BIR Ruling [DA-108-04]

March 9, 2004 BIR RULING [DA-108-04] BIR Ruling No. 020-2002; RA 9136; Secs. 32 (B) (7) (b), 194, & 196, NIRC Power Sector Assets & Liabilities Management Corporation 2nd Floor SGV II Building 6758 Ayala Avenue City of Makati Attention: Mr. Edgardo M. Del Fonso President Gentlemen : This refers to your original letter dated October 15, 2002, ( the "Original Request for Ruling" ) and supplemental letter dated June 2, 2003, requesting for confirmation of your understanding on the tax consequences of transactions relating to or incidental to the privatization of the National Transmission Corporation ("TRANSCO"). HISTORICAL BACKGROUND Since the time that the original request was filed, the Power Sector Assets and Liabilities Management Corporation ("PSALM") has continued the process of finalizing the terms and conditions for the privatization of TRANSCO. As a result, several changes had been introduced in the draft of the Concession Agreement and other related transaction documents that it earlier submitted to this Office. Since these changes have an impact on a number of the transactions covered by the Original Request for Ruling, a supplemental request effectively revised the Original Request for Ruling to take into account the relevant provisions of the revised draft agreements. Certain issues raised in the Original Request for Ruling had not been affected by the changes in the draft agreements. Hence, the need to incorporate the Current Request for Ruling . CASE BACKGROUND A. Privatization of the Operation of the Transmission System In the Original Request for Ruling , it was explained that on June 26, 2001, Republic Act No. 9136, also known as the "Electric Power Industry Reform Act of 2001" ("EPIRA"), was enacted into law. The Act provides the legal framework for the privatization of the National Power Corporation ("NPC") and the restructuring of the electric power industry. As mandated under the EPIRA, PSALM formulated a Privatization Plan which provides recommendation on the structure and process for the privatization of the Transmission assets, Subtransmission assets, generation assets and other assets of the NPC. On March 13, 2002, the Joint Congressional Power Commission ("JCPC") passed JCPC Resolution 2002-1 endorsing for approval of the President of the Philippines, the privatization of TRANSCO through the award of a concession. On October 4, 2002, the President of the Philippines approved the Privatization Plan. With respect to TRANSCO, PSALM is mandated to conduct an open competitive bidding procedure for the award of a Concession to construct, install, improve, expand, operate, maintain, rehabilitate, repair and refurbish the high voltage and medium voltage Transmission systems owned by TRANSCO. The award should result in maximum present value of proceeds to the National Government. In case a Concession Contract is awarded, the Concessionaire shall have a contract period of twenty-five (25) years, subject to review and renewal for a maximum period of another twenty-five (25) years. 1 As regards the Subtransmission facilities, the EPIRA provides that TRANSCO shall sell it to Qualified Distribution Utilities. Prior to privatization, the Subtransmission functions and assets of TRANSCO shall be segregated from the Transmission functions, assets and liabilities for transparency and disposal. The Subtransmission assets shall be operated and maintained by TRANSCO or its Buyer or Concessionaire until their disposal to Qualified Distribution Utilities which are in a position to take over the responsibility for operating, maintaining, upgrading, and expanding said assets. In BIR Ruling No. 20-02 dated May 13, 2002, this Office has ruled on the tax implication of the various transactions relating to the privatization of NPC's generation assets. However, since PSALM was unable to provide the BIR, at that time, with a copy of the Draft Concession Contract, the BIR deferred issuing a ruling on the tax treatment of the Concession, noting that this would depend on the specific terms and conditions of said Concession Contract. IDTSaC FEATURES OF THE CONCESSION UNDER THE CONCESSION AGREEMENT Described below are the pertinent features of the Concession, as provided under the draft Concession Agreement and other related documents. 1. Concession Structure The grant by Congress of a new franchise to TRANSCO, which is assignable to the Concessionaire, is an important component of the privatization so much so that the right to operate the Transmission and Subtransmission systems cannot be granted to the Concessionaire unless such franchise has been obtained. For this reason, House Bill No. 4882 has been certified as a priority bill by the Executive Department to facilitate its deliberation in Congress. Thus, based on the Privatization Plan developed by PSALM, as enunciated in the first draft of the Concession Agreement which has been submitted to this Office, the award of the Concession will be finalized only once a law has been passed granting such franchise. However, to date, the proposed franchise is undergoing interpellation at the Senate of the Philippines. To proceed with the privatization of TRANSCO, which is an essential component to the restructuring of the electric power sector, PSALM has structured the Concession in a manner that would allow the Concessionaire to participate in the Transmission and Subtransmission systems business even prior to the date that a franchise has been awarded to the Concessionaire in accordance with existing laws. The privatization process of the Transmission assets, and the award of the Concession over the Subtransmission assets pending their sale to qualified Distribution Utilities by TRANSCO, will be implemented under three milestones: Selection Date, Award Date, and Franchise Date. i) Selection Date On the Selection Date, PSALM and the winning investor consortium will enter into a Direct Agreement under which PSALM and the investors agree to satisfy certain conditions precedent for the award by PSALM of a Concession to operate, expand, maintain and manage the Transmission and Subtransmission assets during the period that commences on the Award Date (as defined below) and expires on the 25th anniversary thereof, subject to automatic extension until the 50th anniversary thereof in the event that no Concessionaire Default shall have occurred during the five year period immediately preceding the 25th anniversary of the Award Date. ii) Award Date PSALM awards the Concession to the Concessionaire, the entity established by the investors, on the date (the " Award Date ") on which the investors satisfy the conditions precedent. However, since the Concessionaire does not have a franchise to operate the Transmission system, it is not yet qualified to act as a public utility on the Award date. TRANSCO, as the current franchise holder, retains the responsibility to perform the operation of the public utility functions ("Non-Delegable Functions") (as described below), and otherwise perform all functions required of a public utility under the Constitution. The period between Award Date and Franchise Date is referred to as the Non-Franchise Period. During the Non-Franchise Period, the Concessionaire will maintain, rehabilitate and expand the nationwide Transmission and Subtransmission systems and perform all of its obligations under the Concession Agreement other than the Non-Delegable Functions, which, as enumerated in the Agreement, are the following: a. Dispatch power generation facilities and dispatchable loads, whether for the supply of active power or the provision of Ancillary Services; b. Monitor the control of the Systems at the National Control Center, the Regional Control Center, or the Area Control Centers to ensure that the Systems operate in accordance with the requirements of the Grid Code and other Applicable Law and to protect the Systems from electrical transients; c. Energize and de-energize Transmission and Subtransmission lines and determine the optimal operating configuration of the Systems; d. Govern the settings of protective devices and relays used to control automatic load dropping; e. Petition the ERC, as the franchise holder, pursuant to guidelines issued by the ERC; f. Maintain and staff a call center or other method by which Transmission Customers may communicate queries, complaints, and reports of malfunctions of the Systems; provided, however , that the Concessionaire may perform this function for and on behalf of TRANSCO, as TRANSCO's agent, in the name of TRANSCO; and g. Respond to requests for Transmission Service by existing or prospective Transmission customers; provided, however , that the Concessionaire may perform this function for and on behalf of TRANSCO, as TRANSCO's agent, in the name of TRANSCO. 