Amsebastian Public Policy Analysis

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TABLEOFCONTENTS  INTRODUCTIONANDSTATEMENTOFPOLICYPROBLEM....................................................................1 Background.............................................................................................................................................................................1  Problem.....................................................................................................................................................................................5  Client..........................................................................................................................................................................................5  Beneficiaries............................................................................................................................................................................6  RoleofthePolicyAnalyst..................................................................................................................................................6  ORGANIZATIONANDPRESENTATIONOFDATA.......................................................................................8 TheRoleoftheNGOsintheMicrofinanceSector...................................................................................................8  ComputationofTaxes......................................................................................................................................................11  Stakeholders........................................................................................................................................................................12  FORMULATIONOFPOLICYALTERNATIVES.............................................................................................16 ExistingPolicyAlternatives...........................................................................................................................................16  EmergentPolicyAlternatives.......................................................................................................................................18  PRESENTATIONOFCRITERIAFOREVALUATINGTHEPOLICYOPTIONS..................................22 APPLICATIONOFCRITERIAANDPROJECTIONOFOUTCOMES......................................................24 RECOMMENDATION............................................................................................................................................39 WORKSCITED.........................................................................................................................................................42     INCOME TAX IMPOSITION ON NON-GOVERNMENT ORGANIZATIONS IN THE MICROFINANCE SECTOR  INTRODUCTIONANDSTATEMENTOFPOLICYPROBLEM BackgroundofthePolicyTask Silentoppositionagainstincometaximpositionhasbeenbrewingamongthe non-governmentorganizations(NGOs)engagedinmicrofinancesincetherulewas implementedin2007,butnobodyhasinitiatedcollectiveactiontodefine,articulate, andlobbythepositionoftheNGOs.WhilesomeNGOsarereligiouslymonitoredbythe localBureauofInternalRevenue(BIR)office,othersarepreparingfortheeventual auditoftheagency,whichtheyanticipatecouldhappenanytimesoon. TheMicrofinanceCouncilofthePhilippines(MCPI)nowtakesituponitselfas thenationalnetworkofmicrofinanceinstitutionstomakeastandonbehalfofits member-NGOs.Further,theauthoraskedoneofthekeysocialinvestorsontheburning issuesinthesectorandincometaximpositionwasthetopconcernidentified.Sincethe authorcloselyworkswiththeMCPIandthissocialinvestor,thepolicyanalysistaskisa goodvenuetoformallyassesstheoptionsoftheNGO-MFIsinrelationtothistaxissue.   AnOverviewoftheMicrofinanceSector TheNationalAnti-PovertyCommissionisthePhilippinegovernment’s implementingarmforthe“SocialReformandPovertyAlleviationAct”(RepublicAct 8425;seeAnnex1.),institutionalizingtheprocessesoftheSocialReformAgenda.Oneof itspriorityprogramsinalleviatingpovertyismicrofinance. Microfinanceisdefinedas“acreditandsavingsmobilizationprogram exclusivelyforthepoortoimprovetheassetbaseofhouseholdsandexpandtheaccess tosavingsofthepoor.Itinvolvestheuseofviablealternativecreditschemesand savingsprogramsincludingtheextensionofsmallloans,simplifiedloanapplication procedures,groupcharacterloans,collateral-freearrangements,alternativeloan repayments,minimumrequirementsforsavings,andsmalldenominatedsavers' instruments.”(Sec.3J) Theactsupportsmicrofinancethroughtheprovisionofcapacity-building programs,policiesthatpromoteexpansion,productdevelopmentandaccess,and  PublicPolicyAnalysis:IncomeTaxImpositiononNGO-MFIsPage 2  accesstofinancialservices.Organizationsinvolvedinmicrofinancemaybewholesalers (i.e.thosewholendtomicrofinanceinstitutions)andretailers(i.e.thosewhoextend financialservicesdirectlytopoorindividuals).Theretailersormicrofinanceinstitutions (MFIs)maybebanks—mostlyruralbanksandcooperativesbanks—cooperatives,and non-governmentorganizations(NGOs). BasedontheMIXMarketdata,theNGOsservedalmost67percentofthe country’smicrofinancebeneficiariesin2009.Theruralbankscovered32percentofthe totalnumberofmicrofinanceborrowersandtherestwerepartofthecooperative. Becauseofthedifferencesintheirnatureofownershipandoperations,different taxlawsgovernbanks,cooperatives,andNGOsthatareengagedinmicrofinance.While banksareunderthejurisdictionoftheBangkoSentralngPilipinasandthecooperatives undertheCooperativeDevelopmentAuthority,theNGOsareprettymuchleftontheir ownexceptfortheiraccreditationasdoneeinstitutions,whichisafunctionofthe PhilippineCouncilforNGOCertification,Inc.(PCNC).TheNGOsareregisteredinthe SecurityandExchangeCommissionasnot-for-profitcorporationsandassuchtheyare coveredbythetax-exemptionlawundertheTaxReformActof1997orRepublicActNo. 8424(TitleII,ChapterIV,Sec.30G;seeAnnex2.). In2003,theBIRissuedRevenueMemorandumCircularNo.76-2003(seeAnnex 3.),whichemphasizedthatalthoughnon-stock,non-profitcorporationsareexempt fromthepaymentoftaxonincomereceivedbythemassuchorganization,theyare however,subjecttothecorrespondingrevenuetaxesontheirincomederivedfrom“any oftheirproperties,realorpersonal,oranyactivityconductedforprofitregardlessof thedispositionthereof(i.e.rentalpaymentfromtheirbuilding/premises).”Thebureau reasonedinitsmemorandumthattheyhavehad“substantialrevenuelosses…duetothe non-implementationoftaxesduetonon-stock,non-profitcorporations….” In2007,theBIRissuedyetanothermemorandum,theRevenueRegulationsNo. 14-2007,whichaimedto“rationalizethetaxexemptionsoftheseentities[NGOs engagedinmicrofinance]basedonexistinglawsandregulationsandtherelevanttax treatmentoftheprofitsderivedinrelationtotheirdeliveryofmicrofinanceservices.” Specifically,theregulationstipulatesthat“incomeofsuchNGOsfrommicrofinance activities,andwhicharenotinrespectoftheirregisteredactivitiescoveredbySection 30oftheTaxCodeof1997,asamended,regardlessofthedispositionmadeofsuch income,shallbesubjecttotaxundertheTaxCodeof1997,asamended.”