IMPROVING TAXPAYER SERVICES

ON FILING AND PAYMENT

COLLECTION MODES

George Manzano, Ph.D.

John Paul Vergara, Ph.D.
Elmer Aquitania
Edwin Siao
Anna Marie Mendoza, Ph.D.
Merle Asprer

November 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”.
Table of Contents

INTRODUCTION………………………………………………………………...…, 3

THE PROBLEM: ANALYSIS OF CORE PROBLEMS AND ISSUES……….... 4

EMERGING RECOMMENDATIONS FOR THE SHORT TERM:

ALTERNATIVE INCENTIVE ARRANGEMENTS…………………….………… 8
DESIRED CHARACTERISTICS OF AN INCENTIVE ARRANGEMENT:
A FRAMEWORK………………………………………………………….... 8

ANALYSIS OF ALTERNATIVE ARRANGEMENTS…………………… 10

Option 1: Increase float days for OTC transactions………………….. 11
Option 2: Increase days for OTC transactions, decrease days for
EFPS transactions……………………………………….....…...……. 12
Option 3: Impose a fixed transaction fee regardless of channel or
Amount................................................................................................. 14
Option 4: Per-bank variable float day arrangements............................. 16

PROCESS IMPROVEMENT RECOMMENDATIONS......................................... 20

PROCESS RECOMMENDATION 1: Decouple filing form payment............ 21
PROCESS RECOMMENDATION 2: Retain AAB Role in payment
processing; eliminate additional encoding requirements; Widen
payment options................................................................................................ 23
PROCESS RECOMMENDATION 3: Outsource return filing and
Encoding............................................................................................................ 23
PROCESS RECOMMENDATION 4: Strengthen back-end taxpayer
accounting and reconciliation............................................................................ 24

CONCLUSIONS........................................................................................................... 25

References....................................................................................................................... 27

ANNEXES

This study is made possible by the generous support of the American people through the United States
Agency for International Development (USAID), under the Contract of Grant No. 492-A-00-04-0024-00
Ateneo de Manila. The contents presented herein are the responsibility of EPRA and do not necessarily
reflect the views of USAID or the United States government.

No part of this document may be reproduced in any form or by any means without the prior written
permission of EPRA

2
Improving Taxpayer Services on Filing and Payment Collection Modes

I. INTRODUCTION

The Bureau of Internal Revenue’s (BIR) Tax Reforms Agenda identified the
enhancement of tax payments through Accredited Agent Banks (AABs) as a priority
measure. The objective of the task force is to undertake an overall review of tax
payments thru AABs and provide enhanced processes for prompt reconciliation and
revenue accounting. Assistant Commissioner Corazon Pangcog, head of the
Collection Service under the Operations Group and the Project Director for this
reform issue, requested the assistance of EPRA in providing an objective and
independent source of analysis and information on various stakeholders’ issues
regarding the manual filing and payment mode of collection.

Given the current state of the filing and collection systems (see Annex 1) , one of the
objectives of the study is to conduct and provide an empirical analysis on the
effective use of the float as an incentive mechanism to encourage AABs to provide
efficient and effective service in accepting manual and electronic filing and payment
modes of collection. In addition, efficiency changes from organizational and
technological improvements should complement the changes in the incentive
structure.

Thus, this paper employs a two pronged approach in dealing with the concerns over
the current AAB arrangement. The review and analysis of the float system will form
the core of the short-term recommendations, while the study on the process
improvement will address the longer term solutions to improving the general tax
payment and filing system.

The study consists of a diagnostic phase and a recommendation phase. This report
focuses on the recommendation phase of the study and includes:

1) A recap and summary of the problems and issues indicated in the diagnostic
report (see Annex 2)
2) A list of alternatives to the current float arrangement with the AABs
3) Long term process change recommendations on the filing and payment process

3
II. THE PROBLEM: ANALYSIS OF CORE PROBLEMS AND ISSUES

The diagnostic report (see Annex 2) identified the following problems and issues
regarding the filing and payment process:

‐ Long waiting times at the AABs in the acceptance and processing of tax payments
‐ Uneven bank practices and restrictions imposed by banks regarding the
acceptance of tax payments
‐ BIR-imposed penalties on the banks due to procedural/encoding errors
‐ Unreasonable number of fields required in the encoding of transactions
‐ BIR restrictions on out-of-district payments

The typical waiting time for over-the-counter (OTC) payments is 1-2 hours and
depends on the AAB branch, whether the payment is made during a tax deadline, and
on the arrival time of the taxpayer. One extreme case is with the Development Bank
of the Philippines (DBP) branch at Quezon Avenue servicing BIR Revenue District
Office (RDO) 39 and 40, where the average waiting time is 7 hours, taxpayers in that
area prefer the branch because it imposes little or no restrictions.

The study confirmed that restrictions are indeed imposed by AABs on OTC payments,
particularly:

o Designation of particular days and hours for the acceptance of tax payments
o Non-acceptance of other banks’ checks
o Unwillingness of EFPS-accredited banks to accept OTC payments

The above restrictions were observed in several AABs and indicate that bank
practices are indeed uneven. It also suggests that there are insufficient incentives for
AABs to comply and accommodate tax payments. In fact, consultations with the
banks yielded several additional complaints regarding the filing and payment process.

The AABs and the Bankers Association of the Philippines (BAP) have raised issues
regarding the difficulties of the present float system. One of the contentions, as was
expressed by the AABs and BAP, was that the float arrangement allowed by the BIR
is not enough to recover the AABs costs in providing the service 1 .

One complaint is about the unreasonable penalties imposed by the BIR on procedural
errors committed. Upon inspection of the actual penalties imposed, it was noted that
the amounts were not that significant: approximately P3.3M imposed, P0.6M paid,
and P0.4M paid total for all banks for the last three years (2004-2007). However,
these penalties are ultimately charged to the tellers from whose perspective the
individual amounts are steep.

