BIR Ruling [DA-503-04]

September 24, 2004 BIR RULING [DA-503-04] RA 4860; Sec. 20, Art. VII Const. BIR Ruling No. 136-97 Mr. Jose Ma. L. Sarasola General Manager Philippine National Railways Torres Bugallon Street Kalookan City S i r : This refers to the letter of MVM Rail Pty. Ltd. ("MVM Rail") dated August 20, 2004 requesting confirmation that the utilization of the proceeds of the loan granted under the Credit Agreement between the Australian Government's Export Finance and Insurance Corporation ABN ("EFIC") and Philippine National Railways ("PNR")/the Government of the Philippines ("GOP"), as Borrower/Guarantor, in connection with the rehabilitation of PNR's south line more particularly, the "Remaining and Additional Works for the Main Line South Revitalization Project Phase 2," ("Project"), is exempt from all taxes of any nature, direct and indirect, and thus cannot be subject to any deduction or withholding because of taxation pursuant to Section 4-A of Republic Act (R.A.) No. 4860 otherwise known Foreign Borrowings Act, as amended by Presidential Decree (PD) No. 150 dated March 13, 1973. BACKGROUND As originally represented by SGV & Co. in its letter dated August 21, 2003, MVM Rail is a company organized and existing under the laws of Australia. On May 5, 1999, a Credit Agreement (the "Agreement") was entered into between PNR and EFIC for the upgrade and revitalization of the Project. In a letter dated April 22, 2003, PNR informed MVM Rail to proceed with the execution of the Scope of Works as stipulated in the contract documents. The Agreement was last amended by a third Variation Deed dated July 29, 2003. The Agreement was executed to finance the export contract to be entered by the PNR for the execution, completion and maintenance of the Project. The Philippine Government, represented by the Secretary of Finance, gave its guarantee and indemnity in favor of EFIC in respect of PNR's obligations under the Credit Agreement. EFIC was organized for the purpose of facilitating and promoting trade between Australia and foreign countries. It was established by the State of Australia as a government corporation which primarily gets money for its operational requirements from the coffers of the government of Australia. The Credit Agreement granted to PNR by EFIC expresses this purpose of facilitating and promoting trade between Australia and the Philippines. The rehabilitation and modernization of the PNR is authorized under R.A. 6366. R.A. 6366 further provides that PNR, being a factor for socio-economic development and growth, shall be part of the infrastructure program of the government and as such shall remain in and under government ownership during the corporate existence; and that the PNR must be administered with a view of serving the interests of the public by providing them maximum service and, while aiming at its greatest utility by the public, the economy of operation must be ensured so that service can be rendered at the maximum passenger and freight price possible. LEGAL BASES OF THE REQUEST The request for exemption from Philippine taxes is anchored on Paragraph C8, Clause C of the Credit Agreement between EFIC and PNR, which provides for the non-utilization of the proceeds of the loan for the payment of taxes of any nature, to wit: "C8 You (PNR) must make sure that no taxes of any nature which are now or in the future imposed by the Republic of the Philippines (or any political administrative subdivision or taxing authority of or in the Philippines or any federation or association of which the Philippines is at the time of payment a member) ( Philippine taxes ) are deducted or withheld from any amount due under this agreement. . . ." In effect, the agreement provides that the loan proceeds shall be exclusively used for the Project and should not be used for the payment, nor diminished by taxes, duties and other fiscal charges that may be imposed by the Philippine government. In essence, the proceeds of the loan can be used only for the specific purposes enumerated in Paragraph Al, Clause A of the Credit Agreement, which are similar as those found in contracts covering projects funded by OECF of Japan, now called Japan Bank for International Cooperation ("JBIC") Fund and Grant Aids of the Government of Japan ("GOJ"). MVM Rail opines that the Paragraph C8 is not a mere contractual obligation. It posits that the foregoing clause finds legal basis both in the Constitution and in R.A. 4860. A. The Constitution and R.A. 4860 (Foreign Borrowings Act) Now Article VII, Section 20 of the 1987 Constitution has authorized the President of the Philippines to contract or guarantee foreign loans, to wit: "SEC. 20. The President may contract or guarantee foreign loans on behalf of the Republic of the Philippines with the prior concurrence of the Monetary Board and subject to such limitations as may be