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Cablegate: Supreme Court Upholds Expanded Vat Law

This record is a partial extract of the original cable. The full text of the original cable is not available.









E.O. 12958: N/A
SUBJECT: Supreme Court Upholds Expanded VAT Law

Refs: A) Manila 3061, B) Manila 2167, C) Manila 3163,

D) Manila 3154, E) Manila 2781, F) Manila 2879

Sensitive But Unclassified

1. (SBU) Summary: On September 1, the Philippine
Supreme Court upheld the legality of the Expanded Value
Added Tax (EVAT) law but has yet to lift the temporary
restraining order. The TRO that the Court issued on July
1 will remain in place for at least another fifteen days.
During that interval, parties who challenged the law may
appeal the Court's decision. Opposition lawmakers might
file such an appeal as a delaying tactic, but GRP
officials consider the chances of a Supreme Court
reversal slim. They expressed optimism that the GRP will
implement the revenue-raising measure within the fourth
quarter of 2005. Implementing the EVAT is critical to
GRP efforts to reduce the fiscal deficit and temper debt
accumulation while funding essential social expenditures
and infrastructure investment. End Summary.

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Supreme Court Upholds Amended EVAT Law

2. (U) On September 1, two months after it issued its
TRO (Ref A), the Philippine Supreme Court issued a
decision upholding the constitutionality and legality of
the EVAT (Ref B). The Court dismissed all five petitions
filed by opposition lawmakers and other parties
challenging this tax law.

But TRO Not Yet Lifted

3. (SBU) While favoring the GRP, the Supreme Court has
yet to lift the TRO that it issued on July 1 just a few
hours after the law went into effect. The Court
resolution stated that the TRO would be removed "upon
finality of herein decision." According to the usual
practice, the Court gave petitioners another fifteen days
within which to submit another appear based on new
arguments. GRP lawyers expect opposition lawmakers to
file an MOR at the last minute as a delaying tactic but
considered the likelihood of the Supreme Court reversing
its decision slim. They expressed optimism that the law
would be in effect by the fourth quarter of 2005.

Gives Ex-Finance Chief Slap on the Wrist

4. (U) In a separate decision, the Supreme Court cited
former Finance Secretary Purisima for "indirect contempt"
and ordered him to pay a fine of 20,000 pesos ($360).
The former DOF chief, one of ten Cabinet-level officials
who, on July 8, called for the President Arroyo to step
down (Refs C and D), had allegedly insinuated that the
Supreme Court may have been influenced by the President's
Office to issue the TRO and delay the EVAT's
implementation in order to hold off an unpopular tax at a
sensitive political time.

No Undue Delegation of Taxing Authority

5. (U) Addressing one of the most contentious
provisions raised by opposition lawmakers, the Supreme
Court upheld the standby authority granted to the
Philippine President to increase the EVAT rate from 10%
in 2005 to 12% by January 2006, subject to meeting any
one of two conditions. These conditions were 1) the
ratio of EVAT collections to GDP of the previous year
exceeds 2.8% or 2) the ratio of the government deficit to
GDP of the previous year exceeds 1.5%. Opposition
lawmakers had challenged the provision as an allegedly
unconstitutional delegation of tax authority reserved for
the Philippine Congress. Although there were a few
dissenting opinions, majority of the Supreme Court
Justices interpreted this standby authority as mandating
the President to increase the tax rate, rather than an
optional act by the President, if any one of the
stipulated conditions were met. GRP officials have
reiterated that President Arroyo will raise the EVAT rate
in 2006.

--------------------------------------------- ---
Petroleum and Electricity Firms May Pass On EVAT
--------------------------------------------- ---

6. (U) Majority of the Supreme Court Justices also
upheld the right of petroleum and electricity companies --
which will no longer be exempted from EVAT when it goes
into effect -- to pass on the tax burden to their
customers. The Justices noted that the EVAT, by its
nature, was a consumption tax. In their petition before
the Supreme Court, opposition lawmakers and other parties
had alleged that the Congressional bicameral conference
committee tasked to reconcile the House and Senate bills
had overstepped its jurisdiction by deleting the no-pass
through provision contained in both the bills passed by
the two houses of Congress.

