THE COST OF TAX COMPLIANCE FOR PROFESSIONALS AND THE SELF-EMPLOYED

Alvin Ang Rachel Follosco August 2007

DISCLAIMER

“The views expressed in this report are strictly those of the authors and do not necessarily reflect those of the United States Agency for International Development (USAID) and the Ateneo de Manila University”.

MAIN REPORT
DETERMINING THE COSTS OF REGISTRATION AND COMPLIANCE FOR SOLE PROPRIETORSHIPS AND PROFESSIONALS IN THE PHILIPPINES
By Alvin Ang and Rachel Follosco

I.

Introduction

Despite undergoing two major tax reform programs, one in 1986 and another in 1997, the Philippines revenue efforts remain low. While there are various concerns that contributed to this low revenue effort, low tax compliance and the inability to expand the tax base continue to be the major causes of this drawback. In general, tax base can be expanded if the registration process is simplified as not to constitute a barrier to entry into the tax system. Low tax compliance can similarly be addressed by simplifying the requirements. In both cases, the present difficulty can be summarized into time and monetary costs. In this paper, we consider the professional and self-employed taxpayer segments which were specifically identified by the National Tax Research Center (NTRC) as exhibiting large under-reporting of income. We attempt to develop a basis for estimating the time and monetary costs involved and suggest ways to improve the process of compliance both for registration and periodic requirements. This report consists of four (4) parts: the main report, a comprehensive review of literature, a detailed process of tracking the registration and compliance requirements and a summary of a short key informant interview. This paper is organized into six (6) parts: introduction and objectives, summary of major findings from the review of literature, framework, unbundling and counting the costs, summary of the short key informant interview, the last part recommends and concludes. II. Framework of Analysis

To facilitate our analysis, we have drawn in Chart 1 the approach that we took in preparing this report. It is a general conceptual flowchart and what we had expected in each part of the task we have identified. It should be noted that in the course of the study, a number of assumptions have to be made in order to arrive at the objective of determining the costs and their attendant concerns. Difficulties were mainly in reconciling standards as there is no one official publicised procedures for the registration and compliance processes. This is due to the number of agencies involved and specific requirements in each local government. III. Review of Literature

Concerns on how to improve revenue collections have been the focus of a number of studies both locally and internationally. Though most of these studies consider improvement in tax collections in general, there are lessons to be learned that

may apply specifically to income tax gap. The review considered the processes where lesson drawing is possible. Initially, we found that the identified areas of possible improvements have been traced to a number of factors that differs from country to country. What may be considered as common to all countries is the understanding that the process of increasing revenue is affected by the behaviour of existing taxpayers in regard to complying with their tax requirements and the need to expand the tax base of payers. In this section, we consider how the Philippine tax system has been improved along the issues raised. We compare it with best methods used in other countries and trace the theoretical basis on how to further refine the process. a) Philippine tax studies The extent of the income tax gap had been studied by the NTRC. In two studies covering the period 1995-97 and 2001-06, the NTRC used different approaches in estimating the tax gap. The collection rate was 13% during the study period 199597 and this improved to 29% in 2004. Though not directly comparable due to differing approaches used in estimation, these numbers nonetheless show that a large potential income tax remains to be collected both from compensation and from business/professional income segments. Similarly, in both cases, latter segment is often claimed to account for a higher percentage of the uncollected income taxes. Part of the source of the income tax gap had been identified in a number of other studies, notably that of the International Monetary Fund (IMF), World Bank, and the Philippine Institute of Development Studies (PIDS). The IMF, in a 2005 paper, suggested that the issue of revenue collection in the Philippines can be improved by rationalizing tax incentives and improving tax administration especially on the personal income side, among others. It suggested that even if statutory tax rates on personal income are increased, it will have no significant effect on revenue because of the low compliance rate. It therefore recommended that, instead of a rate adjustment, it would be better to improve tax administration. Another study of the IMF and the World Bank in 2006 pointed out that one of the weaknesses of tax administration in the Philippines is the focus of the Bureau of Internal Revenue (“BIR”) on voluntary compliance of existing taxpayers, instead of strict compliance enforcement. These recent findings are not new because these have been considered in previous efforts to improve the overall taxation system in the country. The 1986 Tax Reform and the 1997 Comprehensive Tax Reform Program attempted to identify distinct segments/classes within the category of individual taxpayers. Thus, the classification of individual taxpayers into compensation income earners, taxpayers engaged in the practice of profession, and individuals engaged in business. While both initially improved collection in the individual income tax segment, the improvements under both tax reform efforts were not sustained. This led experts like Dr. Rosario Manasan of the PIDS to suggest that it is not the revision of the tax structure that could sustain revenue growth, but sustained improvement in tax administration. She suggested some administrative solutions to capture evasion and non-compliance, among which are: a) improved monitoring of stop-filers, b) installation of selective audit policy and procedures, and c) use of third party information. Likewise, suggestions have been made to improve personnel image
Main Report: Determining the Costs of Registration and Compliance For Sole Proprietorships and Professionals in the Philippines

