Value Added Tax: Its Impact in the Philippine Economy

Mr. Rico Peamante

Introduction Value added tax or VAT, was introduced less than 50 years ago and remained confined to a handful of countries until the late 1960s. Today, however, most countries impose VAT, which raises on the average about 25% of their tax revenues (International Monetary Fund). VAT was one of the most important fiscal innovations of the second half of the 20th century that largely replaced turnover taxes, a defective form of tax, with no relief for tax paid at previous stages. Here in the Philippines, it is a form of multistage sales tax on consumption levied on the sale, barter or exchange and/or lease of goods or properties and services in the Philippines and on importation of goods into the country.

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Why VAT for revenue generation? First, VAT is payable on a monthly basis. Second, VAT is superior to other sales or turnover tax in terms of progressivity, administration (thru third party confirmation) and efficiency that in turn will result to greater collection efficiency. As shown in past studies, VAT collections were consistently higher than would have been collected in other percentage tax system. For the period of 1988-2003 VAT collection were P98 Billion higher the old sales tax (percentage tax). Looking at the fiscal trends of 1997-2003, the national government (NG) budget imbalance went from a surplus of 0.1% of GDP in 1997 to a deficit of 4.7% in 2003.The consolidated public sector deficit (CPSD, including national & local government, 14 monitored GOCC, SSS and Banko Sentral ng Pilipinas) increased from 1% to 5.8% of GDP in 2003. The principal factors contributing to the swelling of the fiscal deficits are the sharp decline in tax effort by nearly 4.5 percentage points of GDP over 1997-2003, and the large losses of the National Power Corporation (NPC), which added 22% to the CPSD in 2003 alone. The prospects for 2005 and 2006, on the other hand, given the political context, the positive impact of different tax and other administrative measures, have yielded results. The outcome for the first half showed a steady progress towards fiscal consolidation. Total revenue grew by 12% in the first five months of 2005 supported by a significant rise in income tax revenues. This increase was almost twice the growth in expenditures of 6.5% and resulted in a decline in the national government deficit of P68 Billion. This figure is 12% below the 2004 fiscal deficit level. In 2004, the government adopted an aggressive and bold agenda to bring down fiscal deficit over the medium term. The plan centers on achieving balanced budget by 2010 through: Improved tax administration; New tax measures (including reform VAT); Privatization and restructuring of Government owned and controlled corporation (especially the power sector); Rationalized bureaucracy; Improved public debt and expenditure management;

The revival of tax collection and restoration of financial viability thru restructured tax administration will reform strategy to enhance tax collection. The passage of Value Added Tax Law amended 21 sections of National Internal revenue Code of 1997. These amendments involved expanded coverage of VAT that resulted in lifting the exemptions from VAT for some professionals, natural gas, coal, and petroleum products, and increased the VAT rate by 2% from February 2006, under certain
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conditions. The law also arise the corporate tax rate from 32% to 35% until 2008 and the enhanced coverage and rate of gross receipts tax on bank and non-bank financial intermediaries. If collected, it is expected to add additional revenue of 0.5 of GDP for 2005 and about 1.7% of GDP on a full basis in 2006.

Historical background of VAT in the Philippines It was first introduced in the Philippines in 1988 thru Executive Order number 273 replacing the following indirect taxes: Annual fixed taxes; Original sales tax on manufacturers and producers; Turnover tax on subsequent sellers; Advance sales tax; Compensating tax on importation of goods; Miller tax; Percentage tax on contractors, brokers, property/cinematographic films; Excise tax on certain articles;

lessors

of

personal

From 1996 to 2005, the following were the revisions to the Law: 1996: R.A. 7716 - Expanded VAT (EVAT) Law (inclusion of sales, barter, exchange or lease of intangible and real properties; and sale of services in the Philippines by a non-resident person); 1997: R.A. 8241 - Improved VAT (IVAT) Law (restoration of certain operators under the coverage of the common carriers tax) 1998: R.A. 8424 - Tax reform Act of 1997 2005: R.A. 9337 - Expanded VAT Act of 2005 The question on legality of VAT Despite the issues surrounding Republic Act No. 9337, the Supreme Court ruled on the new VAT laws constitutionality, and explained its reasons for resolving the matter. On September 1, 2005, the Supreme Court (SC) declared Republic Act (RA) No. 9337 (the new value-added tax, or VAT, law) as valid and constitutional. RA No. 9337 is projected to generate, for the government, additional revenues of PhP64.3 billion annually.