2 The Concessionaire shall also invoice and collect revenue from all grid users as agent for TRANSCO and manage the completion of the projects of TRANSCO under construction. During the Non-Franchise Period, TRANSCO shall receive the revenues from the operation of the Transmission and Subtransmission systems. The Concessionaire, on the other hand will receive a fee ( the "Transition Fee" ) from TRANSCO as consideration for the services it rendered. iii) Franchise Date On the Franchise Commencement Date, i.e., the date on which the award by Congress of a franchise to the Concessionaire becomes effective, the Concessionaire will commence the performance of the Non-Delegable Functions. The period during which any Franchise remains effective is called the Franchise Period. 2. Concession Fee In consideration for the grant of the Concession and the obligations of TRANSCO arising under the Transaction Documents, the Concessionaire will pay to TRANSCO the Commencement Fee and Extension Deposit on the Award Date and the Deferred Payments in accordance with the prescribed formula. The Commencement Fee and the Deferred Payments represent payment for the first 25 years of the Concession Period, and the Extension Deposit represents payment for the 25-year Extension, if and when granted. A description of each of these payments is summarized below. a. Commencement Fee . Pursuant to the Concession Agreement, on the Award Date, the Concessionaire shall pay to TRANSCO the Commencement Fee. The Parties acknowledge and agree that (i) a portion of the Commencement Fee equal to US$XXX represents payment for the right to use the Subject Assets granted by TRANSCO under the Lease Agreement and constitutes the rent payable. Without limitation of the Concessionaire's other rights and remedies under the Concession Agreement, no part of the Commencement Fee shall be subject to refund to the Concessionaire under any circumstance. 3 b. Extension Deposit . On the Award Date, the Concessionaire shall remit to TRANSCO an amount equal to US$XXX. The Concessionaire acknowledges and agrees that (i) TRANSCO shall have no obligation to return the Extension Deposit to the Concessionaire in the event that the Extension does not occur, or a TRANSCO Default or Concessionaire Default occurs, and (ii) the Termination Payment or the Option Price (as the case may be) subsumes the value of the unutilized portion of the Extension Deposit. DASEac c. Deferred Payments . On each Semi-Annual Payment Date, the Concessionaire shall remit to TRANSCO, without need of demand, an amount equal to the amount as determined by the formula set forth in Schedule 7 of the Draft Concession Agreement. In the even that the Concessionaire fails to remit any portion of any Deferred Payment on any Semi-Annual Payment Date, the Concessionaire shall pay to TRANSCO a Late Payment Penalty in the amount of two percent (2%) of the amount due, plus default interest. 4 3. Least of Transmission and Subtransmission Under Lease Agreement, TRANSCO will lease to the Concessionaire the Transmission System, the Subtransmission System, the Release Assets and the Related Asset Sites. For the Transmission facilities, the term of the lease shall commence on the Award Date and end upon the termination of the Concession Period. For the Subtransmission facilities, the term of the lease shall be the earlier of the termination of the Concession Period or sale of the Subtransmission facility to a qualified distribution utility. The Concessionaire shall pay all taxes, costs, expenses of every character arising in connection with the leased assets, whether to ownership, use, possession, control or improvement of the Assets. 5 4. Real Property Matters TRANSCO will, at all times during the Concession Period, retain ownership to all real estate interests underlying the Transmission System and until the time these are sold to qualified Distribution Utilities, the Subtransmission Assets and the Related Assets necessary for the operation thereof. Thus, as discussed above, it will lease the same to the Concessionaire under the Lease Agreement. Also, under the Concession Agreement, the Concessionaire is appointed by TRANSCO as its sole agent and representative to: a. Commence and pursue diligently all proceedings resulting from TRANSCO's initial exercise of the power of eminent domain granted to TRANSCO under Chapter II, Section 8 of the EPIRA for the purpose of acquiring Documented Property Rights for and on behalf of TRANSCO in the Transmission Site and any New Project Site; b. Litigate, negotiate, settle, and otherwise resolve all Adverse Claims related thereto provided that the Concessionaire's authority will exclude the power to sign documentation on TRANSCO's behalf; and c. Take all other action that the Concessionaire may reasonably deem necessary to acquire and maintain Documented Property Rights in the Sites and any sites for New Project Site ( the "New Projects" ) for and on behalf of TRANSCO, and permit access thereto during the Concession Period. 6 The Concessionaire shall undertake all the above activities at its own cost and expense. 5. Construction of New Transmission Assets The Concessionaire agrees to site, permit, finance, construct and otherwise develop and complete all New Projects (i) contemplated by the Transmission Development Plan (TDP), and (ii) from and after the commencement of the First Regulatory Year of the Second Regulatory Period, included in the relevant capital expenditure program approved by the ERC pursuant to the Transmission Wheeling Rate Guidelines. In each case, the Concessionaire, at its own cost and expense, shall: a. Enter into all agreements and arrangements for the development and completion of each New Project. The Concessionaire acknowledges and agrees that TRANSCO shall have no obligation to assume or guarantee any obligation or liability incurred by the Concessionaire in implementing any New Project; b. Promptly transfer title to each New Project to TRANSCO upon the completion of construction of each New Project; and c. Acquire, for and on behalf of TRANSCO, Documented Property Rights in the New Project Site related to each New Project. 6. Disposal of Subtransmission Assets As provided under the EPIRA, TRANSCO shall sell its Subtransmission assets to qualified distribution utilities. Accordingly, under the Draft Concession Agreement, the Concessionaire acknowledges and agrees that TRANSCO may sell, convey and otherwise transfer any part of the Subtransmission System to Distribution Utilities without obtaining the consent of the Concessionaire. However, TRANSCO shall give the Concessionaire prior written notice of not less than thirty (30) calendar days that it intends to dispose of such components of the Subtransmission System. Also, in the event that the ERC reclassifies the nominal voltage levels that distinguish Transmission assets from Subtransmission assets for the purposes of the EPIRA and the IRRs and such reclassification results in the classification of any part of the Subtransmission System as a Transmission asset, then, in either case, TRANSCO shall not sell, convey or otherwise transfer such reclassified part of the Subtransmission System to any Distribution Utility. Upon the occurrence of any such disposal, TRANSCO shall pay the Concessionaire a fee (the " Disposal Fee ") in consideration for the termination of the Concession with respect to such assets calculated and remitted in accordance with Schedule 11 of the Concession Agreement. 7 7. Termination Payment . In the event that the Concession Period expires and no Concessionaire Default has occurred and is continuing, then TRANSCO shall make the Termination Payment to the Concessionaire, which shall be calculated and remitted in accordance with the formula prescribed in the proposed Put and Call Option Agreement. Reversion of the Subject Assets and the payment of the Transmission Payment is also one of the remedies available to TRANSCO in case there is an occurrence of a Concessionaire Default, as defined under the Draft Concession Agreement. 