2

and capacities of the BIR which include performance evaluation system for revenue officers, training of personnel for computerization, and the creation of data centers. Most of these recommendations are already being implemented through the Tax Administration Strategic Plan (TASP), though possibly lacking in depth and in breadth. b) Improving Registration and Compliance Expanding the tax base requires a significant improvement of the registration process to encourage existing and potential entrepreneurs and professionals to enter the tax net. Meanwhile, to ensure that those who are already registered will pay the correct amount, taxpayers need facilitative processes. These general findings come from the annual Doing Business Study being conducted by the International Finance Corporation (IFC) and the World Bank. The latest survey results of the Doing Business Study showed that the Philippines lowered its rank from 121 in 2005 to 126 in 2006 from a field of 175 countries that were studied. Compared to peer economies in ASEAN, this is a far cry from Thailand (18), Malaysia (25) and Vietnam (98). Much of the weakness in the ranking comes from the number of procedures and number of days required in registering a business. In general, the Philippines registered 11 procedures that take 48 days to complete. In regard to compliance, the Doing Business Study suggests that there are certain countries that have generally lowered their tax rates but still managed to improve their tax revenues significantly. This can be explained by the entry of more businesses into the formal sector. Ease of collections is explained by ease of compliance and less complications for those entering and those already in the system. The overarching lesson for the Philippines from the study is the importance of streamlining and simplifying procedures, thus: a) procedures should be cut down to only the basic steps required; b) one-stop shops for registration should be created as much as possible; c) standard application forms and a single business application process should be adopted; and d) the number of filings and returns required to be made during the year and the time spent to comply with such requirements should be reduced. c) International Studies on Compliance Two groups of studies have shown the link between revenue generation and the need for a sustained compliance. This is not without theoretical basis and neither is this finding unique to the Philippines. In a seminal paper by Nagin in 1990, he already pointed out that there are major policy instruments available to the government to curb non-compliance. In general, these are consistent with the recommendations on tax administration improvement and focused on decreasing the cost of compliance because increases in compliance cost reduce the incentive to file a tax return. Another paper by Feige in 1998 focused on the problems of accurately defining the informal sector. He cautions that a large and growing informal sector will dilute information on the actual state of development of a country based on official statistics and more importantly, it shifts the burden of taxation from the dishonest to the honest, increasing the cost of compliance to any
Main Report: Determining the Costs of Registration and Compliance For Sole Proprietorships and Professionals in the Philippines

3

system of rules and regulations, especially those concerning taxes. Thus, it is equally important to expand the tax base by improving the registration process of businesses and professionals while finding ways to improve the compliance processes for those already within the formal system. Meanwhile in studies on tax compliance made in developed countries, it was found that different industries, different regions and localities, and size of firms affect the cost of compliance. It is basically found that there are three (3) major sources of compliance costs, namely: a) record-keeping requirements; b) complexity of information that are required; and c) lack of coordination among government agencies. It can be noted that these same factors are the drivers of compliance cost in the Philippines. It may likewise be worthwhile to note that the respondents in Erard’s 1999 study in Canada on the tax compliance of firms, were mostly firms that have been in operation for about 20 years and employing at least 15 employees. This suggests that small firms are most likely having difficulty complying. In policy-setting therefore, some focus will have to be given to the compliance concerns and challenges of smaller businesses. In the US, this finding is consistent and showed that smaller firms are paying 30% more on the average cost to comply and this is believed to have caused the failure of about 40% of small firms to comply with regulations. In the UK, the same is true with small firms having to spend five (5) hours more a month to complying with taxation requirements than larger firms. These same small firms list taxation as causing more work. These findings were also found to be the same in Australia and New Zealand. Lastly, the latest US Internal Revenue Service (“IRS”) study in 2003 showed that the average time and cost burden on a taxpayer to comply with taxation requirements is 25.5 hours and US$149, respectively. This increases significantly for those in the self-employed sector where compliance time increases to 59.5 hours and US$163. However, it must be noted that international comparisons can neither be simplified nor standardized due to differences in time coverage of study, quality of data, definitions used, methods used to estimate compliance costs, and baseline of measurement. This is particularly true in developing countries where data is difficult to collect. Nonetheless, from these studies, one can still draw the following generalizations: a) Issues being faced by small businesses in relation to compliance costs are comparable; and b) A major alternative to reduce burden of small firms is to simplify procedures specifically for small firms. The details of this section are in Attachment A.
Main Report: Determining the Costs of Registration and Compliance For Sole Proprietorships and Professionals in the Philippines

4

CHART 1 - OPERATIONAL FRAMEWORK FOR DETERMINING THE COST OF TAX COMPLIANCE
TASK OUTCOMES Drawing approaches from theoretical and actual experiences of other countries in implementing income tax compliance programs

REVIEW OF LITERATURE IN PUBLIC FINANCE

DOCUMENTING THE REGISTRATION AND COMPLIANCE (including audit) PROCESSES

a) Identify the general processes of registration and compliance applicable to all localities for both professionals and self-employed b) Gather and document the registration and compliance processes through representative local governments in Metro Manila Steamline commonalities in the processes of different government agencies/local governments and arrive at a standard/baseline registration and compliance procedures and fees. Use local government standards if available.

STANDARDIZING THE COMPLIANCE PROCEDURES AND FEES

VALIDATING DOCUMENTED PROCEDURES AND COSTS AGAINST ACTUAL AND PERCEIVED COSTS OF REGISTRATION AND COMPLIANCE

a) Validate the registration process through an actual registration of business in one of the local government units. b) Validate the registration process through observations and on-the-spot interviews of actual registrants c) Conduct a survey each for the selfemployed and the professionals in regard to their view on the registration and compliances processes a) Compile information from the baseline compliance procedures and validation from the actual registration, observations and onthe-spot interviews and survey results b) Summarize the fees and costs of time across representative local governments spread over monthly, quarterly and annually

COSTING THE PROCEDURES

IDENTIFY OPTIONS ON REDUCING COSTS (in terms of time and fees) AND PARTS OF THE PROCESSES

a) Use gathered information to pinpoint parts of the procedures that can be improved so as to reduce cost of time and fees. b) Recommend a set of policy intervention to encourage potential registrants to enter the tax net and for those in the tax net to comply accurately Main Report: Determining the Costs of Registration 5
and Compliance For Sole Proprietorships and Professionals in the Philippines

IV.

