Taxing spirits

is the subject of my Trade Tripper column in this Friday-Saturday issue of BusinessWorld:

This is in further continuation of our reflections on the country’s bizarrely unfortunate (but highly revealing) loss in the WTO case Philippines -- Taxes on Distilled Spirits (docketed as DS396 and DS403). The issue in that case essentially is whether the excise tax laws of the Philippines on distilled spirits violated GATT Article III.2. Both the panel which tried the case and the Appellate Body emphatically said yes.

The EU and the US complaint similarly alleged that Section 141(a) of our National Internal Revenue Code impose an excise tax regime on distilled spirits in a manner that violates Article III:2, first and second sentences of the GATT. Under the said provisions, distilled spirits are subject to a specific flat tax rate if two requirements are met: "(i) if distilled spirits are produced from one of the designated raw materials that includes sap of nipa, coconut, cassava, or juice, syrup or sugar of the cane, and (ii) the designated raw materials are produced commercially in the country where they are processed into distilled spirits." Distilled spirits that do not meet either of the above requirements are subject to three different tax rates depending on the net retail price of a 750-milliliter bottle.

In short, low excise taxes are applied by the Philippines to spirits made from certain designated raw materials but allegedly significantly increased for spirits processed from the "non-designated" materials. By sheer coincidence, all domestic distilled spirits (mostly gins or rum type spirits) are culled from one of the above-designated raw materials. The vast majority of imported spirits, however, are made from the non-designated materials. Consequently, the US considered the Philippine taxes on distilled spirits as discriminatory against imported distilled spirits since the tax rates imposed are substantially higher than domestic spirits. The US would argue its claim from several angles: "intent," "likeness," and "discriminatory treatment" but the entire case decisively hinged on the issue of "likeness" of the products involved.

To determine "likeness", the Appellate Body took the same approach as the Panel, analyzing the products based on (i) its properties, (ii) end use, (iii) consumer tastes and habits, and (iv) tariff classification. The four factors were adopted from a Working Party Report on Border Tax Adjustments. The AB also considered the "competitive relationship" between the products as very crucial. The AB took note as well of Canada Periodicals and Korea -- Alcoholic Beverages, declaring that under Article III:2, first sentence, products that are near to being perfectly substitutable can be "like products." Bottom line, products with similar physical characteristics may still not be considered "like," as required under Article III:2, if competitiveness or substitutability is low. On the other hand, products with physical differences could still be considered "like" if the differences do not substantially affect the products’ competitive relationship.

The AB, therefore, upheld the Panel’s finding that the products in question are, indeed, "like" products. From that point, the conclusions were almost comically predictable. The AB ruled that the Philippines violated GATT Article III:2, first sentence. It also agreed with the Panel that both the imported and domestic distilled spirits are "directly competitive or substitutable" products, thus leading to the further conclusion that the Philippines violated GATT Article III:2, second sentence, as well.

So now we are left with the burden -- under time pressure -- of making our excise tax conform to the WTO ruling. In doing so, it’s important to consider certain parameters: the neutrality of the tax’s character and that "like products" be subjected to the same rates of tax. Needless to say, the tax provisions should be simple, not requiring the advanced training of a BIR collector. In terms of structure, the "specific" form of excise taxation would be best, it being easier to administer and does not allow manufacturers or importers to undervalue their invoice.

The DoF-suggested legislation is, by far, the more superior draft legislation, particularly when compared to that coming from the House of Representatives. To comply with the WTO rules, the tax structure based on raw materials must be done away with and the wide variance in tax rates among products eliminated. The DoF’s proposal of changing the tax base to alcohol content and eventually unifying the tax rate after a three-year transition period is quite reasonable, particularly with the expected incremental revenues of P11.2 billion in the first year of implementation, P26.5 billion in the second year, and P53 billion on the third year when the tiers are collapsed into one, and all distilled products are taxed at P150 per proof liter. The proposal includes an "indexation," enabling an annual increase in the specific tax rates. This, in turn, allows for incremental proceeds, providing sufficient funds to finance the universal health care program of the government. Economist Filomeno Sta. Ana posits that increased excise tax on distilled spirits would be "beneficial to the whole society."

Still, it’s interesting why these necessary changes weren’t made sooner. In vino veritas.