SGV & Co.

January 18, 2007 BIR RULING [DA-025-07] P.D. 87; 036-01; DA-001-03; VAT Ruling No. 007-06 SGV & Co. 6760 Ayala Avenue 1226 Makati City Attention: Atty. J.A. Osana Tax Division Gentlemen : This refers to your letter dated August 3, 2006 requesting confirmation on behalf of your clients, Shell Philippines Exploration B.V. ("SPEX"), Shell Philippines LLC ("SPL"), Chevron Malampaya LLC ("CMLLC") and Philippine National Oil Company Exploration Corporation ("PNOC-EC") (collectively referred to as the "Consortium"), of your opinion that the individual income tax liability of the members of the Consortium shall be determined in accordance with the special income tax regime provided under Sections 19 to 25 of Presidential Decree No. 87 ("PD 87"), otherwise known as "The Oil Exploration and Development Act of 1972" and Sections 6 to 8 of Service Contract No. 38 ("SC 38"). BACKGROUND It is represented that SPEX, SPL, CMLLC and PNOC-EC, as members of the Consortium, are petroleum service contractors of the Philippine Government under SC 38. SC 38 was entered into by the Philippine Government and the Consortium members on December 11, 1990, pursuant to the provisions of PD 87. Under the terms of SC 38, the Consortium, under the supervision and control of the Department of Energy ("DOE"), furnishes services, technology and financing relative to the exploration and development of the Malampaya natural gas field located in offshore Palawan. Part of the incentives extended to petroleum service contractors under PD 87 is exemption from all other taxes except income tax. This exemption is also granted, by contract, to the Consortium in Section 6.2 (a) of SC 38. It is also represented that the proceeds of the sale of petroleum produced under SC 38 is the source of funds from which operating expenses and other costs incurred by the service contractor are first reimbursed and thereafter, from what is left of the proceeds, allocated for the government share in the proceeds and the stipulated service fee received by the Consortium as the service contractor. The members of the Consortium are liable to pay corporate income taxes on the service fees received under SC 38, which taxes, are determined in accordance with the special income tax regime statutorily prescribed under PD 87 and contractually mirrored in SC 38. Furthermore, said corporate taxes, are assumed by the DOE pursuant to the terms of SC 38. In 2005, the BIR-Revenue District Office No. ("RDO") 53 issued separate Letters of Authority ("LOAs") to SPEX, SPL, and Chevron covering the tax examination for taxable year 2003. After completing their examination, the revenue officers from RDO 53 recommended in a preliminary report (Notice of Informal Conference) the proposed assessment for deficiency income tax against SPEX, SPL and Chevron. In arriving at the proposed assessments, the revenue officers applied general principles of income taxation under the Tax Code of 1997 which are alleged to be in conflict with the income tax provisions of PD 87 and SC 38. The representatives of the Consortium initiated several meetings and discussions with the revenue officers and officials of RDO 53 and BIR-Revenue Region No. 8 to explain and clarify the special income tax regime governing SC 38. It was agreed in said meetings that the matter of PD 87 governing SC 38 in the treatment and calculation of income tax liability should be resolved at the Commissioner/Deputy Commissioner's level. Hence, on May 16, 2006, representatives of the Consortium, together with the DOE, made a presentation to the BIR, headed by the Deputy Commissioner for Legal and Inspection Group, Lilian B. Hefti, on SC 38 operations and its special income tax regime. aETAHD In a subsequent meeting held on June 1, 2006, another presentation was made before the BIR to demonstrate in detail the method of income tax computation under PD 87 and SC 38. At the end of the same meeting, the BIR confirmed that the applicable provisions of PD 87 and SC 38 and not the Tax Code of 1997 should govern the determination of income tax liabilities of the members of the Consortium. As suggested by the Deputy Commissioner and for the BIR to issue an official confirmatory ruling on this matter, the Consortium now files this formal request for ruling. In connection with the foregoing, you now request confirmation of your opinion that the individual income tax liabilities of the members of the Consortium shall be determined in accordance with the special income tax regime prescribed under Sections 19 to 25 of PD 87 and Sections 6 to 8 of SC38. In reply thereto, please be informed that Section 25 of PD 87 provides as follows: SEC. 25. Applicability of the provisions of the National Revenue Code. All provisions of the National Internal Revenue Code and rules and regulations promulgated in relation therewith which are not inconsistent with the provisions of this Act shall be applicable to the Contractor. Under the afore-quoted provision, it is clear that only the provisions of the Tax Code and its implementing rules and regulations, which are consistent, and therefore, not in conflict, with the provisions of PD 87, shall apply to petroleum service contractors. This is consistent with the rule that a general law must yield to the provisions of the special law. In the case of Commissioner of Internal Revenue vs. Central Luzon Drug Corporation, G.R. No. 159647, April 