Duration of Reduced Percentage Tax Under CREATE Law in Philippines

Introduction

The Corporate Recovery and Tax Incentives for Enterprises (CREATE) Act, officially Republic Act No. 11534, represents a significant overhaul of the Philippine fiscal incentives regime. Enacted on March 26, 2021, amid the economic challenges posed by the COVID-19 pandemic, the law aimed to stimulate investment, enhance competitiveness, and provide tax relief to businesses while rationalizing incentives to ensure fiscal sustainability. One of the key features of CREATE is the introduction of reduced tax rates, including a lowered corporate income tax (CIT) and special incentive schemes such as the Special Corporate Income Tax (SCIT). This article delves comprehensively into the duration aspects of these reduced percentage taxes, examining their applicability, time frames, conditions, and implications within the Philippine legal and economic context.

The "reduced percentage tax" under CREATE primarily refers to two mechanisms: the general reduction in CIT rates for corporations and the SCIT, which is a preferential 5% tax on gross income earned (GIE) available to qualified registered business enterprises (RBEs). These reductions are time-bound to balance investor attraction with government revenue needs. Understanding their durations is crucial for businesses, investors, and policymakers, as they influence long-term planning, compliance, and economic strategy.

Background and Rationale of Reduced Taxes in CREATE

Prior to CREATE, the Philippines had a fragmented incentives system under various laws, including the Tax Reform for Acceleration and Inclusion (TRAIN) Act, which maintained a 30% CIT rate—one of the highest in Southeast Asia. CREATE addressed this by immediately reducing the CIT to 25% for domestic corporations and resident foreign corporations (RFCs), retroactive to July 1, 2020, and to 20% for micro, small, and medium enterprises (MSMEs) with taxable income not exceeding PHP 5 million and total assets (excluding land) not exceeding PHP 100 million.

However, the "reduced percentage tax" in the incentives context goes beyond this general cut. For RBEs registered with investment promotion agencies (IPAs) like the Board of Investments (BOI) or the Philippine Economic Zone Authority (PEZA), CREATE introduces a tiered incentive package that includes an Income Tax Holiday (ITH) followed by either SCIT or enhanced deductions (ED). The SCIT, at 5% on GIE, effectively functions as a reduced percentage tax, replacing the regular CIT and exempting the enterprise from other national and local taxes (except VAT, excise taxes, and certain fees). This shift from net income-based taxation to gross income-based taxation simplifies compliance and reduces the effective tax burden.

The durations of these reduced rates are designed to be finite, promoting sunset clauses to prevent perpetual incentives that could strain public finances. This approach aligns with international standards, such as those from the Organisation for Economic Co-operation and Development (OECD) on base erosion and profit shifting (BEPS), ensuring incentives are performance-based and time-limited.

Core Components of Reduced Percentage Tax Durations

1. General Corporate Income Tax Reduction

The baseline reduction in CIT under CREATE is not strictly time-bound in the same way as incentives but is subject to periodic review and potential adjustments. As of the law's enactment:

• Domestic Corporations and RFCs: CIT is reduced to 25% on taxable income, with no explicit expiration date. However, for proprietary educational institutions and non-profit hospitals, the rate is 1% from July 1, 2020, to June 30, 2023, reverting to 10% thereafter unless extended.
• MSMEs: A 20% CIT rate applies indefinitely, provided they meet the asset and income thresholds. This reduction aims to support smaller enterprises recovering from economic downturns.

While these general reductions lack a fixed duration, they are embedded in the National Internal Revenue Code (NIRC) as amended by CREATE, making them permanent unless amended by future legislation. In practice, fiscal authorities monitor their impact through annual reports from the Department of Finance (DOF) and the Bureau of Internal Revenue (BIR).

2. Special Corporate Income Tax (SCIT) for Registered Business Enterprises

The SCIT is the hallmark reduced percentage tax for incentivized projects. It applies after the ITH period and is available only to RBEs engaged in priority activities under the Strategic Investment Priority Plan (SIPP). The durations vary based on project tiering, which considers factors like investment capital, location (e.g., less developed areas), industry priority (e.g., export-oriented, technology-driven), and economic impact.

• ITH Duration: As a precursor to SCIT, ITH provides 100% exemption from CIT for 4 to 7 years:

  • Tier I: 4 years
  • Tier II: 5 years
  • Tier III: 6 years (for projects in Metropolitan Areas or adjacent areas)
  • Additional 1 year for projects in less developed areas or those recovering from calamities.
  • Export enterprises may qualify for longer ITH if they meet export thresholds (e.g., 70% export sales).