(SeeAnnex4.)  PublicPolicyAnalysis:IncomeTaxImpositiononNGO-MFIsPage 3  Thisappliedtaxmeant32percentonnetincome(Sec.27A)or2percentongross income(Sec.27E.1),whicheverishigher. ThistaxregulationontheNGO-MFIselicitednegativereactionfromthesector. TheNGO-MFIsbelievethat“thisrevenueregulationleavesmuchroomforBIR examinersinthefieldtointerpretormisinterprettheprovisionsunderthissectionand therefore,thereisaneedtoproposerevisionsoradditionstothisparticularsectionto clarifytheregulation.”(MicrofinanceCouncilofthePhilippines)Indeed,dependingon theBIRofficerassignedintheNGOs’areas,the32-percenttaxisappliedeitheronthe totalnetincomeoftheNGOoronitsotherincomesuchasrent.Thisinconsistencyin implementationhascreatedartificialcompetitiveadvantageamongsomeplayers,thus disruptingthemarketforcesorthelevelplayingfield. In2009alone,forexample,theBIRcouldhavecollectedincometaxfromthe19 NGO-MFIsregisteredundertheMIXMarketamountingtoPhp151.8million,thatis,if32 percentonnetincomewereapplied.Althoughtaxesareintendedto“redistribute” wealth,inpracticeandaswrittenalsoinliterature,hardlyaretaxesusedinthis manner.TheNGO-MFIsarguethatthisamountcouldhavebeenusedtoincreasethe loanportfolioextendedtothepoorasmicrocapital,insteadofgivingbacktothe government—somethingthatisagainsttheveryessenceofR.A.8425,whichsupports microfinancethroughpoliciesthatpromoteexpansion,amongothers.Inthegiven example,thePhp151.8millioncouldhavebeengivenasstart-upcapitaltosome30,365 poorhouseholds.Therefore,taximpositionwillcreateinefficiencyinamechanism aimedatredistributingwealthtothepoor. Further,someNGO-MFIssaidthattheyhavenochoicebuttopassonthetaxto themicroborrowerstokeeptheiroperationssustainable,makingthepoor’scostof capitalhigher.Inturn,suchanincreasewilllikewiseraisethehurdlerateorreturnon investmentrequiredofthemicroentrepreneurs(asitis,theinterestonmicroloansis alreadyhighatanaverageeffectiverateof50percentperannum).Basedonrational expectation,thesemicroentrepreneurswouldeitherpassonthecostofdoingbusiness totheend-consumersorwouldbesqueezedoutofthemarket(andresortto “pamamasukan”/informalemployment,whichisneitheralwaysavailablenoralwaysa betteroption).Inthissense,taximpositionmightleadtoeventualmarketdeadweight losses.  PublicPolicyAnalysis:IncomeTaxImpositiononNGO-MFIsPage 4  Still,someNGO-MFIshavebeenclamoringthattheybeexemptfromtheincome taxbecause1)theydonotoperatetogenerateprofitand2)theyaregovernment’s alliesinadvancingthesocialreformagenda(toputitbluntly,“theyaredoing government’sjob”). InternationalfundingagenciesthatnormallyprovideequitytotheNGOsinthe formofgrantssupporttheseNGO-MFIs’stand.AccordingtotheConsultativeGroupto AssistthePoorest(2002)orCGAP 1 ,thereasonforexemptionfromprofittaxisthe principlethattheNGOisrenderingarecognizedpublicbenefitanddoesnotdistribute itsnetsurplusesintothepocketsofprivateshareholdersorotherinsiders,butrather reinveststhemtofinancemoresociallybeneficialwork.(Although)Therearealways waystoevadethespiritofthisnon-distributionprinciple,suchasexcessive compensationandbelowmarketloanstoinsiders…thesepotentialabusesprobably occurnomorecommonlyinNGOsengagedinmicrolendingthaninothertypesof NGOs.(ConsultativeGrouptoAssistthePoorest)ItisaknownpracticethatsomeNGOs, notonlyinmicrofinance,arecreatedbyfor-profitorganizationsfortaxpurposes(astax shieldorfortaxdeductionand/orexemption).Thus,ifincometaxwillbeimposedon theNGO-MFIs,thenitshouldbeimposedaswellonallothertypesofNGOs. Frompolicyanalysisperspective,microfinanceserviceischaracterizedby rivalrousconsumption—thatis,themoneyborrowedbyoneclientcannotbeusedby another—andbyexcludableownership—thatis,serviceprovidershavefullcontroland ownershipoftheservices.Bythesevirtues,microfinanceserviceisaprivategood wheremarketforcesorcompetitionhasbeenworkingwellformorethantwodecades now.AccordingtoBardach(2005),“whenmarketsareworkingreasonablywell,itis hardforgovernmenttointervenewithoutcreatingimportantinefficienciesinthe economy,inefficiencieswhichwouldlikelymakethesumofprivatetroubleseven greaterthantheywerepreviously.”Thisispreciselythecaseoftheincometax impositiononNGO-MFIsbythegovernment.   1 CGAPismadeupof29internationaldonoragenciesthatsupportmicrofinance.  PublicPolicyAnalysis:IncomeTaxImpositiononNGO-MFIsPage 5  Problem TheincometaximpositionontheNGO-MFIsresultedinthefollowingarguments andissues:    Theinconsistencyinimplementationhascreated,orwillcreatesoonerorlater,an artificialcompetitiveadvantage,thusdisruptingthemarketforcesorthelevel playingfield.    Taximpositioncreatesinefficiencyinamechanismaimedatredistributingwealthto thepoor.    Taximpositioncouldleadtoeventualmarketdeadweightlosses,asmicro entrepreneursleavetheirenterprisesforpotentialemployment.    IfincometaxisimposedontheNGO-MFIsindiscriminately,thenitshouldbe imposedaswellonallothertypesofNGOs.  Client TheMicrofinanceCouncilofthePhilippines,Inc.(MCPI)istheonlynationalMF networkinthecountrycomposedof38MFIsand7supportorganizations.Itaimsto promotepovertyalleviationbysupportingtheMFIs’ethicalandinclusivefinancialand non-financialservices,andprovidecapacitybuildingprogramstoitsmember- organizations.Italsoaimstoachieveexcellenceingovernance,stewardship,andservice towardsstaff,clients,andcommunities.Assuch,MCPIwantstomakeastandonthetax issuebasedonrationalanalysis. TheMCPIpositsthatpayingtaxesisjustifiable,aslongasitwillnotmakethe microfinancemarketlessefficient.Infact,MCPIconsidersmakingtaxworkforthe sectorbyincentivizingthoseNGOsthatcatertotheverypoorclientsandtothosein hard-to-reachand/orhigh-riskareas.However,onelimitationofthispropositionisthat notallNGOsdeterminethepovertystatusoftheirclientsorhavethe capacity/technologytodoso. 2    2 In2004,apilotstudyshowsthatsomeNGOs’non-poorclientsuponentryintotheprogramcomprisedabout40 percentto70percentoftheirtotalnumberofnewclients.  PublicPolicyAnalysis:IncomeTaxImpositiononNGO-MFIsPage 6  Beneficiaries AlthoughtheNGO-MFIsareboundtobenefitfromthepolicyresolutionthatthis paperaimstocontribute,theprojectedsocialbenefitwillspillovertothemicrofinance clients—thepoorFilipinohouseholdsingeneral.  RoleofthePolicyAnalyst Theauthor/analystwouldassumetheroleofanobjectivetechniciantothe client,astheclientspecifiesthatitwantsanobjectiveanalysisofthetaxissue.Sincethe issueandthemicrofinancesectorarehighlypolitical,itisbesttouseanalysisand rationalthinkinginestablishingthelegitimacyoftheoutput.Besides,althoughtheissue hasbeenoutsince2007withthepassingofBIRregulation,nobodyhasdonefinancial andsocio-politicalanalysisoftheorder.Further,theclientspecificallyrequeststhata thorough,objectiveanalysisbedone,asitintendstoincorporateitinitspresentationin thesectoralconsultation. Further,boththeMCPIanditsend-client,theNGO-MFIs,whoseinterestthe MCPIwouldliketoprotect,havenoclearpositionyetonthematter—onlythattaxation shouldnotworsenanyinefficiencyinthesector—thustheanalystcouldnotbeaclient’s advocate.Neithercouldtheanalystbeanissueadvocate,asnoambiguityandexcluded valuescouldbeemphasizedwhenanalysisdoesnotsupportadvocacy.   