The 8% final income tax, simple but not quite
As reported, Congress is expecting to pass House Bill No. 5636 or the (new) Tax Reform Acceleration and Inclusion (TRAIN) on second reading this week, but not after intense plenary debates. This bill is the substitute bill of the earlier House Bill No. 4744 and other related tax measures. It adjusted some of the more contentious provisions in the old TRAIN. For legislation with a profound impact on all Filipinos, it is important to hear many arguments, whether pro or anti, in order to make an informed decision.
We welcome the government’s initiative to undertake a comprehensive tax reform with the end view of a fair, simple and efficient tax system. Although administrative reforms should remain a key part of the revenue enhancement strategy, we recognize that relying only on anti-corruption efforts and such administrative reforms may not be enough to bridge the revenue gap considering the country’s investment and infrastructure needs. The government has rolled out its economic and social development roadmap, which we now call “Dutertenomics.” We can no longer afford to maintain the status quo if we want to unlock the country’s potential and take the Philippines to the next level.
While much has been said on the possible effects of the imposition of excise tax on petroleum products, the issue on the proposed 8% final income tax on self-employed and professionals has not been given much attention.
Under the proposed tax reform, the income tax rates of individuals will be adjusted to a more competitive level. However, a distinction has been made between compensation income earners and those who are self-employed or considered professionals. Employees shall be taxed at graduated rates of 0% (for those with compensation income not exceeding P250,000) to a top rate of 35% for compensation income over P5,000,000.
On the other hand, self- employed and professionals shall be subjected to a final income tax rate of 8% based on their annual gross sales or gross receipts if these do not exceed the proposed VAT threshold of P3,000,000. This 8% tax shall come in lieu of the 3% percentage tax. Once the VAT threshold is breached, the self-employed individual/ professional shall be taxed similar to a corporation as to applicable tax rate (30% based on net taxable income or 2% minimum corporate income tax based on gross income, whichever is higher) and allowable deductions (either itemized or optional standard deduction of 40% based on gross income).
Although the proposal for a final income tax is intended to simplify the taxation of self-employed individuals and professionals, what is the logic behind the 8% rate? When we asked the Department of Finance and the Bureau of Internal Revenue (BIR), it seems that this was not part of their proposal but was introduced by the House Committee on Ways and Means.
However, the rationale of the 8% has not been explained so we can only guess that the 8% rate would account for the 3% percentage tax and the 5% is probably the average income tax rate of taxpayers in this position.
But imposing a flat rate would simply be problematic. For one, the 8% tax on gross sales or gross receipts could either be too high and unfair for half of the current and prospective taxpayers, or too low and therefore unwittingly beneficial for the other half. A micro or small businessman will pay an 8% final tax regardless of whether he makes a profit or suffers a loss. His counterpart salaried employee would be better off since compensation income not exceeding P250,000 is exempt from income tax. For businesses that are unduly burdened by the flat tax, this scheme would go against the government’s intention of helping and encouraging the growth of entrepreneurship, especially at the micro and small level.
On the other hand, the 8% flat tax may, unintentionally, influence investment decisions in favor of businesses with cost structures that benefit from it, i.e., businesses with relatively lower deductible expenses, or conversely with relatively higher net income.
Second, while paying an 8% tax is simple, it transfers the burden to the BIR while at the same time imposing a more complex problem for the tax administrators to solve. Those who will benefit from this will always be motivated to weigh the cost (i.e., paying more once the threshold is crossed) against the benefits (i.e., pay less by staying below the threshold).
Hence, this tax may actually be a disincentive to grow beyond the threshold. This may even translate into keeping the growth of sales in check, or may motivate one to “break up” into several businesses (e.g., among family members).
While abuses from related party transactions are usually found among larger, more sophisticated entities, the problem of keeping track of this issue may be pushed down to even smaller, less sophisticated ones, further compounding the problem for the BIR.
Eliminating abuse among related parties is never an easy task, anywhere in the world. Neither is undertaking a comprehensive tax reform with the aim of simplifying our tax system. That is why we continue to commend the efforts and strides that the government has reached thus far. However, the limits of simplification are reached when a proposal could be more harmful than it is beneficial.