Taxability of Income Payments of Service Contractors for the Sale of Petroleum Extracted from the Malampaya Natural Gas Field

November 24, 2003 BIR RULING NO. 018-03 RR 2-98 Department of Energy Energy Center, Merritt Road, Fort Bonifacio, Taguig, Metro Manila Attention: Undersecretary Ben-Hur C. Salcedo Gentlemen : This refers to your letter dated 14 May 2002 requesting for exemption from the 1% creditable withholding tax on income payments made by some top 5,000 corporations to Shell Philippines Exploration B.V. (SPEX) and its other co-venturers in Service Contract No. 38 (SC 38) for the purchase of petroleum extracted from the Malampaya natural gas field. It is represented that in the pursuit of its declared policy to hasten the discovery and production of indigenous petroleum through the utilization of Government and/or private local and foreign resources and pursuant to Presidential Decree No. 87 (PD 87), as amended, the Government of the Republic of the Philippines, on December 11, 1990, entered into SC 38 with SPEX and its other co-venturers ("Service Contractor") for the exploration, development and utilization of the Malampaya natural gas field located in offshore Northwest Palawan; that today, the Service Contractor consists of SPEX (20%), Shell Philippines LLC (25%), Texaco Philippines Inc. (45%), and PNOC Exploration Corporation (10%). The following contracts were entered into between the Government of the Philippines and the Service Contractor, pursuant to PD 87: 1. Service Contract No. 38 2. Gas Sale and Implementation Agreement 3. Support, Assignment and Payment Agreement These contracts are represented to embody the following details relevant to the instant request: Service Contract No. 38 (SC 38) It is represented that under SC 38, the Service Contractor undertakes to perform all Petroleum Operations as defined in PD No. 87, as amended and SC 38, particularly, searching for and obtaining petroleum within the Philippines, through drilling and pressure or suction or the like, and all other operations incidental thereto; that the Service Contractor likewise undertook to transport, store, handle and sell the petroleum so obtained. It is also represented that SC 38 provides that the Government may authorize the Service Contractor to market the Government's share of production and that being authorized as such, the Service Contractor shall remit to the Department of Energy (DOE) an amount equal to sixty percent (60%) of estimated net proceeds from each petroleum lifting operations (Section 7.3(a)) and that the Government, through the DOE shall be entitled to receive in kind petroleum equal in value to sixty percent (60%) of the net proceeds from Petroleum Operations ("Government Share") (Section 7.3 (b));that the Government shall, on the first transaction in each instance where the tax is imposed, assume and pay on behalf of the Service Contractor and its parent company all income taxes payable to the Republic of the Philippines, as well as all withholding taxes, and other taxes imposed by the Government of the Philippines on dividends and the distribution of income and profits derived from petroleum operations to its parent company (Section 6.3);that the Service Contractor, on the other hand, shall retain the remaining forty percent (40%) as its fee or share (Section 7.4);and that the Service Contractor is exempt from all taxes, except income tax (Section 6.2(a)). Gas Sale and Implementation Agreement (GSIA) It is represented that to authorize the Service Contractor to market the Government Share consisting of sixty percent (60%) of petroleum from Petroleum Operations as above-mentioned, the Government, represented by DOE, and the Service Contractor subsequently entered into a Gas Sale and Implementation Agreement (GSIA);that the GSIA irrevocably authorizes the Service Contractor to sell the Government Share of petroleum on the same terms and conditions as the Service Contractor's existing Gas Sales and Purchase Agreements (GSPA) and on the same terms and conditions as will apply to the sale of the Service Contractor's Share of petroleum (Section 1 Article II);that it was also thereby agreed that the Service Contractor shall not acquire title to any Government Share of petroleum and that title to such Government Share shall pass directly and automatically from the Government to the relevant buyer upon delivery to that buyer at the delivery point agreed upon (Section 2, Article II);and that proceeds from the sale of Government Share of petroleum shall be remitted by the Service Contractor to the Department of Energy on or before the third working day of each month (Section 2, Article VI). SAHEIc Support, Assignment and Payment Agreement (SAPA) It is represented that the Service Contractor and the Government, through the DOE and with the conformity of the Department of Finance (DOF),also entered into a Support, Assignment and Payment Agreement (SAPA) which, among others, divides or breaks down the Government share of 60%;that the SAPA essentially divides the 60% Government Share into two parts: (1) Unassigned Petroleum ,and (2) Assigned Petroleum ,that the Unassigned Petroleum pertains to the Government Share paid to the DOE to: (1) pay for and on behalf of the Service Contractor and its parent company all income and other Philippine taxes required under Section 6.3 of SC 38, and (2) make such payments to local government units as are