Unbundling the Costs of Registration and Compliance

In this section, we summarize the processes and steps required to register a sole proprietorship/professional and the periodic requirements that sole proprietorships/professionals need to comply with. Relatedly, we herewith take the composition of professionals and self-employed to mean those engaged in business activity and not pure compensation earners. Note that instead of flowcharting the processes/steps, we have summarized them into tables comparable across different local governments. The details of this section are in Attachment B, including the step by step process, Annexes and Forms for registration and periodic compliance procedures. We separate this section into registration and periodic compliance. We first consider registration. A. The Registration Process and Related Costs The registration process will be discussed in general and thereafter a sample of the process involved in four major cities in Metro Manila, namely, Quezon City, Manila, Makati and Pasig, will be compared to give a clearer distinction of how the process differs from one locality to another. Three (3) main sub-processes are involved in registration, these are: business name registration, local government business permit, and registration with the BIR. A fourth sub-process may be included which is the registrations in compliance with social welfare laws, specifically with the Social Security System (“SSS”), Home Development Mutual Fund (“Pag-IBIG”), and PhilHealth (hereinafter collectively referred to as “Social Welfare/Insurance Agencies”). 1. Business Name Registration In general, the registration process requires the business applicant to transact with several government entities requiring time, effort and other resources. The initial registration is with the Department of Trade and Industry (“DTI”) for sole proprietorship for the business name registration. On the other hand, professionals that choose to practice in the form of general professional partnership (“GPP”) need to register with the Securities and Exchange Commission (“SEC”). To simplify our discussion, we will limit our scenario to those who register at the DTI whether as a business or a professional. DTI registration is a rather simple process and can be completed with the issuance of the certificate of registration within a day. The registration fee is Php300.00 and the documentary stamp tax on the certificate that will be issued is Php15.00. 2. Local Government Business Permit The detailed procedures and relevant fees differ across cities and municipalities but the general requirements are almost the same and they are as follows:

Main Report: Determining the Costs of Registration and Compliance For Sole Proprietorships and Professionals in the Philippines

6

Fees a. Barangay clearance b. Community Tax Certificate c. Mayor’s Permit Php100-P500 Php5.00 – P5,000

Time 1 hour – 1day 1 hour

- barangay clearance; - lease agreement/TCT of place of business; - application form; - DTI Certificate of Registration; and - payment of fees. For the application for the Mayor’s permit, the following are usually required: - locational clearance/zoning permit; - fire safety inspection certificate; - various clearances related to the place of business; and - proof of payment for public liability insurance. Each of the items listed above may require separate fees and the time needed to secure each item varies. For the cities of Manila, Quezon City, Makati, and Pasig, these processes may differ slightly. The summary of the registration process and related costs in each of these LGUs is presented in Annexes “H1”, “I-2”, “J-1”, and “K-3” of Attachment B, respectively. The differences among the local governments are likewise subject to other factors that cannot be standardized. These may include the quality and attitude of service providers and the location of each of the different offices with which a registrant needs to get clearances. One of the objectives of this paper is to determine the cost of registration. This, however, is not easy to establish as there is no standard case that can be used. Moreover, the different requirements of local government units (‘LGUs”), their internal processes, the nature of the business to be pursued, and the familiarity of the person applying for registration with the registration process, among others, all affect the cost and time needed to register. We attempt to count the costs using some assumptions to establish a baseline. Considering the difficulties mentioned above, the following are the assumptions we used for purposes of establishing the baseline costs: a. The registrant is a single proprietor with at least two (2) employees; b. Place of business has no locational/building issues (such as those arising from renovation of the premises); c. Transportation and food costs are at Php200.00/day; d. Fees assessed together with the Mayor’s Permit fee (e.g., garbage fee, zoning fee, and locational fees) assumed to be at a minimum of
Main Report: Determining the Costs of Registration and Compliance For Sole Proprietorships and Professionals in the Philippines

7

Php2,500.00 and public liability insurance, if applicable, is assumed to be at the minimum cost of Php1,300.00; e. Other fees payable in the course of processing the requirements for Mayor’s Permit application such as Locational Clearance and Fire Safety Inspections Certificate fee, while not uniformly applicable or imposed at the same rates, is assumed to aggregate Php400.00;

g. Other post-registration compliance costs which may be applicable such as the cost of physical/health examination of personnel, purchase of fire extinguishers to comply with requirements of the Bureau of Fire Protection, were not factored in; f. There are no lags in processing (registrant diligently pursuing the registration); and g. Conversion of time costs is based on the minimum wage in Metro Manila of Php350.00 per day. The minimum wage is used since it represents a standard that is applicable to any locality in Metro Manila. Similarly, most start-up businesses are likely to consider their costs at the minimum level. Using these, we apply it to the four (4) different cities to arrive at the cost estimates below. Table 1-A indicates the estimated number of days to complete the new business registration process, with the waiting time on the part of the applicant separately indicated while Table 1-B details the cost items. For purposes of costing, only the man days needed to actually complete the registration/Mayor’s Permit requirements of the LGU concerned were included. Waiting time was not assigned any corresponding cost/value.
TABLE 1-A – Comparative Registration Processing Time
(based on Annexes Annexes “H-1”, “I-2”, “J-1”, and “K-3” of Attachment B) Manila Quezon Makati City Pasig City City 1. Business Name 1 day 1 day 1 day 1 day Registration 2. Business Permit A. Estimated days to 4 days 3 days 3 days 4 days process B. Waiting Time: At 3 days + 3 3 days + 3 3-days (no 3-days (no least 1 inspection days days waiting time waiting time for plus period to for the the release of release Mayor’s release of Mayor’s Permit) Permit Mayor’s Permit) C. Total Estimated 10 days 9 days 6 days 7 days Period to Secure Release of Mayor's Permit 3. BIR Registration 2 days 2 days 2days 2 days TOTAL DAYS 13 DAYS 11 DAYS 9 DAYS 10 DAYS

Main Report: Determining the Costs of Registration and Compliance For Sole Proprietorships and Professionals in the Philippines

8

TABLE 1-B – Comparative Registration Costs and Expenses (excluding Postregistration) Manila 1. Cost of Man Days to Process (Php350/day) + Transportation and Food (Php200/day) x Col. A above 2. Barangay Clearance 3. CTC 4. Public Liability Insurance (minimum) 5. Separate fees payable prior to submission of Mayor's Permit Application 6. Total fees assessed with the Mayor's Permit Fee Php2,200 Quezon City Php 1,650 Makati City Php 1,650 Pasig City Php1,650

