ABOUT two months ago, the weather bureau, PAGASA, officially announced the start of the rainy season. Despite sufficient warnings and precautionary measures by the government, these tropical cyclones often bring widespread damage to the country’s infrastructure, disrupt electricity and communication services, destroy crops, and leave behind human casualties.
Mitigating typhoon risks and managing rehabilitation efforts are the government’s primary concerns during calamities. These initiatives not only cost the government precious time and effort, but also consume significant quantities of public funds. It is therefore important for the government to collect taxes in order to raise enough calamity funds for emergency situations.
In the words of the late Justice Isagani A. Cruz, “Taxes are what we pay for a civilized society. Without taxes, the government would be paralyzed for lack of the motive power to activate and operate it. Hence, despite the natural reluctance to surrender part of one’s hard-earned income to the taxing authorities, every person who is able to must contribute his share in the running of the government. The government, for its part, is expected to respond in the form of tangible and intangible benefits intended to improve the lives of the people and enhance their moral and material values. This symbiotic relationship is the rationale of taxation and should dispel the erroneous notion that it is an arbitrary method of exaction by those in the seat of power.”
Nonetheless, majority of Filipino taxpayers see taxes as a burden. As a result, some taxpayers try to escape payment through tax evasion, while others use legal pathways to their own advantage by means of tax avoidance.
The academe, in various textbooks, has provided us with clear-cut distinctions between tax avoidance and tax evasion. In theory, tax avoidance is the legal means of reducing taxes. It is a tax-saving device within the bounds sanctioned by the law. On the other hand, tax evasion is outside of those lawful means and when availed of, it usually subjects the taxpayer to civil or criminal liability. Simply stated, tax avoidance is legitimate, while tax evasion is illegal.
Despite the legality of tax avoidance schemes, several countries have introduced a General Anti-Avoidance Rule (GAAR) to limit tax avoidance schemes and prevent the taxpayers from escaping taxation.
But what does a GAAR specifically prohibit? It prohibits aggressive tax avoidance by providing tax authorities with the power to deny the tax benefits from a transaction or arrangement that lacks commercial or economic substance and is deemed to have an illicit tax-related purpose.
Currently, Section 50 of the 1997 Tax Code is the closest our local laws have come to the GAAR adopted by foreign governments. Specifically, the provision empowers the Commissioner of Internal Revenue (CIR) with the authority “to distribute, apportion or allocate gross income or deductions between or among organization, trade or business, if he determined that it is necessary in order to prevent evasion of taxes or clearly to reflect the income of any organization, trade or business.” Note though that this provision is limited to those organizations, trades or businesses owned or controlled directly or indirectly by the same interests.
The Tax Reform for Attracting Better and High-quality Opportunities (TRABAHO) Bill proposes to expand Section 50 of the Tax Code and intends to augment the powers of the CIR. The draft bill aims to provide the CIR with the authority to:
• Impute income or deductions, if he deems it to be necessary to prevent evasion of taxes or to clearly reflect the income of any organization, trade or business;
• Disregard and consider “tax avoidance” transactions or arrangements as void for income tax purposes; and
• Adjust the taxable income of a person affected by a transaction or arrangement in a way that the CIR thinks appropriate to counteract a tax advantage obtained by the person from or under the arrangement.
The draft bill further enumerates the “tax avoidance” arrangements or transactions to include those which directly or indirectly: a) alter the incidence of any income tax; b) relieve a person from liability to pay income tax or from a potential or prospective liability to future income tax; or c) avoid, postpone, or reduce any liability to income tax, or any potential or prospective liability to future income tax.
Unacceptable tax avoidance exists in the aforesaid instances when such are motivated by obtaining a tax benefit or advantage with no commercial reality or economic effect, and the use of such would not have been the intention of the law. It is likewise worthy to note that the tax avoidance purpose or effect must not merely be incidental but is the primary purpose for entering the said transactions or arrangements.
Some may debate that the proposed GAAR seems to penalize what are known to be legal means of reducing taxes. It may also be argued that the proposed provision is prone to abuse as it gives the CIR extensive authority to punish taxpayers and impose additional taxes by merely contending that the transactions or arrangements entered into are considered “tax avoidance.”
Even so, the introduction of the GAAR will put the Philippines at par with neighbors like Singapore and Malaysia and may serve as a safeguard to thwart the incidence of unacceptable tax avoidance practices, especially for transactions which have illicit tax-related purposes.
With a GAAR scheme in place, it is prudent for our taxpayers to prepare sufficient proof (e.g., transfer pricing documentation, memoranda, among others) and justification to show that their transactions have commercial and economic substance and are not merely entered into for the purpose of avoiding the payment of taxes.
The views or opinions expressed in this article are solely those of the author and do not necessarily represent those of Isla Lipana& Co. The content is for general information purposes only, and should not be used as a substitute for specific advice.
Abigael Demdam is a Tax Manager at the Tax Services Department of Isla Lipana& Co., the Philippine member firm of the PwC network.
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