8 Upon termination of the Concession, the Concessionaire shall: a. Transfer possession and control over the Subject Assets and all New Projects then under construction to TRANSCO or its designee; b. Assign and transfer to TRANSCO or its designee all of the Concessionaire's obligations arising out of, and its rights, title and interest in and to, the Essential Service Contracts, the Construction Contracts, the Security Services MOU, insurance policies and any intellectual property rights held in the name of the Concessionaire and required for the operation of the Systems; and c. Transfer to TRANSCO or its designee title, possession and control over (i) all of the Concessionaire's assets (including equipment, machinery, fittings and spare parts inventory), (ii) all records and files (including designs and drawings) maintained by the Concessionaire, and (iii) any operation or maintenance manuals held or developed by the Concessionaire, in each case other than any assets, record and files or manuals that solely support a related business. ScTaEA B. Remittance of Profits by TRANSCO to PSALM Pursuant to the Implementing Rules and Regulations of the EPIRA ( the "IRR" ), TRANSCO has the obligation, among others, to remit its net profits, if any, to PSALM not later than ninety (90) days after the immediately preceding quarter. Further, the IRR also provides that the net proceeds from the privatization of TRANSCO shall be immediately remitted to PSALM. 9 C. Ancillary Services Pursuant o the provisions of the EPIRA, TRANSCO and subsequently, the Concessionaire is tasked with managing the provision of Ancillary Services. Ancillary Services refer to support services which are necessary to support the transmission capacity and Energy that are essential in maintaining Power and the Reliability and Security of the Grid. 10 The ancillary services are described below: Load Following and Frequency Regulation Service A service that provides Generation Capacity necessary to adjust total system generation over short periods of time to match system load changes that result from random fluctuations in total Transmission System load. Spinning Reserve Service A service that provides Generation necessary to respond immediately to infrequent, but usually large, failures of generating units or transmission plant in accordance with the Grid Code. This service is limited to a period not exceeding 30 minutes. Backup Service The supply of Generation Capacity (Backup Power) and Electricity (Backup Electricity) to a Transmission Customer's transmission system load/s for periods during which the Transmission Customer's Generating Facility is experiencing an Outage, whether scheduled or unscheduled, and Spinning Reserve is no longer available. Reactive Power Supply and Voltage Control Service The injection or absorption of reactive power from Generators to maintain transmission system voltage within required ranges. Black Start The process of recovery from Total System Blackout using a Generating Unit with the capability to start and synchronize with the System without an external power supply. 11 TRANSCO or the Concessionaire, as the case may be, will provide certain ancillary services from its own assets. For other ancillary services such as spinning reserve and backup power, TRANSCO/Concessionaire will negotiate contracts with other power generation facilities that are capable of providing these ancillary services. Charges for Ancillary Services As prescribed by the EPIRA, the WESM Rules shall provide for the methodology for the price and cost recovery of Ancillary Services that are to be provided by the Generation company. 12 The cost of acquiring ancillary services under the agreements will be passed on to Transmission customers on whose behalf TRANSCO is deemed to purchase the ancillary services. III. MATTERS ON WHICH RULING IS REQUESTED In connection with the above representations, the following are submitted for confirmation, to wit: A. Transactions Covered under the Concession Agreement Taxation of TRANSCO 1. Income received by TRANSCO during the Non-Franchise Period arising from its operation of the Transmission and Subtransmission systems, being income derived from the operation of a public utility accruing to the Government of the Philippines, is excluded from gross income for purposes of computing its income tax pursuant to Sec. 32 (B)(7)(b) of the 1997 Tax Code. 2. Income realized by TRANSCO from the privatization of the Transmission system of the NPC is considered income arising from the exercise of essential governmental function accruing to the Government of the Philippines and thus, excluded from gross income, for purposes of income tax, pursuant to Sec. 32(B)(7)(b) of the 1997 Tax Code. Thus, all payments received by TRANSCO (Commencement Fee, Deferred Payments, including the Late Payment Penalty and Interest, and Extension Deposit) pursuant to the Concession Agreement are not subject to income tax and consequently, exempt from withholding tax; 3. The properties constructed by the Concessionaire at its own cost and transferred to TRANSCO, upon completion of the construction thereof, during the Concession Period, and Documented Property Rights acquired by Concessionaire for and on behalf of TRANSCO, also at Concessionaire's own cost, are part of the consideration received by TRANSCO for the grant of the Concession and therefore, exempt from income tax. 4. Revenues received by TRANSCO in connection with the operation of the Transmission and Subtransmission systems during the Non-Franchise Period, and the Concession Fees and all other payments received by TRANSCO, whether in cash or in kind, as consideration for the grant of the Concession, regardless of whether they are received during the Non-Franchise or Franchise Period, are exempt from the 2% franchise tax because TRANSCO, as successor to NPC's franchise, will be exempt from all forms of taxes, including franchise tax; 5. The portion of the Commencement Fee, as provided under the Concession Agreement, that represents payment to TRANSCO for the lease of real property underlying the Subject Assets is subject to documentary stamp tax (DST) pursuant to Sec. 194 of the 1997 Tax Code; 6. TRANSCO's income from the disposal of the Subtransmission assets is exempt from income tax and 2% franchise tax. Taxation of Concessionaire 7. The Transition Fees received by the Concessionaire during the Non-Franchise Period are subject to 2% expanded withholding tax; 8. The Commencement Fee and Deferred Payments paid by the Concessionaire are capital expenditures (Concession Rights) which can be amortized over a period of twenty-five (25) years. For the same reason, the Extension Fee shall be treated as capital expenditure and shall be amortized over the extension period of twenty-five (25) years if the Concession Agreement is extended. The annual amortization of such capital expenditures may be claimed as deduction by the Concessionaire from gross income; 9. All New Projects constructed by the Concessionaire and subsequently transferred to TRANSCO and Documented Property Rights acquired by the Concessionaire for and on behalf of TRANSCO, both in each case at the Concessionaire's own cost and expense, may be recorded by the Concessionaire in its books as an asset (Concession Rights) at an amount equivalent to the cost of the property. The value of such Concession Rights may be amortized over the period expected to be benefited by such expenditures. i.e., from the time they were transferred to or acquired for and on behalf of TRANSCO, as the case may be, until the end of the Concession Period, and such amortization may be claimed as deduction from gross income of the Concessionaire pursuant to Sec. 34 of the 1997 Tax Code. ITCcAD 10. The Transfer of New Projects constructed by the Concessionaire to TRANSCO during the Concession period is not subject to VAT or franchise tax; 11. The transfer of new Transmission projects constructed and all real estate interests acquired by the Concession for and on behalf of TRANSCO and subsequently transferred to TRANSCO during the Concession Period is not a donation subject to donor's tax; 12. Transfer by the Concessionaire to TRANSCO of title over improvements, expansions, repairs and rehabilitations of the Transmission system constituting new Transmission projects are subject to DST; On the other hand, since the Documented Property Rights are acquired by the Concessionaire for and on behalf of TRANSCO, no DST is imposed on the recognition of TRANSCO of title over these assets since the transaction will not involve any transfer or sale of real property between the Concessionaire and TRANSCO. 