BIR Ruling [DA-502-04]

September 24, 2004 BIR RULING [DA-502-04] S.32 DA-312-2004/6-8-04 San Pablo Water District Maharlika Highway, San Gabriel, San Pablo City Attention: Ariston T. Mitra Vice-Chairman Gentlemen : This refers to your letter dated March 1, 2004 on the position of Water Districts in connection with the audit/examination being conducted by your office pursuant to Revenue Memorandum Circular No. 63-2003 dated October 10, 2003. The facts, as you represent, are as follows: The Local Water Districts (LWDs for brevity) were organized pursuant to the provisions of the Provincial Water Utilities Act of 1973, otherwise known as Presidential Decree No. 198 (P.D. 198 for brevity) originally as quasi-public corporations until declared by the Supreme Court as Government-Owned or Controlled Corporations (GOCCs for brevity) on September 13, 1991. The LWDs operate on its own, without any funding support from the National Government (NG for brevity) or from the Local Government Units (LGUs for brevity). As protection and support to their operation, Presidential Decree No. 1987 (P.D. 1987 for brevity) granted exemption from payment of all taxes (national and local), until then President Corazon C. Aquino issued Executive Order No. 93 (EO 93 for brevity) withdrawing tax exemptions including those enjoyed by GOCCs. The LWDs, not being familiar with tax laws, opted to obey and comply with EO 93 and offered no opposition to the passage or enactment of R.A. No. 7109 providing for a limited period of exemption. Notwithstanding the expiration of the exemption provided by R.A. 7109 the LWDs continue to operate as PUBLIC UTILITY providing potable water to more than 25 million Filipinos in the countryside, majority of whom are marginalized. In addition, LWDs provide or extend their services to thousands of private, commercial, industrial establishments and government offices at socialized-affordable tariff in compliance with the mandate of PD 198. The LWDs once organized are required to register themselves with Local Water Utilities Administration (LWUA for brevity), the government agency mandated to oversee, provide loans to finance water supply projects, and regulate their operation. Upon registration, they are issued either a Certificate of Conformance (CC for brevity) or Certificate of Conditional Conformance (CCC for brevity) to be able to operate as a public utility. Similar to electric cooperatives created pursuant to P.D. No. 269 and registered with the National Electrification Administration (NEA for brevity), Water Districts are not holders of legislative franchise. In reply, please be informed of the following: On the issue of Income Tax: It is your position that as Government-Owned and Controlled Corporation, LWDs do not claim to be exempted from payment of Normal Corporate Income Tax. However, as PUBLIC UTILITIES and performing governmental functions similar to NAPOCOR and MWSS, LWDs are entitled to and should avail of the allowable deductions from gross income provided for in Sec. 32(B)(7)(b) of the National Internal Revenue Code (NIRC for brevity). This Office begs to disagree. Sec. 32(B)(7)(b) of the NIRC specifically states that: "Section 32. Gross Income . xxx xxx xxx B. Exclusions from Gross Income . xxx xxx xxx (7) Miscellaneous Items . xxx xxx xxx (b) Income Derived by the Government or its Political Subdivisions . Income derived from any public utility or from the exercise of any essential governmental function accruing to the Government of the Philippines or to any political subdivision thereof." Based on the foregoing provision, before the said income could be exempt from taxes, the same must accrue to the " Government of the Philippines or to any political subdivision thereof. " Such is not the case with LWDs. The income derived by LWDs does not accrue to the Government or any of its political subdivisions. Moreover, unlike public utilities such as MWSS and NAPOCOR, LWDs do not pay dividends to the Government or any of its political subdivisions. In BIR Ruling No. 74-98 dated May 27, 1998, this Office has already ruled that the term "government" shall be limited to the National Government, which refers only to the central government, consisting of the legislative, executive and judicial departments of the government. ( Central Bank v. Court of Appeals, 63 SCRA 431 ) While the term "political subdivision" refers to the local government units established by or in accordance with the Constitution. ( Sec. 2(3), Administrative Code of 1987 ) Accordingly, this Office is of the opinion as it hereby holds that since local water districts are not composite of the National Government itself nor its