BIR Ruling [DA-400-04]

July 22, 2004 BIR RULING [DA-400-04] Secs. 76 & 171, Rev. Regs. No. 2 BIR Ruling No. 018-03 SGV & Co. 6760 Ayala Avenue 1226 Makati City Attention: Cirilo P. Noel Vice Chairman & Deputy Partner Co-head, Tax Services and Luis Jose P. Ferrer Partner, Tax Services Gentlemen : This refers to your letter dated July 12, 2004 requesting on behalf of your client, Philippine Geothermal, Inc. Philippine Branch (PGI) , for confirmation of your opinion that (1) PGI may file, in advance, its quarterly corporate income tax return and pay the corresponding income tax due for the 3rd quarter of 2004 on the settlement amount received from the National Power Corporation (NPC), arising from the Court approved Compromise Agreement with the NPC; and (2) PGI may deduct for income tax purposes from said settlement amount the Historical Issues that will be settled in full by PGI to NPC/PSALM under the court approved Compromise Agreement with the NPC. BACKGROUND Philippine Geothermal, Inc., a wholly owned subsidiary of Union Oil Company of California, was incorporated under the laws of the State of California, U.S.A. in August 1971. It is engaged in the exploration, development and production of geothermal resources for power generation. Philippine Geothermal, Inc., through PGI-Phil. Branch, was granted a license to do business in the Philippines in February 1972 by the Securities and Exchange Commission (SEC). PGI entered into a twenty-five (25) year Consolidated Service Contract (Service Contract), with the NPC for the exploration and exploitation of geothermal resources in certain areas in the Philippines. The term of the Service Contract is from September 1971 to September 1996, renewable for another 25 years under the same terms and conditions at the option of PGI. PGI exercised its option to renew the Service Contract by notifying NPC in 1994. However, NPC claimed that under the 1987 Constitution, the contract is not legally renewable. On July 8, 1996, PGI filed an arbitration case with the Secretariat of the International Court of Arbitration of the Internal Chamber of Commerce while NPC sought declaratory relief with the Quezon City Regional Trial Court (Branch 84) on August 21, 1996. Parenthetically, the case eventually went up to the Supreme Court on a procedural matter. A series of provisional agreements were entered into by NPC and PGI in order not to disrupt the operations in the geothermal fields and to maintain the stability of the electric power system in the Luzon grid. Under these provisional agreements, NPC pays PGI, in accordance with the procedures provided for in the Service Contract, only forty percent (40%) of the billed Service Fee starting October 1, 1996. The other 60% (the "Withheld Fee"), will be subject to settlement once approved by the Court. As NPC and PGI continued to negotiate a mutually beneficial arrangement that would fully and finally settle their dispute, the Philippine Congress enacted into law Republic Act (RA) No. 9136, otherwise known as the Electric Power Industry Reform Act of 2001 (the "EPIRA") where foremost among its objectives were to restructure the power industry and privatize the assets of NPC. The Power Sector Asset and Liabilities Management Corporation (PSALM), was created and mandated under the EPIRA to take title to and possession of NPC's generation assets and to manage their orderly sale, disposition and privatization. On March 17, 2003, PGI and NPC/PSALM, with the conformity of the Department of Energy (DOE), executed a Compromise Agreement (Compromise), (a copy of which is attached to the request as Annex "A"), setting forth the terms of their settlement. The Compromise was later amended in October 2003 principally to accommodate the recommendations of the Office of the Solicitor General, Office of the Government Corporate Counsel and the Office of the President. On December 22, 2003, PGI and NPC filed a Joint Motion to approve the Compromise before the Supreme Court (SC). The SC granted the Joint Motion to Dismiss the case but declined to take jurisdiction on the compromise agreement. CAcEaS Thereafter, on June 4, 2004, the parties filed a Joint Motion to Approve the Compromise Agreement before the Regional Trial Court (RTC) Branch 84. In its Decision dated June 11, 2004, the RTC resolved to approve the Compromise Agreement, as amended, and declared the same as not contrary to law, morals and public policy and enjoined the parties to strictly abide by its terms. While the case was pending in court, the Withheld Fee was held and controlled by NPC. PGI adopts the calendar year ending December 31 for its taxable year and the cash method of accounting in reporting income and expenses for tax purposes. The Court-Approved Compromise Agreement In accordance with the Compromise Agreement approved by the court, NPC/PSALM and PGI entered into a full and final settlement of the Arbitration Case and Court Case, without necessarily conceding any of the positions taken by the parties in those proceedings. The Compromise Agreement also covers the payment by