13. In case the termination of the Concession and receipt of the Termination Payments results in a gain on the part of the Concessionaire, such gain shall be subject to income tax. On the other hand, if the termination results in a loss, such loss may be deducted from gross income by the Concessionaire for purposes of income tax. In computing the gain or loss, if any, on the termination of the Concession, the net book value of the assets to be transferred by the Concessionaire and the unamortized portion of the Concession Rights shall be deducted from the Termination Payment to be received by the Concessionaire; 14. Upon termination of the Concession, the transfer of uncompleted Transmission projects constructed by Concessionaire to TRANSCO is not subject to VAT or franchise tax. B. Remittance of profits from TRANSCO 15. Profits received by PSALM from TRANSCO are exempt from income tax pursuant to Sec. 27(D)(4) of the 1997 Tax Code; 16. The remittance of net privatisation proceeds by TRANSCO to PSALM in excess of dividends declared and paid by TRANSCO to PSALM in any given year shall not be considered loans to which taxable interest income may be imputed; C. On Ancillary Services 17. Ancillary Service Charges collected by the Concessionaire during the Franchise Period for the Ancillary Services provided by Generation companies do not constitute income to the Concessionaire and thus, shall not be considered as part of gross income for purposes of computing its income tax. Also, said fees do not form part of the gross receipts of the Concessionaire for purposes of the franchise tax; and 18. Service fees received by Generation companies for the Ancillary Services that they provide are subject to 0% VAT. In support of the request for ruling, the following documents were furnished by PSALM: 1. Republic Act No. 9136 Electric Power Industry Reform Act of 2001; 2. Rules and Regulations to Implement Republic Act No. 9136; 3. Draft Concession Agreement (April 21, 2001 version); 4. Draft Lease Agreement (April 21, 2003 version); 5. Draft Ancillary Services Procurement Agreement (May 21, 2003 version) 6. Copies of the cases cited herein, and 7. Copies of the rulings cited. IV. BIR REPLY In reply, please be informed that the transactions arising from or relating to the privatization of NPC will be taxed in the manner described below. In this connection, it is to be noted that this ruling shall apply only to the facts as represented, in connection with the applicable provisions of the EPIRA, the IRR, the Tax Code of 1997 and related laws existing as of the date of this ruling. A. Transactions Covered under the Concession Agreement 1. Income received by TRANSCO during the Non-Franchise Period arising from its operation of the Transmission and Subtransmission systems, being income derived from the operation of a public utility accruing to the Government of the Philippines, is exempt from income tax . The EPIRA provides for the transfer of the Transmission and Subtransmission facilities of NPC and all other assets related to Transmission operations, including the nationwide franchise of NPC for the operation of the Transmission system and the grid to NPC within six (6) months from its effectivity. The EPIRA mandates TRANSCO to assume the electrical Transmission functions of NPC and to assume the authority and responsibility of NPC for the planning, construction and centralized operation and maintenance of its high voltage Transmission facilities, including grid interconnections and Ancillary Services. On several occasions, this Office has ruled on the taxation of NPC. Under the NPC Charter, NPC enjoys exemption from all forms of taxes, direct or indirect. However, such tax exemption privileges of NPC were repealed by Presidential Decree No. (PD) 1177. Subsequently, the Fiscal Incentives Review Board (FIRB) issued on June 24, 1987, Resolution No. 17-87, which restored the tax and duty exemption privileges of NPC, with the exception of certain specific transactions. Thereafter, the income tax exemption of NPC was repealed with the amendments introduced by Republic Act No. (RA) 8424. In BIR Ruling No. 18-00 dated January 20, 2000, this Office, however, clarified that the income of NPC from its operations as a public utility is excluded from gross income pursuant to Sec. 32(B)(7)(b) of the Tax Code of 1997. In BIR Ruling No. 020-2002 dated May 13, 2002, we again reiterated the exemption of NPC from income tax. We noted that the transfer of the franchise of NPC necessarily entails also the transfer of the privileges that NPC enjoys under its charter in relation to the operation of the Transmission system in order for it to perform the electrical transmission functions of NPC. On this basis, we ruled that TRANSCO will be taxed in the same manner as NPC. 13 In the light of the foregoing, this Office is of the opinion as it hereby rules that since the income of TRANSCO from the operation of Transmission and Subtransmission systems during the Non-Franchise Period is income from the operation of a public utility accruing to the Government of the Philippines, or to any political subdivision thereof, the same is excluded from its gross income pursuant to Sec. 32 (B)(7)(b) of the Tax Code of 1997. SCHIac 2. All payments received by TRANSCO (Commencement Fee, Deferred Payments, including the Late Payment Penalty and interest, and Extension Deposit) pursuant to the Concession Agreement are excluded from gross income for income tax purposes and consequently, exempt from withholding tax . The privatization of the Transmission system transferred to TRANSCO from NPC is mandated under the EPIRA. Pursuant thereto, PSALM is required to award, in open competitive bidding, the Transmission facilities, including grid interconnections and Ancillary Services, to a qualified party either through an outright sale or a concession contract. Net proceeds from the privatization of TRANSCO shall be immediately remitted to PSALM. 14 The proceeds shall be used solely to pay for outstanding obligations of the National Power Corporation (NPC) arising from loans, issuances of bonds, securities and other instruments of indebtedness transferred to and assumed by PSALM Corporation pursuant to Section 49 of Republic Act No. 9136. We opine that the privatization of the Transmission system, the award by PSALM in open competitive bidding, the transmission facilities, including grid interconnections and Ancillary Services, to a qualified party either through outright sale or a concession contract, and the remittance of the proceeds of such privatization to PSALM to pay off the outstanding obligations of the NPC are essential governmental functions. "Governmental functions" is defined as functions of a government instrumentality which are essential to its existence in the sense of serving the public and which has for its objective the promotion of the public health, safety, morals, general welfare, security, prosperity and contentment of the inhabitant or in the performance of a duty imposed by sovereign power. Thus, governmental functions are limited to legal duties imposed by the state upon its creatures, which it may not omit with impunity, but must perform at its peril. 