A few days ago, House Bill No. 5636 or the Tax Reform for Acceleration and Inclusion (TRAIN) was approved by the House of Representatives in the Philippines.
While the Philippine government’s propaganda to disseminate information about the tax reform is focused on the lowered personal income tax rate resulting from the bracketing changes (see image below), these changes affect more than your personal income tax.
For businesses, the effect of the changes in the personal income tax rate is subtle. The government released a lot of articles and materials to propagate the impact of the tax changes on personal income tax, but this article will focus on the impact on businesses.
A lot of startup founders still hire freelancers in order to sustain their bootstrapping business, and the tax reform also proposes changes in this area. I can’t say for sure if it’s for the better or worse since it depends on your business.
Self-employed and freelance professionals are subject to the 3 percent other percentage tax (OPT) in lieu of VAT (when gross sales or gross receipts do not exceed the VAT threshold of US$38,734).
Under the proposed tax changes, self-employed and/or freelancers are no longer subject to the 3 percent OPT. Here’s a quick summary of the changes:
- VAT threshold will be increased from US$38,734 to US$100,897. This could be a positive change that would allow improved wiggle room for startups, self-employed, and freelancers to pay 3 percent OPT instead of being subjected to a heavy burden of 12 percent VAT.
- Self-employed and/or freelancers whose gross sales or receipts do not exceed the VAT threshold will be subjected to 8 percent income tax on gross sales or receipts in excess of US$5,044.
- Self-employed and/or freelancers whose gross sales or receipts exceed the VAT threshold will be taxed in the same manner as corporations.
Now, is this a good change? If your income is below US$5,044 per year, this is definitely a good change since you don’t have to pay anything. If you earn below US$8,071 a year, you are still better off with the tax reform. But earn more than that and you will start feeling the pain of the 5 percent hike in tax rate.
Now, if you’re currently earning more than US$38,734, you benefit from the tax savings of 7 percent (12 percent VAT less 5 percent new tax rate). But it gets pretty complicated with an income of more than US$100,897. It’s a balance between subjecting your gross income to 12 percent VAT (under the current tax code) and net income to 30 percent income tax (under the tax reform).
TRAIN is still subject to Senate approval, so these provisions might change. But understanding early on how these changes could impact your startup in the Philippines and your personal income is crucial in proper financial planning.
For companies who are previously enjoying zero-rated VAT or VAT exemption, please have a read of the publication or drop an email to your accountant or tax advisor. Your preferential transactional tax could be taken away from you when this reform is implemented.