FOLLOSCO MORALLOS & HERCE

ATTORNEYS AT LAW
TH
25 FLOOR, 88 CORPORATE CENTER
141 VALERO STREET CORNER SEDEÑO STREET
SALCEDO VILLAGE, MAKATI CITY 1227, PHILIPPINES
TELEPHONE NOS. (63 2) 8890808; 7522215
FACSIMILE NO. (63 2) 7522217
EMAIL: info@fmh.ph
WEBSITE: http://www.fmh.ph

23 March 2012

Atty. Solomon B. Castro BY E-MAIL

Managing Director
CFP Transaction Advisors
14th Floor, Net Cube Center
3rd Avenue, Bonifacio Global City

Dear Sol,

Tax Implications of the PPP Project with the Department of Education

DATEM, Inc. (“Project Proponent”) is considering participating in the Public-Private

Partnership (“PPP”) for School Infrastructure Project of the Department of Education
(“DepEd”) (the “Project”). The DepEd envisioned that a Build Lease Transfer arrangement will
govern the contractual arrangement for the Project. The Project Proponent will be tasked with
financing and building the following: (a) school buildings, (b) toilets; and (c) classroom furniture
(collectively, “Project Assets”). As outlined in the bid bulletin, the following are the
responsibilities of the Project Proponent:

a. Upfront financing;

b. Detailed engineering and design according to the Minimum Performance Standards and
Specifications (“MPSS”);

c. Construction of the Project according to the MPSS;

d. Financial Lease;

e. Periodic Maintenance (as described in the MPSS) particularly inspection, repainting and
termite control, once every 4.5 years; and

f. Transfer of ownership of to the Republic of the Philippines after the Lease Period.

The lease term is for a period of ten (10) years and the Republic of the Philippines acting through
the DepEd will pay quarterly lease payments over the 10-year lease period. It is likewise our
understanding that the DepEd prefers that a separate company be established for the purpose of
undertaking the Project.
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DepEd PPP Project – Tax Implications
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Legal Framework

Republic Act (“RA”) No. 6957, as amended, authorizes the private sector to finance, construct
and maintain infrastructure projects that are normally undertaken by the government. Under RA
No. 6957, as amended, build-and-transfer (“BT”) or build-lease-and-transfer (“BLT”) contracts
are among the authorized forms of contractual arrangements that the government can enter
together with private entities. Section 2 of RA No. 6957 defined BT and BLT arrangements as
follows:

(c)Build-and-transfer – A contractual arrangement whereby the project proponent

undertakes the financing and construction of a given infrastructure or development
facility and after its completion turns it over to the government agency or local
government unit concerned, which shall pay the proponent on an agreed schedule its
total investments expended on the project, plus a reasonable rate of return thereon. This
arrangement may be employed in the construction of any infrastructure or development
project, including critical facilities which, for security or strategic reasons, must be
operated directly by the Government.

xxx xxx xxx

(e)Build-lease-and-transfer – A contractual arrangement whereby a project proponent is

authorized to finance and construct an infrastructure or development facility and upon its
completion turns it over to the government agency or local government unit concerned on
a lease arrangement for a fixed period after which ownership of the facility is
automatically transferred to the government agency or local government unit concerned.

The implementing rules and regulations (“IRR”) of RA No. 6957, as amended, provides for a
similar definition for BT and BLT contracts. Section 1.3(f) of the IRR defined BT and BLT
arrangements as follows:

i. Build-and-transfer (BT) — A contractual arrangement whereby the Project

Proponent undertakes the financing and Construction of a given infrastructure or
development facility and after its completion turns it over to the Agency or LGU
concerned, which shall pay the Project Proponent on an agreed schedule its total
investment expended on the project, plus a Reasonable Rate of Return thereon.
This arrangement may be employed in the Construction of any Infrastructure or
Development Projects, including critical facilities which, for security or strategic
reasons, must be operated directly by the Government.

ii. Build-lease-and-transfer (BLT) — A contractual arrangement whereby a Project

Proponent is authorized to finance and construct an infrastructure or
development facility and upon its completion turns it over to the Agency/LGU
concerned on a lease arrangement for a fixed period, after which ownership of
the facility is automatically transferred to the Agency/LGU concerned.

RA No. 6957 provides for the manner of payment for projects undertaken using the various
modes provided for under the law. Specifically, Section 6 discussed the repayment scheme for
the Project as follows:
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Section 6. Repayment Scheme. – For the financing, construction, operation and

maintenance of any infrastructure projects undertaken through the build-operate-and-
transfer arrangement or any of its variations pursuant to the provisions of this Act, the
project proponent shall be repaid by authorizing it to charge and effect reasonable tolls,
fees, and rentals for the use of the project facility not exceeding those incorporated in the
contract and, where applicable, the proponent may likewise be repaid in the form of a
share in the revenue of the project or other non-monetary payments, such as, but not
limited to, the grant of a portion or percentage of the reclaimed land, subject to the
constitutional requirements with respect to the ownership of land: Provided, That for
negotiated contracts, and for projects which have been granted a natural monopoly or
where the public has no access to alternative facilities, the appropriate government
regulatory bodies, shall approve the tolls, fees, and rentals, and charges based on a
reasonable rate or return: Provided, further, That the imposition and collection of tolls,
fees, rentals, and charges shall be for a fixed term as proposed in the bid and
incorporated in the contract but in no case shall this term exceed fifty (50) years:
Provided, further more, That the tolls, fees, rentals and charges may be subject to
adjustment during the life of the contract, based on a predetermined formula using
official price indices and included in the instruction to bidders and in the contract:
Provided, also, That all tolls, fees, rentals, and charges and adjustments thereof shall
take into account the reasonableness of said rates to the end-users of private sector-built
infrastructure: Provided, finally, That during the lifetime of the franchise, the project
proponent shall undertake the necessary maintenance and repair of the facility in
accordance with standards prescribed in the bidding documents and in the contract. In
the case of a build-and-transfer arrangement, the repayment scheme is to be effected
through amortization payments by the government agency or local government unit
concerned to the project proponent according to the scheme proposed in the bid and
incorporated in the contract. (Underscoring supplied)