provided by law . The Monetary Board shall, within thirty days from the end of the quarter of the calendar year, submit to the Congress a complete report of its decisions on applications for loans to be contracted or guaranteed by the Government or government-owned and controlled corporations which would have the effect of increasing the foreign debt, and other matters as may be provided by law." (Emphasis supplied.) Anent the foregoing, R.A. 4860 also specifies what contractual clauses the President of the Philippines can waive or agree on in foreign agreements. "Sec. 1. The President of the Philippines is hereby authorized, on behalf of the Republic of the Philippines, to contract such loans, credits, including supplier's, deferred payment arrangements, and to enter into and conclude bilateral agreements involving of other forms of official assistance such as grants and commodity credit arrangements or indebtedness as may be necessary and upon such terms and conditions as may be agreed upon, not inconsistent with this Act, with Governments of foreign countries with whom the President has diplomatic relations or which are members of the United Nations, their agencies, instrumentalities or financial institutions or with reputable international lending institutions or firms extending supplier's credit or deferred payment arrangements to enable the government of the Republic of the Philippines to: (A) Undertake, through any government, office, agency or instrumentality, or government-owned and/or controlled corporation, industrial, agricultural or other economic and social development projects and feasibility studies, which are authorized by law including but not limited to those enumerated in Annex "A". . . " 1 MVM Rail argues that one such specific authority of the President to grant tax exemption in respect of the loan agreements he is authorized to enter into was expressly provided for by PD No. 150 2 which amended Sec. 4-A of R.A. 4860, viz : "Sec. 4-A. Upon the recommendation of the Secretary of Finance, in consultation with the National Economic and Development Authority and approval of the President of the Republic of the Philippines, loan agreements, as well as contracts involving the availment of or utilization of the proceeds of loans, credits or indebtedness obtained under the provisions of this Act, may provide for the exemption from taxes, charges, or other levies ." (Emphasis supplied.) In short, the foregoing provision provides express legal basis for the President through the Secretary of Finance, to agree to Paragraph C8, Clause C of the Credit Agreement. MVM Rail further proposes that the foregoing provision is the basis of similar provisions in other foreign loans not otherwise governed by other bilateral or multilateral treaties or international agreements entered into by the Republic of the Philippines. MVM Rail thus, concludes that Par. C8, Clause C of the Credit Agreement comes in the nature of a valid and binding international executive agreement the same being a sovereign act authorized both by the Constitution and law; hence, must be observed and respected by the Republic of the Philippines and consequently, by the BIR. B. BIR and VAT Rulings, Letter of Instruction 1. BIR Ruling No. 136-97 dated December 11, 1997 re BIR Tax Computerization Project, used as basis Sec. 4-A of the Foreign Borrowings Act in exempting its consultant from taxes, notwithstanding that such loan was obtained from the World Bank . 2. VAT Ruling No. 23-00 dated July 20, 2000, stating that the exemption or effectively zero-rating may be enjoyed only by the awardees of the contracts from the PDA as provided in the foreign loan agreement or from the contract itself involving the availment of or utilization of the proceeds of the loans . 3. Letter of Instruction No. 1301 dated March 25, 1983, while involving a different subject matter, recognized the authority granted to the President under Sec. 4-A of R.A. 4860, as amended by PD 150 to grant tax exemption in respect to foreign funded projects . 4. DOJ Unnumbered Opinion dated September 24, 2003, which ruled on the propriety and validity of the Credit Agreement and the Variation Deed . BIR REPLY This Office is cognizant of the fact that most foreign government funded projects and Grant Aid agreements entered into by the Government of the Philippines (GOP), carry a provision on the "non-utilization of the proceeds of the loan" in the payment of Philippine taxes. The standard clause on "non-utilization of the proceeds of the loan for payment of taxes" is inferred from the abovecited Section 4-A of R.A. 4860, as amended by PD No. 150. In essence, R.A. 4860 ensures the availability of fund needed to sustain and complete the project. This proscription is obviously a requirement of the foreign government-grantor-creditor in order to ensure that no part of the fund