15, 2005 , the Supreme Court held that: [T]he rule is that on a specific matter the special law shall prevail over the general law, which shall be resorted to only to supply deficiencies in the former." In addition, "[w]here there are two statutes, the earlier special and the later general the terms of the general broad enough to include the matter provided for in the special the fact that one is special and the other is general creates a presumption that the special is to be considered as remaining an exception to the general, one as a general law of the land, the other as the law of a particular case." It bears notice in this case that the Department of Finance ("DOF"), in its November 8, 2001 letter to the DOE, has expressly confirmed that the service contractor under SC 38 shall be liable each taxable year for Philippine income tax computed as provided under Sections 20 through 25 of PD 87. We quote below pertinent portions of the DOF letter: Under Presidential Decree No. 87, otherwise known as "The Oil Exploration and Development Act of 1972", the Contractor in a service contract, whether acting alone or in consortium with others, shall be subject to Philippine income tax only (Section 3[k], 8 and 12[a)]. The Contractor shall, therefore be liable each taxable year for Philippine income tax on income derived from its petroleum operations under its contract of service, computed as provided in Sections 20 through 25 of PD 87. (Section 19 of PD 87) This Office has itself relied on the provisions of PD 87 in confirming the exemption of the instant SC 38 service contractors from documentary stamp tax ("DST"), value-added tax ("VAT") and excise tax. These confirmatory rulings include VAT Ruling No. 007-06 dated June 7, 2006, BIR Ruling No. DA-001-03 dated January 7, 2003, and BIR Ruling No. 036-01 dated August 20, 2001. The special income tax regime provided under Sections 19 to 25 of PD 87 and contractually mirrored under Sections 6 to 8 of SC 38 provide as follows: "TAX PROVISIONS SEC. 19. Imposition of tax. The contractor shall be liable each taxable year for Philippine income tax on income derived from its petroleum operations under its contract of service, computed as provided in Section 20, through 25. SEC. 20. Determination of gross income. The gross income shall consist of: (a) In respect of crude oil exported, the gross proceeds from the sale of crude oil at the posted price; (b) In respect of crude oil sold for consumption in the Philippines, the gross income shall consist of the gross proceeds from the sale thereof at market price per barrel; (c) In respect of natural gas and/or casinghead petroleum exported or sold for consumption in the Philippines the gross income shall consist of the total quantity sold at the prevailing market price thereof; and (d) Such other income which are incidental to and/or arising from any petroleum operation. SEC. 21. Deductions from gross income. In computing the taxable net income, there shall be allowed as deductions: (1) Filipino participation incentive; and (2) Operating expenses reimbursed pursuant to Section 8 (1) which includes amortization and depreciation as provided in Section 22. SEC. 22. Amortization and Depreciation. Intangible exploration costs may be deductible in full; all tangible exploration costs such as capital expenditures and other recoverable capital assets are to be depreciated for a period of ten years. SEC. 23. Deductions not allowed. In ascertaining the taxable net income, no deduction from gross income shall be allowed in respect of any interest or other consideration paid or suffered in respect of the financing of its petroleum operations. SEC. 24. Return and payment of tax. Every party to a service contract shall render to the Petroleum Board a return for each taxable year in duplicate in such form and manner as provided by law setting forth its gross income and the deductions herein allowed. The return shall be filed by the Petroleum Board with the Commissioner of Internal Revenue or his deputies or other persons authorized by him to receive such return within the period specified in the National Internal Revenue Code and the Rules and Regulations promulgated thereunder. Every party to a service contract shall be subject to tax separately on its share of taxable income arising from such contract. SEC. 25. Applicability of the provisions of the National Revenue Code. All provisions of the National Internal Revenue Code and rules and regulations promulgated in relation therewith which are not inconsistent with the provisions of this Act shall be applicable to the Contractor." "SERVICE CONTRACT xxx xxx xxx SEC. VI RIGHTS AND OBLIGATIONS OF THE PARTIES xxx xxx xxx 6.2 Contractor shall have the following rights: (a) Exemption from all taxes except income tax; (b) Exemption from payment of tariff duties and compensating tax on the importation into the Philippines of all machinery, equipment, spare parts and all materials required for and to be used exclusively by CONTRACTOR or subcontractor in Petroleum Operations on the conditions that said machinery, equipment, spare parts and materials of comparable price and quality are not manufactured domestically, are directly and actually needed and will be used exclusively by the CONTRACTOR in its Operations or in the operations for it by a subcontractor; are covered by shipping documents in the name of the CONTRACTOR to whom