INCOME TAX IMPOSITION ON NON-GOVERNMENT ORGANIZATIONS IN THE MICROFINANCE SECTOR

Submitted by Asuncion M. Sebastian

on December 15, 2010 to Dr. Segundo Romero

in partial fulfillment of the requirements in DEVEST Public Policy Analysis

EXECUTIVE SUMMARY
The non-government organizations (NGOs) in the microfinance (MF) sector are

expected to play a vital role in the delivery of financial services to the low-income group, particularly in rural areas, because of their comparative advantage over other types of organizations. The NGOs are able to reach the poor better than other entities and are also more efficient in the use of their assets in serving the poor. However, silent opposition against income tax imposition has been brewing among the NGOs since the rule was implemented, but nobody has initiated collective action to lobby the position of the NGOs. 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. The income tax imposition in 2007 on these NGO-MFIs, which are supposedly tax-exempt entities, has resulted in the following arguments and issues: The inconsistency in implementation has created, or will create sooner or later, an artificial competitive advantage among some players, thus disrupting the market forces. Income tax imposition creates inefficiency in a mechanism aimed at redistributing wealth to the poor. Income tax imposition could lead to eventual market deadweight losses, as NGOs could pass the tax burden to the micro entrepreneurs, who in turn, could leave their enterprises. If income tax is imposed on the NGO-MFIs indiscriminately, then it should be imposed as well on all other types of NGOs. With the MCPI as the client, this policy analysis aims to come up with a solution that will serve the interests of the main stakeholdersthe NGOs in the sector, the Bureau of Internal Revenue, the social investors or donors, and finally, the poor or the MF clients. Bases for evaluation of policy alternatives are equity, efficiency, political acceptability, and ease of implementation. Four policy alternatives are considered: 1. Status quo 2. Apply income tax of 5 percent on gross income from microfinance transactions of the NGO-MFIs

3. Impose tax of 32 percent (based on current corporate tax) on net income from non-MF source 4. Exempt NGO-MFIs from income tax as long as they apply for exemption and meet the required performance standards. It is recommended that tax-exemption be extended to the NGOs that apply and meet the performance standards. 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 before the policy takes effect. To address the potential problem in implementing this policy, it is imperative for the MCPI to consult the NGOs, big and small alike, in setting the performance standards to be used as bases for tax exemption. The reinforcement of PCNCs function as an accrediting body for the NGOs is critical in the implementation, particularly in evaluating the NGOs performance, thus MCPI has to gain the cooperation of this agency. As for the NGOs adopting a new system for client profiling, the cost-benefit presentation is key to influencing the NGOs. The NGOs must realize that adopting a new system is cheaper in the long run than paying 2 percent tax on gross income. Market deadweight losses due to the micro entrepreneurs leaving their enterprises for potential employment or contractual labor can also be avoided if the NGOs are made to realize that it will be cheaper for them to work on their efficiency than to pass on the burden of tax to clients. The average price elasticity of the NGOs is -7.039. This figure means that for every one percent increase in loan interest (e.g. 1 percent of 36 percent interest on loan), an NGO will lose seven clients. At worst, it could be 128 clients per 1 percent increase in interest. Finally, it is necessary for the MCPI to lobby 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 issue of income tax imposition on the NGOs.

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 governments 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

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 banksmostly rural banks and cooperatives bankscooperatives, and non-government organizations (NGOs). Based on the MIX Market data, the NGOs served almost 67 percent of the countrys 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 lossesdue 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.)
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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 governmentsomething 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 poors 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.
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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 governments allies in advancing the social reform agenda (to put it bluntly, they are doing governments 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 CGAP1, 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 insidersthese 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 consumptionthat is, the money borrowed by one client cannot be used by anotherand by excludable ownershipthat 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.

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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.

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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 clientsthe 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 matteronly that taxation should not worsen any inefficiency in the sectorthus the analyst could not be a clients advocate. Neither could the analyst be an issue advocate, as no ambiguity and excluded values could be emphasized when analysis does not support advocacy.

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Source: Weimer and Vining (1999). Policy Analysis: Concepts and Practice (42)

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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 loanswhich ranged from Php3,000 to Php150,000without 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 methodthis 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
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worth of asset to do the same. The average cost per borrower of an NGO is US$70, while a banks 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$12millionsome NGOs are even bigger than some banks, whose average assets amounted to almost US$16millionmakes the NGO-MFIs potential sources of government revenues. For complete data, see Table 1 on next page.

