THE World Bank said the Philippines should broaden its tax base and eliminate a number of existing exemptions on the value-added tax (VAT) to boost revenue and address policy and administration gaps in the system.
In a special segment of its recently released Philippine Economic Update, it said a large and growing number of exemptions undermines the efficiency of the VAT.
“Some of these exemptions also create economic distortions. For instance, most cooperatives are exempt from VAT, which creates an incentive for corporations to restructure themselves as cooperatives in order to reduce their tax liability, even if restructuring is not economically efficient,” the Washington-based multilateral lender said.
Moreover, it noted that the exemption for cooperatives is also largely unnecessary from a policy perspective, as small cooperatives are already protected by the VAT threshold.
At the individual level, the Expanded Senior Citizens Act of 2010 exempts senior citizens from VAT on specific items such as medical services, food, and transportation, but these exemptions are vulnerable to exploitation, the World Bank added.
Meanwhile, it added that the VAT tax gap in the country remains substantial despite narrowing significantly in recent years.
The lender explained that a tax gap is the difference between actual and potential VAT revenues.
“The VAT tax gap can be broken down into a policy gap, which is the result of legal exemptions and other forms of special tax treatment, and an administrative gap, which primarily reflects noncompliance,” it said.
The World Bank said that between 2006 and 2013, the estimated policy gap averaged three percent of GDP, while the estimated administrative gap averaged 3.7 percent of GDP.
“As actual revenues averaged 4 percent of GDP, the VAT gap represented almost two-thirds (63 percent) of potential VAT revenues. Of this, 28 percent reflects legal exemptions and special treatment, while 35 percent results from noncompliance,” it said.
With this, the institution pointed out that eliminating a number of existing exemptions could expand the VAT base and boost revenue as many exemptions that directly target specific individuals or firms have little economic justification, and even those designed to serve legitimate policy purposes could be replaced by superior alternatives.
“Eliminating exemptions on inputs used to produce final goods that are also exempt would alleviate distortions, reduce administrative complexity and improve compliance rates,” it said.
The World Bank stressed that increasing the VAT threshold to around P3 million and indexing it to inflation would lower compliance costs for small enterprises.
Limiting zero-rating to exporters would help curb leakages caused by the current system of zero-rating suppliers of exporters in special economic zones, it said.
In addition, it said VAT administration could be improved by eliminating the use of tax credit certificates and instead, providing prompt VAT refunds in cash.
“The current rule requiring a pre-audit of refunds is not consistent with international good practices and leads to long delays. Relaxing the rule would greatly expedite the refund process,” it recommended.
The World Bank said introducing risk-management techniques would enable low-risk taxpayers to get refunds faster and audits could be completed after the refund was issued.
Low-risk taxpayers caught over-declaring refunds would be reclassified as high-risk and subject to more stringent pre-audit requirements, it said.
“Finally, policymakers should reject any proposal to replace the VAT with either a sales tax or a so-called ‘simplified VAT,’ as doing so would not reflect international good practices,” the lender suggested.