BIR Ruling [DA-516-04]

October 4, 2004 BIR RULING [DA-516-04] Atty. Agnes VST Devanadera Office of the Government Corporate Counsel 3rd Fl., MWSS Administration Bldg., Katipunan Road, Balara Quezon City Dear Hon. Devanadera : Greetings! This is a follow-up on our letter dated August 12, 2004 regarding the issues surrounding the taxability of the local water districts (LWDs) created pursuant to Presidential Decree No. 198 (PD 198), as amended by Republic Act No. 7109 (RA 7109). This Office humbly wishes to reiterate what has already been emphasized in the aforesaid letter that 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 beginning August 14, 1996. In fact, this Office had issued BIR Ruling DA-502-2004 dated September 24, 2004 issued to San Pablo Water District reiterating that LWDs are now subject to income tax, to wit: '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 ) xxx xxx xxx' BIR Ruling No. 038-02 dated November 5, 2002 further distinguished the terms "Republic of the Philippines" and "National Government". It elucidated that: '. . . The terms "Republic of the Philippines" and "National Government" are not interchangeable. The former is broader and synonymous with "Government of the Republic of the Philippines" which the Administrative Code of 1987 defines as the "corporate governmental entity through which the functions of government are exercised throughout the Philippines, including, save as the contrary appears from the context, the various arms through which political authority is made effective in the Philippines, whether pertaining to the autonomous regions, the provincial, city, municipal or barangay subdivisions or other forms of local government.' In the same Ruling, it explained that: 'An "instrumentality" refers to "any agency of the National Government, not integrated within the department framework, vested with special functions or jurisdiction by law, endowed with some if not all corporate powers, administering special funds, and enjoying operational autonomy, usually through a charter. This term includes regulatory agencies, chartered institutions and government-owned and controlled corporations . . . . The exception provided under Section 32(B)(7)(b) of the Tax Code of 1997 where income derived from the exercise of any essential governmental function accruing to the Government of the Philippines or to any political subdivision thereof, shall be excluded from gross income subject to income tax, is not applicable to DFP. If Section 32(B)(7)(b) intended to extend the exception to the agencies and instrumentalities of the National Government, then it should have restated the wording of the law to include the same. And yet, the legislature used the phrase "Government of the Philippines" in Section 32(B)(7)(b) while Section 27(C) expressly mentioned "instrumentalities." Nothing can actually prevent Congress from decreeing that even instrumentalities or agencies of the Government performing governmental functions may be subject to tax. Where it is done precisely to fulfill a constitutional mandate and national policy, no one can doubt its wisdom.' (Emphasis supplied.) Prescinding from all the foregoing, it cannot be over-emphasized that LWDs are not considered part of the National Government itself or its political subdivision. They are classified as instrumentalities as defined above and as such, are not included in the exception under Section 32(B)(7)(b) of the 1997 Tax Code. Moreover, Section 1 of Presidential Decree (PD) No. 1479, which amended Section 6 of PD No. 198, clearly states that: 'SEC. 1. The first paragraph of Section 6 of Presidential Decree No. 198, as amended, is hereby amended to read as follows: "SEC. 6. Formation of District . This Act is the source of authorization and power to form and maintain a district. For purposes of this Act, a district shall be considered as a quasi-public corporation performing public service and supplying public wants. As such, a district shall exercise the powers, rights and privileges given to private corporations under existing laws , in addition to the powers granted in, and subject to such restrictions imposed, under this Act. xxx xxx xxx'" (Emphasis supplied.) Clearly, the amendment contemplated LWDs as " private corporations ". The inescapable conclusion that can only be derived therefrom is that LWDs are performing proprietary functions as contradistinguished to the position of the LWDs that they are performing governmental functions. CSEHcT The contention that LWDs are not liable to the franchise tax has no leg to stand on. Aside from the explanations pronounced in our letter and in the BIR Ruling, the obvious and commonsensical reason is laid down in the law itself. By applying to operate as LWDs under PD No. 198, they, in effect, applied for a franchise. This is precisely the rationale of the law for expressly providing LWDs exemption from franchise tax. More importantly, Republic Act No. 7109 explicitly imposed on LWDs the franchise tax after the lapse of the five-year period. There is no doubt in this Office's mind that LWDs are liable to the franchise tax under Section 119 of the 1997 Tax Code. Very truly yours, Commissioner of Internal Revenue By: (SGD.) JOSE MARIO C. BUAG Deputy Commissioner Legal & Inspection Group