15 The BIR itself, in BIR Ruling 20-2002, cited the case of People's Homesite and Housing Corporation vs. Court of Industrial Relations (G.R. No. L-31890 dated May 29, 1987) to describe what constitutes "essential governmental function", to wit: "It has not always been easy determining which functions are governmental in nature and which are proprietary. The characterization of functions performed by the government has evolved from the traditional "constituent-ministrant" classification [as enumerated in the case of Bacani vs. National Coconut Corporation , (110, Phil 468[1956] to its disavowal in the case of ACCFA v. CUGCO, et. Al . (GR. No. L-221484, November 29, 1969, 30 SCRA 649), where, considering the social justice provision of the 1936 Constitution, we said that the "constituent-ministrant" classification has become unrealistic, if not obsolete. There, we gave our assent to a socio-political philosophy espousing a great socialization of economic forces. We found nothing objectionable in government undertaking in its sovereign capacity activities, which, by the constituent-ministrant test would have been considered as merely optional. "We, thus, rule in said case that the agricultural Credit Administration, tasked as it was with the implementation of the land reform program of the government was an agency performing governmental function." Moreover; it is noted that the EPIRA provides that the privatization value to the National Government of the NPC assets, including the Transmission System that has been transferred to TRANSCO, must be optimized. The more proceeds that PSALM can generate from the privatization of the Transmission system, the more resources it has to liquidate NPC's stranded debts and stranded costs and consequently, the universal charge that will be imposed to end-users may be minimized. In the light of the intention of the law to ensure the affordability of electric power to end-users, income realized by TRANSCO from the privatization of the Transmission system which shall be remitted to PSALM should be optimized. Considering the foregoing and as we previously ruled that income arising from the privatization by TRANSCO of the Transmission system is considered as income from the exercise of essential governmental function and therefore, excluded from gross income pursuant to Sec. 32(B)(7)(b) of the Tax Code of 1997. 16 Thus, the Concession Fees consisting of the Commencement Fee and Deferred Payments, including the Late Payment Penalty and interest, as well as the Extension Deposit to be received by TRANSCO are exempt from income tax and minimum corporate income tax imposed in Section 27(A) and Sec. 27(E), respectively, of the 1997 Tax Code. 3. The properties constructed by the Concessionaire at its own cost and transferred to TRANSCO during the Concession Period, and Documented Property Rights acquired by Concessionaire for and on behalf of TRANSCO, also at Concessionaire's own cost, are part of the consideration received by TRANSCO for the grant of the Concession and therefore, exempt from income tax . The Concessionaire agrees to site, permit, finance, construct and otherwise develop and complete all New Projects (i) contemplated by the Transmission Development Plan (TDP), and (ii) from and after the commencement of the First Regulatory Year of the Second Regulatory Period, included in the relevant capital, expenditure program approved by the ERC pursuant to the Transmission Wheeling Rate Guidelines. Under both cases, Concessionaire shall construct the Transmission projects at its own cost and expense. Upon the completion of construction of each New Project, Concessionaire shall, at no cost or expense to TRANSCO, transfer title of each New Project to TRANSCO. Moreover, as also provided under the Draft Concession Agreement, Concessionaire shall acquire, for and on behalf of TRANSCO subject to law, at the Concessionaire's own cost and expense, Documented Property Rights in the New Project Site related to each New Project. Clearly, the cost and expenses incurred by the Concessionaire in the construction of New Projects and acquisition of Property Rights are considered part of the consideration received by TRANSCO for the grant of the Concession. The Concessionaire agrees to shoulder the cost of constructing or acquiring these properties since these responsibilities are part of the conditions for the award of the Concession. As discussed above, the value of these assets and Documented Property Rights constitutes income arising from an essential governmental function accruing to government and thus, we opine that it is excluded from the gross income of TRANSCO for purposes of income tax pursuant to Sec. 32 (B)(7)(b) of the 1997 Tax Code. STcHEI Furthermore, the EPIRA provides that except as provided for therein, only TRANSCO may own transmission facilities. 4. Revenues received by TRANSCO in connection with the operation of the Transmission and Subtransmission Systems during the Non-Franchise Period, and the Concession Fees and all other payments received by TRANSCO, whether in cash or in kind, as consideration for the grant of the Concession, regardless of whether they are received during the Non-Franchise or Franchise Period, are exempt from the 2% franchise tax . Considering that TRANSCO shall be taxed in the same manner as NPC, 17 it will be exempt from franchise tax just like NPC. Considering further that TRANSCO's franchise is not transferred to the Concessionaire since the latter will have to secure its own franchise and as such, TRANSCO's tax privileges will remain all throughout the Concession period. Consequently, revenues realized by TRANSCO from the operation of the Transmission and Subtransmission systems and all payments received (in cash or in kind) as consideration for the grant of the Concession shall be exempt from franchise tax. Accordingly, TRANSCO's receipts during the entirety of the Concession period, both under the Non-Franchise and Franchise Period, shall be exempt from the franchise tax. 5. The portion of the Commencement Fee, as described under the Lease Agreement, that represents payment to TRANSCO for the lease of real property underlying the Subject Assets, is subject to DST . As represented, in satisfaction of a condition to closing the award of the Concession, TRANSCO and the Concessionaire will enter into a Lease Agreement under which TRANSCO shall lease the Transmission Assets, the Transmission Site, the Subtransmission Assets, the Subtransmission Site, the Related Assets Site to the Concessionaire for a consideration. The portion of the Commencement Fee constituting consideration for the right to use the real property underlying the said assets is considered payment for the lease of said lands or tenements. Accordingly, pursuant to Sec. 194 of the Tax Code of 1997, DST shall be imposed on such lease at the rate of P3.00 for the first P2,000; or fractional part thereof, and an additional P1.00 for every P1,000 in excess of the first P2,000. 6. TRANSCO's income from the disposal of the Subtransmission assets is exempt from income tax and 2% franchise tax . Just like NPC, the exemption of TRANSCO is not limited to the sale of Transmission services but includes transactions incidental to and necessarily connected with the operations of the public utility, such as a sale or transfer on an isolated basis of its assets, which transaction is not conducted as a separate business. 18 Since TRANSCO will retain its franchise, its income from the sale of the Subtransmission system will be excluded from gross income for purposes of computing its income tax pursuant to Sec. 32(B)(7)(b) of the Tax Code of 1997. For the same reason, the sale of the Subtransmission system is exempt from franchise tax. On Concessionaire 7. The Transition Fees received by the Concessionaire during the Non-Franchise Period are subject to 2% creditable withholding tax . During the Non-Franchise Period, the Concessionaire will maintain, rehabilitate and expand the nationwide Transmission and Subtransmission systems in favor of TRANSCO and perform other activities other than Non-Delegable Functions as enumerated in the Agreement. 19 The Concessionaire shall also invoice and collect revenue from all grid users as agent for TRANSCO and manage the completion of the projects of TRANSCO under construction. As an interim measure prior to the Franchise Period and as compensation for performing all of the above services, TRANSCO will pay Transition Fees to the Concessionaire, which shall be determined in accordance with the provisions of the Concession Agreement. Under Section (N) of Revenue Regulations No. 17-2003, income payments, except any casual or single purchase of P10,000 and below, which are made by a government office, national or local, including barangays, or their attached agencies or bodies, and government-owned or controlled corporations, (GOCC), on their purchases of goods and purchases of services from local/resident suppliers are subject to 2% creditable withholding tax. Accordingly, the Transition Fees paid by TRANSCO, a GOCC, for services rendered by the Concessionaire are subject to the 2% creditable withholding tax. 8. The Commencement Fee and Deferred Payments paid by the Concessionaire are capital expenditures, which can be amortized over a period of 25 years. For the same reason, the Extension Fee shall be treated as capital expenditure and shall be amortized over the extension period of twenty-five (25) years if the Concession Agreement is renewed. The annual amortization of such capital expenditures may be claimed as deduction by the Concessionaire from gross income . As earlier opined, the Concessionaire shall be liable to corporate income tax of 32% on its taxable income which shall include the Transmission charge and income from all other sources. It shall be entitled to certain allowable deductions pursuant to Section 34 of the Tax Code of 1997. The capital expenditures may be deducted from gross income through depreciation, depletion or amortization deductions spread over the useful life of the expenditures. The cost of acquiring the intangible should be capitalized when useful lives can be estimated and the applicable amortization is allowed as deduction from gross income of the Concessionaire; otherwise, no amortization is allowable for tax purposes. 