100 100 1,300

100 100 -NA-

100 100 1,300

100 100 1,300

400

400

400

400

3,200

2,100

3,500

2,700

TOTAL

Php7,300

Php4,350

Php7,050

Php4,050

The amounts indicated in Row 6 above were based on actual assessments paid in connection with an initial registration involving different businesses but with comparable area of office premises (see Annexes “H-1”, “I-2”, “J-1”, and “K-3” of Attachment B). It is observed that size of the office may affect the amount of garbage fee assessed, public liability insurance (although for purposes of the table above, only the minimum premium for such insurance is assumed), among other minor fees. The foregoing simply establishes benchmarks for estimating the costs of registration. As mentioned earlier, this may go higher or lower depending on factors specific to the business being registered, the LGU where it seeks to be registered, as well as the know-how/level of experience on the registration process of the person processing the Mayor’s Permit. For a comparison of estimates of registration processing time and costs reported in this Study with some other similar estimates to be meaningful, the underlying assumptions for each set of estimates will necessarily have to be considered. The Quezon City government recently had a press release (July 21, 2007, Philippine Star) indicating that the number of days to register a business in Quezon City government is at a minimum of two (2) days during slack periods and up to a maximum of seven (7) days during peak periods. It is not clear if this includes the time needed to secure the barangay clearance, but it certainly excludes registrations with the DTI, BIR, and Social Welfare/Insurance Agencies. Moreover, while it appears that the 2-day registration period that it has indicated still appears to be quite optimistic, it is evident that their estimates are based on only the actual number of days that the applicant has to
Main Report: Determining the Costs of Registration and Compliance For Sole Proprietorships and Professionals in the Philippines

9

be in the Quezon City Hall to process the required documents and excludes the waiting periods for the issuance of the required permits, conduct of inspection, and the release of the Mayor’s Permit and registration tin plate. If these assumptions for their estimates are correct, then the findings of our Study would be fairly consistent with what is in the press release in certain LGUs such as Quezon City. It may also be worthy of mention that it is difficult to generalize if there is a peak or lean period of business registration except a definite peak during renewal of registrations in January. Similarly, it is difficult to ascertain the type of business that is being registered that would require only 2 to 7 days. Thus, our case for a baseline cost with a number of assumptions. The factor that is certain to dictate the actual time needed to secure a Mayor’s Permit in Quezon City or any other LGU is the requirement for inspections to be conducted. For businesses which are required to undergo one or more inspections, the processing time will necessarily be longer while those businesses which are exempt from any inspection (usually a function of the nature of its business and the size of its proposed place of business) can eliminate waiting time to be able to file the Mayor’s Permit application. This will not, however, exempt such registrants from the waiting to have the Mayor’s Permit and registration tin plate released. a. The experience of Marikina Though not included in our representative cities, we tried to validate the good reviews we have heard from the experience of Marikina. Based on our field visit, we found that business permit will be released in Marikina at a maximum of five (5) working days. This is at least one day faster than our estimate of the process in Makati. Similarly, they have simplified the process for renewal by establishing a Barangay One-stop shop window within the Business Permits office. This could be a process that can be emulated by other cities in the National Capital Region (NCR). 3. Bureau of Internal Revenue (BIR) Registration After the business permit, the registrant has to go to the BIR to register his business and for the appropriate taxes that his business/profession is subject. This process requires that the registrant must have the proof of payment of the registration fee amounting to Php500.00, copy of the business permit, and proof of attendance of the tax briefing. After this, the registrant will be issued a BIR Certificate of Registration (“COR”). This process is usually completed within two (2) days.

Main Report: Determining the Costs of Registration and Compliance For Sole Proprietorships and Professionals in the Philippines

10

4. Registration with Social Welfare/Insurance Agencies A sole proprietorship or a professional employing at least an employee must register with the Social Welfare/Insurance Agencies. If the proprietor of the business himself is not yet registered with these agencies, he also needs to register as a self-employed individual. As these agencies may be located in different areas and possibly even outside the municipality, the registration with these agencies may take more than a day to complete. B. Estimating the Administrative Costs Related to Compliance Once a sole proprietorship/professional is registered, there are existing rules and regulations requiring periodic compliance. These requirements are to be complied with at least in three (3) regular intervals: monthly, quarterly, and annually. There are also changes in the circumstances of the registered business that require additional one-time compliance or what are referred to as “unprogrammed compliance requirements” in Attachment B. For purposes of estimating compliance costs, this Study focuses only on a general estimated baseline that we assume will be widely similar among businesses/professionals, without taking into account some cost differentials attributable to the fact that service/labor costs outside Metro Manila are relatively lower since the difference is not projected to be materially significant. Assumptions Similar to the registration costs, we have to build on a number of assumptions as the same difficulties of differing nature of business and different registration options taken will lead to different results. In general, we will limit the periodic compliance to the following: Monthly Quarterly Annual BIR, Social Welfare/Insurance Agencies BIR, LGU, Social Welfare/Insurance Agencies BIR, LGU, Social Welfare/Insurance Agencies

Towards this end, the following assumptions were considered: a. Baseline Cost is applicable to any city; b. Complying entity is a small business with at least two (2) employees; c. The sole proprietor/professional is registered with the BIR for the following minimum tax types: VAT or percentage tax; Withholding tax-compensation; Withholding tax-expanded;
11

Main Report: Determining the Costs of Registration and Compliance For Sole Proprietorships and Professionals in the Philippines

-

Registration fee; and Income tax.