the shipment will be delivered direct by the customs authorities; and the prior approval of the OFFICE OF ENERGY AFFAIRS was obtained by the CONTRACTOR before the importation of such machinery, equipment, spare parts and materials which approval shall not be unreasonably withheld; provided, however, that the CONTRACTOR or its subcontractor may not sell, transfer or dispose of such machinery, equipment, spare parts and materials within the Philippines without the prior approval of the OFFICE OF ENERGY AFFAIRS and payment of taxes due the Government; provided, further, that should the CONTRACTOR or its subcontractor sell, transfer, or dispose of these machinery, equipment, spare parts of materials within the Philippines without the prior consent of the OFFICE OF ENERGY AFFAIRS, it shall pay twice the amount of the tax exemption granted on the equipment sold, transferred or disposed; provided, finally, that the OFFICE OF ENERGY AFFAIRS shall allow and approve, which shall not be unreasonably withheld, the sale, transfer, or disposition of the said items within the Philippines without tax if made (1) to another contractor; (2) for reasons of technical obsolescence; or (3) for purposes of replacement to improve and/or expand Operations of the Contractor; xxx xxx xxx 6.3 The OFFICE OF ENERGY AFFAIRS shall assume and pay on behalf of CONTRACTOR and its parent company, on the first transaction in each instance where the tax is imposed, all income taxes payable to the Republic of the Philippines based on income and profits and, with respect to CONTRACTOR, on the first transaction in each instance where the tax is imposed, all dividends, withholding taxes and other taxes imposed by the Government of the Philippines on the distribution of income and profits derived from Petroleum Operations to its parent company. The OFFICE OF ENERGY AFFAIRS shall promptly furnishing to CONTRACTOR, without fee or other consideration, the official receipts issued in the name of CONTRACTOR by any duly empowered Government authority, acknowledging the payment of said taxes. SEC. VII RECOVERY OF OPERATING EXPENSES AND ACCOUNTING FOR PROCEEDS OF PRODUCTION 7.1 CONTRACTOR, if authorized by the OFFICE OF ENERGY AFFAIRS to market the OFFICE OF ENERGY AFFAIRS's share of Petroleum produced and saved from Contract Area, shall account for the proceeds from such sales as provided in this Section VII. CONTRACTOR shall have the right and privilege of receiving in kind and disposing of CONTRACTOR's portion of the Petroleum produced and saved from the Contract Area. 7.2 In each Year, CONTRACTOR will recover from the gross proceeds resulting from the sale of all Petroleum produced under this Contract an amount equal to all Operating Expenses; provided, that the amount so recovered shall not exceed seventy percent (70%) of the gross proceeds from production in any Year; provided, further, that if in any Year the operating costs exceed seventy percent (70%) of the gross proceeds from the production or there are no gross proceeds, then the unrecovered expenses shall be recovered from the gross proceeds in succeeding Year(s). This payment shall be calculated in accordance with the U.S. Dollar amounts recorded in the books and accounts pursuant to Section XV. The payment corresponding to the first lifting of the Calendar Year, shall include any adjustments on Government's share of the preceding calendar quarter. 7.3 (a) If the CONTRACTOR has been authorized to market the OFFICE OF ENERGY AFFAIRS's share of production, it shall within three (3) working days from collection date but in no case beyond sixty (60) days from lifting date, remit to the OFFICE OF ENERGY AFFAIRS an amount equal to sixty percent (60%) of estimated net proceeds from each Petroleum lifting operations. This payment shall be calculated in accordance with the U.S. Dollar amounts recorded in the books and accounts pursuant to Section XV. The payment corresponding to the first lifting of the Calendar Year, shall include any adjustments on Government's share of the preceding calendar quarter. SDAaTC In the event that CONTRACTOR is not paid within sixty (60) days from the lifting date, CONTRACTOR shall immediately inform the OFFICE OF ENERGY AFFAIRS. Should delays in collection continue, the Parties shall immediately meet to resolve that sixty (60) day payment requirement. Further, in the event collection within sixty (60) days from lifting dates remains a problem for four (4) months or in the event that a single payment is not paid for an inordinate period, then CONTRACTOR shall meet with the OFFICE OF ENERGY AFFAIRS within thirty (30) days, and if the problem is not completely resolved within sixty (60) days thereafter, CONTRACTOR, at its option, may extend the sixty (60) days from lifting date payment requirement until it collects the entire amount owed on each lifting in dispute. (b) The OFFICE OF ENERGY AFFAIRS shall be entitled to receive in kind Petroleum equal in value to sixty percent (60%) of net proceeds. (c) For purposes of Section VII, net proceeds means the difference between gross income and the sum of the Operating Expenses recovered pursuant to Section 7.2. 7.4 CONTRACTOR will retain an amount equal to its fee of forty percent (40%) of the net proceeds from the Petroleum Operations. 