1
Revenue Regulations No. 13-96 effectively allows the AABs accredited for the manual filing and
payment mode a float of five days while eFPS accredited banks are allowed four days’ float.

4
Moreover, the AABs have reservations about the additional regulatory burden
involved in the tax payment and filing process. In general, some AABs feel that the
additonal requirements imposed on them by the BIR in the task of servicing tax
payments are onerous and largely uncompensated. The AABs admit that many of
their complaints stem from the amount of encoding that comes with the handling of
the tax payments. A Limited Bank Data Entry System (LBDES), provided by the
BIR, is used by the AABs to encode the tax transactions during a business day.
Between 6 to 12 fields per transaction are encoded through LBDES, often done by the
AABs in the backend, after the transactions have been carried out. This encoding
task (the associated number of fields per transaction) is irregular from the point of
view of the AABs particularly when compared to the other transactions that they
service (e.g., utility bill payments), which have relatively simpler encoding
requirements. Errors (and consequently penalties related to those errors) are therefore
more likely in the case of tax payments.

In addition, the BIR is requiring a one-day turnaround of tax returns/documents that

need to be forwarded to the BIR district office from the banks. This results in hiring
of additional contractual personnel for the banks to handle the documents, adding to
the banks’ costs. A more generous allowance for turnaround time can lead to cost
savings by the AABs. The whole filing and payment process, particularly the
OTC/LBDES is deemed tedious, time consuming and therefore costly.

One other AAB complaint is also a taxpayer complaint: tax payments are only
allowed on the district where the taxpayer belongs. However, the restriction is not
absolute, since it is waived for exceptional cases and during peak periods. The reason
why out-of-district transactions are discouraged is, for the most part, due to the
implementation difficulties associated with the requirement that the paper return has
to be eventually transmitted to the correct district. Other reasons identified include
difficulties with proper per-district revenue accounting and stop-filer detection, but it
was noted that these were technically addressable through the BIR’s information
system (ITS).

From the standpoint of the banks and taxpayers, allowing out-of-district payments
provides more flexibility and greater convenience. For banks, out-of-district
payments enable the possibility of servicing the tax payments of their accountholders
which enhances the level of their service and decreases the transaction costs of their
clients. For taxpayers, out-of-district payments offer more payment alternatives and
greater convenience and lower compliance cost, as a consequence.

The consultants observe that at the core of the problems and issues identified is the
current incentive arrangement with the AABs. The tenor of the problems raised by
the AABs, the BIR and the taxpayers requires a revisiting of the current float
arrangement. The noticeable disparity in the level of service between taxpayers
paying through OTC and eFPS (an online payment channel) points to an incentive
problem. Perhaps the float system, currently used to compensate the AABs for the

5
service of tax payments and filing, may not be ideal in meeting the needs of the
AABs nor the BIR. On the other hand, perhaps the float system is still a workable
system but the parameters (float days) may need to be adjusted. Either way, an
analysis of the present system is in order to determine if indeed there is an incentive
problem that needs addressing.

The core of the problem lies with the uneven incentive structure between servicing
OTC/LBDES and eFPS. Given assumptions AABs, under the present float system,
hardly make adequate margins in catering to OTC/LBDES transactions. On the other
hand, the returns on processing eFPS are very high. The combination of higher float
revenue (arising from higher transaction value) and low cost of services, make the
eFPS mode more attractive. In addition, AABs are more exposed to operational risks,
such as those incurred in errors of keying in fields, in the OTC/LBDES mode than the
eFPS. Furthermore, costs associated with congestion in the banking premises are
higher in OTC/LBDES.

The incentive arrangement depends on float revenue and the current policy is that a 5-
day float is given to the AABs for OTC/LBDES transactions, while a 4-day float is
given for EFPS transactions. Naturally, float revenue will depend on the actual peso
amounts; the following table shows the approximate amounts, the number of
transactions coursed through these two channels, and the resulting revenues using
2006 data (see Annex 4 for a discussion on the float arrangement):

Table 1: Profile of Payment Channels

AVERAGE AVERAGE
PAYMENT TOTAL NUMBER OF TRANS FLOAT FLOAT
CHANNEL AMOUNT TRANSACTIONS AMOUNT DAYS REVENUE
LBDES 172,212,240,008 8,411,682 20,472.99 5 13.86
EFPS 342,782,464,409 345,971 990,783.81 4 536.67

The above table assumes an annual interest rate of 6.09375% (less applicable
withholding taxes). Transactions coursed through the EFPS average around PHP
990,000 per transaction while LBDES transaction amounts are around P20,500 only.
The resulting float revenues per transaction (536,67 and 13.86, respectively) are
disproportionate particularly if one considers that EFPS transactions cost less than
LBDES transactions from the point of view of the bank. The following data shows
the discrepancy in returns per transactions of the two channels, given assumptions:

6
Table 2: Float Revenue, Cost of Service and Estimated Margins:
AVERAGE
PAYMENT FLOAT AVERAGE ESTIMATED
CHANNEL REVENUE Cost of Service MARGINS
LBDES 13.86 31.71 (17.85)
EFPS 536.67 7.02 526.66

Comparing average costs with average revenues, it was clear that there is a major
flaw in the current float incentive arrangements. The average float revenue of eFPS is
more than 38 times that of average OTC revenues. In addition, the cost of an eFPS
transaction is more than 4 times lower than that of OTC transactions.

With the current system, it is not surprising that OTC attributes serve as a
disincentive for AABs to service clients (more so for non-clients) via that mode. An
AAB’s tendency to accommodate EFPS transactions and turn away OTC transactions
stems from this disproportionate float revenue.
Because of this, the bulk of OTC transactions fall into the hands of government banks
such as LBP and DBP. This situation further magnifies the difficulties as it becomes a
question of capacity for these banks. Limited capacity causes congestion and long
lines and added inconvenience to taxpayers.