d. Compliance includes those pertaining to Social Welfare/Insurance Agencies; e. Bookkeeping fee per month is Php2,500 for minimal/basic compliance with bookkeeping requirements, although the cost of alternatively using one of the employees or staff of the business is also presented for comparison but with the assumption however that the employee is not an accountant or does not have ample accounting-related experience since the employee’s assumed pay is only the daily minimum wage; f. The cost of preparation and filing of tax returns is estimated to cost Php500 for the simpler and more routine returns but more complicated returns such as the quarterly income tax return and the annual income tax return (which require the preparation of additional forms and schedules), were given higher costs; g. Cost of transportation is not separately indicated and is deemed included because the amount should be very minimal because payment can be made with the bank within the same revenue district as the taxpayer and nearest to the registered place of business; h. Official fees are only deemed included if specifically stated; in general, taxes are excluded from the estimates as taxes are generally computed on the basis of either taxable income or gross receipts, but the applicable tax rate, tax base, and whether or not the taxes are borne by the taxpayer or simply remitted in his capacity as withholding agent are indicated on the last column; i. Assessed renewal fee of the local government business permit will increase by P1,000 from a minimum of P2,500 paid on initial registration due to expected increase in business activity since local business tax is imposed at a rate depending on the nature of the business and the gross receipts of the business during the immediately preceding year; and j. Monthly (Table 2), quarterly (Table 3), and annual compliance costs (Table 4) are accumulated in computing the aggregate annual compliance cost (Table 5). With these assumptions, the different tables below show the estimated costs broken down into monthly, quarterly and annual. The approximations we arrived at should serve only as a guide and for a more accurate estimate, we believe that a survey for existing firms needs to be accomplished. This will be able to show how significant or not are the fees and compliance cost in relation to the total revenues and performance of firms.

Main Report: Determining the Costs of Registration and Compliance For Sole Proprietorships and Professionals in the Philippines

12

Table 2 – Monthly Cost of Compliance
Cost of Compliance Outsourced (Deemed Internal (Not a CPA or gross, Experienced exclusive of Bookkeeper) VAT) Php2,500 Php1,400 (estd as 4 days x Php350/day)

Description

Government Fees

1. Bookkeeping (recording in the accounting journals and ledgers) 2. Periodic Filings a. Percentage Tax or VAT Return

None

500

500 (approx. >1 day's wage and transportation)

b. Withholding Tax on Compensation

500

500 (approx. >1 day's wage and transportation) 500 (approx. >1 day's wage and transportation) 500 (approx. >1 day's wage and transportation)

c. Withholding Tax Expanded

500

d. SSS/PagIBIG/Philhealth

500

3% in case of percentage tax; 12% of Gross Revenue but actual payable may be less if there is available allowable Input VAT 5% to 32% of gross income of employee but this is not borne by the business Depends on applicable rate under RR 2-98, as amended; tax not borne by the business Depends on the salary level and the prescribed contribution rates; only employer's share is borne by the business

Monthly Total

Php 4,500

Php 3,400

As mentioned above, the time estimated for an employee of the business to prepare the returns indicated in the tables takes into account the assumption that the employee is not particularly qualified or experienced to do this kind of work, given the rate he is receiving. On the other hand, an external service provider may have a higher hourly rate but the time he would need to do the same work can be significantly shorter given the service provider’s expertise in the preparation of tax returns.
Table 3 – Quarterly Cost of Compliance
Cost of Compliance Outsourced (Deemed Internal (Not a CPA or gross, exclusive of Experienced Bookkeeper) VAT) Php 1,000 Php 1,200 (based on an estimated 3 days preparation and filing time) 500 Php 1,500 500 Php 1,700

Description

Government Fees

1. Income Tax Return

2. SSS Quarterly Total

5-32% of taxable income less any taxes already paid in the previous quarter of the year None

Main Report: Determining the Costs of Registration and Compliance For Sole Proprietorships and Professionals in the Philippines

13

For quarterly costs, we assumed that only the quarterly income tax and a quarterly filing for SSS is required. While there is a VAT return that is required to be submitted quarterly, we have considered the quarterly VAT to be similar or comparable to the monthly VAT declaration that is filed for each of the first two (2) months of the quarter to simplify the computation. Thus, the cost of filing the quarterly VAT return is reflected in Table 2. No separate costing was provided for the payment of quarterly business taxes since quarterly payment is only an alternative to the annual payment scheme.
Table 4 – Annual Cost of Compliance
Cost of Compliance Description 1. Annual Audit 2. Registration of Books Outsourced Php 7,500 750 (inclusive of cost of manual accounting books) 1,000 Internal Php7,500 (external) 500 (inclusive of cost of manual accounting books, 1/2day wage and transportation) 750 Actual Government Fees/Fees to Third Parties

3. Renewal of Registration (inclusive of renewal fee & costs) 4. Preparation and Filing of Annual Tax Return and related forms 5. Preparation of Annual Alphalists a. Withholding Tax on Compensation b. Withholding Tax Expanded Annual Total Before LGU-related costs and expenses Estimated Mayor's Permit renewal-related costs and expenses: a. Barangay Clearance

Renewal fee of Php500.00

2,500

2,500 (external)

Any remaining unpaid income tax computed at 5%-32% of taxable income

1,000 1,000

800 (2 days wage + transpo) 800 (2 days wage + transpo)

Php13,750

Php12,850

100

100

b. CTC c. Public Liability Insurance (20sq.m, whc is the min. area)

100

100

1,300

1,300

Amount indicated is official fee CTC is official fee; amount indicated is estimate Actual premium charged by insurer for 20sqm area
Amount indicated is estimated official fee inclusive of Php1,000 additional local business tax. Threshold business tax rates provided under the Local Government Code are attached in

d. Mayor's Permit and related fees

3,500

3,500

Main Report: Determining the Costs of Registration and Compliance For Sole Proprietorships and Professionals in the Philippines

14

Attachment B

e. Labor Cost of Php350/day + Transportation and food of Php200/day to process Total LGU Annual Compliance Cost Total Annual Cost