• SCIT Duration: Following ITH, SCIT at 5% on GIE is granted for 10 years. This period is uniform across tiers but can be extended under specific conditions:

  • No extensions beyond 10 years for new projects post-CREATE.
  • For domestic market enterprises (DMEs), SCIT is available only if they qualify under Tier III or involve advanced technologies.

The total incentive period (ITH + SCIT) thus ranges from 14 to 17 years. After this, the enterprise transitions to the regular 25% CIT regime. The SCIT calculation is based on gross income minus direct costs (e.g., cost of goods sold), ensuring it remains a percentage tax on value added.

3. Enhanced Deductions (ED) Alternative

Instead of SCIT, RBEs may opt for ED, which allows additional deductions (e.g., 100% on power expenses, 50% on labor) for 5 to 10 years post-ITH, depending on the tier. While not a direct percentage tax reduction, ED effectively lowers the taxable base under the 25% CIT, mimicking a reduced effective rate. Durations mirror SCIT:

• Tier I: 5 years
• Tier II: 7 years
• Tier III: 10 years

This option is preferable for capital-intensive industries where deductions yield greater benefits than a flat 5% rate.

Transitional and Sunset Provisions

CREATE includes grandfathering rules for pre-existing incentives to avoid abrupt disruptions:

• Existing RBEs (Pre-CREATE): Those enjoying incentives under prior laws (e.g., PEZA's 5% Gross Income Tax or BOI's ITH) can continue until their original terms expire, but no longer than the sunset periods:
  • ITH-only: Up to July 1, 2022 (if remaining period is less than 3 years) or full remaining term.
  • ITH followed by 5% GIT: Continue 5% GIT for the remaining period, up to 10 years from CREATE's effectivity.
  • Perpetual 5% GIT: Sunset after 10 years from CREATE (i.e., until 2031).
• Transitional Reduced CIT: For RFCs previously taxed at preferential rates (e.g., 15% for regional headquarters), a gradual increase to 25% over 5 years starting 2022.
• Vetoed Provisions and Amendments: President Duterte vetoed certain extensions, emphasizing fiscal prudence. Implementing Rules and Regulations (IRR) issued by the Fiscal Incentives Review Board (FIRB) clarify that extensions require FIRB approval for exceptional cases, such as force majeure events delaying project implementation.

Violations, such as non-compliance with export commitments or investment thresholds, can lead to incentive revocation, shortening durations.

Conditions, Extensions, and Limitations

• Eligibility Criteria: To avail of reduced taxes, projects must be registered with IPAs, meet minimum investment (e.g., PHP 1 billion for Tier III), and adhere to performance metrics. Annual reporting to the BIR and DOF is mandatory.
• Extensions: Limited to calamities or delays not attributable to the enterprise, capped at the original duration. For example, during the COVID-19 period, some extensions were granted via BIR rulings.
• Local Government Implications: SCIT exempts from local business taxes, but post-incentive, regular local taxes apply.
• Tax Credit and Refunds: Unused incentives (e.g., from ITH) cannot carry over beyond durations, but tax credits for duties on imports remain available.
• Penalties for Non-Compliance: Early termination if thresholds are unmet, with back taxes plus interest.

Implications and Challenges

The time-bound nature of reduced percentage taxes under CREATE fosters a dynamic investment environment, encouraging efficiency and reinvestment. However, challenges include:

• Investor Uncertainty: Finite durations may deter long-gestation projects.
• Administrative Burdens: Complex tiering and reporting requirements.
• Economic Impact: Studies indicate CREATE has attracted over PHP 1 trillion in investments by 2024, but durations must balance with revenue losses estimated at PHP 100 billion annually.
• International Comparisons: Compared to Vietnam's indefinite incentives or Indonesia's 20-year holidays, Philippine durations are shorter, emphasizing sustainability.

Future amendments could adjust durations based on economic needs, such as extensions for green investments under the SIPP updates.

Conclusion

The durations of reduced percentage taxes under the CREATE Law are meticulously structured to provide targeted relief while safeguarding fiscal health. From the permanent 25% CIT reduction to the 10-year SCIT cap, these provisions reflect a strategic approach to economic recovery and growth. Businesses must navigate these time frames carefully, leveraging IPAs for registration and compliance to maximize benefits. As the Philippine economy evolves, these durations will likely be refined, ensuring the law's enduring relevance in promoting inclusive development.