RA No. 6957 likewise provides for investment incentives for projects in excess of One Billion
Pesos (Php1,000,000,000.00). Section 10 of RA No. 6957 provides:

SECTION 10. Investments Incentives. – Among other incentives, projects in excess of

One billion pesos (P1,000,000,000) shall be entitled to incentives as provided by the
Omnibus Investment Code, upon registration with the Board of Investments.

The IRR of RA No. 6957 likewise discussed the investment incentives that are available to
private entities which will engage in projects authorized by RA No. 6957. Section 13.2 of the
IRR of RA No. 6957 provides:

SECTION 13.2. Investments Incentives. –

The following Investment Incentives will be made available to Project Proponents:

a. Projects undertaken through Contractual Arrangements authorized under these

Revised IRR costing more than PhP1.0 billion shall, upon registration with the Board
of Investments (BOI), be entitled to incentives as provided for under the Omnibus
Investment Code.
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b. Projects undertaken through Contractual Arrangements authorized under these

Revised IRR costing PhP1.0 billion or less may, upon registration with BOI, avail of
incentives provided for under the Omnibus Investment Code subject to inclusion of
the project activity or sector in the current Investment Priorities Plan (IPP) of BOI.

c. Projects undertaken through Contractual Arrangements authorized under these

Revised IRR shall also be entitled to other incentives, as provided under existing
laws, such as, but not limited to incentives under P.D. 535 (1974), otherwise known
as the "Tourism Incentives Program of 1974", and R.A. 7156, otherwise known as the
"Mini-Hydroelectric Power Incentives Act".

d. LGUs may provide additional tax incentives, exemptions, or reliefs, subject to the
provisions of the Local Government Code (LGC) of 1991 and other pertinent laws.

Discussion

At the outset it is important to note that there are no precedent rulings that deal with issues
relating to BLT and BT arrangements. In addition, there is also no clear cut rule on the proper
treatment and tax implications of the eventual transfer of properties from a project proponent to
the government under a BLT arrangement.

Financial Lease vs. Operating Lease

The International Accounting Standard (“IAS”) 17 defined a finance lease and an operating lease
as follows:

The following terms are used in this Standard with the meanings specified:

xxx xxx xxx

A finance lease is a lease that transfers substantially all the risk and rewards incidental
to ownership of an asset. Title may or may not eventually be transferred.

An operating lease is a lease other than a finance lease.

For tax purposes, guidance can be obtained from Revenue Regulations (“RR”) No. 09-04 on
whether a lease should be considered as an operating or a finance lease. It is important to note
that RR No. 09-04 was issued by the Bureau of Internal Revenue (“BIR”) for the purpose of
imposing the gross receipt tax on banks and non-bank financial intermediaries performing quasi-
banking functions and other non-bank financial intermediaries. Sections 2.8 and 2.9 of RR No.
09-04 defined financial lease and operating lease as follows:

2.8. Financial Leasing – shall refer to the mode of extending credit through a non-
cancellable lease contract under which the lessor purchases or acquires, at the instance
of the lessee, machinery, equipment, motor vehicles, appliances, business and office
machines, and other movable or immovable property in consideration of the periodic
payment by the lessee of a fixed amount of money sufficient to amortize at least seventy
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DepEd PPP Project – Tax Implications
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percent (70%) of the purchase price or acquisition cost, including any incidental
expenses and a margin of profit over an obligatory period of not less than two (2) years
during which the lessee has the right to hold and use the leased property with the right to
expense the lease rentals paid to the lessor and bears the cost of repairs, maintenance,
insurance and preservation thereof, but with no obligation or option on his part to
purchase the leased property from the owner-lessor at the end of the lease contract (R.A.
No. 5980 as amended by R.A. No. 8556). A finance lease is a lease that transfers
substantially all the risks and rewards incident to ownership of an asset. Title may or
may not eventually be transferred.

2.9. Operating Lease – shall refer to a lease other than a finance lease of a finance
company.

RR No. 19-861 also provided for a similar definition for operating lease and financial lease.
Section 2.01/1 defined an operating lease as follows:

2.01/1 Operating lease defined – An “operating lease” is a contract under which the
asset is not wholly amortized during the primary period of the lease, and where the lessor
does not rely solely on the rentals during the primary period for his profits, but looks for
the recovery of the balance of his costs and for the rest of his profits from the sale or re-
lease of the returned asset of the primary lease period.

