On March 21, 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 investment to boost market competitiveness, foster innovation, and create high-quality jobs, other public service businesses such as airports, railways, and expressways may now be owned 100% by foreign entities subject to the grant of administrative franchise by the agency tasked to oversee or regulate these undertakings.
As required under the law, the National Economic and Development Authority (NEDA) passed the implementing rules and regulations (IRR) on 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 BUSINESSES 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 60 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 50 years.”
With the amendment under RA No. 11659 and Rule III Section 10 of its IRR, public utility refers to a public service 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 are still governed by the constitutional rules on Filipino ownership of 60% while foreigners may own up to 40% of the capital whether directly or indirectly. A public service business not included in the foregoing enumeration may be owned 100% by foreign nationals except if it is considered critical infrastructure, as is telecommunications, or otherwise identified as such 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 no longer impose any citizenship requirement for those public service businesses not listed as public utilities, they are still empowered to grant administrative franchises 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 as such:
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 right of way and other properties to give way to public use.
As such, tollway operators, broadcast systems, telecommunication systems and light railway operators require the grant of franchise given the nature of their business as opposed to virtual currency platform operators, pawnshops, financing or lending companies, which only need 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 government permits 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 franchises with the relevant governing agency and pay the local franchise tax. It must be noted that public service franchise grantees are 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.
If implemented properly, this landmark reform could usher in a new economic era of public services in the Philippines that are world class and globally competitive, along the way strengthening the fiscal standing of local government units via 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.
Kim M. Aranas is a senior manager from the Tax Advisory & Compliance division at the Cebu office of P&A Grant Thornton, the Philippine member firm of Grant Thornton International Ltd.