20 Notably, the concession fees paid by the Concessionaires of MWSS are similar to the nature of the Commencement Fee and Deferred Payments to TRANSCO. Applying the principles espoused in the ruling on the privatization of the MWSS, the consideration paid by the Concessionaire to TRANSCO for the award of the Concession shall be capitalized as Concession Rights and amortized over the period that is expected to be benefited by such expenditures and the amortization shall be allowed as deduction from the gross income of the Concessionaire for income tax purposes. aDSAEI Accordingly, the consideration paid by the Concessionaire to TRANSCO should be capitalized as Concession Rights and amortized over the period that is expected to be benefited by such expenditures and the amortization shall be allowed as deduction from the gross income of the Concessionaire for income tax purposes. Moreover, since the Concession Period is for twenty-five (25) years with automatic extension for another twenty-five (25) years if the Concessionaire does not incur any Event of Default during the last five (5) years of the Concession Period the Commencement Fee and Deferred Payments shall be amortized over twenty-five (25) years. Similarly, if the concession period is extended, the Extension Deposit shall be amortized over the extension period of twenty-five (25) years. 9. All New Projects constructed by the Concessionaire and subsequently transferred to TRANSCO and Documented Property Rights acquired by the Concessionaire for and on behalf of TRANSCO, both in each case at the Concessionaire's own cost, may be recorded by the Concessionaire in its books as an asset (Concession Rights) at an amount equivalent to the cost of the property. The value of such Concession Rights may be amortized over the period expected to be benefited by such expenditures, i.e., from the time they were transferred to or acquired on behalf of TRANSCO, as the case may be, until the end of the Concession Period. Such amortization may be claimed as deduction from gross income by the Concessionaire . The right to use by the Concessionaire of the assets acquired during the concession period through the exercise of the right of eminent domain is an intangible asset which may be recorded by the Concessionaire as an asset (Concession Right) at an amount equivalent to the cost of the property. 21 Accordingly, the cost of all the New Projects and all Documented Property Rights acquired by the Concessionaire, but titles of which will be transferred to TRANSCO in accordance with the provisions of the Concession Agreement, may be recorded by the latter in its books as an intangible asset (Concession Rights) at an amount equivalent to the cost of the property. The value of such Concession Rights may be amortized from the time they were transferred to or acquired on behalf of TRANSCO until the end of the Concession Period and the annual amortization thereof may be claimed as deduction from gross income of the Concessionaire for income tax purposes pursuant to Sec. 34 of` the Tax Code of 1997. 10. The transfer of New Projects constructed by the Concessionaire to TRANSCO is not subject to VAT or franchise tax . Pursuant to Section 105 in relation to Section 108, both of the 1997 Tax Code, a value-added tax equivalent to ten percent (10%) of the gross selling price or gross value in money, is collected from any person who, in the course of trade or business, sells, barters, exchanges, leases goods or properties, which tax shall be paid by the seller or transferor. The phrase "in the course of trade or business" means the regular conduct or pursuit of a commercial activity, including transactions incidental thereto. The services rendered by the Concessionaire to TRANSCO during the Non-Franchise Period for which it receives a Transition Fees is covered under VAT. In BIR Ruling No. DA-131-2003 dated April 25, 2003, the BIR has clarified that the supply and delivery of asset management and consultancy services by the Concessionaire to TRANSCO under Phase One (i.e., the Non-franchise Period) of the TRANSCO Privatization shall be subject to zero percent (0%) VAT, subject to the condition that the Concessionaire is VAT-registered and shall apply with the Revenue District Office having jurisdiction over its principal place of business for the effective VAT zero-rating. On the other hand, during the Franchise period when the Concessionaire will be operating the Transmission System under a legislative franchise, the Concessionaire shall be covered by the 2% franchise tax on gross receipts derived from the business covered by the franchise. The above notwithstanding, this Office opines and so holds that the transfer of New Projects constructed by the Concessionaire during the Concession period (whether under the Non-Franchise of Franchise Period) to TRANSCO would neither be subject to VAT nor franchise tax, as the case may be. The transfer of said properties will be made by the Concessionaire to TRANSCO as part of the consideration for the grant of the Concession. Since the transfer of these properties is a consequence of award of the Concession and not conducted by the Concessionaire in the course of trade or business, the transfer is considered an isolated transaction, which will, therefore, not be subject to VAT. 22 11. The transfer of New Projects constructed by the Concessionaire to TRANSCO, and all real estate interests acquired by the Concessionaire on TRANSCO's behalf, are not donations and therefore, not subject to donor's tax . This Office hereby opines that the construction by the Concessionaire of new Transmission projects at its own cost during the Concession Period in order to comply With the obligations under the Concession Agreement, as mandated under the EPIRA and its IRR and the subsequent transfer thereof is not a donation subject to donor's tax the same being a part of the consideration for the grant of the Concession, and not a gratuitous act on the part of the Concessionaire. For the same reason, the acquisition by the Concessionaire of the rights of way needed for these projects for and on behalf of TRANSCO is deemed part of the consideration for the grant of the Concession. The acquisition of the rights of way is, therefore, not a donation subject to donor's tax. 12. Transfer of New Projects by the Concessionaire to TRANSCO shall be subject to DST . Any deed of conveyance or transfer of land, tenement or other realty to be executed by the Concessionaire to TRANSCO during the Concession period, in connection with the new Transmission projects pursuant to Concession Agreement shall be subject to DST in accordance with Sec. 196 of the Tax Code of 1997. However, the Documented Property Rights acquired by the Concessionaire for and on behalf of TRANSCO, which, for all intents and purposes, was actually acquired by TRANSCO through the exercise of its eminent domain and the subsequent transfer of title thereto in the name of TRANSCO are not subject to DST. cACEaI 13. In case the termination results in a gain on the part of the Concessionaire, such gain shall be subject to income tax. On the other hand, if the termination results in a loss, such loss may be deducted from gross income by the Concessionaire for purposes of income tax, in the year such loss was incurred. In computing the gain or loss, if any, on the termination of the Concession, the net book value of the assets to be transferred by the Concessionaire and the unamortized portion of the Concession Rights shall be deducted from the Termination Payment received by the Concessionaire . In the event that