Sale or Transfer of Gas Pipeline Subject Only to Documentary Stamp Tax

August 24, 2005 BIR RULING NO. 016-05 Puno and Puno 12th Floor East Tower Philippine Stock Exchange Centre Exchange Road, Ortigas Center Pasig City Attention: Attys . Helena Rosales-Calo and Rosalinda F. Rivera Gentlemen : This refers to your letter dated November 6, 2000 stating that your client, FGP Corporation, is a corporation duly organized and existing under the laws of the Philippines and is registered with the Board of Investments, with a preferred Pioneer Status, as a new operator of a 500MW combined-cycle gas turbine power generating plant (Power Plant); that on April 30, 1998, FGP Corporation entered into a Gas Sale and Purchase Agreement (GSPA) with Shell Philippines Exploration B.V. (SPEX), pursuant to which SPEX is obligated to deliver natural gas to FGP Corporation; that FGP Corporation owned an onshore gas pipeline (the gas pipeline) that was purposely constructed to transport the natural gas from the SPEX refinery located in Tabangao, Batangas to FGP Corporation's Power Plant located in Santa Rita, Batangas; that on August 1, 2001, FGP Corporation transferred ownership of the gas pipeline to SPEX upon the business consideration that SPEX would be obligated to use the gas pipeline for the delivery of natural gas to FGP Corporation and all risks attendant on such delivery would be on SPEX; that as a consequence of the transfer of ownership, SPEX thereafter assumed all the risks associated with the gas pipeline and SPEX would thus operate, maintain and preserve the gas pipeline at its own cost; and that the first delivery of natural gas is expected to take place sometime in 2002 and shall continue until about twenty-two (22) years thereafter. In your supplemental letter dated October 22, 2001, you clarified matters relative to your request on November 26, 2000 that the transfer by FGP Corporation of its pipeline and other related assets to SPEX shall not be subject to donor's tax, capital gains tax and corporate income tax; that to fortify your request, you stated that the Malampaya Gas Field is covered by Service Contract 38 (Service Contract) between the Government and SPEX; that the Service Contract provides for a production-sharing agreement that entitles the Government to 60% share of the net proceeds; that from such share, the Government is expected to earn substantial revenues expected to exceed US$9 Billion over the life of the gas field; that the Philippines will have substantial foreign exchange savings of about US$700 Million (depending on crude oil prices) for every year of foregone oil importation; that FGP Corporation owns the power plant that is one of the anchor loads of the Malampaya Gas; that under the GSPA between FGP Corporation and SPEX, FGP Corporation undertook to pay for the gas on a "take-or-pay" basis, i.e., FGP Corporation is obligated to pay for the natural gas delivered by SPEX, regardless of whether FGP Corporation utilizes the delivered gas or not; that in the course of several discussions between FGP Corporation and its Lenders (Lenders), the delivery point of the gas was one of the most contentious issues; that the original gas pipeline constructed by SPEX stretched from Malampaya, Palawan to SPEX's refinery in Tabangao, Batangas; that the GSPA originally contemplated that the delivery point would be in SPEX's refinery; that FGP Corporation's power plant was eight kilometers away from SPEX's refinery; that although SPEX was willing to construct a pipeline offshore, and charge the cost thereof to FGP Corporation, it would have been an extremely expensive exercise and increase the price of electricity; that FGP Corporation thus agreed to itself construct an 8 kilometer pipeline onshore (the pipeline that is the subject-matter of the transfer from FGP Corporation to SPEX); that the Lenders were opposed to the idea of FGP Corporation assuming any risk in transporting the natural gas from SPEX's refinery to FGP Corporation power plant; that given the take-or-pay arrangement with SPEX, FGP Corporation would be bound to purchase the natural gas even if there is a major leak in the 8-kilometer pipeline and the gas never reaches the power plant; that the Lenders, therefore, required FGP Corporation to transfer the ownership, and consequently, the risks over the said pipeline to SPEX; that the GSPA was thus amended to the effect that (a) the delivery point of the natural gas would be in the Plant Site; and (b) title to, and risk of loss of or damage to, natural gas shall be borne by SPEX during the transportation stage, and shall pass to FGP Corporation only at the new delivery point; that the transfer of ownership of the pipeline from FGP Corporation to SPEX was undertaken solely to transfer the delivery point and thereby comply with the Lenders' requirement to transfer the risks of transporting and delivery to SPEX; that FGP Corporation did not transfer the pipeline for the pursuit of profit; that FGP Corporation did not even get reimbursed for the cost of the pipeline; that the pipeline was transferred to SPEX for a consideration of US$1; that the value of the pipeline will not form part of SPEX's assets; that as a result, SPEX will not claim any depreciation expense with respect to the pipeline; that neither will it result in an additional fiscal burden to the Government; that if the value of the pipeline were taken up in the books of SPEX, such value would form part of SPEX's capital cost recovery, thereby reducing the revenues available for distribution to the government (which would consequently result in vehement objections on the part of the government); that since the value of the pipeline will remain with FGP Corporation, there will not be any additional capital cost recovery on the part of SPEX; that in the books of FGP Corporation, the pipeline cost will be removed from "Property Plant and Equipment" item