April 2021 Articles - Suits the C-Suite | SGV & Co. | EY

26 April 2021

Karen Mae L. Calam-Ibañez And Aiza P. Giltendez

Redefining Philippine Taxation: CREATE (Third part)

Third of four partsRepublic Act No. 11534, also known as the Corporate Recovery and Tax Incentives for Enterprises Act (CREATE), is said to be the first-ever revenue-eroding tax reform package. The largest economic stimulus program in the country’s history, it provides major amendments to our tax and incentives laws with the goal of helping businesses move into post-pandemic recovery while encouraging foreign investments into the country. The law took effect on April 11, 2021.The first and second parts of this four-part article discussed the passage and goals of the CREATE Act, as well as the exemption of foreign-sourced dividends, the repeal of improperly accumulated earnings tax, tax-free exchange, additional provisions to consider and provisions that were vetoed.We continue by discussing the second salient feature of the CREATE Act: the codification and rationalization of Fiscal Incentives. In this third part, we cover the nature of incentives before CREATE, their centralization and administration, and how they are now more performance-based and targeted.INCENTIVES BEFORE CREATEThe Department of Finance (DoF) had long since been pushing for tax reform and the rationalization of fiscal incentives to improve governance in the grant of incentives and promote a fair and accountable incentive system that is performance-based, targeted, time-bound and transparent.Before the passage of CREATE, the various Investment Promotion Agencies (IPAs), such as the Philippine Economic Zone Authority (PEZA), Board of Investments (BoI), Bases Conversion and Development Authority (BCDA), Clark Development Corp. (CDC), and Tourism Infrastructure and Enterprise Zone Authority (TIEZA), administered their own investment regimes to registered business enterprises (RBEs) within their purview. In granting incentives, these IPAs exercised wide discretion, which allegedly resulted in detrimental and economically damaging competition among the IPAs.As ASEAN integration progresses, a regional comparison of tax incentives becomes more relevant. Pre-CREATE, it was indisputable that the scope of tax incentives in the Philippines was far more generous than the rest of ASEAN. The Philippines appears to be the only ASEAN country that grants incentives in perpetuity. The perpetual grant of incentives, which is believed not to have attracted the commensurate new investments, expansion projects or measurable economic contributions, may have discouraged growth and resulted in tax leakages or foregone revenue (estimated at P441 billion in 2017).By adopting a uniform policy and offering a single menu of incentives, the government hopes to cut down on redundancy and lost revenue.CENTRALIZATION OF INCENTIVES IN THE FIRBThe consolidation of IPAs into one centralized agency has been long proposed in order to centralize the promotion and administration of incentives in a single agency, consistent with international best practice.In a nutshell, CREATE centralized the oversight of the grant of incentives in the Fiscal Incentives and Review Board (FIRB). The primary role of the FIRB is to exercise policymaking and oversight functions on all RBEs and IPAs. As such, under CREATE, it is the FIRB that will, among other expanded functions, have the power to approve or disapprove the grant of fiscal incentives upon the recommendation of the IPA. The FIRB shall meanwhile delegate the grant of tax incentives to the IPA for investment projects involving P1 billion and below, though the President has clarified that the power of the IPAs to grant incentives only stems from a delegated authority from the FIRB. The FIRB is authorized to check whether the incentives granted by the IPAs conform with the intent to modernize the incentive system. The threshold, nonetheless, may be increased by the FIRB in the future.Consistent with the declared policy to approve or disapprove applications on merit, the provision granting automatic approval of applications with complete documentary requirements within 20 days of submission was vetoed by the President, who said that there are other mechanisms to address inaction in the approval process.TARGETING OF INCENTIVESCodifying the longstanding intention to make incentives performance-based and targeted, CREATE categorized RBEs into export enterprises, which export at least 70% of their total production or output directly or indirectly; and domestic market enterprises (DMEs). The President vetoed provisions further categorizing DMEs into those that are engaged in activities classified as “critical” by the NEDA, and those with a minimum investment capital of P500 million.Determining the availment period for incentives will be based on both the location and industry of the registered project or activity. This also includes other relevant factors as may be defined in the Strategic Investment Priorities Plan (SIPP), which is currently being worked on by various government agencies in consultation with the private sector.Location is prioritized according to the level of development such that activities in areas outside or not adjacent to the National Capital Region (NCR) or other metropolitan areas can avail of longer incentive periods.Meanwhile, the industry tiering of the registered project or activity is prioritized according to the national industrial strategy specified in the SIPP. We should note that the President vetoed the enumeration of specific industries in the CREATE Act to keep the law flexible enough to meet changing needs. As such, the activities and projects that may qualify should not be hardwired in the law so that the government does not keep on incentivizing obsolete industries and close its doors to technological advances and industries of the future.With the targeted grant of incentives, the government hopes to attract the right kind of investors to do business in the country, particularly those that offer quality jobs and technology transfer, and can introduce new industries that would allow the economy to flourish.In the fourth and final part of this article, we cover the periods of availment and the kind of incentives registered enterprises may enjoy.This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the authors and do not necessarily represent the views of SGV & Co.Karen Mae L. Calam-Ibañez And Aiza P. Giltendez are a Tax Senior Manager and Manager, respectively, of SGV & Co.

