“The proposed value simplified tax system” by Mary Ann C. Capuchino (January 17, 2011)

SUITS THE C-SUITE By Mary Ann C. Capuchino
Business World (01/17/2011)

The new administration has unveiled plans and initiatives that will hopefully improve our country’s socioeconomic condition. But to sustain its plans, the government needs to ensure, among other things, a more efficient tax administration and collection to strengthen its financial condition.

12% VAT

Value-added tax (VAT) is the second largest source of tax revenues, next to income tax. While the present VAT system is generally perceived as better than the sales tax system that was in place more than two decades ago, abuses allegedly committed by some taxpayers in claiming tax credits and discretionary interpretations of certain provisions of the law have led to a significant reduction in actual VAT collections.

The VAT system operates on an output-input mechanism allowing taxpayers to offset input tax as credits against their output VAT liability. This means that companies with significant input tax credits can achieve zero VAT payable if their output tax is lower than their input tax credits. And then there are taxpayers who have been found to have overclaimed input tax credits, or claimed unsupported input tax credits. This is one of the loopholes of the VAT system which House Bill (HB) No. 3850 (authored by House of Representatives Ways and Means Committee Chairman and Batangas Rep. Hermilando Mandanas) seeks to address.

6% VAST under HB No. 3850

HB No. 3850 proposes to simplify the tax system and reduce discretionary interpretations of tax applicability. It seeks to replace VAT with the Value Simplified Tax system (VAST).

Primarily, HB No. 3850 proposes to:

• Reduce the tax rate from 12% to 6%;

• Retain all VAT exemptions;

• Increase exemptions to include retired armed forces, police, coast guard and customs police officers, as well as retired public school teachers who have served for 30 years, or less if retirement is due to injuries or sickness suffered while in the line of duty; in addition, the threshold for VAST-exempt sales will be increased for small vendors and sales/lease of real estate;

• Continue the 3% tax on sales amounting to P2.5 million and below;

• Repeal the input tax and presumptive input VAT; and

• Establish a framework to facilitate further reduction of the VAST rate through simplifications of the system and reduction of complicated and discretionary tax provisions.

Under the HB, enterprises will be subject to 6% VAST only if their annual sales exceed P2.5 million. Otherwise, they will be subject to just a 3% tax rate. For real estate transactions, VAST will apply only if the selling price is higher than the present VAT ceilings of P1.5 million for land and P2.5 million for house-and-lot units. Land sold for less than P2.5 million and house-and-lot units sold for less than P3.5 million will be exempt from the VAST.

If passed into law, the proposed VAST bill is expected to generate additional annual revenue of about P50 billion for the government.

At first glance, the reduction of the tax rate from 12% to 6% seems to favor taxpayers. However, because of the repeal of the input tax and presumptive input VAT provisions, there will be no more tax credits/deductions to offset the 6% VAST.

Registered taxpayers will always end up paying the full 6% VAST on their sales of goods, services and properties, which could significantly increase overall tax payments. This may lead to an increase in prices of goods, properties and services, as legitimate sellers are not precluded from passing the 6% VAST on the consumers.

The absence of allowable credits/deductions will make it easier for tax examiners to conduct examinations on taxpayers’ books of account, since their focus will be only on the proper taxable base and not on the substantiation of input tax credit/deductions claims. Moreover, the BIR’s docket will no longer be clogged with claims for refund or tax credit certificates for unutilized input VAT from zero-rated sales.

The bill states that necessary rules and regulations relative to unused tax credits shall be promulgated within 30 days from the effectivity of the proposed law. These credits will be allowed as a deduction from the gross income of the taxpayer in computing income tax for one year. But then, this will provide only a 30% tax benefit (equivalent to the present regular corporate income tax rate of 30%), compared to the 100% benefit under the VAT system. This loss of tax benefit from unused tax credits may not sit well with taxpayers with substantial input tax balances and with those who are in a tax loss position, as they will not enjoy any tax benefit from the deduction at all.

Another question is whether unused tax credits can be claimed as deduction if the taxpayer is subject to the 2% Minimum Corporate Income Tax (MCIT), since only direct costs can be deducted from gross income in computing MCIT. Considering further the one-year tax deduction claim period, can the unused tax credits form part of the taxpayer’s net operating loss carry over, which can be carried over to the next three years for purposes of computing the 30% regular corporate income tax?

People may easily view the VAST as a step backward, since it is similar to the old sales tax system. Most successful economies in the region, like Singapore, Korea, China and Indonesia, already operate under a VAT regime which includes an input-output mechanism and an audit trail in the counterchecking of taxpayers’ reported sales and purchases.

While the proposed VAST is seen to increase government tax take, Congress and the executive department will need to carefully determine its impact on consumers, taxpayers, and prices. As announced recently, the Department of Finance will thoroughly review this proposed legislation and is expected to submit its comments to Congress. In the end, the ultimate consideration should be what is good for the greater majority of the people.

(Mary Ann C. Capuchino is a Partner of SGV & Co.)

This article was originally published in the BusinessWorld newspaper. It is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co.