Section 2.01/2 defined a finance lease as follows:

2.01/2 Finance lease defined – “Finance lease” or full payout lease is a contract
involving payment over an obligatory period (also called primary or basic period) of
specified rental amounts for the use of a lessor’s property, sufficient in total to authorize
the capital outlay of the lessor and to provide for the lessor’s borrowing costs and
profits. The obligatory period refers to the primary or basic non-cancellable period of
the lease which in no case shall be less than 730 days. The lessee, not the lessor
exercises the choice of the asset and is normally responsible for maintenance, insurance
and such other expenses pertinent to the use, preservation and operation of the asset.
Finance leases may be extended, after the expiration of the primary period, by non-
cancellable secondary or subsequent periods with the rentals significantly reduced. The
residual value shall in no instance be less than five per centum (5%) of the lessor’s
acquisition cost of the leased asset.

1
RR No. 19-86 also provides for the factors to be considered in determining whether a lease can be considered as
conditional sales of the contract. A contract will be considered as a conditional if one or more of the following
compelling persuasive factors are present: (a) lessee is given the option to purchase the asset at anytime during the
obligatory period of the lease, notwithstanding that the option to purchase is equivalent to or higher than the current
fair market value of the asset; (b) lessor acquires automatic ownership of the asset upon payment of the stated
amount of “rentals” which under the contract he is required to make; (c) portions of the periodic rental payments are
credited to the purchase price of the asset; and (d) the receipt of payment indicate that the payment made were
partial or full payments of the asset. We are of the opinion that the compelling persuasive factors to determine
whether a lease should be considered as a conditional sale since RR No. 19-86 specifically provide guidelines for
tangible personal property and not real property.
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DepEd PPP Project – Tax Implications
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Applying the foregoing definitions to the contractual arrangement of the Project, the lease can be
categorized as a finance lease since the DepEd will own the Project Assets after the 10-year lease
period.

Registration with the Board of Investments

As earlier discussed, RA No. 6957 provides for investment incentives for projects in excess of
One Billion Pesos (Php1,000,000,000.00) so long as the project is registered with the Board of
Investments (“BOI”). The IRR of RA 6957 also provides that projects costing One Billion Pesos
(Php1,000,000,000.00) or less, upon registration with the BOI may avail of the incentives
provided under the Omnibus Investment Code provided that the project is included in the current
Investment Priorities Plan (“IPP”) of the BOI. Under the 2011 IPP of the BOI, PPP projects are
included in the preferred activities of investment. Under the Specific Guidelines of the 2011 IPP
it is provided applications for PPP projects must be endorsed by the PPP Center or other
concerned governed agency and approval of the project shall likewise be subject to the
concurrence of the National Economic Development Authority and the Department of Finance.

Under the Omnibus Investment Code, one of incentives granted to a BOI registered enterprise is
an income tax holiday (“ITH”) for a period of six (6) years for pioneer firms and four (4) years
for non-pioneer firms. Article 39(a) provides:

ARTICLE 39. Incentives to Registered Enterprises. – All registered enterprises shall be

granted the following incentives to the extent engaged in a preferred area of investment:

(a) Income Tax Holiday. -

(1) For six (6) years from commercial operations for pioneer firms and four (4) years for
non-pioneer firms, new registered firms shall be fully exempt from income taxes
levied by the national government. Subject to such guidelines as may be prescribed
by the Board, the income tax exemptions will be extended for another year in each of
the following cases:

(i) The project meets the prescribed ratio of capital equipment to number of workers
set by the Board;

(ii) Utilization of indigenous raw materials at rates set by the Board;

(iii) The net foreign exchange savings or earnings amount to at least US$500,000
annually during the first three (3) years of operation.

The preceding paragraph notwithstanding, no registered pioneer firm may avail of

this incentive for a period exceeding eight (8) years.

(2) For a period of three (3) years from commercial operation, registered expanding
firms shall be entitled to an exemption from income taxes levied by the national
government proportionate to their expansion under such terms and conditions as the
Board may determine: Provided, however, That during the period within which this
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incentive is availed of by the expanding firm it shall not be entitled to additional

deduction for incremental labor expense.

(3) The provision of Article 7(14) notwithstanding, registered firms shall not be entitled
to any extension of this incentive.

In addition Section 133(g) of the Local Government Code (“LGC”) provides:

SECTION 133. Common Limitations on the Taxing Powers of Local Government Units. –
Unless otherwise provided herein, the exercise of the taxing power of provinces, cities,
municipalities, and barangays shall not extend to the levy of the following:

xxx xxx xxx

(g) Taxes on business enterprises certified to by the Board of Investments as pioneer or

non-pioneer for a period of six (6) and four (4) years, respectively from the date of
registration;

xxx xxx xxx

Based on the foregoing, if the Project will be registered with the BOI, it will not be liable for
local business taxes for a period of six (6) years if considered as a pioneer enterprise and for a
period of four (4) years if considered as a non-pioneer enterprise. However, if the Project is not
registered with the BOI, it will be subject to local business taxes.