19 April 2021

Karen Mae L. Calam And Aiza P. Giltendez

Redefining Philippine Taxation: CREATE (Second part)

Second of four partsSaid to be the first-ever revenue-eroding tax reform package and the largest economic stimulus program in the country’s history, Republic Act No. 11534 or the Corporate Recovery and Tax Incentives for Enterprises (CREATE) Act was signed by the President on March 26. It amends our tax and incentives laws with the goal of helping businesses move into their post-pandemic recovery while encouraging foreign investment.In the first part of this series, we discussed the passing and goals of the CREATE Act and how it reduces Corporate Income Tax. In this second part, we continue by discussing additional changes: the exemption of foreign-sourced dividends, the repeal of improperly accumulated earnings tax (IAET), tax-free exchange, additional provisions to consider and provisions that were vetoed.EXEMPTION OF FOREIGN-SOURCED DIVIDENDSTo better compete within ASEAN, the CREATE Act adds a new provision on foreign-sourced dividends for domestic corporations with outbound investment. Generally, dividends received by domestic corporations from their subsidiaries abroad are subject to tax. This new provision states that these dividends are now exempt from income tax, provided that the domestic corporation directly holds at least 20% of the outstanding capital stock of the foreign subsidiary for at least two years at the time of dividend distribution. The funds must also be reinvested in the working capital, capital expenditure, dividend payments, investment in domestic subsidiaries, and infrastructure projects of the domestic corporation within the next taxable year from the time when the dividends were received. All these conditions must be met, otherwise the foreign-sourced dividends are subject to Philippine tax.This falls within the objective of encouraging businesses — particularly domestic corporations — to reinvest in the Philippines all profits earned here and overseas to help our economy recover from the downturn caused by the pandemic.REPEAL OF IMPROPERLY ACCUMULATED EARNINGS TAXThere will be no more IAET from 2021 onwards, which is great news for corporations that accumulate earnings beyond the reasonable needs of their business or paid-up capital. The imposition of IAET, ironically, compels the distribution of profits to investors or shareholders, or to repatriate the foreign investor’s money out of the Philippines instead of reinvesting or spending it locally. To address this, the CREATE Act now encourages investors to keep their money in the Philippines and potentially reinvest it in business expansion and generate employment.Since the repeal does not provide any retroactivity, it will follow the general effectivity date of the CREATE Act. As such, any excess retained earnings in 2020 and prior years will still have to be dealt with by the taxpayers and be appropriated or declared as dividends. Otherwise, it will be penalized through the imposition of 10% IAET on excess retained earnings.TAX-FREE EXCHANGEThe CREATE Act now expressly provides that a prior Bureau of Internal Revenue (BIR) confirmatory ruling will not be required to avail of the tax exemption in the case of business reorganizations, including mergers or consolidations, further control, recapitalization, and reincorporation. It likewise reiterates the TRAIN Law provisions that the sale or exchanges of property used for business for shares of stock are exempt from VAT and any gain or loss may not be recognized for tax purposes. This, however, only defers the payment of taxes since any subsequent transfer/s will be subject to