The Comprehensive Tax Reform Program and its potential effects on the real estate market
In the beginning of 2018, the Tax Reform for Acceleration and Inclusion (TRAIN) Law took effect. This law effectively reduced the personal income taxes of most individual taxpayers. The tax savings from this law led to higher levels of disposable income around the country.
On top of TRAIN, there are currently two more impending packages of the comprehensive tax reform program in the legislative pipeline, which are expected to be signed into law by the end of 2020. While the first phase of the CTRP focused on individual income tax, packages two and four will focus on corporate income tax, real proper tax, and passive income final taxes, respectively.
These upcoming tax reform packages can serve as yet another catalyst to propel the Philippine property market into even greater heights.
PACKAGE 2: Corporate Income Tax and Incentives Rationalization
The second package of the Department of Finance’s (DOF) comprehensive tax reform program seeks to slash the regular corporate income tax rate (RCIT) in a bid to stimulate both foreign and domestic investments in the country. Currently, the corporate income tax rate in the country stands at a flat rate of 30% - making it the highest in the entire ASEAN region and one of the highest in the entire world.
Barring any delays in the legislation process, the proposed tax cuts will happen in five tranches beginning in 2021, when tax rates will be cut from 30% to 28%. From there on, rates will be cut by an additional 2% every two years until it reaches 20% by the end of 2029. By then, the RCIT of the Philippines will be at par with that of Cambodia, Thailand, and Vietnam – trailing only Singapore, which has a corporate tax rate of 17%.
The Department of Finance estimates that roughly 98% of the domestic and foreign corporations operating in the Philippines will benefit from the 2nd package of the CTRP. Of this 98%, 90,000 are small and medium enterprises (SMEs) and another 10,000 are micro enterprises. This package is expected to generate significant amounts of tax savings, which companies can use to either (a) expand its operations or (b) distribute as dividends to its shareholders.
Currently, the second package of the tax reform program is still trying to hurdle the legislative process in the House of Representatives. Most recently, HB 4157 or the Corporate Income Tax and Incentives Reform Act (CITRA) has just been approved in the second reading. The Department of Finance hopes that the bill will be signed into law before the end of 2020.
PACKAGE 4: Passive Income and Final Taxes
The fourth and final package of the DOF’s comprehensive tax reform program seeks to promote liquidity and capital movement in the country’s financial and capital markets through the reduction in final taxes and transaction taxes imposed on passive income and financial intermediaries, respectively.
The largest portion of the proposal is to set majority of the final taxes from passive income and capital gains tax to a uniform rate of 15% -- regardless of the source of the income, situs of the payor, and situs of the payee. For comparison, final taxes on interest revenue from bank deposits and trust accounts can be 0%, 5%, 7.50%, 12%, 15%, 20%, 25%, or 30% -- depending on a variety of factors such as length of the deposit term, currency used, and the classification of the taxpayer. Capital gains tax on the sale of shares of domestic companies directly to a buyer is at 15% for individuals and domestic corporations, and either 5% or 10% for foreign corporations. Package four hopes to eliminate the complexity of the final withholding tax system through the use of a uniform final tax and capital gains tax rate of 15%.
Another key feature of package four is the rationalization of the gross receipts taxes (GRT) imposed on banks and financial intermediaries. For a brief background, GRT is the business tax (VAT) imposed on banks. Currently, banks and other financial intermediaries are subject to three rates of gross receipts taxes – 1% for interest income on long term loans (more than five years from maturity), 5% for interest income for short term loans (five years or less from maturity), and 7% on trading gains and other items of gross income. The proposed tax reform aims to simplify these rates through the use of a uniform rate of 5%.
Other salient features of package four is the removal of the tax imposed on initial public offerings (IPOs) and the reduction of transaction taxes on publicly traded instruments – from the current rate of 0.60% to 0.10% within five years.
Through these key changes in the final withholding tax system and the capital gains tax system, the Department of Finance hopes to increase the efficiency in the country’s financial and capital markets through improved liquidity and capital mobility. These benefits are then expected to stimulate more investments in the economy.
HB 304 or the Passive Income and Financial Intermediary Act (PIFITA) has just received the final approval from the House of Representative. The bill now has to make its way through the Senate before eventually being signed into law by the president. The DOF hopes to have the bill enacted by the end of 2020.
EFFECTS ON THE PHILIPPINE REAL ESTATE INDUSTRY
The impending reforms in the country’s income tax system will affect two key macroeconomic variables which drive the property markets: (1) Disposable Income, and (2) Interest Rates.
Package two, which will slash corporate tax rates to 20%, will reduce the tax bills of virtually all corporations by almost 33%. These tax savings will generate higher levels of disposable income for corporations, which it can use to either expand its operations – leading to higher demand for office or warehouse spaces -- or distribute to its shareholders – leading to higher demand for residential and lifestyle spaces. In both cases, the property sector should see a bump in demand.
On the other hand, package four can effectively reduce the effective interest rates in the market in two ways. First, the reduction of final taxes on interest revenue from bank deposits can promote savings formation, leading to higher money supply and lower market interest rates. Second, the reduction of business taxes imposed on banks and financial intermediaries means that these institutions would have more cash that it can lend out to the public. In both cases, the supply of money flowing through the capital markets would increase – leading to lower market interest rates overall.