political subdivision performing essential government function, they are therefore subject to corporate income tax imposed under Section 27(A) of the Tax Code of 1997. ( BIR Ruling No. DA-312-2004 dated June 8, 2004 ) On the issue of Franchise Tax: You state that Section 119 of the NIRC provides that, . . . "electric, gas and water utilities are subject to tax of two (2%) percent on the gross receipts derived from business covered by the law granting the franchise". It is very clear that for electric and water utilities to be covered by the franchise tax impose by Sec. 119 of the Tax Code, said utilities must be holders of legislative franchises, which is not true of electric cooperatives and Local Water Districts. The BIR has in fact upheld this view when it issued Revenue Ruling No. 069-98 on May 21, 1998. Following the rule on uniformity and equity in taxation provided for in Art. VI, Section 28 paragraph I of the Philippine Constitution, you contend the Local Water Districts, which among the GOCCs, do not enjoy any appropriation from the National Government to subsidize their operation cannot be and should not be DEPRIVED from enjoying the rights provided for by law. Finally, you wish it known that the water rates being charged by LWDs to their concessionaires are based on the capability of the lowest income earners in the community a mandated by law. Taxes are passed-on cost to be added to the water bills and eventually paid by the end-users. PD 198 in its Sec. 41 also provides that LWDs operate as non-profit entities but are allowed to maintain a level of income sufficient to meet their contractual obligations (payment of loans and interests) and reserve for operation and maintenance and capital expenditures for expansion of service facilities. Again, this Office begs to disagree with your position. PD 198, as amended by RA 7109, exempted LWDs from the following taxes: (1) income taxes, except taxes on interest income from deposits and on investments that have no direct relation with water service operations; (2) franchise taxes ;(3) duties and taxes on imported machinery, equipment and materials required for its operations: Provided, That such machinery, equipment and materials are not domestically manufactured at comparable and competitive prices and quality. (Section 1, RA 7109); and (4) real property taxes on all lands, buildings, and other real property, including equipment attached thereto, that are used for water supply generation and distribution: Provided, That the land or building is not used for office or any other commercial purposes. (Section 2, RA 7109) However, such tax exemption privileges were limited for a period of five years under Section 3 of RA 7109, to wit: "SEC. 3. Period and Conditions of Exemptions . The tax exemption privileges provided for in Sections 1 and 2 to all water districts shall be enjoyed only for a period of five (5) years from the effectivity of this Act : Provided, That the water districts shall adopt internal control reforms that would bring about their economic and financial viability: Provided, further, That, for a water district to be entitled to the tax exemption, its appropriation for personal services, as well as for travel, transportation or representation expenses and purchase of motor vehicles, shall not be increased by more than twenty-five percent (25%) a year during the period of exemption." (Emphasis supplied.) It is crystal clear from the foregoing that beginning August 13, 1996, all LWDs became liable to income and franchise taxes, as well as duties and taxes on imported machinery, equipment and materials required for its operations and real property taxes. BIR Ruling No. 69-98 dated May 21, 1998, which you cited, applies only to cooperatives created under the Cooperative Code of the Philippines. Clearly, LWDs are not cooperatives. They are created under P.D. No. 198, as last amended by R.A. 7109 dated August 14, 1991 which is obviously a legislative enactment. Furthermore, Section 119 of the Tax Code of 1997 provides that any provision of general or special law to the contrary notwithstanding, there shall be collected a 2% franchise tax on the gross receipts derived from the business covered by the law granting the franchise. ( BIR Ruling No. DA-312-2004 dated June 8, 2004 ) Therefore, the franchise tax imposed under Section 119 of the Tax Code of 1997 shall be applicable to local water districts created as water utilities. EcTaSC It is the hope of this Office that this clarificatory letter will put the present issues to rest. Very truly yours, Commissioner of Internal Revenue By: (SGD.) JOSE MARIO C. BUAG Deputy Commissioner Legal & Inspection Group