Taxation of BLT Arrangements

Documentary Stamp Tax

Section 194 of the Tax Code imposes documentary stamp tax (“DST”) on lease contracts. The
DST due on the lease contract should be paid within five (5)2 days from the close of the month
when the taxable document was made, signed, issued, accepted or transferred. Section 194 of
the Tax Code provides:

SEC. 194. Stamp Tax on Leases and Other Hiring Agreements. – On each lease,
agreement, memorandum, or contract for hire, use or rent of any lands or tenements, or
portions thereof, there shall be collected a documentary stamp tax of Three pesos (P3.00)
for the first Two thousand pesos (P2,000), or fractional part thereof, and an additional
One peso (P1.00) for every One thousand pesos (P1,000) or fractional part thereof, in
excess of the first Two thousand pesos (P2,000) for each year of the term of said contract
or agreement.

The DST attributable to the lease contract should be paid at the time of the execution of the
contract. This is the clear import of BIR Ruling No. 005-983 where the BIR denied the request
of the taxpayer to pay the DST due on the long term lease contract on a yearly basis. In this
2
Pursuant to RR No. 06-01.
3
04 February 1998.
 FOLLOSCO MORALLOS & HERCE
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case, the taxpayer proposed the DST payable for the 25-year lease contract be paid on annual
basis over the lease period instead of paying the entire DST at the time of execution of the lease
contract. The BIR denied the proposal of the taxpayer and discussed as follows:

Nothing in the Code authorizes either the installment payment of the documentary stamp
tax or the computation thereof based in some mode or basis other than the consideration
as appearing in the contract or document itself. Besides, when the Code or the rules
thereof prescribe the time for payment of the tax, any delayed payment thereof would
subject the taxpayer to civil penalties prescribed under Sections 248 and 249 of the Tax
Code. Your proposal could necessarily result in late payment under existing laws and if
you still wish to proceed with the same, the corresponding penalties will apply in the
computation of the documentary stamp tax due in leases of a kind as stated in your letter.

Based on the foregoing, the DST due on the entire lease contract should be paid within five (5)
days from the execution of the lease contract.

The eventual transfer of the Project Assets to the DepEd will be subject to DST in accordance
with Section 196 of the Tax Code, which provides:

SECTION 196. Stamp Tax on Deeds of Sale and Conveyances of Real Property. — 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, there shall be collected a documentary stamp tax, at the rates
herein below prescribed, based on the consideration contracted to be paid for such realty
or on its fair market value determined in accordance with Section 6(E) of this Code,
whichever is higher: Provided, That when one of the contracting parties is the
Government, the tax herein imposed shall be based on the actual consideration:

(a) When the consideration, or value received or contracted to be paid for such realty,
after making proper allowance of any encumbrance, does not exceed One thousand pesos
(P1,000), Fifteen pesos (P15.00).

(b) For each additional One thousand pesos (P1,000), or fractional part thereof in excess
of One thousand pesos (P1,000) of such consideration or value, Fifteen pesos (P15.00).

When it appears that the amount of the documentary stamp tax payable hereunder has
been reduced by an incorrect statement of the consideration in any conveyance, deed,
instrument or writing subject to such tax the Commissioner, provincial or city Treasurer,
or other revenue officer shall, from the assessment rolls or other reliable source of
information, assess the property of its true market value and collect the proper tax
thereon.

Since one of the parties in the transaction is an instrumentality of the government, the DST will
be based on the actual consideration for the transfer of the Project Assets. In any case, given that
the actual consideration for the transfer of the Project Assets will be only for a minimal amount
of Php1.00, the DST due for the transfer will be Php15.00.
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Value Added Tax

In general, a twelve percent (12%) value added tax (“VAT”) is imposed on any person who, in
the course of trade or business, sells, barters, exchanges, leases goods or properties, or renders
services in the Philippines in the ordinary course of trade or business.4 In accordance with
Section 114(C) of the Tax Code, for contracts with the government, the government or any of its
agencies or instrumentalities are required to withhold a five percent (5%) final VAT on all its
payments on account of each purchase of goods from sellers and services rendered by contractors
which are subject to VAT. Section 114(C) provides:

(C) Withholding of Creditable Value-added Tax. – The Government or any of its political
subdivisions, instrumentalities or agencies, including government-owned or controlled
corporations (GOCCs) shall , before making payment on account of each purchase of
goods from sellers and services rendered by contractors which are subject to the value-
added tax imposed in Sections 106 and 108 of this Code, deduct and withhold the value-
added tax due at the rate of five percent (5%) of the gross payment thereof: Provided,
That the payment for lease or use of properties or property rights to non-resident owners
shall be subject to ten percent (10%) withholding tax at the time of payment. For
purpose of this Section, the payor or person in control of the payment shall be considered
as the withholding agent.

The value-added tax withheld under this Section shall be remitted within ten (10) days
following the end of the month the withholding was made.

Section 4.114-2 of RR No. 16-05 as amended by RR No. 04-07 provides that the five percent
(5%) withheld by the government represent the net VAT payable and the remaining seven
percent (7%) shall account for the standard input VAT. If the actual input VAT of the taxpayer
is greater than the 7% assumed input VAT, the excess may form part of the cost. On the other
hand, if the actual input VAT is less than the 7% withheld by the government, the difference will
be treated as additional income. Section 4.114-2 provides:

SECTION 4.114-2. Withholding of VAT on Government Money Payments and

Payments to Non-Residents. —

(a) The government or any of its political subdivisions, instrumentalities or agencies,

including government-owned or controlled corporations (GOCCs) shall, before making
payment on account of each purchase of goods and/or of services taxed at 12% VAT
pursuant to Secs. 106 and 108 of the Tax Code, deduct and withhold a final VAT due at
the rate of five percent (5%) of the gross payment thereof.