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In the five cases separately filed before the Supreme Court, petitioners claimed that RA No. 9337 is unconstitutional because of: Breach of constitutional procedures by the bicameral conference (Bicam) committee. The SC dismissed the petitions and upheld the constitutionality of RA No. 9337, based on the following: 1. The SC ruled that provision of RA No. 9337 on the Presidents standby authority to increase the VAT rate of 12% from the present 10% is not a delegation of legislative power. The principle of non-delegation of powers prohibits Congress from delegating what has been delegated to it- that is, those powers that are strictly, inherently, and exclusively legislative. Thus, Congress cannot abdicate its authority to make a complete law- complete as to time when it shall take effect and as to whom it shall be applicable- and to determine the expediency of its enactment. According to the SC, delegation is valid only if: (a) the law is complete in itself, setting forth the policy to be implemented by the delegate, and (b) it fixes a determinate and determinable standard, to which the delegate must conform. In this case, the Presidents standby authority to increase the VAT rate to 12% is not a delegation of legislative power but simply a delegation of ascertainment of facts upon which enforcement of the increased rate, under the law, is contingent. The legislature left the entire operation or non-operation of the 12% rate upon factual matters outside of the control of the Executive. It is mandatory and ministerial for the President to immediately impose the 12% rate beginning Jan. 1, 2006, as specified by Congress, upon the existence of any of the conditions set also by Congress. 2. The Presidents standby authority to increase the VAT rate of 12%, the 70% cap on input tax credit, and the 5% creditable VAT withholding on government transactions do not violate the constitutional policies on due process, equal protection of rights, and adoption of a uniform, equitable, and evolving progressive taxation. The SC ruled that the 12% VAT rate does not impose an unfair and unnecessary additional tax burden because the alternative conditions therefore are anchored on the principle of fiscal adequacy, thus: a. VAT/GDP ratio > 2.8%- If VAT/GDP is less than 2.8 %, it means that government has weak or no capability to implement the VAT, or the VAT is not effective in the function of tax collection. Hence, there is no value in increasing it to 12% because such action will also be ineffectual. b. National government deficit/GDP > 1.5%- The condition set for increasing VAT when the budget deficit is 1.5% or less means the fiscal condition of government
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has the reached a relatively sound position or is towards the direction of a balanced budget position. Thus, there is no need to increase the VAT rate. Otherwise stated, if the national government deficit/GDP ratio is more than 1.5%, there is a need to increase the VAT rate. The SC explained that the input tax is the tax paid by a person, passed on to him or her by the seller, when the person buys goods. Output tax is the tax due from the person when he or she sells goods. Three possible scenarios may arise in computing the VAT payable: a. If at the end of a taxable quarter the output taxes charged by the seller are equal to the input taxes that the seller paid to (as passed on to him or her by) his or her suppliers, then no payments is required. b. If the output taxes exceed the input taxes, the seller shall be liable for the excess, which has to be paid to the Bureau of Internal Revenue (BIR); and c. If the input taxes exceed the output taxes, the excess shall be carried over to the succeeding quarter/s. Should the input taxes result from zero-rated or effectively zero-rated transactions, any excess over the output taxes shall instead be refunded to the taxpayer or credited against other internal revenue taxes, at the taxpayers option.

Under RA No. 9337, however, a person can credit his or her input tax only up to 70% of the output tax. The Court clarified that a creditable input tax is not a property or property right within the constitutional purview of the due process clause, but merely a statutory privilege, which the State may change or take away by amendatory or superseding law. With respect to the 5% creditable VAT withholding imposed on payments made by the government for VAT-taxable transactions, the Court emphasized that such provision is only a method of collection for a simplified VAT withholding system. Equal protection clause requires equality among equals as determined according to a valid classification, that is, the grouping of persons or things similar to each other in certain particulars and different from all others in these same particulars. Here, Congress intended to treat differently taxable transactions with the government, and such is a valid classification.

