Bureau of Local Government Finance Opinion

July 31, 2003 BUREAU OF LOCAL GOVERNMENT FINANCE OPINION The President Power Sector Assets & Liabilities Management Corporation (PSALM) 2/F SGV II Bldg. Ayala Ave., Makati City S i r : This refers to your letter dated March 10, 2003, requesting confirmation of your opinion concerning, among others, that machinery and equipment owned by the Power Sector Assets and Liabilities Management Corp. (PSALM) shall be exempt from the payment of real property tax and, that other real property owned by the said corporation, shall only be subject to an assessment level of ten percent (10%). The creation of PSALM and TRANSCO is provided under Sections 49 and 8 of the EPIRA law, which we quote as follows: "SECTION 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 the ownership of all existing NPC generations assets, liabilities, IPP contracts, real estate and all other disposable assets. ..." (Emphasis supplied) "Section 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 functions of the National Power Corporation (NPC),and have the powers and functions hereinafter granted. ... "...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. ..." Section 234 (c) of the Local Government Code of 1991 (R.A. No. 7160) provides the following: "Section 2.34. Exemptions from Real Property Tax . The following are exempted from payment of the real property tax: "xxx xxx xxx" "(c) All machineries and equipment that are actually directly and exclusively used by local water districts and government-owned or -controlled corporations engaged in the supply and distribution of water and/or generation and transmission of electric power;" Representation is being made that PSALM and TRANSCO are newly created GOCCs responsible to formulate the privatization of the generation, and transmission, sub-transmission, generation and other assets of NPC. PSALM is tasked to take possession of, administer and conserve the generation assets transferred by NPC; TRANSCO on the other hand, will act as the systems operator of the nationwide electrical transmission and sub-transmission system to be transferred by NPC. Simply put, upon such transfer, PSALM shall sell said generated power to the distribution utilities, electric cooperatives and other users of electricity, until these assets are privatized, and TRANSCO will be in charge of the operation of the transmission of electric power nationwide. A careful reading of Section 49 of the EPIRA law reveals that PSALM is a Government-Owned and Controlled Corporation (GOCC), which shall take the ownership of all existing NPC generation assets, liabilities, IPP contracts, real estate and all other disposable assets. Section 8 of EPIRA likewise created the TRANSCO, which in turn, shall assume the electrical transmission operations of` the NPC including nationwide franchise. Section 1, Rule 22, of the IRR of EPIRA states that TRANSCO shall be wholly owned by PSALM; Please be informed that Sections 218 (d) and 234 (c) of the Local Government Code of 1991 (R.A. No. 7160) provide as follows: "Section 218. Assessment Levels. The assessment levels to be applied to the fair market value of real property to determine its assessed value shall be fixed by ordinances of the Sangguniang Panlalawigan, Sangguniang Panglungsod or Sangguniang Bayan of a municipality within the Metropolitan Manila Area, at the not exceeding the following:" "xxx xxx xxx "(d) On Special Classes: The assessment levels for all lands, buildings, machineries and other improvements; Actual Use Assessment Levels "xxx xxx xxx "Government-owned or controlled corporations engaged in the supply and distribution of water and/or generation and transmission of electric power 10%" "Section 234. Exemption from Real Property Tax . The following are exempted from payment of real property tax: "xxx xxx xxx "(c) All machineries and equipment that are actually, directly and exclusively used by local water districts and government-owned or -controlled corporations engaged in the supply and distribution of water and/or generation and transmission of electric power; "xxx xxx xxx" This Bureau in a number of cases similarly situated, rendered an opinion that only machineries of Government-Owned and Controlled Corporations (GOCCs) engaged in the generation and transmission of electric power shall be exempt from payment of real property tax. However, machineries and equipment of private companies engaged in the generation and transmission of electric power, shall not enjoy the real property tax exemption provided in Sec. 234(c) of the Code. Attached is a copy of our 3rd Indorsement dated January 12, 2000, for your ready reference. Based on the foregoing provisions of law, the real properties, specifically the machineries and equipment owned by NPC, which were transferred to PSALM and TRANSCO by virtue of EPIRA, are exempt from the payment of real property tax, for so long as these machineries and equipment are actually, directly and exclusively used in the generation and transmission of electric power; and the ownership of which, remains with a GOCC, (such as PSALM and TRANSCO), as mandated under R.A. No. 7160. However, all other taxable real properties such as land, building and other improvements, owned by NPC, which were transferred to PSALM and TRANSCO, are subject to the property tax, with an assessment level fixed by an Ordinance, but not exceeding ten percent (10%). This accordingly confirms your opinion in the affirmative. Very truly yours, (SGD.) MA. PRESENTACION R. MONTESA Executive Director ATTACHMENT March 10, 2003 DEPARTMENT OF FINANCE Bureau of Local Government Finance BSP Complex, Roxas Boulevard Manila Gentlemen : We would like to request for confirmation of our opinion concerning the local tax implications of certain transactions relating to or arising from the privatization of the National Power Corporation ("NPC") pursuant to Republic Act No. 9136, otherwise known as the Electric Power Industry Reform Act of 2001 ("EPIRA"). I. MATTERS ON WHICH RULING IS REQUESTED Specifically, we would like to request for confirmation of the following: A. Phase I Transfer of assets of NPC to the Power Sector Asset and Liabilities Management Corporation ("PSALM") and the National Transmission Corporation ("TRANSCO") 1. The transfer of real property of NPC to PSALM and TRANSCO is not subject to the local tax on transfer of real property. B. Phase II Operation of the transferred NPC assets by PSALM and TRANSCO prior to their sale or transfer to qualified buyers/Concessionaire 2. PSALM shall be liable for local business tax on its operation of the generation assets. 3. Subject to the issuance of a court decision confirming that NPC is liable to local franchise tax, TRANSCO, which is the transferee of NPC's franchise, shall be subject to the local franchise tax. 4. TRANSCO shall pay the local franchise tax to the province or city having jurisdiction over the place of business of its transmission customers based on the gross receipts derived by TRANSCO from said customers. 5. TRANSCO's taxable gross receipts for local franchise tax purposes shall exclude collections for the Universal Charge and Ancillary Service Charges. 6. NPC shall be exempt from local business tax. 7. Machinery and equipment owned by PSALM and TRANSCO shall be exempt from the real property tax. Other properties shall be subject to real property tax based on the assessed level of 10%. C. Phase III Privatization of generation and transmission assets 8. The sale by PSALM of real property comprising the generation assets shall be subject to the local tax on transfer of real property. 9. The grant of Concession to operate the transmission and subtransmission assets shall not be subject to the local tax on transfer of real property since the Concession Agreement will not involve any sale or transfer of such property from TRANSCO to the Concessionaire. As a matter of fact, the EPIRA mandates that only TRANSCO can own such assets. 