review of national and local land-related taxes and...

Land Administration and Management Project Phase 2 Valuation and Land Taxation Report – August 2008

Land Equity International Pty Ltd

REVIEW OF NATIONAL AND LOCAL LAND-RELATED TAXES AND FEES

FINAL REPORT

Submitted to the Executive Director, National Tax Research Center August 2008

REPORT D28 28 AUGUST 2008

Prepared by: Land Equity International Pty Ltd


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This report is a result of technical assistance managed by Land Equity International to the Government of the Philippines. The TA was funded by AusAID and the views expressed in this work do not necessarily represent the views of the Commonwealth of Australia.

TABLE OF CONTENTS

Executive Summary viii 1 Introduction 1 1.1 Background 1 1.2 Land‐related Taxes and Fees Evaluation Criteria 1 1.3 Reform Option Principles 3 1.4 Report Structure 3 2 Key Macroeconomic Considerations 4 2.1 Economic Contribution of the Land Sector 4 2.2 The Present State of the Philippine Tax System 8 2.3 The Government’s Tax Reform Agenda 9 3 National Land‐Related Taxes 10 3.1 Introduction 10 3.2 Capital Gains Tax 12 3.3 Documentary Stamp Tax 24 3.4 Estate Tax 27 3.5 Donor’s Tax 34 3.6 VAT 41 3.7 Overall Assessment of National Land‐related Taxes 44 4 Local Land‐related Taxes 45 4.1 Description 45 4.2 History 45 4.3 Tax Base Issues 45 4.4 Overall Revenue Performance 48 4.5 Policy Evaluation 54 4.6 Conclusion 65 5 Comparative Performance of Land‐related Taxes 66 6 Land‐related Fees 67 6.1 Introduction 67


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6.2 DENR Fees 67 6.3 LRA Fees 67 6.4 Accounting Policy Changes 68 6.5 Land Sector’s Fiscal Contribution 68 7 Land‐related Tax Reform Issues and Options 69 7.1 Introduction 69 7.2 National Land‐related Taxes 69 7.3 Local Land‐related Taxes 76


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TABLES

Table 1. GROSS DOMESTIC PRODUCT (GDP) BY REAL PROPERTY‐RELATED

ACTIVITY, 2001‐2005 5

Table 2. COMPARATIVE LAND REGISTRATION PERFROMANCE BY SELECTED ASIAN AND PACIFIC COUNTRIES, 2007

6

Table 3. REVENUES OF NATIONAL LAND‐RELATED TAXES, 2001‐2005 11

Table 4. OPERATING COSTS AND REVENUES OF NATIONAL LAND‐RELATED TAXES, 2005

12

Table 5. VALUE OF EXEMPTIONS TO CAPITAL GAINS TAX, 2004 14

Table 6. PHILIPPINE TAX‐RATES APPLICABLE TO DIFFERENT TYPES OF RESIDENT TAXPAYERS

16

Table 7. CGT COLLECTIONS ON THE SALE OR TRANSFER OF REAL PROPERTIES AND NUMBER OF RETURNS, CY 1994‐2005

22

Table 8. GROWTH INDICES FOR CGT REVENUES, GDP (CURRENT PRICES) AND BIR COLLECTIONS 1997‐2006 (BASE YEAR 1997 = 1000)

23

Table 9. ANNUAL VARIATIONS IN CGT REVENUES, GDP (CURRENT PRICES) AND BIR COLLECTIONS, 1997‐2006

24

Table 10. CURRENT RATES OF ESTATE TAX 29

Table 11. ESTIMATED DEADWEIGHT COSTS FROM CURRENT PHILIPPINE ESTATE TAXES

30

Table 12. ESTATE TAX STATISTICS, CY 2001‐2004 33

Table 13. GROWTH INDICES FOR ESTATE TAX GROSS REVENUES, GDP (CURRENT PRICES) AND BIR COLLECTIONS, 1997‐2005 (BASE YEAR 1997 = 1000)

34

Table 14. CURRENT RATES OF DONOR’S TAX 35

Table 15. ESTIMATED DEADWEIGHT COSTS FROM CURRENT PHILIPPINE DONOR’S TAX

37

Table 16. DONOR’S TAX STATISTICS, CY 2001‐2004 39

Table 17. GROWTH INDICES FOR DONOR’S TAX REVENUES, GDP (CURRENT PRICES) AND BIR COLLECTIONS, 1997‐2005 (BASE YEAR 1997 = 1000)

40

Table 18. VAT ON REAL PROPERTY TRANSACTIONS STATISTICS, CY 2001‐2005 43

Table 19. AVERAGE PROPERTY TAX REVENUES OF LGUS, BY SOURCE, CY 2001‐2005

49

Table 20. COLLECTION EFFICIENCY FOR BASIC REAL PROPERTY TAX, BY LEVEL, CYS 2001‐2005

50

Table 21. 2005 TRENDS IN AVERAGE FAMILY INCOME AND BASIC RPT RECEIPTS FOR 36 PHILIPPINE CITIES

52


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Table 22. GROWTH INDICES FOR BASIC RPT GROSS REVENUES, GDP (CURRENT PRICES) AND BIR COLLECTIONS, 1997‐2005 (BASE YEAR 1997 = 1000)

59

Table 23. ANNUAL VARIATIONS IN RPT REVENUES, GDP (CURRENT PRICES) AND BIR COLLECTIONS, 1997‐2005

60

Table 24. GROWTH INDICES FOR SEF GROSS REVENUES, GDP (CURRENT PRICES) AND BIR COLLECTIONS, 1997‐2006 (BASE YEAR 1997 = 1000)

62

Table 25. GROWTH INDICES FOR LOCAL TRANSFER TAXES, GDP (CURRENT PRICES) AND BIR COLLECTIONS, 1997‐2006 (BASE YEAR 1997 = 1000)

64

Table 26. 2005 DENR AND LRA ESTIMATED BUDGET OUTCOMES 67

Table 27. FISCAL CONTRIBUTION FROM NATIONAL LAND‐RELATED ACTIVITIES 68

Table 28. PRELIMINARY PROJECTIONS FOR REVISED CGT 71


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F IGURES

Figure 1. Growth in Land Taxes, GDP, BIR Collections, 1997‐2005 66


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ANNEXES Annex 1. National and Local Taxes and Fees Evaluation Framework

Annex 2. National Land‐Related Activity Costs and Revenues

Annex 3. Supporting NTRC Working Papers for Land‐Related Tax and Fees Policy Review

Annex 4. Deadweight Cost Estimates for Land‐Related Transaction Taxes


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ACRONYMS

BIR – Bureau of Internal Revenue BLGF – Bureau of Local Government Finance CGT – Capital Gains Tax COA – Commission on Audit CY – Calendar Year DENR – Department of Environment and Natural Resources DST – Documentary Stamp Tax GDP – Gross Domestic Product IRA – Internal Revenue Allotment LAMP II – Second Land Administration and Management Project LGC – Local Government Code LGU – Local Government Unit LRA – Land Registration Authority NIRC – National Internal Revenue Code NGA – National Government Agency NPSTAR – National Program Support for Tax Administration Reform Project NTRC – National Tax Research Center OECD ‐ Organization for Economic Cooperation and Development SPV – Special Purpose Vehicle ROD – Registry of Deeds RPT – Real Property Tax SEF – Special Education Fund SMV – Schedule of Market Value VAT – Value Added tax


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EXECUTIVE SUMMARY This Report discusses the findings of a review of national and local land‐related taxes and fees that the National Tax Research Center (NTRC) has undertaken during 2006/2008. Methodology In late 2006/early 2007 NTRC prepared a series of papers discussing the historical background and recent performance of national and local land‐related taxes and fees. A comprehensive evaluation framework for reviewing national and local land‐related taxes and fees was developed in the 2007 March quarter. The initial evaluation framework was based on the generally accepted tax principles of:

• Efficiency

• Equity

• Administrative simplicity

• Transparency Additional principles comprising revenue adequacy and stability were added to the evaluation framework in 2008. The following taxes and fees were reviewed:

National land‐related taxes and fees:

• Capital Gains Tax (CGT)

• Documentary Stamp Tax (DST)

• Estate Tax

• Donor’s Tax

• Value Added Tax (VAT)

• Fees imposed by national government agencies on land transactions and land registration, principally the Department of Environment and Natural Resources (DENR) and the Land Registration Authority (LRA)/Register of Deeds (ROD).


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Local land‐related taxes:

• Real Property Tax (RPT)

• Special Education Fund (SEF)

• Local Tax on the Transfer of Land

• Special levy

• Idle land tax.

A preliminary report setting out preliminary draft reform options was completed in December 2007. Two additional supporting studies were initiated during the 2007 December quarter to help strengthen the developing policy analyses; these comprised

• A tax compliance study in Naga City to determine the present distribution of property taxes across and within taxpayer categories and levels of compliance.

• A survey of public perceptions of national and local land‐related taxes and fees with

a particular focus on the merits of proposed reform options identified in the 2007 preliminary draft report.

Both of the above studies were completed in the 2008 June quarter. Work undertaken by NTRC in the 2008 June quarter addressed the determination of possible land‐related tax reform options requiring detailed study and the preparation of revised analyses of national and local land‐related taxes having regard to the findings of the Naga City tax compliance study and the survey of public perceptions of national and local land‐related taxes and fees; both studies contributed to a strengthening of the analyses of land‐related taxes. Study Findings

NATIONAL TAXES

CGT and DST The CGT and DST are poor taxes in the context of the tax principles used in the evaluation of these taxes.


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These contribute to the relatively high costs incurred by taxpayers when undertaking property transactions and complying with their tax obligations. Both taxes have a negative impact on property market transactions in that they alter behaviour by:

• Discouraging some buyers from registering their transfers of ownership • Reducing sales values as a result of sellers passing on all or part of the costs of these

taxes to property buyers as a reaction to the overall high compliance costs

• Forcing prospective purchasers of new lots and houses to postpone purchases

• Discouraging owners of existing land lots and houses from selling their properties and reinvesting in other properties

The distortions in property market behaviour arising from the CGT and DST suggest that the deadweight costs associated with these taxes are relatively high; this outcome is consistent with international findings that capital taxes give rise to high deadweight costs. The CGT and DST give rise to considerable horizontal and vertical inequities arising from:

• The frequent practice of taxpayers reporting sale prices on property deeds of sale that are lower than those agreed in sale transactions

• The extensive use of zonal values and SMVs issued by the Bureau of Internal

Revenue (BIR) and local government units (LGUs) that are significantly outdated

• Differences in taxpayers’ understanding in respect of the availability of the CGT principal residence exemption and the practice of passing on all or part of CGT and DST costs to buyers in property transactions

The present transaction base for the CGT favors property owners with large net gains and penalises property owners with either losses or small net gains; this materially weakens vertical equity. The LGU valuation practice of using similar base values for a wide range of properties with different values due to an absence of values for different property category sub‐classes also promotes vertical inequities. In view of the identified vertical inequities, the CGT and DST create regressive outcomes. CGT and DST operating cost assessments suggest that the BIR administration costs for these taxes are in excess of average BIR operating costs, particularly in the case of the DST. In addition to high compliance costs, the level of transparency for these taxes is not high, as taxpayers do not have a sound understanding of either the CGT or the DST; this inhibits taxpayer compliance. The revenue performance of the CGT has been very disappointing since the present tax‐rate came into force on 1 January 1998, having recorded negative growth whilst GDP grew by


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148.6% in the 1997‐2006 period; CGT revenue performance has also been very unstable in the latter period. The exact performance of the DST is not known, as the BIR does not collect disaggregated statistics for any DST based revenues; this is unsatisfactory as it prevents monitoring the performance of these taxes, weakens staff accountability and does not promote good governance. It is assumed that the revenue performance of the DST has been similarly very disappointing to that noted for the CGT. Estate and Donor’s Tax The estate and donor’s tax are also poor taxes in the context of the tax principles used in the evaluation of these taxes. The estate and donor’s have relatively high inefficiencies at present and consequently relatively high deadweight costs arising from:

• Relatively high BIR administration costs

• High taxpayer compliance costs

• High economic inefficiency costs arising from the present structure of estate and donor’s taxes where marginal tax rates for some tax brackets are substantially greater than average taxes.

Delays in the revision of SMVs and zonal values undermine horizontal and vertical equity in respect of the estate and donor’s taxes. With real property assets estimated to represent the majority of the net assets of relatively small estates, the present deficient property valuation practices are likely to create a disproportionate tax burden for smaller estates and net gifts; this results in a regressive impact. The absence of any adjustment to the value of applicable deductions and exemption from estate tax to recognize inflationary trends since 1998 is also having a regressive impact in that lower valued net estates are incurring a greater proportional estate tax burden compared with the position likely to arise if some inflation adjustment was made. Taxpayers have a modest knowledge of estate and donor’s taxes in terms of timing, computation and payment obligations and tax liability suggesting that the level of transparency for these taxes is relatively low. A significant level of tax arrears is incurred with the estate tax due to taxpayers’ ability to pay constraints in respect of this tax. Estate taxes have performed poorly since 1997, recording negative growth in the period 1997‐2005. Donor’s taxes performed better than estate taxes in the latter period, recording growth of 40.3%; this growth was, however, significantly less than GDP growth in the same period. The revenues of both taxes showed considerable volatility in the period 1997‐2005.


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VAT Although the VAT creates distortions in an efficiency context in that prices are increased on transactions attracting VAT, these are very modest compared with those generated by other land‐related national taxes.

The achievement of horizontal equity for the VAT is also undermined by the prevailing fraudulent property valuation reporting practices and the use of outdated SMVs and zonal values. The current VAT exemptions for sale and leasing transactions are designed to provide relief from VAT for entities and persons undertaking relatively small property transactions that are not registered for VAT and therefore promote vertical equity.

It is difficult to determine whether the present exemption levels are appropriate in the absence of robust property market data. The VAT is generally a relatively simple tax to administer with moderate administrative costs; it is also a very efficient tax with moderate compliance costs. There is scope for BIR to improve the quality of its communications with taxpayers in respect of VAT. VAT revenue flows from property sale and lease transactions have performed relatively poorly in the 2001‐2005 period compared with the performance of most other national land‐related taxes; this is attributable to negative valuation impacts, under reporting of property transaction values and evasion of VAT.

LOCAL TAXES RPT and SEF Valuation revisions exert a key influence on maintaining the integrity of the RPT (and SEF) by providing regular updates of taxpayers’ ability to pay these taxes. The RPT and SEF are generally efficient taxes but their efficiency is being materially weakened by inadequate revisions and implementation of updated SMVs. The use of assessment levels and frequent political interventions in valuations resulting in the partial rather than complete implementation of SMVs also result in below market valuations. Data reported in the Naga tax compliance study demonstrates that, nationally, current LGU revenue policy outcomes may generate inefficiencies in that the revenue burden of some taxpayer categories is excessive or too low relative to the respective benefits provided to these categories by LGUs. Hearsay evidence suggests that the business sector often bears a disproportionate share of the funding burden in some LGUs. Funding inefficiencies in LGUs are likely to create material deadweight costs. The possible existence of inefficient revenue policies is not surprising, as the preparation of efficient revenue policies is not addressed in the Local Government Code (LGC).


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The present obligation under the LGU to tax plant and machinery does not promote economic efficiency as this penalises investment in such assets in comparison with other assets such as financial assets. Consequently, the additional taxation of plant and machinery in addition to the taxation of the market value of land and buildings undermines the role of the property tax as a measure of relative ability to pay property taxes across different taxpayer categories. It is uncertain whether the separate taxation of land and buildings promotes funding inefficiencies (or horizontal and vertical equity) in LGUs, as no evidence is currently available on this matter. The LGC currently provides little flexibility when setting SEF tax‐rates; SEF taxes are either levied at 1% of assessed values or not levied at all. The current local government financial management framework is outdated and does not support the development of efficient revenue, RPT and SEF policies or promote appropriate accountabilities amongst politicians or officials. There are no obligations to prepare revenue policies in accordance with a supportive regulatory framework in the Philippines or undertake medium‐term financial planning. Consequently, funding inefficiencies are likely to arise in many LGUs. The achievement of horizontal and vertical equity is undermined by the frequent use of outdated and below‐market SMVs due to LGUs having failed to regularly revise and fully implement revised values. The present practice of applying similar base unit values to a wide range of properties that have different market values also creates vertical inequities. LGUs generally have a very limited understanding of ability to pay distribution trends within taxpayer categories and are not particularly proactive in promoting equitable RPT outcomes. Currently, there is a weak relationship between taxpayers’ ability to pay as measured by household incomes and RPT collection levels. There is also insufficient consideration of ability to pay trends in setting RPT tax rates. The base RPT exemption for all residential properties should be based on their total market value rather than a value for residential buildings. Although the LGC gives specific exemptions from RPT and SEF in certain adverse economic situations, there is currently no formal framework in the LGC for preparing RPT, SEF and overall revenue policies and addressing equity issues including RPT and SEF exemption and postponement policies for individual taxpayers.

Currently, real property taxes (i.e. the RPT and SEF) are frequently very expensive taxes to collect due to the lack of computerization in many LGUs and poor collection levels. Billing and collection practices are frequently very rudimentary and require considerable development. Frequent political intervention in property tax liabilities and the use of legal remedies to recover property tax arrears also undermine RPT revenue collection activity.


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LGU services to taxpayers are generally poor; consequently, taxpayers incur reasonably high compliance costs in meeting their RPT and SEF obligations. The level of transparency for the RPT and SEF is variable but generally poor. In addition to limited knowledge about their RPT and SEF obligations, taxpayers generally have a modest understanding of the impact of valuations on RPT tax rates. An enhanced local government financial management policy regulatory framework should promote increased transparency in local government revenue policies. LGU politicians’ overall level of knowledge about the RPT is insufficient; this impedes RPT policy‐making activities. LGU public consultation procedures are not well developed. Improved procedures should be incorporated in the LGC. Basic RPT and SEF taxes performed very well relative to other land‐related taxes and GDP growth in the period 1997‐2005 with growth rates marginally less than that of GDP growth. The basic RPT performance level was achieved with average collection levels of generally less than 60% indicating the potential of the basic RPT. Basic RPT and SEF revenues were relatively stable in the period 1997‐2006. Local Transfer Tax The local transfer tax exhibits similar efficiency, equity and administration simplicity outcomes to those reported for the CGT and DST. There is considerable uncertainty amongst taxpayers over the basis of calculating liability for the local transfer tax in spite of a relatively high level of awareness of this tax suggesting that the overall level of transparency for this tax is moderate at best. Although the local transfer tax performed relatively poorly in the period 1997‐2006, it has nevertheless outperformed the CGT and DST in terms of growth in the latter period. Local transfer tax revenue flows have been relatively unstable in the period 1997‐2006. Special Levy and Idle Land Tax Both taxes generate minimal revenues and are underdeveloped as revenue mechanisms.

National Fees

The process employed in setting fees for land‐related services is not robust, as it is not based on either the full costs associated with the provision of services or linked to the recovery of the private benefit component of operating expenditures.


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Fee income should be based on operating expenditure projections that reflect the full costs of proposed activity expenditure developed using activity based costing principles. The absence of the use of activity based costing methodology in the preparation of expenditure budgets limits recoveries from user fees. Fee income should also seek to recover the cost of the private benefit component of proposed operating activities, having regard to the respective user fee administration costs.

Comparative Performance of National and Local Land‐related Taxes

Details of the comparative performance of national land‐related taxes and the principal local land‐related taxes in the period 1997/2005 are presented in Figure 1.

Role of Valuation Impediments in Performance of Land‐related Taxes The data presented in Figure 1 demonstrates the poor recent performances of all land‐related transfer taxes (CGT and local transfer tax) and donor’s and estate taxes. The poor performance of these taxes is mainly attributable to inadequate revisions of zonal values and SMVs as well as weaknesses in BIR’s administration of national land‐related taxes and limited transparency about the details of these taxes. The absence of robust property market data is also an impediment to the development of effective land‐related taxes.

Economic Impact

The poor performance of land‐related taxes at a national and local level is constraining economic development.

Figure 1: Growth in Land Taxes, GDP, BIR Collections 1997-2005

-20.00%0.00%

20.00%40.00%60.00%80.00%

100.00%120.00%140.00%160.00%

CGT

Local t

ransfe

r tax

Estate

tax

Donor's

tax

Basic R

PTSEF

GDP

BIR co

llectio

ns

Land Taxes, GDP and BIR Collections

Cha

nge


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At a national level, weaknesses in land‐related taxes are undoubtedly contributing to the progressive deterioration in the contribution of the land sector to Gross Domestic Product (GDP), which has fallen from 11.7% in 1997 to 8.5% in 2005. At a local level, the underperformance of the RPT compared with its potential revenue generating capacity is limiting the raising of funds for expenditure on local infrastructure and services, which in turn acts as a catalyst for local economic development. Recommendations It is important to note that the government’s revenue requirement and present difficult fiscal position have been considered when developing draft reform options. National Land‐related Taxes 1. National Land‐related Tax Reforms

Capital Gains Tax

Two broad options for the reform of the CGT are recommended for consideration:

i. A 50% reduction in the CGT tax rate from 6% to 3%; no change to the present tax base is proposed. The present exemption for principal residences should be made more generous by exempting all sales of principal residences where the lot area is less than 200 square meters (first‐ranked option). The present restriction on the use of the exemption from CGT to once every ten years should be abolished for properties with a lot area less than 200 square meters.

ii. A return to a net gains tax base that was terminated in 1986 (second‐ranked option).

Option 1 Although option 1 offers less scope to reduce current inefficiency costs and inequities than option 2, this option was ranked first as it should not be as difficult to implement as option 2. Assuming the CGT rate reduction was implemented at the commencement of a fiscal year, revenue may well initially decline by as much as 50% in the first year following the rate reduction (say P2 billion). The rate reduction should stimulate increased secondary market property transactions by say 50% (assuming a housing demand elasticity of 1) and increased taxpayer compliance, contributing to a gradual recovery in CGT revenue to more than pre‐CGT rate reduction levels within say five years. The CGT rate reduction should be adopted when a more realistic single valuation base (which would be the Improved Schedule of Market Values of local governments) is already established in the country.


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Option 2 Although option 2 offers more scope to reduce current inefficiency costs and inequities, this option was ranked second as the latter gains are likely to be offset to some degree by a resurgence of the previously experienced administration difficulties associated with the determination of applicable deductions for CGT transactions. Should option 2 be preferred, it is also necessary to make determinations about the following matters that affect the structure of a CGT that taxes net gains:

i. The scope of the CGT tax base ii. CGT rates iii. Treatment of losses

iv. Rollover provisions

v. Principal residence exemption

vi. Inflation adjustment

vii. Treatment of non‐residents The above seven items are discussed in the main report. DST No change is proposed to the DST at this point due to uncertainty about the value of DST revenues generated under Section 196 of the NIRC and a suspicion that the quantity of revenue provided from this source may be considerably higher than previously thought. The analyses of CGT and DST demonstrated that adjustments are required to these taxes. In view of the government’s fiscal constraints and the lack of knowledge about DST revenue flows, it is recommended that initial reforms to national land‐related transaction taxes be restricted to the CGT.

Estate Tax

Changes are recommended to the present structure of the estate tax in terms of increasing the exemption level and revising the tax brackets and associated tax rates to reduce efficiency losses and improve equity. Increases to deduction levels are also recommended in view of the erosion of the real value of current deduction since their introduction on 1 January 1998; these should be regularly reviewed at five‐yearly intervals.


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An examination of a range of estate tax returns is required to establish the extent to which deductions and the exemption from estate tax should be increased. This work will assist the subsequent preparation of revised estate tax brackets and tax rates.

Donor’s Tax

Changes are recommended to the present structure of the donor’s tax in terms of increasing the exemption level and revising the tax brackets and associated tax rates to reduce efficiency losses and improve equity. The development of the estate tax reform proposal must be completed prior to the development of the donor’s tax reform proposal in view of the established linkage between the two taxes.

2. National Land‐related Tax Administration Reforms

Property Valuations The overall poor recent performance of these taxes is partially due to the failure of the BIR and LGUs to regularly revise their respective zonal values and SMVs. Assuming no change in the rules affecting property valuations in the short to medium term, considerable progress in the revision of zonal values could be achieved relatively quickly, say in the course of two years, provided additional budget funds are allocated to the BIR and prompt action is taken by BIR national office officials to process proposed revised zonal values submitted by district revenue offices; revenue gains should substantially exceed the additional operating costs associated with the adoption of a more aggressive approach to revising zonal values. The introduction of a performance requirement into the IRA in respect of LGU valuation revisions to motivate LGUs to take such action is likely to take more than two years to achieve. Consequently, there is merit in intensifying the revision of zonal values in the near term. General Administration A major improvement in BIR’s tax administration is required to improve processing times for national land‐related taxes and promote better taxpayer compliance and transparency. BIR must enhance its own internal revenue record‐keeping to provide a more robust basis for monitoring the performance of these taxes by collecting data in respect of revenues generated by different sections of the tax code; data should also be collected for tax brackets of national land‐related taxes where these are in place.