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Computation of Taxes
Many NGO-MFIs, in practice, separate their financial incomes from other incomes when reporting their financial conditions, thus: 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;
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Financial Revenues Less: Financial Expenses Financial Income Add: Other Income Less: Other expenses Less: Tax

PhpXX,XXX.XX XXX.XX XXX.XX XXX.XX XXX.XX XXX.XX XXX.XX XX.XX

Gross Income (current tax base*) X,XXX.XX Net Income (Before Tax) (current tax base*) Net Income After Tax

*subject to the interpretation of the local BIR official

(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
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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 gapover a million dollars for three NGOsto be attributed to mathematical discrepancies or errors. (See Table 2 on next page.) Based on these two arguments, the BIRs 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.

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Public Policy Analysis: Income Tax Imposition on NGO-MFIs Page 14

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 efficientthat is, to be more conscious of their expenditures and capital investmentsand 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 figuresin 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.
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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 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 Less: Financial Expenses PhpXX,XXX.XX XXX.XX Less: Financial Expenses Financial Income Add: Other Income Less: Other expenses Less: Tax PhpXX,XXX.XX XXX.XX XXX.XX XXX.XX XXX.XX XXX.XX XXX.XX XX.XX

Gross Income (current tax base at 2% tax*) X,XXX.XX Net Income (current tax base at 35% tax*) Net Income After Tax

*subject to discretion of the local BIR official

Financial Income (proposed tax base at 5% tax) XXX.XX

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Public Policy Analysis: Income Tax Imposition on NGO-MFIs

Add: Other Income Gross Income Less: Other expenses Net Income (Before Tax) Less: Tax Net Income After Tax

XXX.XX XXX.XX XXX.XX XXX.XX XX.XX

X,XXX.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 Peoples 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
paid

PhpXX,XXX.XX XXX.XX XXX.XX XXX.XX XXX.XX XXX.XX XXX.XX XX.XX

Less: Financial Expenses Financial Income Add: Other Income Less: Other expenses Net Income (Before Tax) Less: Tax Net Income After Tax

Gross Income*(proposed tax base at 2%) X,XXX.XX

*net of sales returns, allowances, discounts and other costs of services including interest expenses

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.
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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 Microfinance Income Add: Other Revenues Trading of goods XXX.XX XXX.XX XXX.XX XXX.XX XXX.XX XXX.XX XXX.XX XXX.XX XXX.XX XX.XX
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PhpXX,XXX.XX XXX.XX XXX.XX

Less: Financial Expenses from Microfinance

Micro insurance

Income generating services

Total other revenues

Less: Cost of goods/service

Add: Net other income (proposed tax base at 32%) Less: Other operating expenses Net Income (Before Tax) Less: Tax Net Income After Tax

Total income from microfinance and other sources X,XXX.XX

Public Policy Analysis: Income Tax Imposition on NGO-MFIs

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 19

Financial Revenues Less: Financial Expenses Financial Income Add: Other Income Less: Other expenses Net Income (Before Tax) Less: Tax Net Income After Tax

PhpXX,XXX.XX XXX.XX XXX.XX XXX.XX XXX.XX XXX.XX XXX.XX XX.XX

Gross Income (proposed tax base at 2%) X,XXX.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 governments 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
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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 PCNCs main responsibility, then the accreditation of the NGO-MFIs for the similar purpose could be logically assumed in this office.

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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.

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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 BIRs 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 2 3 4
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- Poor - Neutral or mixed effect - Generally acceptable - Good

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 poors 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
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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
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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 taxsomething that does not support the both the BIRs 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 BIRs end, however, the inconsistency in its implementation is an indication of the status quos impracticality. 7.9.
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Based on the rating and criteria for evaluation, this alternative is given a score of

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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 expandespecially if they are not assured they could achieve dramatic expansion such that their marginal income would exceed the tax consequent to their growththus 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, BIRs collection will be more efficient since the provisions are no longer subject to different interpretations.
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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 countrys 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.

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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 MCPIs 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 operationsthough there is nothing in the alternative that may directly result in this NGO behaviorfor 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 MCPIs 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 BIRs goal. Further, BIRs 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 BIRthat is, BIRs loss is the NGOs gain and vice versathis alternative
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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.

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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 standardsespecially those who do not profile their clients yetand therefore not enjoy tax-exemption might pass
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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 BIRs 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.

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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.)

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RECOMMENDATION
Alternative 5granting income tax exemption to NGO-MFIs provided that they apply for it and that they meet the required performance standardsis 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.
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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 PCNCs 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.

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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.

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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 <http://www.bir.gov.ph/about/about.htm>. 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 <http://www.congress.gov.ph/press/details.php?pressid=3146>. 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 <http://www.mixmarket.org/>.

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