2,200 Php7,200 Php20,950

2,200 Php7,200 Php20,050

For annual cost estimates, there are still additional filings that the entity needs to submit and it also needs to renew its Mayor’s Permit with its LGU and its registration with the BIR. Thus, these activities are considered separate from the monthly and quarterly compliance requirements that the business entity/professional has to accomplish. In addition, there is also an annual audit of books that needs to be complied with and per current market standards this is estimated to cost Php7,500, usually quoted net of withholding tax and exclusive of VAT. There remains to be independent auditors who can charge as low as Php5,000, exclusive of VAT and net of withholding tax, but such auditors would normally qualify their engagement to be without the conduct of an actual audit. Thus, they would just sign off on the financial statement prepared internally as long as they are satisfied with the apparent consistency of the financial statements with generally accepted accounting principles. The estimate of compliance cost for the entire year is summarized below.
Table 5 –Administrative Cost of Compliance per Annum
Description Cost of Compliance Outsourced Internal (Deemed gross, (Not a CPA or exclusive of VAT) Experienced Bookkeeper) 54,000 40,800 6,000 6,800 20,950 20,050 Php 80,950 Php67,650

Monthly Total (x 12) Quarterly Total ( x 4) Annual Total TOTAL COMPLIANCE COST – PER ANNUM

The costs presented above are baseline and, as previously mentioned, there is some degree of arbitrariness/reliance on assumptions in arriving at these numbers. The information presented above support the following conclusions: (1) while it is true that registration costs serve as barriers to entry, specifically, into the tax net, all told, the estimated registration costs for all the four cities appear to be acceptable and the time involved is not as long as generally perceived; and (2) the estimated cost for compliance seems to be quite high for a multitude of small business. While it may be true that the administrative cost of compliance diminishes or even becomes negligible as the size of the business increases, the full cost of compliance does not necessarily follow the same trend. It should not be overlooked that compliance requires the payment of taxes, both to the national and
Main Report: Determining the Costs of Registration and Compliance For Sole Proprietorships and Professionals in the Philippines

15

the local governments. Given the way taxes are computed, i.e., generally based on taxable income, gross revenue or gross income, the amount of taxes that are paid in the course of compliance would track any increases or decreases in the tax base, although the administrative cost of compliance remains constant. This point is further articulated below.

C. Actual Full Cost of Compliance It has to be emphasized that the full cost of compliance is still not yet fully captured in the amount of Php80,950 indicated above, since the said amount basically captures only the administrative cost of compliance. To the businessman/professional, the cost of compliance will definitely have to include the taxes that he will in fact be paying in the course of his compliance. The amount of taxes payable were no longer estimated for purposes of this Study as it will require us to over simplify the illustration by assuming a fixed amount of income; nonetheless, the applicable tax rates and tax base are indicated where applicable. Hence, in real cases, this estimation may prove to be on the high side for small and medium firms, but may be low for large ones. Since most new entrants to business start small, this could serve as a barrier to entry. Therefore on the whole, it is not only the registration process that can serve as barrier to entry but equal resistance to formalize one’s business and bring it within the tax net can be traced to the fact that aside from the administrative cost of compliance, there are significant amount of taxes that will become due and demandable from the business once it is in the tax net. Between the difficulty and cost of registration as barrier to entry into the tax net and the cost of full compliance once in the tax net, it is the latter which may in fact be the source of resistance to get one’s self into the tax net. Thus, if enforcement of the requirement to register and comply with all continuing requirements is weak, whether it is an individual or a juridical entity that is conducting business, there is definitely a lot of cost savings and financial incentive to remain outside the tax net for as long as the system allows them to get away with non-registration. Lastly, the cost of defective compliance once the business is already in the tax net is likewise potentially prohibitive. Given that for smaller businesses competent professional services are rather costly and inaccessible and the fact that proprietors of smaller businesses are also generally less sophisticated, there is increased chance of defective (late, incomplete or erroneous) compliance and the need to incur its related costs. When such is the case, their cost of compliance can be greatly increased and can even be doubly prejudicial on their part since such incremental cost would constitute unanticipated or unprogrammed costs unlike the periodic taxes that are due which are arbitrarily factored into the pricing scheme of the business.

Main Report: Determining the Costs of Registration and Compliance For Sole Proprietorships and Professionals in the Philippines

16

V.

Validation through Short Key Informant Interview

To validate the findings above, we tried to elicit ideas and find concerns of self-employed and professionals in complying with the initial registration and periodic compliance requirements of local government units and the Bureau of Internal Revenue (BIR). Taking into consideration the limited timeframe and the possibility of a high level of non-response, we employed a purposive/convenience sampling method. Thus, we caution that there is no general scientific generalization that can be arrived at. We tried to get a mixed group of 30 respondents, equally divided into selfemployed and professionals and was conducted in the Quezon City area. The questionnaire employed was non-structured type and solicited open-ended responses and was implemented through face-to-face interviews. The survey questions asked were as follows: 1. What can you say in general about the business/professional registration process for the self-employed and professionals 2. If your business/practice of profession is registered, a. Did you personally apply for your business permit/professional license b. In your estimate, how long did it take to complete the registration process? c. How much did you spend? d. In the course of registration did you encounter any difficulty? e. Can you specifically identify the part of the process where you encountered difficulties? f. What can you recommend to improve the process? 3. As regards your periodic compliance requirements with the LGU and BIR, do you encounter any difficulty in meeting them? 4. Did you personally take care of your periodic requirements 5. If No, did you hire any professional to assist you? 6. Can you identify the problems with the periodic compliance process? 7. Could you suggest ways of improving it? 8. If you business is not registered, a. What is the reason why you did not register? b. Do you know that the process takes only 4 weeks and that the cost depends on the type of business? c. What can you recommend to improve the process? Analysis of the responses The survey summary shown in Table 6 below reveals that majority of professionals and self-employed small business owners do register their businesses and comply with the requirements. It is important to consider however that the researcher had difficulty getting non-registered businesses to formally respond to the questionnaire. Only 2 respondents were willing to be interviewed and explained that the reason for their non-registration and non-compliance is due to their perception that there are too many requirements, too many fees to pay, and the long waiting time to get the business permit and all the necessary business authorizations. This point is crucial, because it gives the impression that people
Main Report: Determining the Costs of Registration and Compliance For Sole Proprietorships and Professionals in the Philippines

17

do dodge formalities not because they do not want to pay taxes initially, but that they are turned off by the documentation and time requirements. Hence following this perspective, what we can pick from this result will help identify the parts of the compliance process which registered businesses and professionals are finding difficult to comply with or cumbersome. Hopefully, policy changes will be able to simplify and correct the same to make compliance easier.
Table 6 – SUMMARY OF KEY INFORMANTS INTERVIEW

QUESTION 1 a. b. c. d. e. f.