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Estate and Donor’s Tax BIR must improve its collection of information in respect of donor’s and estate tax returns to guide future policy development. Data must be collected covering current taxes payable, arrears, and receipts across tax brackets, gross estate values and net estate and gift values. The NIRC should be amended to provide for:

• The administrators of estates to have the ability to pay estate taxes on an instalment basis within a specified period.

• An increase in the gross value for estates where a supporting certified statement in

respect of assets, deductions and estate tax payable, prepared by a Certified Public Accountant in terms of Section 90(A)(3) of the NIRC is required, from P2million to P5million.

Local Land‐Related Taxes 1. Local Land‐related Tax Reforms LGC The following changes are recommended to the LGC:

i. The Sanggunian’s present ability to approve revised property valuations provided by assessors in terms of Section 212 of the LGC should be amended. The power to certify property valuations should be vested in an independent body; the present VRA bill seeks to achieve this outcome by providing a mechanism for certification that proposed revised property valuations comply with valuation standards prior to their implementation by LGUs.

ii. The use of assessment factors in the determination of values for LGU tax purposes as

provided by Section 218 the LGC should be abolished. This change would result in land and buildings being valued at the respective SMVs and opens up the potential for land and buildings to be taxed at the same tax rate provided the tax rate is less than the maximum rate specified in Section 233 of the LGC.

iii. Replace the present P175,000 buildings exemption from RPT with a larger exemption

based on the total market value of a property iv. Obligations to prepare a RPT policy and a revenue policy should be introduced into

the LGC; details of the possible content of such policies are discussed in the main report. RPT and revenue policies should provide increased flexibility to deal with


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taxpayers with limited ability to pay that have ongoing problems meeting their RPT and SEF obligations.

v. Public consultation obligations consistent with international best practice should be

introduced into the LGC; an outline of possible consultation obligations is presented in the main report.

vi. Introduce obligations requiring public release of key documents in respect of LGU

financial management such as budgets, annual reports and the use of SEF covering SEF budgets and annual reports.

NGAS for LGUs The following changes are recommended to the NGAS for LGUs:

i. Revised annual budget and financial reporting frameworks are required, based on activity basing costing principles to enhance overall transparency as well as that of revenue policy; these should include expanded disclosures of current revenue receipts and arrears recoveries. Medium to long‐term financial planning should also be introduced.

ii. A revised accounting policy framework; this should employ an international best

practice approach for recognizing revenue, including accounting for debtors.

2. Local Land‐related Tax Administration Reforms

LGC In the medium to long term it would be appropriate to:

i. Review the powers and supporting functions of LGUs to ensure that LGUs do not incur any unfunded mandates.

ii. Revise the financial management sections of the LGC to employ a more modern

approach to local government financial management; these would include the preparation of a range of financial management policies that would enhance the transparency of the RPT and SEF and appropriate accountabilities for politicians and officials.

iii. Review the current RPT revenue sharing arrangements between the different tiers of

LGUs. BLGF Guidance to LGUs BLGF should be providing increased guidance to LGUs on revenue topics. As a first step, an independent assessment should be made of BLGF’s present assistance on revenue topics


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and opportunities for BLGF to improve its assistance to LGUs; for example, the provision of guidelines on the special levy and idle land tax. LGU Informal Initiatives There is a considerable amount of activity that LGUs could undertake themselves prior to any adjustments being made to the LGC to improve their RPT, SEF and wider revenue performance; these activities include:

• Computerize accounting, treasury and valuation activities

• Develop integrated accounting, treasury and valuation information systems

• Undertake required SMV revaluations and fully implement these prior to the next revision of SMVs

• Increase valuation sub‐categories where necessary, particularly within the residential

sector, to promote vertical equity

• Prepare ability to pay assessments for major taxpayer categories to assist with the development of revised tax rates following SMV revisions

• Improve billing practices; this includes providing information about the role of the

RPT, the basis of RPT calculations, the availability of prompt payment discounts, methods for paying the RPT and the provision of regular accounts to taxpayers

• Enhance collection practices; this includes being proactive in revenue collection,

taking action against delinquent filers and payers, conducting taxpayer registration drives and cleaning taxpayer registries regularly.

National Fees

The NGAS for government agencies should be amended to provided for the adoption of activity based costing methodology in the preparation of expenditure budgets. COA rules should be revised to encourage government agencies to recover the cost of the private benefit component of proposed operating activities.


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1. Introduction 1.1 Background The National Tax Research Center (NTRC) is participating in the LAMP II component on land valuation and taxation (Component 4). The NTRC is currently conducting a review of land related taxes and fees collected by national government agencies and local government units (LGUs) using an evaluation framework based on generally accepted taxation principles. The assumptions, findings and recommendations of the 2002 Fees and Finance Study1 are also being reviewed and updated in the course of the latter review. This report discusses the findings of the review of land related taxes and fees and presents recommendations for the reform of national and local land taxes and fees where applicable. 1.2 Land‐Related Taxes and Fees Evaluation Criteria A detailed framework for evaluating the merits of current national and local land‐related taxes and fees was prepared in January 2007 based on generally accepted taxation principles. The key evaluation principles employed in the present study are:

• efficiency

• equity

• administrative simplicity

• transparency

• adequacy

• stability The efficiency principle requires that a tax system should not distort economic decisions of individual or business taxpayers in terms of causing any loss in the economic value of consumption and production as a result of taxpayers altering their economic decisions as to how much they should work, save, consume or invest; any distortions may create economic inefficiencies (known as “deadweight costs”) that increase the tax burden on society. Deadweight costs include tax administration costs, taxpayer compliance costs and the costs arising from changes in the economic behaviour of taxpayers; the latter costs usually form the greatest proportion of deadweight costs. Inefficient taxes consequently have relatively

1 LAMP1 “Fees and Finance Policy Study” 29 July, 2002.



high deadweight costs. Taxes on capital income such as CGT and DST produce large deadweight losses2. The equity principle concerns how the burden of taxation should be shared among different income groups. Two related principles of equity are often considered:

a) Horizontal equity is defined as the equal treatment of equals and suggests that taxpayers who are in equal circumstances with regard to the tax base (be it income, property value or wealth) should be treated the same.

b) Vertical equity is defined as the unequal treatment of unequals and means that

taxpayers who do not share similar circumstances should be treated differently. Vertical equity is associated with the concept that individuals should contribute in taxation an amount of money, which represents an equal sacrifice to them. Because the sacrifice of paying an additional dollar of tax is likely to be smaller for people with many pesos than those with few pesos, vertical equity requires that those with higher income or higher value property make a larger tax contribution to tax revenue.

Administrative simplicity requires that the revenue system has administrative costs (to the collection agency) and compliance costs (to taxpayers) in terms of rules, record keeping, computation requirements and understanding the respective tax obligations, which are not large in relation to revenue collected. Successful tax administration is based on a system of voluntary compliance. Taxes that are either too difficult to measure and pay on a voluntary basis or too complex or costly to enforce will detract from a system of voluntary compliance. Transparency requires the disclosure of sufficient information to allow the public to easily understand why particular revenue measures are employed, the details of such measures and their tax obligations. The adequacy principle requires a tax to increase at a similar rate to growth in GDP whilst the stability principle requires a tax to generate short‐run fluctuations in revenue comparable in magnitude to contemporaneous fluctuations in economic activity. The abovementioned detailed evaluation framework is presented as Annex 1. The application of the selected evaluation criteria to the review of specific current national and local land‐related taxes and fees will guide the determination of recommendations for the modification, retention or termination of existing revenue mechanisms.

2 Martin Feldstein, “Taxes on Investment Income Remain Too High and Lead to Multiple Distortions” © The Berkeley

Electronic Press “Economists’ Voice” www.bepress.com/ev June, 2006.



1.3 Reform Option Principles A set of principles for identifying possible policy reforms was developed; the principles comprise criteria that potential policy reform options must satisfy and include:

• Improving overall efficiency in resource allocation by reducing economic losses arising from distortions and inefficiencies created by current national land‐related taxes and fees

• Creating more equitable policy outcomes at a national and local level

• Recognising present deficiencies in the administration of national and local land‐

related taxes and fees

• Creating a supportive policy framework for the real property tax

• Maintaining consistency with the government’s prevailing tax reform agenda 1.4 Report Structure The structure of the rest of the report is as follows:

• Section 2 reviews the recent contribution of the land sector to economic activity in the Philippines, the present structure of national taxes prevailing in the Philippines and the Government’s current tax reform agenda;

• Section 3 outlines and assesses prevailing national land‐related taxes; it also briefly

discusses the merits of devolving responsibility for national land‐related taxes to LGUs

• Section 4 outlines and assesses the current structure of local land‐related taxes

imposed by Philippine LGUs

• Section 5 presents details of the comparative performance of national land‐related taxes and the principal local land‐related taxes in the period 1997/2005

• Section 6 discusses national land‐related fees levied by two major national

government agencies

• Section 7 highlights land‐related tax and fees reform issues and options and presents specific reform recommendations



2. Key Macroeconomic Considerations This section briefly reviews some key macroeconomic considerations that impact on the current study. The economic contribution currently made by the land sector to the Philippines economy, the present state of the Philippines tax system and the government’s tax reform agenda are briefly reviewed. 2.1 Economic Contribution of the Land Sector It is important to recognise the economic contribution currently made by the land sector. Relative land registration costs are an important barometer for assessing the ability of the land sector to contribute to overall economic activity. Estimates of the property sector’s contribution to GDP are presented in Table 1. This data demonstrates that the property sector’s contribution to GDP has eased considerably during the period 2001‐2005 declining from 9.9% in 2001 to 8.7% in 2005. Although it is difficult to identify all the factors contributing to the Philippines land sector’s deteriorating performance, the present relatively high land registration costs are undoubtedly a factor constraining the level of activity in the land sector. The World Bank’s annual “Cost of Doing Business” publication for 2007 provides assessments of the costs of registering property in a total sample of 173 countries compared with a sample of 171 countries in the previous year. The Philippines’ overall performance in respect of property registration based on the number of procedures, time taken and associated costs was very close to the respective sample average in 2007; a ranking of 86th place was achieved in 2007 compared with a ranking of 98th place in 2006 due to a reduction in the estimated total transaction cost as a percentage of the estimated property value from 5.7% in 2006 to 4.2% in 2007. Property registration cost rankings across a sample of Asian and Pacific countries are presented in Table 2 together with the countries’ respective overall “Cost of Doing Business” rankings and performance assessments for the factors supporting the property registration cost rankings. The Philippines’ overall performance was below average in the latter sample, primarily due to the above‐average number of procedures relative to the countries sampled in spite of the reduction in estimated total transaction costs in 2007. Poor overall performance in respect of land registration exerts a negative impact on land sector activity. Poor revenue performance by LGUs acts as a major constraint on local economic development as this limits funds available for the development of local infrastructure and expansion of local services. It also dampens the impact of national government development expenditures in LGUs.



Table 1. GROSS DOMESTIC PRODUCT (GDP) BY REAL PROPERTY RELATED ACTIVITY, 2001‐2005 (In Million Pesos in Constant Price of 1985)

2001 2002 2003* 2004* 2005*

GDP 990,042 1,034,094 1,085,072 1,152,174 1,209,473

Construction 49,487 47,498 47,113 48,718 49,142

Real Estate 8,379 8,317 9,140 10,615 12,245

Ownership of Dwellings 39,740 40,680 41,815 43,039 44,283

Total of real property‐related GDP 97,606 96,495 98,068 102,372 105,670

Real property‐related share of GDP

9.9% 9.3% 9.0% 8.9% 8.7%

* Data are as of May 2006 Source: NTRC based on 2006 Philippine Statistical Yearbook



Table 2. COMPARATIVE LAND REGISTRATION PERFORMANCE BY SELECTED ASIAN AND PACIFIC COUNTRIES, 2007

Registering Property

Country Ease of Doing Business Rank Rank Procedures (number)Time (days)

Cost (% of property

value)

New Zealand 2 1 2 2 0.1

Singapore 1 13 3 9 2.8

Mongolia 52 18 5 11 2.2

Thailand 15 20 2 2 6.3

Taiwan, China 50 24 3 5 6.2

Nepal 111 25 3 5 6.4

Australia 9 27 5 5 4.9

China 83 29 4 29 3.6

Bhutan 119 33 5 64 0

Vietnam 91 38 4 67 1.2

Japan 12 48 6 14 5

Hong Kong, China 4 58 5 54 5

Malaysia 24 67 5 144 2.4

Korea 30 68 7 11 6.3

Philippines 133 86 8 33 4.2

Pakistan 76 88 6 50 5.3

Cambodia 145 98 7 56 4.4

India 120 112 6 62 7.7



Registering Property

Country Ease of Doing Business Rank Rank Procedures (number)Time (days)

Cost (% of property

value)

Indonesia 123 121 7 42 10.5

Sri Lanka 101 134 8 83 5.1

Lao PDR 164 149 9 135 4.2

Afghanistan 159 169 9 250 7

Bangladesh 107 171 8 425 10.3

Sample average 5.5 68 4.8

Source: World Bank 2007 “Cost of Doing Business”



2.2 The Present State of the Philippine Tax System Although the Philippine tax system seeks to establish a relatively comprehensive tax base, this outcome is not being achieved at the present time. The Philippines tax system is currently characterised, however, by shortfalls in revenue generation, relatively weak tax administration and useful opportunities for individual and business taxpayers to avoid taxation. Although there has been some recent recovery in the ratio of tax revenues to Gross Domestic Product (GDP) from 12.5% in 2004 to 14.3% in 20063, the Bureau of Internal Revenue (BIR) was struggling to achieve its planned revenue targets in 2007 as at 30 September 2007; the ratio of tax revenues to GDP was 14.2% in the first nine months of the 2007 calendar year. The tax revenue generation difficulties currently being experienced are partially attributable to two significant failures in proposed tax policies arising from the 1997 Comprehensive Tax Reform Program (CTRP) that have limited efforts to broaden the tax base. Firstly, excise taxes on cigarettes and liquor were restructured from an ad valorem to a specific basis whilst the proposed indexation of these taxes was never implemented; consequently excise taxes contribution to tax revenue has progressively declined from 2.1% of GDP in 2000 to 1.4% of GDP in 20054. Secondly, the proposed rationalization of business tax incentives has not been addressed In addition, there are extensive exemptions from VAT available resulting in a relatively low effective VAT rate5. Poor tax administration distorts the equity of the current Philippine tax system6 and undermines the achievement of a comprehensive tax base. Significant tax avoidance among the self‐employed and professionals together resulting from weak tax administration and extremely generous business tax incentives and tax exemptions result in a greater than justified tax burden being borne by salary and wage earners. Current differences between business and personal tax‐rates and tax‐rates applicable to dividends, interest and capital gains on equity and property investments also create opportunities for individuals and businesses to earn income at substantially lower tax rates than applicable to ordinary personal and business income; this matter is discussed in more detail in section 3.2.

3 Philippines Department of Finance, Fiscal Update, 15 April 2007. 4 World Bank, World Bank Report No: 37772 – PH, Project Appraisal Document: National Program Support

for Tax Administration Reform, 2007, page 25. 5 The effective VAT rate is measured by VAT revenue as a percentage of personal or total consumption

expenditure; in 2005, this rate for both benchmarks was less than 3% compared with the prevailing 10% VAT rate. IMF Working Paper WP /96/79.

6 World Bank, World Bank Report No: 37772 – PH, Project Appraisal Document: National Program Support

for Tax Administration Reform, 2007, page 21.



The major weaknesses in tax administration are now being addressed by way of support from the World Bank through the National Program Support for Tax Administration Reform project (NPSTAR). 2.3 The Government’s Tax Reform Agenda The most significant recent tax reform measure was the increase in the VAT rate from 10% to 12%, effective from 1 February 2006. The government’s current tax reform agenda is concentrated on achieving major improvements in the standard of tax administration, as the implementation of any additional tax reforms in the short‐term is likely to be at least partially offset by tax administration weaknesses. The current review of national and local land‐related taxes and fees must have regard to present taxation outcomes and the government’s tax reform agenda. Consequently any reform proposal(s) in respect of the latter revenue mechanisms must be fiscally neutral at a national government level (i.e. result in no change in net government expenditure).



3. National Land‐Related Taxes 3.1 Introduction This section discusses the present national land‐related taxes and their recent performance. The analyses in this section and the following section addressing local land‐related taxes draw on a series of background papers prepared by NTRC in 2006/2007; a listing of these papers is presented in Annex 3. Currently the government derives revenue from six taxes affecting land transactions:

1) A capital gains tax (CGT) based on the higher of the gross selling price or the current fair market value as determined by the Commissioner of Internal Revenue (using zonal values) or as shown in the schedule of values of the Provincial and City Assessors.

2) A documentary stamp tax (DST), levied under Section 196 of the NIRC, based

on the higher of the consideration specified in deeds of sale and conveyances of real property or the current fair market value as determined by the Commissioner of Internal Revenue (using zonal values) or as shown in the schedule of values of the Provincial and City Assessors.

3) An estate tax, levied on the value of net estates, based on a sliding scale.

4) A donor’s tax. levied on the value of net donations, based on a sliding scale.

5) Value added tax (VAT) that is levied on property leasing and sale transactions

6) Excise tax that is levied on the value of mineral products7.

Reviews of each of the above taxes follow using the criteria presented earlier in section 1.2. Details of estimated operating costs and revenues for the five taxes reviewed in this paper are also presented. Draft assessments have been made of the estimated operating costs for the abovementioned taxes with the exception of the excise tax on mineral products; the methodology employed in developing the latter cost assessments is presented in Annex 2.

Revenue Overview Details of revenues provided by national land‐related taxes in the 2001 and 2005 calendar years are presented in Table 38.

7 This tax is not being considered in the current policy review.



It is important to note that the BIR is currently unable to provide detailed disaggregated statistics for the CGT, DST, estate tax and donor’s tax; this has prevented detailed distribution analyses of these taxes from being undertaken.

Table 3. REVENUES OF NATIONAL LAND‐RELATED TAXES, 2001‐2005

(P million)

Tax Estimated 2001

revenue

Estimated 2005

revenue

Contribution to BIR tax

revenue 2001 (%)

Contribution to BIR tax

revenue 2005(%)

Capital gains tax9 3,180 4,580 0.82 0.84

Documentary stamp tax 795 1,145 0.20 0.21

Estate tax 373 627 0.10 0.12

Donor’s tax 221 295 0.06 0.05

VAT 2,933 3,163 0.75 0.58

Excise tax – mineral products10

120 251 0.03 0.05

Total national land‐related taxes 7,622 10,061 1.96 1.85

Total BIR tax revenue11 388,679 542,697

The overall contribution of national land‐related taxes to BIR tax revenue declined moderately from 1.96% in 2001 to 1.85% in 2005 principally as a result of the reduction in the contribution of VAT from property leasing and sale transactions in the 2001‐2005 period. Cost Overview Details of estimated operating costs and operating revenues for national land‐related taxes in the 2005 calendar year, prepared using the methodology outlined in Annex 212, are presented in Table 4.

8 The DST revenue figure is an estimate based on 25% of CGT revenue as the BIR provides no data on a

disaggregated basis for any DST revenues.

9 A capital gains tax is also levied in the Philippines on realised gains from the sale of unlisted equity investments; this tax is not being addressed in the present review of national and local land taxes and fees.

10 Cost data was not obtained for the excise tax on mineral products, as this tax is not being considered in

the current policy review.

11 BIR 2005 annual report, Table IV, page 52. 12 The estimated 2005 operating costs used in Table 4 are estimated weighted average operating costs for

the period 2001-2005.



Table 4. OPERATING COSTS AND REVENUES OF NATIONAL LAND‐RELATED TAXES, 2005 (P MILLION)13

Tax Estimated 2005

operating costs

Estimated 2005 gross operating revenue

Estimated 2005 net revenue

Operating costs as a % of gross revenue

(2005)

Capital gains tax 59 4,580 4,521 1.29%

Documentary stamp tax

59 1,145 1,086 5.15%

Estate tax 51 627 576 8.13%

Donor’s tax 37 295 258 12.54%

VAT 99 3,163 3,064 3.13%

Total national land‐related taxes

305 9,810 9,505

Total BIR tax revenue

542,697 0.69%

BIR’s overall costs as a percentage of revenue collected are modest at 0.69% of gross revenue. Land‐related taxes are, however, relatively costly for the BIR to collect; cost estimates suggest that the DST, estate and donor’s taxes appear particularly costly to collect compared with other BIR revenues. 3.2 Capital Gains Tax Description Although the present capital gains tax in the Philippines is defined as an income tax, the tax in its current form is effectively a transaction based tax on property sales rather than a traditional capital gains tax that is levied on the net realized capital gain arising from the sale of property by individuals and domestic corporations. In the Philippines the capital gains tax is only applicable to properties that are classified as “capital assets” (as they are not used in the ordinary course of property business activities undertaken by either of the latter taxpayer categories). History Initially, the tax base for the capital gains tax in the Philippines was the traditional form associated with capital gains taxes, namely net realized capital gains. Administration difficulties in the form of understatements of selling price and

13 The excise tax on mineral products was not included in Table 4 as no cost data was obtained for this tax.



overstatements of expenses were incurred14 when the value of net capital gains on relevant transactions was determined. Consequently, the CGT from the schedular rates of 10% and 20% was changed to a single rate of 5% and the taxable base was changed from net capital gains to gross selling price or fair market value at the time of sale, whichever is higher under PD 1994 issued November 5, 1985, effective January 1, 1986. This was further amended by Executive Order No. 37, effective August 1, 1986 by including pacto de retro sales and other forms of conditional sales of individuals including estates and trusts among those subject to the 5% final tax. Current Tax Rate The capital gains tax rate was increased from 5% to 6% in 1997 under Republic Act No. 8424 and the increased rate came into effect on 1 January 1998. A creditable withholding tax of 6% is imposed on sales of properties that are classified as “ordinary assets” by individuals not habitually engaged in the real estate business whilst sales of properties by individuals habitually engaged in the real estate business that are classified as “ordinary assets” attract withholding taxes ranging from 1.5% to 5%. Sales of properties by domestic corporations attract a withholding tax of 6%. Tax‐base Issues The current basis for assessing liability for capital gains tax is based on the higher of the gross selling price or the fair market value as determined by the Commissioner of the BIR (using zonal values), or as shown in the schedule of values of the Provincial and City Assessors. Zonal values are frequently substantially less than prevailing market values. There is no reference in the NIRC to any requirement for regular reviews of zonal values. Resource constraints at a BIR national and regional office level, the length of time taken to complete a revision exercise and delays by the DOF in approving recommended revised zonal values collectively contribute to delays in the determination of revised zonal values. LGU schedules of market values (SMVs) are also frequently substantially below prevailing market values due to LGUs continually failing to revise their SMVs as required by Section 219 of the Local Government Code (LGC). Cost and political considerations are major contributing factors influencing LGU decisions to postpone revisions of SMVs. The LGC imposes no penalties on LGUs that fail to revise their tax values unlike property tax legislation in New Zealand and South Africa that prohibits LGUs from levying property taxes if their valuation rolls are more than three or four years old. The above weaknesses in valuation practices that undermine the CGT tax‐base are compounded by the wide spread practice in the Philippines where parties to property sale transactions specify below‐market values on the supporting

14 NTRC, September-October 2005 “Review of the Capital Gains Tax on the Sale, Exchange or Other

Disposition of Real Properties”, NTRC Tax Research Journal Volume XVII.5 (September – October 2005).



documentation for tax purposes that is subsequently presented to the BIR and the Registry of Deeds; the fraudulent documentation gains official status when it is notarized. Exemptions to the capital gains tax are provided in the following cases:

a. Transfer of lands covered under RA 6657 (Comprehensive Agrarian Reform Law of 1988);

b. Sale or transfer of real properties classified as capital assets by cooperatives

pursuant to RA 6938 (Cooperative Code of the Philippines)15 c. Sale of raw lands used for socialized housing projects pursuant to Sec.

20(d)(2) of RA 7279 (Urban Housing Development Act of 1991); d. Sale or exchange of principal residence, subject to certain conditions,

pursuant to Sec. 24 (D)(2) of the Republic Act No. 8424 of 1997; this exemption is not an automatic one.

e. Sale or transfer of properties by the Government Service Insurance System (GSIS) pursuant to RA 8291 (GSIS Act of 1997); and

f. Transfer of non‐performing assets from the financial institutions to a Special Purpose Vehicle (SPV) or from an SPV to a third party pursuant to RA 9182 (Special Purpose Vehicle Act of 2002) as amended by RA 934316.