is divested through or diminished by any form of GOP's imposition other than the intended project/s authorized under R.A. 4860. Moreover, in the light of the fact that the Philippine Government, represented by the Secretary of Finance, signified its consent to the Credit Agreement by giving its guarantee and indemnity in favor of EFIC in respect of PNR's obligations specified therein, the Credit Agreement is binding to the GOP 3 and the matters it guarantees must necessarily be complied with. On the part of EFIC, the BIR is acquiesced of the fact that it is a government owned corporation primarily sourcing its operational requirements from the coffers of the government of Australia; hence, the Australian Government is deemed a party to the contract. Thus, even without an Exchange of Notes covering the Credit Agreement, the contract covering the Project in the instant case, is clothed with the consent and guarantee of the sovereign states. This Office is not however, impressed with MVM's argument that foreign funded projects are exempt from Philippines taxes. Both the cited Constitutional provision and R.A. 4860 use the permissive word "may" relative to the exercise of authority by the President to contract or guarantee foreign loans, and to grant of tax exemption relative thereto. In short, the Constitutional provision authorizing the President to contract or guarantee foreign loans does not expressly give powers to the President to grant tax exemption. 4 Neither, R.A. 4860 explicitly provides for tax exemption of foreign funded projects as it merely gives the President the discretion to exempt the proceeds of loan from taxes, charges or other levies. Apparently, with the standard clause of the Credit Agreement, the President has indeed exercised the authority under R.A. 4860 to grant tax exemption in connection with foreign funded projects but the incident is limited only to the non-utilization of foreign fund for payment of taxes. In short, the applicable taxes shall still be imposed as a consequent to the execution of the project. As held by the Court in the case of Commissioner of Internal Revenue vs. P.J. Kiener Company, Ltd. 5 thus, a provision in a treaty (Mutual Defense Treaty) between the United States of America and the Republic of the Philippines, stating that no tax of any kind or description will be levied on any material equipment or supplies which may be purchased or otherwise acquired in connection with a construction project was held not to exempt the oil used by private contractor's of that project in the operation of their machines or equipment in pursuance of their contracts. Said the Court: "The exception contained in the tax statutes must be strictly construed against the one claiming the exemption because the law does not look with favor on tax exemptions and that he who would seek to be exempt thus privileged must justify it with words too plain to be mistaken and too categorical to be misinterpreted ." In fine, the terms of the Credit Agreement is sanctioned both by the Constitution and R.A. 4860 and therefore, should be seen in the same light as the Exchange of Notes in the case of OECF-funded and Grant Aid projects. Thus, because of the provision on the non-utilization of the proceeds of the loan for payments of taxes" which is a standard clause in all foreign-funded and Grant Aid projects, the Philippine Government assumes all fiscal levies or taxes in the Philippines in connection with the implementation of the project. Henceforth, to ascertain the extent of tax exemption granted, this Office has to refer to Paragraph C8, Clause C of the Credit Agreement. Likewise, another provision of the Credit Agreement has been considered. It limits the use of loan proceeds exclusively, "to finance the contracts with the exporter and the consultant to buy, among others, new capital goods manufactured or produced in Australia, and services provided by people usually resident in Australia." 6 Both clauses are similar to those provided in the Exchange of Notes between the Government of Japan (GOJ) and GOP, which were clarified in Revenue Memorandum Circular (RMC) No. 42-99. In fine, this Office, in various BIR rulings, 7 has ruled insofar as RMC No. 42-99, to wit: "RMC 42-99 established that under the first clause, it is the intention of the two governments not to use the proceeds of the loan in the payment of all fiscal levies or taxes imposed by the Philippines . In view thereof, this Office held that the executing government agencies should not impose the 8.5% creditable VAT withholding prescribed under Section 114(C) of the National Internal Revenue Code of 1997 for government public works contractors undertaking the OECF-funded projects. Otherwise, the covenant not to subject the funded amount to taxes, which is the clear intent of both the Philippine and Japanese Governments under the Exchange of Notes might be violated. . . ." While the aforementioned rulings deal with JBIC-funded projects which, as mentioned earlier are contemplated by the Exchange of Notes between the GOJ and GOP, a similar tax-free treatment was adopted in the case of ADB-funded projects, on the ground that " its funds are similar to those of OECF Fund which under the Exchange of Notes shall not be used for the tax ." 