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The Court also expounded that uniformity in taxation means that all taxable articles or kinds of property of the same class shall be taxed at the same rate. Different articles may be taxed at different amounts provided that the rate is uniform on the same class everywhere with all people at all times. RA No. 9337 uniformly provides a standard 0% or 10% (or 12%) rate on all goods and services. It does not distinguish as to the type of industry or trade that will bear the 70% limit, five-year amortization on capital goods, or the 5% creditable VAT withholding by the government.

The SC also reasoned that RA No. 9337 is equitable as it is equipped with threshold margins. The VAT rate of 0% or 10% (or 12%) does not apply to gross annual sales or receipts equal to or below PhP1.5 million.

Under RA 9337, basic marine and agricultural food products in their original state are still not subject to tax. Excise taxes on petroleum products and natural gas were reduced. Percentage tax on domestic carries was removed. Power producers are now exempt from paying franchise tax. Congress also increased the income tax rates of corporations from 32% to 35%.

Taxation is progressive when the rate goes up depending on the resources of the person affected. The Court yielded that the VAT is an antithesis of progressive taxation. By its very nature, it is regressive and, at the end of the day, it is really the lower income group or business with low-profit margins that is always hardest hit. But the Court noted that the Constitution does not prohibit the imposition of indirect taxes, like VAT. What it simply provides is that Congress shall evolve a progressive system of taxation.

Finally, the SC admitted that taxes are the lifeblood of the governmentThe Court is neither blind nor is it turning a deaf ear on the plight of the masses. But it does not have the panacea for the malady that the law seeks to remedy. As in other cases, the Court cannot strike down a law as unconstitutional simply because of its yokes.

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Nature of VAT Despite its name, VAT is not generally intended to be a tax on value added as such: rather it is usually intended as a tax on consumption. It is a tax on consumption levied on the sale of goods and services in the Philippines and imports of goods into the Philippines. A form of sales/percentage tax, a broad -based tax levied at multiple stages of production, with taxes on inputs creditable against taxes on output. The VAT is an indirect tax (Section 105 RA 9337) that may be shifted or passed on to the buyer, transferee, or lessee of the goods, properties, or services by the seller who is the one directly responsible for the payment of the tax. VAT employs the tax credit method whereby the VAT registered buyer is allowed to credit the amount of VAT (input VAT) spent on his purchases against the amount of VAT (output VAT) on his sale of goods and services. The VAT is collected on each sale of goods or properties or upon actual or constructive receipt of the consideration for services from the production throughout the different stages of distribution and culminating with the sale the customer.

Benefits of VAT imposition It is expected that upon implementation of reform VAT law (RA 9337), the government will be able to: Simplify tax administration and promote efficient tax collection and monitoring of tax payments by the Bureau of Internal Revenue (BIR) through the VAT sales invoice or VAT official receipts. Foster honesty in tax payment for businessmen will now demand accurate receipts from sellers to accumulate more input tax that can be credited against output tax payable. This gives rise to self-policing mechanism among the taxpayers. Generate higher revenues, because VAT system has a wider tax base. Promote national progress, for VAT system will support economic and public service infrastructure and will sustain economic growth to provide opportunity to foster global competitiveness of the Philippine export products and provide opportunity to build up the countrys dollar reserves; and Curve tax evasion, for VAT system encourages the issuance of receipts, which is necessary to accumulate input tax credits that will minimize output tax liability. The receipts will leave an audit trail or evidence for BIR monitoring purposes and effective tax administration.

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Person Liable to VAT A VAT person is an individual, trust, estate, partnership, corporation, joint venture or cooperative or association who makes or intends to enter into transaction subject to VAT. A person becomes taxable if he undertakes VAT taxable transactions in goods and services related in the course of his trade or business.

Transactions Subject to VAT The following are the transactions covered by reform VAT law; a. Transactions subject to 12% VAT 1. Sale of goods or properties such as but not limited to: Real properties held primarily for sale to customers or held for lease in the ordinary course of trade or business; The right or privilege to use patent, copyright, design or model, plan, secret formula or process, goodwill, trademark, trade brand or other like property or right; The right or privilege to use in the Philippines of any industrial, commercial or scientific equipment; The right or privilege to use motion picture films, tapes and discs; Radio, television, satellite transmission and cable television time; Specialty feeds for race horses, fighting cocks, aquarium fish, zoo animals and other animals generally considered as pets; Lubricating oil, processed gas, grease, wax and petroleum; 2. Importation of goods such as but not limited to: Any vehicle, vessel, aircraft, machinery and other goods for use in the manufacture and merchandise of any kind in commercial quantity;