required by Section 290 of the Local Government Code in connection with the Government Share ("LGU Payments"); that under SAPA, Assigned Petroleum ,on the other hand, pertains to Government share after deducting the Unassigned Petroleum (Section 2, Article 1). It is represented further that the SAPA lays down the manner by which the Service Contractor shall remit payments pertaining to the Unassigned Petroleum ;that Section 5 thereof provides that payment to the DOE in respect of the Unassigned Petroleum shall be remitted as follows: a. the Service Contractor shall determine the amount to be received in respect of the Unassigned Petroleum that should be remitted to the DOE; b. on or before the last day of each month, the Service Contractor shall make payment to the DOE equal in amount to the total amount received in respect of the Unassigned Petroleum, if any. The DOE thereby authorizes and directs the Service Contractor to issue to the DOE two (2) separate checks, one payable to the Bureau of Internal Revenue for Tax Payments and another payable to the DOE for LGU payments; c. the determination in clause (a) of this Section 5 shall be made on the basis of Section 28 of the Tax Reform Act of 1997, Section 8 of SC 38 and Section 290 of the Local Government Code; d. The Service Contractor shall prepare and provide the DOE with a separate annual reconciliation statement for the payments made in respect of the Unassigned Petroleum. The Contractor shall remit to the DOE any underpayments and shall be entitled to retain from amounts received during succeeding periods any overpayments in respect of such Unassigned Petroleum. In addition, it is represented that as the DOE and the Service Contractor subsequently recognized that the remittance of the proceeds from the Unassigned Petroleum cannot be made on the last day of each month in view of banking system constraints affecting the availability of and access to value-dated funds, and the need to convert US Dollars to Philippine pesos (PhP) in order to effect payment of PhP tax obligations, the parties have agreed that remittance of Unassigned Petroleum shall be made on or before the third working day of the succeeding month; that inasmuch as the Service Contractor remits to the DOE on or before the third day of the succeeding month payments of the Unassigned Petroleum, inclusive of the BIR payment, which the DOE in turn immediately remits to the BIR, the Service Contractor thus pays income and branch profits remittance taxes in advance on a monthly basis and that the Service Contractor pays the branch profits remittance taxes even before it actually remits branch profits to its head office. In relation to the foregoing, it is also represented that in a letter addressed to the Secretary of the DOE dated November 8, 2001, the Secretary of the DOF approved the DOE Secretary's request, on behalf of the SPEX, for the DOE to remit to the BIR, on behalf of the Service Contractor, the tax payments of the Service Contractor consisting of income tax and branch profits remittance taxes on a monthly basis. It is finally represented that one of the Gas Sales and Purchase Agreements (GSPA) executed by the Service Contractor on its behalf and on behalf of the Government pursuant to the GSIA and the SAPA is that entered into with First Gas Power Corporation (FGPC); that under its GSPA with FGPC, the Service Contractor undertook to supply FGPC with natural gas for the latter's Santa Rita Plant; that since the Commissioner of Internal Revenue previously classified FGPC as a large taxpayer and required it to withhold one percent (1%) withholding tax on income payments to its local suppliers of goods pursuant to Section 2.57.2 (M) of Revenue Regulations No. 2-98 (RR 2-98) as amended, FGPC intends to withhold a one percent (1%) tax on all income payments to the Service Contractor for the supply of natural gas. You now request for a ruling exempting from the one percent (1%) creditable withholding tax income payments made by the top five thousand (5,000) corporations, such as FGPC, to the Service Contractor for the sale of petroleum extracted from the Malampaya natural gas field pursuant to SC 38, to the extent that the Service Contractor remits income tax payments to the DOE on or before the third day of each month in advance. In reply, please be informed that Section 2.57.2 of RR 2-98, as amended, provides: Sec. 2.57.2 Income Payment subject to creditable withholding tax and rates prescribed thereon Except as herein otherwise provided, there shall be withheld a creditable income tax at the rates herein specified for each class of payee from the following items of income payments to persons residing in the Philippines: (M) Income payments made by the top five thousand corporations Income payments made by any of the top five thousand (5,000) corporations as determined by the Commissioner, to their local supplier of goods One percent (1%). Based on RR 2-98, as amended, the creditable withholding tax of one percent (1%) shall, for the months covering January to November, be paid and the corresponding return is required to be filed within 10 days after the end of each month (for manual filers), or within 15 days after the end of each month (for Electronic Filing Payment System filers). For the month of December, the withholding tax should be paid and the return filed on or before January 15 of the following year (for manual filers), or