Tax Implications of the Sale of Electricity by East Asia Utilities Corp.

August 10, 1999 BIR RULING NO. 117-99 34, 42 (E), RR2-000-00-117-99 Castro Cadiz & Carag Law Offices Suite 25PC, Eisenhower Condominium No. 7 Eisenhower Street 1500 Greenhills, San Juan, Metro Manila Attention: Atty . Othelo C . Carag Gentlemen : This refers to your letter dated May 27, 1999 requesting for a confirmation of your opinion regarding the tax implications of the sale of electricity by East Asia Utilities Corporation (EAUC). prcd It appears that EAUC is a domestic corporation with principal office in Cebu; that under its Articles of Incorporation which is duly registered with the Securities and Exchange Commission, it is authorized to build, equip, own, operate, maintain, sell and lease power generation plants, facilities, machinery and equipment, own, lease or let power generation, telecommunications, transportation and other kinds of equipment, materials or facilities; and at present, EAUC operates a 50.1 MW power plant in Mactan Export Processing Zone (MEPZ); that it has entered into a Power Supply and Purchase Agreement with the Export Processing Zone Authority (now the Philippine Economic Zone Authority (PEZA) under which the latter will purchase its power requirements from EAUC; that EAUC is registered with the Board of Investments (BOI) as a pioneer enterprise and as an operator of a power generating plant with a capacity of 50 MW; that it has been granted by the BOI certain incentives which includes Income Tax Holiday for six years starting from December 1993; that likewise, it is accredited by the Department of Energy (DOE) as a Private Sector Generation Facility (PSGF) under Executive Order No. 215 (E.O. 215) for operating a power plant within the MEPZ; that finally, EAUC was registered on April 27, 1998 with PEZA as an Ecozone Utilities Enterprise pursuant to the provisions of Republic Act No. 7916 (PEZA Law). You are now requesting for opinion that: "1. Being an Ecozone Utilities Enterprise, EAUC is exempt from all national and local taxes; and in lieu thereof, it is subject to a special tax rate of five percent (5%) on gross income derived from its registered operations; "2. On the income derived from its registered operations, EAUC's exemption from national taxes includes exemption from 33% corporate income tax under Section 27 of the National Internal Revenue Code of 1997 (Tax Code), value-added tax (VAT) under Section 105 of the Tax Code, and franchise tax under Section 119 of the Tax Code; "3. The gross income earned by EAUC from its registered operations involving its sale of electricity shall also be subject to certain allowable deductions as enumerated in Section 2(2), Rule XIX, Part VII of the PEZA Rules; "4. However, for the sale of electricity to customs territory enterprises (hereinafter collectively referred to as "income from sources within the customs territory"), EAUC is subject to 33% corporate income tax and 2% franchise tax, but exempt from VAT; and "5. In computing the taxable income of EAUC from sources within the customs territory, its expenditures are deductible from the gross income earned, when allocable to the production of the income thereto or where a ratable part of the general expenditures is apportioned to income from these sources." In reply, please be informed as follows: 1. Under Section 24 of R.A. 7916, otherwise known as "The Special Economic Zone Act of 1995", no taxes, national and a local, shall be imposed on business establishments operating within the Ecozone and that in lieu of paying taxes, five percent (5%) of the gross income earned by all businesses and enterprises from its registered operations within the Ecozone shall be remitted to the national government. 2. Thus, EAUC which is registered in PEZA as an Ecozone Utilities Enterprise, and not a service establishment, is exempt from national and local taxes, which include, among others, corporate income tax, VAT and franchise tax from the income derived from its registered operations, which is the sale of electricity within MEPZ (Sections 24 and 25 of R.A. 7916; Section 2, Rule XVI and 1(A)(1)(2), Rule XIV of the PEZA Rules; BIR Ruling No. 70-97 dated June 9, 1997; BIR Ruling No. 049-99 dated April 13, 1999). 3. In computing for the gross income subject to the special rate of 5% of EAUC, from its registered operations as defined above, the following deductions may be allowed: " Direct salaries, wages or labor expense Service supervision salaries Direct materials, supplies used or resold to another ECOZONE Enterprise Financing charges associated with fixed assets Rent and utility charges for buildings and capital equipment" (Section 2(2), Rule XIX, Part VII of the PEZA Rules) However, EAUC may not simultaneously enjoy its 6-year income tax holiday granted by the BOI with the incentives granted by PEZA. 4. However, for the sale of electricity to customs territory enterprises, not being the registered operations of EAUC, the provisions of the 1997 Tax Code are applicable. And being a Private Sector Generation Facility, EAUC is governed by laws applicable to electric utilities (E.O. 215 and Implementing Rules and Regulations of E.O. 215). Hence, in this instance, EAUC is subject to 33% corporate income tax and 2% franchise tax, (Sections 27 and 119 of the Tax Code). However, EAUC is exempt from VAT being subject to percentage tax. (Section 109(j), Tax Code; VAT Ruling No. 059-90 dated February 28, 1990; VAT Ruling No. 061-99 dated May 18, 1999). 5. Being subject to corporate income tax under Section 27 of the Tax Code for its income derived from the sale of electricity to customs territory enterprises, EAUC may deduct from its items of gross income, the allowable deductions under Section 34 of the Tax Code. However, the expenditures must be allocable to the production of the income thereto or where a ratable part of the general expenditures is apportioned to income from these sources, based on Revenue Regulations No. 2, as amended by RR No. 16-86: "SEC. 160. (a) Apportionment of deductions . From the items specified in Section 37(a) [now Section 42 (E)] as being derived specifically from sources within the Philippines, there shall be deducted the expenses, losses, and other deductions properly allocated thereto and a ratable part of any other expenses, losses, and other deductions effectively connected with the business or trade conducted exclusively within the Philippines which cannot be definitely allocated to some items or class of gross income. The remainder shall be included in full as net income from sources within the Philippines. The ratable part shall be based upon any of the following ratios consistently allowed from year to year: 1. Gross income from sources within the Philippines to the total gross income. 2. Net sales in the Philippines to total net sales. 3. If any other method of allocation is adopted, a written permission from the Commissioner of Internal Revenue shall first be secured." In short, the Ecozone is treated as a separate customs territory from the rest of the Philippines. Hence, the rule on income from sources partly within and partly without the Philippines is applied by analogy (Section 42(E) of the Tax Code). llcd Based on the foregoing, EAUC is subject to a special rate of 5% of its gross income derived from its registered operations less allowable deductions under the PEZA Rules, but exempt from 33% corporate income tax, VAT and 2% franchise tax. However, its sale of electricity to customs territory enterprises is subject to 33% corporate income tax and 2% franchise tax but exempt from VAT; and the expenditures of EAUC are deductible in computing its taxable income, when allocable to the production of income thereto or where a ratable part of the general expenditures is apportioned to income from these sources. This ruling is being issued on the basis of the facts represented. However, if upon investigation, it will be disclosed that the facts are different, then this ruling shall be considered null and void. Very truly yours, (SGD.) BEETHOVEN L. RUALO Commissioner of Internal Revenue