Tax Consequences Arising from or Incidental to the Privatization of the National Power Corp.

May 13, 2002 BIR RULING NO. 020-02 R.A. 9136; R.A. 6395 32.(B).(7).(b); 196; 198 000-00 Power Sector Assets & Liabilities Management Corporation Energy Center, Merrit Road Fort Bonifacio, Taguig Metro Manila Attention: Edgardo M. Del Fonso President Gentlemen : This refers to your letters dated November 12 and 20, 2001 and February 8, 2002 requesting for confirmation of your understanding of the tax consequences arising from or incidental to the privatization of the National Power Corporation (NPC) and taxation of the entities created pursuant to Republic Act (R.A.) No. 9136, also known as the "Electric Power Industry Reform Act of 2001". cDHCAE I. MATTERS ON WHICH RULING IS REQUESTED A. On the transfer of assets and liabilities of the NPC : 1) NPC, as a public utility, is not liable to income tax on the transfer of its assets and liabilities to PSALM and TRANSCO; 2) The transfer of NPC's assets to PSALM and TRANSCO is not subject to franchise tax or VAT pursuant to the NPC Charter; 3) The transfer of NPC's real properties is not subject to documentary stamp tax (DST); 4) Since the transfer of NPC liabilities to PSALM does not involve renewal or continuance of NPC's debts, the same is not subject to DST imposed under Section 198 of the Tax Code of 1997; B. On the operation of the transferred assets during the transition period : 1) The income of PSALM arises from the exercise of essential governmental function, and is, thus exempt from income tax pursuant to Section 32(B)(7)(b) of the Tax Code of 1997; 2) The sale of generated power by PSALM is subject to zero percent (0%) VAT; 3) The transfer of NPC's franchise necessarily entails the transfer of the privileges that NPC enjoys in relation to the operation of the transmission system; hence, since TRANSCO is the transferee of the transmission and sub-transmission facilities of NPC, including all other assets related thereto, it should be taxed in the same manner as NPC; accordingly, the income of TRANSCO is excluded from gross income for purposes of computing its income tax pursuant to Section 32(B)(7)(b) of the Tax Code; and just like NPC, TRANSCO will be exempt from all forms of taxes, including franchise tax, in accordance with P.D. No. 938, as amended; 4) NPC is not liable to income tax on its income arising from the service agreement with PSALM and TRANSCO, as well as to VAT; DIcSHE C. On the privatization of NPC assets : 1) Gain from the sale by PSALM of the generation facilities to qualified buyers is not subject to income tax; 2) The privatization of assets by PSALM is not subject to VAT; 3) The sale, however, of said real property by PSALM is subject to DST; 4) The consideration received by TRANSCO from the sale of the transmission facilities or grant of concession contract is not subject to income tax; 5) Likewise, the concession fee and rental to be received by TRANSCO or proceeds from the sale of the transmission facilities are not subject to VAT; D. The Universal Charge collected by the distribution utilities is not part of their respective taxable revenues nor will it form part of their gross receipts for purposes of determining their franchise tax liability; likewise, the collection of said Universal Charge by PSALM will not be considered as taxable income nor will it form part of its gross receipts for VAT purposes; and E. The interest arising from NPC loans transferred to PSALM remain exempt from income tax. STHDAc II. LEGAL REFERENCES In this ruling, the following terms shall be used in reference to the relevant legislations: EPIRA Republic Act No. 9136, otherwise known as the "Electric Power Industry Reform Act of 2001." IRR Rules and Regulations to Implement Republic Act No. 9136. Tax Code of 1997 Section 3 of Republic Act No. 8424, otherwise known as the "National Internal Revenue Code of 1997." NPC Charter Republic Act No. 6395, as amended, otherwise known as "An Act Revising the Charter of the National Power Corporation." III. BACKGROUND The facts as represented by you are as follows: In pursuance of the constitutional mandate, particularly Section 1, Article XII of the 1987 Constitution, the EPIRA came into law on June 26, 2001. The EPIRA aims to provide a framework for the restructuring of the electric power industry, including the privatization of the assets of NPC, the transition to the desired competitive structure, and the definition of the responsibilities of the various government agencies and private entities. To lend substance to the stated Declaration of Policy of the EPIRA, the EPIRA provides for the creation of two government-owned corporations, namely: the Power Sector Assets and Liabilities Management Corporation ("PSALM") and the National Transmission Corporation ("TRANSCO"). PSALM shall primarily manage the orderly sale, disposition and privatization of NPC generation assets, real estate and other disposable assets, and Independent Power Producer (IPP) contracts with the objective of liquidating all NPC financial obligations, stranded contract costs and stranded debts in an optimal manner. On the other hand, TRANSCO, which is to be wholly owned by PSALM, is mandated to assume the electrical transmission function of the NPC, among others. It shall assume the authority and responsibility of NPC for the planning, construction and centralized operation and maintenance of its high voltage transmission facilities, including grid interconnections and ancillary services. It will likewise be responsible for the operation of the transmission and sub-transmission assets until their disposal to distribution utilities qualified to take over the responsibility for operating, maintaining, upgrading and expanding said assets. The EPIRA has also highlighted the importance of ensuring the reliability, security and affordability of the supply of electric power to end-users. In several provisions of the law, specifically Sections 47(a) 1 and 51(m), 2 it is repeatedly provided that the sale, privatization or disposition of NPC assets must be undertaken in a manner that would optimize the value and sale prices of said assets. You state that this objective must be achieved since the proceeds from the privatization of NPC assets will be utilized by PSALM to liquidate debts of NPC, as any stranded debt will form part of the basis of the Energy and Regulatory Commission ("ERC") in the determination of the Universal Charge that will be imposed on all electricity sold to end-users (Sections 4(vv); 3 34 (a); 4 51 (d), 5 EPIRA). In short, the value of the proceeds from the NPC privatization will determine the amount of Universal Charge that consumers will have to bear. The process of privatizing the assets of NPC will involve three phases, to wit: a. Phase I will entail the transfer of all existing NPC generation assets, real estate and other assets, liabilities and IPP contracts to PSALM within 180 days from the effectivity of the EPIRA. 6 Within the same period of time, the transmission and sub-transmission facilities of NPC and all other assets related to transmission operations, including the nationwide franchise of NPC for the operation of the transmission system and the grid, shall be transferred to TRANSCO. The transmission and sub-transmission related liabilities of NPC are to be transferred to and assumed by PSALM. 7 b. Phase II will cover the administration and operation of the transferred assets by PSALM and TRANSCO prior to the privatization thereof. Until these assets are privatized, PSALM will be selling power from the transferred generation assets and thus, under the IRR of the EPIRA, PSALM will be considered a generation company with respect to its sale of generated power. 8 Considering that the EPIRA provides that PSALM can only hire its own personnel only when absolutely necessary and should avail of itself of the services of personnel from other government agencies, 9 PSALM will be entering into an Operations and Management Agreement (herein referred to for brevity as "O&M Agreement") 10 with NPC for the latter to operate and maintain the generation facilities prior to their sale to the qualified buyers. Specifically, the O&M will cover the comprehensive operation and maintenance services to PSALM in respect of PSALM's generation assets, including thermal, diesel, geothermal and hydroelectric power plants; fuel procurement for independent power projects; marketing activities relating to the sale of the generation companies, including renegotiating transition supply contracts; and selected legal services, among others. TRANSCO, on the other hand, will act as the system operator of the nationwide electrical transmission and sub-transmission system to be transferred by NPC. For this reason, the EPIRA provides for the transfer of the nationwide franchise of NPC for the operation of the transmission system and the grid. 11 To operate the system, TRANSCO will likewise be entering into an Operations & Management Agreement herein referred also as O&M Agreement with NPC for the latter to assign to TRANSCO its employees presently involved in the operation and management of the facilities. c. Phase III involves the total privatization of the transmission and generation assets, real estate, and other disposable assets as well as existing IPP contracts of NPC, except for the assets of Small Power Utilities Group ("SPUG").PSALM will structure the sale, privatization or disposition of NPC assets and IPP contracts and/or their energy output based on such terms and conditions to optimize the value and sale prices of said assets. 12 On the other hand, the transmission facilities, including grid interconnections and ancillary services, may be awarded to the winning qualified bidder through an outright sale or a concession contract ("Concession Contract").The award should result in maximum present value of proceeds to the National Government. In case a Concession Contract is awarded, the Concessionaire shall have a contract period of twenty-five (25) years, subject to review and renewal for a maximum period of another twenty-five (25) years. 13 TRANSCO will negotiate with and transfer the sub-transmission facilities and associated liabilities to the qualified distribution utility or utilities connected to such sub-transmission facilities not later than two (2) years from the effectivity of the EPIRA or the start of open access, whichever comes earlier. 