"Income tax holidays are acknowledged to be among the bluntest incentive instruments most open to abuse. There is little evidence to suggest that the more generous they are, the more effective [they become]," the IFC said.
The IFC is responsible for promoting sustainable private sector investment in developing countries, helping to reduce poverty and improving people's lives. The IFC provides loans, equity, structured finance and risk management products, and in this particular case, advisory services to help build the private sector.
The study noted there is little correlation between incentives and the growth of investment. It identified political and economic stability, rule of law, quality of governance, infrastructure and human capital as the major factors motivating investment.
The IFC report said that additional revenue that comes from removing the income tax holiday could be used to address investor concerns, which it said was a better way to entice investors. Currently, analysts say infrastructure remains the greatest obstacle in attracting foreign investment along with high-energy costs and low productivity.
The Board of Investments (BoI), which operates under the Department of Trade and Industry (DTI), is the lead government agency responsible for investment promotion and is also charged with developing fiscal incentives. The BoI has remained adamant that income tax holidays are necessary in remaining competitive with neighbouring countries in order to attract potential investment.
"With the fierce competition for foreign direct investments in Southeast Asia, the Philippines cannot afford to do away with incentives especially when countries like Thailand and Malaysia are offering much more generous incentives while having better infrastructure and educational systems," Elmer Hernandez, managing head of the BoI, told local media.
Currently, the BoI offers a variety of fiscal incentives including income tax holidays, which range from four to eight years.
While the DTI and BoI strongly encourage the use of income tax holidays, the Department of Finance (DoF) supports the IFC's recommendations.
"The centrepiece of the Philippine incentives system, which is the income tax holiday, is the most redundant type of tax incentive. They need not have been granted because the investment would have been made anyway [...] The government has adopted the income tax holiday policy for so long and yet there is no significant improvement in the level of foreign investment," said Malou Recente, director of the DoF.
The study recommended the Philippines adopt a phased transition away from tax holidays towards a limited combination of available incentives (tax credits, investment and training allowances, accelerated depreciation and extended loss carry-over). It also suggested replacing income tax holidays with a tax on gross income.
Both the IFC and the DoF have stated that performance-based incentives will promote competitiveness and at the same time ensure cost-efficiency and fiscal sustainability. More importantly they will generate additional revenue.
According to figures released by the DoF, the government has been losing more than $4.3bn a year in potential revenue due to the redundancy of financial incentives for investments.
Currently, there are a number of pending pieces of legislation that attempt to rationalise fiscal incentives.
One bill calls for the complete elimination of income tax holidays and suggests the BoI be relieved of its duty as the agency in charge of fiscal incentives while another would establish a uniform set of incentives for all investment promotion agencies and includes income tax holidays as one particular measure.
Finally, legislation endorsed by the Secretary of Finance Margarito B Teves proposes to abolish income tax holidays and replace them with a reduced income tax of 15% with accelerated depreciation, as well as duty exemptions on imported capital equipment, raw materials and source documents. If passed, all income tax holidays would be eliminated within a period of three years.
The issue of rationalised fiscal incentives has gained considerable momentum due to the IFC study. Potential investors, both foreign and domestic, should pay close attention, as the landscape of fiscal incentives is sure to undergo significant change.