10. During the Non-franchise Period, TRANSCO shall be subject to the local franchise tax. 11. The Concessionaire shall be subject to the local business tax. 12. The Concession Fees to be received by TRANSCO shall not be subject to local franchise tax. 13. Upon the commencement of the Franchise Period, the Concessionaire shall be liable for the payment of the local franchise tax in the same manner as TRANSCO when it was operating the transmission and subtransmission assets. II. BACKGROUND A. Privatization of NPC On June 26, 2001, the EPIRA was enacted into law. The Act provides the legal framework for the privatization of NPC and the restructuring of the electric power industry. PSALM formulated a Privatization Plan which provides recommendation on the structure and process for the privatization of the transmission assets, sub-transmission assets, generation assets and other assets of NPC. On October 4, 2002, the President of the Philippines approved the Privatization Plan. Briefly, the privatization process will involve three phases, namely: Phase I covers the transfer of the generation assets, real estate, other disposable assets, Independent Power Producer ("IPP") contracts and liabilities of NPC to the newly-created government-owned and controlled corporation, PSALM, and the transfer, among others, of the transmission and sub-transmission assets of the NPC to TRANSCO. Phase II covers the administration and operation by PSALM and TRANSCO of the respective NPC transferred assets prior to their eventual privatization. PSALM is tasked to take possession of, administer and conserve the assets transferred to it. Hence, until these assets are privatized, PSALM will be selling power from the transferred generation assets. TRANSCO, on the other hand, will act as the system operator of the nationwide electrical transmission and subtransmission systems to be transferred by NPC. For this reason, the EPIRA provided for the transfer to TRANSCO of the nationwide franchise of NPC for the operation of the transmission and sub-transmission systems and the grid. Phase III will involve the privatization of the NPC assets transferred to PSALM and TRANSCO. In the case of PSALM, the generation and other assets will be sold to qualified buyers. PSALM will structure the sale based on such terms and conditions to optimize the value and sale prices of said assets. With respect to TRANSCO, PSALM is mandated to conduct an open competitive bidding procedure for the award of a Concession to construct, install, improve, expand, operate, maintain, rehabilitate, repair and refurbish the high voltage and medium voltage transmission system owned by TRANSCO. 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. Franchise for the Concessionaire The operation of the nationwide transmission and sub-transmission systems is considered a public utility for which a franchise is needed. The EPIRA omitted to grant the Concessionaire a franchise to operate a public utility. The IRRs mandated PSALM and TRANSCO to secure a nationwide franchise for and on behalf of the Concessionaire. As a result, a bill has been filed in Congress seeking to provide for another franchise for TRANSCO that may be assigned to the Concessionaire upon award of the Concession. The Bill, House Bill No. 4882, contains the following salient features: Franchise term of 40 year. Grant or a Concession Contract with a qualified Concessionaire for a period of twenty-five (25) years, subject to review for renewal for a maximum period of another twenty-five (25) years, for the construction, installation, maintenance, operation, improvement and expansion of the transmission and subtransmission systems and the grid. Utilization of the proceeds of the Concession Contract by PSALM to reduce the cost of electricity for the end-user. The proceeds shall be used solely to pay for outstanding obligations of the NPC arising from loans, issuances of bonds, securities and other instruments of indebtedness transferred to and assumed by PSALM pursuant to Section 49 of Republic Act No. 9136. Assignability of the TRANSCO franchise to the Concessionaire. The House version of H.B. No. 4882 has already been approved by the Lower House and is now pending in the Senate. Concession Agreement The grant by Congress of a new franchise to TRANSCO, which is assignable to the Concessionaire, is an important component of the privatization so much so that the right to operate the transmission and subtransmission systems cannot be granted to the Concessionaire unless such franchise has been obtained. Since the proposed franchise is still pending in the Senate, PSALM has structured the Concession in a manner that would allow the Concessionaire to participate in the transmission and subtransmission systems business even prior to the date that a franchise has been awarded. The privatization process of the transmission assets will occur in two separate phases. During Phase One, as depicted in the attached schematic, PSALM awards a Concession to maintain, rehabilitate and expand the nationwide transmission and subtransmission systems in favor of a Concessionaire. As the Concessionaire would not qualify as a public utility on the award date, TRANSCO as the current franchise holder retains the responsibility during Phase One to provide the non-delegable functions, petition the Energy Regulatory Commission, and otherwise perform all functions required of a public utility under the Philippine Constitution. During this period, the Concessionaire, acting as a service contractor of TRANSCO, will maintain, improve, expand and rehabilitate the transmission system. It shall also invoice and collect revenue from all grid users as agent for TRANSCO and manage the completion of the projects of TRANSCO under construction. TRANSCO will pay the Concessionaire service fees as consideration for the various services it will perform. TRANSCO and the Concessionaire would suspend the effectiveness of those provisions of the Concession Agreement that require a franchise until such time Congress awards the concessionaire a new franchise. Phase Two of the privatization commences on the date that Congress awards a franchise to the Concessionaire: The Concessionaire replaces TRANSCO as the grid operator and operates the entire transmission business as a public utility. Consideration for the Grant of the Concession Based on the most recent draft of the said agreement, in consideration with the grant of the Concession, the Concessionaire shall pay to TRANSCO the Commencement Fee, the Deferred Payments and the Extension Deposit, each as set forth in the agreement. The Commencement Fee and the Deferred Payments represent payment for the first twenty-five (25) years of the Concession Period, while the Extension Deposit represents payment for the Extension, if and when it is granted. B. Payment of Local Taxes by NPC NPC enjoys exemption from all forms of taxes under Section 13 of R.A. No. 6395, as amended by P.D. No. 938. However, Republic Act No. 7160, otherwise known as the Local Government Code of 1991 ("LGC"), explicitly provided for the withdrawal of the exemption of government-owned and controlled corporations from local taxes. Specifically, the following are the relevant provisions of the 1991 LGC affecting NPC: 1. Section 193 General repeal Tax exemptions or incentives granted to or presently enjoyed by all persons, within natural or juridical, including government-owned or controlled corporations, are withdrawn, except local water districts, cooperatives duly registered under RA 6938, non-stock and non-profit hospitals and educational institutions. 2. Section 137 On Franchise Tax Notwithstanding any exemption granted by any law or other special law, the province may impose a tax on business enjoying a franchise at a rate not exceeding 50% of 1% of the gross annual receipts for the preceding calendar year, based on the incoming receipts, or realized, within its territorial jurisdiction. 