The five percent (5%) final VAT withholding rate shall represent the net VAT payable of
the seller. The remaining seven percent (7%) effectively accounts for the standard input
VAT for sales of goods or services to government or any of its political subdivisions,
instrumentalities or agencies including GOCCs, in lieu of the actual input VAT directly
attributable or ratably apportioned to such sales. Should actual input VAT exceed seven
percent (7%) of gross payments, the excess may form part of the sellers' cost. Conversely,

4
Section 105, Tax Code.
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if actual input VAT is less than seven 5% (7%) of gross payment, the difference must be
treated as income of the seller.

xxx xxx xxx

Based on the foregoing, the DepEd will withhold the 5% final VAT from all of its payments to
the Project Proponent. Any difference in actual input VAT and the 7% standard input will be
either closed to income or an expense account.

Creditable Withholding Tax

Under Section 2.57.2(C)(1) of RR 2-98, lease payments for real properties are subject to
creditable withholding tax (“CWT”) at the rate of five percent (5%). RR2.57.2 (C)(1) provides:

SECTION 2.57.2. Income Payment Subject to Creditable Withholding Tax and Rates
Prescribed Thereon. – Except as herein otherwise provided, there shall be withheld a
creditable income tax at the rates herein prescribed for each class of payee from the
following items of income payments to persons residing in the Philippines:

xxx xxx xxx

(C) Rentals

(1) Real Properties – On gross rentals for the continued use or possession of real
property used in business which the payor or obligor has not taken or is not taking
title, or in which he has no equity – Five percent (5%).

Based on the above quoted provision, rentals payments to be received by the Project Proponent
will be net of the 5% CWT.5

Donor’s Tax

The transfer of the Project Assets to the DepEd cannot be considered as a gratuitous transfer
since payments made during the lease term is considered as part of the consideration paid.
Moreover, even assuming that the subsequent transfer of the Project Assets to the DepEd is
deemed gratuitous, it will still not be subject to donor’s tax since gifts made to the government
are not subject to donor’s tax.6

5
Note: In BIR Ruling [DA-114-06], dated 13 March 2006, the BIR ruled that lease of personal property if under
financial lease arrangement with leasing and finance companies authorized to operate under R.A. No. 8556 is
exempt from the 5% expanded withholding tax. It is important to note that Section 2.57.2(C)(2) clearly provided for
the exclusion of lease of personal properties under financial lease arrangements with leasing and finance companies
authorized to operated under RA No. 8556. No such exclusion was provided in the provision for lease of real
properties.
6
Section 102(A)(2), Tax Code.
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Real Property Tax

Based on the fundamental principles of real property taxation embodied in the LGC, real
property shall be classified for assessment purposes on the basis of its actual use. Section 199(b)
defined actual use to refer to the purpose for which the property is principally or predominantly
utilized by the person in possession thereof. For this Project, it is our understanding that the
Project Assets will be directly and exclusively used for educational purposes.

Section 234 of the LGC enumerates items that are exempted from real property taxes and
included in this enumeration are properties that are actually, directly and exclusively used for
educational purposes. Section 234(b) of the LGC provides:

SECTION 234. Exemptions from Real Property Tax. – The following are exempted from
payment of real property tax:

xxx xxx xxx

(b) Charitable institutions, churches, parsonages or convents appurtenant thereto,

mosques, nonprofit or religious cemeteries and all lands, buildings, and
improvements actually, directly, and exclusively used for religious, charitable or
educational purposes;

In an opinion issued by the Bureau of Local Government Finance (“BLGF”) dated 13 February
2006, the Bureau opined that real property owned by the Girl Scouts of the Philippines that are
actually used for educational purposes are not subject to real property tax. The Bureau discussed
as follows:

Hence, this Bureau is of the opinion that:

1. The exemption privilege previously enjoyed by GP under its charter (E.O. No. 267)
was already withdrawn upon the passage of the Local Government Code of 1991.

2. However, considering that the “actual use” of the subject property are found to be
indeed for educational purposes being recognized by the DepEd and not being leased
to taxable persons, the subject land owned by GSP, together with the improvements
erected thereon are exempt from the payment of real property tax, pursuant to the
provision of Section 234 of the same Code, which provides in part, as follows: xxx

Based on the foregoing discussion, the Project Assets will not be subject to real property tax
since it will be directly and exclusively used for educational purpose.

Local Transfer Tax

Section 135 of the LGC imposes the tax on transfer of real property ownership. Section 135 of
the LGC provides:
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SECTION 135. Tax on Transfer of Real Property Ownership. – (a) 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 the rate of not more than fifty percent (50%) of one
percent (1%) of the total consideration involved in the acquisition of the property or of
the fair market value in case the monetary consideration involved in the transfer is not
substantial, whichever is higher. The sale, transfer or other disposition of real property
pursuant to R.A. No. 6657 shall be exempt from this tax.

(c) For this purpose, the Register of Deeds of the province concerned shall, before
registering any deed, require the presentation of the evidence of payment of this tax. The
provincial assessor shall likewise make the same requirement before cancelling an old
tax declaration and issuing a new one in place thereof. Notaries public shall furnish the
provincial treasurer with a copy of any deed transferring ownership or title to any real
property within thirty (30) days from the date of notarization.