RESPONSE

2a 2b 2c 2d

2e 2f

3. 4. 5. 6.

Necessary Long process Tedious, but necessary Difficult because of the long queue and plenty requirements Difficult especially if you have no contacts The process of registration is easy, it is the process of acquiring the requirements that is difficult g. It is a slow process and the waiting time is long h. An efficient way of regulating the practice of profession Except for one who engaged a staff, all responses were in the affirmative The responses ranged from one week to two months. The amount spent ranged from P3,000 to P15,000 a. long queue b. Centralized processing c. Too many processes and requirements d. Prevalence of fixers e. Offices are located away from each other f. Inefficient staff of processing office a. application and assessment b. processing and evaluation a. Computerization and on-line processing b. Compel the use of e-filing and e-payment schemes c. Decentralization d. More counters for registration and application e. Provide a schedule for processing f. Introduce One-stop shop g. Make payments staggered h. Separate the requirements of tax registration and social security with that of Business Permit Responses were similar to the issues in the initial registration process Most respondents declared that they personally take care of their periodic requirements Same as above The process of renewal and periodic compliance encounter the same problems as that of new registration. It is noted that periodic compliance is too demanding with respect to time and
18

Main Report: Determining the Costs of Registration and Compliance For Sole Proprietorships and Professionals in the Philippines

7. 8a 8b 8c

documentation, forcing some to hire accountants while those who cannot afford simply do not comply. Similar recommendations on improving registration The perception that there is a lot of requirements and expenses involved Most are aware, but still find the fees expensive Remove red tape

The following are our assessment of the information that can be culled from the survey: a) On the business registration process in general There seems to be a consensus that the process of applying for a business and professional registration is a long, difficult, and tedious process. Nonetheless, majority comply with it because they believe it is necessary for regulation of business and profession. It is also noted that due to the differences in the operational set-up of local governments, there seems to be a perception that some LGUs are more organized than the others. b) Length of time to complete registration process The time involved in the process is one of the reasons that turn off registrants. It should be noted that the range of time involved goes to a low of five (5) working days or one (1) week to a high of eight (8) weeks. However, considering that this survey was done in one city, findings here may not necessarily be consistent with those in the other cities. To have an average viewpoint, we can assume that not all registrants diligently pursued their registration from day 1. It is possible that some deferred the instruction on when to return thus leaving their process hanging. Thus, those that diligently waited for their papers completed the process within a week’s time. Nonetheless, this gives us a clear idea that registration should be facilitated and possibly be completed within a day. There are transaction costs involved and these differ from person to person and from the type of business being applied. c) Monetary Cost of Registration Most respondents gave the minimum amount spent for registration as around Php3,000 and the highest to approximately Php15,000. Respondents tried to recall the total amount they had spent for registration as some of them had been in operation for some time now. There are many factors to consider in aggregating the actual cost incurred by the respondents. For instance, some impliedly considered in their cost – facilitation expense and early release through fixers, though they did not specify how much they gave. But, considering that a number of the respondents gave their expenses to be around Php5,000, it is possible that the facilitation fee of fixers could have gone as high as PhpP10,000. Similarly, it is important to note that the cost we
Main Report: Determining the Costs of Registration and Compliance For Sole Proprietorships and Professionals in the Philippines

19

consider here are the out-of-pocket direct costs incurred and therefore if linked with the previous item on time, the total cost is definitely higher. d) Difficulties encountered during registration and periodic compliance There are numerous difficulties encountered during the registration and periodic compliance. Most common difficulty is the long queue of registrants. This discourages first time applicants and irritates those that are doing their periodic compliance. It can be considered that the reason for the long queue is the centralized processing of LGUs and other government offices. The concept of centralization here, mean that there is a very limited area for getting the registration and periodic compliance done. These results to overflowing of registrants and renewal applicants combined. Likewise, the completion of both processes require the visit to at least two different area offices, LGUs and BIR, making it inconvenient as registrants have to go to two different areas or even more within the LGU office. This is because offices may be located away from each other. Another complaint is that some LGU/BIR staff are inefficient. This may mean that respondents observed that these staff are not working fast or are not facilitative and may actually be slowing down the process. As to the part of the process where these difficulties are actually encountered, most respondents replied during application, assessment and evaluation parts. For practical purposes, these form the general parts of registration and therefore we can safely conclude that there is a general sense of difficulty being encountered in every step of the registration. e) Suggestions to ease difficulties In general, most of the respondents have access to computers and therefore have strongly recommended the full computerization of the process. Though part of the process can be done on-line, the most part still require applicants to go through physical process. It is the view that computerization will help open the possibilities of decentralizing the process and reduce the queue. Additional windows for processing can also fast-track procedures. Likewise, it was suggested by some that it would be good to establish instead a one-stop shop for all the requirements required to be processed, avoiding the need to transfer from one office to another. Here we see a two-stage workable option: first, the opening of satellite registration offices in the major sub-areas of the city/municipality to the extent that the volume of transactions would justify and second, making such extension offices one-stop shops for all the different agency requirements to be completed. Similarly, an alternate on-line registration, renewal, and releasing system can be put into place to further facilitate the process for those who have on-line access.

Main Report: Determining the Costs of Registration and Compliance For Sole Proprietorships and Professionals in the Philippines

20

VI.