on or before January 20 of the following year (for EFPS filers). In accordance with the creditable withholding tax system, taxes withheld on the income payments made by any of the top five thousand corporations ". . . are intended to equal or at least approximate the tax due of the payee on said income." (Sec. 2.57(B), RR 2-98) and corresponding penalties are imposed upon the withholding agent for failure to withhold the required amount at the time the income is paid or payable, whichever comes first (Sec. 2.57.4, RR 2-98). It should be emphasized that while the withholding tax system is more commonly regarded as a mere procedure through which taxes are collected, the importance of following the above rules in ensuring the prompt and efficient collection of taxes should not be ignored. For not only does our withholding tax system encourage voluntary compliance on the part of taxpayers, it also prevents delinquencies and spares the government the effort of collecting through the more complicated means and remedies. In the instant case, however, the DOF had already granted approval on the DOE's request to allow advance remittance of income payments from the petroleum operations undertaken pursuant to SC 38 to the BIR, subject to the following conditions: 1. Monthly corporate income tax payment shall be made using BIR Form No. 0605, otherwise known as "Payment Form"; 2. The nature of the payment falls under Operation Code 09, with the ATC IC070, and tax type category "Income Tax" under Code "IT"; 3. The monthly tax payments shall be creditable and limited to the corporate income tax that shall become due from the service contractor on a quarterly basis, subject to an annual final consolidation of the taxpayer's income tax liability; 4. Advance deposits may be made either monthly or at any time before the quarterly due date for the corporate income tax, and shall only be deemed received by the BIR upon the crediting of the full amount paid in favor of the BIR; 5. Unless otherwise opted by the taxpayer, any and all excess quarterly income tax against income tax due for a taxable year shall be carried over to the succeeding quarters of the taxable year and of the succeeding taxable years. The exercise of such option shall be subject to the provisions of Section 76 of the Tax Code of 1997; 6. Quarterly computation of the corporate income tax due from the service contractor shall nonetheless be made, and any amount still due shall be immediately paid at the time the return is filed for the quarter under consideration. Otherwise, civil penalties shall be correspondingly imposed thereon. Considering this, we find that through the advance payments made in accordance with the conditions set forth in the DOF letter dated November 8, 2001, and addressed to the Secretary of the DOE, the purposes for which the creditable withholding tax is required to be withheld pursuant to RR 2-98, as amended, are served. As RR 2-98 requires monthly remittance of creditable withholding tax, the advance tax payments of service contractors made monthly, through the DOE, to the BIR is in substantial compliance with the requirements under the said regulations. Under the provisions of the SAPA, remittance of taxes to the BIR is ensured as it provides for the issuance of a check payable to the Bureau of Internal Revenue for tax payments upon receipt by the DOE of the Service Contractor's payment. These payments which are promptly remitted to the BIR by the DOE even constitute an amount greater than the 1% creditable withholding tax required to be withheld by one of the top 5,000 corporations and more than substantially complies with the requirement for withholding under RR 2-98. Accordingly, it would be superfluous to insist on withholding 1% from the income payments to service contractors when the actual income tax due for the period is already being voluntarily paid in advance. Furthermore, allowing advance payment and, at the same time, creditable withholding tax to be withheld on the same income would result in a situation where the taxpayer would have to file a claim for refund. This will impose an undue burden on the part of both the taxpayer and the government since the claim will be filed, processed and evaluated in accordance with pertinent laws and regulations. In granting the said request, the DOF said that "Indeed, the voluntary act of the taxpayer to advance its quarterly income tax payments on a monthly basis displays an ability to pay its obligations, and ensures the collection of taxes that shall be used to provide for public goods and services." Such act of voluntary payment should therefore be rewarded rather than punished by subjecting the taxpayer to an unnecessary ordeal of refunding its excess payments. In view of all the foregoing, this Office is of the opinion that income payments received by the service contractor from the top 5,000 corporations, such as FGPC, for the sale of petroleum extracted from the Malampaya natural gas field pursuant to SC 38, should not be subject to the creditable withholding tax of 1% since the requirements under RR 2-98, as amended, for withholding are sufficiently complied through the advance tax payments which have been allowed by the DOF to be made to the BIR subject to certain conditions. 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. AETcSa Very truly yours, (SGD.) GUILLERMO L. PARAYNO, JR. Commissioner of Internal Revenue