Focusing on what matters: A tax regime proposal
“Focus on what matters” isn’t only a phrase that applies to maintaining a proper work-life balance or just bettering your life in general. This phrase is also the key to improving our tax administration.
Under the 2021 Bureau of Internal Revenue (BIR) Annual Report (the latest as of the date of this writing), the total revenue collections for that year amounted to P2.08 trillion. Of that amount, P1.29 trillion, or roughly 64% of the total collection, comes from large taxpayers. In other words, the other 36% comes from small and micro enterprises.
The problem isn’t entirely obvious until you take into account studies by the World Bank (WB). According to Risk-Based Tax Audits published by the WB, small taxpayers (and, presumably, micro enterprises as well) typically contribute only 5% to the revenue collections. The bulk of revenue collections come from medium-sized enterprises (contributing 20-30%) and large enterprises (contributing 60-70%).
In the Philippines, not only is there no category for “medium-sized enterprises” but small-and-medium-sized enterprises are the ones facing the brunt of the problem.
Now, here is where “focusing on what matters” comes in.
Instead of collecting from small and micro enterprises, the government should focus on improving its collections on medium and large taxpayers. To do this, we have proposed a more equitable tax regime that puts its focus to larger entities rather than small taxpayers.
EMPLOYEESThe first part of our proposal is straightforward — separate the employees from Self-employed and Professionals (SEPs). Employees are unique in that they have fixed incomes, unlike SEPs who earn significantly more but pay less taxes. Their salaries are subject to withholding tax and are remitted to the BIR by their employers. The effect of this portion is simple. It allows the government to focus on increased compliance from SEPs who should be paying a flat 10% tax.
MARGINAL INCOME EARNERSThe second portion of our proposal includes the need to increase the threshold for marginal income earners. For reference, our regulations presently recognize the concept of “marginal income earners.” Under RR No. 11-2000, marginal income earners are those who earn annual sales of P100,000. Note that this regulation was issued in the year 2000, almost 22 years ago. And with the soaring inflation rates, the P100,000 annual sales is clearly not enough to encompass those who are truly marginal income earners.
Our proposal is to increase that threshold to those earning not more than P1,000,000. This threshold would sufficiently cover marginal income earners, such as sari-sari (sundry) store owners. The next part involves encouraging them to register. To do this, we can offer a fixed amount of P1,000 to be paid annually. While this amount may seem low, keep in mind that our goal here is to encourage these taxpayers to register and to collect data, not taxes. The effort of collecting more taxes should be directed to medium and large taxpayers.
MICRO ENTERPRISESThe third part requires a review of micro enterprises, specifically the Barangay Micro Business Enterprises or BMBEs. Presently, the BIR has not released any data on how many BMBEs are registered. The problem becomes immediately apparent — we do not know if the taxpayers receiving BMBE certification (and are, therefore, being exempted from income tax) still fall within that threshold. Note that, in renewing BMBE certification, there is no audit process. It is easy for an entity to pretend to be BMBEs even if they no longer qualify.
Our proposal is to mandate the BIR to audit BMBEs every two years before renewing their tax exemption. We can also offer them to pay an optional flat tax of 10% and require them to adopt electronic invoicing. They shall be subject to Tax Compliance Verification Drives to make sure they still properly comply.
SMALL ENTERPRISESFor small enterprises, our proposal remains — offer an optional flat tax of 10% and require them to adopt electronic invoicing. The crucial part of this portion involves the adoption of a risk-based audit.
A risk-based audit is a simple concept. A benchmark is set by the BIR based on how much certain industries generally earn, i.e., profit margin and how much taxes they usually pay effectively. Businesses who pay 30% below the threshold would be considered high-risk, and be subject to a tax audit.
Presently, the BIR conducts “random” audit, but we should dispose of this practice and focus on those that are truly high risk which can generate more revenues.
MEDIUM ENTERPRISESThe goal for this portion is really just to create the “medium taxpayer” category, which is separate from small enterprises whose annual gross sales do not exceed a certain threshold, e.g., P100 billion. Presently, the BIR only recognizes a large taxpayer category. However, there is a need to distinguish medium taxpayers from the rest of the taxpayer base. Recall that, under the WB study cited above, medium taxpayers ought to contribute 20-30% to the total revenue collections.
This is the first taxpayer category the government must start focusing on collecting from. Medium taxpayers must be subjected to a regular audit every three years. Why? Medium taxpayers are those who are earning a lot already. The BIR should focus their audit on them to make sure that they are paying the right taxes. This regular audit every three years is on top of the risk-based audit explained earlier.
This means, essentially, that a medium taxpayer that is high-risk will be subjected to both the regular audit every three years and the risk-based audit. However, medium taxpayers that are low risk will still be subject to audit, but only the regular audit every three years.
In this category, medium taxpayers should be imposed a 25% income tax rate, and they should still be mandated to adopt electronic invoicing.
LARGE ENTERPRISESThe “Large Enterprises” is an established category, comprising those earning P1 billion and above in profit. Under the Corporate Recovery and Tax Incentives for Enterprises (CREATE) Law, they pay 25% corporate income tax. They are required to use electronic invoicing, as per the Tax Reform for Acceleration and Inclusion (TRAIN) Law, and, under RR No. 9-2009, they are also required to maintain Computerized Accounting Systems (CAS) under RR No. 9-2009.
Currently, the BIR has around 3,000 companies in the Large Taxpayer Service (LTS) group under the Office of the Commissioner. The immediate goal is to expand this group to 7,000-10,000 large enterprises that will be subject to risk-based and regular audit every year. From this, the target collection must be set per industry and risk level of large enterprises, owing to the fact that more than 60% of our total tax collections are from the LTS group.
CONCLUSIONThe idea behind this proposed tax regime is really to focus the government’s efforts on places where it matters. In this case, focus must be directed to medium and large enterprises, and the government must relax its grip on small and micro enterprises, and especially marginal income earners. The goal of laws and government regulations, as regards these smaller businesses, must be getting them to register and helping them flourish. It is when these businesses begin to flourish as medium enterprises that we should begin to focus on collecting taxes from them.
This article reflects the personal opinion of the author and does not reflect the official stand of the Management Association of the Philippines or MAP.
Raymond “Mon” A. Abrea is member of the MAP Ease of Doing Business Committee, founding chair and senior tax advisor of the Asian Consulting Group and co-chair of Paying Taxes – EODB Task Force. He is trustee of CSR Philippines — the advocacy partner of the BIR, Department of Trade and Industry, and Anti-Red Tape Authority on ease of doing business and tax reforms.