PublicPolicyAnalysis:IncomeTaxImpositiononNGO-MFIsPage 7              Source:WeimerandVining(1999).PolicyAnalysis:ConceptsandPractice(42)  PublicPolicyAnalysis:IncomeTaxImpositiononNGO-MFIsPage 8  ORGANIZATIONANDPRESENTATIONOFDATA TheRoleoftheNGOsintheMicrofinanceSector TheGrameenmethodoflending,whichoriginatedfromtheGrameenBankof Bangladesh,wasfirstreplicatedinthePhilippinesin1989.Smallloans—whichranged fromPhp3,000toPhp150,000—withoutcollateral,wereextendedtomicro entrepreneurs,whoformedagroupoffivemembersbeforequalifyingforaloan.Three NGOswerethefirstreplicatorsofthisgrouplendingmethod—thismarkedthebirthof microfinanceinthePhilippines.Eventually,individuallending,ormorepopularly knownasASA,whichalsooriginatedfromBangladesh,wasadoptedinthecountry. However,thecooperativesarguethattheyfirstdidmicrofinance,perhapsas earlyasthe1920s,whenruralcreditcooperativeswereformedinsupportofthe agriculturalsector.Therewerealsogovernment-ledlendingprogramsinthe1970s untilmid-1980stargetedattheagriculturalworkers.Inthelate1990s,ruralbanks startedjoiningthemicrofinancebandwagon.WhattheNGO-MFIscouldhaveprobably contributedtothelendingsystemwasintroductionofmicrolendingmethodologiesas wellastheawarenessofthewholenew,viablemarketofmicroentrepreneursthatcut acrossvarioussectors,asthepastinitiativesfocusedonlyonthefarmers,fisherfolks, andotherworkersintheagriculturesector. Ofthe30,000registeredNGOsin2006,around300offeredsomeformofmicro lendingservice;onlyapproximately30NGOshavesizeableoperationsinmicrofinance. The25NGOmembersoftheMCPIservedatotalof867,582activemicrofinance borrowers,whichwas70percentofallactiveborrowerscoveredbytheNGOsin2006. (MicrofinanceCouncilofthePhilippines) Despitetheentryofbanksintothemicrofinancemarket,NGO-MFIsareexpected toplayavitalroleinthedeliveryoffinancialservicestothebasicsector,particularlyin ruralareas,becauseoftheircomparativeadvantageoverbanks.(Lamberte)  Basedontheavailable2009data(TheMicrofinanceInformationExchange),the NGOsareabletoreachthepoorbetterthanotherentities.OnaverageanNGOserves 77,000clientswhileabankhasonaverageonly23,000clients;thesolesample cooperativehas18,500clients. TheNGOsarealsomoreefficientintheuseoftheirassetsinservingthepoor.On averageanNGOinvestsonlyUS$203inassetperclientwhileabanktakesUS$1,233  PublicPolicyAnalysis:IncomeTaxImpositiononNGO-MFIsPage 9  worthofassettodothesame.TheaveragecostperborrowerofanNGOisUS$70,while abank’sisUS$118. However,therearesomeareasthattheNGOsproveinefficientormakeone wonderiftheNGOsareusingitsfundsproperly.SomeNGOsinvestsheavilyoncapital suchthattheNGOs’capitaltoassetratioaverages27percent,comparedtothebanks’ 17percentaverage.Thebankwiththehighestcapital-assetratioregistered44percent, whichisstilllowerthanthreeNGOswithratiofrom49percentto61percent. SomeNGOsindicateunder-utilityoffunds,thatis,theyputtheirmoneyin investmentsinsteadofbuildingtheirloanportfolio.TheNGOs’proportionofloan portfoliotoassetrangesfromahighof88percenttoalowof52percent.Thesefigures combinedwiththeircapitalwouldmeanthattheirallocationforotherassets(i.e.cash, short-terminvestments,andotherreceivables)wouldbebetween2percentand30 percent.AlthoughthereisnoruleastohowmuchofitsassetsshouldanNGO-MFI allocatetoitsloanportfolio,mission-wiseitshouldputmostofitsassetsinoperations orservices;otherwise,itwouldbenodifferentfromthebanks,lendinginvestors,and othernon-bankfinancialinstitutions.Noteworthyalsothat11outofthe20reporting NGOsintheMIXMarkethaveerroneousdata,thatis,thesumoftheircapitalandloan portfolioexceedstheirtotalassets. Further,itseemsthattheNGOsaremakingmoneymorethanthebanksdo.The NGOs’averageyieldonportfolioisanominalannualrateof47percent,whilethebanks’ averageis31percent.ThenetincomeoverfinancialrevenueofNGOsisalmost26 percentonaveragewhilethebanks’isonly18percent.OnenowwouldaskiftheNGOs are“overpricing”oriftheyaresimplymoreefficientthanthebanks,orboth.This, combinedwiththeNGOs’levelofassetsaveragingoverUS$12million—someNGOsare evenbiggerthansomebanks,whoseaverageassetsamountedtoalmost US$16million—makestheNGO-MFIspotentialsourcesofgovernmentrevenues. Forcompletedata,seeTable1onnextpage.    PublicPolicyAnalysis:IncomeTaxImpositiononNGO-MFIsPage 10   PublicPolicyAnalysis:IncomeTaxImpositiononNGO-MFIsPage 11  ComputationofTaxes ManyNGO-MFIs,inpractice,separatetheirfinancialincomesfromother incomeswhenreportingtheirfinancialconditions,thus:  FinancialRevenuesPhpXX,XXX.XX Less:FinancialExpensesXXX.XX FinancialIncomeXXX.XX Add:OtherIncomeXXX.XX GrossIncome (currenttaxbase*) X,XXX.XX Less:OtherexpensesXXX.XX NetIncome(BeforeTax) (currenttaxbase*) XXX.XX Less:TaxXXX.XX NetIncomeAfterTaxXX.XX *subjecttotheinterpretationofthelocalBIRofficial  TheTaxReformActof1997sections31and32(Annex5.,however,presents generaldefinitionsofsomefinancialtermsasfollows: SEC.31.TaxableIncomeDefined.Thetermtaxableincomemeansthepertinent itemsofgrossincomespecifiedinthisCode,lessthedeductionsand/orpersonaland additionalexemptions,ifany,authorizedforsuchtypesofincomebythisCodeorother speciallaws. SEC.32.GrossIncome. (A)GeneralDefinition.ExceptwhenotherwiseprovidedinthisTitle,gross incomemeansallincomederivedfromwhateversource,including(butnotlimitedto) thefollowingitems: (1)Compensationforservicesinwhateverformpaid,including,butnotlimited tofees,salaries,wages,commissions,andsimilaritems; (2)Grossincomederivedfromtheconductoftradeorbusinessortheexercise ofaprofession; (3)Gainsderivedfromdealingsinproperty; (4)Interests; (5)Rents; (6)Royalties;  PublicPolicyAnalysis:IncomeTaxImpositiononNGO-MFIsPage 12  (7)Dividends; (8)Annuities; (9)Prizesandwinnings; (10)Pensions;and (11)Partner'sdistributivesharefromthenetincomeofthegeneralprofessional partnership. BIRRevenueMemorandumCircularNo.76-2003emphasizedtheneedtocollect taxesthatareappliedontheotherincomeoftheNGO-MFIs,whichmayincludebutis notlimitedtorent,saleofassets,andofferingofproductsandservicesnotdirectly relatedtotheoperationofmicrofinance. InconsonancewiththiscircularistheBIRRevenueRegulationsNo.14-2007, stipulatingthat“incomeofsuchNGOsfrommicrofinanceactivities,andwhicharenotin respectoftheirregisteredactivitiescoveredbySection30oftheTaxCodeof1997” shallbesubjecttotaxequivalentto32percentofnetincomebeforetax(orsimply referredtoas“netincome”fromhenceforth)or2percentofgrossincome,whicheveris higher.  Stakeholders Inthispolicyanalysis,fourkeystakeholdersareconsidered:theBIR,theNGO- MFIs,thedonorsandsocialinvestors,andthemicrofinancebeneficiaries. The BIR ismandatedbylawtoassessandcollectallnationalinternalrevenue taxes,feesandcharges,andtoenforceallforfeitures,penaltiesandfinesconnected therewith,includingtheexecutionofjudgmentsinallcasesdecidedinitsfavorbythe CourtofTaxAppealsandtheordinarycourts(Sec.2oftheNationalInternalRevenue Codeof1997;seeAnnex6.).Itsmissionisto“collectinternalrevenuetaxesforthe government.”