--------------------------------------------- --
70% Cap On Input VAT Credits: GRP To Tweak IRRs
--------------------------------------------- --

7. (U) The business sector remains concerned about a
provision in the EVAT that imposes a 70% cap on input
EVAT credits that can be subtracted from output EVAT
payments during any taxable quarter (refs E and F).
Petroleum dealers had challenged this provision before
the Supreme Court, but a majority of the Justices voted
to uphold it. DOF officials maintain that this provision
was not initiated by the GRP and that the Government is
sympathetic to business sector concerns, particularly
high-volume but low-margin enterprises. Implementing
Rules and Regulations (IRRs) had postponed implementation
of this provision to December to give the DOF an
opportunity to seek a legislative amendment increasing
the 70% cap to 90% before that time.

8. 8. (SBU) Because of potential delays in the
legislative process, Finance Department Undersecretary
Emmanuel Bonoan -- who shepherded the amended EVAT law
through the Philippine Congress and helped defend it
before the Supreme Court -- told econoffs that the GRP
now plans to address the issue by "tweaking" the IRRs
towards a more business-friendly interpretation. The
current interpretation imposes the 70% cap whether or not
the input EVAT exceeds the output EVAT. The new
interpretation would impose the 70% cap only if the input
credits exceed the output tax (example below).

Current Revised
Interpretation Interpretation
Input EVAT 80 80
Output EVAT 100 100
Creditable Input VAT 70 80
Uncredited Input EVAT
For Carryover 10 0

--------------------------------------------- ---
EVAT: Fiscal Icing in 2005 But Critical in 2006
--------------------------------------------- ---

9. (U) The Government did not impute incremental
revenues from the EVAT law in the 2005 budget. If
implemented in early October, the GRP estimates raising
perhaps 10 billion pesos ($180 million) in 2005 from the
measure. Implementation becomes critical in 2006, when
the EVAT would boost revenues by 83 billion pesos ($1.5
billion) and keep the 2006 budget program on track. That
amount would represent about 1.4% of 2006 GDP; about half
of the targeted year-on-year expansion in tax
collections; and nearly 64% of the envisioned expansion
in cash disbursements.

10. (U) Implementing the EVAT law will also affect the
Government's goal of financing a larger budget (septel)
while keeping the fiscal deficit in check and tempering
the pace of debt accumulation. With the amended EVAT,
the GRP estimates that it will need to borrow 531.6
billion pesos ($9.5 billion) from domestic and overseas
capital markets during 2006, 7.8% (44.8 billion pesos)
less than in 2005, to plug the fiscal deficit and to
service principal payments on its debt obligations. It
hopes to reduce the ratio of its outstanding debts to GDP
to 63% by the end of 2006, from 72% in 2004 and 70% in

--------------------------------------------- ------------
Philippine Government Fiscal Program
--------------------------------------------- ------------

Billion Pesos Growth (%)
2004 2005 2006 2005 2006
Actual Program Proposal

REVENUES 699.8 783.2 968.6 11.9 23.7

Tax Revenues 598.0 706.2 874.3 18.1 23.8
% of GDP 12.6% 13.3% 14.6%

of which:
EVAT 0.0 0.0 83.0
% of GDP 0.0 0.0 1.4%

Nontax Revenues 101.8 77.0 94.3 -24.4 22.5

DISBURSEMENTS 886.8 963.2 1,093.5 8.6 13.5

SURPLUS/DEF -187.1 -180.0 -124.9 -3.8 -30.6
% of GDP -3.9% -3.4% -2.1%

--------------------------------------------- ------------
Source: Department of Finance


11. (SBU) Many economists, financial and investment
analysts, and credit rating officials welcomed the
Supreme Court decision on the Arroyo Administration's
centerpiece revenue-raising legislation. Militant
groups, however, have vowed to hold street protests. The
political opposition is likely to capitalize on this
alleged "anti-poor law" in the wake of soaring oil prices
to move forward its anti-Arroyo campaign. Meanwhile, the
GRP is working to beef up its public information drive,
stressing that the law is a bitter but necessary pill to
avoid the more disastrous effects of a fiscal crisis.
The Government's ability to curb corruption, fight tax
evasion, collect revenues efficiently, and improve the
delivery of Government services will come under
increasing scrutiny as it calls for further sacrifices in
the midst of economic and political challenges. The
government's track record in all of these areas has been
unimpressive. The revenue collection by the Bureau of
Internal Revenue did show modest improvement during the
last year under former BIR commissioner Parayno, but the
Philippines' tax to GDP ration still remains the lowest
in East Asia.


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