All told, the current incentive structure is skewed towards servicing eFPS than
OTC/LBDES. The paucity of complaints on the part of the taxpaying public, the BIR
and the AABs in the eFPS mode relative to the number of issues under the
OTC/LBDES is symptomatic of the core problem of uneven returns in the present
system.

7
III. EMERGING RECOMMENDATIONS FOR THE SHORT TERM :
ALTERNATIVE INCENTIVE ARRANGEMENTS

This section provides different options for alternatives on the current float
arrangement. A framework on the ‘ideal’ characteristics of an incentive system is
proposed first. Thereafter, alternative systems are evaluated according to the extent to
which they possess the desired characteristics.

DESIRED CHARACTERISTICS OF AN INCENTIVE ARRANGEMENT: A

FRAMEWORK

The general objective of the search for an alternative incentive system is to maximize
the efficiency of AAB tax collection subject to acceptable returns of AABs and levels
of convenience to taxpayers. One behavioral assumption running through the
discussions refers to the link between level of service of AABs and returns. Of
course, while it may follow that addressing an incentive problem may result in
improvement in service levels, there is still a need for monitoring.

By and large, the arrangement should incorporate features where banks ‘run’ after
taxpayers, or that the expectations of taxpayers are not frustrated (i.e. turned away).
This would mean an overall and general improvement in the level of service provided
by the AABs to the taxpayers as a whole.

The following set of criteria is proposed to serve as an indicator of the relative

desirability of the different alternative incentive arrangements:

• Lower cost to government, on the aggregate: Using the foregone interest

rates due to the float for 2006 as benchmark for the cost to government, the
lower the aggregate cost of the alternative arrangement, the higher its
desirability.

• Adequate returns to recover cost and provide reasonable margins to AABs.:

The AABs consider the tax filing and payment service as a business
proposition which competes with other bank operations. Hence, banks should
not only earn from this operation but should have acceptable returns to cover
the opportunity cost, unless there are strategic considerations to operate at
below required rate of returns or even at a loss. Because the current concern
revolves around reported lapses in levels of services in the OTC/LBDES, an
arrangement that generates reasonable returns to processing OTC/LBDES per
transaction should be desirable.

• More equitable distribution of benefits across AABs: In addition, a better

incentive structure is one that improves the returns across banks i.e. make the
service viable.

8
 • Predictability of revenue/benefit derived from the service: The predictability
of the stream of benefits from tax and filing service provided by the AABs is
desirable as it allows them to plan ahead and/or facilitate investment
decisions.

• Productivity-Based: The more clients serviced, the greater the revenues. With
an incentive arrangement linked to the number of transactions processed,
AABs will find it advantageous to service as many taxpayers given their
capacity constraints. Moreover, this characteristic creates incentives to invest
in efficiency enhancing measures which benefits both the taxpayer and the
service provider.

• Able to provide smoother adjustments to structural changes: A ‘dynamic’

incentive arrangement is one that has a built-in mechanism to adapt to the
changing structural variables. For example, in the case of tax filing and
payments, variables that change over time include total amount of tax
collections, number of transactions/taxpayers, costs of service, among others.
When one or more of these variables change, the required revenue to recover
costs will also change. Banks’ motivation and long-term efficiency will
depend on how flexible the incentive arrangement is to adjust to given
changes in the aforementioned parameters.

• Ease of implementation and administrative feasibility: A desirable

arrangement is one that can be implemented. Thus, an arrangement that
requires action that exceeds the administrative capacity of the BIR is less
desirable. Note that the implementation constraints could also include political
feasibility apart from the purely administrative ones.

• Equal incentive on payment modes: The incentive arrangement should be

equal for both eFPS and OTC filing and payment modes. This is so that the
banks will be indifferent and service taxpayers with equal efficiency and
enthusiasm, regardless of the mode.

The status quo is the benchmark for the criteria on aggregate cost to government. All
subsequent alternative arrangements can be compared to the extent that they result to
a lower cost to government in terms of foregone interest earnings. Clearly the present
arrangement does not satisfy the adequate ‘returns’ nor the does it address the
distribution of benefits across individual AABs. Banks that have portfolios oriented
heavily to eFPS naturally tend to be more profitable given the superior revenue and
cost structure of eFPS relative to OTC.

The status quo is indirectly based on productivity, as the more transactions are
processed, the higher revenues. However, the great disparity in returns among the
modes mitigate against servicing more OTC transactions (which has emerged as a
core problem that prompted this study). Structurally, the present system is quite static
and rather invariant to the changes in the parameters (interest rates, cost of service,

9
etc.) It is however, easy to implement as the controls on the float lies within BIR
controls.

ANALYSIS OF ALTERNATIVE ARRANGEMENTS

The per-transaction float revenues presented in the previous section highlight the
current scheme’s dependence on the values of the amounts collected. OTC
transactions have significantly lower average transaction amounts resulting in smaller
float revenues. One immediate response is to increase the float days allocated for
OTC transactions. Consequently, such a revision in float days for OTC transactions
would also suggest a decrease in float days allocated for EFPS transactions.

Ideally, an incentive scheme based on the number of transactions accommodated is

preferred, regardless of the amounts collected. This suggests a transaction-fee based
approach, where banks are compensated with a fixed fee per transaction served,
instead of through float revenues. A hybrid approach, on the other hand, uses float
revenues to implement transaction fees; that is, float days are adjusted on a per-bank
basis so that revenues approximate the transaction-fee based scheme.

The following summarizes these incentive alternatives:

Option 1: Increase float days for OTC transactions

Option 2: Increase float days for OTC transactions; decrease float days for EFPS
transactions
Option 3: Impose a fixed transaction fee regardless of payment channel or amount
Option 4: Per-bank variable float day arrangements

To enhance the effectiveness of some of the above schemes, the arrangements may be
limited to particular AABs:

Bank Selection Option 1: Designate only a few AABs to handle both OTC and EFPS
transactions
Bank Selection Option 2: Designate particular AABs for OTC walk-in transactions;
Other AABs voluntarily handle the OTC/EFPS transactions
of their accountholders

The first option allows the banks to benefit from the volume brought about by the
designation. The second option rewards banks that accommodate the largest sector of
these tax payments—OTC payments from non-accountholders, while giving other
AABs the choice to accommodate their accountholders. Both options may provide
enough incentives for the banks to invest on resources to make the payment process
more efficient and accommodating.