applicable taxes on a substituted-cost basis. This new provision will ultimately reduce the problematic and long-running backlog of the BIR.One notable wording added to the CREATE Act is on “further control” under Section 40 (c)(2). It has put to rest the further control issue, a gray area in the past, by expressly stating that an exchange is tax-free when the “transferor or transferors, collectively, gains or maintains at least 51% of the total voting power of all classes of stocks entitled to vote of the issuing corporation.”ADDITIONAL PROVISIONSThe CREATE Act includes more provisions surrounding exemption from VAT. Upon effectivity of the Act, the sale, importation, printing or publication of educational reading materials, including those in digital or electronic format not principally used for advertisements, are exempt from VAT. Additionally exempted beginning Jan. 1, 2021 are the sale of medicines for cancer, mental illness, tuberculosis, and kidney diseases. Moreover, the sale or importation of COVID-19 drugs, vaccines and medical devices, COVID-19 treatment drugs for use in clinical trials, and the capital equipment, spare parts and raw materials for the production of personal protective equipment components are exempt from Jan. 1, 2021 to Dec. 31, 2023.VETOED PROVISIONSThe President vetoed the increase of the VAT-exempt threshold for the sale of real property by real estate developers, the 90-day period for the processing of general tax refunds, the definition of investment capital and the special corporate income tax incentive for domestic enterprises. Also vetoed were new incentives for same activity of existing registered enterprises, limitations on the power of the Fiscal Incentives Review Board, specific industries under the activity tiers, the power to exempt any investment promotion agency from the reform, and the automatic approval of applications for incentives.With the veto of the VAT-exempt provision on sale of real property, the sale of house and lot and other residential dwellings with a selling price of more than P2 million, along with residential lots regardless of the selling price, shall continue to be subject to 12% VAT beginning Jan. 1, 2021 except those qualified as socialized housing (based on price ceilings set by the Housing and Urban Development Coordinating Council) which remain VAT-exempt, pursuant to the TRAIN Law.Originally, Congress proposed to increase VAT-exempt thresholds to P2.5 million for the sale of house and lot and other residential dwellings, and to P4.2 million for the sale of residential lots which could have benefitted those who can actually afford proper housing. However, the President vetoed it to avoid potential revenue losses of about P155.3 billion.REDEFINING PHILIPPINE TAXATION FOR RECOVERY AND INVESTMENTThe passage of CREATE is certainly welcome to aid businesses during these challenging times, while also serving as a sign to investors that the Philippines is a worthwhile investment destination. Government efforts to redefine Philippine taxation by developing more globally competitive tax incentives and improving the current corporate tax system through wider tax bases, lowered tax rates and reduced tax leakage will hopefully progress the economy further along the path of post-pandemic recovery.In the third and fourth parts of this series, we continue our discussion on the CREATE Act by covering the rationalization of incentives.This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the authors and do not necessarily represent the views of SGV & Co. Karen Mae L. Calam And Aiza P. Giltendez are a Tax Senior Manager and Manager, respectively, of SGV & Co.