(BureauofInternalRevenue) InissuingRevenueRegulationsNo.14-2007,theBIRcouldverywellbereferring totheincomesgeneratedbytheNGOsthatarenotdirectlyconnectedwiththemicro- creditandmicro-savings,asthesetwoservicesaretheonlyonesincludedinthelegal definitionofmicrofinancestatedintheSocialReformandPovertyAlleviationActor R.A.8425,Section3.Theseincomesourcesmayincludemicro-insurance.Sinceits natureisalsofinancial(asopposedtotradingofgoodsorprovisionofhumanresource- basedservices),thisincometypeisincorporatedinthe“FinancialRevenue”item.Since  PublicPolicyAnalysis:IncomeTaxImpositiononNGO-MFIsPage 13  thereisnosegregrationoffinancialincometypes,theBIRlosesrevenuetaxesfrom,in thisexample,micro-insurance.Otherfinancialbutnon-microfinance-relatedrevenues areincomefromforeignexchangeandinterestsearnedfrominvestmentinstruments. AnothersourceofincomeoftheNGO-MFIsistradingofgoodseitheraspartof businessdevelopmentoftheirclientsoraspartofprovidingbasicservicestothe communities(e.g.watersupply,solar-poweredlighting).Anotherisprvidingservicesin theformofconsultingandtrainingprograms.Theseitemsfallunderthe“OtherIncome” butunlikeother“otherincome”,suchasgainsfromthesalefromassetsthatcanbe easilymonitoredbytheBIRthroughthelegalproceedingsinvolved,theseitemscannot beeasilykepttrackthustheBIRstandstoloserevenuetaxesonthesenon-microfinance activities. BasedontheMIXMarketdatain2009,thereportingNGO-MFIs’netincomeis estimatedusingtwoapproaches(exactnetincomefiguresarenotpublished).Oneisby derivingfinancialrevenues,financialexpenses,andoperatingexpensesfromthedata providedandcomputingforthenetincomeusingtheformulaintheprevioussection. Twoisbymultiplyingthegivenreturnonassetrates(whichistheratioofnetincometo totalassets)bythegiventotalassetstogetthenetincomefigures.Comparingthenet incomefiguresderivedfromthesetwoapproaches,thedifferenceismostlikelythe “otherincome”generatedbytheNGO-MFIs.ExceptfromoneNGO(Kasagana-Ka)that hadnodifferenceinthecomputedincomefigures,theresthavetoobigagap—overa milliondollarsforthreeNGOs—tobeattributedtomathematicaldiscrepanciesor errors.(SeeTable2onnextpage.) Basedonthesetwoarguments,theBIR’stighteningupofitsregulationsisthus justified.However,ithasgoneamissontwoaccounts:1)itcameoutwiththe memorandumwithoutpriorconsultationwiththeNGO-MFIs;and2)afteritsissuance, therewasnocommunicationastohowthetaxationwouldbeimplemented.Worse,the revenuedistrictofficeshavevaryinginterpretationsoftheregulation,determiningtax chargesindifferentways,thuselicitingnegativereactionsfromtheNGOs.  PublicPolicyAnalysis:IncomeTaxImpositiononNGO-MFIsPage 14        PublicPolicyAnalysis:IncomeTaxImpositiononNGO-MFIsPage 15  The NGO-MFIs ,ontheirpart,sharedifferentsentiments.Somebelievethatitis onlybutrighttopaytaxestogovernment.Besides,theyopinethattaxwouldforcethe NGOstobeefficient—thatis,tobemoreconsciousoftheirexpendituresandcapital investments—andthus,beascompetitiveasthemicrofinance-orientedbanks.Further, taxingtheNGOswoulddiscouragefor-profitorganizationsfromestablishingNGOsto avoidpayingtaxes. Ontheotherhand,otherswanttax-exemptionbythevirtueoftheirbeingNGOs. Astheyaresupportingthegovernmentinitspovertyalleviationprogramandarethe mosteffectiveinreachingthegrassroots,taxingthemwouldonlyhampertheirwork. Thetaxmoneycouldbeusedintheirmicrofinanceoperations,asawayof redistribution;andtaxesinthehandsofthegovernmentarenotnecessarilyspentthat wayalthoughredistributionisoneofthemainintentionsofthetaxsystem.Finally, shouldtheNGOspassonthetaxestothemicrofinanceclients,thecostsofservices wouldincreaseandthusmaydiscouragetheclientsfromborrowing(andtherefore defeatingtheverypurposeofthemicrofinanceprogram). Theinterestsofthe socialinvestorsanddonors areconsideredaswellinthis analysisastheyaretheoneswhousuallyfinancetheoperationsoftheseNGOseitherin theformofgrantsthatgointotheNGOsfundbalanceorsubsidiesandsoftloansthatgo theiroperations.TheSection101oftheTaxReformActof1997exemptsthese donations,regardlesswhetherfromdomesticorforeignsources,thatareintendedto effectsocialbenefit(Annex7.).TaxingtheNGOsthereforeisineffecttaxingthefunds fromthesestakeholders’groupthatareintendedtocreatesocialbenefits.Ontheflip side,someNGOsincludegrantsanddonationsintheirfinancialrevenuestoimprove theirsustainabilityfigures—inshort,theyusethesetax-freefundsforwindow- dressing. Finally,theultimatestakeholdersinthisissuearethe microfinanceclients , becausetheyareboundtobeaffectedeitherpositivelyornegativelybytaxpolicies. Theycouldbecompelledtopaytheaddedcostoftaxes;worse,theycouldnotbeserved atallbytheNGOs,asoperatingintheirareasmayproveunviablewiththeplus-taxcost structure.     PublicPolicyAnalysis:IncomeTaxImpositiononNGO-MFIsPage 16  FORMULATIONOFPOLICYALTERNATIVES ExistingPolicyAlternatives Followingarethealternativesthathavebeensupportedbyvariousparties.   Alternative1:Statusquo TheNGO-MFIsincountriessuchasTajikistan,Kenya,andTanzaniaaretaxedlike anyothercorporations,thusthismodelmaybeusedinthePhilippinecase.   FinancialRevenuesPhpXX,XXX.XX Less:FinancialExpensesXXX.XX FinancialIncomeXXX.XX Add:OtherIncomeXXX.XX GrossIncome (currenttaxbaseat2%tax*) X,XXX.XX Less:OtherexpensesXXX.XX NetIncome (currenttaxbaseat35%tax*) XXX.XX Less:TaxXXX.XX NetIncomeAfterTaxXX.XX *subjecttodiscretionofthelocalBIRofficial   Alternative2:Applyincometaxof5percentongrossincomefrommicrofinance transactionsoftheNGO-MFIs TheMCPIcraftedthisproposalin2008.Inadditiontothisprovision,itproposed that“NGOsengagedinmicrofinanceactivitieswithequityorfundbalancededicatedto microfinanceoperationsexceedingPhp10millionshallbeclassifiedasnon-bank financialinstitutionsandshallbesubjecttopaymentoftaxonfinancialtransactions equalto5percentofgrossincomeorinterestearnedonmicrofinancetransactions. SuchNGOsshallbeexemptfrompaymentofvalueaddedtaxanddocumentarystamp taxonmicrofinancetransactions.”(MicrofinanceCouncilofthePhilippines,Inc.)  FinancialRevenuesPhpXX,XXX.XX Less:FinancialExpensesXXX.XX FinancialIncome (proposedtaxbaseat5%tax) XXX.XX  PublicPolicyAnalysis:IncomeTaxImpositiononNGO-MFIsPage 17  Add:OtherIncomeXXX.XX GrossIncomeX,XXX.XX Less:OtherexpensesXXX.XX NetIncome(BeforeTax)  XXX.XX Less:TaxXXX.XX NetIncomeAfterTaxXX.XX   Alternative3:CreateofMicroEnterpriseDevelopmentInstitution(MEDI) SuchhasbeenproposedintheSenateBill2596of2008AnActGoverningthe CreationandAccreditationofMicroEnterpriseDevelopmentInstitutions.(SeeAnnex8.) Underthebill,acapitalrequirementofnotlessthanPhp50millionshallbeimposedon MEDIs;inturn,theseorganizationsshallbeexemptedfromtaxes,localandnational, includingthedocumentarystamptax.However,2percentofthegrossincomederived bytheMEDIsshallberemittedtotheNationalGovernmentascontributiontothe People’sDevelopmentTrustFund(establishedunderR.A.No.8425). Thebillclarifiesthattheterm“grossincome”meansgrossreceiptslesssales returns,allowances,discountsandothercostsofservices.Further,itstipulatesthat interestexpensesofaMEDIshallbedeductiblefromgrossreceiptsaspartofcostof servicesinarrivingatgrossincome.Thetermgrossincomeshallexcludedonations. FinancialRevenuesPhpXX,XXX.XX Less:FinancialExpensesXXX.XX FinancialIncomeXXX.XX Add:OtherIncomeXXX.XX GrossIncome* (proposedtaxbaseat2%) X,XXX.XX Less:OtherexpensesXXX.XX NetIncome(BeforeTax)  XXX.XX Less:TaxXXX.XX NetIncomeAfterTaxXX.XX *netofsalesreturns,allowances,discountsandothercostsofservicesincludinginterestexpenses  paid  However,thereisnomentionofpolicythatwouldgovernthoseNGOswithless thanPhp50millioncapitalization,thusimplyingstatusquoforthesmallerplayers.  