3. Section 232 On Real Property Tax A province or city or a municipality within the Metropolitan Manila Area may levy an annual ad valorem tax on real property such as land, building, machinery, and other improvement. The province or city or municipality within the Metropolitan Manila Area shall fix a uniform rate of real property tax as follows: a) In the case of a province, at the rate not exceeding one percent (1%) of the assessed value of real property; b) In the case of a city or a municipality within the Metropolitan Manila Area, at the rate not exceeding two percent (2%) of the assessed value of real property; and c) In addition to the above, a province, city or municipality within the Metropolitan Manila Area may levy and collect an annual tax of one percent (1%) on the assessed value of real property for the Special Education Fund. The same Code also provides under Section 234 that all machineries and equipment that are actually, directly and exclusively used by local water districts and government-owned or controlled corporations engaged in the supply and distribution of water and/or generation and transmission of electric power shall, among others, be exempt from payment of real property tax. 4. Section 291 Share in National Wealth Local government units shall have a share based on the preceding fiscal year from the proceeds derived by any government agency or government-owned or controlled corporation engaged in the utilization and development of the national wealth based on the following formula whichever will produce a higher share for the local government unit: One percent (1%) of the gross sales or receipts of the preceding calendar year; or Forty percent (40%) of the milling taxes, royalties, forestry and fishery charges and such other taxes, fees or charges, including related surcharges, interests, or fines the government agency or government-owned or controlled corporation would have paid if it were not otherwise exempt. The 1991 LGC repeals the tax privileges given to entities who enjoy exemption from local taxes by virtue of a special law or their charter. In one case, the Supreme Court has ruled that the explicit language of Section 137, which authorizes the province to impose franchise tax "notwithstanding any exemption granted by law", is all encompassing and clear. The franchise tax is imposable despite any exemption enjoyed under special laws (City Government of San Pablo, Laguna vs. MERALCO, G. R. No. 127708, dated March 25, 1999) . With respect to NPC, the Department of Finance (DOF), in its Memorandum Order No. 1-98 issued on November 19, 1998, held that NPC's exemption from local taxes has been repealed by the 1991 LGC and as such, it is liable to pay the local franchise tax and real property tax. Moreover, in the case of the Province of Isabela vs. NPC ,the Regional Trial Court (RTC) declared NPC liable for payment of franchise tax. On the basis of said administrative issuance and court decision, NPC has paid the local franchise tax. However, in 2001, the Office of the Solicitor General (OSG), in reply to NPC's query whether to pay its franchise tax obligation to the Provinces of Isabela and Ifugao or not, informed NPC that it has appealed the RTC decision to the Court of Appeals and thus, advised NPC to await the resolution of the case. The OSG also mentioned that it had filed, in behalf of NPC, a case against the city of Cabanatuan for the imposition of franchise tax, which is now pending in the Supreme Court. In both cases, the OSG maintains that NPC is not liable to franchise tax under Sec. 137 of the RA No. 7160 on the ground that it is neither a private corporation nor a business created for profit. The OSG argues further that since NPC is a government-owned or controlled corporation with an original charter and whose shares of stocks are owned by the National Government, NPC is beyond the taxing power of a local government unit Based on this advise and pending the resolution of the case, NPC has ceased payment of local franchise tax since the latter part of 2001. C. Privatization of IPP Contracts In the 1990's, the country experienced severe power crisis. It became apparent that the Philippine government and NPC alone could not solve the power crises because of constraints in financing. Thus, several laws were enacted to allow the entry of the private sector for power projects. NPC contracted with various Independent Power Producers the following types of contracts; 1. Build-Operate-Transfer .Under this arrangement, the private sector builds a power plant and operates it for a specified period and thereafter, transfers to NPC the ownership of the plant. NPC commits to pay fixed capacity, operation and maintenance fees and variable energy fees as well as the provision of fuel supply during the cooperation period. 2. Build-Transfer-Operate .Under this scheme, NPC obtains a loan for the project and for the private contractor builder, which builds the plant on a turnkey basis. The private contractor-builder turns over the plant to NPC, the owner, upon completion of the project and operates the power plant under an operation and maintenance contract with NPC. NPC guarantees purchase of power generated by the plant for the duration of the cooperation period. 3. Build-Operate-Own .This is similar to BOT except that ownership of the plant stays with the proponent after the cooperation period. 4. Operate-Lease .The power plant is built, owned and operated by an IPP. NPC enters into a contract to purchase the power generated by the plant at a guaranteed price for a certain period. 5. Rehabilitate-Operate-Maintain .The scheme applies to existing NPC-owned plants that require massive rehabilitation to be able to operate at its rated capacity. NPC enters into a ROM agreement with a private company whereby the latter puts in the needed investment to either replace or repair aging or inefficient equipment and thereafter, operate and maintain the plant for a certain period. NPC, in turn, purchases the power generated by the plant. 6. Build-Rehabilitate-Operate-Transfer .The scheme is a combination of BOT and ROM where the proponent builds additional power plants and conducts massive rehabilitation of existing NPC power plants. At the end of the cooperation period, the project proponent will transfer the ownership of the power plants to NPC. 7. Rehabilitate-Operate-Lease .Under this arrangement, the private company uses its own financial resource to repair and upgrade the plant to prolong its economic life, improve operational flexibility, recover lost capacity and enhance efficiency. The ROL operator pays NPC a lease rental for the use of the plan during the cooperation period, NPC, on the other hand, guarantees to purchase the energy generated by the plant. As of December 31, 2000, there are 42 existing IPP contracts, with 25 contracts in operation, 6 contracts, are under construction and 10 contracts terminated. Under the IPP contracts, it is provided that NPC shall shoulder all taxes due from the IPP in connection with the contract, except corporate income tax. Thus, NPC presently shoulders the payment of the local business taxes of these IPPs. Energy Transfer Agreement between NPC and PSALM Pursuant to the EPIRA, PSALM shall also take ownership of the IPP contracts, in addition to the existing NPC generation assets, real estate and all other disposable assets. 1 Further, PSALM is granted the power 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. In accordance with this mandate, NPC and PSALM explored the possibility of transferring to PSALM the IPP contracts of NPC. However, due to various reasons, most of the IPPs have not given their consent to such proposed transfer and accordingly, the present agreements between them and NPC remain. To comply with the EPIRA provisions requiring PSALM to take over the disposition of the energy output from these IPP contracts, NPC agrees to transfer ownership of the electrical energy to PSALM shall be the actual costs incurred by NPC under the IPP contracts. Upon such transfer, PSALM shall sell said generated power to the distribution utilities, electric cooperatives and other users of electricity. D. Universal Charge Within a year from the effectivity of EPIRA, a Universal Charge to be determined, fixed and approved by the Energy Regulatory Commission (ERC) shall 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 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-a-vis imported energy fuels; 4) An environmental charge equivalent to one-fourth of one centavo per kilowatt-hour (0.0025/kWh),which shall accrue 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 (2) years. 