VZCZCXRO1998
OO RUEHCHI RUEHDT RUEHHM
DE RUEHML #3718/01 2490756
ZNR UUUUU ZZH
O 060756Z SEP 06
FM AMEMBASSY MANILA
TO RUEHC/SECSTATE WASHDC IMMEDIATE 2816
INFO RUEHZS/ASEAN COLLECTIVE IMMEDIATE
RUCPDOC/USDOC WASHDC IMMEDIATE

UNCLAS SECTION 01 OF 02 MANILA 003718 
 
SIPDIS 
 
SIPDIS 
SENSITIVE 
 
STATE FOR EAP/MTS SCHAUDHARY 
STATE PASS TO USTR FOR DKATZ 
USDOC FOR 4430/ITA/MAC/ SBERLINGUETTE 
 
E.O. 12958: N/A 
TAGS: ETRD EINV ECON RP
SUBJECT:  SENATE PLANS RADICAL REVISIONS TO INVESTOR INCENTIVES 
 
 
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SUMMARY 
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¶1.  (SBU) Following up on President Arroyo's 2004 promise to 
increase government revenue, the Philippine Congress is poised to 
reduce and reform investment incentives.  The Senate proposal under 
discussion draws from a USAID-funded study that recommends 
eliminating income tax holidays as inefficient and expensive. 
Foreign investors, including American companies, argue that 
incentives are needed to compensate for the risks and costs of doing 
business and complain that delayed refunds of tax payments may deter 
new investment.  END SUMMARY. 
 
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STREAMLINING INVESTMENT INCENTIVES 
---------------------------------- 
 
¶2.  (U) The Philippine Congress is poised at last to reduce and 
rationalize investor incentives - the final measure from President 
Arroyo's 2004 plan to increase government revenue.  The GRP 
presently gives reduced income tax rates to firms located in an area 
administered by the Philippine Economic Zone Authority (PEZA).  A 
PEZA firm may concurrently register with the Board of Investment 
(BOI) to qualify for income tax holidays.  Although certain 
incentives are reserved for exporters, the GRP has granted 
eligibility and special tax breaks to a wide array of domestic 
industries through 140 different laws.  According to a study funded 
by USAID, the GRP lost $21 billion in revenue from its incentives 
regime in 2004. 
 
¶3.  (U) The Lower House responded quickly to Arroyo's call for 
incentives rationalization by passing a bill in December 2004 
repealing some of the special incentives laws, but expanding income 
tax holidays.  Rather than streamlining the current incentives 
program, critics argue that the House proposal further complicates 
the system and will not result in increased tax revenue.  By 
contrast, the Senate bill recently released from the Ways and Means 
Committee chaired by Ralph Recto, repeals nearly all special 
incentives laws and consolidates and reconstitutes PEZA and BOI as 
the Philippine Investment Promotion Administration (PIPA).  Only 
exporters and enterprises located in 30 of the Philippines' poorest 
provinces would be eligible for incentives.  The Senate bill also 
eliminates income tax holidays and requires firms to pay value added 
tax (VAT) on imported materials and capital equipment.  Exporters 
can then apply for a refund of VAT paid on those imported materials 
if they can prove the materials were used to manufacture exports. 
New incentives in the Senate bill include reducing corporate tax 
rates to 15%.  The Senate bill includes a grandfather clause which 
allows investors to continue to enjoy current incentives until they 
expire. 
 
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INCENTIVES REDUNDANT AND EXPENSIVE 
---------------------------------- 
 
¶4.  (U)  The author of the USAID funded study, Professor Renato 
Recide, told Embassy officers that Senator Recto drew heavily from 
his research in drafting his bill although the change in VAT 
procedures goes beyond the measures he recommended.  Recide 
concluded that most incentives in the Philippines do little to 
attract incremental investment, and carry a high cost for 
government.  The majority of investors, especially those tapping 
domestic resources (e.g., mineral extraction industries) or 
appealing to a specific local market (telecoms) would choose to 
invest without incentives.  Foreign investors base investment 
decisions on many factors, including political and economic 
stability, transparency, and infrastructure.  When these factors are 
favorable, Recide argued, and the country's tax system is in line 
with international norms, incentives play a limited role if any in 
influencing an investor's decision. 
 
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GOVERNMENT CONCERNS 
------------------- 
 
¶5.  (SBU) Elmer Hernandez, Undersecretary for Investment at the 
Department of Trade and Industry (DTI), admitted to econoffs that 
the investment incentives regime is complicated and lacks a central 
authority.  Since incentives are managed by several agencies, DTI 
cannot track them to formulate policy, Hernandez added. 
Rationalization will bring transparency, he said, and that will 
improve the investment climate.  Nonetheless, Hernandez said, the 
Senate version is too hard on investment.  He speculated that 
Recto's priority is to raise revenue so he is less willing to grant 
incentives.  DTI is concerned Recto's bill would discourage new 
investment or drive away existing investors.  Hernandez said DTI 
 
MANILA 00003718  002 OF 002 
 
 
wants to work with Congress on a law that is investor friendly, 
streamlined, and with clear rules and regulations. 
 
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INVESTOR PERSPECTIVES 
--------------------- 
 
¶6.  (U) The Joint Foreign Chambers of Commerce issued a recent 
statement supporting reduced investment incentives but cautioned the 
GRP to retain the flexibility and authority to grant tax deductions 
for "strategic" investments.  The Chamber asked Congress to invite 
its members to Committee hearings and consult them on incentive 
reform plans.  Amcham members argue the Philippines needs incentives 
to compensate for the country's poor infrastructure, high power 
costs, and widespread corruption.  Major competitors in the region 
offering tax holidays include India, Thailand and Malaysia. 
 
¶7.  (U) The Semiconductor and Electronics Industries of the 
Philippines (SEIPI), which accounts for two-thirds of total exports, 
expressed particular concern about the Senate bill's change to the 
"zero VAT" system.  SEIPI members import over $1 billion in 
materials each year VAT-free.  Under the Senate bill, they must pay 
the VAT up-front and apply for refunds.  Many of the member 
companies have had other types of tax credit claims pending for over 
five years and expressed concern that the VAT refund procedure would 
be similar.  An Intel Corporation representative told Embassy 
officials this provision would cost the company tens of millions of 
dollars monthly.  Intel has cautioned the GRP that it, together with 
other electronic companies, may direct new investments to China if 
this provision is passed. 
 
¶8.  (U) The International Monetary Fund (IMF) strongly supports the 
elimination of many tax incentives.  Academic studies conclude that 
low corporate tax rates induce investment better than tax holidays. 
Preferred incentives also include accelerated depreciation and tax 
credits for capital investments.  The IMF rep told Embassy officials 
that not one company representative had told him incentives such as 
income tax holidays were an important part of their investment 
decision. 
 
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COMMENT 
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¶9.  (SBU)  The GRP's challenge is to implement tax reform 
legislation that increases revenue while improving the investment 
climate in the face of perceived political instability, corruption, 
inadequate infrastructure, and high power costs - not an easy task. 
 
JONES