10
 Option 1: Increase float days for OTC transactions

Increasing float days for OTC transactions so that the resulting revenues would
provide sufficient incentives requires understanding and quantifying bank costs.
Some banks provided their respective cost data per OTC transaction and the average
cost reported is P31.71 per transaction. The float revenue per transaction must
therefore be at least this amount so that bank costs are covered. Using this as a basis,
a 12-day float appears to be the reasonable2 policy:

FLOAT DAYS AVERAGE AVERAGE NET

FLOAT COST
REVENUE
5 (current) 13.86 31.71 (17.85)
12 (proposed) 33.27 31.71 1.56

The above table uses 2006 data for purposes of comparison. The same assumption on
interest rate is used (6.09375% annual interest rate minus 20% tax). Note that
transaction costs and float revenues vary from bank to bank and different net incomes
will result, not necessarily ensuring a positive net income for all banks. Furthermore,
this option increases the cost to the government as it clearly doubles OTC float
revenues provided to the bank. Total cost to government will increase from
P331,728,393 to P510,876,960 using 2006 average 91-day T-Bills rate of 5.35%. The
following table compares consequences on total AAB float revenues for 5 days and
10 days using 2006 figures:

FLOAT DAYS TOTAL APPROXIMATE

FLOAT TOTAL COST
REVENUE
5 (current) 302,318,557 269,244,838
12 (proposed) 465,621,168 269,244,838

The total cost column is computed by multiplying the number of transactions with the
average transaction cost of P31.71.

There is an important caveat however. Given 2006 tax collection data, the current
SDA rate, and average historical margins of the AABs, an increase from 5 days to 14
(or 15) days is most advisable as this recovers the cost and allows bank to earn a
mark-up of 20% - 30% of their costs (See Annex 5 on “Summary Mark-up”). A float
of 12 days will allow them to recover their costs only and earn a minimal spread
mark-up of 5%. However, if one considers the service as just a value-added benefit
2
See Annex 6 which reports on the simulation of the impact to government and AABs of different float
days for OTC/LBDES transactions.

11
 provided by the AABs to their customers, and therefore they would be willing to earn
less mark-up (from the average of 102% to 30%), 15 days of float will cover total
expenses plus a slight mark up. However, an adjustment to 15 days in foregone float
revenues to the government may be too drastic in light of the initial condition of 5
days. Hence, for simulation purposes, a float of 12 days was chosen.

Pros and Cons: The consequences of this policy was simulated and applied to all
banks using 2006 data. It was observed that for the current arrangement, 9 out of 21
banks yielded positive net incomes; for this proposed arrangement, 15 out of 21 banks
yielded a positive net income, while still leaving 6 banks with a negative net income,
mainly because their average transaction amounts were lower than the norm. Clearly,
while this arrangement improves the margin of banks on OTC operations (per
transaction basis), it does not even out the distribution of benefits across banks.

Structurally, save for the altered float days for OTC, this option is identical to the
status quo. Hence, this arrangement suffers from the same limitations of the current
float arrangement (indirectly productivity-based, not dynamic). From the
government's point-of view, the greatest advantage this option promotes, aside from
its being easy to implement, is that it provides additional incentive for AABs to
service more OTC transactions, increasing the profitability of servicing OTC and
equalizes to a slight degree the incentive on modes. These factors can be expected to
lead to better service efficiency relative to the status quo.

The implementation of this option is also reasonably straightforward. The BIR will
just have to increase the allowed number of days float for OTC collections, to a level
that is sufficient enough for AABs to earn a certain margin.

Option 2: Increase days for OTC transactions, decrease days for EFPS transactions

Under the status quo, AABs make considerably higher returns on eFPS than on OTC.
One of the shortcomings of the previous option is that it increases the cost to the
government in terms of forgone interest. Another option that emerges is that the
increase in the number of days float allowed for the OTC could be balanced by the
shortening of the allowed corresponding days float in eFPS.

A similar analysis applies for EFPS transactions. EFPS transaction costs provided by
banks average P7.02 which indicates that the current 4-day float policy is excessive.
A 1-day float policy will in fact more than cover transaction costs 3 :

3
Annex 6 discusses the impact of changing the float days for eFPS and OTC under the second option.

12
Table 5: Simulation Results: eFPS, per transaction Float revenues, cost and net
FLOAT DAYS AVERAGE AVERAGE NET
FLOAT COST
REVENUE
4 (current) 536.67 7.02 529.66
1 (proposed) 134.17 7.02 127.15

Total float revenues and costs for all banks (for EFPS transactions only) are shown in
the following table:

Table 6: Simulation Results: eFPS, Aggregate float revenues and costs

FLOAT DAYS TOTAL APPROXIMATE
FLOAT TOTAL COST
REVENUE
4 (current) 185,673,835 2,428,716
1 (proposed) 46,418,459 2,428,716

The total impact on banks, considering both EFPS and OTC transactions is shown
below:

Table 7: Simulation Results: combination eFPS and OTC: Aggregate float revenues
and costs
FLOAT DAYS TOTAL APPROXIMATE
FLOAT TOTAL COST
REVENUE
5 for OTC, 302,318,557 269,244,838
4 for EFPS (current)
12 for OTC, 326,365,792 269,244,838
1 for EFPS
(proposed)

Note the slight increase in total float revenues implying that the increase in revenue
for OTC transactions in this option exceeds the corresponding revenue decrease for
EFPS transactions.