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3. Transactions subject to 12% VAT (output tax) who can claim tax credits (input). Services and Use or Lease of Properties; Construction and service contractors; Stock, real estate, commercial, customs and immigration brokers; Lessors or distributors of cinematographic films; Persons engaged in milling, processing, manufacturing or repacking goods for others; Proprietors, operators or keepers of hotels, motels, rest houses, pension houses, inns and resorts; Proprietors or operators of restaurants, refreshments parlors, cafes, clubs and caterers; Lending investors; 4. Sale of services such as but not limited to: Transportation contractors of goods or cargoes, including persons who transport goods or cargoes for hire ands other domestic common carriers by land relative to their transport of goods or cargoes; Common carriers by air and sea relative to their transport of passengers, goods or cargoes from one place in the Philippines to an other place in the Philippines; Sales of electricity by generation companies, transmission, and distribution companies; Services of franchise grantees of electric utilities, telephone and telegraph, radio and television broadcasting, toll road operations and all other franchise grantees except non-life insurance companies; The lease or the use of or the right or privilege to use any copyright, patent, design or model, plan, secret formula or process, goodwill, trademark, trade brand or other like property or right; The lease or the use of, or the right to use of any industrial, commercial or scientific equipment; The supply of scientific, technical, industrial or commercial knowledge or information; The lease or the use of, or the right to use of any industrial, commercial or scientific equipment; The supply of scientific, technical, industrial or commercial knowledge or information; The supply of any assistance that is ancillary and subsidiary to and is furnished as a means of enabling the application or enjoyment of any such property; The supply of services by a non-resident person or his employee in connection with the use of property or rights belonging to or the installation or
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operation of any brand machinery or other apparatus purchased from such non-resident person; The lease or the use of or the right to use radio, television, satellite transmission and cable television time; The supply of technical advise, assistance or services rendered in connection with technical management or administration of any scientific, industrial or commercial undertaking, venture, project or scheme; The lease of motion pictures films, tapes and discs; Services rendered by doctors of medicine; Service rendered by lawyers; Sale of residential lot valued at more than one million five hundred thousand pesos (1,500,000); Sale of residential house and lot valued at more than two million five hundred thousand pesos (2,500,000); Lease of residential unit with a monthly rental of more than ten thousand pesos (10,000); Sale or lease of goods or properties or the performance of services other than the transactions mentioned, the gross annual sales and/or receipts amount to one million five hundred thousand pesos (1,500,000) and above. 5. Importation of goods

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Previously exempt transactions that are now subject to VAT: Sale of nonfood agricultural, marine and forest products in their original state by the primary producer or the owner of the land where the same are produced; Sale of cotton and cotton seeds in their original state; Sale or importation of coal and natural gas, in whatever form or state, and petroleum products; Sale and importation of raw materials to be used by the buyer or importer himself in the manufacture of petroleum products subject to excise tax; Importation of passenger and/or cargo vessels of more than five thousand tons (5,000), including engine and spare parts of said vessel to be used by the importer himself as operator; Sale by the artist himself of his work, literary works, musical compositions and similar creations or his services performed for the production of his works; Sale by electric cooperatives duly registered with cooperative development authority or national electrification administration, relative to the generation and distribution of electricity as well as their importation of machineries and equipment, including spare parts, which shall be directly used in the generation and distribution of electricity;

Zero-rated transactions Generally VAT transactions are subject to twelve percent (12%) tax impositions, however there are transactions that are subject to zero percent (0%) tax impositions such as; 1. Export sales such as but not limited to: The sale and actual shipment of goods from the Philippines to a foreign country, irrespective of any shipping arrangement that may be agreed upon which may influence or determine the transfer of ownership of the goods so exported and paid for in acceptable foreign currency or its equivalent in goods or services; Sale of raw materials or packaging materials to a nonresident buyer for delivery to a resident local export-oriented enterprise to be used in manufacturing, processing, packing or repacking in the Philippines for the said buyers goods and paid in acceptable currency; Sale of raw material or packaging materials to export-oriented enterprise whose export sales exceed seventy percent (70%) of total annual production;