It shall be the duty of the seller, donor, transferor, executor or administrator to pay the
tax herein imposed within sixty (60) days from the date of the execution of the deed or
from the date of decedent’s death.

Under the BLT arrangement, the Project Asset are owned by the Project Proponent until the
eventual transfer of the property after the lease term to the DepEd. As such, depending on the
tax ordinance of the province or city where the Project Assets are located, the transfer may be
subject to the local transfer tax equivalent to 50% of 1% and a maximum rate of 75% of 1%7 of
the total consideration in the acquisition of the property or of the fair market value in case the
monetary consideration is not substantial.

In addition, it is important to note that under Section 13.3(c) of the IRR of RA 6957 the
government may enter into a direct government subsidy agreement where the local government
unit can (a) waive or grant special rates for real property taxes on the project during the term of
the contractual arrangement and (b) waive charges or fees relative to business permits or licenses
that are to be obtained for the construction of the project. Section 13.3(c) provides:

SECTION 13.3. Government Undertakings. —

Subject to existing laws, policies, rules and regulations, the Government may provide any
form of direct or indirect support or contribution, such as, but not limited, to the
following, subject to the conditions for Unsolicited Proposals as specified under Section
10.1 hereof:

xxx xxx xxx

c. Direct Government Subsidy — This shall refer to an agreement whereby the

Government, or any of its Agencies/LGUs will: (a) defray, pay for or shoulder a portion
of the Project Cost or the expenses and costs in operating or maintaining the project; (b)
condone or postpone any payments due from the Project Proponent; (c) contribute any
property or assets to the project; (d) in the case of LGUs, waive or grant special rates on
real property taxes on the project during the term of the contractual arrangement; and/or

77
Maximum allowable rate in case the Project Assets are located in a city.
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(e) waive charges or fees relative to business permits or licenses that are to be obtained
for the Construction of the project, all without receiving payment or value from the
Project Proponent and/or Facility operator for such payment, contribution or support.

Taxation of BT Arrangements

We understand that the DepEd is not offering the BT arrangement to ensure that periodic
maintenance on the Project Assets is undertaken by Project Proponent. As such, we deem it
necessary to discuss that Project Proponent can propose to the DepEd that the fee component
attributable to the periodic maintenance work required can be carved out from the total project
cost but, at the same time, a service maintenance agreement will be executed between the DepEd
and the Project Proponent for the periodic maintenance of the Project Assets. In doing this, the
DepEd can be assured that the Project Proponent will comply with the periodic maintenance
requirement for the Project. In addition, it will be clear that the cost for the periodic maintenance
will be considered part of the project cost but will only be payable upon completion of the
periodic maintenance.

Documentary Stamp Tax

In a BT arrangement, the Project Proponent will finance and construct the given infrastructure
and the government will pay the Project Proponent on an agreed schedule. This arrangement can
give rise to two situations: (a) sale of the Project Assets to the DepEd will be on installment
payment basis or (b) a separate loan agreement will be executed between the Project Proponent
and the DepEd for the project cost.

If the BT arrangement between the Project Proponent will already include the schedule for the
payments for the Project Assets the transaction will be subject to DST pursuant to Section 196 of
the Tax Code. If one of the parties to the transaction is an instrumentality of the government,
Section 196 of the Tax Code imposes DST at the rate of Php15.00 for every Php1,000 or
fractional part of the actual consideration for the transfer of real property. For this Project, since
the DepEd is an instrumentality of the government, the transaction will be subject to DST at the
rate of Php15.00 for every Php1,000 or fractional part of the actual consideration.

Section 179 of the Tax Code will be applicable for computing DST if a separate loan agreement
will be entered into by the DepEd and the Project Proponent for the payment of the total project
cost. Section 179 of the Tax Code imposes the DST on all debt instruments. Section 179 of the
Tax Code provides:

SEC. 179. Stamp Tax on All Debt Instruments. – On every original issue of debt
instruments, there shall be collected a documentary stamp tax on One peso (P1.00) on
each Two hundred pesos (P200), or fractional part thereof, of the issue price of any such
debt instruments: Provided, That for such debt instruments with terms of less than one (1)
year, the documentary stamp tax to be collected shall be of a proportional amount in
accordance with the ratio of its term in number of days to three hundred sixty-five (365)
days: Provided, further, That only one documentary stamp tax shall be imposed on either
loan agreement, or promissory notes issued to secure such loan.
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For purposes of this section, the term debt instrument shall mean instruments
representing borrowing and lending transactions including but not limited to debentures,
certificates of indebtedness, due bills, bonds, loan agreements, including those signed
abroad wherein the object of contract is located or used in the Philippines, instruments
and securities issued by the government of any of its instrumentalities, deposit substitute
debt instruments, certificates or other evidences of deposits that are either drawing
interest significantly higher than the regular savings deposit taking into consideration the
size of the deposit and the risks involved or drawing interest and having a specific
maturity date, orders for payment of any sum of money otherwise than at sight or on
demand, promissory notes, whether negotiable or non-negotiable, except bank notes
issued for circulation.

Based on the foregoing, if a loan agreement will be entered into by the Project Proponent and the
DepEd, such arrangement will be subject to DST at the rate of One Peso (Php1.00) on each Two
Hundred Pesos (Php200.00) or fractional part thereof.