The consequences of this policy was also simulated and applied to all banks using
2006 data. The proposed scheme yielded 15 out of 21 banks with positive net
margins (an increase of 6 banks from the current scheme).

Pros and Cons: The advantages and disadvantages of this option are very similar to
the benefits and drawbacks of the previous option (increase OTC float, and retain

13
eFPS float). This option is also easy to implement and it likewise provides additional
incentive for AABs to service more OTC transactions. Furthermore, it somewhat
equalizes the benefit derived by AABs on both modes (by increasing benefit for OTC
and limiting benefit for eFPS).

However, there are also two main drawbacks for such an option. Just like the previous
one, it increases cost to government (compared to the current arrangement). Because
this option is structurally the same as the status quo, the float revenue from the float
will still be relatively unpredictable particularly if the factors largely beyond their
control such as interest rates become very volatile.

Option 3: Impose a fixed transaction fee regardless of channel or amount

The problem with a scheme that uses the float and imposes a uniform number of float
days for all banks is that the resulting revenues are proportional to the amounts
collected instead of the number of transactions served. Particularly since EFPS
transactions yield significantly larger revenues than OTC transactions, the distribution
of EFPS and OTC transactions factor much into the resulting revenues for each bank.
Even average float revenues for each channel vary per bank. For instance, consider
the cases of UNIONBANK and METROBANK:

Table 8: Sample Bank: Unionbank, Float revenue, transaction and cost

UNIONBANK
TOTAL FLOAT REVENUES: P49.28M from 61,558 transactions

AVERAGE AVERAGE
PAYMENT TOTAL NUMBER OF TRANS FLOAT FLOAT
CHANNEL AMOUNT TRANSACTIONS AMOUNT DAYS REVENUE
LBDES 1,032,225,022 18,042 57,212 5 38.74
EFPS 89,690,051,585 43,516 2,061,082 4 1116.42

Table 9: Sample bank: Metrobank, Float revenue, transaction and cost

METROBANK
TOTAL FLOAT REVENUES: P12.22M from 593,833 transactions

AVERAGE AVERAGE
PAYMENT TOTAL NUMBER OF TRANS FLOAT FLOAT
CHANNEL AMOUNT TRANSACTIONS AMOUNT DAYS REVENUE
LBDES 10,787,232,421 538,716 20,023 5 13.56
EFPS 9,081,274,762 55,117 164,764 4 89.25

14
 It is evident from the above tables that incentives are not linked to the number of
transactions served particularly when collections, transactions, and average float
revenues are viewed on a per-bank basis.

The ideal arrangement is to compensate the AABs using a fixed fee per transaction
regardless of payment channel. A fee based incentive system incorporates many
desirable qualities: transparent, predictable, efficient (i.e. productivity based), among
others. More importantly, it is more market oriented and hence, requires less
administrative intervention than the current scheme. The scheme effectively rewards
AABs that serve as many OTC transactions as possible. In the cases of
UNIONBANK and METROBANK, for instance, supposed a fixed fee of 38.50 pesos
per transaction was imposed:

Table 10: Simulation results for specific banks; Fee-based results

BANK TOTAL FEE-BASED FLOAT-BASED
TRANSACTION REVENUES REVENUES
COUNT (PROPOSED) (CURRENT)
UNIONBANK 61,558 2.37M 49.28M
METROBANK 593,833 22.86M 12.22M

The fee may be based on the average revenues collected in the current scheme (38.50
in the above example), and should actually depend on average bank transaction costs 4 .

The computational details in the above table are provided below. Let:

AMOUNT = total tax amount collected by a given AAB

TRANSACTIONS = the number of transactions accommodated to collect this
amount for both EFPS and OTC
DAYS = number of float days provided by the BIR
REVENUES = resulting total revenues from the collection activity, interest revenue
accruing to the AABs
DAILYRATE = daily interest rate used in computing for the interest revenue for
AABs from the float arrangement
FEE = desired per-transaction revenue

The current float-based scheme is dependent on AMOUNT, that is,

REVENUES = AMOUNT*DAYS*DAILYRATE

where DAYS is a quantity uniformly applied to all banks (4 or 5, depending on

payment channel).

4
See Annex 6 for the simulation of the impact of the fee based arrangement on the individual AABs.

15
The fee-based scheme, on the other hand, is dependent on TRANSACTIONS and
FEE, that is,

REVENUES = TRANSACTIONS*FEE

which implies a resulting revenue stream that is directly proportional to transaction

volume.

Pros and Cons: Aside from simplicity, a fee-based arrangement has all the desirable
qualities of an AAB incentive arrangement. First, the fee can be set to allow banks to
earn a certain percentage as margin based on their costs. Since per transaction
revenues are fixed and predictable, AABs have an incentive to lower their transaction
costs to be able to gain better margins. This will encourage efficiency among banks
and will eventually benefit the taxpayers.

A fee-based arrangement can also equalize incentives on payment modes. Fees can be
set based on average AAB cost plus margin for each service. As discussed earlier, a
fee-based incentive arrangement is inherently a productivity-based incentive
arrangement. Since fees will be awarded on the basis of the number of transactions,
the more taxpayers served, whether via eFPS or OTC, the higher the benefits that
AABs receive.

The fee agreement, can be renegotiated or modified when conditions require such
adjustment due to a shift in the structural variables, for example.

From the government's point-of view, a fee-based arrangement does not necessarily
increase costs. As can be seen in the section below, the proposed fee of PhP38.50 per
transaction will only result to a 2% increase on the cost to government, lower
compared to the higher costs of the first and the second options. Furthermore, since it
is productivity based it is expected to result in an increase in the efficiency of service
provided by AABs to taxpayers.

The only, and most significant disadvantage of a fee-based recommendation pertains

to the legislative action required for budget appropriation. Since this type of
arrangement would require the BIR to explicitly shoulder the fee, the
recommendation may entail a lengthy legislative debate. Thus, an implementation
problem with this ideal scheme is that it requires legal and budgetary policy revisions.
To avoid these constraints, the scheme can be approximated by implementing bank-
specific float arrangements, that is described next.

