End to Philippine lockdown clears path to economic reforms

Updated: May 24, 2020

By Andrew Kemp

With the country’s lockdown apparently nearing its end, the government may soon be able return to its economic reform programme

The Philippines – one of the first counties to implement an enhanced community quarantine in response to the coronavirus (COVID-19) pandemic – is now reviewing how to lift its lockdown and kickstart economic activity.

The government announced on April 4 measures to help it identify whether to lift or extend the community quarantine. While Philippine President Rodrigo Duterte said on April 6 that an extension to April 30 was likely, the government is working with a near-term exit strategy that once implemented should breathe new life into an economy the president has said is “at a standstill”.

Prior to the COVID-19 pandemic, the Philippines was hard at work on several new regulations aimed at making the country’s corporate environment more attractive to foreign investors. As the economy emerges from hibernation, Manila will be eager to return its attention to these measures. Investment hurdles

The Philippines has seen inflows of foreign direct investment (FDI) taper off in recent years. After peaking at a record of US$10.26 billion in 2017, net FDI in the Philippines shrank to US$9.8 billion in 2018, according to Bangko Sentral ng Pilipinas (BSP) data. Net FDI in the first 11 months of 2019 fell by 29.9% year on year to US$6.4 billion.

Investor confidence has been undermined over the years by the country’s reputation for red tape, challenges in securing business permits and, at times, unfriendly political rhetoric. The challenges of operating in the country were highlighted by the fact that the country slid from 95th place in the World Bank’s Ease of Doing Business ranking of 189 countries in 2014 to 124th place among 190 countries in 2018.

Investors have been lured away to rival Southeast Asian economies such as Vietnam, Malaysia and Singapore. Vietnam, for example has seen net FDI inflows climb consistently since 2011, reaching US$15.5 billion in 2018, according to WB data.

Manila, aware of the need to streamline the Philippine economy and bolster foreign investor confidence, has embraced economic reforms that have started to yield success.

The WB awarded the Philippines the country’s highest ever Ease of Doing Business ranking – 95th place out of 190 countries – in October 2019. Moreover, Philippine Finance Undersecretary Karl Kendrick Chua said on March 4 that FDI pledges more than doubled year on year in 2019. He said pledge approvals had risen from PHP390 billion (US$7.71 billion) in 2019 compared with PHP183 billion (US$3.62 billion) approved in 2018. From the ground up

The government has adopted a belt and braces approach to its reform process, aiming first at tackling the country’s notorious culture of red tape before offering foreign investors compelling financial incentives.

Philippine President Rodrigo Duterte signed into law the Ease of Doing Business Law (EODB) in 2018, which amended the Anti-Red Tape Act (ARTA) of 2007 and required local governments and state-controlled companies to improve systems relating to national and local government transactions.

The law aims to cut red tape, speed up government transactions and prevent corruption. For example, local governments are now required to ensure that all their departments use a single application form for business permits, clearances and approvals. Government departments must also process simple and complex transactions within three and seven working days respectively following receipt of a submitted application. Twenty days are in turn given for highly technical applications, while multistage applications must be processed in no more than 40 days.

Emerico De Guzman, managing partner of leading Philippine full-service law firm ACCRALAW, said: “The implementing rules for this ARTA Law were a bit delayed and only came out in July 2019. Considering the delay, along with the belated appointment of the director general for the Anti-Red Tape Authority created by the 2018 law, the public has yet to feel the benefits from the significant amendments introduced.”

De Guzman highlighted local governments’ different application requirements for business-related permits and renewals as well as connectivity between and among national and local government offices as areas where the benefits have yet to be felt.

He said: “The ARTA Law has, however, been mandated to streamline procedures for the issuance of local business clearances, it just might take some time for this reform measure to bear fruit.”

There are also initiatives designed to make doing business at the local government unit (LGU) level easier. For example, the Department of Trade and Industry (DTI) has drawn up the Cities and Municipalities Index that recognises LGUs based on economic dynamism, government efficiency, infrastructure and resiliency.

Francis Lim, a senior partner at ACCRALAW and current president of the Management Association of the Philippines (MAP), said: “Business associations like the MAP have entered into partnerships with the DTI to support this endeavor. The LGUs have responded positively, and while it will take some time, it is expected that this initiative will improve the ease of doing business in the Philippines.”

In September 2019, the House of Representatives approved in House Bill (HB) No. 300, which lifted certain restrictions on foreign workers by amending Section 4 of the Foreign Investments Act 1991. HB No. 300 is still to be passed into law, but if it is it will exclude the “practice of professions” from the Foreign Investment Negative List (FINL) and will allow more skilled foreign professionals to work in the Philippines.

That same month saw lawmakers introduced the Corporate Income Tax and Incentives Rationalization Act (CITIRA), which if approved by Congress will offer investors a range of new tax incentives. Implementing this law is one of the most important steps the country can take in preventing rival Asian economies from pulling too far ahead of the Philippines.\

“Business associations have entered into partnerships with the DTI to support this endeavour. The LGUs have responded positively, and while it will take some time, it is expected that this initiative will improve the ease of doing business in the Philippines.”

Francis Lim, Senior Partner, ACCRALAW and current president of the Management Association of the Philippines (MAP)

Tax cuts

At present, the Philippines has the highest corporate income tax (CIT) rate of any Southeast Asian country. This is far from ideal at a time when foreign investors have been rethinking their operations in China, owing to the Sino-US trade war, and are looking to move supply chains to cheaper territories within Asia.

