The government is losing an estimated P43 billion a year in tax leakages to firms that possibly exploit the country’s convoluted corporate income tax (CIT) system and abuse transfer pricing schemes, according to the Department of Finance (DOF).
Finance Undersecretary Karl Kendrick Chua said such projected tax losses are on top of the estimated P301 billion in foregone revenues in 2015 alone as a result of the surfeit of fiscal incentives given out by the government to big companies, many of them in the elite list of Top 1,000 corporations.
Briefing Finance Secretary Carlos Dominguez III on this issue during a recent DOF Executive Committee (Execom) meeting, Chua said that aside from taking advantage of the incentives given to them by 14 investment promotion agencies (IPAs), certain companies abuse the practice of transfer pricing to avoid paying the correct amount of taxes to the government.
Transfer pricing abuse refers to the corporate practice of shifting profits from high-tax jurisdictions in particular countries to tax havens in other places where they get to pay lower taxes or from certain corporations to their related businesses in the same country that is located in special economic zones (SEZs) that grant tax perks.
“Transfer pricing” can also happen when firms shift profits and costs between projects or activities within the same firm to cut their tax payments.
Chua explained that the abuse of transfer pricing schemes by certain firms is among the reasons the DOF is pushing for the congressional approval of CIT reforms, which aim to gradually reduce the CIT rate from 30 to 20 percent over a certain period while reorienting and fixing the government’s intricate incentives system for businesses.
In 2016, there were 3,102 corporations that were granted income tax incentives, of which 2,358 firms paid the special rate of 5 percent tax on gross income earned (GIE).
Because of the differentiated rate, these firms are able to pay a tax rate of just around 6 percent to 13 percent depending on the sectors they belong to, as opposed to regular corporations that paid the 30 percent tax rate, of which about 90,000 are small and medium enterprises (SMEs).
The regular CIT rate of 30 percent remains the highest among the Association of Southeast Asian Nations (ASEAN) economies.
Chua said the proposed reforms to corporate taxation comprise Package 2 of President Duterte’s comprehensive tax reform program (CTRP).
He said there are three possible types of transfer pricing abused by some corporations.
· international transfer pricing, in which profits are shifted from high-tax areas to low-tax jurisdictions;
· domestic transfer pricing, in which firms shift profits to related companies located in economic zones or to related parties enjoying tax incentives; and
· intra-firm transfer pricing or misallocation of profits and costs, which happens when a company with activities in different tax regimes manipulates revenues and costs to minimize their tax obligations.
Intra-firm transfer pricing abuse, Chua said, is done when a company manages to minimize its tax payments by shifting its declared profits under the regular 30 percent CIT regime to another business activity that was granted an income tax holiday (ITH).
A firm can also pad its direct costs with indirect costs to pay even lower taxes under a regime where it only gets to pay the 5-percent GIE tax, Chua said.
Certain favored companies, particularly those in SEZs, get to enjoy this special 5 percent forever under the current tax-incentives system.
Yet another abuse of intra-firm transfer pricing is when a company shifts its direct and indirect costs under the ITH regime to the regular 30 percent CIT to pad his liabilities under the latter and, thus, get to minimize tax payments.
A company can also transfer indirect costs under the 5 percent GIE regime to the regular CIT regime so that the latter can declare bigger deductions.
Intra-firm transfer pricing abuse can also take place when a company shifts its direct costs under the ITH regime to 5 percent GIE regime so that the latter can claim bigger deductions and pay lower taxes.
Estimates by the DOF and the Bureau of Internal Revenue (BIR) on tax leakages occurring from transfer pricing schemes covering the period from 2011 to 2015 show that the government lost some P25.9 billion in 2011, which rose to P36.5 billion in 2012, and slightly fell to P35.1 billion in 2013, but again grew to P40 billion in 2014 and to P42.7 billion in 2015, Chua said.
The DOF-BIR analysis of such tax leakages covered 1,318 firms in 2011, of which 206 were possibly engaged in abusive transfer pricing.
For 2015, the analysis covered 5,155 firms, of which 558 possibly abused the transfer pricing scheme to manipulate tax payments.
Earlier, the DOF estimated that the government gave away about P301 billion in revenues in 2015 alone as a result of tax incentives and other perks granted to only 2,844 firms.
Of this amount, foregone revenues were from the non-payment of income tax totaling P86.3 billion, customs duty incentives which account for P18.1 billion, and the gross amount of the import and local value added a tax of P196.8 billion.
The House of Representatives approved on third and final reading last Sept. 10 its version of Package 2 dubbed the Tax Reform for Attracting Better And High-quality Opportunities (TRABAHO) bill. The Senate is still discussing at the committee level its version of the bill dubbed the Corporate Income Tax and Incentives Reform Act, which is authored by Senate President Vicente Sotto III.
During his 3rd State of the Nation Address (SONA) last July, President Duterte asked the Congress to pass the CIT reform bill and the rest of the CTRP packages before the end of 2018.
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