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Taxing a sovereign wealth fund

In December, the House of Representatives passed on third and final reading House Bill No. 6608, or the proposed Maharlika Investment Fund Act. If signed into law, the measure would establish the Philippines’ first sovereign wealth fund (SWF). The proposal seems to attempt to mirror economic gains in other jurisdictions that have already established their own SWFs, including our Southeast Asian neighbors such as Singapore, Malaysia, and Indonesia.

Section 6 of the House Bill states that one of the proposed fund’s objectives is to “obtain the optimal absolute return and achievable financial gains on its investments.” Thus, as with any investment, taxation can be considered one of the major financial aspects that should be thoroughly studied towards this goal of optimizing the returns on investments. In this article, I will be highlighting a few key tax considerations for this proposed SWF.

PHILIPPINE TAX EXEMPTIONSSection 31 of the House Bill exempts the following transactions and assets of the proposed SWF from local and national taxes, direct and indirect, that may be imposed under the Local Government Code of 1991, and the National Internal Revenue Code of 1997, as amended, pursuant to the regulations to be issued by the Department of Finance, upon recommendation of the Bureau of Internal Revenue:

a. all funds, assets and properties;

b. all revenue, income or investment earnings, as well as accruals thereto; and

c. purchase of supplies, equipment, papers, or documents.

The provision further states that imports of supplies and equipment are exempt from customs duties, in accordance with the provisions of the Customs Modernization and Tariff Act.

The provision finally states that the exemptions granted must be utilized actually, directly, exclusively, and solely for the transactions of the proposed SWF, and not for the purposes of its executives, employees, third parties, and other distinct taxable entities.

At first glance, the tax exemption clause appears broad and sweeping. However, the exemption does not seem absolute. For example, the exemption only covers purchases of “supplies, equipment, papers, or documents” which are in the nature of goods or property. Consequently, it seems that purchase of services as well as lease of goods or properties are not covered by the exemption.

In qualifying the exemption, which does not extend to executives, employees, third parties, and other distinct taxable entities, this qualification appears to be consistent with the apparent aim to ringfence the exemption of the proposed SWF solely to its income and gains and not those of other parties. Consequently, compensation and benefits of its executives and employees remain taxable, subject to withholding tax on compensation or fringe benefits tax, as applicable. Moreover, similar to any domestic corporation, it appears that the SWF will be constituted a withholding agent for its income payments to local and foreign suppliers, under the expanded and final withholding tax systems pursuant to existing withholding tax regulations.

One particular aspect that should be clarified is whether the exemption on “all funds, assets and properties” extends to taxes that may be passed on to the SWF by other entities, such as capital gains tax or stock transaction tax on Philippine equity transactions, and gross receipts tax on domestic financial instruments. While such taxes are the statutory tax liabilities of the other transacting party (e.g., sellers/traders of Philippine shares, financial institutions), in practice, the same may be stipulated as to be shouldered by the investor, which in this case would be the SWF. Given the nature of the SWF, such tax costs may be significant. Perhaps this can be addressed during deliberations of the proposed law in Congress or upon the promulgation of relevant tax regulations once the measure is signed into law.

CROSS-BORDER TAXATIONDuring the World Economic Forum, the Philippine delegation, headed by the President himself, attempted to spark global interest in the proposed SWF. As an investment vehicle, the government has expressed its intention to use the proposed fund to invest in a wide range of outlets, including foreign ones. Naturally, foreign tax implications should also be duly considered to ensure that such tax costs do not significantly erode the returns on the proposed SWF’s foreign-sourced or outbound investments.

Tax rules vary in each jurisdiction. Nonetheless, the various tax approaches to SWF income can be summarized as follows:

• Exemption by way of domestic law in the foreign jurisdiction;

• Exemption through administrative practice;

• Exemption under an applicable double tax treaty; or

• Taxation under general tax rules, in the same way as any other non-resident company.

To conclude, taxation should be carefully taken into consideration to ascertain that the SWF’s objective of optimal returns and, correspondingly, its ultimate ambitions of promoting economic growth, accelerating job creation, and improving the welfare of Filipinos can be achieved. While this author is also mindful of the other crucial aspects of the proposed SWF (e.g., sources of initial capitalization, necessary safeguards, corporate governance, current macroeconomic factors) which have been broadly debated by various sectors and concerned citizens, this author nevertheless personally views this proposal with cautious optimism as this could aid in the country’s long-term progress if done correctly.

The views or opinions expressed in this article are solely those of the author and do not necessarily represent those of Isla Lipana & Co. The content is for general information purposes only, and should not be used as a substitute for specific advice.

Marion D. Castañeda is a senior manager at the Tax Services department of Isla Lipana & Co., the Philippine member firm of the PwC network.

marion.castaneda@pwc.com

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