2 The EPIRA provides that the Universal Charge is non-by-passable 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 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. Any end-user or self-generating entity not connected to a distribution utility shall remit its corresponding Universal Charge directly to TRANSCO. 3 PSALM will create a Special Trust Fund to be disbursed only for the purpose specified herein in an open and transparent manner. All amount collected for the Universal Charge shall be distributed to the respective beneficiaries within a reasonable period to be provided by the ERC. 4 E. Ancillary Services Agreement TRANSCO, as the System Operator of the nationwide electrical transmission and sub-transmission system, is responsible from acquiring the ancillary services required to maintain the reliability and security of the nationwide grid, and the quality of the electricity transmitted therein. 5 Ancillary services refer to those services that are necessary to support the transmission of capacity and energy from resources to loads while maintaining reliable operation of the transmission system in accordance with good utility practice and the Grid Code to be adopted in accordance with the Act. Ancilliary services are only required for the generation and provision of quality electric power. Only generators can provide most of these services depending on their capability and modes of operation. Ancillary services include: rapid start, flexible and responsive operation, on standby, partially or lightly loaded operation, etc. These services are described below. Spinning Reserves All generators can provide various levels of spinning reserves when they do not run at full load. However, it is necessary that generator controls do not lock or fix their level of output and that they are responsive to the power demand of the system. This service is necessary so that when the demand suddenly increases or when a generator suddenly stops, the spinning reserves immediately take the slack and continuously provide generated power to the customers. Backup Reserves All generators provide backup reserves when on standby operation. However, they have to be available to run at the order of the System Operator. This service is necessary in order to allow regular maintenance of generating equipment without interrupting the provision of generated power to electricity consumers. These same units provide supplemental reserves in case a generator stops, or drastically reduces its output. Load Following and Frequency Regulation This service is provided by generators that have the flexibility of following the real-time fluctuation of the demand for electricity by monitoring the system frequency to keep it at 60Hz (+/-0.5%).Such variation occurs every time a light is turned on or off, every time an air conditioner turns on, a refrigerator door opens, a television set is switched on, etc. These generators get paid for this special capability, which the system demands from the supplier of generated power. Black Star, Maintenance, Commissioning, and similar services Some generators cannot start without first drawing power from the grid or they need electric power from the grid while under maintenance or commissioning stage. Maintenance or commissioning power can come from other generators that are already running. Ultimately, black start power can only come from a power generator that can start on its own. Reactive Supply and Voltage Control from Generators This service is necessary because generated power cannot just be at any voltage level. The supply must be within +/-5% of the nominal value otherwise, the quality of service is deemed poor and inadequate. All generators provide this service at various levels of quantity and quality. However, additional levels of service can only be obtained by reducing the level of generated power to give way for the generation of reactive supply to improve the voltage of the generated power. Energy Imbalance This service is the automatic provision of generated power to replace any shortfall in the output of a previously scheduled generator. This service also works in the other direction: when the output of a generator exceeds its scheduled level, the provider of this service must automatically reduce its output to maintain the balance between supply and demand of generated power. Charges for Ancillary Services The IRR provides that rules will be set for the methodology for the price and cost recovery of Ancillary Services that are to be provided by the Generation Company. The cost of acquiring ancillary services under the agreement will be passed through to transmission customers on whose behalf TRANSCO is deemed to purchase the ancillary services. III. REQUEST FOR CONFIRMATION We respectfully request confirmation of the local tax implications of the following transactions: Phase I Transfer of assets of NPC to PSALM and TRANSCO 1. The transfer of real property of NPC to PSALM and TRANSCO is not subject to the local tax on transfer of real property . Pursuant to Section 135 of the 1991 LGC, the province may impose a tax on the sale, donation, barter or on any other mode of transferring ownership or title of real property at a rate not exceeding one-half (1/2) of one percent (1%) of the total consideration or the fair market value, whichever is higher. Cities may also impose the same tax at a rate not exceeding seventy-five percent (75%) of one percent (1%), in accordance with Section 151 of the LGC. The transfer of title over the property of NPC to PSALM and TRANSCO is for the purpose of privatizing them in accordance with the provisions of the EPIRA . NPC, PSALM and TRANSCO are different legal entities and thus, when the real property of NPC is transferred to PSALM and TRANSCO, there will be a change in the title over said property. However, it is noted that the transfer of title to PSALM and TRANSCO shall be implemented solely for the purpose of privatizing these properties. As noted by the Bureau of Internal Revenue (BIR) in the ruling it issued confirming that the said transfer is not subject to the documentary stamp tax generally imposed on sale, assignment, transfer or other forms of conveyance of real property, the transfer of NPC's generation assets and systems to PSALM, as well as of the transmission and sub-transmission assets and systems to TRANSCO, all of which are government-owned and controlled corporations, are mandated by law, (Bureau of Internal Revenue Ruling No. 020-2002, dated May 13, 2002) PSALM was created and the NPC generation assets, including real property, were transferred to PSALM by virtue of Section 49 of the EPIRA which we likewise quote in part below: "SECTION 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 the ownership of all existing NPC generation assets, liabilities, IPP contracts, real estate and all other disposable assets. ..." (emphasis supplied) Similarly, TRANSCO was also created and the NPC transmission assets, including real property where these assets are situated, were transferred to TRANSCO by virtue of Section 8 of the EPIRA which we quote in part below: "SECTION 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 functions of the National Power Corporation (NPC),and have the powers and functions hereinafter granted. ... "...