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The Tax Reform for Acceleration and Inclusion program proposed by the Department of Finance (DOF) is a very laudable initiative and should be strongly supported by the Philippine Congress. The major attractions of the package are the decrease in tax rates for corporations and for the middle-income households, who are the strong foundation of our consumption-driven economy and the more progressive approach to increasing the taxes on the higher-income households, on affluent consumption, and on highly profitable industries that no longer need tax incentives or subsidies. The reforms have to be taken in the context of a total approach to integral human development or sustainable and inclusive economic development which includes, among others, implementing the Executive Order on Freedom of Information; significantly cutting red-tape, increasing ease of doing of business, beginning with longer validity of passport and licenses; bringing down internet cost and/or raising internet speed; increasing coverage and benefits of PhilHealth; increasing amount of conditional cash transfer (4P program) coupled with training and livelihood programs; reducing traffic congestion and enhancing the railroad system; and addressing crime and drugs.
It is necessary, however, to identify a few exceptions to the general approach of removing tax incentives on industries or sectors already perceived as profitable in themselves without the incentives. I am referring to regional headquarters of multinational corporations (MNCs) that have decided to locate in the Philippines over the years since the Omnibus Investment Code was passed in 1987 (with the subsequent amendments) through Executive Order (EO) 226, which was enacted to encourage foreign investments into the country. Currently, there are 158 ROHQs in the Philippines with a combined US $2 billion in employee wages and benefits, employing over 50,000 workers. These ROHQs perform various high-level services that require above-average skills and provide above-average wages and salaries to professionals. These ROHQs have significant multiplier effects on other sectors of the economy because they engage local service firms for their operational support and project needs, giving rise to thousands of additional jobs of highly skilled workers.
The ROHQs have been attracted to locate in the Philippines through fiscal and non-fiscal incentives, including a preferential 10% tax on corporate income, exemptions from customs duties and local taxes, and a 15% preferential tax treatment (PTR) for employees occupying managerial and technical positions who earn a gross annual taxable compensation of at least Php 975,000. Under the tax reforms currently being considered by Congress, the DOF proposes to remove the 15% PTR. This removal of an incentive may be coming at a crucial time when MNCs are eyeing the ASEAN Economic Community as the next growth area that will be competing for foreign direct investments with the likes of China and India in the so-called Asian Century. When the legislators enacted the original law, their avowed intention was to make the Philippines “at par with other ASEAN countries granting the same privileges to regional operating headquarters operating in their countries” in view of the competition within the Asia Pacific region. The Philippines is already currently handicapped in this competition, especially as regards our peers like Vietnam and Indonesia, because of the many restrictions against foreign direct investments that are still enshrined in our Constitution. FDIs into these two countries over the last ten years have been anywhere from two to three times the annual flows experienced by the Philippines. The potential loss of this critical employee incentive coupled with the extreme difficulty of securing VAT refunds legally owed to the MNCs would further diminish significantly the attractiveness of investing in the Philippines.
The 15% Preferential Tax Treatment (PTR) given to middle-income employees (who are supposed to be the avowed beneficiaries of the tax reforms) has been very crucial to the operations of the ROHQs. This tax incentive, accorded to only select technical and managerial employees, has consistently been a weighty factor in attracting top Philippine talents whether locally or from abroad. It has also been critical in reducing the attrition rate in the employment of these talents who are very marketable and highly desired candidates for jobs overseas because of the regional/global flexibilities and business competencies they have developed. The 15% PTR is a major factor in motivating them to stay in the country, thus helping to attract the ROHQs to locate in the Philippines. It must be stressed that these ROHQs, being in the premier and high skilled segment of the service industry, cannot afford the high rate of attrition typical of outsourcing firms.
By retaining the PTR for these middle-level employees, the Tax Reform will reinforce its stated objective of giving relief to the middle-income Filipinos who have borne the brunt of taxes in the past. With the removal of all tax exemptions/deductions and the 15% PTR, workers in the ROHQs would suffer more than 10% reduction of their take-home pay, at least in the first year. It is estimated that the impact of the removal of the PTR incentive with an annual salary of Php 2 million is an increase in their Effective Tax Rate (ETR) to 25% vs their current ETR of less than 14%, which will lead to a 12% reduction in their take home pay during year one. Retaining the 15% PTR would not go against the objective of the DOF of achieving “efficiency, equity and simplicity” in the tax system. The reason is that only those employees earning more than Php 975,000 annually who are in technical managerial roles qualify for the incentive. It is actually more equitable to maintain the PTR in order to attract those top talents that will help move the industry up the value chain of ROHQ services. This point needs stressing since there is a serious threat that the lower-valued BPO services will be made redundant with increased automation and robotization. It is important for Filipino workers to upgrade their skills in the value chain of knowledge process outsourcing industry. The ROHQs are excellent training grounds for these higher-value services. For comments, my email address is email@example.com.