Option 4: Per-bank variable float day arrangements

Instead of a direct fee transfer by BIR to AABs for collection services, the
compensation of the AABs can be calibrated by allowing them to earn interest

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revenue via float days that varies with their ‘productivity.’ In essence, the granting of
float is the payment channel of BIR to the AABs for the service of tax collection.

The proposal is to make the float arrangement based on the average transaction
amount collected by each bank and adjusted so that it approximates the desired
“transaction fee”. Put another way, allowing banks to earn interest from float has the
same effect as paying them a fee to process tax payments. Because different banks
process different tax amounts and transactions, in theory they should receive varying
fee payments. The different amounts of fee payments can be proxied under the
scheme of variable float days, which can be “reverse-computed” for each bank by
equating the two formulas:

AMOUNT*DAYS*DAILYRATE = TRANSACTIONS*FEE

which results in

DAYS = (TRANSACTIONS*FEE) / (AMOUNT*DAILYRATE).

Equivalently,

DAYS = (FEE/DAILYRATE) / (AMOUNT/TRANSACTIONS).

In the above equation, the quantity in parentheses is the average transaction amount
for the given AAB.

For example, using the cases of UNIONBANK and METROBANK:

Table 11: Float days for sample banks from variable approach
BANK AMOUNT TRANSACTIONS DAYS
UNIONBANK 90,722,276,607 61,558 0.19
METROBANK 19,868,507,183 593,833 8.28

Float days should be in whole numbers, so a rounding step is necessary. Also, a

minimum and maximum number of float days could be imposed (for example, at least
1 day and at most 10 days float, regardless of the result of the formula). The
minimum float days will account for the minimum payment that AABs receive for
processing tax payments, as their cost of service is not zero. The maximum float
should, in theory, be placed as a safeguard to control the implicit cost of BIR in
processing tax payments through the AABs. These rules will unfortunately result in
some variance between the expected revenues and actual revenues for each bank.

Necessarily, data from a previous period or periods will have to be used to compute
the number of float days for a future period. In fact, at least a 2-period lag is
inevitable because some time is needed to finalize and reconcile the transaction data

17
after the end of a period. This means that alternating periods’ performances will be
used as the benchmark to calculate for the period after the upcoming period. For
example, period 1’s data is used to compute for the banks’ number of float days for
period 3, not period 2. Period 2’s data, in turn will be used to obtain period 4’s banks’
number of float days, and so on. The setup will turn out to be most appropriate if
each period is a semester (i.e., January to June or July to December) of a given year
since semestral conditions are similar across years.

A straightforward setup is to compute float days from the data in a previous semester
(using the formula given above) to be imposed for the same semester the following
year. The period between the two semesters could then be used to reconcile and
finalize the transaction amounts and numbers, as well as negotiate and settle other
parameters such as the transaction fee and interest rate.

Upon presentation to the MANCOM of the BIR of this variable float day option, a
system was proposed where declarations are made by the AABs on float income and
tax transactions processed, to be audited later by the BIR. In this system, each bank
is assigned a Tax Filing & Collection Account. This account will be used to monitor
each accredited bank’s total float revenues versus fees due. At the end of each period,
the account will have a balance computed as follows:

ENDING BALANCE = BEGINNING BALANCE

+ (AMOUNT*DAYS*DAILYRATE)
- (TRANSACTIONS*FEE)

Before the first period, each bank’s Tax Filing & Collection Account balance will be
set to zero. At the end of a period, a positive balance means there is excess float
revenue, a negative balance means BIR “owes” the banks for transactions carried out.

For this option, the DAYS quantity is computed based on a projected total collections
figure (AMOUNT) and a transaction count figure (TRANSACTIONS) for the
upcoming period. The intent is to have an ending balance of zero at the end of that
period, although during implementation, it will be rare that the balance will actually
be zero.

Projections on AMOUNT and TRANSACTIONS may be based on previous periods

but during end-of-period computations, the actual quantities for that period will be
used.

The following steps summarize the process under this option:

(For purposes of demonstration, we suppose it is the beginning of period P. Let P-1
and P+1 denote the previous and succeeding periods, respectively.)

1. Each bank provides a statement at the beginning of period P as follows:

‐ For period P-1: Beginning and ending balances using actual figures

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 ‐ For period P: Projected ending balance using projected figures and approved
float days for period P
‐ For period P+1: Projected ending balance using projected figures and
proposed float days for period P+1

2. BIR validates each bank’s declaration, reviews/disputes the figures used, resulting
in an approved number of float days (DAYS) for period P+1

3. Implement period P. At the end of period P, go to step 1.

Computation of DAYS for period P+1 is as follows:

BEGBAL = Balance at the end of period P (projected);

equivalently, this is the projected balance at the beginning of period P+1
AMOUNT = Projected collections for period P+1
DAILY RATE = Projected daily rate for the period P+1
TRANSACTIONS = Projected transaction count for period P+1

DAYS = ((TRANSACTIONS*FEE) – BEGBAL)/( AMOUNT *DAILYRATE)

Pros and Cons: Since the variable float mimics the ideal-fee based incentive arrangement,
it also has all the structural advantages of the fee-based arrangement (productivity based,
equal incentives to modes, etc). The built-in review system in the implementation plan
provides a ‘dynamic’ mechanism for adjustment to changes in structural variables. More
importantly, unlike the fee-based arrangement, this variable float incentive does
not require legal and budgetary policy revisions which can take several years to acquire.
The likely limitation of this option pertains to the relative administrative complexity of
implementing the plan, as this demands periodic renegotiation of float days by the BIR
and the AABs.