12 April 2021

Karen Mae L. Calam And Aiza P. Giltendez

Redefining Philippine Taxation: CREATE (First part)

First of four partsA long period of uncertainty was ended after President Rodrigo R. Duterte signed Republic Act No. 11534, known as the Corporate Recovery and Tax Incentives for Enterprises (CREATE) Act on March 26.The CREATE Act is said to be the first-ever revenue-eroding tax reform package and the largest economic stimulus program in the country’s history, with major amendments to our tax and incentives laws. With the pandemic continuing to negatively impact the business landscape, it is hoped that these changes will support post-pandemic recovery while attracting more foreign investment into the country.In the first part of this four-part series, we discuss the passage and goals of the CREATE Act and how it reduces Corporate Income Tax (CIT).IMPROVING THE EFFICIENCY OF THE TAX SYSTEMSet to take effect on April 11, this legislation is part of the Comprehensive Tax Reform Program rolled out by the Duterte administration in 2017. After the passage of TRAIN Law in December 2017, the House of Representatives passed the Tax Reform for Attracting Better and Higher Quality Opportunities (TRABAHO) bill in September 2018. A year after it was transmitted to the Senate, the Senate renamed its version to the proposed Corporate Income Tax and Incentives Rationalization Act (CITIRA) bill.Neither bill had seen the light of day when COVID-19 hit. To combat the pandemic, governments around the world imposed strict lockdown measures that led to the reduction of business operations or outright business closures. Extended lockdowns severely impacted the business community, leading the government to realign its priorities in response to the needs of the economy while simultaneously encouraging investor interest in the Philippines. With this in mind, CREATE was drafted to improve the equity and efficiency of the corporate tax system by lowering the tax rate, widening the tax base, reducing tax distortions and leakages, and developing a more responsive and globally-competitive tax incentives regime that is performance-based, targeted, time-bound, and transparent.The House of Representatives and the Senate approved and passed different versions of the CREATE bill before deliberations by the Bicameral Conference Committee. On the last day of the 30-day period to act on the enrolled CREATE bill, the President signed it into law but vetoed certain provisions. These include the VAT-exempt threshold on the sale of real properties by real estate developers and the special corporate income tax incentive for domestic enterprises, among others.REDUCTION IN CORPORATE INCOME TAXAs of 2020, the Philippines imposes the highest CIT rate at 30% in ASEAN, where the regional average is 23%. To address this, the CREATE Act lowers the CIT rate for domestic corporations (including one-person corporations) to 25% of the taxable income beginning July 1, 2020 while that for companies with total assets not exceeding P100 million and taxable income not exceeding P5 million is lowered to 20% of the taxable income. In valuing the P100 million threshold, we should note that the land on which the particular corporation’s office, plant and equipment are situated shall be excluded as the appreciation of its value may remove small businesses from the 20% bracket. This threshold shall be determined on a taxable year basis.For resident foreign corporations (including branch offices), the CIT rate is lowered from 30% to 25% of the taxable income beginning July 1, 2020 while the interest income from a depository bank under the expanded foreign currency deposit system and gains from sale of shares not traded in the stock exchange received by the resident foreign corporations shall be taxed at 15%.Regional operating headquarters are subject to 25% CIT beginning Jan. 1, 2022. However, they may apply for incentives under the CREATE Act. The CIT rate for non-resident foreign corporations is lowered from 30% to 25% of the gross income beginning Jan. 1, 2021.With the lowering of the CIT rate, the non-allowable