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 TRANSCO. ..." (emphasis supplied) The taking of title over the assets of NPC by PSALM and TRANSCO is merely for the purpose of selling or disposing them in accordance with the provisions of the EPIRA. Subject transfer is not the taxable transaction contemplated under Sec. 135. It is noted that the transfer will not fall squarely with the concept of a sale, barter or donation, which are the transactions usually subject to the local tax on transfer of real property. Pursuant to Article 1458 in relation to Article 1318 of the Civil Code, the following are the essential requisites to a contract of sale: a. 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 therefore a price certain in money or its equivalent; b. Object certain which is the subject matter of the contract; c. 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 case as far as the vendee is concerned is the acquisition of the thing which is the object of the contract. If the consideration of the contract consists partly in money and partly in another thing, the transaction shall be characterized by the manifest intention of the parties. If such intention does not clearly appear, it shall be considered a barter if the value of the thing given as a part of the consideration exceeds the amount of the money or its equivalent; otherwise, it is a sale. (Article 1486, Civil Code of the Philippines) The transfer of real property of NPC is not a sale or barter. There is no positive offer to sell and buy the aforesaid NPC properties. Consideration (whether cash or in kind),which should be the prime reason for the transfer of real property, is not availing to the parties in the transfer of NPC assets to PSALM and TRANSCO. 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 not does it play any role in the determination of the amount of the liabilities that it will assume. The same holds true for TRANSCO. Neither can the transfer by NPC of its real property to PSALM and TRANSCO be considered as a donation. Donation is an act of liberality whereby a person disposes gratuitously of a thing or right in favor of another, who accepts it. (Article 725, Civil Code of the Philippines) In the instant case, the transfer of NPC's assets is mandated by law and cannot be deemed as a gratuitous act on the part of NPC. Benefits from the privatization of property accrue to NPC. In the case of the properties of NPC, it is noted that the transfer is a transaction between and among government-owned and controlled corporations pursuant to a law calling for the reorganization of NPC assets. The proceeds from the privatization of the assets will be used by PSALM solely to pay for the outstanding obligations of the NPC arising from loans, issuances of bonds, securities and other instruments of indebtedness transferred to and assumed by PSALM pursuant to Section 49 of Republic Act No. 9136. Hence, while PSALM and TRANSCO were made to assume title over the real property of NPC, the benefits from the proceeds of the privatization thereof accrue ultimately to NPC. It is noted that where real property is transferred from one party to another but the beneficial ownership over said property is retained by the original party, the transfer is not taxable. A case in point is the transfer of undivided interest in the common areas by the condominium owners to the Condominium Corporation. Pursuant to Section 5 of the Condominium Act (Republic Act No. 4726), "any transfer or conveyance of a unit or an apartment, office or store or other office space therein, shall include the transfer or conveyance of the undivided interest in the common areas or, in the proper case, the membership of shareholders in the condominium corporation." In other words, each purchaser of a condominium unit becomes part owner of the common areas in the condominium. Hence, when title of the common area is transferred to the condominium corporation composed of the unit owners, the developers-corporation receives no additional payment. The conveyance is without any monetary consideration and is not in connection with any sale in favor of the condominium corporation. As such, it is not taxable. Based on the foregoing, the transfer of real property by NPC to PSALM and TRANSCO is not subject to the local tax on transfer of real property since said transfer will be made without consideration and beneficial use of the proceeds from the privatization of these assets will be used to settle NPC's liabilities. Phase II Operation of the transferred NPC assets by PSALM and TRANSCO prior to their sale or transfer to qualified buyers or grant to Concessionaire of the right to operate the transmission system . 2. PSALM shall be liable to local business tax on its operation of the generation assets . Under the EPIRA, PSALM is created as a government-owned and controlled corporation. Since the EPIRA did not provide for any special tax privileges for PSALM, it shall be liable for the payment of regular taxes, both national and local. As a service contractor, it shall, therefore, be subject to the local business tax as a contractor pursuant to Section 142 and Section 151 of the LGC. It shall pay said tax to the different municipalities or cities having jurisdiction over the places where the generation plants are located based on the gross sales derived from each locality. Under the LGC, the local business tax shall be based on the gross receipts realized during the preceding year. Generally, the term "gross receipts", as defined, refers to the total amount of money or its equivalent representing the contract price, compensation or service fee, including the amount charged or materials 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. However, in the case of construction contractors, a modified definition of gross receipts has been prescribed. Pursuant to Local Finance Circular No. 03-95 (May 22, 1995) of the Department of Finance, the taxable gross receipts shall be the amounts received by the principal contractor, which is the total contract price, less the amount paid to a subcontractor under a subcontract agreement. We believe that a similar definition of taxable gross receipts should be adopted in determining the local business tax liability of PSALM. It is noted that the generated power to be sold by PSALM will come from two sources: (1) power generated from NPC generation assets that were transferred to PSALM, and (2) power generated from plants owned by IPPs that are acquired by NPC under existing IPP contracts, which NPC will subsequently sell to PSALM at cost under the proposed Energy Transfer Agreement described above. The Relationship of PSALM and the IPPs can be described as having the same characteristics as that of a principal contractor and subcontractor. Just like a subcontractor, the IPPs will be producing part of the generated power that will be sold by PSALM. Based on the foregoing, we believe that the local business tax of PSALM should be based on the sales from the generated power actually received by it, which is net of the amount paid to the IPPs. The IPPs will, of course, be subject to the business tax imposed therein. 3. TRANSCO shall be subject to the local franchise tax . Under Section 137 of the LGC, the province may impose a tax on business enjoying a franchise at the rate not exceeding 50% of 1% to wit: "SEC. 137. Franchise Tax . Notwithstanding any exemption granted by any law or other special law, the province may impose a tax on business enjoying a franchise at a rate not exceeding fifty percent (50%) of one percent (1%) of the gross annual receipts for the preceding calendar year based on the incoming receipt, or realized within its territorial jurisdiction. ..." The power to impose the local franchise tax is also given to cities, pursuant to Section 151 of the LGC "SEC. 151. Scope of Taxing Powers . Except as otherwise provided in this Code, the city may levy the taxes, fees, and charges which the province or municipality may impose: Provided, however , That the taxes, fees and charges levied and collected by highly urbanized and independent component cities shall accrue to them and distributed in accordance with the provisions of this Code. "The rates of taxes that the city may levy may exceed the maximum rates allowed for the province or municipality by not more than fifty percent (50%) except the rates of professional and amusement taxes." Section 8 of the EPIRA provides that the transmission and subtransmission facilities of NPC and all other assets related to the transmission operation, including the nationwide franchise of NPC for the operation of the transmission and subtransmission systems, shall be transferred to TRANSCO. Once the franchise of NPC is transferred to TRANSCO, it shall be taxed in the same manner as NPC. The BIR has ruled that the tax privileges of NPC shall be enjoyed by TRANSCO. Following the same reasons, TRANSCO should be subject to the local franchise tax. The above liability of TRANSCO, however, shall be dependent on the final resolution of the cases filed by the OSG. In case the court rules that NPC is exempt from the local franchise tax, TRANSCO, as successor or the tax privileges of NOC, shall also be exempt. 