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Sale of gold to the Bangko Sentral ng Pilipinas; Those considered export sales under executive order no. 226, otherwise known as the omnibus investment code of 1987; The sale of goods, supplies, equipment and fuel to persons engaged in international shipping or international air transport operations; Foreign Currency Denominated Sale; Sales to persons or entities whose exemption under special laws or international agreements to which the Philippines is a signatory;

2. Services performed in the Philippines by VAT-registered person as follows: Processing, manufacturing or repacking goods for other persons doing business outside the Philippines which goods are subsequently exported, where the services are paid for in acceptable foreign currency; Services rendered to a person engaged in business conducted outside Philippines or to a person not engaged in business who is outside the Philippines when the services are performed; Services rendered to persons or entities whose exemptions under special laws or international agreements to which the Philippines is a signatory to zero percent (0%) rate; Services rendered to persons engaged in international shipping or international air transport operations, including leases of property; 3. Services subject to zero percent VAT includes but not limited to; Performed by subcontractor and/or contractors in processing, converting, or manufacturing goods for an enterprise whose export sales exceed seventy percent (70%) of total annual production; Transport of passengers and cargo by air sea vessels from the Philippines to a foreign country (the input taxes shall be allocated ratably between his zero-rated and non-zero rated sales) Sale of power or fuel generated through renewable sources of energy such as, but not limited to, biomass, solar, wind, hydropower, geothermal, ocean energy, and other emergency energy sources using technologies such as fuel cells and hydrogen fuels

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VAT exempt transactions and VAT mitigating measures Despite the tax burden imposed by VAT, the law also provides for mitigating measures and exemptions such as: I. Mitigating measures; Reduction of excise tax rate on petroleum products 1. Regular gasoline from P4.80 to P4.35 2. Kerosene from P0.60 to P0.00 3. Diesel fuel from P1.63 to P0.00 4. Bunker fuel oil from P0.60 to P0.00 Removal of 2% franchise tax on electric utilities Deletion of 3% common carrier tax on local air and sea transport passengers 1. 2% excise tax on natural gas 2. Franchise tax on airline companies Adjustments of threshold amounts 1. Exemptions of sale of house and lots and residential dwellings value at P2.5 M and below 2. Exemptions of lease of residential units with monthly rental of P10,000 3. Exemption of marginal transaction with gross sales/receipts not exceeding P1.5 M. II. Transactions exempted from VAT; The following transactions shall be exempt from the VAT. Sale or importation of agriculture and marine food products in their original state such as but not limited to: 1. Rice, corn grits, raw cane sugar and molasses, ordinary salt and copra: 2. Fish, prawns, squid, shrimps, crabs, and other sea foods; 3. Chicken, pork, beef and other meat products 4. Vegetables 5. Fruits Sale or importation of fertilizers, seeds, seedlings, and fingerlings, fish, prawns, livestock and poultry feeds, including ingredients, whether locally produced or imported, used in the manufacture of finished feeds (except specialty feeds for race horses, fighting cocks, aquarium fish, zoo animals and other animals considered pets); Importation of personal and household effects belonging to the residents of the Philippines returning from abroad and nonresidents citizens coming to resettle in the Philippines: provided, that such goods are exempt from
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customs duties under the Tariff and Custom Code of the Philippines without creditable input; Importation of professional instruments and implements, wearing apparel, domestic animals and personal household effects belonging to the persons coming to settle in the Philippines for their own use and not for sale (except any vehicle, vessel, aircraft, machinery, other goods for use in the manufacture and merchandise of any kind in commercial quantity) -without creditable input; Services subject to Percentage Tax -without creditable input; Services by agricultural contract growers and milling for others of palay into rice, corn into grits and sugar cane into raw sugar -without creditable input; Medical, dental, hospital and veterinary services, such as -without creditable input: Hospital rooms, services and facilities (e.g. nursery, operating equipment and facilities) Laboratory services (e.g. x-ray) Educational services rendered by private educational institutions, duly accredited by DepEd, CHED, TESDA and those rendered by government educational institutions -without creditable input. Services rendered by individuals pursuant to an employer-employee relationship -without creditable input; Service rendered by regional or area head-quarters by multinational corporations which act as supervisory, coordinating centers or their affiliates or branches in the Asia-Pacific Region and do not earn or derive income from the Philippines -without creditable input; Transactions, which are exempt under international agreements to which the Philippines is a signatory or under special laws except P.D. 529 Petroleum Act of 1949 without creditable input; Sales by agricultural cooperatives to their members as well as sale of their produce to non-members, their importation of direct farm inputs, machineries and equipment, including spare parts thereof to be used directly and exclusive in the production and/or processing of their produce without creditable input; Gross receipts from lending activities by credit or multipurpose cooperatives without creditable input;