deduction for interest expense is likewise reduced from 33% to 20% of the interest income subjected to final tax. However, if the interest income tax is adjusted in the future, possibly in the tax reform package 4 or the proposed Passive Income and Financial Intermediary Taxation Act, the interest expense reduction rate may likewise be adjusted.To compute the CIT due, corporations adopting calendar year ending Dec. 31, 2020 are to multiply the total annual taxable income by the effective rate of 27.5% (under the 25% CIT rate) or 25% (under the 20% CIT rate), whichever is applicable, for domestic corporations, and 27.5% for resident foreign corporations.For corporations adopting fiscal years, the multiplier shall vary depending on the year ending. One way to compute the CIT due for those using fiscal years is to divide the total annual taxable income by 12 and multiply it by the number of months covered by the new rate. For example, for corporations with fiscal year ending March 31, 2021, the total annual taxable income shall be divided by 12 and the aggregate income from April 1, 2020 to June 30, 2020 is to be taxed at 30%, while the aggregate income from July 1, 2020 to March 31, 2021 will be taxed at 25% or 20%, whichever is applicable.This was put in place to ensure that taxpayers do not resort to the allocation of income and expenses that will yield a lower tax due.Since the CIT rate is reduced, a reduction of Expanded or Creditable Withholding Tax (EWT) rate should also follow suit to avoid any tax leakage. This will avoid a situation where the EWT tax due will be much higher compared to the income tax due of certain suppliers and hence, creating tax leakage. As a measure, the CREATE Act directs the Department of Finance (DoF) to revisit or amend EWT rules and regulations, including the tax rates, every 3 years.An additional benefit in the form of a deduction from gross income is also provided under the CREATE Act wherein businesses are given an additional deduction of 50% of the value of labor training expenses incurred for skills gained by enterprise-based trainees enrolled in public senior high schools, public higher educational institutions, or public technical and vocational institutions covered by an Apprenticeship Agreement, provided they secure proper government certification and the additional 50% labor training expense deduction does not exceed 10% of the direct labor wage.The CREATE Act also provides additional temporary relief to taxpayers beginning July 1, 2020 to June 30, 2023 by reducing the minimum corporate income tax from 2% to 1%, the CIT rate for proprietary educational institutions and non-stock and non-profit hospitals from 10% to 1%, and percentage tax from 3% to 1%.The adjustments in CIT rates will not only support big businesses but will ultimately provide relief to micro, small and medium enterprises, which constitute 99.5% of the total business enterprises in the Philippines, employ 62.4% of the total labor force, and account for 35% of gross domestic product and 35.7% of economic value. While this tax reform package will reduce the government’s revenue, the DoF hopes that this will help revitalize businesses and consequently, create more jobs for workers who have been greatly affected by the pandemic.While known for its skilled labor and professionals and relatively lower operating costs, the Philippines has unfortunately been left behind as investors tend to lean towards the more attractive fiscal system of our ASEAN neighbors. This recent development in our tax laws may be a good pull for foreign investors looking for more opportunities.In the second part of this four-part series, we will discuss more effected changes: the exemption of foreign-sourced dividends, the repeal of improperly accumulated earnings tax, tax-free exchange, additional provisions to consider and provisions that were vetoed.This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the authors and do not necessarily represent the views of SGV & Co. Karen Mae L. Calam And Aiza P. Giltendez are a Tax Senior Manager and Manager, respectively, of SGV & Co.

