make sense if we separate a graduated income tax table exclusive for employees (i.e., salary tax similar to Hong Kong), and focus on high value executives who should be declaring at least P2 million annual compensation income.

In view of this, increasing the income tax exemption to P250,000 is but necessary if we will limit this to employees. Removing the additional exemption for dependents will further promote ease in tax administration as all employees will be given P250,000 exemption. Companies can instead provide incentives for those performing employees with more dependents which will be covered by the increased P100,000 tax-exempt 13th month and bonuses.

3. Lower flat tax for start-ups and small businesses, and higher flat tax for licensed professionals. Given that this sector is the most noncompliant, we need to simplify taxation for them to encourage voluntary compliance and implement mandatory risk-based audit every 2 or 3 years.

For start-ups and small businesses with less than P5 million annual gross sales or less than P14,000 daily gross sales, a lower flat tax of 5% (in lieu of income and percentage tax) must be implemented. The goal is to encourage all sari-sari stores and other retailers in the informal economy to register their business. Caveat on the potential conflict with the existing income tax exemption as provided by the Barangay Micro Business Enterprise (BMBE) Law which does not include a cap on gross sales but instead qualify any business with P3 million or less in total assets or capital.

For licensed professionals, a higher flat tax of 15% (in lieu of income tax and VAT) owing to the fact that they have higher margin or lower costs. This can be payable quarterly to encourage voluntary compliance with simplified bookkeeping requirements.

4. Fixed personal and corporate income rate. Whether a sole proprietor or an incorporated enterprise other than those classified as small businesses, a standard 25% income tax rate should be imposed with 40% optional standard deduction as default method (or 15% effective rate similar to licensed professionals, except that non-small business will still have to pay 12% VAT). Those who will opt the itemized deduction will have to submit their company for audit.

5. Rationalize fiscal incentives. This has been long overdue. We need more political will to cut tax holidays of big foreign corporations that are unnecessarily enjoying incentives while local startups are burdened by high tax rates and costly tax compliance requirements.

6. Automate business registration, tax compliance, and risk-based audit. We have less than 3,000 BIR examiners who will never get to audit more than 15 million registered taxpayers and 2 million SMEs. Large taxpayers must be the priority, subject to a risk-based audit per industry.

7. Incentivize honest tax payment. Let’s support the campaign of BIR Commissioner Caesar Dulay in instituting a culture of honesty and integrity in the BIR and in paying taxes in the country. In pursuit of this, he issued RMC 60-2017 to officially launch the Seal of Honesty Certification Program to encourage voluntary compliance without penalties and compromises. Taxpayers, individuals, and corporations alike, who will be awarded the seal will not be included in the priority audit. For more details, visit www.sealofhonesty.ph.

(The article reflects the personal opinion of the author and does not reflect the official stand of the Management Association of the Philippines or the M.A.P.)

Popularly known as the Philippine Tax Whiz, Raymond A. Abrea is one of the 2016 Outstanding Persons of the World, one of the 2015 The Outstanding Young Men of the Philippines (TOYM), and founder of the Abrea Consulting Group and Center for Strategic Reforms of the Philippines (CSR Philippines). He currently serves as Adviser to the Commissioner of Internal Revenue of the Philippine government on tax administration reform in promoting inclusive growth.

Twitter (@askthetaxwhiz) or visit his Facebook page.

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