Let's Talk Tax

The grant and taxation of public service franchises

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By:
Atty. Kim M. Aranas
Contents

On 21 March 2022, RA No. 11659, otherwise known as an Act Amending CA No. 146 or the Public Service Act, was signed into law, thereby amending the decades-old Public Service Act. With the end view of attracting foreign investments to the country to boost market competitiveness, foster innovation, and create high-quality jobs, other public service business as airport operation, railway, and even expressways may now be owned 100% by foreign entities subject to the grant of administrative franchise by the concerned administrative agencies tasked to oversee or regulate these undertakings.

Now, as required under the said law, the National Economic and Development Authority (NEDA) passed its implementing rules and regulations last March 20, 2023. With these recent reforms, one must ascertain a public service franchise is required and its peculiar tax consequence.

Public Utilities vis-à-vis Public Service Business with Public Interest

Section 11, Article XII of the 1987 Philippine Constitution expressly provides that, “No franchise, certificate, or any other form of authorization for the operation of a public utility shall be granted except to citizens of the Philippines or to corporations or associations organized under the laws of the Philippines at least sixty per centum of whose capital is owned by such citizens, nor shall such franchise, certificate, or authorization be exclusive in character or for a longer period than fifty years.”

With the amendment under RA No. 11659 and Rule III Section 10 of its IRR, public utility refers to a public service act that operates, manages, or controls for public use any of the following:

  1. Distribution of electricity;
  2. Transmission of electricity;
  3. Petroleum and petroleum products pipeline transmission systems;
  4. Water pipeline distribution systems and wastewater pipeline systems, including sewerage pipeline system;
  5. Seaports; and,
  6. Public utility vehicles (PUVs).

As public utilities, foregoing industries shall be governed by the constitutional limitation on Filipino reserved ownership of 60% while foreigners may own up to 40% of its capital whether directly or indirectly. Stated otherwise, a public service business not included in the foregoing enumeration may be owned 100% by foreign nationals except if it is considered a critical infrastructure, as telecommunications, or as to be identified by the President pursuant to NEDA’s recommendation.

Local tax obligation of a franchise grantee

As enunciated under the Act and its IRR, while the administrative agencies will not anymore impose any citizenship requirement for those public service businesses not listed as public utilities, they are still empowered to grant administrative franchise and monitor and audit the public service entities. Now, what are the peculiar tax considerations that these grantees should take into consideration?

In New Vision Satellite Network, Inc. v. Province of Cagayan, G.R. No. 248840, July 5, 2021, our High Tribunal clarified on the distinction between a franchise and a secondary license or permit. For a franchise grantee, it follows that the local government (province or city) may impose the franchise tax thereon in addition to other national tax obligations. 

The Supreme Court explained this distinction in this wise:

First, a survey of franchises recognized in jurisprudence shows that they involve: (i) public utilities and common carriers; (ii) economic activities which are in the nature of natural monopolies, or industries where the most efficient number of operators is one or only a few; (iii) industries where the first entrants or incumbents have near monopoly status because of prohibitive fixed costs, economies of scale, and network effects, such that the first entrants or incumbent market players have a high degree of market dominance that impose an insurmountable barrier on potential entrants to enter the market and compete; and (iv) industries that require the use of natural resources or other scarce resources  (such as the airwaves), which utilization thereof necessitates the exclusion of other persons or entities.  Second, economic activities covered by franchises are typically charged with public use. Third, the delegation of the authority to exercise the sovereign power of eminent domain is unmistakably a grant of franchise. This is typical in public utilities where certain public infrastructure facilities require the compulsory sale of lands and acquisition of rights of way and other properties to give way to public use.

As such, tollway operators, broadcast system, telecommunication system and light railway operators require the grant of franchises given the nature of their business as opposed to virtual currency platform operator, pawnshop, financing, or lending company which only needs to secure a secondary license or permit. The Supreme Court notes that in the case of a financing company, lending company, virtual currency exchange operator, pawnshops, and other similar regulated entities requiring a secondary license in addition to general business and local permits, there can be as many market players as are qualified and eligible under the specific laws regulating the business activity. This is because these entities are not engaged in industries which are natural monopolies, or industries where first entrants do not have monopoly or near-monopoly status. Succeeding market players are free to enter the market as long as they comply with the requirements for the issuance of the administrative license to operate these businesses. Moreover, the requirement of obtaining prior government permit to operate these businesses is merely within the dictates of general welfare, and not because the economic reality of the industry involves scarce resources.

Hence, other than the license or permit to operate, it is crucial for public service companies to secure administrative franchise with the relevant governing administrative body and the payment of the local franchise tax. It must be noted that public service franchise grantees shall be subject to national taxes under the Tax Code except if it is a franchise grant allowing payment of a fixed national franchise tax in lieu of other taxes.

Truly, if implemented properly, this landmark reform could usher a new economic era of public service in the Philippines that is world-class and globally competitive. Relative thereto is the strengthened fiscal standing of local government units on the local taxes collected from administrative franchise grantees.

Let's Talk Tax is a weekly newspaper column of P&A Grant Thornton that aims to keep the public informed of various developments in taxation. This article is not intended to be a substitute for competent professional advice.

 

As published in BusinessWorld, dated 18 April 2023

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