05 April 2021

Aris C. Malantic

Embracing a new operating reality for corporate reporting

In the face of COVID-19, finance leaders find themselves having to strike a difficult balance in delivering corporate reporting. On one hand, they must respond to the pandemic with resilience and transparency; on the other hand, they must also generate long-term, sustainable value for stakeholders that focuses not only on financial outcomes but also on environmental and social impact.With performance now measured across broader dimensions, pressure is mounting to meet the demands for non-financial information in addition to credible financial disclosures. Finance leaders need to rethink how finance and corporate reporting can play central roles to meet the changing expectations of stakeholders, such as investors and regulators, and ensure that reporting remains relevant.It becomes imperative for corporate reporting to evolve and fully embrace optimizing value, with the goals of meeting the increasingly wide insight requirements of stakeholders and making corporate reporting central in realizing long-term value ambitions. The pandemic accelerated the demand for richer insights during this period of uncertainty, and such demand is unlikely to decline even when the pandemic is over. Stakeholders will very likely continue to search for organizations with a focus on long-term value creation.For corporate reporting to play an important role, finance teams must transition to the new operating reality and virtual environment imposed by the pandemic and its ongoing implications.THE CHALLENGES OF TRANSFORMATIONRespondents to the 2020 EY Global Financial Accounting and Advisory Services (FAAS) corporate reporting survey, who are composed of a thousand Chief Financial Officers (CFOs), financial controllers and other senior finance leaders, say that they are satisfied with this new operating reality shift, though it is not without its challenges. While communication with existing colleagues is effective, building personal relationships with new colleagues gained through acquisition or investments can prove difficult. More than half the respondents (56%) have also shared resistance to some of the changes introduced in their transformation journey. Moreover, 51% shared that when they failed to adopt new processes, finance team members simply reverted to traditional methods.Returning to previous ways of working could prove disadvantageous and failing to focus on the future of reporting could have significant consequences. It could result in cumbersome operating models and in finance teams being less relevant and agile, hindering their ability to provide the forward-looking insights stakeholders look for.With the increasing demand for non-financial information such as environmental, social and governance (ESG) and sustainability reporting from both stakeholders and regulators, CFOs are tasked with growing value along with their previous mandate of protecting enterprise value.Another challenge lies in the potential obstacles that can obstruct the means of measuring and communicating long-term value. One such obstacle identified by one in five respondents from the EY survey was the lack of formal reporting frameworks showing how the connection between intangible and tangible assets contributes to long-term value creation.Finance leaders need to consider how best to challenge traditional ways of working while mapping out an innovative future for the function. They can step in the right direction by focusing on building trust in technology and transforming finance and corporate reporting operating models.ACCELERATING SMART TECHNOLOGIES TO TRANSFORM THE FINANCE MODELTrusting technology, artificial intelligence (AI) in particular, is difficult when controls, governance and ethical frameworks still need further development and refinement. From the EY survey, nearly half the respondents (47%) share that finance data produced by AI cannot be trusted in quality compared to the data produced by the usual finance systems. This lack of trust could be reflective of a lack of understanding in how these systems work. Both AI and machine learning arrive at conclusions based on a large number of data sets, instead of an individual examining a single set with the possibility of introducing their own biases. This is why smart machines can likely perform data-driven tasks with more consistency, accuracy and efficiency.The future finance function looks very different in the eyes of the survey respondents, specifically due to a major shift to a more open and intelligent finance operating model. The survey shares that 53% of finance leaders anticipate that half of the finance and reporting tasks performed by a human workforce will be done by machines over the next three years. It becomes important to define a partner or managed services strategy to achieve the organization’s transformational goals, where many reporting activities could be handled by accredited providers of managed services instead of handled in-house. A cloud-based solution also becomes a major priority in tandem with advanced analytics and AI, providing infrastructure for AI processing as well as space for vast amounts of data.REINVENTING LEADERSHIP ROLES AND FINANCE SKILLSWith the evolution of the finance function, CFOs and financial controllers are likely to see their roles evolve as well. As much as 67% of survey respondents agree that CFOs will focus more on driving enterprise-wide digital transformation and growth than traditional finance responsibilities.Finance leaders will need to reassess the skills of their teams, and ensure they have people with knowledge of both digital processes and digital accounting. Even though machine learning can perform certain tasks more efficiently, a finance team will always need people capable of reading and understanding International Financial Reporting Standards (IFRS) statements. Finance operations will need problem-solvers with holistic views, logic and critical thinking. Leaders must take an innovative approach to reskill their people and equip them with the capabilities required for the future finance function.EMBRACING THIS NEW REALITY FOR THE FUTUREThough the pandemic continues to pose a significant challenge for finance leaders to deliver corporate reporting, the new operating reality and its implications invite CFOs and finance teams to approach the finance function with a fresh perspective. The New Normal dictates that finance leaders consider the reporting needs Now, anticipate the challenges to come Next and find ways to take the finance function Beyond.Those with foresight will likely find opportunity in today’s uncertain environment to challenge traditional ways of reporting and reaffirm its relevance beyond the pandemic.This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the author and do not necessarily represent the views of SGV & Co.Aris C. Malantic is the Financial Accounting Advisory Services (FAAS) Leader of SGV & Co. and EY ASEAN. He is also a Market Group Leader in SGV & Co.

April 2021

Redefining Philippine Taxation: CREATE (Third part)

Redefining Philippine Taxation: CREATE (Second part)

Redefining Philippine Taxation: CREATE (First part)

Embracing a new operating reality for corporate reporting

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