14 The plans for the privatization of NPC assets are contained in the Privatization Plan that PSALM submitted to the Joint Congressional Power Commission ("JCPC") for endorsement of approval to the President of the Philippines. Upon approval of the privatization plan, PSALM will implement the same. It is further explained that within a year from the effectivity of the EPIRA, a Universal Charge to be determined, fixed and approved by the ERC will be imposed on electricity end-users for the following purposes: 1. Payment for the stranded debts in excess of the amount assumed by the National Government and stranded contract cost of NPC as well as qualified stranded contract cost of distribution utilities resulting from the restructuring of the industry; 2. Missionary electrification; 3. The equalization of the taxes and royalties applied to indigenous or renewable sources of energy vis--vis imported energy fuels; 4. An environmental charge equivalent to one-fourth of one centavo per kilowatt-hour (P.0025/kwh),which accrues to an environmental fund to be used solely for watershed rehabilitation and management; and 5. A charge to account for all forms of cross-subsidies for a period not exceeding three (3) years. that the EPIRA provides that the Universal Charge is a non-bypassable charge, which shall be passed on and collected from the end-users on a monthly basis by the distribution utilities; that collections of the Universal Charge by the distribution utilities and the TRANSCO in any given month shall be remitted to PSALM on or before the fifteenth (15th) of the succeeding month, net of any amount due to the distribution utility; that PSALM will create a Special Trust Fund to be disbursed only for the purposes specified in Section 34 15 of the EPIRA, in an open and transparent manner; and that all amounts collected for the Universal Charge shall be distributed to the respective beneficiaries within a reasonable period to be provided by the ERC. Furthermore, it is also represented that the EPIRA mandates the transfer to PSALM of all outstanding obligations of NPC arising from loans, issuances of bonds, securities and other instruments of indebtedness; 16 and that under Section 51(j) 17 of the EPIRA, PSALM was granted power to borrow money and incur such liabilities, including the issuance of bonds, securities or other indebtedness utilizing its assets as collateral and/or through the guarantees of the National Government, provided, however, all such debts or borrowings should be paid off or settled before the end of its corporate life. In the meantime, you also represented that NPC's foreign obligations that will be transferred to PSALM may be grouped into three categories, namely: "(a) Loans extended by foreign governments, financing institutions owned or controlled or enjoying financing from foreign governments, or international or regional financial institutions established by foreign governments; (b) Commercial loans; and (c) Bonds. Finally, you represented that with respect to the mode by which PSALM may privatize the transmission facilities, including grid interconnections and ancillary services, of NPC, the then on-going discussions of the Joint Congress Power Commission (JCPC) that was constituted under the law to review and approve the IRR implementing the EPIRA indicate that there is a growing consensus that a concession arrangement is the preferred approach; that PSALM is inclined to privatize the transmission facilities through a concession arrangement; that while the concession approach is still subject to approval of the President of the Philippines, together with other issues contained in the Privatization Plan, you believe that the discussions of the JCPC will be given due consideration; that in the meantime, you need a BIR ruling on the tax implication of the award by the TRANSCO to a qualified party of a Concession Contract for the operation and management of the transmission facilities; and that in the event, however, that the President decides to pursue the outright sale option, you shall request an opinion on the tax implication thereof. IV. DISCUSSION A. Transfer of assets and liabilities of NPC Phase I 1) To PSALM Section 51 18 in relation to Section 49 19 of the EPIRA mandates that PSALM, a wholly government-owned and -controlled corporation shall take title to and possession of, administer and conserve all the existing NPC generation assets, liabilities, IPP contracts, real estate and all other disposable assets transferred to it. Likewise, all outstanding obligations of the NPC arising from loans, issuances of bonds, securities and other instruments of indebtedness shall be transferred to and assumed by PSALM within one hundred eighty (180) days from the approval of the EPIRA. Furthermore, Paragraph 3 of Section 8 20 of the EPIRA provides that all transmission and subtransmission related liabilities of NPC shall be transferred to and assumed by the PSALM. 2) To TRANSCO With respect, however, to the electrical transmission activities of the NPC, the same Section 8 of the EPIRA created the TRANSCO to assume such functions, to wit: "xxx xxx xxx "Within six months from the effectivity of this Act, the transmission and subtransmission facilities of NPC and all other assets related to transmission operations, including the nationwide franchise of NPC for the operation of the transmission system and grid, shall be transferred to the TRANSCO. The TRANSCO shall be wholly owned by the Power Sector Assets and Liabilities Management Corporation (PSALM Corp.). "xxx xxx xxx" Section 2 of Rule 22 of the IRR enumerates "all other assets" related to transmission and subtransmission facilities, to include, but not limited to the following: 1. System operations facilities such as telecommunications and Supervisory Control and Data Acquisition (SCADA) systems including offices and laboratory buildings housing these equipment; and 2. TRANSCO offices and real estate properties, vehicles, laboratory and test equipment, spare parts and other physical structures. B. Operation of the transferred assets during the transition period (after transfer of assets but prior to privatization) Phase II Pursuant to Section 47(j) 21 in relation to the assets transferred to PSALM, NPC may generate and sell electricity only from the undisposed generating assets and IPP contracts of PSALM Corp. and shall not incur any new obligations to purchase power through bilateral contracts with generation companies or other suppliers during the transition period. In respect of the subtransmission functions and assets, pursuant to Paragraph 3 also of the same Section 8 of the EPIRA, the same shall be segregated from the transmission functions, assets and liabilities for transparency and disposal: Provided, that the subtransmission assets shall be operated and maintained by TRANSCO until their disposal to qualified distribution utilities which are in a position to take over the responsibility for operating, maintaining, upgrading, and expanding said assets. Moreover, under Section 18 22 of the EPIRA, the net profit, if any, of TRANSCO shall be remitted to the PSALM not later than ninety (90) days after the immediately preceding quarter. C. On the privatization of NPC's assets Phase III 1. Generation assets, real estate and other disposable assets as well as IPP contracts. CEcaTH Pursuant to Section 47 of the EPIRA, except for the assets of Small Power Utilities Group (SPUG), the generation assets, real estate, and other disposable assets, as well as the IPP contracts of NPC, shall be privatized; within six (6) months from the effectivity of the EPIRA, PSALM shall submit a plan for the endorsement by the Joint Congressional Power Commission (JCPC) and the approval of the President of the Philippines, on the total privatization of the generation assets, real estate, other disposable assets, as well as existing IPP contracts of NPC, and thereafter, implement the same, in accordance, with the following guidelines, among others, to wit: a) The privatization value to the National Government of the generation assets, real estate, other disposable assets as well as IPP contracts shall be optimized [Sec. 47(a), EPIRA]; b) The NPC plants and/or its IPP contracts assigned to IPP Administrators, its related assets and assigned liabilities, if any, shall be grouped in a manner which shall promote the viability of the resulting Generation Companies, ensure economic efficiency, encourage competition, foster reasonable electricity rates and create market appeal to optimize returns to the government from the sale and disposition of such assets in a manner consistent with the objectives of Act. ...[Sec. 47(c), Ibid. ]; c) All assets of NPC shall be sold in an open and transparent manner through public bidding, and the same shall apply to the disposition of IPP contracts [Sec. 47(d), Ibid. ]; d) The Agus and the Pulangui complexes in Mindanao shall be excluded from among the generation companies that will be initially privatized. The ownership shall be transferred to PSALM and both shall continue to be operated by the NPC. Said complexes may be privatized not earlier than ten (10) years from the effectivity of this Act, and except for Agus III, shall not be subject to Build-Operate-Transfer (B-O-T), Build-Rehabilitate-Operate-Transfer (B-R-O-T) and other variations thereof pursuant to Republic Act No. 6957 (BOT Law), as amended by Republic Act No. 7718. The privatization of Agus and Pulangui complexes shall be left to the discretion of PSALM in consultation with Congress. [Section 47(f), Ibid. ]; e) The steamfield assets and generating plants of each geothermal complex shall not be sold separately. They shall be combined and each geothermal complex shall be sold as one package through public bidding. The geothermal complexes covered by this requirement include, but are not limited to, Tiwi-Makban, Leyte A and B, Tongonan, Palinpinon, and Mt. Apo. [Sec. 47(g), Ibid ];and f) The ownership of the Caliraya-Botokan-Kalayaan (CBK) pump storage shall be transferred to PSALM. [Sec. 47(h), Ibid ]. 