Limited recent data is available in respect of the value of the above exemptions. Assessments of the value of the most of the above exemptions in 2004 (excluding those arising under RA 8424 and RA 665717) are presented in Table 5. No data is currently available for the 2005 year.

Table 5. VALUE OF EXEMPTIONS TO CAPITAL GAINS TAX, 2004

(P) Laws Amount of CGT Waived (P)

R.A. No. 7279 7,879,154

R.A. No. 9182 17,776,673

R.A. No. 8291 20,148

R.A. No. 6938 96,434

15 NTRC, 2006, Comparative Structure of and Experience on Transfer Taxes in Selected Asian Countries,

page 5.

16 This legislation is a temporary measure. 17 NTRC, “Review of the Capital Gains Tax on the Sale, Exchange or Other Disposition of Real Properties”,

NTRC Tax Research Journal Volume XVII.5 (September – October 2005): Table 1, page 10.



The principal residence exemption is, however, relatively limited by international standards and is subject to the following conditions: a) That the proceeds shall be utilized in acquiring or constructing a new principal

residence within eighteen months from the date of sale or disposition b) That the Commissioner of Internal Revenue shall be notified by the taxpayer

within thirty days from the date of sale or disposition through a prescribed return of his intention to avail of the tax exemption

c) That the exemption can only be availed of once every ten years d) If there is no full utilization of the sale or disposition, the portion of the gain

presumed to have been realized from the sale or disposition shall be subject to capital gains tax. As such the gross selling price or fair market value at the time of sale, whichever is higher, shall be multiplied by a fraction which the “unutilized amount bears to the gross selling price in order to determine these taxable portion.”18

A commentary on equity issues associated with the principal residence exemption is included later in the policy evaluation part of this section. In addition, differences between corporate and personal income tax‐rates and tax‐rates applicable to dividends, interest and capital gains from property sales create opportunities for individuals and corporations to earn income from property sales that attracts substantially lower tax rates than applicable to ordinary personal and corporate income; details of relevant tax‐rates are presented in Table 6. Consequently the capital gains tax (and the current tax‐rates on dividends, interest and equity capital gains) do not promote the achievement of a comprehensive tax base.

18 NTRC, “Review of the Capital Gains Tax on the Sale, Exchange or other Disposition of Real Properties”,

NTRC Tax Research Journal Volume XVII.5 (September – October): Page 12.



Table 6. PHILIPPINE TAX RATES APPLICABLE TO DIFFERENT TYPES OF RESIDENT TAXPAYERS

Type of Income Tax‐rate

Individual Income 32% (Highest)

Corporate Income 35% (Highest)

Dividend Income from Domestic Corporations By Individual

10% Final Withholding Tax

Dividend Income By Corporations Non‐Taxable or 0%

Interest Income (Individual and Corporations)

20% Final Withholding Tax

Capital Gains From Shares of Stock Not Traded in the Stock Exchange (Individual and Corporations)

5% or 10% Final Withholding Tax

Property Gains on Capital Assets (Individuals and Corporations)

6% Capital Gains Tax

Property Gains on Ordinary Assets (Individuals and Corporations)

6% Creditable Withholding Tax (Highest)

Policy Evaluation Efficiency The present CGT (together with other property transaction taxes) distorts property market activity as it discourages several categories of private individuals owning properties that are “capital assets” from undertaking property transactions particularly those with less ability to pay. Owners of properties that are designated “capital assets” who earn below‐average incomes and where the current values of their properties for CGT purposes show relatively minor appreciation compared with the respective purchase price will be reluctant to sell their properties to reinvest in other properties when they have to pay a 6% tax on the tax value of their property (as well as an estimated 7% in other taxes and costs19 to complete their purchases). Individual owners of properties that are “capital assets” where current tax values are less than the respective purchase prices will also be reluctant to sell their properties, as they are unable to claim any deductions for their projected losses, unlike the owners of similar valued properties that are “ordinary assets” in a tax context.

19 Additional costs to be borne when properties are sold and the proceeds are reinvested in other properties comprise DST (1.5%), local transfer tax (0.5%) and legal and other costs including commissions and facilitation fees (say 5%).



Corporate taxpayers with limited ability to pay owning properties that are “capital assets” are also reluctant to dispose of properties showing either modest capital appreciation or losses. The CGT contributes substantially to the relatively high compliance costs currently associated with property transactions in the Philippines (in terms of the time taken to complete property transactions and the cost of taxes and other related costs including the cost of agents employed to coordinate the processing of property transactions). The relatively high compliance costs result in numerous secondary market transactions (i.e. the sale of existing rather than new houses and lots) being undertaken on a private basis and not being officially reported to the BIR or Registrar of Deeds due to property owners’ inability and/or unwillingness to pay the CGT and other associated transaction taxes. This practice also extends to some LGUs that are unwilling to pay the CGT associated with the transfer of properties into their names that have been acquired as a result of forced sales due to property tax arrears. Difficulties are experienced in the Philippines in determining the market value of property transactions due to the very limited availability of current property market information and the frequent use of relatively outdated property valuations by the BIR and LGUs in their respective prevailing zonal values and SMVs as noted earlier; this situation weakens the CGT tax base, promotes a distorted property market and impedes efficient resource allocation. The present practice of irregular revisions of zonal values weakens the integrity and role of the CGT as zonal values were introduced to overcome the administration difficulties experienced when capital gains were previously taxed on a net realized basis. Sellers of capital assets frequently manage to negotiate with buyers for part or all of their CGT liabilities to be paid by property buyers due to the amount of CGT payable on transactions; this behaviour has the effect of reducing property sale prices and undermines the objective of the CGT, namely to tax those selling capital assets. Corporate purchasers of capital assets will seek to pass on these costs in their pricing structures if their capital assets are inputs for other land‐related business activities. It is important to note that a comprehensive capital gains tax may not necessarily generate significant tax revenue, as this is dependent on the structure of the remainder of the tax system. Whilst many Asian countries tax capital gains from property transactions, the resulting revenues are frequently incorporated in income tax revenues and there is little data readily available to indicate the relative significance of these revenues. It is interesting to note that the Malaysian capital gains tax that previously generated 0.2% of government revenue was abolished last year effective 1 April 200720.

20 Bloomberg News, March 22, 2007. According to the Malaysian Prime Minister, this decision was made

to “inject more excitement and dynamism into both the property and financial sectors”. The latter decision suggests that the Malaysian government was conscious of the negative impact of its capital gains tax on the property sector.



In addition, some countries do not comprehensively tax individual taxpayers on capital gains on property transactions due to the application of a rigorous policy for taxing gains from business activities. In New Zealand, for example, the nature of the taxation of business income and treatment of individuals who are property dealers is perceived to limit capital gains tax revenue opportunities; consequently New Zealand does not have a capital gains tax due to the anticipated modest revenue flows. The present tax base for capital gains on property transactions undertaken by individuals and corporations is inappropriate if the BIR wishes to apply an efficient tax on capital gains (assuming no major related administration difficulties) and is most unusual in an international tax policy context. The tax base should be based on net capital gains rather than gross sales values. The CGT therefore creates inefficiencies in an economic context by reducing the volume of potential transactions through distorting the normal property market behaviour of individuals owning properties classified as “capital assets”. The latter distortions create deadweight costs that have a negative economic impact in that they reduce employment, tax revenue and the contribution of the land sector to the economy (as measured by GDP); anecdotal evidence suggests that the value of deadweight costs may be significant in comparison with the total value of receipts from property transfer taxes (including the CGT). Equity

Horizontal Equity The achievement of horizontal equity is undermined by the prevailing fraudulent reporting practices in respect of property transaction values associated with CGT payments where taxpayers report sale prices on property deeds of sale that are lower than those agreed in the respective sale transactions and the use of outdated SMVs and zonal values due to LGUs and the BIR having failed to regularly revise these values; this creates opportunities for the sellers of properties with similar sale values across different LGUs to make different CGT payments. Horizontal equity difficulties also arise due to property owners having a limited understanding of the rules applicable to CGT. It is evident that lack of knowledge of the available principal residence exemption creates horizontal equity problems between those property owners who know about this exemption and those who do not. Similarly, some property owners are not aware of the widespread practice where sellers of properties arrange for the respective buyers to reimburse them for their CGT liability; the former group in their ignorance pays the CGT whilst the latter group does not.



Vertical Equity The present transaction approach employed in the CGT tax base results in taxpayers incurring net losses or small net gains from property sales having to pay the same rate of CGT as taxpayers recording large net gains from property sales; this is contrary to the vertical equity principle. The use of outdated SMVs and zonal values by LGUs and the BIR accentuates vertical inequities as higher valued properties are frequently being under‐valued to a greater degree than lower valued properties; consequently, the variation in zonal and market values between lower and higher value properties is materially less than that revealed in open market sales for these property categories. The latter trends have been observed in Iloilo City and Naga City during the conduct of the LAMP II valuation simulation studies in these cities. In addition, there is evidence that some LGUs are using similar base unit values for a wide range of properties with different values due to an absence of values for different property category sub‐classes which further compromises the vertical equity principle; this outcome was noted and reported on in the September 2005 LAMP2 valuation simulation study in the City of Antipolo21. The latter valuation practice undermines the achievement of vertical equity in the application of the CGT. The practice of using similar values for a wide range of properties is even more marked in the case of zonal values. Variations in awareness of the present rules applicable to the CGT principal residence exemption and the utilization of this exemption creates vertical inequities across property owners selling their principal residences at different values as the exemptions may or may not be utilized. The present level of exemption from the capital gains tax for principal residences in the Philippines is not particularly generous. Although the owners of principal residences enjoy an exemption from the capital gains tax in the event that the sale proceeds from the sale of an existing principal residence are totally reinvested in another principal residence, the capital gains tax is levied on any funds that are not reinvested in another principal residence. The exemption from capital gains tax for the purchase of another principal residence may only be utilised once every ten years; this reduces the ability of taxpayers to change principal residences. No recognition is given to differences in taxpayers’ wealth when funds from the sale of a principal residence are only partly reinvested in another principal residence. Funds released in the event of a partial reinvestment in a principal residence attract the same capital gains tax rate irrespective of whether the principal residence sold was relatively high or relatively low i.e. the release of P100,000 from the sale of a P1million principal residence attracts the same amount of capital gains tax as the

21 LAMP1 “Valuation Simulation Study City of Antipolo September 2005”, para 5 page 2.



release of P100,000 from the sale of a P500,000 principal residence; this approach is unfair. Many developed countries employ a more generous approach to the imposition of capital gains taxes on the sale of principal residences than that currently applied in the Philippines. The present level of exemption from the capital gains tax for principal residences in the Philippines is relatively low by international standards. A survey of capital gains taxes undertaken by the OECD in 200422 demonstrated that twenty of the thirty countries surveyed gave more generous treatment in respect of principal residences than the Philippines; ten countries provided a total exemption with no conditions and all taxation of capital gains was imposed on a net gain basis, unlike the gross basis used in the Philippines. The present overall exemption for principal residences is very inequitable and should be increased. Additional matters to be considered in any revision of exemptions for principal residences could address factors such as setting a maximum area for any principal residence to ensure that very large and valuable properties are not exempted, prescribing a required period of ownership to qualify for an exemption and introducing a permitted level for the realization of development potential when small blocks of land adjacent to a principal residence are sold. Although the CGT is a proportional tax, it results in a regressive outcome that is inconsistent with the vertical equity principle. The lack of vertical equity associated with the CGT reflects the fact that taxpayers tend to spend a decreasing share of their total income on housing and have a lower proportion of their net assets invested in their principal residence as their income increases. Administrative Simplicity and Transparency The CGT in its present form should be a relatively simple tax to administer. The CGT, however, is a relatively expensive tax to collect (although less expensive than other national property‐related taxes) as noted earlier in this chapter23. Shortcomings in associated tax filing and valuation practices together with weaknesses in the BIR administration system are likely to accentuate the time spent by BIR officials in processing CGT returns as well as constraining CGT revenues. The CGT imposes relatively high deadweight costs on taxpayers, as noted earlier, due to high compliance costs and distortions in property market activity. The relatively high taxpayer compliance costs in respect of the CGT are partially due to taxpayers frequently resorting to using agents to assist them in completing their

22 OECD, “Taxation of Capital Gains of Individuals: Policy considerations and approaches”, 2006. 23 Data obtained on VAT operating costs was insufficient for making an assessment of likely national VAT

operating costs as a percentage of VAT revenue.



transactions and their respective tax payments due to uncertainty about the nature of their tax obligations and BIR’s prevailing lax enforcement policy for CGT transactions that results in varied taxpayer CGT assessments. Evidence from the perceptions survey suggests that taxpayers do make facilitation payments to BIR staff to ensure prompt processing of their transactions. The widespread incidence of sellers of residential properties passing on all or part of their CGT liabilities to the respective buyers of their properties points to many taxpayers viewing their CGT liabilities (including compliance costs) to be unacceptably high24. Taxpayers’ uncertainty about their CGT obligations is substantially due to the poor quality of information about the CGT made available by the BIR25 and the present weaknesses in property valuation practices. The overall level of transparency for the CGT is consequently modest in view of the relatively low level of public understanding discussed above26. The level of transparency for the rules in respect of the principal residence exemption is poor. The poor standard of BIR’s CGT tax administration results in significant non‐compliance by taxpayers; this may well lead to the CGT revenue shortfall being shifted to other taxpayers. Adequacy CGT revenues generated by individuals in the period 1994‐2005 are presented in Table 7; no data is available for capital gains tax payments made by corporations.

24 More than half of respondents in the perceptions survey, on an informed basis, considered that the CGT

rate was high. 25 More than 40% of respondents in the perceptions survey did not know how the CGT was computed or

who was legally liable to pay the CGT. 26 More than 40% of respondents in the perceptions survey believed more information on the CGT should be

disseminated to the public.



Table 7. CGT COLLECTIONS ON THE SALE OR TRANSFER OF REAL PROPERTIES AND NUMBER OF RETURNS, CY 1994‐200527

(P MILLION)

Growth Rate % Year

CGT Collection (P million)

Number of CGT Returns CGT Collection CGT Returns

1994 5,731 159,141

1995 3,793 148,856 ‐33.82 ‐6.46

1996 4,175 156,238 10.07 4.96

1997 5,204 151,265 24.67 ‐3.18

1998 4,415 136,327 ‐15.18 ‐9.88

1999 3,697 133,310 ‐16.26 ‐2.21

2000 3,499 122,823 ‐5.36 ‐7.87

2001 3,180 124,207 ‐9.11 1.13

2002 4,155 131,882 30.68 6.18

2003 4,103 137,044 ‐1.25 3.91

2004 4,220 159,487 2.85 16.38

2005 4,580 171,591 8.53 7.59

Note: Data includes only those from individuals and does not include capital gains tax collection and returns from corporations.

Source of Data: BIR Annual Reports

Although there has been no significant growth in the value of CGT revenues in recent years, the tax in its current form remains a relatively good revenue generator relative to current assessed operating costs compared with other national land‐related taxes; this reflects the present overall relatively low level of BIR’s operating expenditure.

The CGT remains a narrowly based tax. The proportion of individual taxpayers paying the CGT each year is probably between 2% and 4% of all individual taxpayers (based on the 1990 census figure for owner‐households in occupied housing units)28.

27 NTRC, 2006, Comparative Structure of and Experience on Transfer Taxes in Selected Asian Countries, page 6

28 Philippines National Statistics Office – Housing Statistics 1990 - Table 8. Owner-Households in Occupied

Housing Units by Tenure Status of Lot and Region, Urban-Rural: 1990.



CGT revenues have, however, performed poorly from an adequacy perspective in the period since 1997 having recorded negative growth and substantially under performed in comparison with growth in GDP and BIR collections. In the period 1997‐2006 CGT revenues recorded negative growth (‐7.66%) compared with GDP growth (+148.59%) and growth in the value of BIR collections (+107.42%); details of growth indices for CGT revenues, GDP and BIR collections in the latter period are presented in Table 8. Consequently the CGT generated a negative long‐run elasticity of (0.0516) in the period 1997‐200629.

Table 8. GROWTH INDICES FOR CGT REVENUES, GDP (CURRENT PRICES) AND

BIR COLLECTIONS, 1997‐2006 (BASE YEAR 1997 = 1000)

Year

CGT Revenues GDP BIR collections

2006 923 2,486 2,074

2005 880 2,241 1,725

2004 811 2,007 1,488

2003 788 1,779 1,354

2002 798 1,633 1,254

2001 611 1,496 1,235

2000 672 1,382 1,147

1999 710 1,227 1,085

1998 848 1,098 1,071

1997 1,000 1,000 1,000

The CGT’s poor performance reflects the previously mentioned under‐valuation of LGU SMVs and BIR zonal values, weaknesses in BIR administration and possible non‐compliance by some taxpayers who retain real property assets as capital assets rather than as ordinary assets. Preliminary data for CGT revenues in 2007 showed a decline in revenue from P4.805 billion in 2006 to P3.519 billion in 2007. Stability CGT revenues have recorded significant annual variations in the period 1997‐2006 compared with those recorded in GDP and BIR collections; details of these variations are presented in Table 9.

29 The long-run elasticity was calculated by dividing the CGT growth rate in 1997-2006 by the GDP growth rate in the same period.



Table 9. ANNUAL VARIATIONS IN CGT REVENUES, GDP (CURRENT PRICES) AND BIR COLLECTIONS, 1997‐2006

Year

Annual % change in CGT revenue

Annual % change inGDP

Annual % change in BIR Collections

2006 4.92% 10.94% 20.28%

2005 8.53% 11.63% 15.92%

2004 2.85% 12.86% 9.90%

2003 ‐1.25% 8.89% 7.97%

2002 30.66% 9.15% 1.51%

2001 ‐9.12% 8.25% 7.73%

2000 ‐5.36% 12.69% 5.71%

1999 ‐16.26% 11.70% 1.23%

1998 ‐15.16% 9.82% 7.14%

Consequently, the CGT’s recent performance has been very unstable.

Conclusion The preceding evaluation demonstrates that the CGT in its current form is a weak tax from the perspective of the tax principles employed in the evaluation framework; this suggests that the CGT should be restructured to reduce current efficiency losses and inequities. The present performance of the CGT is substantially undermined by weaknesses in BIR administration and the supporting valuation practices of the BIR and LGUs; these weaknesses together with the need to recognize the government’s fiscal requirement limit possible reform options. 3.3 Documentary Stamp Tax

Description The DST, levied on deeds of sale and conveyances of real property under Section 196 of the NIRC, is a conventional transaction based tax on property sales. History Documentary stamp taxes are long‐established taxes in the Philippines. The 1904 Internal Revenue Law (Act 1189) created documentary stamp taxes, including the present stamp tax on property deeds of sale and conveyances.



The DST plays an important legal role in the Philippines as evidence of payment of the DST effectively confers de facto legal title to the purchaser of a property, irrespective of whether the supporting transaction was lawful30. Current Tax Rate The current stamp rates for property deeds of sale and conveyances (15 pesos on the first 1000 pesos of consideration and 15 pesos per thousand pesos of consideration thereafter) were introduced in Republic Act No. 7660 in 1993.

Tax‐base Issues Although the DST tax base incorporates similar elements to that of the CGT tax base, it is wider as it includes transactions in ordinary assets. Consequently the negative factors reported earlier affecting the performance of the CGT, in terms of shortcomings in valuation practices by BIR and LGUs and specification of below‐market values on the supporting tax documentation, also contribute to an under‐valuation of the prevailing DST tax base.

Policy Evaluation

Efficiency The DST contributes moderately to the current high cost of property transactions in the Philippines. Ability to pay constraints faced by property buyers and /or unwillingness to pay the DST on property transactions reduces property market sales and the registration of property transfers. Corporate property buyers will seek to pass on DST costs in their pricing structures if their property assets are inputs for other land‐related business activities. The DST, like the capital gains tax, reduces property transactions and consequently generates a negative economic impact in terms of reducing employment, tax revenue and the contribution of the land sector to the economy (as measured by GDP). The DST consequently creates inefficiencies in an economic context by particularly reducing the volume of potential transactions through distorting the normal land market behaviour of individuals owning properties.

30 In Philippine Home Assurance Corporation vs. Court of Appeals (301 SCRA 443 [1999]), the Supreme

Court ruled that documentary stamp taxes are levied on the exercise by persons of certain privileges conferred by law for the creation, revision, or termination of specific legal relationships through the execution of specific instruments, independently of the legal status of the transactions giving rise thereto (Republic of the Philippines COURT OF APPEALS Manila SECOND DIVISION CA-G.R. SP No. 70600).



Equity

Horizontal Equity The current outcome for the DST in a horizontal equity context is similar to that reported previously for the CGT, viz. the achievement of horizontal equity is undermined by the prevailing fraudulent property valuation reporting practices and the use of outdated SMVs and zonal values. Vertical Equity The fixed percentage approach employed in the DST tax base results in taxpayers incurring net losses or small net gains from property sales having to pay the same rate of DST as taxpayers recording large net gains from property sales if their properties are similarly valued for DST purposes. Although the DST is a proportional tax, it results in a regressive outcome that is inconsistent with the vertical equity principle. The lack of vertical equity associated with the DST reflects the fact that taxpayers tend to spend a decreasing share of their total income on housing and have a lower proportion of their net assets invested in their principal residence as their income increases. Administrative Simplicity and Transparency The tax burden associated with the DST tax is theoretically very understandable as it is simple to calculate. The DST, however, is a relatively expensive tax to collect (more expensive than the CGT but less expensive than the donor’s and estate taxes) as demonstrated earlier in Table 4. Taxpayer compliance costs in respect of the DST are relatively high as taxpayers frequently resort to using agents to assist them in completing their transactions and their respective tax payments due to uncertainty about the nature of their tax obligations and BIR’s prevailing lax compliance policy for DST transactions. Taxpayers’ uncertainty about their DST obligations is substantially due to the inadequate quality of information provided by the BIR to taxpayers (demonstrated in the perceptions survey where more than 40% of the respondents were not able to correctly compute DST payments or correctly identify taxpayers’ liability for this tax) and the present weaknesses in property valuation practices. Taxpayers or their agents often have to make facilitation payments to BIR staff to ensure prompt processing of their transactions. The overall level of transparency for the DST is modest in view of the relatively low level of public understanding discussed above.



The poor standard of BIR’s DST administration results in significant non‐compliance by taxpayers; this may well lead to the DST revenue shortfall being shifted to other taxpayers. Adequacy

In the absence of any robust data, DST revenue estimates are based on those of the CGT as noted earlier; these estimates exclude any allowance for documentary stamp tax revenue arising from the sale of properties designated “ordinary assets” and are likely to be relatively conservative. The DST is assumed to have performed poorly in the period 1997‐2006, in a similar manner to that reported earlier for the CGT, reflecting the previously mentioned under‐valuation of properties and weaknesses in BIR administration. Stability

CGT revenue flows suggest that DST revenues have been very unstable in the period 1997‐2006.

Conclusion The preceding evaluation demonstrates that the DST on property in its current form is also a weak tax from the perspective of the tax principles employed in the evaluation framework; this suggests that the DST should be either abolished or restructured to reduce current efficiency losses and inequities. The present performance of the DST is most likely also being substantially undermined by weaknesses in BIR administration and the supporting valuation practices of the BIR and LGUs. Addressing the weaknesses of the DST is constrained by the current unavailability of data in respect of DST revenue flows. 3.4 Estate Tax

Description The estate tax is levied on the net estate of decedents as determined by Section 86 of the NIRC. History Estate taxes are long‐established taxes in the Philippines and were first imposed in 1939. The current rules and estate duty tax rates were introduced in 1997 when the National Internal Revenue Code (NIRC) was substantially revised as a result of the enactment of the 1997 Tax Reform Act that took effect on January 1, 1998.



The net estate is computed by deducting from the gross estate the expenses, losses, indebtedness, property previously taxed and standard deduction. Section 86 of the NIRC provides that the following are deductible from the estate of a citizen or resident of the Philippines:

a. Expenses, losses, indebtedness, and taxes

• Actual funeral expenses or in an amount equal to 5% of the gross estate,

whichever is lower, but in no case to exceed P200, 000 • Judicial expenses of the testamentary or intestate proceedings • Claims against the estate • Claims of the deceased against insolvent persons where the value of

decedent’s interest therein is included in the value of the gross estate • Unpaid mortgages

b. Property previously taxed

c. Transfers for public use

d. The family home‐ up to the value of P1 million e. Standard deduction – an amount equivalent to P1 million f. Medical expenses incurred by the decedent within one year prior to his death

duly substantiated with receipts but not to exceed P500, 000 g. Amount received by heirs from the decedent employer as a consequence of the

death of the decedent‐employee in accordance with RA 4917 The net share of the surviving spouse in the conjugal partnership property as diminished by the obligations properly chargeable to such property is also deductible from the net estate of the decedent. Current Estate Tax Rates The estate tax is computed pursuant to a graduated tax structure with rates ranging from 0% to 20% of the net estate; details of current estate tax rates are presented in Table 10.