PublicPolicyAnalysis:IncomeTaxImpositiononNGO-MFIsPage 18  AttheforefrontofthelobbyingofthisbillisTSPIDevelopmentCorporation,an NGO-MFI.ManyotherNGOsdonotsupportthebill,however,forthereasonthatthey werenotconsultedinthewritingofthebill.  EmergentPolicyAlternatives Thesearethepossiblepolicysolutionsthataredrawnfromtheproblemanalysis aswellasfromthepracticesofourcountries.   Alternative4:Imposetaxonnetincomefromnon-MFsource Favorabletransactiontaxtreatmentshouldbebasedonthetypeofactivityor transaction,regardlessofthenatureoftheinstitutionandwhetheritisprudentially licensed.(ConsultativeGrouptoAssistthePoorest)Followingthisprincipleexpressed bytheCGAP,taxshallbeappliedonlyonNGO-MFIs’incomegeneratedfromnon- microfinanceactivitiessuchassaleofassets,rentincome,non-clienttrainingservices, amongotherswhileincomefrommicrofinanceoperationsshallbetax-exempt. ThispolicyshallentailtheNGOs’restructuringtheirfinancialreportingsuchthat thesourcesofrevenuesshallbesegregatedandreportedindetails. FinancialRevenuesfromMicrofinancePhpXX,XXX.XX Less:FinancialExpensesfromMicrofinanceXXX.XX MicrofinanceIncomeXXX.XX Add:OtherRevenues MicroinsuranceXXX.XX TradingofgoodsXXX.XX IncomegeneratingservicesXXX.XX TotalotherrevenuesXXX.XX Less:Costofgoods/serviceXXX.XX Add:Netotherincome (proposedtaxbaseat32%) XXX.XX TotalincomefrommicrofinanceandothersourcesX,XXX.XX Less:OtheroperatingexpensesXXX.XX NetIncome(BeforeTax)XXX.XX Less:TaxXXX.XX NetIncomeAfterTaxXX.XX  PublicPolicyAnalysis:IncomeTaxImpositiononNGO-MFIsPage 19  Ataxrateof32percentshallbeappliedonnetotherincome,followingthe provisionsofthecorporatetaxlaw. Onepointofcontentionthatmayberaisedagainstthisalternativeisthe inclusionofmicroinsuranceandotherservicesthatprovidedirectbenefitstothe microfinanceclientstothetaxableincomesource.Technically,suchservicesarenot includedinthedefinitionofmicrofinanceinR.A.8425Sec.3J(seealsopage2)butarein factfinancialservicesatmicrolevel.Thus,alongsidethisproposal,amendmentofthe R.A.8425,whichwasenactedin1997,mustbeproposedtoincludeotherappropriate productsthatcamelaterinthemarketinthedefinitionofmicrofinance.Micro insurance,forexample,wasintroducedinthemarketin2001. Shouldthisbeapproved,thentheaccountingsystemsoftheNGO-MFIsmustbe adjusted/re-programmedtosegregatethe“OtherRevenue”itemsfromthe“Financial Revenues”.   Alternative5:ExemptNGO-MFIsfromincometaxaslongastheyapplyfor exemptionandmeettherequiredperformancestandards ThisproposalfollowsthepremisethattheNGOsareeffectiveinreachingthe grassrootsandefficientintheuseofassets. TheperformancestandardsthatwillqualifytheNGOsfortaxexemptionmaybe thefollowing(basedontheMIXMarketdata),butsubjecttorefinementsandapproval oftheNGOsuponconsultationwiththem:    assetperclient:US$150orPhp6,600    loanportfolio-assetratio:atleast69percent    operatingoradministrativeexpenses:notmorethan36percentoftheloan portfolio(ornotmorethan20percentbasedonthePESOstandard) 3     percentageofpoorclients(uponentry)tototalnewclients:80percent ShouldanNGOfailtomeetanyoneoftheseperformancestandards,itwillbe subjecttotaxof2percentongrossincome.    3 BasedonthesetofperformancestandardsforalltypesofmicrofinanceinstitutionsbytheTechnical WorkingGroupthatwasconvenedbytheNationalCreditCouncilcalledtheP.E.S.OStandard.The acronymstandsforPortfolioquality,Efficiency,Sustainability,andOutreach.  PublicPolicyAnalysis:IncomeTaxImpositiononNGO-MFIsPage 20  FinancialRevenuesPhpXX,XXX.XX Less:FinancialExpensesXXX.XX FinancialIncomeXXX.XX Add:OtherIncomeXXX.XX GrossIncome (proposedtaxbaseat2%) X,XXX.XX Less:OtherexpensesXXX.XX NetIncome(BeforeTax)  XXX.XX Less:TaxXXX.XX NetIncomeAfterTaxXX.XX  ThisproposalisarefinementofHouseBill6016thatwaspassedinMarch2009. Thebillproposedtaxreliefonthe“qualifiedNGOs”,as“asincentivefortheirsupportto thegovernment  ’ spovertyalleviationefforts”.ItexemptstheNGOsfrompaymentof valueaddedtax,incometax,otherpercentagetaxesandgrossreceiptstaxes,and likewisemandatedtheBIRtoissuetaxexemptioncertificatestoNGO-MFIsduly screened,evaluatedandapprovedforsuchbytheDOF(noelaborationthoughonthe qualificationforexemption).(Macabeo) AsinIndia,theNGO-MFIsaretax-exemptonlyiftheyapplyforit,whichwould requirethemtosubjectthemselvestogovernmentmonitoring. Shouldthisalternativebeapproved,monitoringoftheperformancestandardsof theNGO-MFIswillbeanissue.Offhand,eitherBIRcarriesthecostofmonitoringorthe PhilippineCouncilforNGOCertification,Inc.(PCNC)does. PCNCisanon-stock,non-profitcorporation,whichwasestablishedin1998by severalNGOnetworks(e.g.,CaucusofDevelopmentNGONetworks(CODE-NGO), PhilippineBusinessforSocialProgress(PBSP),AssociationofFoundations(AF),League ofCorporateFoundations(LCF),Bishops-Businessmen'sConferenceforHuman Development(BBC),andtheNationalCouncilforSocialDevelopmentFoundation (NCSD).IthasbeendulydesignatedbytheSecretaryofFinanceasan“Accrediting Entity”toestablishandoperationalizeasystemtodeterminethequalificationofnon- stock,non-profitcorporationsororganizationsandNGOsforaccreditationasdonee institutions.TheSecretaryofFinanceandtheCommissionerofInternalRevenue oversee,monitor,andcoordinatewithPCNCtoensurethattheprovisionsofthese  PublicPolicyAnalysis:IncomeTaxImpositiononNGO-MFIsPage 21  Regulationsarecompliedwith.(BIRRevenueRegulationsNo.13-98Sec.1d;seeAnnex 9.) SincetheaccreditationoftheNGOsfortaxpurposehasbeenPCNC’smain responsibility,thentheaccreditationoftheNGO-MFIsforthesimilarpurposecouldbe logicallyassumedinthisoffice.    PublicPolicyAnalysis:IncomeTaxImpositiononNGO-MFIsPage 22  PRESENTATIONOFCRITERIAFOREVALUATINGTHEPOLICY OPTIONS Theclient,MCPI,highlightedthefollowingcriteriaintheevaluationofthe alternatives:    ThatnoNGOwillbeexcluded,discriminatedagainst,orfavoredbythepolicy (equity);    ThatnoNGOwillbeusedasaformoftax-exemptbyfor-profitinstitutions(equity);    ThattheNGOswillnotbediscouragedfromexpandingtheiroperations(efficiency);    ThattheNGOswillbeencouragedtooperateefficiently(efficiency);and    Totaltaxexemptionisnotanoption(politicalacceptability). Inaddition,thefollowingcriteriaareaddedbasedontheinterestsofother stakeholders:    ThatnoindividualshallprofitfromtheNGO(efficiency);    ThatclosemonitoringofNGOs,thoughideal,isnotsubsumedunderanyregulatory bodythusthealternativemustbepracticalandeasilyimplemented (practicality/easeofimplementation). Thefollowingcriteriawillbeappliedinevaluatingtheoutcomesofthepolicy alternatives,basedontheinterestsofthekeystakeholders:  Equityandfairness. Thealternativemusttakeintoaccountthelevel-playingfieldin themicrofinancemarketaswellastheprinciplethatthe NGOs are“renderinga recognizedpublicbenefitanddoesnotdistributeitsnetsurplusesintothepocketsof privateshareholdersorotherinsiders,butratherreinveststhemtofinancemore sociallybeneficialwork.”