2. TRANSCO Privatization Section 21 23 of the EPIRA provides that "within six (6) months from its effectivity, the PSALM Corp. shall submit a plan for the endorsement by the Joint Power Commission and the approval of the President of the Philippines who shall thereafter direct PSALM Corp. to award, in open competitive bidding, the transmission facilities, including grid interconnections and ancillary services to a qualified party either through an outright sale or a concession contract .The buyer/concessionaire shall be responsible for the improvement, expansion, operation, and/or maintenance of its transmission assets and the operation of any related business." Under Section 11(a) 24 of Rule 22 of the IRR, PSALM and TRANSCO shall secure a nationwide franchise to the Buyer/Concessionaire for the operation of the transmission system and grid. The award is expected to result in maximum present value of proceeds to the National Government. In case a Concession Contract is awarded, the concessionaire shall have a contract period of twenty-five (25) years subject to review and renewal for a maximum period of another 25 years. Upon the expiration or termination of the Concession Contract, the transmission facilities and assets, including the nationwide franchise for the operation of the transmission system and grid shall revert to TRANSCO. Paragraph 4 of Section 8 of EPIRA defines the manner and terms under which the aforementioned transmission systems and facilities shall be transferred, to wit: "TRANSCO shall negotiate with and thereafter transfer such functions, assets, and associated liabilities to the qualified distribution utility or utilities connected to such subtransmission facilities not later than two (2) years from the effectivity of the Act of the start of the open access, whichever comes earlier: Provided, That in the case of electric cooperatives, the TRANSCO shall grant concessional financing over a period of twenty (20) years: Provided, however, That the installment payments to TRANSCO for the acquisition of subtransmission facilities shall be given first priority by the electric cooperatives out of the net income derived from such facilities. The TRANSCO shall determine the disposal value of the subtransmission assets based on the revenue potential of such assets." Consistent therewith, paragraphs 8 and 9 of Section 8 of the EPIRA respectively provide that: "Aside from PSALM Corp.,TRANSCO and connected distribution utilities, no third party shall be allowed ownership or management participation, in whole or in part, in such subtransmission entity. "The TRANSCO may exercise the power of eminent domain subject to the requirements of the Constitution and existing laws. Except as provided herein, no person, company or entity other than TRANSCO shall own any transmission facilities." Thus, considering the restriction imposed with respect to the ownership or management participation, in whole or in part, over the subtransmission entity, it has been discussed and agreed, as represented, that TRANSCO will enter into a concession contract to implement the mandated privatization of NPC's assets. V. REQUESTED RULING In reply, please be informed that the transactions arising from or relating to the privatization of NPC will be taxed in the manner described below. In this connection, it is to be noted that this ruling shall apply only to the facts as represented, in connection with the applicable provisions of the EPIRA, the IRR, the Tax Code of 1997 and related laws existing as of the date of this ruling. A. Transfer of assets and liabilities of NPC 1. NPC is not liable to income tax on the transfer of its assets to PSALM and TRANSCO. Under the NPC Charter, NPC enjoys exemption from all forms of taxes, direct or indirect. However, such tax exemption privileges of NPC were repealed by P.D. 1177. Section 23 of said P.D. 1177 allows organizations otherwise exempted by law from payment of internal revenue taxes to ask for subsidy from the General Fund in the exact amount of taxes/duties due, which shall be automatically considered as both revenue and expenditure in the General Fund. As cited by the Supreme Court in Maceda vs. Macaraig, Jr. (233 SCRA 217), there was reason to believe that NPC availed of the subsidy granted to tax exempt GOCCs. Thereafter, E.O. 93, series of 1987, was promulgated specifically to correct the presidential restoration of the grant of tax exemption to some government and private entities pursuant to P.D. 1931, without the benefit of review by the FIRB, thus, all tax and duty incentives granted to the government and private entities were withdrawn except, among others, those covered by the non-impairment clause of the Constitution. As a rule, contractual exemptions which are granted pursuant to a contract entered into by the taxing authority under an enabling law falls within the purview of the non-impairment clause of the Constitution. They should not, however, be confused with exemptions granted under franchises. ( Cagayan Electric Co. vs. CIR, G.R. L-601026, 25 September 1985).A franchise is a special privilege conferred by governmental authority, acting as such on an undertaking that is within the scope of governmental functions. Maintaining the tax-exempt status of NPC pursuant to its charter and its availment of the tax subsidy under P.D. 1177, the FIRB issued on June 24, 1987, Resolution No. 17-87, which clarified the coverage of the exemption under Sec. 8 (b), CA No. 120 (later, Section 13 of R.A. 6395) and restored the tax and duty exemption privileges of the NPC, but excluded certain transactions from the coverage, to wit: 1. Importation of fuel (crude equivalent to coal); 2. Commercially-funded importations ( i.e. ,importations which include but are limited to those financed by the NPC's own internal funds domestic borrowings from any source whatsoever; borrowings from foreign based financial institutions, etc.);and 3. Interest income derived from any source. Thereafter, the income tax exemption of NPC was repealed with the amendments introduced by RA 8424. Consistent with Section 7 (B) of R.A. 8424, Section 27 (C) of the Tax Code of 1997 provides that " (C) Government-Owned or Controlled Corporations, Agencies or Instrumentalities. The provisions of existing special or general laws to the contrary notwithstanding, all corporations, agencies, or instrumentalities owned or controlled by the Government, except the Government Service Insurance System (GSIS),the Social Security System (SSS),the Philippine Health Insurance Corporation (PHIC),the Philippine Charity Sweepstakes Office (PCSO) and the Philippine Amusement and Gaming Corporation (PAGCOR),shall pay such rate of tax upon their taxable income as are imposed by this Section upon corporations or associations engaged in a similar business, industry, or activity." Considering that NPC is not among the government corporations enumerated, its exemption from income tax was deemed repealed. However, in BIR Ruling No. 18-00 dated January 20, 2000, the BIR clarified that the income of NPC from the operation of a public utility is excluded from gross income pursuant to Section 32 (B) (7) (b) of the Tax Code of 1997, which reads: "(B) Exclusions from Gross Income. The following items shall not be included in gross income and shall be exempt from taxation under this Title: "(7) ... "(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. On the basis of said ruling, NPC is not paying income taxes on its income arising from its operation as a public utility. The exemption of NPC is not limited only to the sale and transmission of generated power, but includes transactions incidental to and necessarily connected with the operations of the public utility, such as a sale or transfer on an isolated basis of its assets, which transaction is not conducted as a separate business. ( Radio Communications vs. Court of Tax Appeals, G.R. No. 60547, July 11, 1985; Phil. Power Development Co. vs. Commissioner, CTA Case No. 1152, Oct. 13, 1965),"Where something is done as a mere incident to, or as a necessary consequence of, the principal business, it is not ordinarily taxed as an independent business in itself. What is usually taken as essential is the main activity in which the taxpayer is engaged. All the various transactions tending to better accomplish the principal end in view must be treated as merely incidental." ( De la Rama Steamship Co. vs. Comm. of Internal Revenue , CTA No. 1499, March 5, 1967). Thus, the income, if any, from the sale or transfer of NPC's assets is not income from other business activities conducted by NPC but rather earnings and profits realized in connection with the business conducted in accordance with the franchise, and thus covered by the exemptions provided for in Section 32 (B) (7) (b) of the Tax Code of 1997. 2. NPC is not liable to franchise tax or VAT on the transfer of its assets to PSALM and TRANSCO. Section 27 (c) of the Tax Code of 1997 repealed only the income tax exemptions of NPC. Hence, the NPC Charter is controlling as regards franchise tax. As above stated, the use of the phrase "all forms of taxes" in P.D. 938, which is an amendment of the NPC Charter, evinces a clear legislative intention to exempt NPC from any kind of tax. ( Maceda vs. Macaraig, Jr., 223 SCRA 217). Accordingly, the transfer of assets by NPC to PSALM and TRANSCO is not subject to franchise tax. Moreover, since NPC is not a VAT-taxable entity and the transfer of its assets is not necessary to carry out its primary function as a utility and neither is it done in the course of its trade or business, such transfer shall not be subject to VAT. (BIR Ruling No. 113-98 dated July 23, 1998). TaCDcE 3. The transfer of real properties from NPC to PSALM and TRANSCO is not subject to Documentary Stamp Taxes (DST) under Section 196 of the Tax Code of 1997. Section 196 of the Tax Code provides that DST "shall be imposed on all conveyances, deeds, instruments, or writings other than grants, patents or original certificates of adjudication issued by the Government, 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 . The DST will be computed at the rate of P15.00 for every P1,000, based on the consideration contracted to be paid for such realty or its fair market value determined in accordance with Section 6 (E) of this Code, whichever is higher. When one of the contracting parties is the Government, the tax herein imposed shall be based on the actual consideration, . . . Based on the foregoing, DST under Section 196 of the Tax Code of 1997 is imposed on all conveyances, deeds, instruments, or writings involving the sale of land, tenement or other realty, computed based on the consideration contracted to be paid for such realty or its fair market value determined in accordance with Section 6 (E) of the Tax Code, or when one of the contracting parties is the government, on the actual consideration. As to whether or not the transfer of NPC assets to PSALM or TRANSCO, as the case may be, will fall squarely within the very concept of "sale," reference to the provision of Article 1458 of the Civil Code must be made. This law provides for the following essential requisites to a contract of sale, viz. : 1. Consent of the contracting parties by virtue of which the vendor obligates himself to transfer the ownership of and to deliver a determinate thing, and the vendee obligates himself to pay therefor a price certain in money or its equivalent. 2. Object certain which is the subject matter of the contract. 