NPC/PSALM of the fifty percent (50%) of the Withheld Fee. 1 It also includes the settlement in full of Historical Issues 2 being claimed by both parties against each other. All the outstanding Historical Issues that arose before the Transition Agreement and listed in Annex "D" of the Compromise Agreement are thus settled in full with PGI paying NPC the net amount thereof. The payment of the net amount of the Historical Issues by PGI to NPC/PSALM shall be made by offsetting this amount from PGI's share of the Withheld Fee. BIR REPLY We reply as follows: 1) Advance Payment of Corporate Quarterly Income Tax Section 76 of the Tax Code provides that every corporation shall file a quarterly summary declaration of its gross income and deductions on a cumulative basis for the preceding quarter or quarters upon which the income tax shall be levied, collected and paid. The quarterly corporate declaration or quarterly corporate income tax return (BIR Form No. 1702Q) shall be filed within sixty (60) days following the close of each of the first three (3) quarters of the taxable year 3 and the income tax due thereon shall be paid at the time the declaration or return is filed. 4 In BIR Ruling No. 018-03 dated November 24, 2003, a Service Contractor composed of Shell Philippine Exploration B.V., Shell Philippines LLC, Texaco Philippines, Inc. and PNOC Exploration Corporation, was allowed to make monthly tax payments of its corporate income tax and even ruled that income payments received by the service contractor from the top 5,000 (now top 10,000) corporation, for the sale of petroleum extracted from the Malampaya natural gas filed should not be subject to the creditable withholding tax since the requirements of Revenue Regulations No. 2-98 for withholding are sufficiently complied through advance tax payments. In the same ruling, the BIR cited the observation of the Department of Finance that "the voluntary act of the taxpayer to advance its quarterly income tax payments on a monthly basis displays an ability to pay its obligations, and ensures the collection of taxes that shall be used to provide for public goods and services." The BIR added that such act of voluntary payment should therefore be rewarded rather than punished. Indeed, PGI's voluntary act of paying in advance its quarterly corporate income tax for the 3rd quarter of 2004 shows its sincere desire to immediately remit to the BIR the tax due on the settlement amount received from NPC. In view of the foregoing, this Office confirms your opinion that PGI may file, in advance, its quarterly corporate income tax return and pay the corresponding income tax due for the 3rd quarter of 2004 on the settlement amount received from the NPC, arising from the Court approved Compromise Agreement with the NPC. 2) Deduction of the Settlement of the Historical Issues : We took note of your representation that NPC is due to pay PGI the settlement amount provided in the Compromise Agreement, and which PGI will report as part of its gross income for the current year ; and that the settlement of the Historical Issues with NPC/PSALM will actually be matched with the settlement amount to be received by the PGI from NPC/PSALM under the court-approved Compromise Agreement with NPC/PSALM. Section 76 of Revenue Regulations (Rev. Regs.) No. 2, otherwise known as the "Income Tax Regulations", provides that " judgements or other binding judicial adjudication, on account of damages for patent infringement, personal injuries, or other cause are deductible from gross income when the claim is so adjudicated or paid , unless taken under other methods of accounting which clearly reflect the correct deduction, less any amount of such damages as may have been compensated for by insurance or otherwise. . . ." Moreover, pursuant to Section 171 of same Rev. Regs. No. 2 " the deductions and credits must be taken for the taxable year in which "paid or accrued" or "paid or incurred", unless in order clearly to reflect the income such deductions or credits should be taken as of a different period . On the above basis, PGI may claim as deductions from its gross income for the year 2004 the full settlement of the Historical Issues with NPC/PSALM under the court-approved compromise agreement in order to clearly reflect the income of the Company. Consequently, the settlement in full of the Historical Issues with NPC/PSALM may be allowed as deductions from PGI's gross income for taxable year 2004. 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, this ruling shall be considered null and void. Very truly yours, (SGD.) JOSE MARIO C. BUAG Deputy Commissioner Legal & Inspection Group Footnotes 1. See Section 7.2 of the Compromise Agreement). 2. Historical Issues refer to those issues arising out of the Service Contract, to wit: 1) For PGI, those receivables from the Binary Generation, Mak-Ban Plant D, Tiwi Unit 4 Decommissioning and other receivables; and 2) For NPC/PSALM, those involved audit exceptions and authority for expenditure issues. 3. Sec. 77(B), Tax Code of 1997. 4. Sec. 77(C), Tax Code of 1997.