Table 10. CURRENT RATES OF ESTATE TAX (P)

Over But Not Over The Tax Shall Be Plus Of Excess Over

‐ 200,000 Exempt ‐ ‐

200,000 500,000 0 5% 200,000

500,000 2,000,000 15,000 8% 500,000

2,000,000 5,000,000 135,000 11% 2,000,000

5,000,000 10,000,000 465,000 15% 5,000,000

10,000,000 And Over 1,215,000 20% 10,000,000

Tax Base Issues The methodology for valuing properties owned by estates is whichever is the higher of: (1) the fair market value as determined by the Commissioner of Internal Revenue (i.e. zonal values), or (2) the fair market value as shown in the schedule of values of the Provincial and City Assessors (i.e. SMVs). Policy Evaluation Efficiency The present estate tax creates considerable deadweight costs; these arise from relatively high tax administration costs incurred by the BIR, high taxpayer compliance costs owing to limited understanding of the estate tax and the length of time taken to process estate tax transactions together with costs arising from changes in the economic behavior of taxpayers; the latter costs usually form the greatest proportion of deadweight costs. In the United States, it is argued that the distortions arising from estate taxes have resulted in “the inefficient allocation of resources, discouraging savings and investment and lowering the after‐tax return on investments31”. The inefficiencies resulting from the estate tax in the United States result in deadweight costs being incurred. In addition, the estate tax creates significant compliance costs in the United States (and elsewhere) which some writers claim may equal the value of estate tax revenues32.

31 Joint Economic Committee United States Congress, June 2003, The Economics of the Estate Tax: An

Update, page (i). 32 Joint Economic Committee United States Congress, May 2006, Costs and Consequences of the Federal

Estate Tax, page 17.



A United States academic, Garry Robbins, argues that a rough measure of the distortions created by estate taxes (i.e. the deadweight costs) is the ratio of marginal to average estate tax rates for those paying the tax33. Details of average estate tax rates in the Philippines and the resulting estimated deadweight cost for a range of estate values are presented in Table 11.

Table 11. ESTIMATED DEADWEIGHT COSTS FROM CURRENT PHILIPPINE STATE TAXES (P)

Net estate value (P)

Estate tax Payable (P)

Average estate tax rate

Marginal rate Ratio of marginal rate

to average rate

Deadweight cost per additional

peso of revenue

200,000

300,000 5,000 0.0167 0.05 3.00 2.00

400,000 10,000 0.0250 0.05 2.00 1.00

500,000 15,000 0.0300 0.08 2.67 1.67

600,000 23,000 0.0383 0.08 2.09 1.09

700,000 31,000 0.0443 0.08 1.81 0.81

800,000 39,000 0.0488 0.08 1.64 0.64

833,475 41,678 0.0500 0.08 1.60 0.60

900,000 47,000 0.0522 0.08 1.53 0.53

1,000,000 55,000 0.0550 0.08 1.45 0.45

2,000,000 135,000 0.0675 0.2 2.96 1.96

3,000,000 245,000 0.0817 0.2 2.45 1.45

4,000,000 355,000 0.0888 0.2 2.25 1.25

5,000,000 465,000 0.0930 0.2 2.15 1.15

6,000,000 615,000 0.1025 0.2 1.95 0.95

7,000,000 765,000 0.1093 0.2 1.83 0.83

8,000,000 915,000 0.1144 0.2 1.75 0.75

9,000,000 1,065,000 0.1183 0.2 1.69 0.69

10,000,000 1,215,000 0.1215 0.2 1.65 0.65

11,000,000 1,415,000 0.1286 0.2 1.55 0.55

12,000,000 1,615,000 0.1346 0.2 1.49 0.49

13,000,000 1,815,000 0.1396 0.2 1.43 0.43

14,000,000 2,015,000 0.1439 0.2 1.39 0.39

15,000,000 2,215,000 0.1477 0.2 1.35 0.35

16,000,000 2,415,000 0.1509 0.2 1.33 0.33

17,000,000 2,615,000 0.1538 0.2 1.30 0.30

18,000,000 2,815,000 0.1564 0.2 1.28 0.28

19,000,000 3,015,000 0.1587 0.2 1.26 0.26

20,000,000 3,215,000 0.1608 0.2 1.24 0.24

33 Estate Taxes: An Historical Perspective by Gary Robbins Institute for Policy Innovation, TaxAction Analysis

Backgrounder #1719 and Gary and Aldona Robbins, The Case for Burying the Estate Tax, Institute for Policy Innovation, TaxAction Analysis, Policy Report No. 150, March 1999. This report is available at the Web site www.ipi.org.



The data in Table 11 shows that estimated deadweight costs are very high for net estates less than P600,000 and also those in the P2 million to P5 million range. For all net estates less than P600,000 and between P2 million and P5 million, the estimated deadweight costs for each additional peso of revenue exceed the value of each additional peso of revenue received as the marginal rate of estate tax exceeds the average estate tax payable by more than 100%; it should be noted that the estimated average net estate value in the Philippines in 2004 presented later in this section in Table 12 was approximately P450,000. The latter negative outcome from part of the current Philippine estate tax scale is one reason why developed countries such as Australia, Canada and New Zealand34 have abolished estate taxes. The data presented in Table 11 also shows that whilst the average rate of estate tax payable increases with increases in the value of net estates, the amount of deadweight costs is considerably less for very large net estates. In addition, the current differences between the top individual marginal tax‐rate and effective estate tax rates create opportunities for tax avoidance by wealthy individuals and consequent distortion of their investment behavior. Equity Horizontal Equity Real property assets are believed to form the largest percentage of the value of smaller net estates. Consequently, the achievement of horizontal equity is undermined by delays in the revision of SMVs and zonal values. Vertical Equity Delays in the revision of SMVs and zonal values are most likely eroding vertical equity as these may disproportionately benefit larger net estates than smaller net estates by contributing to lower overall net estate values. The absence of the use of the market value of properties when properties are valued for estate tax purposes may result in a proportionately greater undervaluation of assets in the case of larger estates compared with the position prevailing in smaller estates. If true, the latter trends would create a regressive effect on smaller estates. The absence of any adjustment to the value of applicable deductions and exemption from estate tax to recognize inflationary trends since 1998 is having a regressive impact in that lower valued net estates are incurring a greater proportional estate tax burden compared with the position likely to arise if some inflation adjustment was made. The absence of the latter adjustment was reflected in numerous responses in the perceptions survey, viz.: the majority of respondents thought that

34 New Zealand does not see estate tax filling any gap in the income tax base: New Zealand Government,

Tax Review 2001 – Final Report, Overview, page IV.



the present estate tax rates are high whilst the vast majority of respondents thought that there should be periodic reviews of the estate tax35 principally due to increasing medical and funeral costs. The majority of respondents were opposed to a possible simplification of the structure of a combined donor’s/estate tax to no more than three brackets36 primarily due to concern over the impact of such changes on low income taxpayers; this is indicative of concerns about taxpayers’ ability to pay donor and estate taxes. The latter concerns also contributed to the significant support for allowing estate taxes to be paid on an instalment basis37 for ability to pay reasons. Currently paying estate taxes on an instalment basis may only be done with the approval of the Commissioner. The NIRC should be amended to make instalment payments for estate taxes an automatic payment option. Administrative Simplicity and Transparency Currently, estate taxes are relatively expensive to collect compared with the BIR’s average collection costs due to the significant staff input required for the processing of estate tax returns. Taxpayer compliance costs are relatively high for estate taxes partly due to taxpayers’ modest knowledge of estate taxes as particularly noted in the discussion in the perceptions study on taxpayers’ awareness of timing, computation and payment obligations, tax liability and tax reduction strategies. A significant level of tax arrears is incurred with the estate tax due to taxpayers’ ability to pay constraints. Section 90(A)(3) of the NIRC requires estate tax returns showing a gross value exceeding P2 million to be supported by a certified statement in respect of assets, deductions and estate tax payable, prepared by a Certified Public Accountant; this figures should be increased from P2 million to say P5million. The results of the perceptions study suggest that the level of transparency of the estate tax is relatively low. Adequacy Details of returns, average collections and estimated average net estate values for the period 2001‐2004 are presented in Table 12.

35 “Survey of Public Perceptions on Real Property-Related Taxes and Fees”, Draft Report, April 2008, Page V-

21. 36 “Survey of Public Perceptions on Real Property-Related Taxes and Fees”, Draft Report, April 2008, Page V-

21. 37 “Survey of Public Perceptions on Real Property-Related Taxes and Fees”, Draft Report, April 2008, Page V-

2.



Table 12. ESTATE TAX STATISTICS CY, 2001‐2004

2001 2002 2003 2004

Number of returns 23,786 25,902 27,919 30,373

Collections (P million) 373.110 312.060 470.35 422.69

Average collection (P)(1) 15,686 12,048 16,8476 13,917

Estimated average net estate value (P) (2) 508,576 240,954 523,087 448,963

Estimated average effective estate tax rate (3) 3.08% 5.00% 3.22% 3.10% Source: NTRC N.B. (1) The average collection was obtained by dividing the collections data by the number of returns. (2) The estimated average net estate value was based on the average amount of estate tax collected (3) The estimated average effective estate tax rate was obtained by dividing the average collection figure by estimated average net estate value

There was no increase in the estimated average net estate value over the four years ended 2004 in spite of a 27.69% growth in the number of returns. Nil estate tax returns are apparently included in the reported number of returns; no adjusted figures are currently available allowing for the exclusion of nil returns. The estimated average effective estate tax rate set out in Table 12 is very low. This data, unadjusted for nil returns, suggests that either the estate tax is not currently geared to address average net estate values or alternatively the current deductions for determining the value of net estates is overly generous or very wealthy individuals have been able to reduce their estate tax liabilities by avoidance or evasion of estate tax. No national data is currently available showing the distribution of returns by the highest marginal estate tax rate paid by estates. Whilst estate tax revenues grew slightly in the period 2001‐2004, these revenues performed very poorly relative to most other land‐related taxes in the period 1997‐2005 (apart from the CGT) with negative growth of –3.5%, significantly less than that of GDP growth (+124.1%) and growth in the value of BIR collections (+72.5%); details of growth indices for estate tax revenues, GDP and BIR collections in the latter period are presented in Table 13. Consequently the estate tax generated a very negative long‐run elasticity of ‐0.35 in the period 1997‐2005.



Table 13. GROWTH INDICES FOR ESTATE TAX GROSS REVENUES, GDP (CURRENT PRICES) AND BIR COLLECTIONS 1997‐2005

(BASE YEAR 1997 = 1000)

Year Estate tax revenues GDP BIR collections

2006 2,486 2,074

2005 965 2,241 1,725

2004 650 2,007 1,488

2003 724 1,779 1,354

2002 480 1,633 1,254

2001 574 1,496 1,235

2000 406 1,382 1,147

1999 577 1,227 1,085

1998 403 1,098 1,071

1997 1,000 1,000 1,000

The reported weaknesses in the supporting property valuation practices for the estate tax together with avoidance or evasion of estate tax by wealthy individuals are likely to be restraining growth in estate tax revenue, as there has been little change in estimated average net estate values in recent years. Stability Estate tax revenues were very unstable throughout the period 1997‐2005.

Conclusion The preceding evaluation demonstrates that the estate tax in its current form is a weak tax from the perspective of the tax principles employed in the evaluation framework. The present situation could be partially addressed by changes in the structure of the tax in terms of deductions, exemptions, payment arrangements and tax brackets that would respectively improve efficiency, vertical equity and compliance. The estate tax is likely to remain a relatively expensive tax to administer in the foreseeable future.

3.5 Donor’s tax

Description The donor’s tax is levied on the transfer of property, real or personal, tangible or intangible (monetary and non‐monetary) property for nil consideration. This tax has been developed to supplement the death and inheritance taxes by preventing the



tax‐free divesting of a person’s property during his lifetime. Normally, the donor is responsible for paying the gift tax but under special arrangements the donee may agree to pay the tax instead. History The donor’s tax is a long‐established tax in the Philippines and was first imposed in 1939. The current rules and donor’s tax rates were introduced in 1997 when the NIRC was substantially revised as a result of the enactment of the 1997 Tax Reform Act that took effect on January 1, 1998. Current Donor’s Tax Rates Details of current donor’s tax rates are presented in Table 14.

Table 14. CURRENT RATES OF DONOR’S TAX (P)

Over But Not Over The Tax Shall Be Plus Of Excess Over

‐ 100,000 Exempt ‐ ‐

100,000 200,000 0 2% 100,000

200,000 500,000 2,000 4% 200,000

500,000 1,000,000 14,000 6% 500,000

1,000,000 3,000,000 44,000 8% 1,000,000

3,000,000 5,000,000 204,000 10% 3,000,000

5,000,000 10,000,000 404,000 12% 5,000,000

10,000,000 1,004,000 15% 10,000,000

If the donee is a stranger,38 the donor’s tax rate is 30%. On the other hand, if the donation is mortis causa, that is to take effect upon the death of the donor, it is not subject to donor’s tax but to estate tax. Certain gifts are exempt from donor’s tax such as (a) dowries or gifts on account of marriage (maximum of P10, 000); (b) gifts made to or for the use of the National Government or its agencies which is not conducted for profit; and (c) gifts in favor of an educational and/or charitable, religious, cultural or social welfare organization; Donor’s tax rates were established at a level lower than those applicable to estate tax rates when these were revised in 1997 to encourage taxpayers to gift assets during their lifetime.

38 For the purpose of donor’s tax, a “stranger” is a person who is not a: (1) brother, sister (whether by

whole or half-blood), spouse, ancestor, and lineal descendant; or (2) relative by consanguinity in the collateral line within the fourth degree of relationship. (Section 99 (B), NIRC).



Tax Base Issues The methodology for valuing properties for assessing donor’s tax liabilities whichever is the higher of: (1) the fair market value as determined by the Commissioner of Internal Revenue (i.e. zonal values), or (2) the fair market value as shown in the schedule of values of the Provincial and City Assessors (i.e. SMVs). Policy Evaluation Efficiency The present donor’s tax creates considerable deadweight costs; these arise from relatively high tax administration costs incurred by the BIR and high taxpayer compliance costs owing to limited understanding of the donor’s tax together with costs arising from changes in the economic behavior of taxpayers; the latter costs usually form the greatest proportion of deadweight costs. A United States academic, Garry Robbins, argues that a rough measure of the distortions created by estate (and also applicable to donor) taxes (i.e. the deadweight costs) is the ratio of marginal to average donor’s tax rates for those paying the tax39. Estimates of deadweight costs have been prepared using a similar methodology to that used in the preceding analysis of estimated deadweight costs for estate taxes; details of average donor’s tax rates in the Philippines and the resulting deadweight cost for a range of net gift values are presented in Table 15.

39 Estate Taxes: An Historical Perspective by Gary Robbins Institute for Policy Innovation, TaxAction Analysis

Backgrounder #1719 and Gary and Aldona Robbins, The Case for Burying the Estate Tax, Institute for Policy Innovation, TaxAction Analysis, Policy Report No. 150, March 1999. This report is available at the Web site www.ipi.org.



TABLE 15. ESTIMATED DEADWEIGHT COSTS FROM CURRENT PHILIPPINE DONOR’S TAX (P)

Net gift value

(P)

Donor’s tax Payable

(P)

Average donor’s tax rate

Marginal rate

Ratio of marginal rate to average rate

Deadweight cost per additional

peso of revenue (P)

100,000

200,000 2,000 0.0100 0.04 4.00 3.00

300,000 6,000 0.0200 0.04 2.00 1.00

400,000 10,000 0.0250 0.04 1.60 0.60

500,000 14,000 0.0280 0.06 2.14 1.14

600,000 20,000 0.0333 0.06 1.80 0.80

700,000 26,000 0.0371 0.06 1.62 0.62

800,000 32,000 0.0400 0.06 1.50 0.50

900,000 38,000 0.0422 0.06 1.42 0.42

1,000,000 44,000 0.0440 0.08 1.82 0.82

2,000,000 124,000 0.0620 0.08 1.29 0.29

3,000,000 204,000 0.0680 0.1 1.47 0.47

4,000,000 304,000 0.0760 0.1 1.32 0.32

5,000,000 404,000 0.0808 0.12 1.49 0.49

6,000,000 524,000 0.0873 0.12 1.37 0.37

7,000,000 644,000 0.0920 0.12 1.30 0.30

8,000,000 764,000 0.0955 0.12 1.26 0.26

9,000,000 884,000 0.0982 0.12 1.22 0.22

10,000,000 1,004,000 0.1004 0.15 1.49 0.49

11,000,000 1,154,000 0.1049 0.15 1.43 0.43

12,000,000 1,304,000 0.1087 0.15 1.38 0.38

13,000,000 1,454,000 0.1118 0.15 1.34 0.34

14,000,000 1,604,000 0.1146 0.15 1.31 0.31

15,000,000 1,754,000 0.1169 0.15 1.28 0.28

16,000,000 1,904,000 0.1190 0.15 1.26 0.26

17,000,000 2,054,000 0.1208 0.15 1.24 0.24

18,000,000 2,204,000 0.1224 0.15 1.23 0.23

19,000,000 2,354,000 0.1239 0.15 1.21 0.21

20,000,000 2,504,000 0.1252 0.15 1.20 0.20

The data in Table 15 shows that for most net gifts less than P500,000 (net gifts between P400,000 and P500,000 are the exception) the estimated deadweight costs for each additional peso of revenue exceed the value of each additional peso of revenue generated as the marginal rate of donor’s tax exceeds the average donor’s



tax payable; it should be noted that the estimated average net gift value in the Philippines in 2004 presented later in Table 16 was approximately P463,000. The data presented in Table 15 also shows that whilst the average rate of donor’s tax payable increases on a progressive basis, the amount of deadweight costs is considerably less for very large net gifts. In addition, the current differences between the top individual marginal tax‐rate and effective donor’s tax rates create opportunities for tax avoidance by wealthy individuals and consequent distortion of their investment behavior. Equity Horizontal Equity The achievement of horizontal equity is undermined by delays in the revision of SMVs and zonal values. Vertical Equity Delays in the revision of SMVs and zonal values are most likely eroding vertical equity as these may disproportionately benefit larger net gifts than smaller net gifts by contributing to lower overall net gift values. The absence of the use of the market value of properties when properties are valued for donor’s tax purposes may result in a proportionately greater undervaluation of assets in the case of larger net gifts compared with the position prevailing for smaller net gifts. If true, the latter trends would create a regressive effect on smaller net gifts. The majority of respondents were opposed to a possible simplification of the structure of a combined donor’s/estate tax to no more than three brackets40 primarily due to concern over the impact of such changes on low income taxpayers; this is indicative of concerns about taxpayers’ ability to pay donor’s (and estate taxes). Some increase in the value of the permitted exemptions used when determining the value of net gifts is justified on equity grounds if the donor’s tax is to be retained in its 1997 form. Administrative Simplicity and Transparency Currently, donor’s taxes are relatively expensive to collect compared with the BIR’s average collection costs due to the significant staff input required for the processing of estate tax returns.

40 “Survey of Public Perceptions on Real Property-Related Taxes and Fees”, Draft Report, April 2008, Page V-

21.



Taxpayer compliance costs are relatively high for donor’s taxes partly due to taxpayers’ modest knowledge of donor’s taxes in terms of timing, computation and payment obligations and tax liability as highlighted in the perceptions study. The results of the perceptions study also suggest that the level of transparency of the donor’s tax is relatively low. Adequacy Details of returns, average collections and estimated average net gift values for the period 2001‐2004 are presented in Table 16.

Table 16. DONOR’S TAX STATISTICS, CY 2001‐2004 2001 2002 2003 2004

Number of returns 17,176 16,833 20,546 20,394

Collections (P million) 191.81 165.45 179.89 255.48

Average collection (P) (1) 11,167.33 9,828.91 8,755.48 12,527.21

Estimated average net gift value (P) (2) 429,183.25 395,722.69 368,887 463,180.25

Estimated average effective net gift tax rate (3) 2.60% 2.48% 2.37% 2.70% Source: NTRC

N.B. (1) The average collection was obtained by dividing the donor’s tax collection data by the number of returns. (2) The estimated average net gift value was based on the average amount of donor’s tax collected (3) The estimated average effective donor’s tax rate was obtained by dividing the average collection figure by estimated average net gift value

There has been some growth in the donor’s tax base recently during 2004/2005 and consequent increase in the average net gift. The estimated average effective net gift tax rate remains relatively low at 2.79%. This data suggests that the donor’s tax is not currently geared to address average net gift values or alternatively the current exemption for determining the value of net gifts is overly generous or there is some avoidance or evasion of donor’s tax occurring.



No national data is currently available showing the distribution of returns by the highest marginal donor’s tax rate paid by donors.

Donor’ tax revenues have performed reasonably well relative to other land‐related taxes in the period 1997‐2005 with growth of 40.3%, still substantially less than that of GDP growth (+124.1%) and growth in the value of BIR collections (+72.5%); details of growth indices for donor’s tax revenues, GDP and BIR collections in the latter period are presented in Table 17. Consequently the donor’s tax generated a low long‐run elasticity of 0.32 in the period 1997‐2005.

Table 17. GROWTH INDICES FOR DONOR’S TAX REVENUES, GDP (CURRENT

PRICES) AND BIR COLLECTIONS 1997‐2005 (BASE YEAR 1997 = 1000)

Year Donor’s Tax revenues GDP BIR Collections

2005 1,403 2,241 1,725

2004 1,217 2,007 1,488

2003 857 1,779 1,354

2002 788 1,633 1,254

2001 913 1,496 1,235

2000 743 1,382 1,147

1999 586 1,227 1,085

1998 638 1,098 1,071

1997 1,000 1,000 1,000

The reported weaknesses in the supporting property valuation practices for the donor’s tax are likely also to be restraining growth in donor’s tax revenues. Stability Donor’s tax revenues displayed considerable volatility in the period 1997‐2005.

Conclusion The preceding evaluation demonstrates that the donor’s tax in its current form is a weak tax from the perspective of the tax principles employed in the evaluation framework. The present situation could be partially addressed by changes in the structure of the tax in terms of exemptions and tax brackets that would respectively improve efficiency and vertical equity. The donor’s tax is likely to remain a relatively expensive tax to administer in the foreseeable future.



3.6 VAT41 Description The value added tax (VAT) is a broad‐based consumption tax levied on the sale of goods and services and is applicable to property sale and lease transactions. History The VAT came into operation in 1988. The initial VAT rate was 10%; this was recently increased to 12%, effective 1 February 2006 by Republic Act No. 9337. Tax Base Issues The tax base for VAT on property sale and lease transactions is limited to transactions undertaken by persons and entities in the property business, such as real estate developers and lessors. VAT is only applicable to transactions whose selling price and lease cost are above the nominated thresholds for exemption from VAT specified in Revenue Ruling 16‐2005 (P1.5 million for the sale of a residential lot, P2.5 million for a residential house and lot and other residential dwellings and leases where the monthly rental is P10,000 or less).

Also exempt are real properties not primarily held for sale to customers or held for lease in the ordinary course of trade or business; sale of real properties utilized for low‐cost housing42 where the unit selling price is within the ceiling of P750,000; and sale of real properties utilized for socialized housing43 where the ceiling is P225,000. Transfers of non‐performing assets from financial institutions to special purpose vehicles (SPVs) are also exempt from VAT44.

41 This section draws extensively on NTRC’s paper titled, Analysis of the Revenue Performance of the Value Added

Tax (VAT) on Real Property, CYs 2001 – 2005*, 13 June 2007.

42 Low-cost housing refers to housing projects intended for homeless low-income family beneficiaries, undertaken by the government or private developers, which may either be a subdivision or a condominium registered and licensed by the Housing and Land Use Regulatory Board. 43 Socialized housing refers to housing programs and budget covering houses and lots or home lots only undertaken by the government or private sector for the underprivileged and homeless citizens which shall include site and services development, long-term financing and liberated terms on interest payments. It also refers to projects whose housing package selling price is within the lowest interest rates under the Unified Home Lending Program (UHLP) or any equivalent housing program of the government, the private sector or non-governmental organizations.

44 RA No. 9343, effective April 24, 2006 extended the tax exemptions of non performing assets for a limited period of two years from date of acquisition by SPVs of NPAs from the financial institutions and five years from SPVs to third persons.