3. Cause of the obligation which is established. The cause as far as the vendor is concerned is the acquisition of the price certain in money or its equivalent, while the cause as far as the vendee is concerned is the acquisition of the thing which is the object of the contract. Thus, the contract of sale is characterized as consensual, bilateral and reciprocal, principal, onerous, commutative, and nominate. In this case, the transfer of NPC's generation assets and liabilities to PSALM, as well as of the transmission and subtransmission assets and systems to TRANSCO, all of which are government-owned and -controlled corporations is mandated by law. There is no positive offer to sell and buy the aforesaid NPC properties. Moreover, consideration, which should be the prime reason for the transfer of abovementioned assets, is not availing to the parties in the transfer of the aforementioned NPC assets. Although it has been stated earlier, it should bear stressing that this is a transaction between and among government-owned and -controlled corporations pursuant to a law calling for the reorganization of NPC's assets. Consideration is defined as the inducement to a contract. It is the reason or material cause of a contract. It is some right, interest, profit, or benefit accruing to one party. (Black's Law Dictionary, 6th Edition) In the case of PSALM, its assumption of NPC's liabilities is mandated by law. Normally, the transfer of property by a person (transferor) to another person (transferee) in exchange for the assumption by said person of the transferor's liability will be considered a sale, where the assumption of liability constitutes a consideration for the assets. The gain, if any, from the transfer is the difference between the higher of the consideration received or zonal value, if applicable, and the value of the assets given up. The amount of the liabilities transferred is treated as part of the consideration. Likewise, the taking of title over the assets of NPC by PSALM for the purpose of selling or disposing them, is consistent with the guidelines set under the EPIRA. Unlike in an ordinary business transaction, PSALM, as the entity assuming the obligation, does not exercise any discretion whether to accept the assets and liabilities to be transferred nor does it play any role in the determination of the amount of the liabilities that it will assume. Accordingly, the transfer of ownership over NPC properties to PSALM is not a transaction contemplated within Section 196 of the Tax Code, and therefore neither NPC, PSALM nor TRANSCO is subject to DST under the said section. The notarial certification, is however, subject to the DST of fifteen pesos (P15.00) imposed under Section 188 of the Tax Code of 1997. ScaEIT 4. The transfer of liabilities of NPC to PSALM is not subject to DST imposed under Section 198 of the Tax Code of 1997. Pursuant to Section 198 of the Tax Code, DST is imposed on every renewal or continuance of any agreement, contract or any evidence of obligation or indebtedness at the same rate as that imposed on the original instrument. Pursuant to Article 1291 of the Civil Code, obligations may be modified by, among others, substituting the person of the debtor. Novation is a juridical act with a dual function: It extinguishes an obligation and creates a new one. Manresa says that novation is the extinguishment of an obligation by the substitution or change of the obligation by a subsequent one which extinguishes or modifies the first either by changing the object or principal conditions, or by substituting the person of the debtor or subrogating a third person to the rights of the creditor (4 Tolentino, Civil Code 352; Joven de Cortes v. Venturanza ,79 SCRA 709, 722; Peterson v. Azada ,8 Phil. 432). The four essential requisites of novation are: (1) previous valid obligation; (2) the agreement of all parties to the new contract, (3) the extinguishment of the old contract, and (4) the validity of the new one. ( Tiu Siuco v. Habana ,45 Phil. 707, 712) In the instant case, there is an existing valid obligation entered into by NPC. As mandated by the EPIRA, PSALM shall take over the liabilities of NPC, thereby subrogating the latter as debtor with respect to such obligations. Both NPC and PSALM are wholly owned by the National Government, which acts as guarantor of the loans, regardless of whether NPC or PSALM is the debtor. Also, to comply with the provisions of EPIRA, NPC is discussing with its various creditors the possible assumption by PSALM of these obligations. The process would, by novation, completely create a new obligation between the original NPC creditors and PSALM, thereby falling within the purview of Article 1291 of the Civil Code. IcADSE It should, however, be noted that the transfer of NPC's obligations is by operation of law, with the intent of preserving the NPC loans for the benefit of the NPC creditors. The intention of the law is to allow for the restructuring of the electric power industry, which includes the privatization of the assets of the NPC 25 and the transfer of its liabilities to PSALM, 26 which PSALM is mandated to restructure and liquidate. 27 In this particular instance, the transfer of the loans is actually a transfer of such loans from one government vehicle (that is, NPC) to another (that is, PSALM) both of which share the same objective and governmental purpose of ensuring supply of electricity to the country. It is also to be noted, in the case of foreign loans, Section 8(b) of the NPC Charter provides that the National Government guarantees the same absolutely and unconditionally as a primary obligor and not merely as a surety. Considering that both entities serve similar purposes, and that they are both vehicles used by the National Government to achieve the identical objective of providing electrification to the country, the transfer of the NPC loans does not give rise in this case to a new obligation, as the National Government remains the guarantor for the original loans even after they are transferred to PSALM. Accordingly, no DST under Section 180 of the Tax Code of 1997 should be imposed on the transfer of the NPC loans to PSALM. It has also been ascertained with the Department of Finance, Corporate Affairs Division, that NPC's real assets were never subjected to any mortgage. Thus, neither shall DST under Section 198 in relation to Section 195 of the Tax Code of 1997 be imposed. B. Operation of the transferred assets during the transition period (after transfer of assets but prior to privatization) 1. Income of PSALM arises from the exercise of essential government function and, thus, exempt from tax. The mandate of PSALM under Section 50 28 of the EPIRA is to manage the orderly sale, disposition, and privatization of NPC generation assets, real estate and other disposable assets, and IPP contracts; and to liquidate the NPC stranded debts and stranded costs by utilizing the proceeds from the privatization and other property contributed to it, including the proceeds from the Universal Charge. Although the operation by PSALM of the NPC assets transferred to it, is not its principal purpose, nonetheless, because of the provisions of EPIRA mandating the transfer of the assets of NPC, PSALM is required to continue to operate the generation assets of NPC until the same are eventually sold/privatized. 29 Otherwise there would be massive interruption in the supply of electricity, which is contrary to the goal of the EPIRA of ensuring the quality, reliability, security and affordability of the supply of electric power. IDSaEA The foregoing defined activities of PSALM are essentially governmental functions. Under Section 32(B)(7)(b) of the Tax Code of 1997, income derived from the exercise of any essential government function accruing to the Government of the Philippines is excluded from gross income. On what constitutes "essential government function," the Supreme Court, in the case of People's Homesite and Housing Corporation vs. Court of Industrial Relations (G.R. No. L-31890 dated May 29, 1987) expressed this view: "It has not always been easy determining which functions are governmental in nature and which are proprietary. The characterization of functions performed by the government has evolved from the traditional "constituent-ministrant" classification [as enumerated in the case of Bacani vs. National Coconut Corporation, (110 Phil. 468 [1956]) to its disavowal in the case of ACCFA v. CUGCO, et al. (GR No. L-221484, November 29, 1969, 30 SCRA 649), where, considering the social justice provision of the 1936 Constitution, we said that the "constituent-ministrant" classification has become unrealistic, if not obsolete. There, we gave our assent to a socio-political philosophy espousing a great socialization of economic forces. We found nothing objectionable in government undertaking in its sovereign capacity activities which, by the constituent-ministrant test would have been considered as merely optional. "We, thus, ruled in said case that the Agricultural Credit Administration, tasked as it was with the implementation of the land reform program of the government was an agency performing governmental functions. .." Considering the foregoing, this Office opines that the activities undertaken by PSALM pursuant to the provisions of the EPIRA are essential government functions and as such, any income received by it arising from, or relating to, such activities is deemed income from the exercise of essential government function and therefore, excluded from gross income pursuant to Section 32 (B) (7) (b) of the Tax Code of 1997. Furthermore, the operation by PSALM of NPC's generation assets, the same being consequential to its mandate of holding/administering NPC's assets until the same are disposed or privatized, is deemed included in its governmental function. Hence, income derived from the operation of such generation assets is exempt from income tax and minimum corporate income tax imposed in Section 27(A) and Section 27(E) respectively, of the Tax Code of 1997. 2. Sale of generated power by PSALM is subject to zero percent (0%) VAT. Section 102 of the Tax Code of 1997 imposes VAT equivalent to ten percent (10%) of gross receipts derived from the sale or exchange or services in the course of trade or business in the Philippines, provided the annual gross receipts exceed P550,000. Section 6(b),Rule 5 30 of the IRR in relation to Section 4(x) of the EPIRA, 31 however, expressly provides that the sale of generated power by generation companies shall, upon the effectivity of the Act, be subject to zero percent (0%) VAT. Since PSALM, once registered with the ERC will fall within the definition of a Generation Company under Rule 5 of the aforesaid IRR with respect to its sale of generated power, we confirm your opinion that its sale of generated power will be subject to VAT at the rate of zero percent (0%). 3. TRANSCO shall be taxed in the same manner as NPC. Section 8 of the EPIRA provides that the transmission and sub-transmission facilities of NPC and all other assets related to transmission operation, including the nationwide franchise of NPC for the operation of the transmission system and the grid shall be transferred to TRANSCO. The transfer of the franchise of NPC necessarily entails also the transfer of the privileges that NPC enjoys under its charter in relation to the operation of the transmission system in order for it to perform the electrical transmission functions of the NPC. As previously ruled, the income of NPC from the operation of a public utility is excluded from gross income. In this regard, Section 18 and 55(f) of the EPIRA state that "the net profit, if any, of TRANSCO shall be remitted to the PSALM Corp. not later than ninety (90) days after the immediately preceding quarter" and "the following funds, assets, contributions and other property shall constitute the property of the PSALM Corp.: . . . net profit of TRANSCO". As stated earlier, PSALM will be wholly-owned by the National Government. aSADIC Thus, we confirm your opinion that TRANSCO should be taxed in the same manner as NPC, to wit: i) With respect to income tax, the income of TRANSCO is excluded from gross income for purposes of computing its income tax pursuant to Section 32(B)(7)(b) of the Tax Code of 1997. ii) On franchise tax, just like NPC, TRANSCO will be exempt from all forms of taxes, including franchise tax, because the NPC franchise, including the privileges related thereto, have been transferred by operation of law to TRANSCO. 