Some Policy Suggestions

This Study has generally shown the need to simplify registration and compliance procedures. Our baseline estimates show that compliance requirements are the same regardless of the size of business, profit or even nature of business or profession. This uniformity of requirements seems to be one area where the difficulty arises particularly for the small and/or start-up businesses. Consistent with the findings of studies in the US, Canada, and other developed countries, it is the small businesses or start up professional services that are severely affected by compliance processes in terms of time and costs. In relation to this, we similarly support the need for further simplification of the registration and compliance requirements as well as more intensive efforts to disseminate basic information regarding compliance requirements and procedures to small businesses to reduce and possibly eliminate the risk of costly defective compliance. In particular, we would like to recommend the following: 1. Creation of one-stop shops by LGUs which will allow the applicant to just proceed to one office window, submit one (1) set of requirements (instead of one (1) set of documents for every office where a permit or clearances is required to be obtained), and pick up the Mayor’s Permit upon payment, after the lapse of a definite period of time. Barangays, at least during the month of January when all renewals are scheduled to be completed, should likewise already send representatives to the LGU’s one-stop shop to issue the requisite barangay clearance. This practice is already being implemented in Marikina. 2. Make the forms simple and make available instructions in the vernacular. In the LGUs, if the applicant is simply renewing its Mayor’s Permit, the application form, requirements, and procedures should be substantially simplified or reduced, particularly if the applicant will not be transferring its place of business or there is no material change in its business and/or place of business. In particular, LGUs which have computerized data base of applicants’ information should be able to reduce information/documentary requirements from the applicants to the extent that the applicant represents that there are no changes in its circumstances. At the least, an applicant for Mayor’s Permit renewal only needs to disclose the gross revenue of the business during the preceding year as the same serves as basis for the local business tax assessment. 3. Uniformity of requirements actually discriminates against small business/professionals. We strongly recommend the establishment of a threshold for small business and professionals based on their cost of capital, initially and thereafter, based on their gross revenue. For example, the following variations may be implemented to simplify procedures and minimize cost for small businesses: a. Exemption from routine fees, particularly those specifically assessed for permits/clearances where there is in fact no cost involved for their issuance, such as when there is no inspection required. Some LGUs, for example, impose a fee for the issuance of a locational clearance. LGU could be
Main Report: Determining the Costs of Registration and Compliance For Sole Proprietorships and Professionals in the Philippines

21

encouraged to waive the payment of such fee if the business applicant is a business whose capital/gross revenue does not exceed the set threshold. b. Allow less frequent periodic compliance for small businesses, for example, monthly periodic requirements should be submitted quarterly instead. SSS, Philhealth, and Pag-IBIG should likewise issue guidelines allowing quarterly instead of monthly remittance for employees’ and employers’ contribution if the number of employees is ten (10) or less. Percentage tax return for businesses that do not meet the threshold of Php1,500,000 for purposes of VAT coverage should be allowed to file and pay their percentage tax on a quarterly basis instead of filing and paying monthly. In the same way that the BIR has special rules for taxpayers which it has determined to be “Large Taxpayers”, it is may also be worthwhile for the BIR to consider creating a new class of taxpayers, “Small Taxpayers”, which will be subject to more reasonable periodic compliance requirements. A Small Taxpayers Section will primarily focus on assisting and encouraging small businesses to register and comply with at least the minimum requirements instead of being made to comply with the same number/volume of compliance requirements as big businesses. They should be properly guided rather than subjected to strict enforcement. More lenient rules should be applied to them and technical rules should be explained to them, the assumption being that, they have no accountants and lawyers to rely on. In the long term, this should encourage voluntary compliance and registration, and ultimately expand the number of taxpayers in the tax net. c. Evaluate the possibility of increasing the revenue threshold for purposes of imposing the requirement for the audit of financial statements of the business. At present, all businesses with gross revenue of at least Php150,000 are required to have their financial statements audited. Considering that a good estimate of the cost for such an audit is Php7,500, or 5% of the gross revenue threshold, the requirement should only be imposed on those earning at least Php500,000 in annual gross revenue. This may, however, require statutory amendment as the threshold amount of Php150,000 is prescribed in the National Internal Revenue Code of 1997. d. Waiver of compromise penalties for failure to file tax returns where no tax is due from the business particularly if there is no fiscal prejudice on the part of the government. They should, as much as possible, except on the grounds of wilful, fraudulent or repeated violations, be shielded as much as possible from fear of tax audits and assessments for each and every violation that they commit. e. Intensive information dissemination, particularly of new rules and regulations/issuances and regular free and more intensive briefing particularly for small businesses. This is important so as not to make small business suffer considerable additional costs due to defective compliance
Main Report: Determining the Costs of Registration and Compliance For Sole Proprietorships and Professionals in the Philippines

22

arising from their lack of information of changes in the rules and regulations of the BIR. The present means of information dissemination of the BIR appears to be inadequate. At least flyers should be given to notify taxpayers of changes in important tax requirements/regulations. These flyers can be conveniently distributed at the BIR offices or through authorized agent banks which receive tax payments from taxpayers. It is particularly upsetting for taxpayers to find out about a change in the regulations, including the imposition of new requirements, only at the time when penalties are already being assessed against them for failing to observe the new regulations. A recent example is the imposition of the requirement that for VAT-registered taxpayers to be able to subject their sales of services prior to 1 February 2006 but collected after 1 February 2000 to VAT at the old rate of 10% instead of 12%, they should have submitted an inventory of their receivables from services rendered prior to 1 February 2006 to the BIR, otherwise, they will have to compute VAT thereon at 12%. This requirement was not likewise specifically made clear and discussed in the tax briefings which were conducted in connection with the increase of the VAT from 10% to 12%. Thus, taxpayers had to unnecessarily subject revenue otherwise subject to 10% VAT to 12% VAT. This range of recommendations focuses primarily on facilitation and easing the registration and compliance procedures. We believe that they are administrative in nature and thus can be unilaterally accomplished by each agency or local government unit. They do involve significant costs in terms of time and money that affect potential and existing taxpayers. Government agencies however need to work together in order to standardize the basic registration and compliance procedures in the country in order to make it predictable and transparent.

Main Report: Determining the Costs of Registration and Compliance For Sole Proprietorships and Professionals in the Philippines

23

Sign up to vote on this title
UsefulNot useful