Policy Evaluation

Efficiency VAT is generally viewed as a highly efficient tax as it usually generates less deadweight costs than most other taxes. For example, Diewert and Lawrence (1994) found that the deadweight costs associated with labor taxation (primarily taxation on the income of wage earners and the self‐employed) in New Zealand were around 18% for the marginal dollar of income tax revenue raised and around 14% of the marginal dollar of consumption tax revenue raised45. Although the VAT creates distortions in an efficiency context in that prices are increased on transactions attracting VAT, these are very modest compared with those generated by other land‐related national taxes. Equity Horizontal Equity The current outcome for the VAT in a horizontal equity context is similar to that reported previously for the CGT and DST, namely that the achievement of horizontal equity is undermined by the prevailing fraudulent property valuation reporting practices and the use of outdated SMVs and zonal values. Vertical Equity The current exemptions are designed to provide relief from VAT for entities and persons undertaking relatively small property transactions that are not registered for VAT. It is difficult to determine whether the present exemption levels are appropriate in the absence of robust property market data. Administrative Simplicity and Transparency The VAT is generally a relatively simple tax to administer with moderate administrative costs; it is also a very efficient tax with moderate compliance costs. Although the tax burden associated with the VAT is relatively understandable by corporate taxpayers, the taxpayer perceptions study reported a relatively low level of understanding of VAT topics by respondents; this may well be attributable to the limited number of respondents who are actually registered for VAT.

45 Diewert, E. and D. Lawrence (1994), Measuring New Zealand’s Productivity. Treasury Working Paper, No. 94/5, Wellington.



There is scope for BIR to improve the quality of its communications with taxpayers in respect of VAT. Adequacy VAT revenue flows from property sale and lease transactions have performed relatively poorly in the 2001‐2005 period compared with the performance of most other national land‐related taxes. As noted earlier in Table 3, the overall contribution of the VAT to BIR tax revenue has declined from 0.75% to 0.58% during the five‐year period of 2001‐2005. Despite the latter performance, the VAT from property sale and lease transactions is now the second largest contributor to BIR revenues although this contribution remains very modest. The revenues generated by the VAT on real property transactions in the period 2001‐2005 are presented in Table 18.

Table 18. VAT ON REAL PROPERTY TRANSACTIONS STATISTICS, CY 2001‐2005 (P MILLION)

Year Sale Lease Total

2001 1,075.47 1,857.72 2,933.19

2002 1,209.46 1,997.49 3,206.95

2003 976.53 2,016.82 2,993.35

2004 731.43 2,162.82 2,894.25

2005 950.21 2,213.39 3,163.60

Average. 988.62 2,049.65 3,038.27

Source: NTRC The tax base of the VAT on real property transactions is relatively large compared with that of other national land‐related taxes, VAT revenues generated by real property transactions grew by only 7.9% in the period 2001‐2005 compared with the 49.7% growth in GDP in the same period; this outcome suggests that some evasion of VAT is taking place as suggested in the perception study’s findings46 in addition to the under reporting of property transaction values.

46 “Survey of Public Perceptions on Real Property-Related Taxes and Fees”, Draft Report, April 2008, Page

IV-21.



Stability VAT revenues on real property transactions have been moderately unstable recently compared with GDP trends.

Conclusion The VAT is a very good tax on land related transactions undertaken by parties dealing in property. Some attention to improving taxpayer compliance and understanding of VAT is required. 3.7 Overall Assessment of National Land‐related Taxes Except for the VAT, all other national land‐related taxes (capital gains tax, DST, estate tax and donor’s tax) require major adjustments to reduce the current inefficiency costs and inequities they create; these are attributable to current tax‐rates, tax bases, current BIR and LGU valuation practices and property conveyancing practices. The findings presented in this section support similar conclusions reached by NTRC in earlier work undertaken on the taxation of property transactions. The need for reform in land‐related taxes must be weighed against the government’s fiscal requirements when proposing reform options.



4. Local Land‐Related Taxes47 4.1 Description Current local taxes on real property comprise the basic real property tax (RPT), special education fund (SEF) tax, special levy, transfer tax and the idle land tax. Their roles as local government revenue mechanisms arise from land’s status as a permanent and stable tax base. These taxes serve different objectives and have varying impacts on land markets. 4.2 History The current arrangements for local land‐related taxes were formulated in the development of the LGC in 1991. Property taxes have a long history in the Philippines, having been introduced in 1901. 4.3 Tax Base Issues Property related taxes are imposed on all forms of real property such as land, buildings, improvements and machinery. However, real properties owned by government, charitable institutions, churches, cooperatives, and those that are used in the supply and generation of water and electric power as well as equipment for pollution control and environmental protection are exempted.

The property related taxes are as follows:

1. Basic Real Property Tax (RPT) – This is levied by provinces, cities and municipalities within Metro Manila48 on owners of land, building, machinery and other improvements.49 It is based on the assessed value of the property, which is derived upon the application of the assessment levels (in percentage) to the fair market value of the property.50

1.1 The assessment levels for land are differentiated depending on their actual use. Commercial, industrial, and mineral lands are assessed at the highest rate of 50%, agricultural lands at 40%, and residential and timberlands at the lowest rate of 20%.51

For buildings and other improvements, the assessment levels are graduated i.e., they increase directly with the fair market values, from zero percent for

47 This section draws extensively on NTRC’s paper “Analysis of the Revenue Performance of Local Taxes on

Real Properties, CYs 2001-2005”, February 2007. 48 As of 2007, the only municipality within Metro Manila is Pateros. 49 Section 232 of the Local Government Code (LGC). 50 Section 198 (g) and (h), Ibid. 51 Section 218 (a), Ibid.



residential buildings worth P175,000 and less to 80% for commercial and industrial properties worth over P10,000,000.52

Machineries are likewise assessed in relation to their actual use. The lowest level is assigned to machineries used for agricultural purposes at 40%, and the highest level to commercial and industrial machineries at 80%. Machineries used for residential purposes are subject to an assessment level of 50%.53

The assessment levels and tax rates vary among different LGUs as enacted through an ordinance passed by the local councils but subject to the ceilings prescribed in the LGC.

1.2 The tax due is computed by applying the basic RPT rates of not exceeding one percent (1%) in the case of provinces and two percent (2%) for cities and municipalities within Metro Manila to the assessed value of the property.54

1.3 The proceeds derived by a province, city or a municipality within Metro Manila from the basic RPT are distributed as follows:55

(a) In the case of provinces:

Province 35% accrues to the general fund of the province.

Municipality 40% accrues to the general fund of the municipality where the property is located.

Barangay 25% accrues to the barangay where the property is located.

(b) In the case of cities:

City 70% accrues to the general fund of the city.

Barangay 30% is distributed among the component barangays where the property is located in the following manner:

(i) 50% accrues to the barangay where the property is located; and

(ii) 50% accrues equally to all component barangays of the city.

52 Section 218 (b). Ibid.

53 Section 218 (c ), Ibid.

54 Section 233, Ibid.




(c) In the case of municipalities within Metro Manila:

Metropolitan Manila Authority

35% accrues to the general fund of the Authority.

Municipality 35% accrues to the general fund of the municipality.

Barangay 30% is distributed among the component barangays of the municipality where the property is located in the following manner:

(i) 50% accrues to the barangay where the property is located; and

(ii) 50% accrues equally to all component barangays of the municipality.

The theoretical purpose of the real property tax is to finance LGUs’ residual funding requirement that is used to partially or fully fund the public good component of planned operating expenditure and any unfunded private good component of planned operating expenditure.

2. Special Education Fund (SEF) Tax – This is an annual tax imposed by the province

or city, or a municipality within Metro Manila at one percent (1%) on the assessed value of real property, which is in addition to the basic RPT. 56 The proceeds exclusively accrue to the local school boards. However, in case of the province, the proceeds are divided equally between the provincial and municipal boards. 57

The theoretical purpose of the SEF tax is to fund a local public good, namely provincial and municipal school board expenditure.

3. Idle Land Tax‐ This is levied by the province or city, or a municipality within

Metro Manila as an annual tax on idle lands at a rate of not exceeding five percent (5%) on the assessed value of the property. 58 This is also in addition to the basic RPT. The proceeds solely accrue to the respective general fund of the province or city where the land is located. In the case of a municipality within Metro Manila, the proceeds accrue equally to the Metropolitan Manila Authority and the municipality where the land is located. 59



58 Section 236,Ibid. 59 Section 273, Ibid.



The theoretical purpose of the idle land tax is to encourage the efficient use of all land in LGU’s.

4. Special Levy ‐ This is imposed by the province, city or municipality on lands

specially benefited by public works projects or improvements funded by the LGU concerned. The levy should correspond only to a part not exceeding 60% of the actual cost of such projects and improvements, including the cost of acquiring land and other real properties. However, the special levy shall not apply to lands exempt from basic RPT and the remainder of the land portions of which have been donated to the LGU concerned for the construction of such projects or improvements. 60 The proceeds of the special levy benefited by public works accrue to the general fund of the LGU, which financed such public works, projects or other improvements. The theoretical purpose of the special levy is to promote equity in the financing of infrastructure by ensuring that the funding load is apportioned fairly between existing residents and future residents of LGUs.

5. Tax on the Transfer of Real Property Ownership61‐ This is imposed by a province or city on the sale, donation, barter, or any other mode of transferring ownership or title of real property at the rate not exceeding 50% of one percent of the total consideration involved in the acquisition of the property or of the fair market value in case the monetary consideration involved in the transfer is not substantial, whichever is higher. The proceeds of the tax accrue entirely to the general fund of the province or city concerned.

The theoretical purpose of the transfer tax is to generate revenues for LGUs from property transactions.

4.4 Overall Revenue Performance

Details of the performance of all property taxes in the period 2001‐2005 are presented in Table 19.

60 Section 240, Ibid. 61 Section 135, Ibid.



Table 19. AVERAGE PROPERTY TAX REVENUES OF LGUS, BY SOURCE, CY 2001‐2005 (P MILLION)

Average Source 2001 2002 2003 2004 2005

Amount (%)

Distribution Growth (%) Rate

1. Property Taxes 16.600 19,240 22,844 22,659 25,947 21,458 100.00% 12.08%

1.1 Real Property Taxes 15,654 18,059 21,687 21,453 24,452 20,261 94.40% 12.09%

a. Basic 7,769 9,274 11,244 10,656 12,235 10,236 47.68% 12.55%

b. SEF 7,885 8,784 10,443 10,796 12,217 10,025 46.72% 11.71%

1.2 Transfer Tax

878 1,136 1,105 1,169 1,419 1,141 5.33% 13.45%

1.3 Special Assessments 40 44 48 33 53 44 0.21% 12.10%

1.2 Idle Land Tax 28 1 3 4 23 12 0.06% 163.23%

Source of Basic Data: Local Government Audit office Annual Report

From 2001 to 2005, revenues from all property taxes comprising of basic RPT, SEF tax, special assessment, transfer tax and idle land tax represented on an annual average, 12.94% of the total local government revenues from all sources. On average, revenues from all property taxes grew modestly at 12.08% during the period, slightly higher than the average growth rate of the Gross Domestic Product (GDP) at 10.53%.62 This means that property tax revenue was able to keep pace with the changes in national income. Comparatively, the average annual revenues from property taxes grew slightly faster than business taxes (11.57%), other taxes (3.24%) and non‐tax revenue sources (10.65%). LGUs continued, however, to rely heavily on externally generated revenues comprising mainly of the internal revenue allotment (IRA), share from the utilization of national wealth, grants and aids, borrowings and others, as they contributed 67.24% to total local revenues. Specifically, the IRA accounted for the biggest share at 64.97% of the total. The basic RPT (47.68%) and the SEF tax (46.72%) were the chief revenue sources accounting for a combined share of 94.40% of the total property tax revenues. The transfer tax contributed 5.33%, while the special assessment and the idle land tax made meagre contributions of only 0.21% and 0.06% respectively, to the total.

62National Accounts of the Philippines for CYs 2001 to 2005, NSCB.



Some improvement in the collection efficiency of the basic RPT was recorded in the 2001‐2005 period; details of collection efficiency in this period are presented in Table 20. Table 20. COLLECTION EFFICIENCY FOR BASIC REAL PROPERTY TAX, BY LEVEL,

CY 2001‐2005

Year Provinces Cities Municipalities within

Metro Manila All levels

2001 56% 50% 44% 51%

2002 54% 49% 44% 50%

2003 60% 56% 47% 57%

2004 56% 58% 50% 58%

2005 52% 64% 41% 61%

Average 56% 55% 45% 55% Source: NTRC 63 Although the overall collection efficiency rate for the basic RPT improved from 51% to 61% in the five years ended 2005, the performance level achieved in 2005 was nevertheless disappointing. A number of factors contribute to the poor performance of the RPT. Collection practices are not well developed. The Asian Development Bank and the World Bank have suggested that RPT collections could be increased by “(i) creating incentives for LGU revenue assessors and collectors; (ii) enforcement action against delinquent filers and payers; (iii) conducting taxpayer registration drives; (iv) cleaning taxpayer registries regularly; (v) investing in information technology; (vi) increasing the quality and quantity of audits; and (vii) improving taxpayer services”64. The Asian Development Bank and the World Bank have also cited the sharing of property taxes between provinces and municipalities as a possible factor contributing to collection inefficiency in that “it is likely that provinces decide to collect fewer revenues as a result of the fact that they only receive 35 percent of total collections, assuming that executives weigh the administrative and political costs of collection against the likely benefits”.65 This point raises the question of the need for a review of the appropriate powers and functions of the different tiers of local government in the Philippines.

63 NTRC, “Analysis of the Revenue Performance of Local Taxes on Real Properties, CYs 2001-2005”,

February 2007, Table E. 64 Asian Development Bank and the World Bank, March 31 2005, Decentralization in the Philippines

Strengthening Local Government Financing & Resource Management in the Short Term, page vi.

65 Asian Development Bank and the World Bank, March 31 2005, Decentralization in the Philippines Strengthening Local Government Financing & Resource Management in the Short Term, page 18.



There is widespread acceptance in local government circles stakeholders that the dominance of the IRA in the revenues of local governments provides a disincentive for LGUs to exert more effort in collecting the RPT. This undermines the revenue generation process of LGUs. The poverty of taxpayers has been cited as a reason for the ongoing poor performance of the property tax as a revenue mechanism66. An analysis of the performance of the basic RPT in 2005 across thirty‐six large Philippine cities in 2005 demonstrated that there was no significant linear relationship between ability to pay as measured by household income and total basic RPT receipts for each LGU and also household income and the proportion of total revenue provided by the basic RPT; these findings are significant as they are based on 62.46% of basic RPT receipts (and 21.62% of the Philippine population). The latter result is not surprising in view of delays in revising SMVs, inconsistent collection performances across LGUs and modest consideration of equity issues in property tax policies and suggests that adjustments are required to the LGC to promote the development of more equitable RPT policies. Details of part of the supporting spreadsheet are presented in Table 21

66 NTRC, “Analysis of the Revenue Performance of Local Taxes on Real Properties, CYs 2001-2005”,

February 2007, page 7.



Table 21. 2005 TRENDS IN AVERAGE FAMILY INCOME (P) AND BASIC RPT RECEIPTS FOR 36 PHILIPPINE CITIES

City Households

2005 Average familyincome – 2005

LGU revenue

Basic RPT Total RPT IRA Basic RPT % revenue

P P P P P

Iloilo city 79,320 592,970 842,789,000 113,225,104 196,738,676 326,543,397 13.43%

Las Piñas 106,007 489,150 1,141,760,377 144,170,410 315,712,824 395,438,110 12.63%

City of Antipolo 111,390 423,728 811,875,208 102,748,298 234,106,919 452,553,291 12.66%

Makati City 106,292 423,009 6,433,939,007 1,455,853,060 2,625,168,193 436,412,813 22.63%

Tacloban City 38,318 415,506 458,746,366 23,705,417 52,573,383 248,477,627 5.17%

Pasig City 116,691 319,426 3,230,895,024 503,077,968 880,000,692 425,447,909 15.57%

Manila 360,941 286,338 6,583,786,939 1,261,678,429 2,211,926,663 1,154,093,301 19.16%

Olongapo City 46,861 271,716 563,882,108 30,566,941 50,729,436 259,171,079 5.42%

Caloocan City 270,063 264,594 2,156,932,087 246,640,585 453,534,890 844,569,045 11.43%

San Fernando(Capital) 48,154 256,563 480,011,539 32,308,408 73,728,855 233,694,217 6.73%

Lapu‐lapu City(Opon) 49,778 246,638 581,393,398 39,422,626 83,617,205 226,144,425 6.78%

Malabon 80,226 235,956 551,752,541 47,910,974 103,021,199 305,835,479 8.68%

Mandaluyong City 64,584 221,128 1,592,716,822 282,351,784 503,032,375 288,354,715 17.73%

Muntinlupa City 84,423 200,101 1,280,926,225 199,872,094 406,214,804 333,920,965 15.60%

Pasay City 84,601 196,202 1,450,561,721 344,747,276 580,264,555 300,931,249 23.77%

Parañaque City 101,838 191,307 1,596,219,890 302,964,172 577,417,181 381,927,272 18.98%

Batangas City 55,388 191,174 985,530,771 171,653,590 335,044,487 304,485,969 17.42%



City Households

2005 Average familyincome – 2005

LGU revenue

Basic RPT Total RPT IRA Basic RPT % revenue

P P P P P

Angeles City 61,426 187,026 510,400,776 53,905,637 92,503,286 268,050,281 10.56%

Quezon City 520,097 186,825 6,950,818,750 1,024,715,524 1,860,236,067 1,548,169,743 14.74%

Cabanatuan City 49,434 186,556 459,286,382 19,785,318 42,226,472 295,443,780 4.31%

Mandaue City 61,476 183,206 606,685,529 50,606,866 106,324,177 245,020,674 8.34%

Taguig/Pateros 111,159 180,286 1,061,634,680 132,759,313 280,775,053 390,476,294 12.51%

Zamboanga City 129,866 171,593 1,184,596,326 25,562,196 61,902,747 844,597,291 2.16%

San Jose del Monte 76,746 170,054 411,912,703 22,525,407 54,710,842 302,305,322 5.47%

Iligan City 63,717 164,705 770,461,554 45,178,794 100,460,665 472,370,555 5.86%

Butuan City 54,921 153,578 664,605,917 21,960,260 43,040,744 464,131,456 3.30%

Bacolod City 96,584 142,622 707,066,279 62,895,444 122,085,329 390,861,007 8.90%

Valenzuela 115,119 140,181 1,245,732,912 182,857,017 372,804,085 413,264,365 14.68%

Marikina City 86,743 139,381 1,199,773,357 203,862,159 387,766,242 337,637,974 16.99%

Cebu City(Capital) 165,334 138,186 1,914,383,995 209,320,045 365,504,994 640,589,936 10.93%

Davao City 261,134 119,233 2,430,800,796 115,346,691 265,571,044 1,480,201,417 4.75%

Tarlac(Capital) 235,736 116,562 494,893,852 19,017,428 44,154,460 317,581,465 3.84%

Lipa City 46,277 115,336 572,197,665 51,635,907 119,835,417 266,331,141 9.02%

Tagum 39,403 99,472 418,287,555 16,616,615 40,970,462 240,171,405 3.97%

Cagayan de Oro City 105,530 97,536 975,897,491 65,062,367 119,724,726 484,851,556 6.67%

San Pablo City 49,021 88,236 416,574,561 15,836,773 38,126,855 258,671,427 3.80%



4.5 Policy Evaluation Real Property Tax Efficiency Public goods theory suggests that the role of the property tax in a local government finance context is to finance the provision of services that exhibit local public good attributes. In public goods theory, property valuations represent the effective tax price that property owners are prepared to pay for the provision of public good services; property valuations are therefore a proxy for individuals’ ability and willingness to pay for public good services. Consequently, it is essential that LGUs regularly revise their SMVs to ensure that they have relatively recent assessments of taxpayers’ ability to pay the RPT. In practice, the RPT finances not only pure local public goods but also local mixed and private goods that are unable to be financed by user charges, due to cost and equity considerations. International best practice in respect of real property taxes results in RPT revenues normally being used to finance the residual funding requirements of LGUs after allowance for user charges, transfers from national government and any other revenues such as business taxes and investment income. The real property tax funding burden should therefore be distributed on the basis of either shares of the total valuation of LGUs at a uniform tax rate or alternatively on a differential basis to achieve a better match with the distribution of ability to pay across different property taxpayer categories than achieved by basing the respective real property tax rates entirely on valuation shares. Excessive total funding loads (i.e. property taxes, business taxes and user charges) on different property taxpayer categories compared with benefits accruing from operating expenditures and associated unjustifiable cross‐subsidies will create funding inefficiencies and consequent inefficiencies in resource allocation in the form of deadweight costs. Data reported in the Naga tax compliance study demonstrates that, nationally, current LGU revenue policy outcomes may generate inefficiencies in that the revenue burden of some taxpayer categories is excessive or too low relative to the respective benefits provided to these categories by LGUs; in Naga, it appears that the revenue burden on the commercial sector may be too high whilst the revenue burden on the agricultural and residential sectors may be too low. Hearsay evidence suggests that the business sector often bears a disproportionate share of the funding burden in some LGUs. Funding inefficiencies in LGUs are likely to create material deadweight costs. The possible existence of inefficient revenue policies is not surprising as the preparation of efficient revenue policies is not addressed in the LGC. The present LGC and supporting valuation practices contribute to such revenue inefficiencies. RPT liabilities are based on assessed values that are derived from applying



assessment levels67 (specified in the LGC) to LGU SMVs that are frequently outdated and below current market values. Frequent political interventions in valuations resulting in the partial rather than complete implementation of SMVs also result in below market valuations. The evidence from LAMP II simulation studies suggests that the discrepancies between assessed values, SMVs and market values are frequently enormous. The latter valuation distortions and practices undermine the essential role of the valuation process in local government finance, which is to regularly provide a relative measure of taxpayers’ ability to pay for local government services to guide LGUs in the determination of RPT tax rates across taxpayer categories, and create inefficiencies in the resultant application of valuations to determine RPT liabilities. It is uncertain whether the separate taxation of land and buildings promotes funding inefficiencies in LGUs. The current local government revenue policy regulatory framework in the Philippines is underdeveloped. There are no obligations in the LGC to prepare revenue or specific RPT policies or undertake medium‐term financial planning. No robust consideration is given to the relationship between the mix of benefits and funding across LGU services and property taxpayer categories or taxpayer ability to pay trends. In addition, the use of a general fund does not promote consideration of the merits of using particular revenue mechanisms to fund particular service expenditures. Consequently, funding inefficiencies are likely to arise in many LGUs. The introduction of a more economically efficient approach to funding local government services is also likely to be hampered by LGUs’ present broad approach to funding their operations. LGUs’ revenue forecasts are frequently relatively conservative and do not provide a meaningful basis for budgeting operating expenditure. In view of the variability in their revenue forecasts, LGUs only make expenditure commitments on the basis of revenues actually received. This is in stark contrast to LGUs in more developed countries where there is considerably less variation between budgeted and actual revenues. Equity Horizontal Equity The achievement of horizontal equity is undermined by the frequent use of outdated and below‐market SMVs due to LGUs having failed to regularly revise and fully implement revised values. The use of separate valuations for land and buildings for RPT purposes should be reviewed as this approach may undermine the achievement of horizontal equity.

67 The assessment levels specified in the LGC are the maximum levels that may be applied.



Vertical Equity The achievement of vertical equity is also undermined by the frequent use of outdated and below market SMVs due to LGUs having failed to regularly revise and fully implement these values. The present practice of applying similar base unit values to a wide range of properties that have different market values also creates vertical inequities. LGUs generally have a very limited understanding of ability to pay distribution trends within taxpayer categories and are not particularly proactive in promoting equitable RPT outcomes although Section 130(e) of the LGC calls for the development of progressive revenue policies. No major national review of the impact of ability to pay trends across property taxpayer categories on RPT revenues appears to have been undertaken to date. Currently, there is a weak relationship between taxpayers’ ability to pay as measured by household incomes and RPT collection levels. There is also insufficient consideration of ability to pay trends in setting RPT tax rates. Although Section 218(b)(1) of the LGC provides for an exemption of up to P175,000 of the fair market value of “buildings and other structures” when determining RPT assessment values for residential taxpayers, no exemption is given in respect of land. The base RPT exemption for all residential properties should be based on their total market value.68 The common use of the maximum assessment levels permitted by the LGC need not guarantee a useful alignment between ability to pay trends across taxpayer categories and property tax rates; a more flexible approach is required to address this matter. The use of separate valuations for land and buildings for RPT purposes should be reviewed as this approach may not necessarily promote vertical equity. Although the LGC gives specific exemptions from RPT in certain adverse economic situations, there is currently no formal framework in the LGC for preparing RPT and overall revenue policies and addressing equity issues including RPT exemption and postponement policies for individual taxpayers. Administrative Simplicity and Transparency Currently, real property taxes (i.e. the RPT and SEF) are frequently very expensive taxes to collect due to the lack of computerization in many LGUs and poor collection levels. Based on use of time estimates provided by LGU staff in Iloilo and Naga, respective collection costs in these LGUs in 2005 appear relatively high. Very preliminary data from Naga suggests that currently, for about 50% of residential properties in Naga, RPT administration costs exceed RPT revenues.