4. NPC's tax liability on its income arising from the service agreements with PSALM and TRANSCO. After the assets will have been transferred to PSALM, NPC will enter into an O&M Agreement with PSALM so it can continue to operate the generation facilities and sell power, for and on behalf of PSALM. In respect to the operations of the transmission system, TRANSCO will enter into an O&M Agreement with NPC providing for the assignment of the latter's employees to TRANSCO to render the services required to be performed pursuant to the provisions of the EPIRA. As discussed earlier, Section 8 32 of the EPIRA mandates, among others, the transfer of NPC's nationwide franchise to TRANSCO. The tax exemption privileges being enjoyed by NPC were granted under its franchise. When such franchise was accordingly transferred to TRANSCO, NPC was automatically divested of the privileges accruing to the franchise. It would have been different if what had been transferred to TRANSCO were merely the NPC properties or facilities used in its operations without the corresponding transfer of franchise. In such a case, NPC would continue to enjoy the privileges granted under the franchise. A legislative franchise is in the nature of a contract between the taxing authority and the grantee, thus, subject to the non-impairment clause of the Constitution. Normally, tax exemptions and privileges are granted to the grantee/holder as an incentive to the performance of its franchise. Such tax exemption privileges are exclusive to the grantee: once the grantee is divested of such function and the franchise is removed, it can no longer enjoy the privileges emanating therefrom. Furthermore, unless the law expressly states, being exclusive in nature, such franchise can never be shared by two entities much more, by the original franchisee which has been stripped of such franchise. Under the foregoing circumstances, essential governmental functions have been transferred and assumed by PSALM. In the case of TRANSCO, as a public utility, it now enjoys the franchise of its predecessor, the NPC, pursuant to Section 8 of the EPIRA. Following the foregoing, the categorical transfer of such functions and franchise will necessarily entail the transfer of tax exemption privileges granted thereunder, unless the EPIRA declares otherwise. However, there is no provision in the EPIRA that categorically allows simultaneous enjoyment of the franchise by both TRANSCO and NPC. aCcHEI There is no tax by silence but, where the law levies a tax, so also must the tax exemption be explicit in the law. Thus, as held in the case Floro Cement vs. Gorospe (200 SCRA 480), tax exemptions are not presumed. Applying this in the case of NPC, it can no longer invoke continuous enjoyment of tax exemption privileges granted under the franchise without a clear and specific provision under the EPIRA. On the other hand, while the EPIRA does provide for the withdrawal of NPC tax exemption privileges in view of the transfer of its franchise to TRANSCO, it has been repeatedly held though that there is, however, no prohibition against the government taxing itself .(Bisaya Land Transportation Co.,Inc. vs. Collector of Internal Revenue, L-11812, 29 May 1959). Presently, the general rule on income taxation of government-owned and/or -controlled corporations is embodied in Section 27(C) of the Tax Code of 1997: except for five (5) government corporations specifically mentioned therein, all other government and government-owned and -controlled corporations are now subject to income tax. Since the service to be rendered by NPC to PSALM and TRANSCO under the O&M Agreements will not be an activity essentially governmental in nature, any income derived therefrom by NPC will not be covered by said provision and thus subject to income tax and minimum corporate income tax imposed under Section 27(A) and (E), respectively, of the Tax Code of 1997. Moreover, services rendered by NPC under the O&M Agreement are deemed rendered in the course of its business, hence, subject to VAT or the appropriate percentage tax, as the case may be. In the meantime, under Section 70 33 of the EPIRA, as implemented by Section 2 of Rule 3 of the IRR, NPC shall be responsible for providing power generation and its associated power delivery systems in areas that are not connected to the transmission system through SPUG. SPUG 34 refers to the functional unit of NPC created to pursue missionary electrification function to some areas in the country where there is no electricity and as provided. Thus, while power generation shall no longer be considered a public utility operation, hence, not required to secure a national franchise pursuant to Paragraph 3, Section 6 of the EPIRA, it may however, be considered an essential governmental function insofar as the operation by NPC of the assets of SPUG is concerned. Such being the case, income derived therefrom will be excluded from gross income pursuant to Section 32(B)(7)(b) of the Tax Code of 1997. Moreover, sale of generated power by NPC through SPUG shall be subject to the zero percent (0%) VAT pursuant to Section 6 of the EPIRA, as implemented by Section 6(b), Rule 5 of the IRR. Accordingly, NPC will be subject to income tax and VAT and/or percentage tax on its O&M income; and 0% VAT on its income from generating electricity through SPUG. C. Privatization of Assets. As stated earlier, the following ruling is based on the law existing as of the date of this ruling. EcDSHT 1. Gain from the sale by PSALM of the generation facilities to qualified buyers is not subject to income tax. The eventual sale, disposition or privatization of the generation assets, real estate and other disposable assets, and IPP contracts, will be a mere incident to, or a necessary consequence of, the generation activity that PSALM will undertake as discussed in B.1.,above, which should therefore not be taxed as an independent business in itself. ( De la Rama Steamship Co. vs. Comm. of Internal Revenue, Ibid ).Accordingly, any income that PSALM may derive from such sale will also not be subject to income tax. 2. Privatization of assets by PSALM is not subject to VAT. Pursuant to Section 105 in relation to Section 106, both of the Tax Code of 1997, a value-added tax equivalent to ten percent (10%) of the gross selling price or gross value in money of the goods, is collected from any person, who, in the course of trade or business, sells, barters, exchanges, leases goods or properties, which tax shall be paid by the seller or transferor. The phrase "in the course of trade or business" means the regular conduct or pursuit of a commercial activity, including transactions incidental thereto. Since the disposition or sale of the assets is a consequence of PSALM's mandate to ensure the orderly sale or disposition of the property and thereafter to liquidate the outstanding loans and obligations of NPC, utilizing the proceeds from sales and other property contributed to it, including the proceeds from the Universal Charge, and not conducted in pursuit of any commercial or profitable activity, including transactions incidental thereto, the same will be considered an isolated transaction, which will therefore not be subject to VAT. (BIR Ruling No. 113-98 dated July 23, 1998) 3. The sale of real property by PSALM is subject to DST. Pursuant to Section 196 of the Tax Code of 1997, the sale of real properties by PSALM will be subject to DST at the rate of P15.00 for every P1,000 based on the consideration contracted to be paid for such realty or its fair market value determined in accordance with Section 6(E) thereof, whichever is higher. When one of the contracting parties is the government, the tax to be imposed shall be based on the actual consideration subject to the proviso that, where one party to the transaction is exempt, the other party shall pay the tax. (Section 173 of the Tax Code of 1997) Accordingly, the sale of real property by PSALM pursuant to the privatization of the generation assets will be subject to DST based on the actual consideration that PSALM will receive from the qualified buyers. This tax consequence is in contrast to the Phase I transfer of NPC assets to PSALM and TRANSCO, which is not subject to DST on the premise that the transaction does not constitute a "sale" for reasons discussed in relevant sections of this ruling. SaETCI 4 & 5. Tax Consequence of concession fee and rental to be received by TRANSCO or proceeds from the award of concession to qualified concessionaire/s or sale of the transmission facilities. As represented, the sale of the transmission facilities or the award of concession agreement and lease arrangement that TRANSCO will enter into with the qualified concessionaires are activities undertaken to implement the privatization of the transmission system of NPC as mandated by Section 21 35 of the EPIRA. The award is expected to result in the maximum present value of the proceeds to the National Government, the reason being that said proceeds will be remitted by TRANSCO to PSALM, which the latter will utilize to liquidate the stranded debts of NPC. While this office is being apprised of the foregoing plan to grant concession right to private persons, for failure however, on your part to submit a copy of the Concession Contract, the requested ruling is hereby deferred as the tax treatment of the concession would depend on the specific terms and conditions of said Concession Contract. It should also be noted that TRANSCO's franchise is not transferred to the concessionaire since the concessionaire will have to secure its own franchise through the efforts of PSALM and TRANSCO. 