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Sale by non-agricultural, non-electric and non-credit cooperative duly registered with the Cooperative Development Authority; provided that the share of each member does not exceed fifteen thousand pesos (15,000) without creditable input; Export sales by persons who are not VAT-registered without creditable input; Sale of real properties not primarily held for sale to customers or held for lease in the ordinary course of trade or business or real property utilized for low-cost and socialized housing without creditable input; Sale of residential lots valued at not more than 1.5 million without creditable input; Sale of residential dwellings valued at not more than 2.5 million without creditable input; Lease of a residential unit with a monthly rental not exceeding ten thousand pesos (10,000) without creditable input; Sale, importation, printing or publication of books and any newspaper, magazine, review or bulletin which appears at regular intervals with fixed prices for subscription and sale without creditable input; Sale, importation or lease of passenger or cargo vessels and aircraft, including engine, equipment and spare-parts without creditable input; Importation of fuel, goods and supplies by persons engaged in international shipping or air transport operations without creditable input; Services of banks, non-bank financial intermediaries performing quasibanking functions, and other non-bank financial intermediaries without creditable input; Sale or lease of goods or properties or the performance of services other than the transactions mentioned in the preceding paragraphs, the gross annual sales and/or receipts do not exceed the amount of one million five hundred thousand p e s o s (1,500,000) without creditable input.

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How can VAT taxpayers ease the burden from VAT imposition? A person liable to VAT can avail as creditable input tax, which can be deducted from the output tax on sales. Any input tax evidenced by a VAT invoice or official receipt on the following transactions shall be creditable against the output tax. The following are creditable input tax transactions: Purchase or Importation of goods 1. For sale; 2. For conversion into or intended to part of an finished product for sale including packaging materials; 3. For use as supplies in the course of business; 4. For use as raw materials supplied in the sale of services 5. For use in trade or business for which deduction for declaration or amortization except automobiles, aircraft and yachts Purchase of services on which VAT has actually been paid. Transaction deemed sale Transitional Input Tax Presumptive Input Tax The input tax on domestic purchase or importation of goods or properties by a VAT-registered person shall be creditable: To the purchaser upon consummation of sale and in importation of goods or properties; To the importer upon payment of the VAT prior to the release of the goods from custody of the Bureau of Customs. The input tax on capital goods purchased or imported in a calendar months for use in trade or business for which deduction for depreciation is allowed, shall be spread evenly over the month of acquisition and the fifty-nine (59) succeeding months if aggregate acquisition cost for such goods, exceeds one million pesos (1,000,000). 1. If the estimate useful life of the capital goods is less than five (5) years as used for depreciation purposes, the input VAT shall be spread over such a shorter period. 2. If the depreciable capital good is sold/ transferred within a period of 5 years or prior to the exhaustion of the amortizable input tax thereon, the entire unamortized input tax on the capital goods, sold/ transferred can be claimed as inputs tax credit during the month/ quarter when sale or transfer was made subject to the rule on 70% cap.

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In case of purchase of services, lease or use of properties, the input tax shall be creditable to the purchaser, lessee or licensee upon payment of the compensation, rental royalty or fee. A VAT-registered person who is also engaged in transactions not subject to VAT shall be allowed tax credit as follows: 1. Total input tax which can be directly attributed to transactions subject to VAT; and 2. A retable portion of any input tax which cannot be directly attributed to either activity A person who becomes liable for VAT or any person who shall be allowed input tax on his beginning inventory of goods, materials and supplies equivalent to two percent (2%) of the value of such inventory or the actual VAT paid on such goods, materials and supplies, whichever is higher, which shall be creditable against the output tax. Person or firms engaged in the processing of sardines, mackerel and milk, and in manufacturing refined sugar, cooking oil and packed noodles-based instant meals, shall be allowed a presumptive input tax, creditable against the out put tax, equivalent to four percent (4%) of the gross value in money of their purchases of primary agricultural products which are used as inputs to their production.