4. If taxable, TRANSCO shall pay the local franchise tax to the province or city having jurisdiction over the place of business of its customers. In case the court issues a decision that NPC is subject to the local franchise tax, we propose that the franchise tax of TRANSCO be paid to the province or city having jurisdiction over the place of business of its transmission and/or subtransmission customers based on the gross receipts derived therefrom. Pursuant to Sec. 137 of the 1991 LGC, the province may impose a franchise tax at a rate not exceeding 50% of one percent (1%) of the gross annual receipts realized during the preceding calendar year within its territorial jurisdiction. The implementing rules and regulations of the LGC clarified that the province shall not impose tax on businesses enjoying franchise operating within the territorial jurisdiction of any city located in the province. Accordingly, if a business enjoying a franchise has a principal office and branch, the gross receipts to be declared in the province/city government concerned shall be based on the gross receipts respectively derived from each territory. In the case of NPC, prior to the suspension of its local franchise tax payments, it pays its taxes to the city or provincial government where its generation plants are situated based on gross sales from electricity produced in each of these plants. However, this practice may no longer be applicable in a regime where the business of generating power has been separated from the business of providing transmission and sub-transmission services. TRANSCO will be maintaining its head/principal office in Quezon City. While it may have substation facilities outside Metro Manila, these offices will be maintained just to monitor the transmission and subtransmission assets. The people in these offices will not be dealing with the customers. As such, the substation facilities cannot be considered as branch office. If the rules discussed above are followed strictly, TRANSCO will, therefore, be paying local franchise tax to the Quezon City government. This may not be deemed equitable by other local government. Notably, the transmission and sub-transmission services rendered by TRANSCO involve the transport of power from the site of the generation plant to its customers, such as the distribution utilities, electric cooperatives, local government unit-owned and operated distribution systems, economic zones and entities duly authorized to operate within said zones, and large industrial users directly connected to the transmission grid. Theoretically, the services will, therefore, be rendered starting from the places where the generation plants and transmission customers are located, and in all other places where the transmission lines traverse. To address this issue, we propose that TRANSCO be made to pay local franchise tax to the provinces/cities where its transmission customers are loaded. This arrangement will maximize the number of local government units that would benefit from the local franchise tax payment of TRANSCO as all provinces/cities have distribution utilities or electric cooperatives providing electricity to the people located within their jurisdiction. Under this arrangement, TRANSCO's gross receipts to be reported to the city or provincial governments shall be based on sales made to distribution utilities and electric cooperatives and any other transmission customers within their respective jurisdiction. 5. TRANSCO's taxable gross receipts will exclude collection for Universal Charge and Ancillary Service Charge. The Universal Charge will be collected from all end-users by the distribution utilities and TRANSCO. These charges will be remitted to PSALM and will be used exclusively for the following purposes: a. 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 costs of distribution utilities resulting from the restructuring of the industry; b. Missionary electrification; c. The equalization of the 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; and e. A charge to account for all forms of cross-subsidies for a period not exceeding three (3) years. 6 The EPIRA provides that the Universal Charge is a non-by passable charge. 7 Accordingly, since the Universal Charges to be collected by TRANSCO does not belong to it and before, would not redound to its benefit, it should not form part of TRANSCO's gross receipts for purposes of determining its franchise tax liability. 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 person other than the taxpayer (Commissioner of Internal Revenue v. Manila Jockey Club, Inc. 108 Phil. 821 [1960]) . For the same reason, the Ancillary Service Charges to be collected by TRANSCO should also not be considered as part of its taxable gross receipts. TRANSCO, as the System Operator of the nationwide electrical transmission and sub-transmission system, is responsible for acquiring the ancillary services required to maintain the reliability and security of the nationwide grid, and the quality of the electricity transmitted therein. To fulfill its functions as System Operator, TRANSCO will enter into Ancillary Service Agreements with qualified generation companies to provide sufficient ancillary services that will ensure the reliability and security of the grid. The cost of acquiring Ancillary Services will be passed on to transmission customers on whose behalf TRANSCO is deemed to purchase the Ancillary Services. TRANSCO, upon approval of the ERC, will be given the authority to charge and collect tariff for Ancillary Services from private sector generating facility customers. 8 Since TRANSCO is merely collecting the cost of such ancillary services from the transmission customers, which amounts are intended to be paid to qualified generation companies, the Ancillary Services Charges do not form party of the gross receipts of TRANSCO for franchise tax purposes. The ancillary services fees are not compensation for services performed by TRANSCO. 