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Cablegate: Senate Plans Radical Revisions to Investor Incentives

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
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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
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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
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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
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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

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