and will be reclassified to the "Other Assets" item; that it will be subject only to amortization for financial accounting purposes but not for tax purposes; that such treatment will result in a permanent reconciling item between financial income and taxable income, since no deductions will be claimed by FGP Corporation from the amortization; that the pipeline cost will be removed from the "Property Plant and Equipment" item as a consequence of FGP Corporation's parting of` ownership and risk over the pipeline; and that since FGP Corporation paid for the capital costs of building the pipeline, it will be charging its customers, Manila Electric Company (MERALCO), a Pipeline Capital Cost Recovery Charge as part of its billings for the sale of electricity throughout the life of its contract with MERALCO. Based on the foregoing representations, you now request for a ruling that the sale or transfer by FGP Corporation of its gas pipeline to SPEX is not subject to donor's tax, capital gains tax, corporate income tax and to value-added tax but only to the documentary stamp tax imposed under Section 196 of the Tax Code of 1997. In reply thereto, please be informed that the term "donation" is an act of liberality whereby a person disposes gratuitously of a thing or right in favor of another who accepts it and pursuant to Section 98 of the Tax Code of 1997, a gift tax computed as provided in Section 99 of the said Code shall be levied, assessed, collected and paid upon the transfer, whether direct or indirect, in trust or otherwise, by any person, resident or non-resident of the property by gift. A donor's tax shall be imposed whether the transfer is in trust or otherwise, whether the gift is direct or indirect, and whether the property is real or personal, tangible or intangible. In the instant case, considering that the transfer of the gas pipeline by FGP Corporation to SPEX is business consideration, i.e., to transfer all risks ownership to SPEX as required by FGP Corporation's lenders and to obligate SPEX to use the gas pipelines to deliver the gas to FGP Corporation, the transfer cannot be deemed as a transfer for less than adequate and full consideration. Thus, the transfer is not subject to donor's tax imposed under Section 98 of the Tax Code of 1997, since there is a clear absence of donative intent. On the other hand, Section 27(D)(5) of the Tax Code of 1997 provides that a final tax of six percent (6%) is hereby imposed on the gain presumed to have been realized on the sale, exchange or disposition of lands and/or buildings which are not actually used in the business of a corporation and are treated as capital assets, based on the gross selling price or fair market value as determined in accordance with Section 6(E) of the said Code, whichever is higher, of such lands and/or buildings. CIDaTc Inasmuch as the gas pipeline is neither land nor building and is deemed not a capital asset of FGP Corporation, the intended transfer thereof is not subject to capital gains tax imposed under Section 27(D)(5) of the Tax Code. Neither is the transfer of the gas pipeline subject to ordinary corporate income tax imposed under Section 27(A) of the Tax Code of 1997. The transfer of the gas pipeline intended merely to transfer risk of ownership did not generate any income subject to income tax. The asset will remain in FGP Corporation's books albeit under "other assets" and not subject to depreciation. SPEX will not take up the asset in its books albeit by agreement it will assume all risks of ownership. As explained during the meeting in August 2003, the construction by FGP Corporation of the gas pipeline and transfer thereof to SPEX was the only compromise solution found to satisfy the Lender's requirements that the gas be delivered at FGP Corporation's plant site with SPEX assuming all risks of delivery and SPEX's willingness to construct the pipeline offshore but which would be so expensive and result in more expensive electricity contrary to the use in pursuit of the Malampaya project. There is no value-added tax as the transfer is not in the ordinary course of business and the property is not held primarily for sale to customers or for lease in the ordinary course of business. ( Section 106, Tax Code, RMC No. 3-96, BIR Ruling Nos. 063-97 and 027-00 ) As to the documentary stamp tax, Section 196 of the Tax Code of 1997 provides that on all conveyances, deeds, instruments, or writings, whereby any land, tenement or other realty sold shall be granted, assigned, transferred or otherwise conveyed to the purchaser, or purchasers, or to any other person or persons designated by such purchaser or purchasers, there shall be collected a documentary stamp tax, based on the consideration contracted to be paid for such realty or on its fair market value determined in accordance with Section 6(E) of the said Code, whichever is higher. The Supreme Court held in the case of Meralco Securities Industrial Corporation vs . Central Board of Assessment Appeals, et al ., L-46245, May 31, 1982 ; 5 SCAD 214 , that a gas pipeline system being a construction adhering to the soil is classified as real property. In support of its ruling, (i)t cited Article 415(1) and (3) of the Civil Code of the Philippines which provides that real property may consist of constructions of all kinds adhered to the soil and everything attached to an immovable in a fixed manner, in such a way that it cannot be separated therefrom without breaking the material or deterioration of the object. Accordingly, the conveyance of the gas pipeline shall be subject to documentary stamp tax imposed under Section 196 of the Tax Code of 1997. AaIDCS This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it will be disclosed that the facts are different, then this ruling shall be considered null and void. Very truly yours, (SGD.) JOSE MARIO C. BUAG OIC-Commissioner of Internal Revenue