6. NPC is not liable for the payment of local franchise tax or local business tax . Upon the transfer of its franchise to TRANSCO, NPC ceases to be a franchise grantee and thus, it is no longer liable for the payment of the local franchise tax. Additionally, we believe that NPC shall neither be subject to the local business tax provided under Sec. 143 of the 1991 LGC. After the assets have been transferred to PSALM, NPC will continue to exist as a government-owned and controlled corporation. However, its activities will be limited to the following. a. Missionary Electrification Services. Under Section 70 of the EPIRA, as implemented by Section 2 of Rules 3 of the IRR, NPC shall be responsible for providing power generation and its association power deliver systems in areas that are not connected to the transmission system through its Small Power Utilities Group or "SPUG". SPUG refers to the functional unit of NPC created to pursue missionary electrification function to some areas in the country where there is no electricity. The activities of SPUG shall be funded from the revenues from sales in the missionary areas and from the Universal Charge to be collected from all electricity end-users. b. Operations and Management ("O&M") Services. Prior to the privatization of the generation assets to private entities, PSALM is mandated to operate these assets. However, since it does not have the personnel to operate these transferred assets/facilities, PSALM will be entering into an O&M Agreement with NPC so its personnel can continue to operate the generation facilities, for and on behalf of PSALM. Under the plan, NPC will perform operations, maintenance, management, and engineering tasks necessary for the optimum operation of the thermal and diesel power plants, geothermal plants and hydroelectric plants, including mothballed facilities. In addition to performing the O&M Services, NPC shall also perform the following additional functions and services: Generating Assets Under Construction or Refurbishment. NPC shall manage, or cause to be managed, the refurbishment, construction and commissioning of such Power Plants in accordance with (a) Standard Industry Practices, (b) NPC's standard procedures relating to the management of construction activities, (c) all Applicable Laws, (d) the Loan Agreements Covenants; and (e) the covenants and other obligations entered into by PSALM under any asset sale and purchase agreement or other agreements made in connection with the sale and transfer of all or a portion of the Generating Assets to a third party, as such covenants or agreements related to the construction, operation and maintenance of the Generating Assets. Engineering and Technical Services. NPC shall, at PSALM's request from time to time, perform engineering and technical services, such as turnover and transfer procedures for the IPPs, site investigation studies and other studies necessary for PSALM to consider the relocation of Power Plants and the components thereof, fabrication of replacement components and parts for the Generating Assets and perform other specialized engineering and machining services, procedures necessary to mothball Power Plants in accordance with Standard Industry Practice and Applicable Laws, legal services concerning expropriation cases related to the Generating Assets and the real property interests that NPC will transfer to PSALM and services related to filings with the ERC, the DOE and the Marked Operator. A compensation for the performance of the Services by NPC, PSALM shall pay to NPC all reasonable and documented costs NPC incurs in performing the O&M Services (collectively, the "O&M Costs" ) and the Additional Services. This will cover the salaries paid by NPC to its employees and the actual expenses incurred in providing the services. NPC will not realize a profit from this arrangement. c. Energy Transfer Agreement ("ETA").As discussed above, NPC will continue to manage the IPP contracts, which cannot be transferred to PSALM. Under the ETA, NPC will transfer the power arising from these IPP contracts to PSALM at cost. Considering that NPC is a government-owned and controlled corporation and it will not derive profit from the remaining activities it will perform after its assets have been transferred to PSALM and TRANSCO, NPC shall not be liable for the payment of the local business tax. The local business tax is imposed on entities engaging in business. The term "business", as defined in the 1991 LGC, means trade or commercial activity regularly engaged in as a means of livelihood or with a view to profit. NPC clearly will not be conducting the above-described activities with a view of making profit. In fact, its charges for missionary electrification services would not even be sufficient to cover the cost of such operations and as such, will be dependent on the support of collections from the Universal Charge. On the other hand, compensation for the O&M services to be provided by NPC to PSALM will simply be a reimbursement of actual salaries and expenses incurred by NPC. Likewise, the power acquired by NPC from the IPPs will be transferred to PSALM at cost. 7. Machinery and equipment owned by PSALM and TRANSCO shall be exempt from the real property tax. Other real property shall be subject to real property tax based on the assessed level of 10% . Under the Local Government Code, real property tax may be imposed by a province, city or a municipality within the Metropolitan Manila area on real property such as land, building, machinery and other improvements, situated within their respective jurisdiction. In the case of a province, the basic tax rate shall not exceed 1% of the assessed value of real property. On the other hand, for a city or municipality within the Metropolitan Manila area, the rate of the basic tax shall not exceed 2% of the assessed value. An additional levy equal to 1% if the assessed value of real property may be levied by a province, city or municipality within the Metropolitan Manila area. The proceeds of said additional real property tax shall accrue exclusively to the Special Education Fund (SEF). For purposes of determining the real property tax, the tax base is the assessed value of the property which is the fair market value thereof multiplied by the prescribed assessment level. The LGC provides for a preferential assessment level for property used in the generation and transmission of electric power. We quote Section 216 and the relevant portions of Section 218 as follows: "SEC. 216. Special Classes of Real Property . All lands, buildings and other improvements thereon actually, directly and exclusively ...used by local water districts, and government-owned or controlled corporations rendering essential public services in the supply and distribution of water and/or generation and transmission of electric power shall be classified as special." "SEC. 218. Assessments Levels . The assessment levels to be applied to the fair market value of real property to determine its assessed value shall be fixed by ordinances of the Sangguniang Panlalawigan, Sangguniang Panglungsod or Sangguniang Bayan of a municipality within the Metropolitan Manila Area, at the rates not exceeding the following: ... "(d) On Special Classes: The assessment levels for all lands, buildings, machineries and other improvements; xxx xxx xxx "Local water districts, government-owned 10% or controlled corporations engaged in the supply and distribution of water and/or generation and transmission of electric power" Further, Section 234 of the LGC provides for the exemption from real property tax of machinery and equipment owned by government-owned and controlled corporations engaged in the generation and transmission of electric power. We quote the provision of law as follows: "SEC. 234. Exemption from Real Property Tax . The following are exempted from payment of the real property tax: "(a) Real property owned by the Republic of the Philippines or any of its political subdivisions except when the beneficial use thereof has been granted, for consideration or otherwise, to a taxable person; "xxx xxx xxx "(c) All machineries and equipment that are actually, directly and exclusively used by local water districts and government-owned or controlled corporations engaged in the supply and distribution of water and/or generation and transmission of electric power; "xxx xxx xxx "Except as provided herein, any exemption from payment of real property tax previously granted to, or presently enjoyed by, all persons, whether natural or juridical, including all government-owned or controlled corporations are hereby withdrawn upon the effectivity of this Code." By virtue of the above-cited provisions, NPC is exempt from real property tax on its machinery and equipment, while its taxable real property are subject to real property tax based on the assessment level of 10%.When the real properties of NPC are transferred to PSALM and TRANSCO, we believe that the same preferential treatment shall be granted since PSALM and TRANSCO are both government-owned and controlled corporations engaged in the generation and transmission of electric power, respectively. Hence, the machinery and equipment of PSALM and TRANSCO shall be exempt from real property tax, while the assessed value of their taxable real property shall be determined based on the preferential assessed level of 10%. Phase III Privatization of the generation assets by PSALM through outright sale thereof and the transmission assets by TRANSCO through grant of Concession 8. The sale by PSALM of real property forming part of the generation assets and other real property transferred from NPC shall be subject to the local tax on transfer of real property . When the real properties owned by PSALM are sold to private entities, the transfer shall be subject to the local tax on transfer of real property. The transfer is made for a consideration and intended to transfer ownership of the property to private entities. 