the Concession Period expires and no Concessionaire Default has occurred and is continuing, the Concession shall be terminated and TRANSCO shall make the Termination Payment to the Concessionaire, which shall be calculated and remitted in accordance with the formula prescribed in the proposed Put and Call Option Agreement. Also, the reversion of the Subject Assets to TRANSCO and the payment of the Termination Payment are the remedies available to TRANSCO in case there is an occurrence of a Concessionaire Default, as defined under the Concession Agreement. The receipt of the Termination Payment may give rise to either a gain or loss to the Concessionaire, depending on the difference between the Termination Pay and the unrecoverable cost of the Concession to the Concessionaire. Gains realized by the Concessionaire from the termination shall be subject to income tax. On the other hand, if the receipt of the Termination Payments results in a loss, such loss is considered as loss of the useful value of property (i.e. Concession Rights). Therefore, since the termination of the Agreement will cut short the chance of the Concessionaire to recover the unamortized portion of the Concession Rights and therefore the remaining amount pertaining thereto is determined to be useless and must be completely written off to the extent not recovered through the receipt of the Termination Payment, the Concessionaire may claim as deduction from gross income the actual loss sustained pursuant to Revenue Regulations No. 2. Moreover, considering that at the time of the termination, the unrecoverable cost will be the unamortized amount of the Concession Rights increased by the book value of the uncompleted New Projects that are required to be transferred by Concessionaire to TRANSCO. Accordingly, for purposes of determining the gain or loss from the termination for income tax purposes, the Concessionaire shall be allowed to deduct from the Termination Payment the net book value of the assets to be transferred by the Concessionaire and the unamortized portion of the Concession Rights. 14. The transfer of uncompleted New Projects constructed by the Concessionaire, upon termination of the Concession, is not subject to VAT or franchise tax . The transfer of the uncompleted New Projects directly arises from the termination of the Concession. It does not result from the sale of goods or services by the Concessionaire, but is merely an incident to, or a necessary consequence of, the Concession. Thus, if the termination occurs during the Non-Franchise Period, the transfer of the uncompleted New Projects by the Concessionaire, upon termination of the Concession, to TRANSCO is not subject to VAT since the transfer of said assets is not in the course of trade or business of the Concessionaire pursuant to Sec. 99 of the Tax Code. On the other hand, if the Concession is terminated during the Franchise Period, the transfer of uncompleted Transmission projects shall not be subject to franchise tax. B. Remittance of Profits by TRANSCO to PSALM 15. Profits remitted by TRANSCO to PSALM are not subject to income tax . The EPIRA and its IRR, mandate TRANSCO, among others, to remit its net profits, if any, as well as the net proceeds from its privatization to PSALM not later than ninety (90) days after the immediately preceding quarter. 23 Pursuant to Section 27(D)(4) of the Tax Code of 1997, dividends received by a domestic corporation from another domestic corporation shall not be subject to tax. Dividends, for the purpose of the law, comprise any distribution whether in cash or other property, in the ordinary course of business, even though extraordinary in amount, made by a domestic or resident foreign corporation, joint-stock company, partnership, joint account ( cuenta en participation ), association, or insurance company to the shareholders or members out of its earnings or profits accumulated since March 1, 1913. ( Revenue Regulations No. 2, Sec. 250 ) Accordingly, profits of TRANSCO received by PSALM are not taxable and thus, not subject to withholding tax. 16. The remittance of net privatization proceeds by TRANSCO to PSALM in excess of the dividends declared and paid by TRANSCO to PSALM in any given year shall not be considered loans to which taxable interest may be imputed . Pursuant to the provisions of the EPIRA, as discussed above, TRANSCO is required to remit immediately to PSALM the net proceeds from excess the privatization. Hence, the remittance of the Concession fees to PSALM in excess of the amount declared and paid by TRANSCO to PSALM as dividend in any given year will be deemed as Advances to PSALM by TRANSCO. In Revenue Memorandum Circular No. 63-99, it was stated that where one member of a group of controlled entities makes a loan or advances directly or indirectly, or otherwise becomes a creditor of another member of such group, and charges no interest, or charges interest at a rate which is not equal to an arm's length rate, the BIR Commissioner may make appropriate allocations to reflect an arm's length interest rate for the use of such loan or advance. For purposes of determining the arm's length rate in domestic transactions, the interest rate to be used is the Bank Reference Rate (BRR) prescribed by the Bangko Sentral ng Pilipinas (BSP). As defined under existing laws, a loan is a contract whereby one of the parties delivers to another money with the understanding that the same amount of the same kind and quality shall be paid. 24 The foregoing rules find no application in the instant case considering that TRANSCO will be remitting these proceeds to PSALM to comply with the EPIRA provision mandating it to immediately make such payment in order that the latter may utilize it to reduce the stranded debts and stranded costs of NPC. Accordingly, the provisions of RMC No. 63-99 shall not apply with respect to said advances and thus, no interest shall be imputed thereon. EADSIa C. Ancillary Services 17. Ancillary Service Charges collected by TRANSCO or the Concessionaire for Ancillary Services provided by generation companies do not constitute income. Also, said fees do not form part of the gross receipts of the Concessionaire for purposes of the franchise tax ; As represented, since TRANSCO or the Concessionaire ( the Transmission Provider/System Operator ), as the System Operator of the nationwide electrical Transmission and Sub-transmission systems responsible to maintain the quality of the electricity transmitted therein, it will enter into Ancillary Services Agreements with qualified generation companies ( the "A/S Provider" ) to provide sufficient Ancillary Services which will ensure the reliability and security of the grid. In consideration thereof, the Transmission Provider/System Operator shall pay the A/S Provider Ancillary Service Procurement based on the rates for Ancillary Service Charges at which transmission customers will be paying Transmission Provider, as approved by the ERC. 25 Likewise, under the proposed procedures for billing and payment of Ancillary Service Procurement Fees which shall be as follows: "(A) Billing Procedure . (1) Within ten (10) days from the end of each Billing Period, the Transmission Provider/System Operator shall submit to the A/S Provider a statement specifying the Ancillary Service Procurement Fees due to the A/S Provider for the preceding month ( the "Statement of Account" ). The Statement of Account shall affix the billing invoice and statement forms ( the "Billing Statements" ) issued by the Transmission Provider/System Operator to Transmission Customers for the same Billing Period. The Billing Statements shall provide the Ancillary Service Charges for ancillary services provided by the Transmission Provider/System Operator for the same Billing Period. (2) Within five (5) days from receipt of the Statement of Account, the A/S Provider shall either: (i) submit to the Transmission Provider/System Operator an invoice for the Ancillary Service Procurement Fees provided in the Statement of Account ( the "Invoice" ); or (ii) where it disputes any amount or item in the Statement of Account, submit to the Transmission Provider/System Operator an Invoice for such amount, as it, acting in good faith, believes is due for ancillary services provided, together with a written notice (the "Claim") specifying the amount contested and the grounds for such contest. All Claims shall be subject to the dispute resolution procedures in the OATS Rules. (2) The A/S Provider shall be deemed to have agreed with the Statement of Account of the Transmission Provider/System Operator if it fails to submit a Claim as provided in the Ancillary Services Agreement. 