68 There have apparently already been some discussions within the Department of Finance about raising this exemption

level to P500,000.



Computerisation of billing, collection and valuation functions in both of the latter LGUs could result in lower cost structures if staff time savings were realized and collection levels improved. Billing and collection practices are frequently very rudimentary and require considerable development. RPT tax amnesties do not appear to have significantly changed taxpayer payment attitudes. LGUs are not very proactive in collecting outstanding RPT revenues; this partially reflects the perception of many taxpayers that payment of the RPT is a voluntary obligation. Frequent political intervention in property tax liabilities and the use of legal remedies to recover property tax arrears also undermine RPT revenue collection activity.

Incentives to encourage improved RPT collection levels are required. There is widespread acceptance in local government circles stakeholders that the dominance of the IRA in the revenues of local governments provides a disincentive for LGUs to exert more effort in collecting the RPT. This undermines the revenue generation process of LGUs.

The introduction of RPT and valuation revision performance requirements for receiving 100% of the designated IRA, with IRA reductions taking place in the event of poor performance, should have a positive impact on LGU RPT collection performance; suitable adjustments to recognize major differences in ability to pay across LGUs would of course be required if a RPT performance requirement was incorporated in the IRA formula. LGU services to taxpayers are generally poor. Information about how the RPT is spent and individual taxpayer RPT obligations is generally not made readily available to taxpayers. Taxpayers have limited knowledge of how to calculate their RPT liability and the availability of prompt payment discounts. Regular accounts are not provided to taxpayers. There are limited methods for paying the RPT and taxpayers are not provided with regular accounts. Consequently, taxpayers incur reasonably high compliance costs in meeting their RPT obligations. The level of transparency for the RPT is variable but generally poor. In addition to limited knowledge about their RPT obligations, taxpayers generally have a modest understanding of the impact of valuations on RPT tax rates. An enhanced local government revenue policy regulatory framework should promote increased transparency in local government revenue policies. LGU politicians’ overall level of knowledge about the RPT is insufficient; this impedes RPT policy‐making activities. LGU public consultation procedures are not well developed. In spite of the prevailing relatively poor consultation procedures, public interest in RPT and SEF issues appears commensurate with that in medium‐sized LGUs in developing countries. Improved



consultation procedures should be incorporated in the LGC as LGUs are not meeting taxpayers’ information and policy‐making demands. Improved local government accounting standards would indirectly promote transparency of the RPT; these are prescribed in the “New Government Accounting System” for LGUs (NGAS). The NGAS currently make no provision for the use of activity based costing methodology in local government, reflecting a similar approach being applied at a national government level. LGU revenue policy development is materially impeded by the failure to develop operating budgets on a true activity basis; this prevents the public from seeing the relationship between property taxes and the delivery of services. Separate disclosures of operating and capital expenditure by activity are also necessary. These changes would improve the level of transparency in LGU budgets and annual reports. LGUs normally make minimal adjustments to their RPT deferred liability account in their balance sheets to reflect assessments that the respective property taxpayers will not be making the forecast property tax payments as they have no or very limited ability to pay. The current practice for recognizing doubtful debts in respect of property taxes (and other income) is not well developed. The current accounting standards and COA guidance for preparing budgets, statements of revenue and expenditure and balance sheets together with those addressing the recognition of doubtful debts in respect of property taxes (and other income) should be revised to promote greater transparency. Adequacy Basic RPT gross revenues performed very well relative to other land‐related taxes in the period 1997‐2005 with growth of 112.2% marginally less than that of GDP growth (+124.1%) but in excess of BIR collections (+72.5%); details of growth indices for RPT revenues, GDP and BIR collections in the latter period are presented in Table 22. Consequently the RPT generated a buoyant long‐run elasticity of .9 in the period 1997‐2005.



Table 22. GROWTH INDICES FOR BASIC RPT GROSS REVENUES, GDP (CURRENT PRICES) AND BIR COLLECTIONS, 1997‐2005 (BASE YEAR 1997 = 1000)

Year RPT revenues GDP BIR collections

2006 2,486 2,074

2005 2,122 2,241 1,725

2004 1,848 2,007 1,488

2003 1,950 1,779 1,354

2002 1,608 1,633 1,254

2001 1,347 1,496 1,235

2000 1,269 1,382 1,147

1999 1,114 1,227 1,085

1998 1,065 1,098 1,071

1997 1,000 1,000 1,000

The supporting data for the RPT revenue indices presented in Table 18 represent gross RPT revenue collection. A more appropriate measure of revenue growth would be the growth in current year billings; this data is not readily available. It is interesting to note that the abovementioned basic RPT performance level was achieved with average collection levels of generally less than 60% indicating the potential of the basic RPT. Stability Although basic RPT revenues displayed greater annual variations in the period 1997‐2005 on average compared with those recorded in GDP and BIR collections, they were relatively stable in the period under review and significantly more stable than revenues provided by the national land‐related taxes; details of these variations are presented in Table 23.



Table 23. ANNUAL VARIATIONS IN RPT REVENUES, GDP (CURRENT PRICES) AND BIR COLLECTIONS, 1998‐2005

Year

Annual % change in RPT revenue

Annual % change inGDP

Annual % change in BIR Collections

2006

2005 14.81% 11.63% 15.92%

2004 ‐5.23% 12.86% 9.90%

2003 21.24% 8.89% 7.97%

2002 19.38% 9.15% 1.51%

2001 6.16% 8.25% 7.73%

2000 13.86% 12.69% 5.71%

1999 4.61% 11.70% 1.23%

1998 6.54% 9.82% 7.14%

Conclusion The basic RPT is a good tax and has performed well in the period since 1997 compared with the performance of national land‐related taxes in spite of ongoing disappointing collection levels. Weak valuation and under‐developed policy development practices are, however, undermining the efficiency of the RPT and the promotion of horizontal and vertical equity. RPT administration practices in terms of billing and collection are frequently very rudimentary and require significant development. There is scope to introduce disincentives and incentives into the flow of IRA payments to LGUs, linked to RPT ability to pay and collection levels; this approach could also be used by national government to claw back any revenue lost from any future changes initiated to either the capital gains tax or DST. Some major structural changes to the RPT provisions in the LGU are required; these matters are discussed later in the section 5 of the report. SEF Efficiency

The efficiency concerns arising from current valuation practices that were previously identified for the RPT are also applicable to the SEF.

The use of the RPT to fund local education expenditure may well generate greater inefficiencies and deadweight costs than in the case of the RPT as the revenue burden of some taxpayer categories, particularly business taxpayer categories, may well be excessive



relative to the respective community (or public) benefits provided; this may also be too low in the case of agricultural and residential taxpayers in some LGUs. The LGC currently provides little flexibility when setting SEF tax‐rates; SEF taxes are either levied at 1% of assessed values or not levied at all. The SEF will create economic inefficiencies in LGUs where the distribution of funded SEF benefits differs materially from the funded RPT benefit distribution. More flexibility in setting SEF tax‐rates is consequently required to promote efficient use of resources; a prudent maximum rate should be provided for in the LGC. Equity Horizontal Equity The previous comments made on valuation topics that impede horizontal equity in the case of the RPT also apply to the SEF. Vertical Equity The previous comments made on valuation topics that impede vertical equity in the case of the RPT also apply to the SEF. LGUs generally have a very limited understanding of distribution trends in respect of ability to pay across and within taxpayer categories and benefits accruing to different taxpayer categories. In view of the a weak relationship that exists between taxpayers’ ability to pay as measured by household incomes and likely SEF collection levels (based on RPT collection levels), it is questionable whether the present P175,000 buildings exemption is an appropriate measure for addressing ability to pay constraints for residential taxpayers. A more robust approach would be to base the SEF exemption for all residential properties on a measure of their total market value.69 The use of pre‐determined assessment levels need not guarantee a useful alignment between ability to pay trends across taxpayer categories and property tax rates; consequently the use of assessment levels in determining SEF tax liabilities should be abolished. Although the LGC gives specific exemptions from SEF in certain adverse economic situations, there is currently no formal framework in the LGC for preparing policies to address SEF exemption and postponement policies for individual taxpayers.

69 There have apparently already been some discussions within the Department of Finance about raising this exemption

level to P500,000.



Administrative Simplicity and Transparency The previous comments applicable to the administration of the RPT and associated taxpayer compliance costs are also applicable to the SEF. The level of transparency is variable but generally poor. As in the case of the RPT, LGU public consultation procedures in respect of the SEF are not well developed. There is minimal disclosure about the budgets funded by the SEF or annual reports showing the use of SEF funds. Improved procedures should be incorporated in the LGC. Previously recommended improvements in RPT local government accounting standards would also indirectly promote improved transparency of the SEF. The present lack of robust activity based operating budgets prevents the public from seeing the relationship between the RPT and SEF and the delivery of services. Adequacy SEF gross revenues performed very well relative to other land‐related taxes in the period 1997‐2006 with growth of 141.8%, marginally less than that of GDP growth (+148.6%) and growth in the value of BIR collections (+107.4%); details of growth indices for SEF revenues, GDP and BIR collections in the latter period are presented in Table 24. Consequently the SEF generated a reasonable long‐run elasticity of 0.95 in the period 1997‐2006.

Table 24. GROWTH INDICES FOR SEF GROSS REVENUES, GDP (CURRENT PRICES)

AND BIR COLLECTIONS, 1997‐2006 (BASE YEAR 1997 = 1000)

Year SEF revenues GDP BIR collections

2006 2,418 2,486 2,074

2005 2,351 2,241 1,725

2004 2,077 2,007 1,488

2003 2,009 1,779 1,354

2002 1,690 1,633 1,254

2001 1,517 1,496 1,235

2000 1,423 1,382 1,147

1999 1,241 1,227 1,085

1998 1,101 1,098 1,071

1997 1,000 1,000 1,000

The supporting data for the SEF revenue indices presented in Table 14 represent gross SEF revenue collections. A more appropriate measure of revenue growth would be the growth in current year billings; LGUs should disclose separate data for current year billings and arrears recoveries.



Stability On average, SEF revenues were relatively stable in the period 1997‐2006. Conclusion The SEF has performed relatively well in the period since 1997. It experiences similar current weaknesses to those reported by the RPT; significant effort is required to improve the transparency of the SEF. Local Transfer Tax Efficiency The local transfer tax reduces property market transactions in a similar manner to that previously reported for the CGT and the DST (although the scale of the reduction is materially less), which in turn reduces economic activity, tax revenue and the contribution of the land sector to the economy (as measured by GDP). Equity The local transfer tax undermines the achievement of horizontal and vertical equity in a similar manner to that previously reported for the CGT and the DST. Administrative Simplicity and Transparency The tax burden associated with the local transfer tax is theoretically very understandable as it is simple to calculate. Preliminary assessments of local transfer tax collection costs suggest these are not unreasonable. Taxpayer compliance costs in respect of the local transfer tax are relatively high as taxpayers frequently resort to using agents to assist them in completing their transactions and their respective tax payments due to uncertainty about the nature of their tax obligations. There is considerable uncertainty amongst taxpayers over the basis of calculating liability for the local transfer tax in spite of a relatively high level of awareness of this tax suggesting that the overall level of transparency for this tax is moderate at best. Adequacy

The local transfer tax has performed relatively poorly recently. In the 1997/2006 period revenue grew by only 52.9% compared GDP growth (+148.6%) and growth in the value of BIR collections (+107.4%); details of growth indices for the local transfer tax, GDP and BIR collections in the latter period are presented in Table 25. The local transfer tax generated a relatively low long‐run elasticity of 0.95 in the period 1997‐2006.



Table 25. GROWTH INDICES FOR LOCAL TRANSFER TAXES, GDP (CURRENT PRICES) AND BIR COLLECTIONS, 1997‐2006 (BASE YEAR 1997 = 1000)

Year Local Transfer Taxes GDP BIR collections

2006 1,529 2,486 2,074

2005 1,621 2,241 1,725

2004 1,335 2,007 1,488

2003 1,262 1,779 1,354

2002 1,298 1,633 1,254

2001 1,004 1,496 1,235

2000 1,114 1,382 1,147

1999 939 1,227 1,085

1998 812 1,098 1,071

1997 1,000 1,000 1,000

The local transfer tax’s poor performance in the period 1997‐2006 is attributable to the previously mentioned under‐valuation of properties and failure of the BIR to revise zonal values. Stability

Local transfer tax revenue flows have been relatively unstable in the period 1997‐2006.

Conclusion To be developed having regard to collection costs Special Levy and Idle Land Tax Efficiency Neither the special levy or idle land tax are creating any significant inefficiencies in resource allocation due to their minimal use. The present LGU revenue environment is not conducive to the effective use of an idle land tax as LGU schedules of fair market values are generally substantially out‐dated and assessment records are often incomplete and not always linked to the permitted use of properties70. In addition, there is probably little apparent linkage between idle land tax policies and LGU land use objectives.

70Roberto P. Albado III, 2005, Managing Vacant Lands within Central Business Districts: Implications of Implementing

Idle Land Taxation.



Equity The special levy should be a useful mechanism for promoting equity in the funding of local government infrastructure. Guidance to LGUs on the use of the special levy is urgently required to raise their awareness of the purpose and merits of this revenue mechanism. LGUs are generally making limited use of the idle land tax due to a lack of guidance on the application of this tax. There is also some concern on the part of LGUs that they do not consider that the affected property taxpayers have the ability to pay any additional local government taxes. Administrative Simplicity and Transparency No major administrative concerns are evident as LGUs have difficulty using the special levy and the idle land tax. Transparency is limited. Adequacy and Stability The special levy and the idle land tax are obviously providing inadequate revenues. Conclusion The special levy and the idle land tax are significantly underdeveloped as revenue mechanisms. Guidance to LGUs on the use of these taxes is required.

4.6 Conclusion Weaknesses in valuation methodologies are significantly undermining the role of valuation in the application of local land‐related taxes. Material reforms in the frameworks for supervising local government valuations and conducting revenue management are necessary to create a more supportive environment for achieving higher collection efficiency. Material reforms are also required in the overall structure of local government to create greater overall accountability for financial management amongst politicians and officials.



5. Comparative Performance of Land‐Related Taxes Details of the comparative performance of national land‐related taxes and the principal local land‐related taxes in the period 1997/2005 are presented in Figure 1.

The data presented in Figure 1 demonstrates the poor recent performances of all land‐related transfer taxes (CGT and local transfer tax)71 and donor’s and estate taxes. The poor performance of the latter taxes is mainly attributable to inadequate revisions of zonal values and SMVs, weaknesses in BIR’s administration of national land‐related taxes and limited transparency about the details of these taxes. Recommendations for land‐related tax reforms are presented in the following section.

71 The DST was not included in Figure 1 as actual DST (Section 196) revenue data is not available. The performance of

the DST is expected to be similar to that of the CGT.

Figure 1: Growth in Land Taxes, GDP, BIR Collections 1997-2005

-20.00%0.00%

20.00%40.00%60.00%80.00%

100.00%120.00%140.00%160.00%

CGT

Local tr

ansfer

tax

Estate

tax

Donor's

tax

Basic R

PTSEF

GDP

BIR co

llecti

ons

Land Taxes, GDP and BIR Collections

Cha

nge



6. Land Related Fees 6.1 Introduction Fees levied on land‐related services principally comprise fees charged by two national government agencies, namely the Department of Environment and Natural Resources (DENR) and the Land Registration Authority (LRA). Limited analysis of the fees of the latter agencies has been undertaken to date due to general and specific problems in obtaining data on land‐related fee income; work is continuing in this regard at the date of writing this report. The current national government accounting standards do not require national government agencies to report on an activity‐based basis using activity based costing methodologies; this is the norm in developed countries such as Australia and New Zealand where financial management practice is very well developed. 6.2 DENR Fees An analysis of the costs of DENR land‐related activities and associated fee income has been partially completed at this point. 6.3 LRA Fees No significant analysis of LRA activities and fees has been undertaken to date due to institutional impediments that have arisen that have delayed this study. Details of estimated DENR and actual LRA reported operating costs and fees in 2005 are presented in Table 26.

Table 26. 2005 DENR AND LRA ESTIMATED BUDGET OUTCOMES (P)

Operating expenditure

Operating income

Surplus

LRA 601,945,523 2,434,443,228 1,832,497,705

DENR – LMB 60,404,000 24,348,408 ‐ 36,055,592

DENR ‐ Land management services 970,332,703 193,707,919 ‐ 776,624,784

Total 1,632,682,226 2,652,499,555 1,019,817,329

The LRA has generated a surplus of P1.84 billion in 2005. This surplus is unjustifiable and is effectively a tax. The surplus must be viewed in a cautious manner, as it is not sustainable. The current resources available to Register of Deeds offices is appalling and the current levels of operating costs and revenues cannot be justified if the Register of Deeds intends to provide even a reasonable level of service.



The LRA surplus should also be examined in an overall land‐activity context. The operations of DENR and LRA generated a combined surplus of just over P1 billion in 2005. 6.4 Accounting policy changes The NGAS for government agencies should be amended to provide for the adoption of activity based costing methodology in the preparation of expenditure budgets. Government agencies do not currently give any consideration to identifying the level of private benefit in government services when developing fee proposals. COA rules should be revised to encourage government agencies to recover the cost of the private benefit component of proposed operating activities. 6.5 Land Sector’s Fiscal Contribution Adding the data in respect of operating costs and revenues attributable to national taxes presented earlier in Table 4 to the data provided above in Table 26 provides an estimate of the land sector’s net fiscal contribution which was provisionally estimated at P10.5 billion in 2005; details are presented in Table 27.

Table 27. FISCAL CONTRIBUTION FROM NATIONAL LAND‐RELATED ACTIVITIES (P MILLION)

Operating expenditure

Operating income

Surplus

National fees

LRA 602 2,434 1,832

DENR – LMB 60 24 ‐ 36

DENR ‐ Land management services 970 194 ‐ 777

Total national fees 1,633 2,652 1,020

National taxes 305 9810 9,505

Fiscal outcome 1,938 12,462 10,525



7. Land‐Related Tax Reform Issues and Options 7.1 Introduction This section discusses specific recommendations for the reform of national and local land‐related taxes and explores issues that arise with particular taxes. It is important to note that the government’s revenue requirement and present difficult fiscal position have been considered when developing draft reform options. 7.2 National Land‐related Taxes

7.2.1 Introduction

The policy evaluations presented in section 3 demonstrated that the CGT, DST, donor’s and estate taxes were poor taxes in terms of the evaluation criteria employed to assess these taxes and that adjustments should be made to these taxes. There are a number of issues associated with the present administration of the abovementioned national related taxes that should be addressed. The overall poor recent performance of these taxes is partially due to the failure of the BIR and LGUs to regularly revise their respective zonal values and SMVs. Considerable progress in the revision of zonal values could be achieved relatively quickly, say in the course of two years, provided additional budget funds are allocated to the BIR and prompt action is taken by BIR national office officials to process proposed revised zonal values submitted by District Revenue Offices; revenue gains should substantially exceed the additional operating costs associated with the adoption of a more aggressive approach to revising zonal values. The desirability of introducing a performance requirement into the IRA in respect of LGU valuation revisions to motivate LGUs to take such action (as SMV values will affect the assessment of national land‐related taxes if they exceed zonal values) was discussed in the preceding chapter but this is likely to take more than two years to achieve. A more realistic structure of zonal values should be adopted in the meantime that the LAMP 2 objective of having a single valuation base for tax purposes (which would be the Improved Schedule of Market Values of local governments) is not yet in place. The abolition of zonal values and the adoption of more realistic SMVs will not only promote simplicity in tax administration, it will also eliminate confusion as to the statutory value of real properties. A major improvement in BIR’s tax administration is required to improve processing times, taxpayer compliance and transparency for these taxes. BIR must enhance its own internal record‐keeping to provide a more robust basis for monitoring the performance of these taxes by collecting more detailed data in respect of revenues generated by different



sections of the tax code; this should include revenues across different tax brackets for those taxes with tax brackets.

7.2.2 National Land‐Related Tax Reform Options

No change is proposed to the DST at this point due to uncertainty about the value of DST revenues generated under Section 196 of the NIRC and a suspicion that the quantity of revenue provided from this source may be considerably higher than previously thought. The analyses of CGT and DST demonstrated that adjustments are required to these taxes. However, the adjustments should consider government’s fiscal constraints and the lack of knowledge about revenue flows. Reforms are also proposed to the donor’s tax and estate tax.

7.2.3 Recommended Capital Gains Tax Reform Options

Two broad options for the reform of the CGT are recommended for consideration:

i. A 50% reduction in the CGT tax rate from 6% to 3%; no change to the present tax base is proposed. The present exemption for principal residences should be made more generous by exempting all sales of principal residences where the lot area is less than 200 square meters (first‐ranked option). The present restriction on the use of the exemption from CGT to once every ten years should be abolished for properties with a lot area less than 200 square meters.

ii. A return to a net gains tax base that was terminated in 1986 (second‐ranked option).

Option 1 Although option 1 offers less scope to reduce current inefficiency costs and inequities than option 2, this option was ranked first as it should not be as difficult to implement as option 2. Assuming the CGT rate reduction was implemented at the commencement of a fiscal year, revenue may well initially decline by as much as 50% in the first year following the rate reduction (say Php 2 billion). The rate reduction should stimulate increased secondary market property transactions by say 50% (assuming a housing demand elasticity of 1) and increased taxpayer compliance in respect of the CGT and DST, contributing to a gradual recovery in CGT revenue to pre‐CGT rate reduction levels within say five years; preliminary estimates are presented in Table 28. The CGT rate reduction should be adopted when a more realistic single valuation base (which would be the Improved Schedule of market values of local governments) is already established in the country.



Table 28. PRELIMINARY PROJECTIONS FOR REVISED CGT (P MILLION)

Year Projected Revenue (P millions)

0 3,500

1 2,000

2 2,400

3 2,900

4 3,500

5 4,300

Option 2 Although option 2 offers more scope to reduce current inefficiency costs and inequities, this option was ranked second as the latter gains are likely to be offset to some degree by a resurgence of the previously experienced administration difficulties associated with the determination of applicable deductions for CGT transactions. Should option 2 be preferred, it is also necessary to make determinations about the following matters that affect the structure of a CGT that taxes net gains:

i. The scope of the CGT tax base ii. CGT rates

iii. Treatment of losses

iv. Rollover provisions

v. Principal residence exemption

vi. Inflation adjustment

vii. Treatment of non‐residents A discussion of the above seven items is presented below. i) Scope of CGT Tax Base. The scope of the tax base requires consideration. Issues to arise include ensuring consistency in the tax base, the extent of exemptions (if any) and the merits of imposing a holding period to form the basis for exemptions or higher statutory tax rates on shorter‐term gains versus longer‐term gains



The extent of the differences in tax rules for different investment categories that should be imposed on corporations compared with those applicable to individuals should be considered in policy development. Any obvious improvements should be promoted if option 2 is to be recommended. The merits of retaining current exemptions to CGT other than those applicable to principal residences in the event of the adoption of a net gains basis must be considered. The policy issues associated with each exemption must be identified. The taxation of gains recorded by individuals from trading in listed shares is limited to a 1/2 of 1% transaction tax levied on the gross sale proceeds; there is no holding period where long‐term gains are taxed more lightly than short‐term gains. Providing preferential treatment for “long‐term” capital gains lowers the effective tax rate on capital gains accruing over the entire holding period, once the threshold‐holding period is passed. Consequently, there is no justification from a consistency perspective for imposing a holding period on sales of properties by individuals. ii) Treatment of capital gains income and CGT tax rates

Under Batas Pambansa Bilang 37, capital gains were excluded from taxable income subject to ordinary income tax. This approach should be incorporated in any revised net gains based CGT. The latter approach is consistent with international practice where CGT is employed and reflects a concern to avoid “lock‐in effects” where the recognition of losses may be delayed to ensure offsets against gains or sales of assets showing net gains are postponed (and consequently the receipt of revenues from asset sales is deferred). Lock‐in effects may create inefficiencies in an economy by postponing reinvestment of poor‐performing assets elsewhere in an economy. The re‐introduction of a net gains CGT may result in a decline in CGT revenue in the short‐term as investors rebalance their portfolios and dispose of poor‐performing property investments. To protect the tax base, the CGT tax rate should be set at a level that avoids materially creating tax planning incentives and lock‐in effects. A CGT rate set above or below the tax rate on interest and dividends may also distort investor behaviour and preferences by undermining tax neutrality across different types of investments; this would raise efficiency concerns. Numerous countries have set CGT rates (based on realized gains) at a relatively low effective tax rate compared with ordinary income and other capital income (for example dividends and interest); this implies reduced amounts of tax to be deferred, relative to sales price, implying reduced lock‐in incentives.