Thailand, for example, introduced a stimulus package in September 2019 that introduces new tax incentives as well as reforms that aim to improve the ease of doing business in the country.

CITIRA is a direct response to these regional challenges, introducing a range of incentives such as an up to 100% deduction on research and development (R&D) and labour training expenses, a zero customs duty on raw material and equipment imports and an extension of the net operating loss carry-over (NOLCO) to five years.

Ruby Yusi, a senior tax partner at ACCRALAW, said: “Under the Senate version, CIT rates will be reduced by 1 percentage point every year from the current 30% to 20% by 2029.” Finance Undersecretary Chua said the bill had been updated since its first introduction to offer companies two options when applying for tax incentives.

The first will allow qualified enterprises to apply for a two- to four-year income tax holiday (ITH), which will then be followed by a special corporate income tax (SCIT) that will last for three to four years and can be extended up to a maximum of 12 years. The ITH and SCIT serve in lieu of all other taxes. The rate will be increased from 5% at present to 8% in 2020, 9% in 2021 and 10% in 2022.

Alternatively, qualified enterprises can adopt the regular CIT rate that comes with enhanced deductions for a period of five to eight years. This can be extended by a further three or four years, up to a maximum duration of 12 years. The enhanced deductions include an up to 50% saving on power costs, an up to 50% additional saving on labour expenditure, an up to 100% additional discount on R&D as well as an up to 50% additional deduction on domestic input expenditure.

Yusi said: “The Senate version also extends the sunset period for firms currently paying the current 5% of gross income earned in lieu of all taxes, to seven years (from five years in the House version) for firms that export 100% of their output, employ 10,000 Filipino workers in certain activities or are engaged in ‘footloose’ manufacturing.”

Footloose manufacturing is defined as having a direct labour expense to asset ratio of at least 70% for three consecutive years immediately preceding the year of CITIRA’s implementation, the export of 100% of manufactured goods and whose base of operations is outside Metro Manila.

Yusi: “It has been reported that the Department of Finance [DOF] Secretary is pleased with the Senate version as it kept the DOF policy of granting tax incentives based on performance and is time-bound. The version will undergo interpellations when the Senate resumes its sessions in May 2020.”

CIT rates will be reduced by 1 percentage point every year from the current 30% to 20% by 2029

Ruby Yusi, Senior tax partner at ACCRALAW

Along with reducing corporate tax burdens, the government is also looking to widen the availability of business opportunities for foreign investors.

The House on February 18 approved proposed amendments to the Public Service Act (PSA) on its second reading.

The amendments seek to provide a clear statutory definition of “public utility”, thereby narrowing the list of public utilities where foreign equity ownership is restricted to a maximum of 40%. For example, while foreign investment in power, water and sewerage utilities would still be restricted, areas such as transportation and telecommunications could be opened to full foreign ownership.

The National Economic and Development Authority (NEDA) has said the amendments promise a significant reduction in investment restrictions across several service industries. The Philippine Judiciary, meanwhile, has also been working to introduce reforms to significantly bolster foreign investor interest. Upon entering office in October 2019, Chief Justice Diosdado Peralta said his priority concerns were the reduction of court dockets and speedier resolution of court cases. To this end, the new Rules of Civil Procedure and the Revised Rules in Evidence will come into effect on May 1.

Among others, these rules aim to eliminate prolonged hearings; prescribe an expanded list of prohibited motions; allow the possibility of electronic filing and electronic service; limit the period for the presentation of evidence to less than a year, with a mandate for litigants to be ready to present evidence upon filing of the complaint or answer; and directing judges to resolve cases within three months from submission of the case for resolution. De Guzman said: “These reforms will hopefully fast track and streamline the litigation process and enhance justice delivery in the Philippines.” Outlook

The government’s reforms, once fully realised, will make the country more attractive to foreign investors. The country does still face challenges on the international and domestic front, however.

There are critics of the government’s efforts at lowering barriers to foreign investment, arguing that economic nationalism is the key to developing the domestic market and that majority foreign ownership of utilities poses privacy and national security risk. On the international front, meanwhile, if the Philippines is slow in approving reforms that ease FDI restrictions then the country runs the risk of losing foreign investor interest to other Southeast Asian economies.

"These reforms will hopefully fast track and streamline the litigation process and enhance justice delivery in the Philippines"

Emerico De Guzman, Managing Partner, ACCRALAW

Finance Undersecretary Chua said: “The strong performance of FDI pledges in 2019 is a positive signal that the international community continues to regard the Philippines as one of the prime investment destinations in Asia. The sooner CITIRA is passed, the sooner these investments will materialise.”

In light of the COVID-19 pandemic, and the continuing enhanced community quarantine imposed in the Philippines, the enactment of the above reforms will inevitably be deferred. ACCRALAW, however, anticipates that with both Houses of the Philippine Congress agreeing in principle on the key provisions of these measures, the government should eventually be able to implement these reforms, attracting much-needed FDI the process.

This article was written by Andrew Kemp for Conventus Law in association with ACCRALAW.

For further information on FDI in The Philippines, please contact: Emerico De Guzman, Managing Partner, ACCRALAW eodeguzman@accralaw.com

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