BIR Ruling [DA-718-06]

December 15, 2006 BIR RULING [DA-718-06] 34 (A) (1); 34 (H); RR 2-98; #016-2006 Hydro Electric Development Corporation 214 Obulan, Ambuklao Road, Beckel, La Trinidad, Benguet Attention: Mr. Jose Venancio Batiquin Gentlemen : This refers to your letter dated November 12, 2004 requesting confirmation of your opinion that: 1. The payments made by Hydro Electric Development Corporation (HEDC) denominated as "donation" and "share" under the Memoranda of Agreement (MOA) between HEDC and the Municipalities of Tuba, Sablan and La Trinidad all of Benguet Province are in reality consideration for the use of HEDC of the municipal water resources and other public properties of said municipalities. 2. Considering the nature of said payments HEDC can claim the same as an ordinary and necessary expense under Section 34A(1) of the Tax Code as amended 3. Since the payees are local government units the said expense is not subject to withholding tax. BACKGROUND HEDCOR is engaged in the business of developing potential sites for hydroelectric power in the Province of Benguet. It has been registered as such pursuant to Republic Act No. 7156 otherwise known as "An Act Granting Incentives to Mini-Hydroelectric Power Developers and For Other Purposes" and its Implementing Rules & Regulations. It is presently registered as a VAT Taxpayer with the Bureau of Internal Revenue under VAT Registration Number 609-000134. HEDC entered into three (3) separate Memoranda of Agreement with the Municipalities of Tuba, Sablan and La Trinidad all of Benguet Province defining the terms and conditions for the construction, operation and/or maintenance of a mini hydro electric plant in suitable sites in the said municipalities A. With respect to the Municipality of Sablan : Under the terms of the MOA, HEDC agreed to share with the community a part of its income and voluntarily offers to "donate" to the MUNICIPALITY and the Barangays where the plants will be located, the following: TCcDaE a) 2% of its NET SALE (power generated and sold to either BENECO or NPC or both or to other third parties) to the Municipality of Sablan, Benguet Province. (Paragraph 1(a) of the MOA) b) 1% of its NET SALE (power generated and sold to either BENECO or NPC or both or to other third parties) to the specific barangay(s) where the mini-hydro electric plants are located. (Paragraph 1 (b) of the MOA) B. With respect to the Municipality of La Trinidad : Under the terms of the MOA, HEDC agreed to share with the community a part of its income and voluntarily offers to remit to the MUNICIPALITY and the Barangays where the plants will be located, the following: c) 2% of its NET SALE (power generated and sold to either BENECO or NPC or both or to other third parties) to the Municipality of La Trinidad, Benguet Province. (Paragraph 2(a) of the MOA) d) 1% of its NET SALE (power generated and sold to either BENECO or NPC or both or to other third parties) to the specific barangay(s) where the mini-hydro electric plants are located. (Paragraph 2(b) of the MOA. C. With respect to the Municipality of Tuba : Under the terms of the MOA, HEDC agreed to share with the Municipality of Tuba one (1%) of its net share effective November 1997. (paragraph 1 page 2 of MOA). In exchange/consideration of the above-mentioned payments, the three (3) municipalities in each MOA agree to allow use of municipal properties and to do the following services: a) The protection of watersheds b) The ensurance of peace and order c) The ensurance of cooperation of the municipal officials with the management/employees and the plant's staff BIR REPLY The National Internal Revenue Code, as amended, provides: "Section 34 "xxx xxx xxx "(H) Charitable and Other Contributions. "(1) In General. Contributions or gifts actually paid or made within the taxable year to, or for the use of the Government of the Philippines or any of its agencies or any political subdivision thereof exclusively for public purposes, or to accredited domestic corporations or associations organized and operated exclusively for religious, charitable, scientific, youth and sports development, cultural or educational purposes or for the rehabilitation of veterans, or to social welfare institutions, or to nongovernment organizations, in accordance with rules and regulations promulgated by the Secretary of Finance, upon recommendation of the Commissioner, no part of the net income of which inures to the benefit of any private stockholder or individual in an amount not in excess of ten percent (10%) in the case of an individual, and five percent (5%) in the case of a corporation, of the taxpayer's taxable income derived from trade, business or profession as computed without the benefit of this and the following subparagraphs. "(2) Contributions Deductible in Full. Notwithstanding the provisions of the preceding subparagraph, donations to the following