VAT impact in the Philippine economy It is important to acknowledge that the government has signaled a strong commitment to fiscal consolidation by developing medium-term fiscal framework supported by submission and passage of a comprehensive new revenue bill, while pursuing continues expenditure management. The VAT legislation initiated the VAT implementation and reiterated its commitment to introduced increase in tax rate. Under this scenario, the government would manage to front load the fiscal adjustment as, cumulatively, the new revenue measures are likely to generate close to 1.8-2.0% of GDP.

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The Reform Value Added Tax Act 2005 raising the tax rate from 10% to 12% and removing some exemptions has already been put in effect. Let us take a look at the merits of the reform VAT with respect to its impact in our domestic economy and looming fiscal condition. Using input-output analysis, the economic impact of VAT Law demonstrated below:
Removed Exempt - 0.1 + 0.2 +13.8

GDP % of Change Inflation Rate Revenues VAT-Related Revenues Income Tax Total

+2% VAT - 0.3 + 0.5 +34.9

Total - 0.4 + 0.7 +48.7 9.0 +57.7

VAT Law Additional Revenues

Removal of exemptions 0 (zero)-Rating of outgoing airline passengers Lowering excise on petroleum products Adding exemptions Others Investment goods (subject to 5 year amortization) Seventy percent (70%) maximum input credit Total VAT system changes +2% VAT rate increase Increased corporate tax Total additional revenues 17.07 (3.21) (14.40) (1.54) (1.08) 10.00 6.00 13.84 34.90 9.00 57.74

Some individuals or groups continue to call for major amendments or even outright abolition of the reform VAT law. But looking into its advantages, there are good reasons why the government prefers this tax for revenue generation. It will increase tax collections from the period of its effectivity, since VAT is paid monthly. The potential additional revenues from increasing the VAT rate although were dissipated with the postponement at the beginning of the year were counter react with the tax revenues from the previously-exempted sources which were collected immediately from time of its imposition.

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I. VAT, in general terms is considered as superior than the percentage tax, in terms of tax rate, whereby percentage taxes range from two percent (2%) to ten percent (10%), while RVAT is twelve percent (12%). Considering its administration, the self-checking mechanism of VAT, the output tax of the seller will be the input tax of the buyer. Being a consumption tax, it is more efficient, less distortive and results to greater collection because of few exemptions. A study presented by the Department of Finance in the Senate hearing during its deliberation prior to its enactment into law, showed the relationship of sales/percentage taxes and VAT to some macroeconomic variables. The report revealed that starting 1993, VAT collections were consistently higher than would have been collected under the old sales/percentage system. Thus, for the period 1988-2003 VAT collections were P98 billion higher than the old sales/percentage tax system or some 20% over projected tax revenues. II. On the two percent (2%) increase, or from ten percent (10%) to twelve percent (12%). The President of the Philippines, upon the recommendation of the Secretary of Finance, exercised her standby power to increase VAT rate from ten percent (10%) to twelve percent (12%) effective February 1, 2006. As provided for under R.A. 9337: The VAT rate is retained at 10%. The President of the Philippines however has been conferred stand-by authority by Congress effective Jan. 1, 2006 to increase the VAT rate from 10% to 12% upon the recommendation of the Secretary of finance after any of the following conditions is satisfied: 1. Value Added Tax collection as a percentage of Gross Domestic Product (GDP) of the previous year exceeds two and fourth-fifths percent (2 4/5%); or 2. National Government Deficit as a percentage of GDP of the previous year exceeds one and one-half percent (1 1/2%) 3. The 2% VAT rate hike was effected beginning February 1, 2006 despite the opposition of many sectors in the society, saying revenue generation can be done through efficient tax collection (studies show that 30%-50% of VAT collection were wasted from VAT evasion and collection inefficiency, thus, what is not being collected is anywhere between P57 B to P95B) and not by imposing additional tax burden. Nevertheless, the potential gains are considerable enough to warrant changes with benefits, which are structural and long-term in nature. III. On the removal and retention of Exemptions