Value Added Tax

As earlier discussed, a twelve percent (12%) value added tax (“VAT”) is imposed on any person
who, in the course of trade or business, sells, barters, exchanges, leases goods or properties, or
renders services in the Philippines in the ordinary course of trade or business.8 However, with
respect to transactions with the government, the government or any of its agencies or
instrumentalities are required to withhold a five percent (5%) final VAT on all its payments on
account of each purchase of goods from sellers and services rendered by contractors which are
subject to VAT. Accordingly, the instalment payments to be received by the Project Proponent
will be subject to the 5% final VAT. Any difference in actual input VAT and the 7% standard
input will be either closed to income or an expense account.

Creditable Withholding Tax

In general, sale of real property by an entity not habitually engaged in the real estate business is
subject to CWT at the rate of 6%. Section 2.57.2(J) of RR 2-98, as amended, partially provides:

SECTION 2.57.2. Income Payment Subject to Creditable Withholding Tax and Rates
Prescribed Thereon. – Except as herein otherwise provided, there shall be withheld a
creditable income tax at the rates herein prescribed for each class of payee from the
following items of income payments to persons residing in the Philippines:

xxx xxx xxx

(J) Gross selling price or total amount of consideration or its equivalent paid to the
seller/owner for the sale, exchange or transfer of real property classified as ordinary
asset —xxx

8
Section 105, Tax Code.
 FOLLOSCO MORALLOS & HERCE
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C. Where the seller/transferor is not habitually engaged in the real estate business –
6%

xxx xxx xxx

Gross selling price shall mean the consideration stated in the sales document or the fair
market value determined in accordance with Section 6 (E) of the Code, whichever is
higher. In an exchange, the fair market value of the property received in exchange shall
be considered as the consideration.

If the buyer is an individual not engaged in trade or business, the following rules shall
apply:

(i) If the sale is a sale of property on the installment plan (i.e., payments in the year
of sale do not exceed twenty five percent (25%) of the selling price), no withholding is
required to be made on the periodic installment payments. In such a case, the applicable
rate of tax based on the gross selling price or fair market value of the property at the time
of the execution of the contract to sell, whichever is higher, shall be withheld on the last
installment or installments immediately prior to such last installment, if the last
installment is not sufficient to cover the tax due, to be paid to the seller until the tax is
fully paid.

(ii) If, on the other hand, the sale is on a "cash basis" or is a "deferred-payment sale
not on the installment plan" (that is, payments in the year of sale exceed 25% of the
selling price), the buyer shall withhold the tax based on the gross selling price or fair
market value of the property, whichever is higher, on the first installment.

However, if the buyer is engaged in trade or business, whether a corporation or

otherwise, these rules shall apply:

(i) If the sale is a sale of property on the installment plan [i.e., payments in the year
of sale do not exceed twenty five percent (25%) of the selling price], the tax shall be
deducted and withheld by the buyer from every installment which tax shall be based on
the ratio of actual collection of the consideration against the agreed consideration
appearing in the Contract to Sell applied to the gross selling price or fair market value of
the property at the time of the execution of the Contract to Sell, whichever is higher.

The term 'consideration' refers to the selling price exclusive of interest. Interest earned as
an incident of installment payment, if any, shall be subject to the ordinary income tax
rate.

(ii) If, on the other hand, the sale is on a "cash basis" or is a "deferred-payment sale
not on the installment plan" (that is, payments in the year of sale exceed 25% of the
selling price), the buyer shall withhold the tax based on the gross selling price or fair
market value of the property, whichever is higher, on the first installment.

xxx xxx xxx

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Based on the foregoing, the sale of the Project Assets to DepEd will be subject to CWT at the
rate of 6%. In addition, since the buyer is not an individual and payments in the year of sale of
the Project Assets do not exceed 25% of the selling price, the CWT shall be deducted and
withheld by the DepEd from every installment paid to the Project Proponent.

With respect to the service maintenance component of the BT contract, the corresponding fee
would be subject to CWT. In general, payments to contractors are subject to CWT at the rate of
two percent (2%). Section 2.57.2(E)(2) of RR 2-98, as amended requires that the payor to
withhold two percent (2%) from its gross payment to general building contractors. Section
2.57.2(E)(2) of RR 2-98 provides:

SECTION 2.57.2. Income Payment Subject to Creditable Withholding Tax and Rates
Prescribed Thereon. – Except as herein otherwise provided, there shall be withheld a
creditable income tax at the rates herein prescribed for each class of payee from the
following items of income payments to persons residing in the Philippines:

xxx xxx xxx

(E) Income payment to certain contractors. – On gross payments to the following

contractors, whether individual or corporate – Two percent (2%)

xxx xxx xxx

(2) General Building contractors – Those whose principal contracting business in

connection with any structure built for the support, shelter and enclosure of persons,
animals, chattels, or movable property of any kind, requiring in its construction the use
of more than two unrelated building trades or crafts, or to do or superintend the whole or
any part thereto. Such structure includes sewers and sewerage disposal plants and
systems, parks, playgrounds and other recreational works, refineries, chemical plants
and similar industrial plants requiring specialized engineering knowledge and skills,
powerhouse, power plants and other utility plants and installations, mines and
metallurgical plants, cement and concrete works in connection with the above-mentioned
fixed works.