9. The grant of Concession shall not be subject to the local tax on transfer of real property since the agreement will not involve any transfer of such assets from TRANSCO to the Concessionaire . As provided under the IRRs, ownership of the transmission assets shall, at all times, remain with TRANSCO. Hence, under the Concession arrangement, the Concessionaire is only given the right to lease and operate the transmission and subtransmission assets once it has obtained a franchise. Since there will be no transfer of ownership of real property, the Concession Agreement is not subject to the local tax on transfer of real property. 10. During the Non-franchise Period of the Concession, TRANSCO shall be subject to the local franchise tax . As discussed above, since the proposed franchise is still pending in Congress, PSALM has structured the Concession Agreement in a manner that would allow the Concessionaire to participate in the transmission system business even prior to the date that a franchise has been awarded. Under the proposed Concession Agreement, during Phase I of the Concession, TRANSCO, as the current franchise holder, will operate the transmission and subtransmission systems. Hence, it will perform the non-delegable functions, petition the ERC, and perform all functions required of a public utility under the Philippine Constitution. TRANSCO shall, therefore, continue to derive revenues from the transmission and subtransmission business and accordingly, be liable for the local franchise tax on such activity. However, it is noted that the activities performed by TRANSCO and the Concessionaire are dependent of each other and as such, are equally important for the operation of the regulated transmission and subtransmission business. During Phase I of the Concession period, TRANSCO will be able to provide transmission services to its clients since the Concessionaire undertakes to perform activities critical to support the operations of the transmission and subtransmission systems. For this cooperation to work, an Operations Committee, comprising of representatives from TRANSCO and the Concessionaire, will be created to coordinate and foster consultation among TRANSCO and the Concessionaire regarding TRANSCO's performance during the Non-Franchise Period of the Non-delegable functions and the Concessionaire's performance of its obligations. The impact of the services to be performed by the Concessionaire of the ability of TRANSCO to operate the transmission and subtransmission business is also apparent in the relationship of the service fees to be paid to the Concessionaire to the total revenues of TRANSCO. After TRANSCO deducts from its revenues the collections for the Universal Charge and Ancillary Service Charge, it will pay bulk of the remaining amount of its revenues in the Concessionaire as compensation for the latter's services. Based on the foregoing, it is clear then that the activities performed by TRANSCO and the Concessionaire during Phase I should be viewed collectively as conducted in pursuit of the transmission and subtransmission business and as such, revenues arising from said activities should be subjected to local tax only once. During Phase I, the relationship between TRANSCO and the Concessionaire is akin to that of a construction contractor and subcontractor, with TRANSCO receiving; the entire transmission and subtransmission revenues from its customers and the Concessionaire receiving payment from such revenues for the services it performs. Applying the provisions of Local Finance Circular No. 03-95 on the tax base for construction contractors, we believe that the taxable gross receipts of TRANSCO, for purposes of determining its local franchise tax liability during Phase I of the Concession, should be the transmission service fees it will receive less the amount of service fees it will pay to the Concessionaire. 11. The Concessionaire shall be subject to the local business tax . On the other hand, the Concessionaire shall be subject to the local business tax on the service fees it will receive during Phase I of the Concession. Just like TRANSCO, the Concessionaire will only have a head/principal office. However, the transmission and subtransmission assets of TRANSCO that it will maintain, on behalf of TRANSCO, shall be located in various places nationwide. To achieve, therefore, the same objective of maximizing the number of local government units that would benefit from the local business tax payments of the Concessionaire, we believe that it should pay said tax in the local government units where TRANSCO's transmission and subtransmission customers are located. 12. The Concession Fees to be received by TRANSCO shall not be subject to local franchise tax . Under the proposed Concession Agreement, in consideration for the grant of the Concession, the Concessionaire shall pay to TRANSCO the Commencement Fee, the Deferred Payments and the Extension Deposit, as set forth in the agreement. The Commencement Fee and the Deferred Payments represent payment for the first twenty-five (25) years of the Concession Period, while the Extension Deposit represents payment for the Extension, if and when it is granted. It is noted that the Concession fees will be received by TRANSCO in connection with the privatization of the transmission and subtransmission systems, as mandated under the EPIRA. These fees are not derived by TRANSCO from a commercial activity that it is engaged in with a view to profit. Moreover, by its very nature, the Concessionaire Fees to be received by TRANSCO represent the discounted value of the revenues that TRANSCO expects to receive for the operation of the transmission assets in the next 50 years. It is the price that the Concessionaire will bear in order to receive the actual revenues arising from the operation of the transmission system. With respect to TRANSCO, the collection of the Concession Fees is merely an arrangement entered into by TRANSCO to receive in advance the fruits of future operations. Thus, the Concession Fees do not constitute part of TRANSCO's receipts from its business, and as such, do not form part of its taxable gross receipts for local franchise tax purposes. As discussed above, during Phase I, the business of TRANSCO is the operation of the transmission and subtransmission systems and thus, its income from this activity should be the one subject to local franchise tax. 13. On Franchise Date, the Concessionaire shall be subject to the local franchise tax in the same manner as TRANSCO when it was operating the transmission and sub-transmission assets . Under Phase II of the Concession, once the Concessionaire obtains a franchise to operate the transmission assets, it shall take over the responsibilities of TRANSCO. As a franchise holder, Concessionaire will be liable for the payment of the local franchise tax and shall pay said tax in the same manner as TRANSCO. We hope for your immediate attention and favorable action on this request. Very truly yours, (SGD.) EDGARDO M. DEL FONSO President Footnotes 1. Section 49, EPIRA; Rule 3, Section 5 of the IRR. 2. Section 34, EPIRA 3. Ibid .,2nd Paragraph 4. Ibid .,3rd Paragraph 5. Rule 6, Section 7 (d),IRR. 6. Section 34, EPIRA 7. Ibid .,2nd paragraph 8. Rule 6, Section 12(a),IRR.