institutions or entities shall be deductible in full: "(a) Donations to the Government. Donations to the Government of the Philippines or to any of its agencies or political subdivisions, including fully-owned government corporations, exclusively to finance, to provide for, or to be used in undertaking priority activities in education, health, youth and sports development, human settlements, science and culture, and in economic development according to a National Priority Plan determined by the National Economic and Development Authority (NEDA), in consultation with appropriate government agencies, including its regional development councils and private philanthropic persons and institutions: Provided, That any donation which is made to the Government or to any of its agencies or political subdivisions not in accordance with the said annual priority plan shall be subject to the limitations prescribed in paragraph (1) of this Subsection; cTCEIS Pursuant to the above-quoted provisions of law, donations to charitable and other institutions are deductible subject to certain qualifications. However, in order to determine whether said contribution may be considered a donation it is necessary to determine first what constitutes donation or gift. A gift is generally defined as a voluntary transfer of property by one to another without any consideration or compensation therefore. 1 The definition of a donation is found in the Civil Code. Article 725 of said Code defines donation as: ". . . an act of liberality whereby a person disposes gratuitously of a thing or right in favor of another, who accepts it." Donation has the following elements: (a) the reduction of the patrimony of the donor; (b) the increase in the patrimony of the donee; and, (c) the intent to do an act of liberality or animus donandi. 2 In this particular case, the payments made by HEDC denominated as "donation" and "share" in favor of the Municipalities of Tuba, Sablan and La Trinidad, all of Benguet Province clearly do not qualify as a donation. 3 The MOA which embody the agreement between HEDC and the said municipalities clearly reflect the intention of both parties to regard said payments as consideration by the latter for the use by HEDC of the municipal resource and property. The dependence of said payments on the existence of net sales before payment is made moreover belies the fact that it was the intention of HEDC to do an act of liberality in favor of the municipalities. Moreover, there is no reduction or increase of patrimony to speak of. Ordinary and necessary expense pursuant to the Tax Code, as amended constitute the following: "Section 34 (A) Expenses. (1) Ordinary and necessary trade, business or professional expenses. (a) In general. There shall be allowed as deduction from gross income all ordinary and necessary expenses paid or incurred during the taxable year in carrying on, or which are directly attributable to, the development, management, operation and/or conduct of the trade, business or exercise of a profession." Simply put, to be deductible from gross income, the subject expense must comply with the following requisites: (a) the expense must be ordinary and necessary; (b) it must have been paid or incurred during the taxable year; (c) it must have been paid or incurred in carrying on the trade or business of the taxpayer; and (d) it must be supported by receipts, records or other pertinent papers. 4 Using the guidelines enunciated above, HEDC's payment for the use of municipal resources and properties is an ordinary and necessary expense since the use of said resources and properties is essential, necessary, and constitutes the primary source of generated electricity for HEDC, hence, said expense or such use was or is being legitimately incurred in carrying on its business. The income payments that HEDC pays as aforementioned to the Municipalities of Tuba, Sablan and La Trinidad all of Benguet Province constitute payment to government instrumentalities which are not subject to the expanded withholding tax under Section 4 of Revenue Regulations No. 12-94 amending Revenue Regulations No. 6-85. 5 It is also not subject to any creditable withholding tax (CWT) under Revenue Regulations No. 2-98, as amended. 6 This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it will be ascertained that the facts are different, then this ruling shall be considered void. Very truly yours, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service Footnotes 1. (28 C.J. 620; Santos vs. Robledo , 28 Phil. 250). 2. Manuel G. Abello, Jose C. Concepcion, Teodoro D. Regala and Avelino V. Cruz vs. Commissioner of Internal Revenue , C.T.A. Case No. 4296. October 7, 1991 3. BIR Ruling No. 016-2006 4. Commissioner of Internal Revenue vs. General Foods (PHILS.), Inc ., G.R. No. 143672. April 24, 2003. 5. BIR UN Ruling No. 410-95 dated 11-20-1995 6. BIR Ruling No. 008-05 dated 7-28-2005