Based on the foregoing, payments received by the Project Proponent for the service maintenance
component of the BT contract will be net of the 2% creditable withholding tax.

BLT v. BT

The difference in taxes between a BLT and BT arrangement are essentially the following:

BLT BT
5% CWT withheld from lease 6% CWT withheld from payments
payments made for sale of real property by an
entity not habitually engaged in the
real estate business.
 FOLLOSCO MORALLOS & HERCE
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2% CWT withheld from payment to

general contractors for the service
maintenance component of the BT
contract.

DST on lease contract- Php3.00 for
the first Php2,000 and Php1.00 for
every 1,000 in excess of the first
Php2,000
DST for the actual transfer of the
Project Assets to the DepEd - Project
Assets will be transferred only for a
minimal amount of Php1.00 the DST
due for the transfer will be Php15.00.
Contract of sale of real property will
be subject to DST at the rate of
Php15.00 for every Php1,000 or
fractional part of the actual
consideration.
If a separate loan agreement will be
executed - DST for loan agreements –
at the rate of Php1.00 for every
Php200.00

Local transfer tax for the transfer of Local transfer tax for the transfer of
ownership of the Project Assets from ownership of the Project Assets from
the Project Proponent to the DepEd. the Project Proponent to the DepEd.

It is important to consider the amount of CWT withheld by the DepEd since it can potentially
impact the cash position of the Project Proponent. CWT withheld from income payment can be
credited against the income tax payable of a taxpayer. However, if the CWT exceeds the income
tax payable of the taxpayer, it can remain unutilized for a number of years. In addition, it is
important to consider that obtaining a refund for unutilized excess CWT can be a tedious process
since the BIR would most likely not act on the request for refund. In fact, more often than not,
the claim for refund will be litigated before the Court of Tax Appeals.

In a BT arrangement, it is likely that the 6% CWT withheld will not be completely utilized by
the Project Proponent for the following reasons: (a) 6% CWT is based on the gross amount of
payments made by the DepEd; (b) relatively high operating expenses; and (c) minimal profit
margin for the Project.

On the other hand, the CWT withheld by the DepEd for the transfer of the Project Assets under a
BLT arrangement will still be substantial but slightly lower that the CWT for the BT
arrangement since the CWT rate is only 5%.

Finally, as earlier discussed, the Project whether under the BLT or BT arrangement will be
subject to local business taxes. However, if the Project will be registered with the BOI, it will
not be liable for local business taxes for a period of six (6) years if considered as a pioneer
enterprise and for a period of four (4) years if considered as a non-pioneer enterprise.
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Creation of a Special Purpose Company to Undertake the Project

The IRR of RA 6957 specifically allows the creation of a Special Purpose Company (“SPC”)
that shall assume and accede to all the rights and obligations of the Project Proponent. Section
11.4 of the IRR of RA 6957 also provides for the conditions for the creation of an SPC:

SECTION 11.4. Formation of Special Purpose Company. —

The winning Project Proponent may cause the incorporation of a special purpose
company (SPC) that shall assume and accede to all the rights and obligations of the
winning Project Proponent, Provided, that:

a. the SPC is registered in accordance with applicable Philippine

corporate/commercial/investment laws;

b. the winning Project Proponent subscribes to and pays for a significant/principal

shareholding or controlling interest in the SPC, subject to the nationality and
ownership requirements under the Constitution and other applicable laws. The
required level of share ownership may be indicated in the tender documents or
determined as a condition prior to contract award;

c. in the case of a joint venture/consortium, all members thereof shall present proof of
contractual or other legally binding ties to or relationships with the SPC for the
development and implementation of the project in accordance with their submitted
business plan, e.g., for facility owners/developers/equity investors — subscription to
and payment for a significant number of shares in the SPC; for Contractors or
operators — binding appointment and undertaking to be the Contractor/operator or
duly signed engineering, procurement and Construction (EPC) contract/operation
and maintenance agreement; for financial institutions — letter of firm commitment
to raise or provide financing to the project;

d. an accession undertaking is executed by the SPC and the winning proponent in

favor of the Agency/LGU making the SPC principally liable for the performance of
the winning Project Proponent’s obligations under the Notice of Award and/or the
contract;

e. a written notice to form the SPC and the proposed accession are submitted to the
Agency/LGU within five (5) calendar days from date of receipt of Notice of Award.

Based on our understanding, the DepEd is requiring that an SPC be created for the purpose of
undertaking this Project. If the creation of an SPC is a mandatory requirement imposed by the
DepEd, the Project Proponent will be constrained to establish an SPC to undertake this Project.
On the other hand, if the creation of an SPC is optional, the Project Proponent may consider the
profitability of the Project in deciding whether the creation of a new entity will be beneficial. If
the Project Proponent foresees that the Project will be profitable, it may consider letting its least
profitable subsidiary or affiliate undertake the Project. This can result in the reduction of the
total taxable income since the income earned by the Project can be reduced by whatever losses
the subsidiary or affiliate is incurring. Conversely, if the level of uncertainty regarding the
 FOLLOSCO MORALLOS & HERCE
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Project is relatively high, the Project Proponent may consider establishing a new entity so any
possible liability will only be limited to the new entity.

We hope you find the foregoing useful for your purposes. Should you have further questions,
please let us know.

Yours sincerely,

Rachel P. Follosco

Cielito May T. Velasquez