Kidding aside, one of several privileges enjoyed by taxpayers under our tax system is the privilege of transacting business and exercising corporate franchises granted by the government. Under Section 137 of the Local Government Code (LGC), a province may impose tax on a business enjoying a franchise within its territorial jurisdiction. Corollary to this, Section 131 of the LGC defines a franchise subject to franchise tax as a right or privilege affected with public interest, which is conferred upon persons or corporations under such terms and conditions as the government and its political subdivisions may impose in the interest of public welfare, security, and safety.
Surprisingly, while the definition of franchise under the LGC appears to be clear, there have been several attempts by some local government units (LGUs) to impose franchise tax even on persons or corporations enjoying only general privileges to engage in business. These past few months, the Court of Tax Appeals has issued decisions on several assessment cases involving LGUs trying to impose franchise tax on entities engaged in power generation. This somehow shows that LGUs are taking every opportunity to create their own sources of revenue as a necessary privilege of having fiscal autonomy.
The growing interest of LGUs on franchise tax has piqued my curiosity to revisit the existing jurisprudence and rulings of the Courts on the coverage of franchise tax under Section 137 of the LGC.
The Philippine Supreme Court (SC) has already explained what types of privileges Section 137 of the LGC embraces. A 2003 SC case (G.R. No. 149110 dated 9 April 2003) is very instructive and provides an exhaustive discussion on this matter. In that case, the High Court stated that franchise tax is a tax on the privilege of transacting business in the state and exercising a corporate franchise granted by the state. It is not levied on a corporation simply for existing as a corporation, or upon its property or its income, but on its exercise of the exclusive rights or privileges granted to it by the government.
The SC went on to further distinguish a general or primary franchise from a special or secondary one, in order to emphasize that the franchise tax under Section 137 in relation to Section 131 of the LGC applies only to a special or secondary franchise. A general franchise relates to the right to exist as a corporation, by virtue of duly approved Articles of Incorporation. On the other hand, a special franchise refers to the rights or privileges conferred upon an existing corporation such as the right to use the streets of the LGU to lay pipes, erect poles or string wires. In other words, special franchises are charged with a public use. Thus, to be liable for franchise tax, one must have a franchise in the context of a secondary franchise, i.e., a special privilege conferred by the government on a person or corporation to do certain things which are not available to ordinary corporations. Further, in a 2006 case (G.R. No. 160528 dated 9 October 2006), the SC categorically stated that a franchise is a legislative grant to operate a public utility. In a long line of court cases, it has been consistently ruled that to be considered a public utility, the related activity must essentially be one of public use.
It may also be interesting to look back at what was the rule on franchise tax in the old days. In the earlier Tax Codes, one would find that franchise tax was then imposed on franchises granted by law to operate certain public utilities such as communication, power, and transportation. The term franchise has always been defined as a right or privilege acquired by special grant from the public through the legislature. Moreover, from the congressional deliberations on the LGC, it would appear that the lawmakers recognized the nature of an authority to grant franchise as essentially a legislative act. This supports a conclusion that the Congress intended to limit the collection of franchise tax only from grantees of legislative franchise and not from every franchise holder.
Even today, franchise taxes collected by the national government under Section 119 of the National Internal Revenue Code (NIRC) are imposed only on public utility companies such as those engaged in radio and/or television broadcasting, gas and water utilities, and others granted with special franchises. Significantly, Section 137 of the LGC merely replicates Section 119 of the NIRC.
All the above circumstances point to one thing -- franchise tax specifically applies to a grant of the privilege to operate a public utility.
Arguably, any action by the LGUs to expand the coverage of the franchise tax law may be considered ultra vires, i.e., an action in excess of one’s authority. While LGUs have residual taxing powers, such cannot cover franchise tax because the latter is a special-mentioned tax under the LGC with a well-defined subject matter which is a franchise in its strict and limited sense.
It is understandable that the LGUs would take every opportunity to impose taxes. History tells us that the Constitution granted LGUs fiscal autonomy so that they can create their own sources of revenue and minimize their dependency on the national government in terms of delivering basic services to their constituents. However, LGUs should keep in mind that their taxing power is a constitutional grant that is subject to limitations under the law. They should therefore exercise this authority with caution and within the confines of the law. After all, such a great privilege carries immense responsibility and accountability.
Brando C. Cabalsi is a director at the Tax Services Department of Isla Lipana & Co., the Philippine member firm of the PwC network.
brando.cabalsi@ph.pwc.com
source: Businessworld
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