(CGAP)Itmustnotexclude,penalize,orprejudiceanyNGO. Thealternativemustalsoprotecttheinterestofthe BIR suchthatitwillnot encouragefor-profitorganizationstoestablishoruseanNGOforitstaxmanagement. Likewise,thealternativemustmaximizetheuseoftheNGOs’fundbalanceor donors’ contributioninservingthepoor. Finally,thealternativemustnotdiscouragetheNGOsfromservingasmany poor  aspossible.   PublicPolicyAnalysis:IncomeTaxImpositiononNGO-MFIsPage 23  Efficiency. Thiscriterionmeansoptimizationoftheuseofresources.Specifically,the alternativeshouldencouragethe NGOs tomaximizetheproductivityoftheirresources andtobeprudentwiththeirspendingand/orinvestmentsintermsofsocialbenefits theycreate,andnotintermsofprofittotheorganizationsorindividuals.Sincepartof theirfundscomesfromthe donors ,thesedonorswouldalsobeinterestedinthe prudentexpenditureoftheNGOsasaresultofthepolicysolution. Thiscriterion,in BIR ’sperspective,meansefficiencyincollection,whileforthe poor ,efficiencyofthealternativemeansreachingtoasmanyofthemandservingas manyoftheirneedsaspossible.  Politicalacceptability. Thealternativemustbeacceptabletoboththe NGOs andthe BIR .Thedonorsandthepoor,althoughtheyarekeystakeholders,playaremotepartin thepoliticalunderpinningsofthemicrofinancesectoranddonothavedirect involvementinthebackroomoperationsortransactionsoftheNGOs.  Practicalityandeaseofimplementation. Thealternativemustbeeasilyappliedand implemented,notsubjecttomanyinterpretations,andmustnotbeanadministrative burdentoanyorganization;otherwise,thealternative,ifapproved,willnotbe implementedcorrectlyand/orwillberesistedbythepartiesinvolved.  Basedonconsultationwithclient,equityisitstoppriority,followedby efficiency,thenpoliticalacceptability.Thusthecriteriawillbegivenweightsasfollows: Equityandfairness–40% Efficiency–30% Politicalacceptability–20% Practicalityandeaseofimplementation–10% Eachalternativewillbegivenaratingpercriterionthus: 1-Poor 2-Neutralormixedeffect 3-Generallyacceptable 4-Good   PublicPolicyAnalysis:IncomeTaxImpositiononNGO-MFIsPage 24  APPLICATIONOFCRITERIAANDPROJECTIONOFOUTCOMES SeveralbigMFplayers,includingtheMCPI,haveopposedAlternative3(2%tax appliedongrossincomeofMEDIs,aclassificationofNGOswithafundbalanceofat leastPhp50million)becauseitwasdraftedwithoutconsultationwithotherNGOs.Even ifitprovedrationalandoptimal,theexistingperceptionthatitfavorsthebigNGOs, includingitsproponent,hinderstheacceptabilityofthealternativetotheentiresector. Hence,thisalternativeistakenoutfromthelistforevaluation. Onlyfourimplementablepolicyoptionsremain:    Alternative1:Statusquo    Alternative2:Applyincometaxof5percentongrossincomefrom microfinancetransactionsoftheNGO-MFIs    Alternative4:Imposetaxonnetincomefromnon-MFsource    Alternative5:ExemptNGO-MFIsfromincometaxaslongastheyapplyfor exemptionandmeettherequiredperformancestandards   Alternative1:Statusquo  Equityandfairness. Underthestatusquo,noNGOisdiscriminatedagainst,excluded, orpenalized,astaxisappliedtoallNGOs(althoughitsimplementationisinconsistent) andthus,noNGOcouldbeusedas“taxshield”byfor-profitorganization. However,donors’money,whichisnormallypartoftheNGOs’fundbalanceand issupposedlytax-exempt,istaxedbythevirtueofthispolicy.Further,taxlimitsthe outreachoftheNGOsinthatthefundthatcouldbeusedfortheirmicrofinance operationsisremittedtogovernmentinstead.In2009,forexample,assuming35 percenttaxisappliedtoall20NGOsinthesample(seeEstimatedIncomesonTable2 onpage11),governmentwouldhavecollectedbetweenPhp103millionandPhp191 million(IFthepolicywereconsistentlyandefficientlyimplemented),whichcouldbe easilytranslatedtomicroloansextendedtopoorclientsofbetween20,500and38,000. EitherthisscenariooccursortheNGOspassonthetaxestotheborrowers,thus increasingthepoor’scostofborrowing.SincePhp191millionisroughly4percentof theaverageyieldoftheNGO-MFIsin2009,thenthismovemightresulttotheir increasinginterestby4percentagepoints(ora10percentincreasefromtheaverage  PublicPolicyAnalysis:IncomeTaxImpositiononNGO-MFIsPage 25  yieldonportfolioof47percent).Shouldthishappen,thepoorwouldeitherpassonthe highercosttotheirend-customers/buyersortotallydropoutofthemicrofinance programtoseekothersourcesofincome(contractedlabor,forexample).Bothways, deadweightlossesintheeconomywouldbecreated. Belowisthepriceelasticitycomputation:               Theaveragepriceelasticityofthe12NGO-MFIswithcompleteMixmarketdatais -7.039,whichmeansthatforevery1percentincreaseininterest(e.g.1percentof50 percentinterestmeans0.5percentincrease)anNGOwouldlose7clients.Worstcase, anNGOmaylose128clients.Supposethese12NGOsincreasetheirinterestratesby4 percentagepointsor10percentoftheaverageinterest,thencollectivelytheymight losebetween840clients(assuminganelasticityof-7.039)and15,360clients (assumingtheworstelasticityof-128.36).  Efficiency. ThepressurethattaxationexertsoftheNGOs’financialsislikelyto encouragethemtoruntheiroperationsmoreefficiently.Thisefficiency,ifattained, enablestheNGOstoreachtomorepoorpeople;however,ifNGOsfailtodoso,theyare likelytolimittheiroperations. Experienceshowsthatcollectionisinefficientinthestatusquoduetothe differinginterpretationofthepolicybytheBIRofficials.Besides,applyingtaxonnet  PublicPolicyAnalysis:IncomeTaxImpositiononNGO-MFIsPage 26  incomewillencouragetheNGOstospendinordertoincreaseitsoperatingexpenses andtherebydecreasingitstaxablenetincome.ThisisarationaloptionfortheNGOs,for reasonthatitwouldbebetteroffspendingthemoneyfortheorganization(e.g. declaringbonuses,joiningtrainingprograms,traveling)thanpayingitoutintheformof tax—somethingthatdoesnotsupporttheboththeBIR’sandthedonors’interests.  Politicalacceptability. Thestatusquo,initiatedbytheBIR,iscertainlynotacceptable totheNGOs.  Practicality/easeofimplementation. OntheNGOs’part,noadjustmentsintheir systemsorreportingarerequired.OnBIR’send,however,theinconsistencyinits implementationisanindicationofthestatusquo’simpracticality.  Basedontheratingandcriteriaforevaluation,thisalternativeisgivenascoreof 7.9 .                    PublicPolicyAnalysis:IncomeTaxImpositiononNGO-MFIsPage 27                    PublicPolicyAnalysis:IncomeTaxImpositiononNGO-MFIsPage 28    Alternative2:Applyincometaxof5percentongrossincomefrommicrofinance transactionsoftheNGO-MFIs   Equityandfairness. TheproposedpolicyprotectsthesmallerNGOswithcapitalization ofnotmorethanPhp10million.AlthoughsomeNGOsarguethatthestart-upsneed someleewaybeforetheygetestablishedintheiroperations,otherscouldabusethis provisionbycreatingseveralsmallNGOstoavoidtaxes.However,thedonorswould tendtofavorthisalternativeinthatmostoftheirinterestwouldbeprotected. Similartoalternative1,thisproposedtaxpolicylimitstheoutreachoftheNGOs inthatthefundthatcouldbeusedfortheirmicrofinanceoperationsisremittedto governmentinstead.Asanexample,assumingthisisappliedin2009,(seeEstimated FinancialIncome[equivalenttogrossincome]onTable2onpage11),government wouldhavecollectedPhp169million,whichcouldbetranslatedtoalmost34,000micro loans. Similartoalternative1still,theNGOscouldpassonthetaxestotheborrowers, whichwouldcreatedeadweightlossesintheeconomy.Theissueonelasticityin Alternative1alsoappliesinthiscase.  