36 With respect however, to the sale arrangement, considering that TRANSCO will retain its franchise, TRANSCO's income from the sale will be excluded from gross income for purposes of computing its income tax pursuant to the provision of Section 32(B)(7)(b) of the Tax Code of 1997. Moreover, TRANSCO will be exempt from all taxes, except income tax, in accordance with the NPC Charter, on such sale. However, for the same reasons stated in the immediately preceding section, the transfer of real property assets by sale will be subject to DST under Section 196 of the Tax Code of 1997. Since TRANSCO is exempt from all taxes, including the DST under the said Section 196, the qualified winning bidder shall be the one directly liable for the DST pursuant to Section 173 of the Tax Code of 1997. D. Collection of Universal Charge by distribution utilities is not part of their taxable revenues nor will it be part of their gross receipts for purposes of determining their franchise taxes. Likewise, the collection of Universal Charge by PSALM will not be considered as taxable income nor will it form part of its gross receipts for VAT purposes. The Universal Charge will be collected from all end-users by the distribution utilities. These charges will be remitted to PSALM and will be used exclusively for the liquidation of the stranded debts and stranded costs of NPC as well as qualified stranded contract costs of distribution utilities resulting from the restructuring of the industry. The EPIRA provides that the Universal Charge is a non-bypassable charge. Accordingly, since the Universal Charges to be collected by the distribution utilities do not belong to them and therefore, would not redound to their benefit, the same will not be considered in the nature of income. Neither will the same form part of the gross receipts of the distribution utilities for purposes of determining their franchise tax liability. Gross receipts of a taxpayer do not include monies or receipts entrusted to the taxpayer which do not belong to them and do not redound to the taxpayer's benefit; and it is not necessary that there must be a law or regulation which would exempt such monies and receipts within the meaning of gross receipts under the Tax Code. 38 In another case, the Supreme Court ruled that the gross receipts of a taxpayer should not include any money which although delivered to it has been especially earmarked by law or regulation for some reason other than the taxpayer. 39 However, we require that the Universal Charge appear as a separate item in the bill. On the other hand, the Universal Charge received by PSALM will not be subject to income tax since it will not be in the nature of income as defined in Sec. 32(A) of the Tax Code of 1997, which includes gains, profits, and income derived from salaries, wages, or compensation for personal services of whatever kind and in whatever form paid, or from professions, vocations, trades, business, commerce, sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; also from interests, rents, dividends, securities, or transactions or any business carried on for gain or profits, and income derived from any source whatever. Income, in a broad sense, means all wealth that flows into the taxpayer other than as a mere return of capital. ( Section 36, Revenue Regulations No. 2, otherwise known as the Income Tax Regulations ). The Universal Charge is not a flow of wealth to PSALM as it would not accrue to its benefit but would be remitted to the Special Trust Fund, as provided under the EPIRA. PSALM is just the administrator of the fund, which shall be disbursed/distributed to its respective beneficiaries only for the following purposes: 1) payment for the stranded debts in excess of the amounts assumed by the National Government and stranded contract costs of NPC as well as qualified stranded contract costs of distribution utilities resulting from the restructuring of the industry; 2) missionary electrification; 3) the equalization of the taxes and royalties applied to indigenous or renewable sources of energy vis--vis imported energy fuels; 4) an environmental charge equivalent to one-fourth of one centavo per kilowatt-hour (P0.0025/kWh), which shall accrue to an environmental fund to be used solely for watershed rehabilitation and management (this environmental fund will be managed by NPC under existing arrangements); and 5) a charge to account for all forms of cross-subsidies for a period not exceeding three (3) years. 40 Neither can the Universal Charge be deemed part of the gross receipts of PSALM for VAT purposes. The term "gross receipts" means the total amount of money or its equivalent representing the contract price, compensation or service fee, including the amount charged for materials supplied with the services and deposits or advance payments actually or constructively received during the taxable quarter for the services performed or to be performed for another person. The Universal Charge is not compensation for services performed by PSALM. While it is authorized under the EPIRA to receive said charges, it is earmarked to be utilized for purposes mentioned in the immediately preceding paragraph. E. Interest arising from NPC loans transferred to PSALM is exempt from income tax. You represented that NPC's foreign obligations that will be transferred to PSALM may be grouped into three categories, namely: 1. Loans extended by foreign governments, financing institutions owned or controlled or enjoying financing from foreign governments, or international or regional financial institutions established by foreign governments; 2. Commercial loans; and 3. Bonds, and that NPC does not withhold tax on interest payments made in connection with these obligations. Section 8 of NPC's Charter, as amended by P.D. 1360, provides: "Sec. 8. Authority to Incur Indebtedness and Issue Bonds; Their Conditions, Privileges and Exemptions; Sinking Funds; Guarantee. "(a) Domestic Indebtedness. Whenever the Board deems it necessary for the Corporation to incur indebtedness by contracting loans with domestic financial institutions or to issue bonds to carry out the purpose for which the Corporation has been organized, it shall, by resolution, approved by at least four members of the Board, so declare and state the proposed debt is to be incurred and the conditions as it shall deem appropriate for the accomplishment of the said purpose; Provided, that in the case of bond issues, the same shall be subject to the approval by the President of the Philippines upon recommendation of the Secretary of Finance. "The bonds issued under the authority of this subsection shall be exempt from the payment of all taxes by the Republic of the Philippines, or by any authority, branch, division or political subdivision thereof, which facts shall be stated upon the face of the said bonds. Said bonds shall be receivables as security in any transaction with the Government in which such security is required. "The Republic of the Philippines hereby guarantees the payment by the Corporation of both the principal and interest of the bonds issued by said Corporation by virtue of this Act, and shall pay such principal and interest in case the Corporation fails to do so, and there are hereby appropriated, out of the general funds in the National Treasury not otherwise appropriated, the sums necessary to make the payments guaranteed by this Act; Provided ,That the sum so paid by the Republic of the Philippines shall be refunded by the Corporation; Provided, further, That the Corporation shall set aside five per centum of its annual net operating revenues before interests as a reserve or sinking fund to answer for amounts advanced to it by the National Government for any loan, credit and indebtedness contracted by the former for which the latter shall be answerable as primary obligor or guarantor under the provisions of this Act; Provided, furthermore, That the setting aside of the amounts mentioned herein shall automatically cease the moment the accumulated sinking fund or reserve exceeds the amounts advanced to the Corporation by the National Government under this Act; And, Provided, finally, That the Corporation may periodically make partial payments to the National Government out of the said reserves. "(b) Foreign Loans. The Corporation is hereby authorized to contract loans, credits, in any convertible foreign currency, or capital goods, and indebtedness from time to time from foreign governments, or any international financial institution or fund source, or to issue bonds, in such amount and in any foreign currency on such terms and conditions as it shall deem appropriate the accomplishment of its purposes and to enter into and execute agreements and other documents specifying such terms and conditions. "The President of the Philippines, by himself, or through his duly authorized representative, is hereby authorized to guarantee, absolutely and unconditionally as primary obligor and not as surety merely, in the name and on behalf of the Republic of the Philippines, the payment of the loans, credits, indebtedness and bonds issued up to the amount herein authorized, which shall be over and above the amount which the President of the Philippines is authorized to guarantee under Republic Act Numbered Sixty One Hundred Forty-Two, as amended, as well as the performance of all or any of the obligations undertaken by the Corporation in the territory of the Republic of the Philippines pursuant to the loan agreements entered into with foreign governments or any international financial institutions or fund sources. "In the contracting of any loan credit or indebtedness under this Act, the President of the Philippines may, when necessary agree to waive or modify the application of any law granting any preferences or imposing restrictions on international competitive bidding, including among others, Act Numbered Four Thousand Two Hundred Thirty-Nine, Commonwealth Act Numbered One Hundred Thirty-Eight, the provisions of Commonwealth Act Numbered Five Hundred Forty-One, Republic Act Numbered Five Thousand One Hundred Eighty-Three, insofar as such provisions do not pertain to constructions primarily for defense or security purposes; Provided, however, That as far as practicable, utilization of the services of qualified domestic firms in the prosecution of projects financed under this Act shall be encouraged; Provided, further, That in case where international competitive bidding shall be conducted reference of at least fifteen per centum shall be granted in favor of articles, materials or supplies of the growth production of manufacture of the Philippines, Provided, finally, That the method and procedure and the comparison of bids shall be the subject of agreement between the Philippine Government and the lending institution. "The loans, credits and indebtedness contracted under this subsection and the payment of the principal, interest and other charges thereon, as well as the importation of machinery, equipment, materials and supplies by the Corporation, paid from the proceeds of any loan, credit or indebtedness incurred under this Act, shall also be exempt from all taxes, fees, imposts, other charges and restrictions, including import restrictions, by the Republic of the Philippines, or any of its agencies and political subdivisions." (Emphasis supplied) Pursuant to the foregoing provision, interest on bonds under Section 8 (a) and foreign loans incurred under Section 8 (b) of the NPC Charter are exempt from income tax. In following discussion, the term "NPC loans" refers to the bonds issued under Section 8 (a) and the foreign loans incurred under Section 8(b) of the NPC Charter, which are exempt pursuant to the said provisions of the charter. While the EPIRA does not provide for the same treatment of the NPC loans once they are transferred to PSALM, the interest arising from these loans shall continue to be exempt from income tax because the