There is also the question of the rules for different investment categories that should be imposed on corporations compared with those applicable to individuals. A 10% final tax rate for revised net gains CGT is recommended; this is similar to that currently applied to dividends. iii) Treatment of Losses A desire to protect the tax base is usually associated with policies adopted in respect of the treatment of losses arising from the sale of capital assets. The current rules set out in Sections 39(C) and (D) of the NIRC for unlisted shares are acceptable; these limit the deductibility of losses in a particular year to the value of gains in that year. N.B. A different rule applies to ordinary assets where losses on the sale of ordinary assets may be offset against taxable income. Currently, Section 39(D) of the NIRC only allows capital losses to be carried forward for one year; this is unduly harsh and should be moderated. There are different rules for corporations and different rules for different assets. Any changes to corporate tax legislation arising from this review should not materially disadvantage corporations. Issues affecting corporate taxation should be considered when a formal comprehensive review of corporate taxation matters is next reviewed. iv) Rollover Provisions Some countries permit transfers of property assets within a family without attracting CGT. These are generally linked to transfers between spouses and may or may not be attributable to a marriage breakdown. v) Principal Residence Exemption Many developed countries employ a more generous approach to the imposition of capital gains taxes on the sale of principal residences than that currently applied in the Philippines. The present level of exemption from the capital gains tax for principal residences in the Philippines is relatively low by international standards. A survey of capital gains taxes undertaken by the OECD in 200472 demonstrated that twenty of the thirty countries surveyed gave more generous treatment in respect of principal residences than the Philippines; ten countries provided a total exemption with no conditions and all taxation of capital gains was imposed on a net gain basis, unlike the gross basis used in the Philippines. The present overall level of exemption for principal residences is very inequitable and should be increased. Additional matters to be considered in any revision of exemptions for principal residences could address factors such as setting a maximum area for any principal residence to ensure that very large and valuable properties are not exempted, prescribing a required period of

72 OECD, “Taxation of Capital Gains of Individuals: Policy considerations and approaches”, 2006.



ownership to qualify for an exemption and introducing a permitted level for the realization of development potential when small blocks of land adjacent to a principal residence are sold. The current exemption should be revised to provide an exemption for all properties with houses that have a lot size less than200 square meters. vi) Inflation Adjustments There has been reduced attention internationally in the treatment of the inflation component of (nominal) capital gains in recent years; this was addressed through indexation in some countries although many countries did not introduce such policies. With a general easing in inflation rates, there has been a trend for countries to abandon indexation policies. No indexation‐related attribute is proposed. vii) Treatment of Non‐residents A 25% final tax rate for a revised net gains CGT for non‐residents is recommended; this is similar to that currently applied to dividends.

7.2.4 Supporting Recommendations for CGT Reform Options

There are a number of issues associated with the present administration of the abovementioned national related taxes to be addressed. The overall poor recent performance of these taxes is partially due to the failure of the BIR and LGUs to regularly revise their respective zonal values and SMVs. Assuming no change in the rules affecting property valuations in the short to medium term, considerable progress in the revision of zonal values could be achieved relatively quickly, say in the course of two years, provided additional budget funds are allocated to the BIR and prompt action is taken by BIR national office officials to process proposed revised zonal values submitted by District Revenue Offices; revenue gains should substantially exceed the additional operating costs associated with the adoption of a more aggressive approach to revising zonal values.

The desirability of introducing a performance requirement into the IRA in respect of LGU valuation revisions to motivate LGUs to take such action (as SMV values will affect the assessment of national land‐related taxes if they exceed zonal values) was discussed in the preceding chapter but this is likely to take more than two years to achieve. A more realistic structure of zonal values should be adopted in the meantime that the LAMP 2 objective of having a single valuation base for tax purposes (which would be the Improved Schedule of Market Values of local governments) is not yet in place. The abolition of zonal values and the adoption of more realistic SMVs will not only promote simplicity in tax administration, it will also eliminate confusion as to the statutory value of real properties.



A major improvement in BIR’s tax administration is required to improve processing times for these taxes and promote better taxpayer compliance and the transparency of national land‐related taxes. BIR must enhance its own internal revenue record‐keeping to provide a more robust basis for monitoring the performance of these taxes by collecting data in respect of revenues generated by different sections of the tax code; data should also be collected for tax brackets of national land‐related taxes where these are in place.

7.2.5 Recommended Estate Tax Reforms

Changes are recommended to the present structure of the estate tax in terms of increasing the exemption level and revising the tax brackets and associated tax rates to reduce efficiency losses and improve equity. Increases to deduction levels are also recommended in view of the erosion of the real value of current deduction since their introduction on 1 January 1998; these should be regularly reviewed at five‐yearly intervals. An examination of a range of estate tax returns is required to establish the extent to which deductions and the exemption from estate tax should be increased. This work will assist the subsequent preparation of revised estate tax brackets and tax rates.

7.2.6 Recommended Donor’s Tax Reforms

Changes are recommended to the present structure of the donor’s tax in terms of increasing the exemption level and revising the tax brackets and associated tax rates to reduce efficiency losses and improve equity. The development of the estate tax reform proposal must be completed prior to the development of the donor’s tax reform proposal in view of the established linkage between the two taxes.

7.2.7 Supporting Recommendations for Donor’s and Estate Tax Reform Options

BIR must improve its collection of information in respect of donor’s and estate tax returns to guide future policy development. Data must be collected covering current taxes payable, arrears, receipts across tax brackets, gross estate values and net estate and gift values. The NIRC should be amended to provide for:

• The administrators of estates to have the ability to pay estate taxes on an instalment basis within a certain period (say, one year after the death of the property owner or after the normal period of mourning which is also one year from the death of the decedent or two years to align with the extension of payment of the estate tax in the case of extrajudicial settlement under Section 91 (b) NIRC of 1997).



• An increase in the gross value for estates where a supporting certified statement in

respect of assets, deductions and estate tax payable, prepared by a Certified Public Accountant in terms of Section 90(A)(3) of the NIRC is required, from P2million to P5million.

7.2.8. Devolution of Responsibility for National Land‐related Taxes to LGUs The merits of devolving administrative responsibility for national land‐related taxes from the BIR to LGUs was raised in the course of the 2002 taxes and fees study. The LGU financial management regulatory framework is under‐developed. LGUs are currently not geared to undertaking more complex debt collection management due to human and institutional capacity constraints. Any major transfer of administrative responsibilities for national land‐related taxes to LGUs could not be accommodated quickly and would have to be phased in; some short to medium‐term losses in revenues from national land‐related taxes would be likely. Consequently, the transfer of any significant administrative responsibilities for national land‐related taxes from the BIR to LGUs does not appear to be justifiable. 7.3 Local Land‐Related Taxes

7.3.1 Introduction

The policy evaluations presented in section 4 demonstrated that some changes are required to the LGC and NGAS to create an improved supporting environment for the administration of the RPT. The performance of the RPT could be materially enhanced in the short to medium term by the introduction of numerous measures that do not require legislative change to facilitate their introduction. Recommended reforms to the LGC, NGAS, IRA and informal reforms that LGUs could immediately commence to apply are presented in the next section. 7.3.2 Recommended Changes to the LGC The following changes are recommended to the LGC as soon as practicable:

i. The sanggunian’s present ability to approve revised property valuations provided by assessors in terms of Section 212 of the LGC should be amended. The power to certify property valuations should be vested in an independent body; the present VRA bill seeks to achieve this outcome by providing a mechanism for certification that proposed revised property valuations comply with valuation standards prior to their implementation by LGUs.



ii. The use of assessment factors in the determination of values for LGU tax purposes as provided by Section 218 the LGC should be abolished. This change would result in land and buildings being valued at the respective SMVs and opens up the potential for land and buildings to be taxed at the same tax rate provided the tax rate is less than the maximum rate specified in Section 233 of the LGC.

iii. Replace the present P175,000 buildings exemption from RPT with a larger exemption

based on the total market value of a property iv. Obligations to prepare a RPT policy and a revenue policy should be introduced into

the LGC; details of the possible content of such policies are discussed in section 7.3.7 below. RPT and revenue policies should provide increased flexibility to deal with taxpayers with limited ability to pay that have ongoing problems meeting their RPT and SEF obligations.

v. Public consultation obligations consistent with international best practice should be

introduced into the LGC; an outline of possible consultation obligations is presented in section 7.3.8 below.

vi. Introduce obligations requiring public release of key documents in respect of LGU

financial management such as budgets, annual reports and the use of SEF covering SEF budgets and annual reports.

In the medium to long term it would be appropriate to:

i. Review the powers and supporting functions of LGUs to ensure that LGUs do not incur any unfunded mandates.

ii. Revise the financial management sections of the LGC to employ a more modern

approach to local government financial management; this would require the preparation of a range of financial management policies and enhance the transparency of the RPT and SEF.

iii. Review the current revenue sharing arrangements between the different tiers of

LGUs. 7.3.3 Recommended Changes to the NGAS The following changes are recommended to the NGAS:

i. Revised annual budget and financial reporting frameworks are required, based on activity basing costing principles to enhance overall transparency as well as that of revenue policy; these should include expanded disclosures of current revenue receipts and arrears recoveries. Medium to long‐term financial planning should also be introduced.



ii. A revised accounting policy framework; this should employ an international best practice approach for recognizing revenue, including accounting for debtors.

7.3.4 Recommended Guidance to LGUs by BLGF BLGF should be providing increased guidance to LGUs on revenue topics. As a first step, an independent assessment should be made of BLGF’s present assistance on revenue topics and opportunities for BLGF to improve its assistance to LGUs; for example, the provision of guidelines on the special levy and idle land tax. 7.3.5 Recommended LGU Informal Initiatives There is a considerable amount of activity that LGUs could undertake themselves prior to any adjustments being made to the LGC to improve their RPT, SEF and wider revenue performance; these activities include:

• Computerize accounting, treasury and valuation activities

• Develop integrated accounting, treasury and valuation information systems

• Undertake required SMV revaluations and fully implement these prior to the next revision of SMVs

• Increase valuation sub‐categories where necessary, particularly within the residential

sector, to promote vertical equity

• Prepare ability to pay assessments for major taxpayer categories to assist with the development of revised tax rates following SMV revisions

• Improve billing practices; this includes providing information about the role of the

RPT, the basis of RPT calculations, the availability of prompt payment discounts, methods for paying the RPT and the provision of regular accounts to taxpayers

• Enhance collection practices; this includes being proactive in revenue collection,

taking action against delinquent filers and payers, conducting taxpayer registration drives and cleaning taxpayer registries regularly.

7.3.6 Recommended RPT and Revenue Policy Frameworks LGUs should prepare a revenue policy that addresses the funding of expenditure by proposed activities based on benefit assessments and a real property taxes policy that sets out how real property taxes will be applied to taxpayers; the possible content of these policies is presented below.



Funding of Expenditure LGUs should fund their expenditures for each activity to be undertaken from sources they determine to be appropriate, following consideration of: (i) The community outcomes to which the activity primarily contributes; and (ii) The distribution of benefits between the community as a whole, any identifiable part

of the community, and individuals; and (iii) The period in or over which those benefits are expected to occur; and

(iv) The extent to which the actions or inaction of particular individuals or a group

contribute to the need to undertake the activity; and (v) The costs and benefits, including consequences for transparency and accountability,

of funding the activity distinctly from other activities.

Revenue Policy

LGUs should adopt a revenue policy, which states the sources of funding to be used in funding operating and capital expenditure.

The sources of funding are likely to include:

• Real property taxes • Business taxes • Fees and charges • Interest and dividends from investments • Borrowing: • Proceeds from asset sales • Grants, subsidies and the internal revenue allotment (IRA)

LGUs should show in their revenue policy how they have addressed their obligations to consider the matters relating to the funding of expenditure.

Real Property Taxes Policy

LGUs should adopt a real property taxes policy which: (a) treats persons liable for real property taxes equitably; (b) determines the criteria to be applied by LGUs if they‐

(i) levy different tax rates for different categories of properties;



(ii) exempt any specific category of owners of properties, or the owners of a specific category of properties, from payment of a real property tax on their properties;

(iii) grant to a specific category of owners of properties, or to the owners of a specific

category of properties, a reduction in real property taxes payable in respect of their properties; or

(iv) increase property taxes

(c) sets out the real property taxes to be employed by LGUs.

The real property taxes policy should also determine, or provide criteria for the determination of ‐

(i) categories of properties for the purpose of levying different tax rates (ii) categories of owners of properties, or categories of properties, for the purpose of

granting exemptions or reductions

(iii) any phasing in of tax‐rates on specific categories of properties When considering the criteria to be applied in respect of any exemptions or reductions on properties, LGUs should consider the extent of services provided by the LGUs to different taxpayer categories. No real property tax exemptions or reductions should be allowed unless these are specified in adopted real property tax policies. LGUs should annually review, and if necessary, amend their real property tax policies. Amendments to real property tax policies should be made through LGUs’ annual budget processes. 7.3.7 Recommended LGU Public Consultation Framework The content of a consultation framework to be included in the LGC to address LGUs’ consultations on all proposed policies and financial plans (including RPT and SEF policies) should require that:

• All affected taxpayers and non‐taxpayers should be provided with reasonable access to the relevant information in a manner and format that is appropriate to their needs

• Persons who will or may be affected by, or have an interest in, the decision or matter

should be encouraged to present their views to LGUs

• LGUs should give clear information about the scope of decisions to be taken following the consultation to those persons who have been encouraged to present their views to LGUs



• LGUs should give persons who wish to have their views on the decision or matter

considered a reasonable opportunity to present their views to LGUs in a manner and format that is appropriate to their needs

• LGUs should receive views presented to them with an open mind and give due

consideration to these views

• LGUs should provide information concerning both the relevant decisions that are ultimately taken and the reasons for those decisions to the persons who presented views to the LGUs

Land Administration and Management Project Phase 2 Valuation and Land Taxation Report – Annex


ANNEXES

Land Administration and Management Project Phase 2 Valuation and Land Taxation Report – Annex 1


ANNEX 1 NATIONAL AND LOCAL TAXES AND FEES

EVALUATION FRAMEWORK



1. Introduction This annex discusses the evaluation framework employed when reviewing national and local land‐related taxes and fees. 2. Land‐Related Taxes and Fees Evaluation Framework An initial framework for conducting evaluations of national and local land‐related tax and fee policies was prepared in January 2007; this framework drew on generally accepted tax evaluation criteria, namely:

• Efficiency

• Equity

• Simplicity

• Transparency

• Moderate administrative and compliance costs A series of questions was prepared to guide the evaluations of the prevailing land taxes and fees policies using the above criteria; these are presented in Tables 1 to 6 below.

Table 1. EFFICIENCY RELATED QUESTIONS FOR INDIVIDUAL LAND TAXES

1. Does the proposal tax income, spending, assets, and investments differentially? (a) Tax rate (b) History of the specific tax in question: Date when first introduced;

subsequent developments with the management of the tax; costs and revenues

(c) Which decisions are likely to be distorted? (d) What other distortions arise, if any?

2. What social goals, if any, is the tax trying to promote?

(a) Is there an efficiency justification for the goal, or is the goal justified on other grounds, such as equity?



3. Do estimates of the cost of achieving the goal include efficiency costs?

4. What are the trade‐offs between equity, efficiency, and the other criteria?

5. What are the efficiency gains or losses arising from increases or reductions in the tax rate? (a) Are estimates of economic activity (e.g., change in labour supply or

change in GDP) that will be encouraged or discouraged by changes in the tax rate?

(b) Are estimates of the efficiency loss or gain associated with these changes

in economic activity?

N.B. Indicate major changes if quantitative data is unavailable.

6. How would changes in the tax rate affect leisure versus work decisions?

7. How would changes in the tax rate affect savings versus consumption decisions?

8. How would changes in the tax rate affect decisions about foreign versus

domestic investment?

9. How would changes in the tax rate affect choices between different types of investments and different types of consumption?

10. Are changes in the tax rate likely to increase economic growth?

(a) Is the growth achieved through a onetime rearranging of resources? (b) Is the growth achieved through a permanent increase in the rate of

growth? (c) What impact would tax rate changes have on growth (often measured by

changes in GDP) and estimates of the costs of achieving the growth (such as reduced leisure time)?

11. In addition to efficiency effects, will the proposal have other economic effects

by increasing or reducing the deficit?



Table 2. EQUITY RELATED QUESTIONS FOR INDIVIDUAL LAND TAXES

1. How is a taxpayer’s ability to pay broadly defined for the tax being evaluated:

(a) Income? (b) Consumption?

(c) A broader definition of overall wealth?

2. What factors other than income, such as medical expenses, number of

dependents, and so forth, does the present tax account for when considering a taxpayer’s ability to pay the tax?

3. Will taxpayers with equal ability to pay the tax pay the same amount?

(a) If not, what provisions of the proposal do not adhere to the principle of horizontal equity?

4. Are any factors incorporated in the tax that recognises people with differing

ability to pay? (a) Is the statutory tax rate progressive, proportional, or regressive? (b) Is the average effective tax rate progressive, proportional, or regressive

(accounting for credits, deductions, and other tax expenditures), where applicable?

5. Is the tax justified on the benefits received principle?

(a) Are the proceeds of the tax earmarked for a particular government programme?

(b) If so, what mechanisms are in place to determine that taxpayers who pay

the tax for a particular government programme are the same taxpayers who benefit from the provisions of that program?

6. What impact on the distribution of the tax would result from either increases

or reductions in the tax rate? (a) Who would pay more and who would pay less in the event of increases or

reductions in the tax rate?

7. Has a distributional analysis been done? (a) What time period was covered? For example, does the distributional

analysis measure the lifetime or annual effects of the tax system? (b) How is ability to pay (income, consumption, or wealth) measured?



(c) What is the unit of analysis (individuals, households, or taxpaying units)? (d) What assumptions are made about tax incidence (e.g., who is assumed to

pay the corporate income tax)?

(e) What measures (e.g., tax rate, share of tax liability) are being used to calculate the distribution of tax burden?

Table 3. SIMPLICITY, TRANSPARENCY, AND ADMINISTRATIVE SIMPLICITY

EQUITY RELATED QUESTIONS FOR INDIVIDUAL LAND TAXES

1. What impact would tax rate changes have on the compliance burden that taxpayers face? (a) Will more or fewer taxpayers be required to fill out tax forms and file

them with BIR? (b) What information are taxpayers required to provide on the tax forms?

2. Will taxpayers’ planning responsibilities (record keeping, research, etc.) likely

increase or decrease in comparison to those under the current tax rate?

3. Is the proposed tax rate transparent? (a) Can taxpayers identify their tax liability easily? (b) What media mediums are used to promote transparency?

(c) Can taxpayers understand the logic behind the tax that they are paying?

(d) Do taxpayers know what their true tax burden is (i.e., do they understand

the incidence of the tax system)?

(e) Do taxpayers understand the incidence of the tax system in terms of the tax burdens of other taxpayers?

(f) Are taxpayers aware of the extent of compliance by others?

4. How is the current tax administered?

(a) What is the role of taxpayers, employers, information return providers, and the BIR?

(b) What is the current effect on budgetary costs?



5. What would be the impact of tax rate changes on BIR? (a) How would BIR functions of processing, compliance, collections, and

taxpayer assistance be affected? (b) What enforcement tools (e.g., withholding and information reporting)

would be added or taken away from tax administrators?

(c) What effect would tax rate changes have on compliance?

6. Would there be any trade‐offs between simplicity, transparency, and administrative simplicity in the event of any tax rate changes?

Table 4. EFFICIENCY RELATED QUESTIONS FOR INDIVIDUAL LAND FEES

1. What is the purpose of the fee? Is it based on the private benefit or

exacerbator principle?

2. What are the present charges associated with the fee?

3. Does the fee create any distortions? If so, what kinds of distortions are created? How significant are the identified distortions?

4. What social goals, if any, is the fee trying to promote?

(a) Is there an efficiency justification for the goal, or is the goal justified on other grounds, such as equity?

5. Do estimates of the cost of achieving the goal include efficiency costs?

Table 5. EQUITY RELATED QUESTIONS FOR INDIVIDUAL LAND FEES

1. Is there any recognition of differences in ability to pay in the present scale of

fees? 2. Are differences in ability to pay recognised from a horizontal or vertical

equity perspective?

3. How is a user’s ability to pay broadly defined for the fee being evaluated: (a) Income? (b) Consumption?

(c) A broader definition of overall wealth?



4. What factors other than income, such as medical expenses, number of

dependents, and so forth, does the present fee account for when considering a user’s ability to pay the fee?

5. What impact on the level of service usage would result from either increases

or reductions in the fee scale? Who would pay more and who would pay less in the event of increases or reductions in the fee scale?

6. Has a distributional analysis been done?

(a) What time period was covered? For example, does the distributional analysis measure the lifetime or annual effects of the fee?

(b) How is ability to pay (income, consumption, or wealth) measured?

(c) What is the unit of analysis (individuals, households, or fee paying units)?

(d) What assumptions are made about fee incidence?

(e) What measures (e.g., fee rate) are being used to calculate the distribution

of contributions to fee income across user categories?

Table 6. SIMPLICITY, TRANSPARENCY, AND ADMINISTRATIVE SIMPLICITY

EQUITY RELATED QUESTIONS FOR INDIVIDUAL LAND FEES

1. What are the transaction costs associated with the fee? (Collection, compliance and enforcement costs?)

2. Is there any significant evasion in respect of the payment of the fee?

3. Will users’ planning responsibilities (record keeping, research, etc.) likely

increase or decrease in comparison to those under the current user charge?

4. Is the proposed user charge transparent? (a) Can users identify their fee obligation easily? (b) What media mediums are used to promote transparency?

(c) Can users understand the logic behind the fee that they are paying?

(d) Do users know what their true fee burden is (i.e., do they understand the

incidence of the fee system)?

(e) Do users understand the incidence of the fee in terms of the burdens



imposed on other taxpayers?

(f) Are users aware of the extent of compliance by others?

5. How is the current fee administered?

(a) What is the role of users, employers, information return providers, and the BIR?

(b) What is the current effect on budgetary costs?

6. What would be the impact of fee rate changes on BIR?

(a) How would BIR functions of processing, compliance, collections, and user assistance be affected?

(b) What enforcement tools (e.g., withholding and information reporting) would be added or taken away from fee administrators?

(c) What effect would fee rate changes have on compliance?

7. Would there be any trade‐offs between simplicity, transparency, and administrative simplicity in the event of any fee rate changes?

8. What consultation is traditionally undertaken with key stakeholders

regarding the fee? 3. Inclusion of Additional Criteria: 2008 March Quarter The principles of adequacy and stability were added to the evaluation framework in the 2008 March quarter. The adequacy principle requires revenues for individual taxes to increase at a similar rate to growth in GDP. Comparisons of GDP growth rates and those of each land‐related tax were made. The stability principle requires a tax to generate short‐run fluctuations in revenue comparable in magnitude to contemporaneous fluctuations in economic activity, as measured by GDP. The relative stability of each land‐related tax was identified.