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IV. PROCESS IMPROVEMENT RECOMMENDATIONS

From the viewpoint of the taxpayer, the filing and payment process is
straightforward: the tax return and associated payment are presented to a teller at the
AAB and then the taxpayer waits for a copy of the return indicating that the
transaction is complete. The process takes around 1 minute per transaction, usually
less than a minute if all documents presented are in order.

From the viewpoint of the AAB, the front-end process is also relatively
straightforward: the payment and return is received and validated for completeness
and compliance, and then encoded into the bank’s IT system; a copy of the return is
then returned to the taxpayer. At the bank-end, these returns are batched and then
encoded into the LBDES (Limited Bank Data Entry System); LBDES encoding (6-12
fields, depending on type of tax and payment) takes less than 1 minute per transaction.
The batched data are then submitted electronically to the BIR while the batched tax
returns are later on picked up by a BIR RDO representative.

Although the filing and payment process itself is straightforward, there are still
complaints from taxpayers and banks. One common issue is the relatively long
waiting time at an AAB before a transaction is entertained (the transaction itself
usually takes less than a minute, once the taxpayer reaches the teller counter).
Another common issue relates to the day and/or time restrictions imposed by some
AABs which limit the locations the taxpayer can go to for tax payments. On the side
of the banks, the most common issue is the additional encoding task the banks have to
bear, coupled with a float incentive perceived to be insufficient (see previous section).

Banks process many other payments: phone, electricity, water, cable, and credit card
bills to name a few. Bill payments for these cases generate less complaints from both
the consumers and the banks because the paper requirements as well as the encoding
requirements are simpler—typically only a bill accompanies the payment and only an
account number and the payment amount is needed during encoding. In addition, the
consumer has other payment options: payments through phone-banking, ATM, or
internet-banking as well as Bayad Centers.

A general direction in the long term is to target a level of convenience similar to

utility payments. Consequently, this means preparing the filing and payment process
so that other payment alternatives are enabled. One main stumbling block is that the
submission of a document (the tax return) has to be done simultaneously with the tax
payment. This requirement in fact distinguishes tax payments from other payments
that banks process and is a main reason why many alternative channels are almost
immediately discounted. The following list of process improvement
recommendations begins with addressing this restriction and proceeds with
possibilities that open up as a result.

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PROCESS RECOMMENDATION 1: Decouple filing from payment.

Separating payment from filing releases the restriction of having only one entity
facilitate and handle taxpayer transactions. Payment processing and return filing
require different activities and expertise: payment processing primarily involves
financial accounting and reconciliation while return filing involves information
verification and manual collation of forms.

The following diagram presents the current state of the OTC filing and payment
process:

Figure 1: Current State OTC Filing and Payment Process

The next diagram summarizes the process change recommendation:

Figure 2: Change recommendation

The decoupling allows banks to focus on what they are used to: processing payments.
This is desirable from their viewpoint and will lessen their information processing
and manual return collation obligations. The taxpayer now has two logical steps to
carry out: payment and return submission. These do not necessarily have to be done
in separate locations and the order in which these two steps are carried does not
matter: payment can occur before or after filing. The following diagram depicts the
case where payment is made after filing:

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Figure 3: Process where payment is made after filing

Here, a return is filed and some verification that all information is in order is fed back
to the taxpayer, after which the payment is made. In some sense, the electronic filing
and payment system (EFPS) follows this flow: online filing is carried out thru the
BIR’s server, and when that is completed, an electronic online payment is made with
the bank.

The order can be reversed as shown in the next diagram:

Figure 4: Alternative sequence for payment and filing

Here, a payment is first made, a payment confirmation is received and then the
confirmation is presented with the return during filing. In some sense, the ESM
(efficient service machine) currently in operation with LandBank follows this flow.

Notice that both flow proposals already have corresponding instances already in
operation. However, for these examples, the steps are still tightly coupled in the
sense that payment and processing still have to be done at the same time, and, at least
in the case of the ESM example, handled by the same entity. Nevertheless, these
examples demonstrate the feasibility of the recommendation to decouple these steps.

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The reason for the tight coupling, in theory, is to minimize the risk of discrepancies:
the possibility that a return is filed without payment or that a payment is made
without a return filed. These discrepancies, in turn, increase the burden of
reconciliation from the BIR’s standpoint. On the other hand, tight coupling also
increases the risk of anomalies particularly if the same entity (in the current case, the
AAB) is in charge of both components: the case where both a return and its
corresponding tax payment are omitted upon submission to the BIR is a case that is
often left unchecked.

We stress that the main advantage of this recommendation is that many alternatives
open up, as described in the next recommendation.

PROCESS RECOMMENDATION 2: Retain AAB role in payment processing;

eliminate additional encoding requirements, widen payment options.

Banks will more willingly handle tax payments over the counter if the associated
return handling and encoding requirements are eliminated. If only a TIN (taxpayer
identification number) and a tax payment amount are needed during the transaction,
then it matches most of the other payments the banks process. It is understandable
that some essential additional information might be required such as tax type and tax
period but the extra information, in theory, can be encoded in a few additional digits
as an extension to the TIN. For example 111-222-333-1-3 might mean the taxpayer
whose TIN is 111-222-333 is paying tax of type 1, for period 3. Banks would
typically tolerate up to 16 digits and possibly more which is more than sufficient for
tax payments.

More importantly, payment options will widen. For example, internet and phone
banking payments are now enabled (because associated returns do not need to
accompany the payment), using the banks current online infrastructure. These modes
often have a payment confirmation number which could be used to verify payments
when reconciling against corresponding tax returns. Channels available in the cases
of utility and credit card payments such as Bayad Centers are now likewise available.
Annex 3 provides more detailed descriptions and examples of these channels (e.g.,
internet banking and Bayad Centers).

Convenience to the taxpayers will increase because the banks will be more willing to
accommodate the payments and more payment channels will be available.

The return filing component in the transaction is described next.

PROCESS RECOMMENDATION 3: Outsource return filing and encoding.