8 Moreover, it so happens that it is only the advance 8.5% VAT withholding that is connected with the non-tax utilization aspect of the loan. The withholding tax, income tax or the regular 10% input VAT are the objects of the tax assumption scheme which operates only in favor of the contractor/nationals of the grantor-creditor. In consideration of the foregoing reason it will be seen that in long list of foreign funded projects, the Philippine government appropriates a counterpart fund equivalent to the amount of taxes that are due to be paid in connection with the project. Accordingly, this Office hereby opines that since MVM Rail is an Australian entity undertaking EFIC-funded project under the subject. Credit Agreement, 9 it can be accorded the same tax treatment as that enjoyed by Japanese contractors undertaking OECF-funded and Grant Aid projects or contractors undertaking ADB-funded projects. Consequently, adopting the same rationale and procedure as that provided in RMC 42-99, this Office rules as follows: 1. Considering that money payments to MVM Rail shall come from the proceeds of the loan and following the non-tax utilization aspect of the fund, PNR, as the executing government agency, shall not withhold the 8.5% creditable withholding prescribed under Section 114(C) of the Tax Code of 1997 or any creditable or final withholding tax from the billings of MVM Rail; 2. MVM Rail will pass on to PNR 10% VAT on its invoice billings and the input VAT passed on to MVM Rail by domestic suppliers of goods and services in the implementation of the Project shall be passed on to PNR as part of the invoice billings; 3. Since VAT and other taxes is the responsibility of the executing agency of the Government of the Philippines, i.e. , PNR , and whatever delay (if any) in the payment thereof is attributable to the executing agency, this Office finds the request meritorious. Thus, MVM Rail is allowed to file its monthly VAT declarations and quarter VAT returns within the time prescribed by law. In case of delay in payment by PNR of the 10% VAT passed on to MVM Rail, the payment of the VAT due on MVM Rails VAT declarations/returns may be extended, without imposition of penalty for late payment, provided that MVM Rail shall remit the VAT within ten (10) days following the date in which the amount intended for payment of the VAT is actually received by MVM Rail from PNR. ( VAT Ruling No. 004-01 dated January 15, 2001 ); and 4. Finally, as to your further request for clarification on whether or not PNR should withhold the contractor's tax on the project, please be informed that said contractor's tax imposed on principal contractor, as well as other business/percentage taxes imposed on certain sellers of services have been abolished and replaced by the value-added tax. Hence, in no instance shall PNR withhold a contractor's tax from MVM Rail. CETIDH It is, however, clarified that notwithstanding the non-imposition of the advance VAT withholding, MVM Rail, an Australian contractor undertaking the Project remains subject to the normal 10% VAT by way of output tax. 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 considered null and void. Very truly yours, (SGD.) JOSE MARIO C. BUAG Deputy Commissioner Legal & Inspection Group Footnotes 1. Section 1 of the Foreign Borrowings Act. 2. March 13, 1973. 3. Propriety and validity of the Credit Agreement and the third Variation Deed has been ruled upon by the DOJ, Ibid. 4. The Constitutional provision and the law referred are to read together with Art. VI, Sec. 28, par. 4 of the 1987 Constitution re: inherent limitation of taxation. 5. 65 SCRA 143. 6. Paragraph A1, Clause A of the Credit Agreement. The aforesaid condition set forth in Paragraph A1, Clause of the Credit Agreement is similar to that found in the Exchange of Notes covering JBIC-funded and Grant Aid projects of Japan, to wit: . . . (2) that, the grant will be used by the Government of the RP property and exclusively for the purchase of the products of Japan or the RP and the services of Japanese or Philippine nationals . . . " 7. Ruling Nos. DA-086-2004 dated 03-01-2004; DA-122-2004 dated 03-19-2004; DA-123-2004 dated 3-19-2004; DA-144-2004 dated 2-29-2004; DA-145-2004 dated 3-29-2004; VAT Ruling No. 24-2000. 8. BIR Ruling Nos. DA-202-2003 DATED June 30, 2003; DA-135-2004 dated 03-29-2004; DA-136-2004 dated 3-26-2004; DA-114-2004 dated 3-29-2004. 9. Paragraph A1, Clause A of the Credit Agreement, Ibid .