ANNEX 2

NATIONAL LAND-RELATED ACTIVITY COSTS AND REVENUES



1. Introduction This annex discusses the methodology employed when preparing assessments of operating costs and revenues applicable to national (and local) land‐related taxes and fees. 2. Methodology for Undertaking Financial Analyses of Land‐Related Taxes and Fees The methodology for undertaking the financial analysis of land taxes and fees, adopted in January 2007, employed an activity‐based costing approach to ensure a relatively comprehensive assessment of the respective costs and revenues was made in the study. The adopted financial analysis methodology is presented in the following seven figures:

• A flow‐chart that sets out the principal tasks in the proposed supporting financial analysis (Figure 1)

• More detailed flow‐charts addressing the tasks outlined in Figure 1 for:

• developing operating cost estimates by directorates in departments

(Figure 2) • developing operating cost estimates for land activities in departments

(Figure 3)

• developing operating revenue estimates for land activities in departments (Figure 4)

• assessing revenue efficiency of land taxes (Figure 5) and • assessing revenue efficiency of land fees (Figure 6)



Figure 1. Overview of Supporting Financial Analysis

Identify land activities by department

Develop operating costs by directorate

Identify land activities undertaken by directorates

Assess time spent in directorates on land activities

Assess operating costs for each land activity by department

Assess operating revenue for each land activity by department

Assess efficiency of current land taxes and charges



Figure 2. Developing Operating Costs by Directorates in Departments

Identify staff numbers per directorate by grade

Determine average salary costs per staff grade

Calculate direct staff costs for land directorates

Determine multiplier for allocating indirect staff costs across land directorates (total direct staff

costs by department divided by total indirect staff costs by department)

Calculate indirect staff costs per land directorate (Direct staff costs multiplied by multiplier for

departmental indirect staff costs)

Calculate total staff operating costs for land directorates (add direct and indirect staff costs by

directorate to get total staff costs across directorates)

Determine multiplier for allocating indirect operating costs (i.e. all non staff costs) to land directorates in each department (total staff

operating costs by department divided by total non staff operating costs by department)

Calculate indirect operating costs for each land directorate (Staff operating costs per land

department multiplied by department multiplier for indirect operating costs)

Calculate total operating costs for land directorates (add staff operating costs and indirect operating costs by land directorates to calculate

total operating costs by land directorates)



Figure 3. Developing Operating Costs by Land Activities in Departments

Assess use of staff time on each identified land activity by directorate (either by staff grade (a

better approach), or total staff, of directorate) (say number of staff engaged full‐time, 75%, 50%, 25%

or 0% of their time on land activities)

Calculate direct staff costs for each identified land activity by directorate (multiply staff numbers in each grade times average grade direct salary by percentage of time spent on each land activity)

Calculate total direct staff costs for each identified land activity across all directorates (add direct staff

costs for each identified land activity by directorate to get total direct staff costs for each

identified land activity)

Calculate indirect staff costs for each identified land activity across all directorates (multiply total

direct staff costs in each activity in each department by respective department indirect cost multiplier to derive total indirect operating costs

for each land activity)

Calculate total staff costs for each land activity within a department (add total direct staff costs

and total indirect staff costs for each land activity))

Calculate indirect operating costs for each land activity within a department (Staff operating costs

per land activity multiplied by department multiplier for indirect operating costs)

Calculate total operating costs for each land activity within a department (add staff operating costs and indirect operating costs to calculate total

operating costs by land activity)



Figure 4. Developing Operating Revenue by Land Activities in Departments

Identify reported revenue by land activity (if available)

Estimate revenue for each land activity based on number of transactions if required (number of

transactions times average fee)

Estimate revenue based on tax base if required (tax base times tax rate)

Figure 5. Assessing Revenue Efficiency of Land Taxes

Identify tax policy criteria issues for each tax

Identify level of recovery of operating costs for each land tax (tax revenues as a percentage of

operating costs)

Assess effectiveness of each land tax

Figure 6: Assessing Revenue Efficiency of Land Fees

Identify level of recovery of operating costs for each land activity or sub‐activity (operating revenue as a percentage of operating costs)

Assess private benefit component of each land activity and theoretical cost recovery level and

estimated fee requirement

Calculate fee revenue over‐recovery/under‐recovery to demonstrate relative efficiency from a

benefits received perspective



The methodology proposed that a supporting spreadsheet to record the above‐mentioned data would be prepared. A summary of the information required for undertaking the adopted methodology and the respective information sources is presented in Table 1.

Table 1. INFORMATION SOURCES

Costs Desired cost information:

• Staff numbers by grade across all directorates engaging in land activities (department directorates)

• Total staff operating costs by grade across all directorates engaging in land activities (department directorates)

• Total indirect operating costs by grade across all directorates engaging in land activities (department directorates)

If desired cost information is unavailable:

• Average grade salaries (NTRC) • Direct staff costs (guidance on downloaded COA reports provided by NTRC) • Indirect staff costs (guidance on downloaded COA reports provided by NTRC) • Indirect operating costs (from downloaded COA reports) • Use of time data across directorates within each department (from

directorates) Revenue Desired revenue information

• Revenue by user charge and tax category across directorates (department directorates)

• Transaction volumes for each user charge and tax (department directorates) If desired revenue information is unavailable:

• Calculate average unit revenue per user charge in consultation with directorates

• Calculate tax base or taxes based on transaction data generated by possible surveys



3. Application of Methodology for Assessing National Land‐Related Activity Costs and Revenues The assessment of operating costs for national land‐related taxes was completed using the methodology outlined earlier in Figure 3. Appropriate data for assessing the operating costs of the capital gains tax (“CGT”), the documentary stamp tax (“DST”), estate tax and donor’s tax was provided by the BIR’s RDO29, RDO 31 and Iloilo offices; the information provided by the BIR’s Naga office in respect of the latter taxes was not used due to some problems that were identified after this had been provided. Salary costs across the above‐mentioned taxes were identified on the basis of use‐of‐time assessments prepared by BIR staff. This information was subsequently used to assess the distribution of staff costs; the resulting distribution of staff costs was used to assess non‐staff operating costs across the above‐mentioned taxes. Details of these calculations for RDO 29 and RDO 31 are presented in Table 2 whilst those for the Iloilo office are presented in Table 3. Total operating costs for the CGT, the DST, estate tax and donor’s tax in BIR’s RDO29, RDO 31 and Iloilo offices were subsequently determined and the distribution of total operating costs across these taxes in the latter offices was derived; details of these calculations are presented in Table 4. The latter total operating cost distribution was used to assess total national operating costs for the CGT, the DST, estate tax and donor’s tax, based on the BIR’s 2005 operating cost figure of P3.731 billion; details of these calculations are presented in Table 5. Total national VAT operating costs were derived in a similar manner to that used for the CGT, the DST, estate tax and donor’s tax; this data was based on assessments provided by the BIR’s RDO 31, Iloilo and Naga offices; details of these calculations are presented in Table 6. A summary of total operating costs and revenues for the five national land‐related taxes is presented in Table 7; this data is presented as Table 4 in the main report.



Table 2. RDO 29 AND RDO 31 NATIONAL LAND‐RELATED TAX OPERATING COSTS (EXCLUDING VAT) (P)

CGT DST Estate Donors Land Total Non‐land Total Total

RDO 29

Salary expenses 178,692 178,692 128,030 25,789 511,203 11,046,699 11,557,902

Total staff costs including indirect costs 261,771 261,771 187,554 37,779 748,874 16,182,590 16,931,464

MOOE costs 38,808 38,808 27,805 5,601 111,022 3,566,134 3,677,156

Total operating costs 300,579 300,579 215,359 43,380 859,897 19,748,724 20,608,621

RDO 31 Total

Salary expenses 143,697 143,697 132,516 110,152 634,624 8,836,601 9,471,225

Total staff costs including indirect costs 219,864 219,864 202,756 168,539 971,008 13,520,476 14,491,485

MOOE costs 65,730 65,730 60,615 50,386 290,288 4,042,013 4,332,300

Total operating costs 285,594 285,594 263,371 218,925 1,261,296 17,562,489 18,823,785

Table 3. ILOILO RDO NATIONAL LAND‐RELATED TAX OPERATING COSTS (P)

CGT DST Estate Donors VAT Land Total Non‐land Total Total

Salary expenses 145,061 145,061 145,061 145,061 343,723 923,968 7,268,288 8,192,256

Salary distribution 1.77% 1.77% 1.77% 1.77% 4.20% 11.28% 88.72% 100.00%

Total operating costs 293,304 293,304 293,304 293,304 694,985 1,868,200 14,695,989 16,564,189



Table 4. ACCUMULATED OPERATING COSTS FOR RDO 29, RDO 31 AND ILOILO

(P)

CGT DST Estate Donors VAT Total Non‐land taxes Total

RDO 29 300,579 300,579 215,359 43,380 859,897 20,608,621

RDO 31 285,594 285,594 263,371 218,925 1,053,483 18,823,785

Iloilo 293,304 293,304 293,304 293,304 1,173,216 16,564,189

‐

Total costs per category 879,476 879,476 772,034 555,608 ‐ 3,086,595 ‐ 55,996,595

Cost distribution 1.57% 1.57% 1.38% 0.99%

Table 5. ESTIMATED NATIONAL OPERATING COSTS FOR CGT, DST, ESTATE AND DONOR’S TAXES (P)

CGT DST Estate Donors BIR Total

Cost distribution 1.57% 1.57% 1.38% 0.99%

Estimated operating costs 58,598,679 58,598,679 51,439,893 37,019,664 3,731,000,000



Table 6. ESTIMATED NATIONAL OPERATING COSTS FOR VAT (P)

VAT VAT costs Grand total

RDO 31 207,813 18,823,785

Iloilo 694,985 16,564,189

Naga 574,686 20,356,968

Total costs for RDO 31, Iloilo and Naga 1,477,483 55,744,942

Cost distribution 2.65%

BIR operating costs 2005 3,731,000,000

BIR VAT national property costs (million) 98.88

BIR VAT national property revenue (million) 3,163

BIR VAT national property costs as % of revenue 3.13%

Table 7: ESTIMATED 2005 OPERATING COSTS FOR NATIONAL LAND‐RELATED TAXES AS A PERCENTAGE OF OPERATING REVENUE (P)

CGT DST Estate Donors VAT

Estimated 2005 BIR operating costs 59,000,000 59,000,000 51,000,000 37,000,000 99,000,000

BIR 2005 revenue 4,580,000,000 1,145,000,000 627,000,000 295,000,000 3,163,000,000

Operating costs as % of revenue 1.29% 5.15% 8.13% 12.54% 3.13%



ANNEX 3

SUPPORTING NTRC WORKING PAPERS FOR LAND-RELATED TAX AND FEES POLICY REVIEW



1. Introduction This annex lists the background papers prepared by NTRC in 2006 and 2007 to assist the review of national and local land‐related taxes and fees. 2. NTRC Background Papers NTRC prepared the following papers in 2006 and 2007 to support the review of national and local land‐related taxes and fees:

1. Value‐Added Taxation (VAT) on Real Estate Properties in Other Countries. (Indirect Taxes Branch)

2. Documentary Stamp Tax on Real Property Transactions Imposed on Selected

ASEAN Countries, Australia, The European Union, The United States of America and the Other Countries. (Economics Branch)

3. Comparative Structure of Transfer Taxes in Selected Countries. (Direct

Taxes Branch)

4. Input to the Background Information on Land Related Fees and Charges. (Special Research & Technical Services Branch)

5. Comparative Property Titling Procedures of ASEAN‐Member Countries, Some

Asian and Other Selected Countries and Their Corresponding Fees and Charges. (Special Research & Technical Services Branch)

6. Comments on the Revised Zonal Values of Sta. Rosa Per Department Order

No. 33‐05. (Tax Statistics Branch)

7. A Paper on One‐Time Transactions: Procedure on Property Transfer at the Bureau of Internal Revenue (BIR). (Direct Taxes Branch)

8. Latest Developments in the Value‐Added Tax (VAT) Affecting Real Estate

Properties in the Philippines. (Indirect Taxes Branch)

9. Rationalize Property‐Related Taxes and Fees and Recommend Necessary Legislatives and Administrative Reforms (RPVT002) (Tax Statistics Branch)

10. Provide Guidelines as to the Impact of the Proposed Valuation Reforms on

Both the LGU and the BIR Property Taxes (RPVT 005). (Tax Statistics Branch)

11. Inventory of Fees and Charges Imposed by the Land Registration Authority (LRA). (Special Research & Technical Services Branch)

12. The Analytical Framework of the Tax Policy Study. (Economics Branch)



13. List of Laws on Land Acquisition and Titling. (Special Research & Technical

Services)

14. Analytical Framework for Fees and Charges Policy Group. (Special Research & Technical Services Branch)

15. Analysis of the Revenue Performance of Local Taxes on Real Properties, CYs

2001‐2005: LT19WP03 (Local Finance Branch)

16. Analysis of the Revenue Performance of the Value Added Tax (VAT) on Real Property, CYs 2001‐2005 (Indirect Taxes Branch)



ANNEX 4

DEADWEIGHT COST ESTIMATES FOR LAND-RELATED TRANSACTION TAXES



1. Introduction This annex provides an estimate of the overall economic inefficiency or “deadweight” costs for the three taxes levied on land transactions, namely the capital gains tax (“CGT”), the documentary stamp tax (“DST”) and the local transfer tax. 2. Definition of Deadweight Costs The cost to an economy in terms of lost output arising from a tax is known as the “deadweight cost”; inefficient taxes have relatively high deadweight costs. A 1998 New Zealand government tax report1 noted “A conservative estimate2 of the allocative or deadweight costs relating to taxing employment income in New Zealand in 1991 was 18 cents per dollar collected. The deadweight costs of taxes on income from capital, for example, interest, dividends and rent, would be considerably higher”. The United States Office of Management and Budget (OMB) incorporates a 25 percent deadweight loss measure into federal cost‐benefit analyses.3 OMB rules require that each additional dollar of tax revenue count as a cost of $1.25 because taxes "create an excess burden which is a net loss to society." 3. Estimate of Deadweight Costs 3.1 Methodology The methodology employed in preparing the present deadweight cost estimate measures the deadweight costs associated with the current transaction taxes (amounting to 8% of the value of each property transaction4) based on an assessment of the volume of sales currently deferred and average current transaction taxes. The methodology also allows the calculation of the additional deadweight costs incurred on a per peso basis in the event of any increase in the latter taxes. The methodology is based on that employed by Hird in his June 2007 study of the impact of Australian stamp duty on households exchanging houses5

1 Tax Compliance, Report to the Treasurer and Minister of Revenue by a Committee of Experts on Tax

Compliance, New Zealand Government, December 1998 2 Diewert and Lawrence, 1994, The Marginal Costs of Taxation in New Zealand, Swan Consultants Ltd. 3 Economic Benefits of Personal Income Tax Rate Deductions, Joint Economic Committee United States

Congress, April 2001, Page 13 4 The current taxes on land transactions comprise a 6% capital gains tax, a 1.5% documentary stamp tax and a 0.5% local transfer tax 5 Hidden Costs of Stamp Duty Taxation, Tom Hird, NERA Economic Consulting, June 2007



(rather than total house sales) and represents a static analysis of the impact of higher transaction taxes on the deadweight costs of these taxes. It is important to note that recent work undertaken by Feldstein6 has demonstrated that an assessment of deadweight costs on taxes on capital income should be undertaken from a life‐cycle and a general‐equilibrium perspective; this represents a broader approach than that applied in the current analysis. Feldstein concluded, “taxes on capital income produce large deadweight losses”. The methodology employed in the present assessment of deadweight costs therefore incorporates a relatively conservative approach as it recognises the one‐off impact of changes to the current transaction taxes. The methodology for assessing current total deadweight costs requires assumptions for the following variables:

• Volume of house sales

• Median house prices

• Demand price elasticity of housing

• Transaction tax rates

• Other costs associated with moving house 3.2 Development of Assumptions House Sale Volumes The quantification of the total value of deadweight costs for all residential house sales is, however, limited by the absence of robust data for the annual value of property sales and median house prices in the Philippines. A figure of say 300,000 housing sales per year (equivalent to approximately 2% of households) has been assumed in this analysis. Median House Prices Although data for national median house prices in the Philippines is not readily available, data for the average value of new houses started provide some guidance for developing an estimate of the national median house price. The average value of new houses started in the 2007 quarter was P818,000 according to the Philippines

6 Martin Feldstein, The Effect of Taxes on Growth and Efficiency, NBER Working Paper 12201 (May 2006).



National Statistics Office7. A conservative national median house price of P1million has been assumed in the draft analysis, based on an assumed average land component of P182,000. Demand Price Elasticity of Housing The level of households’ sensitivity to changes in the cost of moving may be measured by the demand price elasticity for housing. There are varied assessments of the value of this measure in the literature; some United States studies suggest a range of 0.7% to 0.9%8 whilst Hird used a value of 0.8%. Generally, limited work of this nature has been undertaken in developing countries. Ballesteros 9 undertook a study of housing demand in the Philippines in 2000 based on the 1997 Philippines household income and expenditure survey and found a significantly lower price elasticity of ‐0.45 for the urban non‐poor category; this figure has been used in the draft analysis and implies that a 1% increase or decline in house prices would reduce or increase the demand for housing (and the number of households moving) by 0.45%10. The latter price elasticity value may well, however, be quite low having regard to international trends. Malpezzi discussed the findings of selected international housing studies in developing countries in a 1999 paper and noted that estimates of the price elasticity for housing “was close to 1 in absolute value, ranging from ‐0.76 to ‐1.08, with the exception of Manila owners whose price elasticity is estimated to be ‐0.4” (in a 1971 study)11. A housing demand price elasticity value was also developed based on the changes in transaction tax revenues in the period 1998‐2006 following the increase in the capital gains tax rate from 5% to 6% that was effective from 1 January 1998. Revenue estimates for the capital gains tax, documentary stamp tax and local transfer tax for the period since 1997 are presented in Table 1.

7 Table 2. Number of Residential Building Construction Started, Floor Area and Value of Constructions, by

Type of Building, by Region, Province and Municipality for the First Quarter of 2007, Industry Statistics Division, Industry and Trade Statistics Department, National Statistics Office

8 See E O Olsen ‘A competitive theory of the housing market’ (1969) 59 American Economic Review 612-

622, These studies suggest that a 1% reduction in price results in a 0.7 to 0.9 increase in demand. See also A M Polinsky and D T Ellwood, ‘An empirical reconciliation of micro and group estimates of the demand for housing’ (1979) 61 Review of Economics and Statistics 199-205.

9 The Dynamics of Housing Demand in the Philippines: Income and Lifecycle Effects Marife M. Ballesteros

Philippine Institute of Development Studies Discussion Paper Series No. 2001-15 10 A price elasticity of 1 means that a 1% increase or decrease in price results in a 1% decrease or increase

in demand 11 Malpezzi, Stephen, 1999. "Economic analysis of housing markets in developing and transition

economies," Handbook of Regional and Urban Economics, in: P. C. Cheshire & E. S. Mills (ed.), Handbook of Regional and Urban Economics, edition 1, volume 3, chapter 44, pages 1791-1864 Elsevier, page 1801.



Table 1. PROPERTY TRANSFER TAX REVENUES 1997‐2006 (P MILLIONS)

CGT (actual)

Estimated DST

(NTRC)12 Local transfer tax

(actual) Total revenues

2007 3,519 (1) 880 NA NA

2006 4,805 1,201 1,339 7,345

2005 4,580 1,145 1,419 7,144

2004 4,220 1,055 1,169 6,444

2003 4,103 1,026 1,105 6,234

2002 4,155 1,039 1,136 6,330

2001 3,180 795 878 4,853

2000 3,499 875 975 5,349

1999 3,697 924 821 5,442

1998 4,415 1,104 710 6,229

1997 5,204 1,301 875 7,380

A housing demand price elasticity value may be obtained by dividing the change in average total property tax transfer tax revenues for the period 1998‐2006 compared with those prevailing in 1997 (before the increase in the capital gains tax rate from 5% to 6%) by the change in total property transaction tax rates. The calculation of a housing demand price elasticity value using the data provided in Table 1 for total property transfer tax revenues is presented in Table 2. Table 2. HOUSING DEMAND PRICE ELASTICITY VALUE BASED ON PROPERTY

TRANSFER TAX REVENUES, 1997‐2006 Average total property transfer tax revenues 1998/2006: P6.152 billion 1997 total property transfer tax revenues: P7.38 billion Change in average total property transfer tax revenues 1998/2006 following increase in capital gains tax rate: ‐16.64% (rounded) Effective increase in total property transfer tax rate in 1998: 14.29% (rounded) Long‐run housing demand price elasticity value: ‐16.64%/14.29% = ‐1.16 A more narrow measure of the housing demand price elasticity value based only on capital gains tax revenues for the period 1997‐2006 is presented in Table 3; data for

12 The BIR provides no data in respect of the DST revenue; NTRC has to date estimated these revenues by

using 25% of reported CGT revenues.



the 2007 year was excluded from these calculations as currently only preliminary data is available. Table 3. HOUSING DEMAND PRICE ELASTICITY VALUE BASED ON CAPITAL

GAINS TAX REVENUES, 1997‐2006 Average capital gains tax revenues 1998/2006: P4.073 billion 1997 capital gains tax revenues P5.204 billion Change in average capital gains tax revenues 1998/2006 following increase in capital gains tax rate: ‐21.74% (rounded) Increase in capital gains tax rate in 1998: 20% Long‐run housing demand price elasticity value: ‐21.74%/20% = ‐1.09 The data presented in Table 1 is not, however, adjusted for inflation. Long‐run housing demand price elasticity values in excess of –2 were obtained when the data presented in Tables 2 and 3 were adjusted for inflation. A housing demand price elasticity of 1 in absolute value was used in the current assessment of deadweight costs. Transaction Tax Rates Transaction taxes amount to 8% of the value of a property transaction. Other Costs There are other costs incurred in exchanging properties, particularly agent and/or legal costs. Other costs excluding transaction taxes are currently estimated at 5% of the national median house price (P50,000). The total cost of moving house is therefore estimated at 13% of the national median house price (P130,000). 3.3 Development of Deadweight Cost Estimates The present transaction taxes represent 61.54% of the total cost of moving house (P80,000/P130,000). Abolishing all the current transaction taxes would increase the number of moves by 61.54%; the increase in moves is calculated by multiplying the share of moving costs represented by transaction taxes by the housing demand price elasticity absolute value (61.54% x 1.0). This means that for every move that occurs



(raising P80,000 in revenue)13 there are another 0.6154 moves that do not occur at an average cost to the community of P40,000 (P80,000 divided by 2). Consequently, the P80,000 in transaction taxes raised in each house sale costs a further P24,615 in hidden costs imposed on households arising from the delay in moving house; this is calculated by multiplying the average cost to the community (P40,000) by 0.6154; the P24,615 of hidden costs equates to 30.77 centavos per peso of transaction tax revenue. Using the figure of say 300,000 housing sales per year, the estimated annual value of deadweight costs arising from the current transaction taxes was therefore P 7.385 billion (300,000 x P24,615 = P7.384 billion) in 2005 compared with transaction tax revenues of P7.144 billion in 2005 (assuming all house sales contribute to transaction tax revenues). This methodology is presented in Table 4. Examining the impact of a 10% increase in transaction taxes also highlights the scope of estimated deadweight costs. Increasing the total value of transaction taxes by 10% on the median Philippines house transaction will increase the cost of moving by 6.15% (P8000 divided by P130,000 equals 6.15%) and discourage the number of moves by the same amount (6.15% times the housing demand price elasticity absolute value of 1 = 6.15%). Whilst additional transaction taxes are earned on an extra 10% of the 93.85% of moves that continue to occur resulting in a 7.51% revenue increase (93.85% times 8% equals 7.51%) there is a reduction in transaction taxes of one hundred percent on the 6.15% of discouraged moves resulting from the 10% transaction tax increase (100% of 6.15% times the housing demand price elasticity absolute value of 1 = 6.15%); the resulting net impact on revenue is a 1.35% increase in revenue (7.51% less 6.15% = 1.35%). Thus, hidden costs created by the 10% transaction tax increase represent around 6.15% of revenue prior to the tax increase but increased revenues only represent 1.35%. The ratio of these represents the hidden costs created per peso raised (i.e. 4.55=6.15/1.35). That is, for every P1 of extra revenue raised there is around P4.55 in additional hidden costs created. Put simply, for every P1 extra in revenue earned in transaction taxes, Philippines households, in aggregate, lose around P5.55 ‐ comprising P1 in transaction taxes plus a further P4.55 in hidden costs.

13 The analysis assumes that every house sale contributes P80,000 in transaction tax revenue; this may not

always arise as some houses may be designated “ordinary assets”.



Table 4. METHODOLOGY FOR ASSESSING DEADWEIGHT COSTS (HIRD) – BASE CASE

Assumptions Estimated value

National median house price P1,000,000

Demand price elasticity of housing ‐1.0

Transaction taxes (as % of purchase price) 8%

Other costs excluding taxes relating to property purchase (as % of purchase price)

5%

Total costs (as % of purchase price) 13%

Total costs (transaction tax = P80,000 and other costs = P50,000) P130,000

Transaction taxes (as % of total costs) (8% divided by 13%) 61.54%

Increase in household moves if transaction taxes are abolished (transaction tax rate x price elasticity = 61.54% x 1.0)

61.54%

Average deadweight cost per house sale (average tax paid x increase in housing sales if transaction taxes are abolished = P40,000 x 61.54%)

P24,615

Current estimated total deadweight costs based on 300,000 house sales (P billion)

7.385

The present estimate of current total deadweight costs is sensitive to changes in the five variables used in the abovementioned calculations. Increases (or decreases) in the volume of house moves and the national median house price will result in increases (or decreases) in average and total deadweight costs. Increases (or decreases) in the price elasticity value with no increases in the average national median house price will result in increases (or decreases) in the number of house moves in the event that transaction taxes are removed and increases (or decreases) in the average deadweight cost per house sale. 4.0 Conclusion The deadweight costs presented in this study are consistent with the results of the previously mentioned 1998 New Zealand government tax report that suggested average deadweight costs per peso of property transaction tax would amount to a figure considerably greater than P0.18. The above findings suggest that the deadweight costs arising from current land transaction taxes are likely to be significant and that house exchanges are likely to increase strongly following the abolition of transaction taxes.

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