In an ideal setting, the BIR should handle return filing and encoding but taking into
account capacity constraints within the Bureau, the possibility of outsourcing these

23
activities should be considered. While there are confidentiality issues these can often
be addressed though taxpayer consent. Taxpayer agents or consolidators either as
individuals or business entities can take part in this filing process and serve as liaison
between the taxpayer and the BIR as far as return filing and encoding are concerned.

Concretely, from the point of view of the taxpayer, a typical tax transaction might
involve a payment to a bank or Bayad Center, and then a submission of the payment
confirmation together with the tax return to a third party tax consolidator or agent.
The consolidator then encodes and submits tax information (and returns, as
necessary) to the BIR. This might pose convenience problems for the taxpayer since
two entities need to be dealt with. One strategy is to enable delivery arrangements
between these two entities so that a taxpayer deals with only one entity, for example,
the bank or the Bayad Center.

There will be associated charges and these could be shouldered either by the taxpayer
or the BIR.

PROCESS RECOMMENDATION 4: Strengthen back-end taxpayer accounting and

reconciliation.

Once the point is reached where payment processing and return filing are handled by
separate entities, it is inevitable that reconciliation activities in the BIR will increase.
This necessitates a stronger position with respect to taxpayer accounting: the Bureau
should be able to establish all payments made by a taxpayer and all returns that
taxpayer filed. Reconciliation between these two components (payment and filing)
will be done regularly and perhaps fed back promptly to the taxpayers and the tax
consolidators.

In many respects, the current state of the process places the burden of proof for
payment and return filing to the taxpayer, which is why taxpayers expect their returns
stamped when they pay and file (perhaps to be shown to an investigator during audit).
The proposed scenario is that the BIR more actively establishes payment and return
information and provide a statement to the taxpayer regarding previous payment and
filing activity as soon as possible after the activities are carried out. This can be
likened to the way our utility bills or bank statements are presented to consumers:
information on previous consumption or payment activity is shown together with the
current month’s bill.

Many other advantages in other areas in the Bureau will emerge once this proposed
state is reached. Taxpayer assistance and audit services, for instance, will improve
once some level of maturity is reached with respect to filing and payment accounting,
since the same information is used by the assistance and audit sectors of the Bureau.

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 V. CONCLUSIONS

From the feedback gathered as well as the verification of the diagnostic report, it
appears that neither the BIR, the taxpaying public, nor the AABs were completely
satisfied with the current arrangement of compensating the AABs for tax collection
and filing services. The consultants traced the core problem to an incentive issue
surrounding the OTC transactions. The efforts at resolving the incentive problem is
then directed towards exploring alternative incentive arrangements.

Inasmuch as the system of tax collection and filing operates in a changing

environment, a two pronged approach to improve the current system is proposed.
Because alternative incentive arrangements can be implemented relatively quickly,
they form part of the short-term solutions. Four main options are proposed in this
study. A matrix that outlines the desirable characteristics of the different options is
provided below as a summary:

Table 12: Summary Matrix of Alternative Arrangements and Characteristics

FLOAT OPTIONS
Option 1: Option 2: Option 3: Option 4:
Characteristics Status Quo OTC OTC,eFPS Fee Variable
Profititability 9/21 15/21 15/21 21/21 17/21
Predictability No no No yes no
Equal Incentives
Modes No no No yes yes
AABs

Productivity indirect indirect Indirect direct direct

Dynamic no no No no yes
Cost benchmark increase Increase neutral neutral
Administrative simple simple Simple simple complex
GOV'T

Likely Level of
Service benchmark increase Increase increase increase

Note: Option 1 assumes 12 days of float for OTC, Option 2 assumes float of 12 and 1
day for OTC and eFPS respectively; Option 3 uses fee of PhP 37.50 for an 18% mark
up; the indicator of profitability is (n1/n2) where n1 is the number of banks enjoying
positive margins out of total AABs, n2; equal incentives refer to the returns to
processing eFPS and OTC transactions; increase cost refers to the aggregate cost to
government from the alternative incentive arrangement where increase means higher
than the cost from the status quo; service refers to the likely improvement of levels of
service of AABs towards OTC taxpayers.

As the matrix reports, Option 3 (fee-based incentive) is close to a dominant option,

except for the ‘dynamic’ criterion. The main constraint for implementing this option,
however, is that it requires legislation and budget support. The matrix highlights the

25
trade offs among the other options. Of course, the ‘desirability’ of the options will
depend on the number of float days assumed (the matrix uses 10 days for OTC). The
hybrid option (option 4) posses the desirable qualities of option 3 without the
legal/budgetary constraints. While the aforementioned option may be more
demanding in terms of administration, the constraint does not appear to be
insurmountable. In the end, the BIR will have to determine the option given the
trade-offs as summarized in the matrix. Since all options address the main incentive
problem in OTC transactions in varying degrees, the level of service of AABs will
likely improve. Of course, there is still a need to monitor the AABs.

Equally important are process improvements, but they require more time to
implement. Improvements in this area are designed to enhance the overall efficiency
of the system, regardless of the incentive system. The study proposed a number of
recommendations that will drive down transaction costs which includes decoupling
filing from payment and employing alternative payment options. Improved incentive
arrangements coupled with systemic improvements to drive down costs will address
the long-term concerns of both the AABs, BIR and the taxpaying public.

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References:

1. Bondoc, K. and G. Manzano (2003). “The cost of Financial

Intermediation.” Recent Economic Indicators.
2. http://www.bsp.gov.ph
3. Manasan, Rosario (2004). “Fiscal Reform Agenda: Getting Ready for
the Bumpy Ride Ahead.” Philippine Institute for Development
Studies No. 2004 – 26.
4. Pasadilla, G.O. and M. Milo (2005). “Effect of Liberalization on
Banking and Competition.” Philippine Institute for Development
Studies.
5. Rose, Peter. Commercial Bank Management, United States: The
McGraw Hill Companies, Inc. 1999

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