7.5 If the OFFICE OF ENERGY AFFAIRS and the CONTRACTOR elect to take their respective shares in kind, the Parties to this Contract will enter into separate agreement providing among others, for the manner and form of deliveries and appropriate quarterly adjustments. For the purpose of determining gross proceeds, Petroleum shall be valued as follows: (a) All Crude Oil sold for consumption in the Philippines shall be valued at Market Price for such Crude Oil. (b) All Crude Oil Exported shall be valued at the Posted Price. (c) All Natural Gas and/or Casinghead Petroleum Spirit exported or sold for consumption in the Philippines shall be valued at the prevailing Market Price thereof. (d) Reasonable commissions or brokerage incurred in connection with sales to third parties, if any, shall be deducted from gross proceeds but shall not exceed the customary and prevailing rate. (e) Filipino Participation Incentive Allowance, if any, shall be deducted from gross proceeds. This Allowance shall be computed on a sliding scale, as provided in the appropriate circular issued by the OFFICE OF ENERGY AFFAIRS, provided that the Filipino Participation Incentive Allowance shall be granted under this Contract if qualifying Filipino Participation is secured prior to \the commencement of the first drilling operation. The Allowance shall be deducted from the higher of Section 7.6 (a) and 7.6 (b). SEC. VIII INCOME TAXES 8.1 CONTRACTOR shall be liable each taxable year for Philippine income tax under the provisions of the National Internal Revenue Code and the Oil Exploration and Development Act of 1972, as amended. The CONTRACTOR's gross income shall consist of: (a) Gross proceeds determined in accordance with Section 7.6 above; and (b) Such other income which is incidental to and/or arising from any Petroleum Operation or other aspects of the Contract. DECcAS In computing the Taxable Net Income, CONTRACTOR shall be allowed to deduct Operating Expenses recovered pursuant to Section 7.2 above. 8.2 In ascertaining the CONTRACTOR's Taxable Net income, deduction from gross income shall be allowed in respect of any interest or other consideration paid or suffered in respect of the financing of its Petroleum Operations to the extent allowed by the Accounting Procedure, Part II, Section 14. 8.3 CONTRACTOR shall render to the OFFICE OF ENERGY AFFAIRS a return for each taxable year in duplicate in such forms and manner as provided by law setting forth its gross income and the deduction herein allowed. The return shall be filed by the OFFICE OF ENERGY AFFAIRS with the Commissioner of Internal Revenue or his deputies or other persons authorized by him to receive such return within the period specified in the National Internal Revenue Code and the Rules and Regulations promulgated thereunder. 8.4 The OFFICE OF ENERGY AFFAIRS, upon payment by it of CONTRACTOR's income taxes, shall procure official receipts in the name of CONTRACTOR evidencing such payment. Each of the second parties, if more than one (1), shall be subject to tax separately on its share of income and the OFFICE OF ENERGY AFFAIRS shall supply each with an individual receipt in its own name." xxx xxx xxx This Office is of the opinion that the above provisions should prevail over the ordinary rules of income taxation provided in the Tax Code of 1997 as far as the income taxation of Consortium members under SC 38 is concerned. This is in recognition of the fact that the special income tax regime laid down under PD 87 and SC 38 is specifically intended to address the particular circumstances applicable only to petroleum service contractors. aSTHDc Moreover, we confirm that SC 38, as with all service contracts concluded under PD 87, is a contractual undertaking by the Philippine Government and hence, protected by the non-impairment clause enshrined under the 1987 Philippine Constitution. Furthermore, Section 12 (g) of PD 87 provides that rights and obligations in any contract concluded pursuant to PD 87 shall be deemed as essential considerations for the conclusion thereof and shall not be unilaterally changed or impaired. CaESTA In the recently issued VAT Ruling No. 007-06 dated June 7, 2006, this Office has acknowledged that the tax exemption privilege of the Service Contractor, provided under Section 6.2 of SC 38, is a contractual tax exemption granted by the government in exchange for a valid and material consideration, and hence, may not be unilaterally changed or impaired. As stated in the ruling, said valid and material consideration obtained by the Government consists of the service contractor's obligation (i) to furnish services, technology, and financing for, and (ii) to assume all risk relating to, the conduct of petroleum operations. Considering that the special income tax regime for SC 38 is part of the contractual stipulations under SC 38, we rule that the same may not be revoked unilaterally without violating the principle on the non-impairment of contracts under the 1987 Constitution and Section 12 (g) PD 87. cCTAIE IN VIEW OF THE FOREGOING, this Office hereby rules that the individual income tax liabilities of the members of the Consortium shall be determined in accordance with the special income tax regime prescribed under Sections 19 to 25 of PD 87 and Sections 6 to 8 of SC 38. This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it will be ascertained that the facts are different, then this ruling shall be considered void. DHcESI Very truly yours, (SGD.) JOSE MARIO C. BUAG Commissioner of Internal Revenue