26 it is clear that the cost of acquiring Ancillary Services are mere by passed-through to Transmission Customers on whose behalf TRANSCO is deemed to purchase the Ancillary Services. Thus, we hereby opine that Ancillary Services Charges collected by TRANSCO or the Concessionaire for Ancillary Services provided by generation companies are not subject to income tax since, with respect to TRANSCO or the Concessionaire, it is not in the nature of income. Income, in a broad sense, means all wealth that flows into the taxpayer other than as a mere return of capital. ( Section 36, Revenue Regulations No. 2, otherwise known as the Income Tax Regulations ). The Ancillary Service Charges do not constitute a flow of wealth to TRANSCO or the Concessionaire as it would not accrue to their benefit but would be remitted to and is especially earmarked for the generation companies. 27 As represented, during the Non-Franchise Period, TRANSCO, as the operator of the Transmission system, will be collecting the Ancillary Services Charges, both for services rendered by itself and by the generation companies. Once the Concessionaire is granted a franchise, this responsibility shall be performed by the Concessionaire. Thus, TRANSCO or the Concessionaire is merely collecting the cost of such Ancillary Services from the Transmission Customers, which is intended to be paid to Qualified Generation Companies. Accordingly, the Ancillary Services Charges collected by TRANSCO or the Concessionaire for Ancillary Services provided by generation companies are not subject to income tax since, with respect to TRANSCO or the Concessionaire, it is not in the nature of income. Moreover, the Ancillary Services Charges for Ancillary Services provided by generation companies also do not form part of the gross receipts of the Concessionaire for franchise tax purposes. The term "gross receipts" means the total amount of money or its equivalent representing the contract price, compensation or service fee, including the amount charged for materials supplied with the services and deposits or advance payments actually or constructively received during the taxable quarter for the services performed or to be performed for another person. The Ancillary Services Charges are not compensation for services performed by TRANSCO or Concessionaire. TRANSCO or the Concessionaire merely collect the fees on behalf of the generation companies and such fees have already been earmarked therefore. Money collected, which has been earmarked for the true owner thereof, does not form part of gross receipts, notwithstanding the definition of the term "gross receipts" as referring to the entire earnings from all operations. 28 Moreover, to be considered part of the taxpayer's gross receipts, the payments should be received by it as compensation for services rendered; and the same should inure to the taxpayer's benefit. 29 18. Ancillary Services Charges received by qualified generation companies for Ancillary Services performed by them are zero-rated for VAT purposes . The sale of generated power by a generation company is zero-rated for VAT purposes. 30 Under existing laws, the transactions subject to VAT are not limited only to the sale of taxable goods or services but also includes incidental transactions. Generation companies are required to provide Ancillary Services, which are inherent to their generation of power. Ancillary services, as described above, are essential in maintaining Power Quality and Reliability and Security of the Grid. Accordingly, the sale by generation companies of Ancillary Services are also subject to 0% VAT. ADHaTC This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it shall be disclosed that the facts are different, then this ruling shall be considered null and void. Very truly yours, (SGD.) JOSE MARIO C. BUAG Deputy Commissioner Legal & Inspection Group Footnotes 1. Section 21, Republic Act No. 9136 (EPIRA). 2. Schedule 10, Page "Schedule 11-2", Draft Concession Agreement (April 21, 2003). 3. Section 6.02, Page 6, Draft Concession Agreement (April 21, 2003). 4. Section 6.03, Page 10, Draft Concession Agreement (April 21, 2003). 5. Section 5, Page 3, Draft Lease Agreement (April 21, 2003). 6. Section 9.01, Draft Concession Agreement (April 21, 2003). 7. Section 8.03, Page 14, Draft Concession Agreement (April 21, 2003). 8. Section 17.01, Page 25, Draft Concession Agreement (April 21, 2003). 9. Section 8. Obligations of TRANSCO. The TRANSCO shall have, among others, the following obligations: xxx xxx xxx (c) Remit its net profit, if any, to the PSALM not later than ninety (90) days after the immediately preceding quarter subject to annual reconciliation when the audited and certified annual financial statements are finally made available. [Consistent with Sec. 18 and Sec. 55] Net profit is defined as: Net profit = Total Utility Revenue - ( Total Operating Expense - Other Income + Interest & Other Charges ) Net proceeds from the Privatization of TRANSCO shall be immediately remitted to PSALM. xxx xxx xxx 10. Section 1.6, Grid Code. 11. Draft Open Access Transmission Services (OATS) Rules (May 21, 2003). 12. Rule 6, Section 12 of the IRR. 13. "3. TRANSCO shall be taxed in the same manner as NPC. "Section 8 of the EPIRA provides that the Transmission and Subtransmission facilities of NPC and all other assets related to Transmission operation, including the nationwide franchise of NPC for the operation of the Transmission system and the grid shall be transferred to TRANSCO. The transfer of the franchise of NPC necessarily entails also the transfer of the privileges that NPC enjoys under its charter in relation to the operation of the Transmission system in order for it to perform the electrical transmission functions of the NPC. As previously ruled, the income of NPC from the operation of a public utility is excluded from gross income. In this regard, Section 18 and 55(f) of the EPIRA state that "the net profit, if any, of TRANSCO shall be remitted to PSALM Corp. not later than ninety (90) days after the immediately preceding quarter" and "the following funds, assets, contributions and other property shall constitute the property of PSALM Corp.: . . . net profit of TRANSCO". As stated earlier, PSALM will be wholly-owned by the National Government. "Thus, we confirm your opinion that TRANSCO should be taxed in the same manner as NPC, to wit: i) With respect to income tax, the income of TRANSCO is excluded from gross income for purposes of computing its income tax pursuant to Section 32(B)(7)(b) of the Tax Code of 1997. ii) On franchise tax, just like NPC, TRANSCO will be exempt from all forms of taxes, including franchise tax , because the NPC franchise, including the privileges related thereto, have been transferred by operation of law to TRANSCO." (Emphasis ours) 14. See Footnote No. 9. 15. BIR Ruling [DA-215-10-22-0 1]. 16. BIR Ruling No. 20-2002, supra . 17. BIR Ruling No. 020-2002, supra . 18. Radio Communications vs. Court of Tax Appeals . G.R. No. 60547, July 11, 1985, supra . 19. See Description of the Features of the Concession Under the Concession Agreement under item (ii) Award Date. This feature of the Concession Structure is found in Schedule 10, Page "Schedule 11-2", Draft Concession Agreement (April 21, 2002), supra . 20. BIR Ruling No. 6-97 dated January 17, 1997 re: MWSS Privatization, supra . 21. MWSS Ruling, supra . 22. Position taken by the BIR in MWSS Ruling, supra . 23. Section 8 Obligations of TRANSCO, supra . 24. Article 1953 of the Civil Code. 25. Under Schedule 4 of the Draft Ancillary Services Procurement Agreement dated May 21, 2003, the Ancillary Service Charges were approved by the ERC in its order dated June 26, 2002, supra . 26. See Item of Draft Ancillary Services Agreement. 27. As represented by PSALM. 28. The Commissioner of Internal Revenue vs. Manila Jockey Club, Inc ., G.R. Nos. L-13890 & L-13887, June 30, 1960 . 29. Commissioner of Internal Revenue vs. Tours Specialist, Inc ., G.R. No. 66416 dated March 21, 1990; Manila Mandarin Hotel vs. Commissioner of Internal Revenue, CTA Case No. 5046 dated March 24, 1997; VAT Ruling No. 038-02 dated June 21, 2002 . 30. Section 6, EPIRA, Rule 5, Section 6 of the IRR.