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The premise is that the more comprehensive the VAT collection is, the more efficient and effective it gets. Thus, there were exemptions that were removed and there were those, which directly affect the poor were kept. There are 26 types of exemptions and 5 zero-rated transactions. In most instances, these exemptions are not granted in the other 8 ASEAN countries.
Table of Removals of Vat Exemption Sector Sale or importation of coal, natural gas, and petroleum products Sale or importation of raw material used in the manufacture of petroleum products Importation of passenger/cargo vessels more than 5 tons Sales of cooperatives Sales, importation, printing or publication of books, newspapers and magazines Services rendered by doctors of medicine Services rendered by lawyers Sale of electricity by generation, transmission, distribution Sale/importation of non-food agricultural products, marine & forest products Sale of cotton, cotton seeds [& copra] Sale by the artist of his works of art, literary works, musical compositions Importation of personal and household effects (above a threshold) RVAT R R

R R (electric) E

R R R R

R R R

Note: R-Removed; E-Exempted

The first two items in the table were lifted from VAT exemption because according to Department of Energy, petroleum products taxes in the country are among the lowest as compared to our neighboring countries. Moreover, petroleum companies do not oppose removal of the exemptions. Exempting passenger/cargo vessels weighing more than 5,000 tons have no real basis for being exempt, except to lower the investment cost for these vessels. After all the cost is depreciated over some 20 years, so the annual cost impact is quite small.

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The exemption of all kinds of cooperatives under the old VAT law from VAT is to promote the cooperative movement, especially for agricultural products and rural communities. The exemption for electric cooperatives and the other types of cooperatives should be for small cooperatives. The exemption of books, newspapers and magazines was due to the adverse reaction by media when the R-VAT was passed. However, if at all any exemption is to be kept, it should cover only newspapers. There is no valid reason to exempt books and magazines. The retention of copra is recommended because it is an agricultural product that is nearly in its original state, and that a big chunk of the agricultural sector is reliant on the coconut industry. Importation of personal and household effects should be exempted only below a certain threshold or reasonable amount/value. Exemptions must be more at the retail level, to have the desired effect of lower prices of the exempt commodities. The farther the exemption is from the retail level, the opposite happens. Prices, in general, go up higher. This is because the exempted sector, which cannot claim input VAT on their VATable purchases will instead include their VAT paid on inputs as part of their expenses, and thereby raising their prices. The exemption of canned goods does not impact the poor sector. The marginalized sector tend to consume agricultural products in their original state or in dried form which is already VAT-exempt. Besides there are so many other canned goods that are not consumed by the poor. The same holds for instant noodles whose consumption is not limited to the poor. The poor ordinarily buy goods from public markets, or sari-sari stores. These are mostly VAT-exempt too.

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Conclusions In conclusion, VAT may be initially conceived as anti-poor. However, in a macro level, VAT is the bitter pill that we need to take to boost the sagging Philippine economy in the face of an expected 0.4% GDP cut, the 1.0% GDP increase in revenue and the additional inflation rate of 0.7% over two years. It is the governments intelligent, equitable and honest dispose over the peoples resources.

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References: Expanded Value Added Tax (RA 9337) PRIMER, Bureau of Internal Revenue Revised October 27, 2005 v.10.27.05 More Losses than Gains, Recent Economic Indicators (May 2005) UA & P, Short of Economics, pp.4-5 Republic Act 9337 : An Act amending sections 27, 28, 34, 106, 107, 108, 109. 110, 111, 112, 113, 114, 116, 117, 119, 121, 148, 151, 236, 237 & 288 of the national Internal Revenue Code of 1997 as amended, & for other purposes. Revenue & Regulation 16-2005 Bureau of Internal Revenue, Sept. 1, 2005 The economy on a cusp: The proposed VAT amendments and their larger significance, University of the Philippines School of Economics. Discussion Paper, E. de Dios, B. Diokno, E. Esguerra, R. Fabella, Ma. Bautista, F. Medalla, S. Monsod, E. Pernia, R. Reside, Jr., G. Sicat and E. Tan (March 2005) Supreme Court Looks Beyond the VAT Yoke, Jose A. Osana and Jean G. Pantaleon, The SGV Review, Vol3, No. 4 December 2005. VAT with conditions Huwag Taxsil project for the Department of Finance, Victor Abola & Leandro Tan (2005) VAT vs Sales & Percentage Taxes: Comparison of Effectiveness using Econometrics, Estelita C. Aguirre, 2005 (unpublished paper)

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