Efficiency. Thisalternativewouldlikelyhavemixedresultsintermsofpromoting efficiencyamongtheNGOs.Thosewhowillbetaxedwilltendtobemoreconsciousof managingtheirresourcesbutprobablynotthesmallerNGOs. Further,thesmallerNGOsmightbediscouragedtoexpand—especiallyifthey arenotassuredtheycouldachievedramaticexpansionsuchthattheirmarginalincome wouldexceedthetaxconsequenttotheirgrowth—thusultimately,theunreachedpoor willsuffer. Donorswillalsotendtofavorthisalternative,astaxappliedonthegrossincome discouragesimprudentexpendituresofthemanagement(thatis,withorwithout spending,theirtaxwillbethesame). Likewise,BIR’scollectionwillbemoreefficientsincetheprovisionsareno longersubjecttodifferentinterpretations.   PublicPolicyAnalysis:IncomeTaxImpositiononNGO-MFIsPage 29  Politicalacceptability. ThisalternativemaybeacceptabletomanyNGO-MFIsbut probablynottothebigones(specificallythe25MCPI-memberNGOsthataccountfor practically70percentofthecountry’stotalmicrofinanceclients). ItmayalsoproveacceptabletotheBIR,aspotentialtaxcollectionofPhp169 millionisonly11percentlessthanwhatitcouldhavecollectedunderthecurrent policy.  Practicality/easeofimplementation. Theproposedpolicycanbeeasily implemented,onbothBIRandNGOpart,sincetheprovisionsarecutanddried.  Basedontheratingandcriteriaforevaluation,thisalternativeisgivenascoreof 7.8 .  PublicPolicyAnalysis:IncomeTaxImpositiononNGO-MFIsPage 30   PublicPolicyAnalysis:IncomeTaxImpositiononNGO-MFIsPage 31    Alternative4:Imposetaxonnetincomefromnon-MFsource   Equityandfairness. Underthisproposedpolicy,noNGOwillbeprotectedorexcluded andthus,noNGOcanbeusedtoavoidtaxes,exceptforthosethatareengagedin microfinanceonly(whichisprobablyonlyfewbecauseofthenewproductslaunchedin themarketintherecentyearsandtheMCPI’scampaigntotheMFIstogobeyond provisionofcreditalone).Similarly,noprovisioninthealternativewouldhinderthe NGOsfromgrowing. Sincedonors’moneyusuallygoestomicrofinanceoperations,thisalternative protectstheirinterestsinthatonlynon-microfinanceactivitieswillbesubjecttotax. AssumingthatthediscrepancyintheestimatedincomesinTable2onpage13 representsthe“otherincome”,andapplyingtheincometaxof32percent,thenBIR wouldhavecollectedalmostPhp79millionintaxes.  Efficiency. Theselectivenatureofthealternativewillencourageneitherefficiencyin themicrofinanceoperationsoftheNGOs(duetoabsenceofpressureontheNGOsto achieveso)norservicingofotherneedsofthepoor(duetotax).Consequently,the NGOsmaynotexpandtheiroperations—thoughthereisnothinginthealternativethat maydirectlyresultinthisNGObehavior—forthereasonthatthenon-microfinance productsandservicesarenecessarytobeviableinthemarket.Thus,theeffectofthis policymaygoagainsttheMCPI’scampaignfortheMFIstogobeyondprovidingcredit alone. Thedonors’interestwillbeprotected,however,becausetheNGOscanrecord the“(personal)benefits”underexpensesinnon-microfinanceactivitiestominimizetax, which,ontheotherhand,isnotsupportiveofBIR’sgoal.Further,BIR’scollectionmay notbeefficientunderthisalternativesincethecurrentaccountingpracticedoesnot requireseparationofmicro-insuranceandotherfinancialproductsthatproducesocial benefits,whicharetechnicallynotincludedinthelegaldefinitionofmicrofinance,from theNGOs’financialrevenues.  Politicalacceptability. AstaxationissimplydividingthesamepiebetweentheNGOs andtheBIR—thatis,BIR’slossistheNGOs’gainandviceversa—thisalternative  PublicPolicyAnalysis:IncomeTaxImpositiononNGO-MFIsPage 32  providesagoodcompromisebetweentheNGOsandtheBIR.Assumingthisproposed policyisappliedinthe2009sampledata(seeDifferenceinEstimatedNetIncomes [whichcouldbeattributedtootherincomesgeneratedbytheNGOs]Table2onpage 11),taxcollectedwouldhavebeen50percentlowerthanwhatBIRcouldhavecollected underthestatusquo.  Practicality/easeofimplementation. Thisalternativemaynotbeeasily implementedonthepartofboththeNGOsandBIRsincethecurrentaccounting practicedoesnotrequireseparationofmicrofinanceandnon-microfinancefinancial accounts.  Basedontheratingandcriteriaforevaluation,thisalternativeisgivenascoreof 9.6 .     PublicPolicyAnalysis:IncomeTaxImpositiononNGO-MFIsPage 33     PublicPolicyAnalysis:IncomeTaxImpositiononNGO-MFIsPage 34    Alternative5:ExemptNGO-MFIsfromincometaxaslongastheyapplyfor exemptionandmeettherequiredperformancestandards   Equityandfairness .Underthisproposedpolicy,noNGOwillbefavored,astax exemptionwillbegrantedtoallwhoapply and meetthefollowingperformance standards(exactmetricssubjecttotheapprovaloftheNGOs): o   assetperclient(US$150orPhp6,600)–ensuresthatassetsaremaximizedin servingclientsandthatNGOwillbeencouragedtoincreasethenumberofclients andnotjustgoforthebigborrowersthatbloatstheportfolio.Themedianassetper clientinthesampleis$150orroughlyPhp6,600. Further,ifaclientmovesoutofpovertywithin(theaverageestimateof)five yearsafterjoiningtheprogram,thenanNGO-MFIwillhavetogeneratenewclients constantlytoreplacethe“graduates”.Withthisassumption,theestimatedaverage assetperclientwillbearoundPhp6,400,whichisnotsofarfromthemedian. o   loanportfolio-assetratio(atleast69percent)–ensuresthatassetsareallocatedto loanportfolioandnottofor-profitinvestments.Theratioofthe19NGOs(erroneous datumisexcluded)inthesampleaveraged69percentwhilemedianiscloseat68 percent. o   operatingoradministrativeexpenses(notmorethan36percentoftheportfolio)– limitsexpensestoareasonablelevel.Themeanoperatingexpenseofthe20NGOsis thesameasthemedianat36percent.However,theP.E.S.O.standardrequiresthatit benomorethan20percent. o   percentageofpoorclients(uponentry)tototalnewclients(80percent)– encouragestheNGOstolendtothepoorclients.AtpresentonlyanumberofNGOs areprofilingtheirclientsaccordingtotheirpovertystatusandsomeareworkingto achieve80percent,whichisdeemedanacceptableproportion. TheperformancestandardswillensurethattheNGOswillbedoingtheir functionswellandthattherewillbenopseudo-NGO-MFIsthatwillbeusedfortax avoidance.Bythesamevirtue,thedonors’interestwillalsobeprotectedandultimately thepoorareboundtogainifthemicrofinancesectorwillbemademoreeffective. However,thosewhowillnotmeettheperformancestandards—especiallythose whodonotprofiletheirclientsyet—andthereforenotenjoytax-exemptionmightpass  PublicPolicyAnalysis:IncomeTaxImpositiononNGO-MFIsPage 35  ontheburdenoftaxtotheborrowersandthuscreatedeadweightlossesinthe economy(asinAlternatives1and2).  Efficiency. Giventheperformancestandardsrequiredbythisalternative,itwillmost likelyleadtoamoreefficientoperationoftheNGOandwithoutreach(assetperclient) asanindicator,morepeoplecouldbereachedbythemicrofinanceservices. Theefficiencystandard(operatingexpenses),coupledwiththetaxbaseongross income,ensuresthatthedonors’interestwillbeprotected. BIRcollectionwillalsobemoreefficientwiththehelpofthePCNC.  