exemption in the NPC Charter is granted not to NPC, which is a borrower, but rather on the loans, credits and indebtedness as well as on the payment of the principal, interest and other charges. In effect, the exemption is granted to the lender, which is the entity earning the interest income. Such being the case, interest payments on the aforementioned foreign loans originally incurred by NPC under its charter, as amended by PD No. 1360, and which will be transferred to and assumed by PSALM, shall remain exempt from tax. On the other hand, foreign loans that PSALM may incur in the future in connection with the performance of its functions and for the attainment of its objective 41 shall no longer be covered by the foregoing tax exemption provision of the NPC Charter. They may, however, still be exempt from income tax pursuant to Section 32 (B) (7) (a) of the Tax Code of 1997 pertinent portion of which provides as follows: "(B) Exclusions from Gross Income. The following items shall not be included in the gross income and shall be exempt from Taxation under this Title: "(7) Miscellaneous Items. "(a) Income Derived by Foreign Government. Income derived from investments in the Philippines in loans, stocks, bonds or other domestic securities, or from interest on deposits in banks in the Philippines by (i) foreign governments, (ii) financing institutions owned, controlled, or enjoying refinancing from foreign governments, and (iii) international or regional financial institutions established by foreign governments." Also, the interest arising from such loans may also be exempt from income tax or be subject to a preferential tax rate if the creditor is a resident of a country with which the Philippines has an existing treaty, subject to the conditions stated in such treaty. 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 be considered null and void. Very truly yours, (SGD.) REN G. BAEZ Commissioner of Internal Revenue Footnotes 1. SEC. 47. NPC Privatization. Except for the assets of SPUG, the generation assets, real estate and other disposable assets as well as IPP contracts of NPC shall be privatized in accordance with this Act. Within six (6) months from the effectivity of this Act, the PSALM Corp. shall submit a plan for the endorsement by the Joint Congressional Power Commission and the approval of the President of the Philippines, on the total privatization of the generation assets, real estate, other disposable assets as well as existing IPP contracts of NPC and thereafter, implement the same, in accordance with the following guidelines, except as provided for in paragraph (f) herein: (a) The privatization value to the National Government of the NPC generation assets, real estate, other disposable assets as well as IPP contracts shall be optimized;" 2. SEC. 51. Powers. The PSALM Corp. shall, in the performance of its functions and for the attainment of its objective, have the following powers: xxx xxx xxx (m) To structure the sale, privatization or disposition of NPC assets and IPP contracts and/or their energy output based on such terms and conditions which shall optimize the value and sale prices of said assets." 3. "(vv) Stranded Debts of NPC" refer to any unpaid financial obligations of NPC which have not been liquidated by the proceeds from the sales and privatization of NPC assets;" 4. "SEC. 34. Universal Charge. Within one (1) year from the effectivity of this Act, a universal charge to be determined, fixed and approved by the ERC, shall be imposed on all electricity end-users for the following purposes: (a) Payment for the stranded debts in excess of the amount assumed by the National Government and stranded contract costs of NPC and as well as qualified stranded contract costs of distribution utilities resulting from the restructuring of the industry;" 5. "SEC. 51. Powers. The PSALM Corp. shall, in the performance of its functions and for the attainment of its objective, have the following powers: xxx xxx xxx (d) To calculate the amount of the stranded debts and stranded costs of NPC which shall form the basis for ERC in the determination of the universal charge;" 6. "SEC. 49. Creation of Power Sector Assets and Liabilities Management Corporation. There is hereby created a government-owned and -controlled corporation to be known as the "Power Sector Assets and Liabilities Management Corporation", hereinafter referred to as the "PSALM Corp.", which shall take ownership of all existing NPC generation assets, liabilities, IPP contracts, real estate and all other disposable assets. All outstanding obligations of the NPC arising from loans, issuances of bonds, securities and other instruments of indebtedness shall be transferred to and assumed by the PSALM Corp. within one hundred eighty (180) days from the approval of this Act." 7. "SEC. 8. Creation of the National Transmission Company. There is hereby created a National Transmission Corporation, hereinafter referred to as TRANSCO, which shall assume the electrical transmission function of the National Power Corporation (NPC),and have the powers and functions hereinafter granted. The TRANSCO shall assume the authority and responsibility of NPC for the planning, construction and centralized operation and maintenance of its high voltage transmission facilities, including grid interconnections and ancillary services. Within six (6) months from the effectivity of this Act, the transmission and subtransmission facilities of NPC and all other assets related to transmission operations, including the nationwide franchise of NPC for the operation of the transmission system and the grid, shall be transferred to the TRANSCO. The TRANSCO shall be wholly owned by the Power Assets and Liabilities Management Corporation (PSALM Corp.). The subtransmission functions and assets shall be segregated from the transmission functions, assets and liabilities for transparency and disposal: Provided, That the subtransmission assets shall be operated and maintained by TRANSCO until their disposal to qualified distribution utilities which are in a position to take over the responsibility for operating, maintaining, upgrading and expanding said assets. All transmission and subtransmission related liabilities of NPC shall be transferred to and assumed by the PSALM Corp. TRANSCO shall negotiate with and thereafter transfer such functions, assets, and associated liabilities to the qualified distribution utility or utilities connected to such subtransmission facilities not later than two (2) years from the effectivity of this Act or the start of open access, whichever comes earlier: Provided ,That in the case of electric cooperatives, the TRANSCO shall grant concession financing over a period of twenty (20) years: Provided, however, That the installment payments to TRANSCO for the acquisition of subtransmission facilities shall be given first priority by the electric cooperatives out of the net income derived from such facilities. The TRANSCO shall determine the disposal value of the subtransmission assets based on the revenue potential of such assets. xxx xxx xxx" 8. " Sec. 5. Powers. The PSALM Corp. shall, in the performance of its functions and for the attainment of its objectives, have the following powers: xxx xxx xxx (q) To operate the generation assets, directly or through NPC, prior to Privatization of such assets. Towards this end, while PSALM operates the generation assets, it shall be considered a Generation Company; xxx xxx xxx" (Rule 21, IRR) 9. "SEC. 51. Powers. The PSALM Corp. shall, in the performance of its functions and for the attainment of its objectives, have the following powers: xxx xxx xxx (h) To appoint or hire, transfer, remove and fix the compensation of its personnel and advisors or other Persons as may be necessary in the sale, Privatization and disposition of NPC assets and IPP contracts; Provided, however, That the PSALM shall hire its own personnel only if absolutely necessary, and as far as practicable, shall avail itself of the services of personnel detailed from other government agencies;" 10. " Sec. 5. Powers. The PSALM Corp. shall, in the performance of its functions and for the attainment of its objectives, have the following powers: xxx xxx xxx (b) To take title to possession of, administer and conserve the assets transferred to it, including the execution of bilateral contracts to sell power from undisposed assets and contracts transferred by NPC; xxx xxx xxx (q) To operate the generation assets, directly or through NPC, prior to Privatization of such assets. Towards this end, while PSALM operates the generation assets, it shall be considered a Generation Company." (Rule 21, IRR) 11. See Footnote No. 7. 12. "SEC. 5. Powers. The PSALM Corp. shall, in the performance of its functions and for the attainment of its objectives, have the following powers: xxx xxx xxx (o) To structure the sale, Privatization or disposition of NPC assets and IPP contracts and/or their energy output based on such terms and conditions which shall optimize the value and sale prices of said assets." (Rule 21, IRR) 13. "SEC. 21. TRANSCO Privatization. Within six (6) months from the effectivity of this Act, the PSALM Corp. shall submit a plan for the endorsement by the Joint Power Commission and the approval of the President of the Philippines. The President of the Philippines thereafter shall direct PSALM Corp. to award, in open competitive bidding, the transmission facilities, including grid interconnections and ancillary services to a qualified party either through an outright sale or a concession contract. The buyer/concessionaire shall be responsible for the improvement, expansion, operation, and/or maintenance of its transmission assets and the operation of any related business. The award shall result in maximum present value of proceeds to the national government. In case a concession contract is awarded, the concessionaire shall have a contract period of twenty-five (25) years, subject to review and renewal for a maximum period of another twenty-five (25) years. xxx xxx xxx" (EPIRA) 14. See Footnote No. 7. 