First of four parts
A long period of uncertainty was ended after President Rodrigo R. Duterte signed Republic Act No. 11534, known as the Corporate Recovery and Tax Incentives for Enterprises (CREATE) Act on March 26.
The CREATE Act is said to be the first-ever revenue-eroding tax reform package and the largest economic stimulus program in the country’s history, with major amendments to our tax and incentives laws. With the pandemic continuing to negatively impact the business landscape, it is hoped that these changes will support post-pandemic recovery while attracting more foreign investment into the country.
In the first part of this four-part series, we discuss the passage and goals of the CREATE Act and how it reduces Corporate Income Tax (CIT).
IMPROVING THE EFFICIENCY OF THE TAX SYSTEM
Set to take effect on April 11, this legislation is part of the Comprehensive Tax Reform Program rolled out by the Duterte administration in 2017. After the passage of TRAIN Law in December 2017, the House of Representatives passed the Tax Reform for Attracting Better and Higher Quality Opportunities (TRABAHO) bill in September 2018. A year after it was transmitted to the Senate, the Senate renamed its version to the proposed Corporate Income Tax and Incentives Rationalization Act (CITIRA) bill.
Neither bill had seen the light of day when COVID-19 hit. To combat the pandemic, governments around the world imposed strict lockdown measures that led to the reduction of business operations or outright business closures. Extended lockdowns severely impacted the business community, leading the government to realign its priorities in response to the needs of the economy while simultaneously encouraging investor interest in the Philippines. With this in mind, CREATE was drafted to improve the equity and efficiency of the corporate tax system by lowering the tax rate, widening the tax base, reducing tax distortions and leakages, and developing a more responsive and globally-competitive tax incentives regime that is performance-based, targeted, time-bound, and transparent.
The House of Representatives and the Senate approved and passed different versions of the CREATE bill before deliberations by the Bicameral Conference Committee. On the last day of the 30-day period to act on the enrolled CREATE bill, the President signed it into law but vetoed certain provisions. These include the VAT-exempt threshold on the sale of real properties by real estate developers and the special corporate income tax incentive for domestic enterprises, among others.
REDUCTION IN CORPORATE INCOME TAX
As of 2020, the Philippines imposes the highest CIT rate at 30% in ASEAN, where the regional average is 23%. To address this, the CREATE Act lowers the CIT rate for domestic corporations (including one-person corporations) to 25% of the taxable income beginning July 1, 2020 while that for companies with total assets not exceeding P100 million and taxable income not exceeding P5 million is lowered to 20% of the taxable income. In valuing the P100 million threshold, we should note that the land on which the particular corporation’s office, plant and equipment are situated shall be excluded as the appreciation of its value may remove small businesses from the 20% bracket. This threshold shall be determined on a taxable year basis.
For resident foreign corporations (including branch offices), the CIT rate is lowered from 30% to 25% of the taxable income beginning July 1, 2020 while the interest income from a depository bank under the expanded foreign currency deposit system and gains from sale of shares not traded in the stock exchange received by the resident foreign corporations shall be taxed at 15%.
Regional operating headquarters are subject to 25% CIT beginning Jan. 1, 2022. However, they may apply for incentives under the CREATE Act. The CIT rate for non-resident foreign corporations is lowered from 30% to 25% of the gross income beginning Jan. 1, 2021.
With the lowering of the CIT rate, the non-allowable deduction for interest expense is likewise reduced from 33% to 20% of the interest income subjected to final tax. However, if the interest income tax is adjusted in the future, possibly in the tax reform package 4 or the proposed Passive Income and Financial Intermediary Taxation Act, the interest expense reduction rate may likewise be adjusted.
To compute the CIT due, corporations adopting calendar year ending Dec. 31, 2020 are to multiply the total annual taxable income by the effective rate of 27.5% (under the 25% CIT rate) or 25% (under the 20% CIT rate), whichever is applicable, for domestic corporations, and 27.5% for resident foreign corporations.
For corporations adopting fiscal years, the multiplier shall vary depending on the year ending. One way to compute the CIT due for those using fiscal years is to divide the total annual taxable income by 12 and multiply it by the number of months covered by the new rate. For example, for corporations with fiscal year ending March 31, 2021, the total annual taxable income shall be divided by 12 and the aggregate income from April 1, 2020 to June 30, 2020 is to be taxed at 30%, while the aggregate income from July 1, 2020 to March 31, 2021 will be taxed at 25% or 20%, whichever is applicable.
This was put in place to ensure that taxpayers do not resort to the allocation of income and expenses that will yield a lower tax due.
Since the CIT rate is reduced, a reduction of Expanded or Creditable Withholding Tax (EWT) rate should also follow suit to avoid any tax leakage. This will avoid a situation where the EWT tax due will be much higher compared to the income tax due of certain suppliers and hence, creating tax leakage. As a measure, the CREATE Act directs the Department of Finance (DoF) to revisit or amend EWT rules and regulations, including the tax rates, every 3 years.
An additional benefit in the form of a deduction from gross income is also provided under the CREATE Act wherein businesses are given an additional deduction of 50% of the value of labor training expenses incurred for skills gained by enterprise-based trainees enrolled in public senior high schools, public higher educational institutions, or public technical and vocational institutions covered by an Apprenticeship Agreement, provided they secure proper government certification and the additional 50% labor training expense deduction does not exceed 10% of the direct labor wage.
The CREATE Act also provides additional temporary relief to taxpayers beginning July 1, 2020 to June 30, 2023 by reducing the minimum corporate income tax from 2% to 1%, the CIT rate for proprietary educational institutions and non-stock and non-profit hospitals from 10% to 1%, and percentage tax from 3% to 1%.
The adjustments in CIT rates will not only support big businesses but will ultimately provide relief to micro, small and medium enterprises, which constitute 99.5% of the total business enterprises in the Philippines, employ 62.4% of the total labor force, and account for 35% of gross domestic product and 35.7% of economic value. While this tax reform package will reduce the government’s revenue, the DoF hopes that this will help revitalize businesses and consequently, create more jobs for workers who have been greatly affected by the pandemic.
While known for its skilled labor and professionals and relatively lower operating costs, the Philippines has unfortunately been left behind as investors tend to lean towards the more attractive fiscal system of our ASEAN neighbors. This recent development in our tax laws may be a good pull for foreign investors looking for more opportunities.
In the second part of this four-part series, we will discuss more effected changes: the exemption of foreign-sourced dividends, the repeal of improperly accumulated earnings tax, tax-free exchange, additional provisions to consider and provisions that were vetoed.
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.