Politicalacceptability. Althoughthisproposedtaxexemptionwillmostlikelybe attractivetotheNGOs,therequiredperformancestandardsmaynotbeacceptableto them.OnBIR’spart,thisalternativewillresultintheleastamountoftaxrevenuesfor thegovernmentatPhp67million(computedbasedontheassumptionthatall20NGOs inthesampledidnotmeettheperformancestandards)in2009.  Practicality/easeofimplementation. AsfortheBIR,thisalternativemaybethemost convenient,asPCNCwillassistthemintheaccreditation.However,fortheNGOs,this alternativecouldbethemostdifficult,asitrequiresthemtoadoptanewsystemfor clientprofiling.  Basedontheratingandcriteriaforevaluation,thisalternativeisgivenascoreof 12.0, thehighestamongthefouralternatives.   PublicPolicyAnalysis:IncomeTaxImpositiononNGO-MFIsPage 36                           PublicPolicyAnalysis:IncomeTaxImpositiononNGO-MFIsPage 37  Ifthefouralternativeswouldberankedaccordingtotheevaluationcriteria,it wouldbeasfollows: 1.   Alternative5:ExemptNGO-MFIsfromincometaxaslongastheyapplyfor exemptionandmeettherequiredperformancestandards(12points) 2.   Alternative4:Imposetaxonnetincomefromnon-MFsource(9.6points) 3.   Alternative1:Statusquo(7.9points) 4.   Alternative2:Applyincometaxof5percentongrossincomefrom microfinancetransactionsoftheNGO-MFIs(7.8points) Inthecomputationofcostsandbenefits,thetotalforeachstakeholderis aggregatedtocomeupwiththe“totalsectoralcostsandbenefits”.Still,usingthis computation,Alternative5hasthehighestpositivetotalsectoralnetbenefitofmore thanPhp1billionandthehighestsectoralbenefit-costratioof39.Evenunderamore realisticscenario,wherebyonlyhalfoftheNGOswillcomplywiththeperformance standards,stillAlternative5willhavegeneratedatotalsectoralnetbenefitofPhp582 millionandasectoralbenefit-costratioof12.79.(SeeTable4forCost-Benefit ComparisonperAlternativeonnextpage.)  PublicPolicyAnalysis:IncomeTaxImpositiononNGO-MFIsPage 38   PublicPolicyAnalysis:IncomeTaxImpositiononNGO-MFIsPage 39  RECOMMENDATION Alternative5—grantingincometaxexemptiontoNGO-MFIsprovidedthatthey applyforitandthattheymeettherequiredperformancestandards—ishereby recommended.Asidefromgeneratingthehighestpotentialnetbenefit(between Php582milliontoPhp1,165million)andbenefit-costratio(between12and39),it favorsallfourstakeholdersintermsofpromotingequityandefficiency(exceptfor thoseNGOswhowillnotmeetthestandards).Althoughitmayencountersome problemsintheareaofpoliticalacceptabilityandeaseofimplementation,thesematters maybeaddressedbeforehand. Toaddressthepotentialprobleminimplementingthispolicy,itisimperativefor theMCPItoconsulttheNGOsinsettingtheperformancestandardstobeusedasbases fortaxexemption.IncommunicatingwiththeNGOs,theMCPImustemphasizethatthe indicatorsandmeasuresattachedinthispolicyanalysisaresubjecttotheNGOs’ approvalandthattheyserveonlyasdiscussionpoints. However,theconstraintsthatpreventredistributionofwealthtothelow-income groupsaretheverysameconstraintstoimplementationofthispolicy.Asof2007,ofthe 300NGOsnationwide,only62havereportingcapability,whichisafunctionofboth managementinformationsystemandhumanresources.SeveraloftheseNGOsare single-branch,operatinglocally,ofteninhigh-riskorfar-flungareas,orboth.Inshort, manyofthesesmallNGO-MFIsaretechnologically-and/orresource-challenged, isolatedfromthemainstreamsector.Chancesare,onlythebigNGOswillparticipatein sectoralconsultation.ThechallengethereforetoMCPI,asthenationalnetworkofMFIs, istoengagethesmallerNGOsinthediscussion. AsfortheNGOsadoptinganewsystemforclientprofiling,thecost-benefit presentationiscritical.TheNGOsmustrealizethatadoptinganewsystemischeaperin thelongrunthanpaying2percenttaxongrossincome. Onaverage,NGOswouldhavepaidPhp3millioneachintaxesin2009(i.e.2 percenttaxongrossincome).However,installingaclientprofilingsystemwouldcost anNGOaninitialoutlayofoverPhp1.5millionandarecurringexpenseformaintenance ofPhp300,000annually.ThetaxsavingsofPhp3millionexceedthecostofinstallinga newsystematPhp1.5million,thusitmakessensefortheNGOstomaketheirsystem moreefficient.   PublicPolicyAnalysis:IncomeTaxImpositiononNGO-MFIsPage 40       Asidefromthefactthatitearnedthehighestrating,thisalternativealso addressestheconcernsposedbythecurrentlyenforcedpolicy.    Therewillbenomoreinconsistenciesintheimplementationasthepolicycuts acrossallNGOsizesandallmicrofinanceandnon-microfinanceservices.The metricsforexemptionalsomakestheassessmentprocessobjectiveandlesssubject tointerpretationthanthecurrentpolicy.Further,thereinforcementofPCNC’s functionasanaccreditingbodyfortheNGOswillfacilitatetheimplementationof thistaxpolicy.    Withtheperformancestandardsassafeguardagainstleakagesandinefficiencies, thetaximposedwillaidthemicrofinancesectorachieveitsprimarygoalto redistributewealthtothepoor.    Marketdeadweightlossesduetothemicroentrepreneursleavingtheirenterprises foremploymentcanbeavoidedoncetheNGOsrealizethatitwillbecheaperfor themtoworkonefficiencythantopassontheburdenoftaxtoclients. Basedonthefive-yeardataofthe12NGOsintheMIXMarketreport,the averagepriceelasticityoftheNGOsis-7.039.Thisfiguremeansthatforeveryone percentincreaseinloaninterest(oryieldonportfoliointhiscase,whichisusedasa proxyindicatorofinterestforthepurposethisstudy),anNGOwillloseseven clients.(SeeTable3onpage24forcomputationofpriceelasticityforNGOs.) Thiscasemaybeparticularlytrueiftheclientsperceivethattheincreasein interestisnotjustified,say,byincreaseintheservicesofferedbytheNGOs.Data showthatatworst,anNGOmayloseasmanyas128clientswithaone-percent increaseinprice(however,themodeldoesnotincludeallotherfactorsthatmay affectthenumberofborrowers).TheNGOsshouldlookatthelostsocialbenefitby multiplyingthisnumberoflostclientsbytheirlostincomestogetthemagnitudeof theimpact.  PublicPolicyAnalysis:IncomeTaxImpositiononNGO-MFIsPage 41     BecauseoftheexemptionextendedtotheperformingNGOs,thentheissueof imposingincometaxestoallothertypesofNGOsforequitypurposeswillnowlose ground. Finally,itisnecessaryfortheMCPItopushfortheamendmentoftheRepublic Act8425Sec.3Jtoexpandthedefinitionof“microfinance”frommerely“acreditand savingsmobilizationprogram”toincludeotherfinancialservicesextendedtothemicro levelandintendedtocreatesocialbenefits,suchasthemicroinsurance.Althoughthe amendmentwillnotaffecttheproposedpolicysolution,itcouldbeanopportunetime toaddressthismattertogetherwithtaximposition.     PublicPolicyAnalysis:IncomeTaxImpositiononNGO-MFIsPage 42  WORKSCITED  Bardach,Eugene.APracticalGuideforPolicyAnalysis:TheEightfoldPathtoMore EffectiveProblemSolving.2005.  BureauofInternalRevenue.AboutUs.2004.19November2010 .  ConsultativeGrouptoAssistthePoorest."GuidingPrinciplesonRegulationand SupervisionofMicrofinance."ConsultativeGrouptoAssistthePoorest,March2002.31.  Macabeo,Abigail."PressReleases."07March2009.HouseofRepresentativesofthe Philippines.31October2010 .  MicrofinanceCouncilofthePhilippines.MicrofinanceIndustryAssesmentAReporton thePhilippines.AssessmentReport.Pasig,2008.  TheMicrofinanceInformationExchange.MIXMarket.25October2010 .    