15. SEC. 34. Universal Charge. Within one (1) year from the effectivity of this Act, a universal charge to be determined, fixed and approved by the ERC, shall be imposed on electricity end-users for the following purposes: (a) Payment for the stranded debts in excess of the amount assumed by the National Government and stranded contract costs of NPC and as well as qualified stranded contract costs of distribution utilities resulting from the restructuring of the industry; (b) Missionary electrification; (c) The equalization of taxes and royalties applied to indigenous or renewable sources of energy vis--vis imported energy fuels; (d) An environmental charge equivalent to one-fourth of one centavo per kilowatt-hour (P.0025/kWh),which shall accrue to an environmental fund to be used solely for watershed rehabilitation and management. Said fund shall be managed by NPC under existing arrangements; and (e) A charge to account for all forms of cross-subsidies for a period not exceeding three (3) years. The Universal Charge shall be a non-bypassable charge which shall be passed on and collected from all end-users on a monthly basis by the distribution utilities. Collections by the distribution utilities and the TRANSCO in any given month shall be remitted to the PSALM Corp. on or before the fifteenth (15th) of the succeeding month, net of any amount due to the distribution utility. Any end-user or self-generating entity not connected to a distribution utility shall remit its corresponding universal charge directly to the TRANSCO. The PSALM Corp.,as administrator of the fund, shall create a Special Trust Fund which shall be disbursed only for the purposes specified herein in an open and transparent manner. All amounts collected for the universal charge shall be distributed to the respective beneficiaries within a reasonable period to be provided by the ERC." 16. See Footnote No. 6. 17. "Sec. 51. Powers. The PSALM Corp. shall, in the performance of its functions and for the attainment of its objectives, have the following powers: xxx xxx xxx (j) To borrow money and incur such liabilities, as may be required to service all obligations transferred from NPC and loans from ECs assumed from NEA in accordance with the relevant sections of these Rules, including the issuance of bonds, securities or other evidences of indebtedness utilizing its assets as collateral and/or through the guarantees of the National Government: Provided, That all such debts or borrowings shall have been paid off before the end of its corporate life;" 18. "Sec. 51. Powers. The PSALM Corp. shall, in the performance of its functions and for the attainment of its objectives, have the following powers: xxx xxx xxx (b) To take title to and possession of, administer and conserve the assets transferred to it; to sell or dispose of the same at such price and under such terms and conditions as it may deem necessary or proper, subject to applicable laws, rules and regulations; (c) To take title to and possession of the NPC IPP contracts and to appoint, after public bidding in transparent and open manner, qualified independent entities who shall act as the IPP Administrators in accordance with this Act; xxx xxx xxx (k) To restructure existing loans of NPC; xxx xxx xxx 19. See Footnote No. 6. 20. See Footnote No. 7. 21. "SEC. 47. NPC Privatization. Except for the assets of SPUG, the generation assets, real estate, and other disposable assets as well as IPP contracts of NPC shall be privatized in accordance with this Act. Within six (6) months from the effectivity of this Act, the PSALM Corp. shall submit a plan for the endorsement by the Joint Congressional Power Commission and the approval of the President of the Philippines, on the total privatization of the generation assets, real estate, and other disposable assets as well as existing UPP contracts of NPC and thereafter, implement in the same, in accordance with the following guidelines, except as provided for in paragraph (f) herein: xxx xxx xxx (j) NPC may generate and sell electricity only from the undisposed generating assets and IPP contracts of PSALM Corp. and shall not incur any new obligations to purchase power through bilateral contracts with generation companies or other suppliers." 22. "SEC. 18. Profits. The net profit, if any, of TRANSCO shall be remitted to the PSALM Corp. not later than ninety (90) days after the immediately preceding quarter." 23. See Footnote No. 13. 24. "SEC. 11 TRANSCO Privatization. (a) Within six (6) months from the effectivity of the Act, the PSALM shall submit a Privatization Plan for endorsement by the Power Commission and the approval of the President of the Philippines. The President of the Philippines thereafter shall direct PSALM to award, in open competitive bidding, the transmission facilities, including grid interconnections and Ancillary Services to a qualified party either through an outright sale, a Concession Contract or any other means not inconsistent with the objectives of the Act. The Buyer or Concessionaire or any other successor-in-interest to TRANSCO shall be responsible for the improvement, expansion, operation, or maintenance of the transmission assets and the operation of any related business. PSALM and TRANSCO shall secure a nationwide franchise for and in behalf of the Buyer or Concessionaire. The award shall result in maximum present value of proceeds to the National Government. In case a Concession Contract is awarded, the Concessionaire shall have a contract period of twenty-five (25) years, subject to review and renewal for a maximum period of another twenty-five (25) years. Upon the expiration or termination of the Concession Contract, the transmission facilities and assets, including the nationwide franchise for the operation of the transmission system and Grid shall revert to TRANSCO." 25. "SEC. 3. Scope. This Act shall provide a framework for the restructuring of the electric power industry, including the privatization of the assets of NPC, the transition to the desired competitive structure, and the definition of the responsibilities of the various government agencies and private entities." 26. Section 49, EPIRA. See Footnote No. 6. 27. "SEC. 50. Purpose and Objective, Domicile and Term of Existence. The principal purpose of the PSALM Corp. is to manage the orderly sale, disposition, and privatization of NPC generation assets, real estate and other disposable assets, and IPP contracts with the objective of liquidating all NPC financial obligations and stranded contract costs in an optimal manner. The PSALM Corp. shall have its principal office and place of business within Metro Manila. The PSALM Corp. shall exist for a period of twenty-five (25) years from the effectivity of this Act, unless otherwise provided by law, and all assets held by it, all moneys and properties belonging to it, and all its liabilities outstanding upon the expiration of its term of existence shall revert to and be assumed by the National Government." Sec. 51. Powers. The PSALM Corp. shall, in the performance of its functions and for the attainment of its objectives, have the following powers: xxx xxx xxx (k) To restructure existing loans of the NPC; xxx xxx xxx" (EPIRA) 28. "SEC. 50. Purpose and Objective, Domicile and Term of Existence. The principal purpose of the PSALM Corp. is to manage the orderly sale, disposition, and privatization of NPC generation assets, real estate and other disposable assets, and IPP contracts with the objective of liquidating all NPC financial obligations and stranded contract costs in an optimal manner. xxx xxx xxx 29. See Footnote No. 18. 30. " Section 6. Generation Charges and VAT. xxx xxx xxx (b) Pursuant to the policy of reducing electricity rates to End-Users, sales of generated power by a Generation Company shall, from the effectivity of the Act, be zero-rated for the purpose of imposition of value-added tax. Towards this end, the imposition of zero percent (0%) VAT shall apply to the sale of generated power by a Generation Company through all stages of sale until it reaches the End-user. The DOF, through the BIR, shall issue the necessary revenue regulation within sixty (60) calendar days from effectivity of these Rules." 31. "(x) "Generation Company" refers to any person or entity authorized by the ERC to operate facilities used in the generation of electricity." (Sec. 4, EPIRA) 32. See Footnote No. 7. 33. "SEC. 70. Missionary Electrification. Notwithstanding the divestment or privatization of NPC assets, IPP contracts and spun-off corporations, NPC shall remain as a National Government-owned and-controlled corporation to perform the missionary electrification function through the Small Power Utilities Group (SPUG) and shall be responsible for providing power generation and its associated power delivery systems in areas that are not connected to the transmission system. The missionary electrification function shall be funded from the revenues from sales in missionary areas and from the universal charge to be collected from all electricity end-users as determined by the ERC." 34. "SEC. 4. Definition of Terms. xxx xxx xxx (tt) "Small Power Utilities Group" or "SPUG" refers to the functional unit of NPC created to pursue missionary electrification function;" (EPIRA) 35. See Footnote No. 12. 36. See Footnote No. 24. 37. "SEC. 34. Universal Charge. Within one (1) year from the effectivity of this Act, a universal charge to be determined, fixed and approved by the ERC, shall be imposed on all electricity end-users for the following purposes: (a) Payment for the stranded debts in excess of the amount assumed by the National Government and stranded contract costs of NPC and as well as qualified stranded contract costs of distribution utilities resulting from the restructuring of the industry; (b) Missionary electrification; (c) The equalization of taxes and royalties applied to indigenous or renewable sources of energy vis--vis imported energy fuels; (d) An environmental charge equivalent to one-fourth of one centavo per kilowatt-hour (P0.0025/kWh),which shall accrue to an environmental fund to be used solely for watershed rehabilitation and management. Said fund shall be managed by NPC under existing arrangements; and (e) A charge to account for all forms of cross-subsidies for a period not exceeding three (3) years. The universal charge shall be a non-bypassable charge which shall be passed on and collected from all end-users on a monthly basis by the distribution utilities. Collections by the distribution utilities and the TRANSCO in any given month shall be remitted to the PSALM Corp. on or before the fifteenth (15th) of the succeeding month, net of any amount due to the distribution utility. Any end-user or self-generating entity not connected to a distribution utility shall remit its corresponding universal charge directly to the TRANSCO. The PSALM Corp.,as administrator of the fund shall create a Special Trust Fund which shall be disbursed only for the purposes specified herein in an open and transparent manner. All amounts collected for the universal charge shall be distributed to the respective beneficiaries within a reasonable period to be provided by the ERC." 38. Commissioner of Internal Revenue vs. Tours Specialists, Inc. and the Court of Tax Appeals, G.R. No. 66416, March 21, 1990. 39. Commissioner of Internal Revenue vs. Manila Jockey Club, Inc. (108 Phil. 821 [1960]). 40. Section 34, EPIRA. 41. " Section 5. Powers. ... (k) To borrow money and incur such liabilities, as may be required to service all obligations transferred from NPC and loans from ECs assumed from NEA in accordance with the relevant sections of these Rules, including the issuance of bonds, securities or other evidence of indebtedness utilizing its assets as collateral and/or through the guarantees of the National Government: Provided, That all such debts or borrowings shall have been paid off or settled before the end of its corporate life;" (Rule 21, IRR)